-----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, F8HGaKWVmvtLSNRjnfwU2Ei4OX3J6JQhsoJAw+7OUoNDsTjGh7sca9jfQJ9qiVu3 2Q0qQRyYTc5He5F0javq3Q== 0000898430-96-001665.txt : 19960510 0000898430-96-001665.hdr.sgml : 19960510 ACCESSION NUMBER: 0000898430-96-001665 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19951231 FILED AS OF DATE: 19960508 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: SUNBASE ASIA INC CENTRAL INDEX KEY: 0000095626 STANDARD INDUSTRIAL CLASSIFICATION: CRUDE PETROLEUM & NATURAL GAS [1311] IRS NUMBER: 941612110 STATE OF INCORPORATION: NV FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 000-03132 FILM NUMBER: 96558219 BUSINESS ADDRESS: STREET 1: 19 F FIRST PACIFIC BANK CENTERE STREET 2: 51-57 GLOUCESTER ROAD CITY: WANCHAI HONG KONG STATE: K3 BUSINESS PHONE: 01185228651511 MAIL ADDRESS: STREET 1: P O BOX 2600 CITY: BAKERSFIELD STATE: CA ZIP: 93303 FORMER COMPANY: FORMER CONFORMED NAME: PAN AMERICAN INDUSTRIES INC DATE OF NAME CHANGE: 19941216 FORMER COMPANY: FORMER CONFORMED NAME: PAN AMERICAN ENERGY CORPORATION DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: SUPREME OIL & GAS CORP DATE OF NAME CHANGE: 19901029 10-K405 1 FORM 10-K FOR THE FISCAL ENDED 12/31/195 U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED) For the fiscal year ended December 31, 1995 [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED) For the transition period from __________________ to _________________. Commission File Number: 0-3132 SUNBASE ASIA, INC. (Exact Name of Registrant as specified in its charter) Nevada 94-1612110 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 19/F, First Pacific Bank Centre 51-57 Gloucester Road Wanchai, Hong Kong (Address of principal executive offices) Registrant's telephone number, including area code: (852) 2865-1511 SECURITIES REGISTERED UNDER SECTION 12(b) OF THE ACT: None SECURITIES REGISTERED UNDER SECTION 12(g) OF THE ACT: Common Stock Indicate by check mark whether the Registrant: (1) 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 [X] No [_] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of March 15, 1996, 11,700,063 shares of Common Stock were outstanding. The aggregate market value of the outstanding stock of the Registrant held by non-affiliates on March 15, 1996 was $11,520,707. Documents incorporated by reference: Certain exhibits are incorporated by reference to the Registrant's Form 8-K dated December 22, 1994, the Registrant's Form 8-K/A dated December 22, 1994 and the Company's Form 10-K dated March 3, 1995. The total number of pages in this report is 255. The exhibit index is located on pages 39 through 42. 2 PART I. Item 1. BUSINESS. General - ------- Sunbase Asia, Inc., a Nevada corporation (the "Company," which term shall include, when the context so requires, its subsidiaries and affiliates), is engaged in the design, manufacture and distribution of a broad range of bearing products in the People's Republic of China ("China" or the "PRC"), the United States ("US"), Europe, Asia, South America and Africa. The Company's subsidiary in China, Harbin Bearing Company, Ltd. ("Harbin Bearing"), employs approximately 13,000 personnel. Harbin Bearing is the largest precision bearing manufacturer and the third largest bearing manufacturer overall in China. Harbin Bearing produces a wide variety of precision and commercial-grade, rolling-element bearings in sizes ranging from 10mm to 1000mm (internal diameter). Rolling-element bearings use small metal balls or cylinders to facilitate rotation with minimal friction and are typically used in vehicles, aircraft, appliances, machine tools, general machinery and virtually any product that contains rotating or revolving parts. On January 16, 1996 (effective December 29, 1995), the Company acquired Southwest Products Company ("Southwest Products"), an engineering- intensive company that produces precision spherical bearings for US, European and Asian aerospace and high tech commercial applications and the US military. Precision bearings are bearings that are produced to more exacting dimensional tolerances and to higher performance characteristics than standard commercial bearings. The manufacturing process for precision bearings generally requires the labor of highly-skilled machinists and the use of sophisticated machine tools. Southwest Products recently established a joint venture company in Shanghai, China (the "Shanghai Joint Venture") that will begin production in 1996 of a line of precision grade, high-profit-margin spherical bearings primarily for distribution to international aircraft original equipment manufacturers (OEMs) that have major "offset" commitments to purchase made-in- China parts. Over 90% of Harbin Bearing's sales are made to the OEM and replacement markets in China. Based on low production costs in China and the on-going world-wide demand for bearings, management has been increasing Harbin Bearing's efficiency and production output with the intent of creating a substantial export business to complement the Company's strong domestic position in the Chinese markets. Historically, Harbin Bearing export sales have been made through trade intermediaries and by receiving customer orders that are placed directly to its offices in China. Southwest Products will provide engineering and technical support, and will market and distribute Harbin Bearing products internationally, focusing on exports of the products to the US. In addition, Southwest Products will assist Harbin Bearing in implementing US manufacturing methods, improving quality control procedures and in developing new products at Harbin Bearing's facilities in China. 3 The Company's overall plan is to combine the management style, technology, quality control and production methods found in the West with low- cost Chinese manufacturing capacity so as to become a major international designer, manufacturer and distributor of bearing products. The following diagram shows the corporate structure of the Company and its affiliated entities. [CHART APPEARS HERE] 4 HARBIN BEARING Harbin Bearing presently produces a wide range of bearings, ranging from 10mm to 1000mm (internal diameter). Harbin Bearing specializes in the manufacture of precision bearings and has the capability of manufacturing more than 5,000 of the approximately 6,000 different specifications of bearings that are available in China today. Harbin Bearing produces seven major types of bearings: deep-groove ball bearings, self-aligning ball bearings, cylindrical rolling bearings, angular-contact ball bearings, tapered rolling bearings, thrust ball bearings and linear-motion ball bearings. Each of such bearings are manufactured in micro, small, medium and large sizes. In 1995, deep-groove bearings comprised approximately 75% of Harbin Bearing's sales in units, and approximately 43% of sales in revenue. Based on increasing demand and profit opportunities, Harbin Bearing increased its production of all sizes and grades of cylindrical rolling bearings and angular-contact ball bearings, (particularly in medium sizes and precision grades). In order to enhance the profitability for deep-groove ball bearings, Harbin Bearing has shifted its production mix of such bearings by increasing its production of medium-sized deep-groove ball bearings (especially in precision grades). The shift in production to medium-sized and precision grade bearings has enabled Harbin Bearing to expand its customer base, improve its profit margins, and meet the demand of many of its existing PRC customers for a full line of bearings. In addition, Harbin Bearing plans to increase its production of high-speed angular-contact and precision angular-contact ball bearings and to generally improve the quality of its non-precision bearings so they meet ISO standards. Harbin Bearing has recently expanded its product line to include self- aligning roller bearings. Self-aligning roller bearings are used predominantly in mining and extraction machinery. Management believes that based on the PRC government's policy of developing its mining and extraction industry, the demand for self-aligning roller bearings will likely remain strong in the near future. Harbin Bearing has also recently expanded its product line to include railway freight car bearings (Harbin Bearing is currently the leading supplier of railway passenger car bearings in China). Management believes that demand for railway freight car bearings is growing rapidly and that demand for such bearings will remain strong. Pursuant to the Strategic Plan, Harbin Bearing has installed certain equipment which has enabled Harbin Bearing to commence the production of railway freight car bearings and increase its production of railway passenger car bearings. Marketing - --------- The major end-users of Harbin Bearing's products are manufacturers of electrical machinery, machine tools, mining and extraction machinery, automobiles, motorcycles, household appliances and aircraft and aerospace equipment. In 1995, approximately 32% of Harbin Bearing's sales were made to OEMs in the machinery, transportation and electrical equipment 5 industries representing, respectively, approximately 28%, 30% and 35% of its total sales to OEMs. The remaining 7% of sales were made to miscellaneous categories of OEM customers. Approximately 68% of Harbin Bearing's sales in 1995 were made to distributors. Harbin Bearing has 18 sales offices in major cities in China, including Beijing, Shanghai and Guangzhou. All sales are coordinated through Harbin Bearing's headquarters in Harbin, including sales to local distributors and transportation industries, overseas agents, and domestic import and export companies. Harbin Bearing's sales force consists of 152 sales personnel and 288 support personnel who are responsible for product promotion, marketing, aftermarket services and technical support. Harbin Bearing sells its bearings in China and abroad under the "HRB" trademark. Harbin Bearing's products are considered to be the highest grade inside of China and medium-grade in world-wide markets. Harbin Bearing's pricing is considered to be very competitive in the international market. In 1994, the US was Harbin Bearing's largest export market, accounting for approximately 60% of total export sales. It is the Company's intention to increase Harbin Bearing's export sales to the US, Europe and certain developing countries in South America and Southeast Asia. Harbin Bearing delivers its bearings by rail (approximately 80% of Harbin Bearing's domestic deliveries are made by rail), truck, ocean freight and air freight. Harbin Bearing leases trucks from Harbin Precision Machinery Manufacturing Company which are used mostly for short-haul deliveries. See ITEM 13, "CERTAIN RELATIONSHIPS AND TRANSACTIONS." Bearings which are exported are generally shipped by ocean freight. Chinese Bearing Industry - ------------------------ Based on the Ministry of Machinery & Industry's 1993 Annual Report, China's aggregate domestic demand for bearings in 1995 was expected to be approximately 900 million units, representing an average annual increase of approximately 17% based on China's aggregate demand of 560 million units in 1992. Prior to 1989, under China's planned economy, the production, pricing and sales of bearings were fixed by the Chinese government. Beginning in 1988, demand for bearings exceeded the available supply, particularly for small and medium-sized bearings. Beginning in 1989, in connection with the implementation of economic reform measures undertaken by the Chinese government, production quotas and raw material subsidies were abolished. By 1991, competition among manufacturers of low-quality, small and medium-sized bearings had increased. This competition created an excess supply of such bearings and resulted in a decrease of profit margins. In July 1992, all price controls on bearing prices were removed. Even though supply still generally exceeds demand for small and medium-sized bearings in the low end market, demand continues to be strong for higher-quality small and medium-sized bearings used in the automobile, motorcycle, agricultural, electrical appliance and machinery industries. Overall, demand for bearings used in large agricultural machinery, mineral and extraction machinery and electric generating equipment, and demand for precision, special-purpose, large and extra-large-sized bearings continued to grow through 1995. 6 Competition - ----------- Chinese Competition Harbin Bearing's main competitors can be separated into three principal groups: (i) two nationwide domestic bearing manufacturers with wide product lines; (ii) small bearing production facilities which compete on a local basis by manufacturing small-sized, commodity-type bearings; and (iii) foreign bearing manufacturers. Harbin Bearing, Wafangdian Bearing Factory and Luoyang Bearing Factory are the three largest bearing manufacturers in China, based on 1994 sales. The combined sales revenues of these three manufacturers accounted for 30% of the US $1.09 billion of total sales revenue of China's bearing industry (figures are approximate). By comparison, the aggregate sales revenue of the fourth, fifth and sixth largest Chinese bearing manufacturers accounted for only approximately 9.5% of the total sales revenue of China's bearing industry. Wafangdian Bearing Factory does not produce high-precision aerospace- quality rolling-element bearings, a market in which Harbin Bearing has a 70% domestic share (the remaining 30% market share is split among Luoyang Bearing Factory and Hongshan Bearing Factory). Luoyang Bearing Factory and Wafangdian Bearing Factory produce nine of the ten classified types of bearings in China in a full range of sizes. Wafangdian Bearing Factory, like Harbin Bearing, produces a full line of rolling-element bearings, but it does not produce a full series of sizes of bearings for the majority of its product line. Luoyang Bearing Factory only produces large-size rolling-element bearings. In addition to the manufacturers described above, there are approximately 270 other manufacturers of ball bearings in China, including a number of small bearing factories in China, located mainly in the coastal and southeastern provinces, that were established after 1988 when demand for small-sized bearings greatly exceeded the available supply. The bearings manufactured by these small factories are generally of lower quality and are used mostly as replacement bearings in the electrical appliance and agricultural equipment industry. Harbin Bearing's other significant domestic competitors are mostly manufacturers that specialize in certain types of bearings, such as Hongshan Bearing Factory and Shanghai Micro Bearing Factory. Hongshan Bearing Factory, located in Guizhou, produces mainly lower-rated precision bearings. Shanghai Micro Bearing Factory produces almost exclusively small-sized deep-groove ball bearings. Chinese Competition from Imports Foreign bearing manufacturers are able to supply types and grades of bearings which are not available from Chinese domestic suppliers, particularly precision bearings of the highest durability and quality. Imported foreign bearings are generally higher in quality than Chinese-manufactured bearings, but are also priced higher due to China's low production costs and the assessment on imported bearings of a 15% or 20% import tariff. The 15% import tariff applies to bearings imported from countries that have established a tax treaty with China and the 20% import tariff applies to imports from other countries. Some foreign bearing manufacturers have established bearing manufacturing facilities in China, typically through joint ventures with 7 local bearing manufacturers. Such ventures, if successful, would likely increase competition for Harbin Bearing in the higher-quality and precision- bearing market segments. Competition in International Markets In the international bearing markets, Harbin Bearing's main competitors are Eastern European manufacturers and manufacturers located in China. To a lesser extent, Harbin Bearing also competes with large international bearing manufacturers such as SKF, FAG and NTN. Management believes that the assistance of Southwest Products in implementing US manufacturing methods and quality control procedures and in developing new products, Harbin Bearing's general competitive position will be substantially improved. In addition, Harbin Bearing will be able to compete in market segments that demand products with higher precision levels and will more effectively penetrate those market segments that utilize commodity-type bearings. Leading industrial countries such as the US, Japan and countries in Europe impose import tariffs on bearings. For example, the US import tariff for bearings is 9% for ball bearings and 5% for cylindrical bearings. Raw Materials - ------------- The principal raw materials used by Harbin Bearing to manufacture bearings are carbon steel and stainless steel rod, wire and tubing. These steels are specialized alloys designed for hardness, durability and resistance to rust. A small amount of copper and aluminum tubing and rods are also used to produce seals, cages and other ancillary bearing components. Harbin Bearing sources most of its bearing steel directly from four domestic mills located in Heilongjiang Province, Liaoning Province and Shanghai. Harbin Bearing imported less than 1% of its raw materials in 1995. In January 1993, the Chinese government lifted price controls on steel products and, as a result, the price of bearing steel in 1993 increased by more than 35.2% based on 1992 prices. The price of bearing steel in China is now approximately the same as the international price of bearing steel and has remained at approximately US $660.00 per ton since the end of 1993. Harbin Bearing believes that its sources of bearing steel are stable and, consistent with industry practice in China, has not entered into any long-term supply contracts for bearing steel. Harbin Bearing generally maintains a raw material inventory sufficient for approximately one-and-a-half months of production. Railroad tracks leading directly to two of Harbin Bearing's raw material warehouses are used exclusively to transport raw materials, such as bearing steel, to Harbin Bearing. In the future, Harbin Bearing intends to purchase bearing steel from South Korea and other countries. South Korean steel is price-competitive and is much higher quality than most Chinese steel. Accordingly, the use of South Korean steel will improve the quality of 8 Harbin Bearing's products while reducing the amount of products that are scrapped due to the use of lower-quality steel. Workforce - --------- As of January 16, 1996, Harbin Bearing employs approximately 13,000 full-time personnel in the following areas: executive and administrative (658), sales and service (507), manufacturing and production (11,492), and research and development (319). Management believes that in general, its employee relations are good. Harbin Bearing has recently begun to enter into employment contracts with all of its employees. The use of such employment contracts is an example of the steps Harbin Bearing is taking to raise its workforce productivity and efficiency. Harbin Bearing has begun to revise its compensation system to provide incentives to employees by linking productivity with compensation. Part of the revised compensation system was instituted in May 1994, and governs the wages of production employees. Depending on actual productivity, which is determined according to unit output and standard labor hours, a production employee may be paid more or less than the average wage. Harbin Bearing has also revised its compensation system with respect to its sales personnel. Harbin Bearing sets a monthly sales target for each sales office and each salesman. If the target is reached, the sales personnel will receive a bonus in addition to basic wages and allowances. In 1995, the total labor cost of Harbin Bearing comprised approximately 15% of total production costs. The Harbin Municipal Government promulgated regulations that were effective January 1994, which provide for the establishment of a pension fund program to which both employer and employee must contribute. Harbin Bearing is required to contribute a monthly amount equivalent to 20% of its employees' aggregate monthly income, and each employee is required to contribute a monthly amount that is equivalent to 2% of such employees' monthly income. All of the employees of Harbin Bearing are members of a trade union. To date, Harbin Bearing has not been subject to any strikes or other significant labor disputes and is not a party to any collective bargaining agreements. Harbin Bearing presently recruits graduates of the Harbin Bearing Technical Institute and universities all over China and provides ongoing training for its management and production employees in the form of a series of training seminars. SOUTHWEST PRODUCTS COMPANY Southwest Products, located at a 55,000 square foot facility in Irwindale, California, designs, engineers and manufactures custom, short-order spherical bearing products, such as high-precision spherical bearings, rod-end bearings, bushings and push-pull controls, for aerospace and high tech commercial applications. Southwest Products employs 58 full-time 9 personnel in the following areas: executive and administrative (5); sales and service (5); manufacturing (35) and engineering, research and development (13). The average length of employee tenure at Southwest Products is in excess of eight years. Southwest Products specializes in the design and manufacture of spherical bearings for use in extremely demanding and flight-critical applications. Such bearings meet unique load and tolerance requirements and are known as "Specials." Southwest Products produces small orders of custom bearings, the sales price of which typically includes the cost of product design, engineering and development. Southwest Products is respected worldwide for its ability to engineer and produce precision bearings, which are used in the Space Shuttle, commercial jet aircraft (Boeing and McDonnell Douglas), military aircraft (including the B-2 Stealth Bomber, F-117 Stealthfighter, F-15, F-16, C-17 and F-18), submarines, (Los Angeles Class, Ohio Class, Seawolf and Centurion), and nuclear power plants. Southwest Products' bearings are used by Northrop Grumman, Lockheed Martin, NASA, all US military services, Mitsubishi Heavy Industries, Korean Heavy Industries (Hanjun), Fluor Daniel, General Electric, Westinghouse, General Dynamics, Textron Marine, Ingalls Shipbuilding and Newport News Shipbuilding. Southwest Products' bearings have been used by NASA in all manned space programs since the launch of Mercury and are used in most NASA orbiters, including Viking, Magellan and Galileo. Southwest Products has operated continuously since it was established in 1945. The assets of Southwest Products were purchased during a Chapter 11 bankruptcy proceeding in 1991 by an investment group led by James McN. Stancill, a distinguished author and professor of finance at the University of Southern California. The investment group developed a plan for Southwest Products pursuant to which it would increase its production and sales of higher-volume standard spherical bearings. Standard spherical bearings rely on technology that is similar to the technology used to produce Specials, but require less sophisticated design and manufacturing methods. Standards are produced and used in substantially greater volume than Specials, and price and delivery are the primary competitive factors. Generally, Standards are ordered in large quantities for delivery over a number of years, whereas Specials are usually ordered in very small quantities. Typically, Standards sell for about $25 per unit while Specials sell for over $150 per unit. Certain Specials sell for $25,000 per unit or more. To facilitate its entrance into the Standards market, Southwest Products has been developing its production capacity for standard spherical bearings at the Shanghai Southwest Bearing Company, Ltd. Joint Venture ("Shanghai Joint Venture") and has contributed to the Shanghai Joint Venture certain proprietary technology, engineering assistance, technical support, training and plant management. The Shanghai Joint Venture partner has contributed the plant (which is now operational), equipment and general labor force. Upon completion of the transfer of certain technology (expected to be completed by May of 1996), Southwest Products will have a 28% interest in the Shanghai Joint Venture and the exclusive right to purchase up to 100% of the Shanghai Joint Venture's production, with the exclusive rights to distribute all of the Shanghai Joint Venture's products that are exported from China. Southwest Products also has the right to appoint the General Manager, manage the day-to-day operations and establish the long-term plans of the Shanghai Joint Venture. Southwest Products has commenced the training of the Shanghai 10 Joint Venture workforce and has completed the production of product prototypes. Qualification testing to ensure that the products of the Shanghai Joint Venture meet US Navy standards has begun, and commercial production is expected to commence in the fall of 1996. See "Shanghai Joint Venture." Southwest Products' Proprietary Technology - ------------------------------------------ Southwest Products manufactures both metal-on-metal bearings and self- lubricating bearings, based on Southwest Products' design and on OEM specifications. Self-lubricating bearings are lined with either Dyflon or Kentlon, which are both proprietary liner systems of Southwest Products. Kentlon is qualified by the United States Navy to Mil-B-81820, Mil-B-81934 and Mil-B-81935. It is used in military aircraft, tanks, ground support equipment, commercial aircraft, space vehicles, launch and payload systems and in the oil refinery, automotive and heavy manufacturing industries. Dyflon is one of only two liner systems in existence that is moldable and machineable that also performs successfully when fully submersed in water. Accordingly, in addition to the uses described above for Kentlon, Dyflon-lined parts are used in submarines, surface ships and nuclear power plants. Although Southwest Products has federally registered its trademarks "Dyflon" and "Kentlon," Southwest Products has chosen not to patent its various technologies because the specific formulae and methods for manufacturing Dyflon and Kentlon would then become a matter of public record. SHANGHAI JOINT VENTURE In 1991, principals of Southwest Products met with principals of Hong Xing Bearing Company ("HXBC") to discuss the establishment of a joint venture between Southwest Products and HXBC that would manufacture standard spherical bearings in Shanghai, PRC. Such a joint venture would assist Southwest Products in effectively penetrating the Standards market by improving Southwest Products' international cost competitiveness. In late 1992, Southwest Products and HXBC signed a Technology Transfer Agreement pursuant to which Southwest Products licenses technology to the Shanghai Joint Venture and manages the Shanghai Joint Venture's manufacturing activities. Because the types of bearings covered by the Technology Transfer Agreement are restricted commodities covered by the US Export Administration Regulations Commerce Control List, the transfer of technology relating to such bearings was subject to Southwest Products receiving from the United States Department of Commerce a Validated Export License ("License"), which permits the technology to be transferred by Southwest Products to the PRC. The License was issued in February 1994 after being reviewed and approved by the US Department of Defense. To management's knowledge, Southwest Products is the only company in the US to possess such a license. Immediately following the issuance of the License, Southwest Products and HXBC entered into a Joint Venture Agreement, thereby forming the Shanghai Southwest Bearing 11 Company, Ltd. Joint Venture, the main objective of which is to manufacture standard spherical bearings primarily for sale outside the PRC. The transfer of technology commenced in mid-1994 and the formal training by Southwest Products of Chinese manufacturing personnel commenced in March 1995. The Shanghai Joint Venture will employ 57 personnel in the following areas: executive, management and administration (5), sales and service (2), manufacturing (40), product quality and control (8), and engineering and research and development (2). The Shanghai Joint Venture ordered new machinery and equipment for its facility in mid-1994, most of which is already installed. The Shanghai Joint Venture is located at a new 35,000 square foot facility and has the option to expand its operation into an additional 50,000 square feet. The qualification of the Shanghai Joint Venture's bearing prototypes by the United States Navy to the Navy's Mil-B-81820, Mil-B-81934 and Mil-B-81935 standards will enable the Shanghai Joint Venture to sell such bearings to substantially all international users of such bearings. The worldwide annual market for bearings employing Mil- B-81820 qualified liners is in excess of $400,000,000. Southwest Products will supervise all aspects of the qualification process and anticipates that such bearing prototypes will be qualified by summer 1996. At present, the Boeing Commercial Airplane Group, McDonnell Douglas Corporation and Airbus Industries have "offset" agreements with the PRC under which these OEMs have committed to purchase equipment and parts from Chinese producers for use on commercial aircraft as an "offset" to China's substantial purchases of jet aircraft. Due to shortages of high-quality Chinese-made aircraft parts, these OEMs have not been able to purchase a sufficient volume of products from China at competitive prices to satisfy their purchase requirements under the offset program. Although the Shanghai Joint Venture cannot sell its products to these OEMs until the product prototypes have been qualified by the US Navy, management and Boeing and McDonnell Douglas have engaged in preliminary discussions regarding purchase of the Shanghai Joint Venture's products which, management believes, will likely lead to sales of such products to these OEMs. OPERATING IN CHINA ------------------ Because the production operations of the Company are based to a substantial extent in China, the Company (through Harbin Bearing and the Shanghai Joint Venture) is subject to rules and restrictions governing China's legal and economic system as well as general economic and political conditions in that country. These include the following: POLITICAL AND ECONOMIC MATTERS. Under its current leadership, the Chinese government has been pursuing economic reform policies, which include the encouragement of private economic activity and greater economic decentralization. There can be no assurance, however, that the Chinese government will continue to pursue such policies, or that such policies will be successful if pursued. Changes in policies made by the Chinese government may result in new laws, regulations, or the interpretation thereof, confiscatory taxation, restrictions on imports, currency devaluations or the expropriation of private enterprise which may, in turn, adversely affect the Company. Furthermore, business operations in China can become subject to the risk of nationalization, which could result in the total loss of investments in China. Finally, economic 12 development may be limited by the imposition of austerity measures intended to reduce inflation, the inadequate development of an infrastructure, and the potential unavailability of adequate power and water, transportation, communication networks, raw materials and parts. LEGAL SYSTEM. The PRC's legal system is a civil law system based on written statutes. Unlike the common law system in the United States, decided legal cases in the PRC have little value as precedents. Furthermore, the PRC does not have a well-developed body of laws governing foreign investment enterprises. Definitive regulations and policies with respect to such matters as the permissible percentage of foreign investment and permissible rates of equity returns have not yet been published, statements regarding these evolving policies have been conflicting, and any such policies, as administered, are likely to be subject to broad interpretation and modification, perhaps on a case-by-case basis. As the legal system in the PRC develops with respect to such new forms of enterprise, foreign investors may be adversely affected by new laws, changes in existing laws (or interpretation thereof) and the preemption of provincial or local laws by national laws. Some of the Company's operations in China are subject to administrative review and approval by various national and local agencies of the PRC government. Although management believes that the Company's operations are currently in compliance with applicable administrative requirements, there is no assurance that administrative approvals, when necessary or advisable, will be forthcoming. In addition, although China has promulgated an administrative law permitting appeal to the courts with respect to certain administrative actions, this law appears largely untested in the context of administrative approvals. INFLATION/ECONOMIC POLICIES. In recent years, the Chinese economy has experienced periods of rapid growth and high rates of inflation, which have, from time to time, led to the adoption by the PRC government of various corrective measures designed to regulate growth and contain inflation. In 1995, China's overall inflation rate was estimated to be 14.8%, compared to 21.4% in 1994 and 13.2% in 1993. High inflation has in the past and may in the future cause the PRC government to impose controls on prices, or to take other action which could inhibit economic activity in China, which in turn could affect demand for the Company's products. The Company carefully monitors the effects of inflation on its performance in China, and Harbin Bearing is usually able to increase its selling prices to shift a portion of its inflated costs to its customers. The price of bearing steel, the major raw material used by Harbin Bearing, remained fairly stable during 1994 and 1995 and the only major impact of inflation on Harbin Bearing's costs was on the cost of labor (due to the rising level of compensation of Harbin Bearing's employees). Due to economies of scale and improved control of Harbin Bearing's production costs, management believes that an increased inflation rate would have a favorable impact on its market position, as smaller bearing manufacturers in China would have greater difficulties in dealing with the effects of increasing inflation. FOREIGN CURRENCY EXCHANGE. The Renminbi ("Rmb"), the currency of China, is not a freely convertible currency. Both conversion of Rmb into foreign currencies and the remittance of Rmb abroad are subject to PRC government approval. The Company earns the majority of its revenues, and incurs the majority of its costs, in Rmb. Prior to January 1, 1994, Rmb that were earned within the PRC were not freely convertible into foreign currencies except with government 13 permission, at rates determined in place at swap centers, where the exchange rates often differed substantially from the official rates quoted by the People's Bank of China (the "PBOC"). On January 1, 1994, the official exchange rate was abolished pursuant to a Notice (the "PBOC Notice") of the PBOC and a new managed floating rate system was implemented. This new rate system effectively replaced the dual exchange rate system with a unitary exchange rate system. All future foreign currency exchange transactions are to be conducted through a unified interbank foreign exchange trading market based upon rates set by the PBOC. According to the PBOC Notice, enterprises operating in the PRC may no longer sell their products in the PRC for foreign currency; all sales of goods and services in the PRC must now be priced and paid for in Rmb. Domestic enterprises are required to sell all of their foreign exchange revenues to the authorized foreign exchange banks in the PRC and may obtain foreign currency for expenditures only upon SAEC approval. However, Sino-foreign equity joint ventures, such as the Shanghai Joint Venture, as foreign investment enterprises, are not required to sell their foreign exchange revenues to such banks. Although the China Foreign Exchange Center and the new rate system were fully established as of April 1994, as of May 1, 1996, the swap centers have remained in existence. VOLATILITY OF EXCHANGE RATES. The January 1, 1994 establishment of the unitary exchange rate system produced a significant devaluation of the Rmb, resulting in the US Dollar-Rmb exchange rate increasing from $1.00 to Rmb 5.7 to approximately $1.00 to Rmb 8.7. The US Dollar-Rmb exchange rate has been relatively stable since January 1, 1994 and the exchange rate quoted by the PBOC on December 31, 1995 was $1.00 to Rmb 8.32. However, the US Dollar-Rmb exchange rate may vary in the future and, as in 1993, the US Dollar-Rmb exchange rate could become volatile. Any devaluation of the Rmb against the US Dollar will have an adverse effect upon the US Dollar equivalent of the Company's net income and will increase the effective cost of any foreign currency expenses and liabilities, including any distributions to the shareholders of the Company which are to be made in US Dollars. Currently, the Company is unable to hedge its US Dollar-Rmb exchange rate exposure in China because neither the PBOC nor any other financial institution authorized to engage in foreign currency transactions offers forward exchange contracts with respect to Rmb. ORGANIZATION OF THE COMPANY --------------------------- Harbin Bearing was the successor to the manufacturing operations of Harbin Bearing General Factory (the "Bearing Factory"), a Chinese state-owned enterprise established in 1950. Harbin Bearing was established in 1993 as a joint stock limited company. Pursuant to an agreement between the Bearing Factory and Harbin Bearing, the bearing manufacturing and sales business together with certain assets and liabilities of the Bearing Factory were transferred to Harbin Bearing (the "Restructuring"). Certain other assets and liabilities were transferred to Harbin Precision Machinery Manufacturing Company ("Harbin Precision") and certain ancillary operations were transferred to Harbin Bearing Holdings Company ("Harbin Holdings"). Harbin Holdings and Harbin Precision were and are affiliates of the Harbin Municipal Government. 14 As part of the Restructuring, Sunbase International (Holdings) Ltd. ("Sunbase International"), a Hong Kong corporation, through a series of affiliated entities, acquired an effective ownership interest in Harbin Bearing of 51.4%. Substantially all of the remaining interests in Harbin Bearing were and continue to be owned by the employees of Harbin Bearing (approximately 15%) and Harbin Holdings. After the acquisition of the controlling interest in Harbin Bearing, Sunbase International implemented various programs to strengthen the business and operations of Harbin Bearing. These programs resulted in a shift in product mix to larger, higher margin bearings which, in turn, increased profitability. The work force was reduced approximately 25% with minimal negative effects on production. Incentive-based pay programs and western-style accounting and reporting systems were implemented to further strengthen and improve Harbin Bearing's business and operations. In December 1994, the Company (which was then called Pan American Industries, Inc.) acquired a 51.4% effective interest in Harbin Bearing by issuing to Asean Capital Limited ("Asean Capital") newly issued shares representing a controlling interest in the Company. Asean Capital was, and is, owned 90% by Sunbase International and 10% by an unrelated company, New China Hong Kong Capital Ltd. ("New China Hong Kong"). See ITEM 13, "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS." 15 ITEM 2. PROPERTIES. Harbin Bearing - -------------- Harbin Bearing operates twelve finished product plants and seventeen auxiliary plants. With the exception of a finished product plant in Wucangzian, all of the Company's plants are located in four plant compounds in Harbin. Harbin Bearing plans to relocate the Wucangzian finished product plant, now located approximately 260 kilometers from the main site, to a new facility currently under construction approximately 17 kilometers from the main site. The Company believes the costs associated with the relocation to be approximately RMB 27 million. The Harbin branch office of the State Asset Administration Bureau has granted Harbin Holdings the right to use the properties where Harbin Bearing's production and other facilities, which include the Wucangzian finished product plant and the four plant compounds. The site is approximately 540,000 km/(2)/ of which production facilities occupy approximately 290,000 km/(2)/ square meters. Harbin Holdings has entered into a lease agreement with the Company for use of its buildings for five years. See Item 13, "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS." Southwest Products - ------------------ Southwest Products leases a 55,000 square foot facility in Irwindale, California on a month to month basis at a monthly rent of $14,000. ITEM 3. LEGAL PROCEEDINGS The Company is not a party to, nor is any of its property subject to, any pending legal proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matters were submitted to a vote of the Company's security holders during the fourth quarter of 1995. 16 PART II. ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. Commencing on February 9, 1996, the Company's Common Stock began trading on the National Market of NASDAQ under the symbol ASIA. Prior thereto, the Common Stock was listed for trading on the NASDAQ's Electronic Bulletin Board (the "Bulletin Board") and on the Pink Sheets. The following tables set forth the high and low closing prices of the Company's Common Stock on NASDAQ or the Bulletin Board. Such prices reflect prices between dealers in securities and do not include any retail markup, markdown or commission and may not necessarily represent actual transactions. There was no established trading market for the Company's Common Stock during fiscal 1994.
High Low ------ ----- Fiscal 1995 ----------- Quarter Ended March 31, 1995 3 2 Quarter Ended June 30, 1995 5 1/2 2 Quarter Ended September 30, 1995 5 1/4 2 Quarter Ended December 31, 1995 6 4 1/2 Fiscal 1996 ----------- Quarter Ended March 31, 1996 6-1/32 7-7/8
The approximate number of record security holders of the Common Stock at March 15, 1996 was 1,700. The Company has paid no cash dividends on its Common Stock and has no present intention of paying cash dividends in the foreseeable future. It is the present policy of the Board of Directors to retain all earnings to provide for the growth of the Company. Payment of cash dividends in the future will depend upon, among other things, future cash flow and requirements for capital improvements. Applicable Chinese laws and regulations provide that a joint stock company (such as Harbin Bearing) cannot distribute its after-tax earnings and profits made in a fiscal year unless 17 the losses of the previous years have been made up and certain funds retained. A joint stock company is required by applicable Company Law to reserve 10% of its after-tax earnings and profits as the mandatory retained fund and 5% of its after-tax earnings and profits as the public welfare fund. The joint stock company does not have to reserve for the mandatory retained fund if the amount of such fund has reached 50% of the company's registered capital. For 1994, Harbin Bearing contributed 10% and 5%, respectively, of after-tax profits as determined under Chinese accounting principles for such purposes. Distributions of dividends by Harbin Bearing to its shareholders are required to be in proportion to each shareholder's percentage interest in the Harbin Bearing. All distributions by Harbin Bearing will be paid to its shareholders of record, which include the joint venture partners. Applicable Chinese laws and regulations require that, before a Sino-foreign equity joint venture (such as the joint venture partners) distributes dividends, it must: (1) satisfy all tax liabilities; (2) provide for losses in previous years; and (3) make allocations of capital to its official surplus accumulation fund and public welfare fund. The Company indirectly owns 99% and 99.9% of the two joint venture partners and, therefore, approximately 1.1% of distributions received by such partners will be paid to the Chinese parties of these joint ventures. ITEM 6. SELECTED FINANCIAL DATA The following selected financial data (expressed in thousands) have been derived from the audited financial statements of Harbin Bearing General Factory for the year ended December 31, 1993 and the audited financial statements of the Company for the years ended December 31, 1994 and 1995. All U.S. dollar amounts have been converted from Renminbi based on the exchange rate on December 31, 1995 of $1.00 US to each RMB 8.32 as quoted at the People's Bank of China. Due to the reorganization of the Harbin Bearing General Factory on January 1, 1994, the 1993 financial information was prepared on a pro-forma basis as if the acquisition of China Bearing and Harbin Bearing had occurred on January 1, 1993. 18
OPERATING DATA PROFORMA 1993 1994 1995 1995 RMB RMB RMB US$ Net sales 687,064 719,842 672,359 80,812 Cost of sales (439,417) (441,854) (381,377) (45,838) Gross profit 247,647 277,988 290,982 34,974 Selling, general and administrative expense. (91,197) (95,218) (113,002) (13,582) Interest expense, net (40,638) (43,446) (48,446) (5,822) Foreign exchange gain/loss - 725 - - Reorganization expenses (7,307) (7,307) - - Income before income taxes 108,505 132,742 129,534 15,570 Provision for income taxes (16,700) (22,687) (20,472) (2,461) Income before minority interests 91,805 110,055 109,062 13,109 Minority interests (50,495) (58,447) (54,967) (6,607) Net income 41,310 51,608 54,095 6,502 BALANCE SHEET PROFORMA 1993 1994 1995 1995 RMB RMB RMB US$ Current Assets 580,412 893,994 1,032,600 124,110 Working Capital 256,004 247,990 306,288 36,812 Long-Term Debt 216,915 235,656 218,383 26,248 Minority Interests 229,728 288,175 343,142 41,243 Shareholders' Equity 189,267 248,182 330,565 39,731 Total Assets 960,318 1,418,017 1,618,402 194,520
19 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. OVERVIEW - -------- The Company owns, through various subsidiaries and joint venture interests, a 51.4% indirect ownership in Harbin Bearing, which develops and manufactures bearings in China and sells bearings in China as well as western countries, including the United States. The Company produces seven types of bearings: deep groove ball bearings, self-aligning bearings, cylindrical roller bearings, angular contact ball bearings, tapered roller bearings, thrust bearings and linear-motion ball bearings, with a focus on medium and large sized bearings which have a relatively higher profit margin. During the year, 92 new bearing products were introduced. These new bearing products are mainly medium and large sized self- aligning ball bearings and angular contact ball bearings which are used for motor vehicles and machine-tools applications, respectively. The Company raised the selling price of all bearing products effective July 1, 1995 by an average of 3-5% in order to cover increasing costs, as compared to July 1, 1994 when there was a sales price increase of 5-8%. In the last quarter of 1995, the Company changed its marketing strategy by shifting smaller OEM accounts to designated distributors in order to reduce marketing costs and credit risks. Effective December 29, 1995, the Company acquired Southwest Products Company ("Southwest Products") which is a small but strategically-positioned, engineering-intensive company that produces precision spherical bearings for US, European and Asian aerospace and high tech commercial applications and the US military. Southwest Products recently established a joint venture company in Shanghai, China (the "Shanghai Joint Venture") that is expected to begin production in the second half of 1996 of a line of precision-grade, high-profit- margin spherical bearings primarily for distribution to international aircraft original equipment manufacturers ("OEMs") that have major "offset" commitments to purchase made-in-China parts. The acquisition of Southwest Products has been treated as a business combination and is accounted for under the purchase method of accounting. However, since the acquisition was deemed to have been consummated on December 29, 1995, the results of Southwest Products have not been consolidated into the Company and will be included in the Company's consolidated results of operations from January 1, 1996. The assets and liabilities of Southwest Products have been incorporated into the consolidated balance sheet of the Group at December 31, 1995. After acquiring Southwest Products, the management of the Company has developed a Strategic Plan to foster future growth. The Strategic Plan has three main objectives: 20 1. To increase export sales of Harbin Bearing's products in the US by selling its products through Southwest Products' distribution network, and by changing its export product mix to meet the demands of the international marketplace. 2. To transfer US manufacturing and product development expertise and technology from Southwest Products to Harbin Bearing to increase production, efficiency and product quality. 3. To achieve rapid growth of the Shanghai Joint Venture by targeting customers with "offset" commitments to purchase made-in-China parts. Unless specifically stated, all amounts in this Management's Discussion and Analysis are in thousands (RMB000). 21 RESULTS OF OPERATIONS - --------------------- RESULTS FOR 1995 COMPARED TO 1994
Year ended Year ended December 31, December 31, 1995 1994 RMB RMB ------------ ------------ Net sales 672,359 719,842 Cost of sales (381,377) (441,854) -------- -------- Gross Profit 290,982 277,988 Gross Profit percentage 43.3% 38.6% Selling expenses (18,942) (20,471) General and Administrative expenses (94,060) (74,747) Interest Expense (48,446) (42,721) Reorganization Expenses - (7,307) -------- -------- Income Before Income Taxes 129,534 132,742 Provision for Income Taxes (20,472) (22,687) -------- -------- Income Before Minority Interests 109,062 110,055 Minority Interests (54,967) (58,447) -------- -------- Net Income 54,095 51,608 ======== ========
NET SALES - --------- Net sales decreased by RMB 47,483 or 6.6% in 1995 as compared to 1994. The decrease was mainly due to the change in the Company's marketing strategy in order to further enhance its credit control on sales in the last quarter of 1995 whereby a contracted sales order was entered into with a major distributor, which is a related party beneficially owned by the Harbin Municipal Government. Delivery was not made in respect of this transaction at December 31, 1995 and thus this sale was not recognized in the Financial Statements. However, in anticipation of this transaction, the Company reduced the delivery of its products to other customers. As a result of the aforementioned contracted sales order in the last quarter of 1995, the net reported sales in the last quarter of 1995 was RMB 21,289. 22 Throughout 1995, the Company continued to adjust its product mix by shifting from small and medium sized bearings to higher margin medium and large sized bearings in order to improve profitability and to cope with the growth in market demand on these new products. GROSS PROFIT - ------------ Gross profit increased by RMB 12,994 or 4.7% in 1995 as compared to 1994. Gross profit as a percentage of revenue increased from 38.6% in 1994 to 43.3% in 1995. The increase in gross profit was mainly attributable to the effect of the sales mix change to higher-margin products, the improved operational efficiency and a reduction in purchase price of major raw materials. In previous quarters in 1995, cost of sales was calculated with reference to the average gross profit ratio for 1994, being 38.6% on revenue. The average gross profit ratio for 1995 of 43.3% on revenue was computed from actual results throughout the year after taking into account various year-end closing inventory adjustments such as a write-back of obsolete inventories sold during the year which amounted to RMB 15,805 and adjustment to reflect under absorption of labor and overhead of approximately RMB 4,700. The gross profit margin for 1995 would have been only 39.2% on revenue if no account was taken of the year end adjustments on closing inventories. SELLING EXPENSES - ---------------- Selling expenses decreased by RMB 1,529 or 7.5% in 1995 as compared to 1994. The decrease was in line with the decrease in sales this year. Selling expenses as a percentage of revenue has remained constant at a rate of 2.8%. GENERAL AND ADMINISTRATIVE EXPENSES - ----------------------------------- General and Administrative expenses increased by RMB 19,313 or 25.8% in 1995 as compared to 1994. General and Administrative expenses as a percentage of revenues increased from 10.4% to 14.0%. The increase in General and Administrative expenses was mainly attributable to: a. An increase in staff wages and welfare costs of RMB 7,550 as a result of increments given to the staff this year. b. There was a loss of RMB 4,829 on disposal of fixed assets as compared to a gain on disposal of fixed assets of RMB 1,087 in 1994. 23 c. A cash discount of RMB 6,490 was granted in 1995 for incentives to customers for early settlement of debt in order to accelerate the cash collection. In 1995, an additional bad debt provision of RMB 2,627 was provided (1994: RMB 11,300) on certain aged debt. d. An increase in management fee of RMB 1,716 payable to Harbin Bearing Holdings Company as a result of a 10% inflation adjustment. e. An increase in insurance premium paid of RMB 1,979 on the increase in assets. INTEREST EXPENSE - ---------------- Interest Expense increased by RMB 5,725 or 13.4% in 1995 as compared to 1994. The increase was attributable to interest expense of 8% related to a US$ 5,000 promissory note issued on December 30, 1994 and to a 1.3% increase in interest rate on increased amounts of short-term bank loans effective July 1, 1995. REORGANIZATION EXPENSES - ----------------------- There was no similar charges in 1995 of the one time reorganization expenses in 1994 which were incurred in connection with the acquisition of China Bearing Holdings Limited. LIQUIDITY AND CAPITAL RESOURCES - ------------------------------- OPERATING ACTIVITIES - -------------------- The Company utilized cash in operating activities of RMB 39,057 in 1995 as compared to RMB 86,312 used in operating activities in 1994. The decrease in cash used in operating activities was mainly due to net improvements in cash settlements from accounts receivable. The Company continues to strengthen the enforcement of credit controls and the acceleration of cash collections. As of December 31, 1995, the Company's working capital had increased to RMB 306,288 as compared to RMB 247,990 at December 31, 1994. The Company's current ratio was 1.42:1 as of December 31, 1995 as compared to 1.38:1 at December 31, 1994. 24 INVESTING ACTIVITIES - -------------------- As of December 31, 1995, the Company had outstanding capital expenditure commitments of RMB 46,027 (December 31, 1994: RMB 91,500). These capital commitments are expected to be funded through December 1996. Total capital expenditure for 1995 were RMB 92,571 and were mainly for construction of new plant, buildings and renovating existing facilities and equipment. They were financed primarily by internally generated funds and short-term and long-term bank loans (see below). FINANCING ACTIVITIES - -------------------- The Company relies on both short-term and long-term bank loans from Chinese banks to support its operating and capital requirements. Short-term bank loans have terms ranging from three months to six months, and are reviewed on a revolving basis. During the year of 1995, new short-term bank loans (after deducting repayment of previous loans) totaled RMB 49,735. The net proceeds from short-term bank loans in 1995 were mainly utilized to fund capital expansion projects. Long-term bank loans have terms ranging from 2 to 4 years and are utilized for funding capital expansion projects. During the year 1995, new long-term bank loans after deducting repayment of previous loans totaled RMB 42,246. The Company believes that it will be able to continue to maintain and expand its bank borrowings under existing terms and conditions. The Company believes that cash flow from operations, combined with cash and bank balances and bank borrowings, will provide sufficient cash flow to finance internal growth, capital projects and debt service requirements for the foreseeable future. EFFECT OF INFLATION - ------------------- In China, the general inflation rate continued to be in excess of 10% during the year 1995 but it is expected that the Chinese government will continue to make substantial efforts to curb inflation over the near term. During the last quarter of 1995, the inflation growth rate has begun to slow down. The Company constantly monitors the effects of inflation. In general, the Company is able to raise its selling prices to shift a portion of the inflated costs to the customers. The price of the major raw material used by the Company (bearing steel) remained fairly stable during 1994 and 1995. The major impact of inflation on cost was from labor costs due to 25 increases in employees wages. However, the improved operational efficiency, as reflected by the increased gross profit ratio during the year of 1995, managed to offset the effects of inflation. RESULTS FOR ACTUAL 1994 COMPARED TO PROFORMA 1993
Actual Proforma Year ended Year ended December 31, December 31, 1994 1993 RMB RMB ------------ ------------ Sales 719,842 711,420 Sales Tax - (24,356) -------- -------- Net sales 719,842 687,064 Cost of sales (441,854) (439,417) -------- -------- Gross Profit 277,988 247,647 Gross Profit percentage 38.6% 36.0% Selling Expenses (20,471) (14,765) General and Administrative expenses (74,747) (76,432) Interest Expense (42,721) (40,638) Reorganization Expenses (7,307) (7,307) -------- -------- Income Before Income Taxes and Minority Interests 132,742 108,505 ======== ========
The above pro forma results for the year ended December 31, 1993 were prepared on the basis as if the reorganization of Harbin Bearing General Factory and the acquisition of China Bearing and the Company had occurred on January 1, 1993 which are extracted from the Unaudited Proforma Consolidated Statement of Income for the year ended December 31, 1993 after giving effect to the proforma adjustments described in further detail in the aforesaid Proforma Financial Statements. The proforma results of operations have been prepared for comparative purposes only and do not purport to indicate the results of operation which would actually have incurred had the acquisition been in effect on January 1, 1993 or which may occur in the future. 26 SALES - ----- Sales increased by RMB 8,422 or 1.2% in 1994 compared to 1993. The increase in sales was mainly due to general sales price increases. GROSS PROFIT - ------------ Gross profit increased by 12.3% or RMB 30,341 in 1994 compared to 1993. Gross profit as a percentage of revenue increased to 38.6% in 1994 from 34.8% in 1993, primarily due to the slight increase in general sales price and the effect of the sales mix change to higher margin products and the change in VAT system in China effective January 1, 1994. SELLING EXPENSES - ---------------- Selling expenses increased by 38.6% or RMB 5,706 in 1994 compared to 1993 which was mainly due to an increase in government taxes of RMB 7,651. This was offset by a decrease in transportation expenses of RMB 1,500 in 1994 compared to 1993 as a result of the passing of its transportation costs directly to certain customers arising from the introduction of the new VAT system in China. GENERAL AND ADMINISTRATION EXPENSES - ----------------------------------- General and Administrative expenses decreased by 2.2% or RMB 1,685 in 1994 compared to 1993. General and Administrative expenses as a percentage of revenues decreased from 10.7% to 10.4%. Although there was a large decrease in the bad debt provision of RMB 17,000, this decrease was however largely offset by a one-time formation expense of RMB 2,637 and special compensation payments to workers for early retirement totalling RMB 7,243 in 1994. This was offset by having no gain on disposal of fixed assets, whereas a gain was recorded in 1993 for RMB 4,700. INTEREST EXPENSE - ---------------- Interest expense increased 5.1% or RMB 2,083 in 1994 compared to 1993 which was mainly due to an increase in interest rates during 1994. REORGANIZATION EXPENSES - ----------------------- On a proforma basis, the one time reorganization expenses in connection with the acquisition of China Bearing Holdings Limited were assumed to be incurred on January 1, 1993. 27 LIQUIDITY AND CAPITAL RESOURCES - ------------------------------- The Company's overall cash position decreased by RMB 101,000 in 1994 from 1993. The cash used in operating activities decreased from RMB 87,500 in 1993 to RMB 86,300 in 1994. The cash was mainly used to finance accounts receivable. In 1994, cash used in investing activities amounted to RMB 153,000 compared to RMB 26,000 in 1993. The increase was attributable to the investment in new equipment and construction of a new plant in order to cope with the future expansion. Cash from financing activities was decreased from RMB 266,500 in 1993 to RMB 138,300 in 1994. In 1994, the cash received was mainly in the form of loans to finance working capital and capital projects whereas in 1993, the cash from financing was mainly arising from equity financing for the joint venture and employees' stock comprised RMB 300,000. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The financial statements and exhibits are listed at Item 14 "Exhibits, Financial Statement Schedules and Reports on Form 8-K". Certain unaudited quarterly financial information is set forth in the following table:
Net Net Gross Net Income Sales Profit Income Per Share (Thousands of RMB, except per share data) (Exchange Rate at 12/31/95: 8:32 RMB to $1) 1995 RMB RMB RMB RMB First Quarter 198,854 76,758 15,328 1.00 Second Quarter 235,979 92,392 24,872 1.62 Third Quarter 216,237 84,336 18,846 1.23 Fourth Quarter 21,289 37,496 (4,861) (0.31) 1994 First Quarter 182,677 66,312 12,360 0.81 Second Quarter 208,362 80,259 21,715 1.42 Third Quarter 198,321 81,158 15,925 1.04 Fourth Quarter 130,482 50,259 1,608 0.1
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Not Applicable. 28 PART III. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. A. Directors --------- The Board of Directors of the Company is comprised of only one class. The Company's current directors are listed below. The Directors are elected to serve until the following annual shareholders' meeting.
Name Age First Elected - ---- --- ------------- Gunter Gao 40 1994 Billy Kan 43 1996 William McKay 41 1996 (Roger) Li Yuen Fai 35 1994 Linda Yang 35 1994 (Franco) Ho Cho Hing 43 1994
B. Executive Officers ------------------ The Company's current executive officers are listed below. Executive officers are elected to serve until the following annual meeting of the Company's Board of Directors:
Name Age Office First Elected - ---- --- ------ ------------- Gunter Gao 40 Chairman 1994 William McKay 41 Chief Executive 1996 Officer and President (Roger) Li Yuen Fai 35 Vice President and 1994 Chief Financial Officer (Dickens) Chang Shing Yam 29 Chief Accounting 1995 Officer (John) Chong Chi Yeung 28 Corporate Secretary 1995
GUNTER GAO, CHAIRMAN AND DIRECTOR, 40. Mr. Gao, a Hong Kong businessman who has extensive business experience in China, is the Chairman of the Board and a principal of Sunbase International, which indirectly owns a controlling position in Sunbase Asia. Sunbase International has various industrial holdings in China, in industries such as aviation, transportation, cement, 29 steel and retail. Mr. Gao is also the Chairman of the Board of Sunbase Asia. Mr. Gao is responsible for the general strategy of the Company and maintains overall control of the Company's operations. Mr. Gao is actively and directly involved in all operational and strategic issues that require his experience and expertise in handling a wide variety of Chinese business transactions. During the 1980s, Mr. Gao engaged in trading and investment activities in industries such as food, timber, real estate, coal and textiles. Based on his success in these activities and with the support of several banks in China, Mr. Gao has turned Sunbase International into a leading China industrial company. Mr. Gao is currently a member of China's congress, known as the People's Political Consultative Conference. Mr. Gao is the youngest member of the congress and is widely respected for his contributions to the country's development. Mr. Gao's strong reputation in China has enabled Sunbase International to engage in and complete many difficult transactions, including acquiring a majority interest in Harbin Bearing and obtaining a license to create an airline in China. Now known as Northern Swan Airlines, this airline enjoys international prominence and the financial support of the Bank of China and the People's Construction Bank of China. Mr. Gao serves as a Senior Economic Advisor to several Chinese municipal and provincial governments, including the governments of Tianjin, Hebei, Xinjiang and Harbin. In addition, Mr. Gao is the deputy director of the Sino- Foreign Entrepreneurs Cooperative Committee. BILLY KAN, DIRECTOR, 43. Mr. Kan has been a director of Sunbase Asia since the beginning of 1996. In his capacity at Sunbase International, Mr. Kan reports directly to its Board of Directors and serves as the communications and support link in various parts of the world. Mr. Kan holds a Bachelor of Science Degree from the University of East Anglia, a United Kingdom university, and is a member of The Institute of Chartered Accountants in England & Wales as well as the Hong Kong Society of Accountants. Prior to joining Sunbase International, Mr. Kan held many directorships and senior management positions in a wide range of professions and industries including banking, retailing, manufacturing, property, investment and corporate consulting. WILLIAM MCKAY, CHIEF EXECUTIVE OFFICER, PRESIDENT AND DIRECTOR, 41. Mr. McKay has recently been elected as the Chief Executive Officer, President and a Director of Sunbase Asia, and has been a Director and President of Southwest Products since 1991. Prior to becoming President of Southwest Products, he was Southwest Products' General Manager since 1986. Mr. McKay has substantial experience in conducting business with China, and is very familiar with Sino- American joint venture law and policies. Mr. McKay was instrumental in establishing the joint venture between Southwest Products and Shanghai Hong Xing Bearing Factory. Mr. McKay is responsible for the day-to-day operations of, and the long-term planning for, the Company in the areas of product development, marketing, financing and general operations. Prior to jointing Southwest Products, Mr. McKay practiced law, specializing in the areas of business and real estate. Mr. McKay holds a Juris Doctorate Degree, Masters in Business Administration and Bachelor of Arts degree with a major in History and minor in International Relations from the University of Southern California. (ROGER) LI YUEN FAI, GROUP FINANCIAL CONTROLLER, CHIEF FINANCIAL OFFICER, VICE- PRESIDENT AND DIRECTOR, 35. Mr. Li has been the Group Financial Controller of Sunbase International since 30 1994. He has been the Chief Financial Officer and a Director of Sunbase Asia since 1995 and has recently been elected as the Vice-President of Sunbase Asia. From 1990 to 1991 he was compliance manager of Hong Kong Securities Clearing Company Limited. Mr. Li was employed by Coopers & Lybrand in Hong Kong from 1980 to 1990 (his most recent position was audit manager) and was a partner in a Hong Kong accounting firm from 1992 to 1993. LINDA YANG, DIRECTOR, 35. Ms. Yang has been the Executive Director and a principal of Sunbase International since 1989. Ms. Yang was a co-founder of Sunbase International, has extensive experience in China business operations and holds a degree from a Chinese university. She is the wife of Gunter Gao. (FRANCO) HO CHO HING, DIRECTOR, 43. Mr. Ho has been a Director of the New China Hong Kong Group since 1993, and a Director of Sunbase Asia since 1995. Mr. Ho is also a registered investment advisor with the Securities and Futures Commission in Hong Kong. Mr. Ho held executive positions with Trenomics Securities Limited (1981 to 1983), Shun Loong Bear Stearns Asia Limited (1985 to 1988) and Best Securities Company (1991 to 1993). KEY MANAGEMENT MR. MA JI BO, GENERAL MANAGER, 57. Mr. Ma is the General Manager of Harbin Bearing and is responsible for the day-to-day operations of Harbin Bearing as well as strategic planning in the areas of marketing, product development and general operations. Mr. Ma has made significant contributions relating to the design and manufacture of a broad range of Harbin Bearing's products. Mr. Ma has been awarded various provincial and national Chinese awards for scientific and technological progress in the Chinese bearing industry and holds a degree in rocket science from Northwest China Engineering University. MR. MEI HAI YOU, DEPUTY GENERAL MANAGER, 59. Mr. Mei is the Deputy General Manager of Harbin Bearing where he has been employed for 35 years. Mr. Mei is the head of Harbin Bearing's manufacturing operations and has extensive experience in the fields of research and development, product development and manufacturing engineering. Mr. Mei is the author of a number of works on mechanical engineering and bearings and holds a degree in mechanical engineering from Harbin Polytechnic University. MR. ZHANG ZHENG BIN, DEPUTY GENERAL MANAGER, 50. Mr. Zhang has been employed by Harbin Bearing as Deputy General Manager of Sales and Marketing for 10 years. Mr. Zhang has extensive contacts in the Chinese engineering community and has proven very effective at penetrating existing markets and developing new markets for Harbin Bearing. Mr. Zhang holds a degree in engineering from Harbin Polytechnic University. (DICKENS) CHANG SHING YAM, ASSISTANT MANAGER AND CHIEF ACCOUNTING OFFICER, 29. Since 1994, Mr. Chang has been the Assistant Manager of Finance of Sunbase International and has been the Chief Accounting Officer of Sunbase Asia since 1995. Mr. Chang was employed by 31 the international accounting firm of Ernst & Young in Hong Kong from 1989 to 1994, most recently as audit manager. TODD STOCKBAUER, FINANCE MANAGER, 33. Mr. Stockbauer has been employed as the Finance Manager of Southwest Products since 1991 and directs its financial and administrative operations. Prior to 1991, he was employed in the public accounting sector, specializing in bankruptcy, litigation support and business turnarounds. Mr. Stockbauer holds a Bachelor of Arts degree in business and economics from the University of California at Santa Barbara with an emphasis in accounting, and is a Certified Public Accountant in the State of California. ERNST RENEZEDER, DIRECTOR OF MANUFACTURING, 59. Mr. Renezeder has been the Director of Manufacturing at Southwest Products since 1992. Mr. Renezeder has over 24 years experience in manufacturing, engineering, management, and product research and development. Mr. Renezeder holds a Bachelor of Science degree in Molding and Foundry, which is equivalent to a Bachelor of Science in manufacturing engineering with an emphasis in mechanical engineering. JOHN LEONIAK, CHIEF ENGINEER, 59. Mr. Leoniak has been the Chief Engineer at Southwest Products since 1991. As Chief Engineer, Mr. Leoniak supervises Southwest Products' engineering and research and development. Prior to joining Southwest Products, Mr. Leoniak was employed by Grumman Aircraft Systems as the head of its Landing Gear, Armament, Carrier Suitability and Survivability Group. Mr. Leoniak has contributed to the writing of various US Navy manufacturing specifications, including MIL-B-8942, MIL-B-81820, MIL-B-81819 and MIL-STD-1599. Mr. Leoniak holds a Bachelor of Science in mechanical engineering from the Polytechnic Institute of Brooklyn. PETER WANG, QUALITY CONTROL MANAGER, 35. Mr. Wang has been the Quality Control Manager of Southwest Products since 1993 where he supervises the Quality Control and Inspection Departments. Prior to joining Southwest Products, Mr. Wang held positions as a mechanical engineer and a senior quality engineer. Mr. Wang has extensive experience in quality and statistical process control, is fluent in Mandarin and holds a Master of Science degree in mechanical engineering from North Carolina A&T State University and a Bachelor of Science degree in physics from Lenoir Rhyne College. 32 COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT - ------------------------------------------------- Based solely on a review of Forms 3 and 4 and amendments thereto furnished to the Company during its most recent fiscal year and certain written representations, no persons who were either a director, officer, beneficial owner of more than 10% of the Company's common stock, failed to file on a timely basis reports required by Section 16(a) of the Exchange Act during the most recent fiscal year. ITEM 11. EXECUTIVE COMPENSATION. MANAGEMENT COMPENSATION No compensation was earned by or awarded to any of the Company's officers or directors in 1995. In 1995, in connection with a Management and Services Agreement between China Bearing Holdings Limited and Sunbase International, Sunbase International provided to the Company and its affiliates office space and equipment, administrative services and the services of Mr. Gao and other employees of Sunbase International (such as Ms. Yang, Mr. Li and Mr. Chang). In consideration of the provision of such services, China Bearing Holdings Limited paid Sunbase International a total of US $30,000 plus certain out-of-pocket expenses such as travel and entertainment. See ITEM 13 "CERTAIN RELATIONSHIPS AND TRANSACTIONS." Based on the foregoing, no executive officer of the Company received compensation of US $100,000 or more from the Company. STOCK OPTION PLAN On January 2, 1996, the Company's Board of Directors adopted the 1995 Sunbase Asia, Inc. Stock Option Plan (the "Plan"). The Plan permits the grant of options to purchase an aggregate of up to 2,500,000 Shares of the Common Stock of the Company. Under the Plan, incentive stock options and non-qualified stock options may be issued. Eligible participants under the Plan are those individuals and entities that the stock option committee of the Company (the "Committee") in its discretion determines should be awarded such incentives given the best interests of the Company; provided, however, that incentive stock options may only be granted to employees of the Company and its affiliates. The Committee has the power to determine the price, terms and vesting schedule of the options granted, subject to the express provisions of the Plan. All incentive stock options will have option exercise prices per option share not less than the fair market value of a share of the Common Stock on the date the option is granted, except that in the case of incentive stock options granted to any person possessing more than 10% of the total combined voting power of all classes of stock of the Company or any affiliate of the Company, the price shall not be less than 110% of such fair market value. The Plan terminates on the earlier of that date on which no additional shares of Common Stock are available for issuance under the Plan or January 2, 2006. In connection with an employment agreement entered into by and between the Company and William R. McKay on January 16, 1996, and pursuant to the Plan, the Company 33 granted Mr. McKay the option to purchase an aggregate of up to 800,000 shares of Common Stock of the Company. The option is intended by the Company and Mr. McKay to be, and will be treated as, an incentive stock option. The options granted to Mr. McKay vest at the rate of 160,000 shares per each full year of Mr. McKay's employment under the Agreement. Mr. McKay may exercise the options that have vested and purchase shares of the Common Stock of the Company at the following prices:
Exercise Price of Full Years of Options that Vest Employment After Each Such Year ----------- -------------------- One $ 6.65 Two $ 7.75 Three $ 9.25 Four $10.75 Five $12.75
All unexercised options will expire on that date which is six years after the date on which such options have vested. EMPLOYMENT AGREEMENT On January 16, 1996, Sunbase Asia and Southwest Products entered into an employment agreement with William R. McKay (the "Agreement") pursuant to which Mr. McKay is employed to serve as President and Chief Executive Officer of Southwest Products and as President and Chief Executive Officer of Sunbase Asia. Under the terms of the Agreement, Mr. McKay will be paid an annual base salary of $285,000. The base salary may be increased or decreased (to a minimum of $225,000), based upon an annual review of Mr. McKay's performance. In addition to the base salary, the Board of Directors of Sunbase Asia may, at its sole discretion, pay Mr. McKay a bonus for any particular year of his employment. On January 16, 1996, in connection with the execution of the Agreement, Sunbase Asia, Southwest Products and Mr. McKay entered into a Confidentiality and Non- Competition Agreement pursuant to which Mr. McKay agrees to keep certain information of Sunbase Asia, Southwest Products and their affiliates confidential, and is prohibited from competing with Sunbase Asia, Southwest Products and their affiliates. 34 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The following table sets forth, as of March 15, 1996, the stock ownership of all persons known to own beneficially five percent (5%) or more of the equity securities of the Company, and all directors and officers of the Company and its affiliates, individually and as a group. Each person has sole voting and investment power over the shares indicated, except as noted.
Equity Ownership Voting Rights ---------------- ------------- Amount of Percent Amount of Name and Beneficial of Beneficial Address Ownership/(1)/ Class/(2)/ Ownership/(1)/ Percent - -------- -------------------- ------------ ---------------- -------- Asean Capital 13,711,000/(3)/ 85.80% 28,111,000/(4)/ 92.53% Gunter Gao 13,711,000/(2) (5)/ 77.22% 25,299,900/(4)/ 83.28% Chairman and Director Linda Yang 13,711,000/(2) (5)/ 77.22% 25,299,900/(4)/ 83.28% Director William McKay/(6)/ - - - - Chief Executive Officer, President and Director Li Yuen Fai (Roger) - - - - Chief Financial Officer, Vice President and Director Dickens Chang - - - - Chief Accounting Officer Billy Kan - - - - Director Ho Cho Hing (Franco) - - - - Director Sunbase International 13,711,000 77.22% 25,299,900 83.28% (Holdings) Limited/(7)/ All directors and officers 13,711,000 85.80% 28,111,000 92.50% of the Company as a Group/(8)/
_________________________ * less than 1 percent (1) As used in this table, "beneficial ownership" means the sole or shared power to vote, or to direct the voting of, a security, or the sole or share investment power with respect to a security (i.e., the power to dispose of, or to direct the disposition of a security). (2) Based on 15,980,063 shares of Common Stock outstanding on a fully-diluted basis calculated as follows: (a) 11,700,063 shares outstanding; (b) 3,600,000 shares issuable upon conversion of the Series A Preferred Stock and (c) 680,000 shares issuable upon conversion of the Series B Preferred Stock. 35 (3) Includes 10,111,000 outstanding shares of Common Stock and 3,600,000 shares of Common Stock issuable upon conversion of the Series A Preferred Stock. (4) Includes 10,111,000 voting rights held by way of Asean Capital's ownership of 10,111,000 shares of Common Stock and 18,000,000 voting rights held by way of Asean Capital's ownership of 36 shares of the Series A Preferred Stock. (5) Includes shares of Sunbase Common Stock and Preferred Stock beneficially owned by Gunter Gao and Linda Yang, husband and wife, by way of the ownership by each of Mr. Gao and Ms. Yang of 50% of the capital stock of Sunbase International, which in turn owns 90% of the capital stock of Asean Capital. Each of Ms. Yang and Mr. Gao disclaims beneficial ownership of the shares held by the other, although their ownership has been aggregated for purposes of this table. (6) Does not include 800,000 shares of Common Stock issuable upon exercise of the stock options granted to Mr. McKay. See "Stock Option Plan." (7) Consists of 10,111,000 outstanding shares of Common Stock and 3,600,000 shares of Common Stock issuable upon conversion of the Series A Preferred Stock owned by Asean Capital, of which Sunbase International owns 90%. (8) Consists of shares beneficially owned by Gunter Gao and Linda Yang. 36 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. As discussed above (See ITEM 1 "BUSINESS ORGANIZATION OF THE COMPANY"), an effective 51.4% in Harbin Bearing was acquired at the end of 1993 by then affiliates of Sunbase International. This was accomplished by the acquisition by China Bearing Holdings Limited ("China Bearing") of China International Bearing (Holdings) Limited ("China International"). China International was incorporated to act as the holding company of two Sino-foreign joint venture companies which in turn were formed to acquire in the aggregate a 51.6% interest in Harbin Bearing. China International has a 99.9% equity interest in one of the joint venture companies and a 99% equity interest in the other, which in turn hold a 41.6% and 10% interest, respectively, in Harbin Bearing (See, "Organizational Chart"). The aggregate cash consideration contributed by the joint venture companies was Rmb 232.1 million which was principally financed by an interest free loan from Sunbase International to China International (the "Sunbase Loan"). China International in turn made equity contributions and loans to the two joint venture companies. In April 1994, New China Hong Kong acquired from Sunbase International 10% of the outstanding stock of China Bearing and 10% of the Sunbase Loan. The Sunbase Loan was later assigned to China Bearing, and China Bearing assumed the Sunbase Loan for a consideration of the same amount payable to it by China International. The obligations under the Sunbase Loan were extinguished by Sunbase International and New China Hong Kong, and the amount thereof was treated as a contribution of cash to China Bearing and credited to its contributed surplus account. Thereafter, the shares of China Bearing owned by Sunbase International and New China Hong Kong were transferred to Asean Capital, in which Sunbase International and New China Hong Kong own 90% and 10%, respectively. As set forth above, in December 1994, Asean Capital transferred all of its interest in China Bearing to the Company. Pursuant to a Management Services Agreement between Sunbase International and China Bearing dated January 1, 1994, Sunbase International agreed to provide China Bearing and its affiliates, including the Company, advice and consultation, including strategic management, business planning and development services, accounting and financial service, human resource service, sales and marketing service and such additional services as may be agreed upon for an annual fee of US $30,000. China Bearing is also obligated to reimburse Sunbase International for its direct out-of-pocket costs incurred in providing the management services. The Agreement's term was two years and it expired on December 31, 1995. Harbin Bearing and Harbin Precision have entered into leases (the "Ancillary Transport Equipment Lease" and the "Manufacturing Machinery Lease"), covering all equipment and assets of the Bearing Factory relating to the bearing operations which were not contributed to the Company in the Restructuring. The Leases cover cars, trucks, machinery and equipment used in manufacturing, office administration and power generation and provide for total annual payments of US $3,267,000. At the expiration of the two Leases in December 31, 1998 and December 31, 2001, respectively, Harbin Bearing has the right to either renew the Leases or acquire the equipment. 37 Harbin Bearing and Harbin Holdings have entered into a lease covering plants and buildings used in Harbin Bearing business which were not contributed to Harbin Bearing in the Restructuring (the "Plant Lease"). The Plant Lease provides for annual rent payments of US $451,000. At the expiration of the lease on December 31, 1998, Harbin Bearing has the right to extend the lease at market rent for another five years. Harbin Holdings and Harbin Bearing have entered into a lease providing for the use of land by Harbin Bearing at US $301,000 per annum. As a result of the Restructuring, Harbin Holdings owns the rights to the trademark "HRB." Pursuant to an exclusive and perpetual trademark license agreement, Harbin Holdings has granted Harbin Bearing the exclusive and perpetual right to use the "HRB" trademark on its products and marketing materials. The royalty on the trademark license agreement is 0.5% of annual sales from 1994 to 2003 and 0.3% from 2004 to 2013. Pursuant to the Restructuring, Harbin Holdings assumed responsibilities of the pension payments of all employees of the Bearing Factory who retired or left the Bearing Factory prior to the Restructuring. Harbin Bearing and Harbin Holdings have entered into an agreement (the "Pension Agreement") relating to pension arrangements after the Restructuring. The Pension Agreement provides that Harbin Bearing may satisfy the statutory requirement to pay an amount equal to 20% of annual wages to the municipal government to fund future pension obligations of its existing employees, by making such payments to Harbin Holdings as representative of the municipal government of Harbin, and Harbin Holdings agrees to be responsible for all pension obligations to employees of Harbin Bearing who retire or leave after the Restructuring. Subsequent to December 31, 1993, Harbin Bearing and Harbin Holdings entered into a management and administrative services agreement. The agreement provides for the payment by Harbin Bearing of an annual fee of Rmb 17,160,000 (approximately US $2,049,000) in connection with services for medical, heating, education and other staff-related benefits provided by Harbin Holdings for a term of three years. The costs of these services were previously fully paid by the Bearing Factory and have now been superseded by the above agreement. The fees are subject to an annual 10% inflation adjustment. Agreements were also entered into by Harbin Bearing with the two joint venture holding companies of Harbin Bearing in respect of general management services to be provided by the joint venture companies from January 1, 1994 to December 31, 1995 at an annual fee of Rmb 150,000 (US $18,000) payable to each of the joint venture companies. 38 PART IV. ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a) The following financial statements and exhibits are filed with and as a part of this Report.
Page No.(s) ----------- (1) Financial Statements. -------------------- Index to Financial Statements 46 Report of Independent Auditors 47 Consolidated Balance Sheets as of December 31, 1994 and December 31, 1995 48 Consolidated Statements of Income for the years ending December 31, 1994 and December 31, 1995 50 Consolidated Statements of Cash Flows for the years ending December 31, 1994 and December 31, 1995 51 Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1994 and December 31, 1995 53 Notes to Consolidated Financial Statements 54 (2) Exhibits
Exhibit No. Description of Document Page No.(s) ----------- ----------------------- ----------- (a) Exhibits. The following exhibits of the Company are included herein. (2) Plan of acquisition, reorganization, arrangement, liquidation or succession.
39 2.1 Share Exchange Agreement, dated December 2, 1994, between the Company, Valley Financial, Inc., Wayne Crumpley and China Bearing Holdings, Ltd. and Asean Capital Limited, a subsidiary of Sunbase Intentional./(1)/ 2.2 Asset Transfer and Assumption Agreement dated December 16, 1994, between the Company and Valley Financial Corporation./(1)/ (3) Certificates of Incorporation and Bylaws 3.1 Nevada Articles of Incorporation./(1)/ 3.2 Articles of Merger./(1)/ 3.3 Amended and Restated Certificate of Designation for Series A Convertible Preferred Stock./(1)/ 3.4 Secured Promissory Note in favor of Asean Capital Limited./(2)/ 3.5 Third Amended and Restated Certificate of 75 Designation for Series B Preferred Stock (10) Material contracts 10.1 Agreement between the Company and New China Hong Kong with respect to the Sale and Purchase of shares of China Bearing, together with the Deed of Novation./(3)/ 10.2 Memorandum and Articles of Association of China International./(3)/ 10.3 Joint Venture Contract between China International and Harbin Hazhou Bearing Distributing Company with respect to Harbin Sunbase./(3)/
40 10.4 Joint Venture Contract between China Intentional and Harbin Bearing Everising Construction and Development Ltd. with respect to Harbin Xinhengli./(3)/ 10.5 Amended Articles of Association of Harbin Sunbase./(3)/ 10.6 Articles of Association of Harbin Xinhengli./(3)/ 10.7 Articles of Association of Harbin Bearing./(3)/ 10.8 Agreement between Harbin Sunbase and Harbin Bearing with respect to the provision of financial management services to Harbin Bearing./(3)/ 10.9 Agreement between Harbin Xinhengli and Harbin Bearing with respect to the provisions of sales and marketing services to Harbin Bearing./(3)/ 10.10 Pension Fund Aggregation Agreement Harbin Bearing and Harbin Holdings with respect to pension payments for existing employees./(3)/ 10.11 Trademark Licensing Agreement between Harbin Bearing and Harbin Holdings with respect to the "HRB" trademark./(3)/ 10.12 Service Agreement between Harbin Holdings and Harbin Bearing./(3)/ 10.13 Land Use Right Lease Agreement between Harbin Holdings and Harbin Bearing./(3)/ 10.14 Power Supply and Manufacturing Equipment Lease Agreement between Harbin Precision and Harbin Bearing./(3)/ 10.15 Plant Buildings Lease Agreement between Harbin Precision and Harbin Bearing./(3)/
41 10.16 Ancillary and Transport Equipment Lease Agreement between Harbin Precision and Harbin Bearing./(3)/ 10.17 Know-How Contract dated December 18, 84 1992 between Southwest Products and Shanghai Hong Xing Bearing Factory. 10.18 Contract for Joint Ventures dated March 21, 124 1994 between Southwest Products and Shanghai Hong Xing Bearing Factory. 10.19 Articles of Association for Joint Venture 158 dated March 21, 1994 relating to the Shanghai Joint Venture. 10.20 Agreement and Plan of Reorganization and 190 Merger dated as of December 29, 1995 among the Company, Southwest Products and the shareholders of Southwest Products. 10.21 Employment Agreement dated as of January 232 16, 1996 between the Company, Southwest Products and William McKay. 10.22 1995 Stock Option Plan. 245
_____________ (1) Filed with the Company's Form 8-K, dated December 22, 1994 and incorporated herein. (2) Filed with the Company's Form 8-K/A, dated December 22, 1994 and incorporated by reference herein. (3) Filed with the Company's Form 10-K dated March 3, 1995 and incorporated by reference herein. 22 The Company's subsidiaries are:
Effective Percentage Name of Subsidiary Ownership Place of Incorporation - --------------------------- ---------- ------------------------- CHINA BEARING 100% Bermuda Holding Company HOLDINGS LIMITED CHINA INTERNATIONAL 100% Hong Kong Holding Company BEARING HOLDINGS LIMITED
42 HARBIN SUNBASE 99% PRC JV Holding Co. DEVELOPMENT COMPANY LIMITED HARBIN XINHENGLI 99.90% PRC JV Holding Co. DEVELOPMENT COMPANY LIMITED HARBIN BEARING 51.4% PRC Joint Stock Company COMPANY, LTD. SOUTHWEST PRODUCTS 100% California Corporation COMPANY SHANGHAI SOUTHWEST 28% PRC Joint Venture BEARING COMPANY COMPANY
______________ (b) No Reports on Form 8-K were filed during or related to the last quarter of 1995. 43 SIGNATURES ---------- In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Sunbase Asia, Inc. Date: May 3, 1996 By: /s/ William McKay ------------------------ William McKay, President Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Date: May 3, 1996 By: /s/ Gunter Gao ------------------------ Gunter Gao, Chairman Date: May 3, 1996 By: /s/ Billy Kan ------------------------ Billy Kan, Director Date: May 3, 1996 By: /s/ William McKay ------------------------ William McKay, Chief Executive Officer, President and Director Date: May 3, 1996 By: /s/ Roger Li ------------------------ (Roger) Li Yuen Fai, Vice President and Chief Financial Officer and Director Date: May 3, 1996 By: /s/ Linda Yang ------------------------ Linda Yang, Director Date: May 3, 1996 By: /s/ Franco Ho Cho Hing ------------------------ (Franco) Ho Cho Hing, Director Date: May 3, 1996 By: /s/ Dickens Chang ------------------------ (Dickens) Change Shing Yam, Chief Accounting Officer 44 Financial Statements SUNBASE ASIA, INC. AND SUBSIDIARIES ERNST & YOUNG HONG KONG INDEX TO FINANCIAL STATEMENTS
Page ---- SUNBASE ASIA, INC. AND SUBSIDIARIES: Report of Independent Auditors F-2 Consolidated Balance Sheets as of December 31, 1994 F-3 - 4 and December 31, 1995 Consolidated Statements of Income F-5 for the years ended December 31, 1994 and December 31, 1995 Consolidated Statements of Cash Flows F-6 - 7 for the years ended December 31, 1994 and December 31, 1995 Consolidated Statements of Changes in Shareholders' F-8 Equity for the years ended December 31, 1994 and December 31, 1995 Notes to Consolidated Financial Statements F-9 - 29
F-1 REPORT OF INDEPENDENT AUDITORS To the Board of Directors and Shareholders Sunbase Asia, Inc. We have audited the accompanying consolidated balance sheets of Sunbase Asia, Inc. and its subsidiaries as of December 31, 1995 and 1994 and the related statements of income, cash flows and changes in shareholders' equity for each of the years in the two-year period ended December 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sunbase Asia, Inc. and its subsidiaries at December 31, 1995 and 1994, and the consolidated results of their operations and cash flows for each of the years in the two-year period ended December 31, 1995, in conformity with accounting principles generally accepted in the United States of America. ERNST & YOUNG Hong Kong April 5, 1996 F-2 SUNBASE ASIA, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1994 AND DECEMBER 31, 1995 (AMOUNTS IN THOUSANDS, EXCEPT NUMBER OF SHARES AND PER SHARE DATA)
NOTES 1994 1995 1995 RMB RMB US$ --------- --------- ------- ASSETS Current assets Cash and bank balances 65,646 30,944 3,719 Accounts receivable, net 5 261,184 264,186 31,753 Notes receivable -- 25,756 3,096 Inventories, net 6 361,455 476,997 57,331 Prepaid VAT -- 40,429 4,859 Other receivables 35,636 57,209 6,876 Due from related companies 23 170,073 137,079 16,476 --------- --------- ------- Total current assets 893,994 1,032,600 124,110 Fixed Assets 7 481,295 554,086 66,597 Deferred asset 8 35,729 18,134 2,180 Long term investments 9 6,999 1,438 173 Goodwill 10 -- 12,144 1,460 --------- --------- ------- Total assets 1,418,017 1,618,402 194,520 ========= ========= ======= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities Short term bank loans 11 227,078 276,813 33,271 Accounts payable 151,853 116,205 13,967 Notes payable 12 -- 15,627 1,878 Accrued liabilities and other 44,761 90,108 10,831 payables Short term obligations under 13 15,873 17,269 2,075 capital leases Other loans 14 33,810 33,810 4,064 Secured promissory note 1,15 -- 41,600 5,000 Income tax payable 4 9,342 5,874 706 Taxes other than income 20,970 -- -- Due to related companies 130,635 111,654 13,420 Due to shareholders 11,682 17,352 2,086 --------- --------- ------- Total current liabilities 646,004 726,312 87,298 Long term bank loans 16 68,424 110,670 13,302 Long term obligations 13 124,982 107,713 12,946 under capital leases Secured promissory note 1,15 42,250 -- -- Minority interests 288,175 343,142 41,243 --------- --------- ------- 1,169,835 1,287,837 154,789 Obligations and commitments 13 -- -- --
Continued on next page The accompanying notes form an integral part of these consolidated financial statements F-3 SUNBASE ASIA, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1994 AND DECEMBER 31, 1995 (continued) (AMOUNTS IN THOUSANDS, EXCEPT NUMBER OF SHARES AND PER SHARE DATA)
NOTES 1994 1995 1995 RMB RMB US$ --------- --------- ------- Shareholders' equity: Common Stock, par value US$0.001 each, 19 99 99 12 50,000,000 shares authorized; 11,700,063 issued, and fully paid up Preferred Stock, par value US$0.001 each, 25,000,000 shares authorized, Convertible Preferred Stock - Series A; 36 shares issued and outstanding 1, 19 44,533 44,533 5,352 Convertible Preferred Stock - Series B; 6,800 shares issued and outstanding (1994: Nil issued) 1 - 28,288 3,400 Contributed surplus 19 151,942 151,942 18,262 Reserves 20 13,011 25,266 3,037 Retained earnings 38,597 80,437 9,668 --------- --------- ------- Total shareholders' equity 248,182 330,565 39,731 --------- --------- ------- Total liabilities and shareholders' 1,418,017 1,618,402 194,520 equity ========= ========= =======
The accompanying notes form an integral part of these consolidated financial statements F-4 SUNBASE ASIA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1994 AND DECEMBER 31, 1995 (AMOUNTS IN THOUSANDS, EXCEPT NUMBER OF SHARES AND PER SHARE DATA)
NOTES 1994 1995 1995 RMB RMB US$ ----------- ----------- ----------- Net Sales to - third parties 655,848 569,248 68,419 - related parties 23 63,994 103,111 12,393 ---------- ---------- ---------- 719,842 672,359 80,812 Cost of sales (441,854) (381,377) (45,838) ---------- ---------- ---------- Gross profit 277,988 290,982 34,974 Selling, general and administrative expenses - third parties (57,434) (71,820) (8,632) - related parties 23 (37,784) (41,182) (4,950) ---------- ---------- ---------- (95,218) (113,002) (13,582) Interest expense - third parties (30,128) (37,136) (4,463) - related parties 23 (12,593) (11,310) (1,359) ---------- ---------- ---------- (42,721) (48,446) (5,822) Reorganization expenses 21 (7,307) -- -- ---------- ---------- ---------- Income before income taxes 132,742 129,534 15,570 Provision for income taxes: 4 - Current (19,087) (20,472) (2,461) - Deferred (3,600) -- -- ---------- ---------- ---------- (22,687) (20,472) (2,461) ---------- ---------- ---------- Income before minority interests 110,055 109,062 13,109 Minority interests (58,447) (54,967) (6,607) ---------- ---------- ---------- Net income 51,608 54,095 6,502 ========== ========== ========== Earnings per common share 17 3.37 3.54 0.42 ========== ========== ========== Numbers of shares outstanding 17 15,300,063 15,300,063 15,300,063 ========== ========== ==========
The accompanying notes form an integral part of these consolidated financial statements F-5 SUNBASE ASIA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1994 AND DECEMBER 31, 1995 (AMOUNTS IN THOUSANDS)
NOTES 1994 1995 1995 RMB RMB US$ --------- --------- -------- Cash flows from operating activities: Net income 51,608 54,095 6,502 Adjustments to reconcile income to net cash provided by operating activities: Minority interests 58,447 54,967 6,606 Depreciation 44,562 44,447 5,342 Loss on disposal of fixed assets -- 4,829 580 Exchange difference on secured promissory note -- (650) (78) Reorganization expenses 7,307 -- -- Others 1,226 17,595 2,115 (Increase) decrease in assets: Accounts receivable (261,184) (1,312) (157) Inventories (80,457) (107,824) (12,960) Notes receivable -- (25,756) (3,096) Prepaid VAT -- (40,429) (4,859) Other receivables 32,372 (21,086) (2,534) Due from related companies (157,118) 32,994 3,965 Deferred tax asset 3,600 -- -- Increase (decrease) in liabilities: Accounts payable 34,947 (41,836) (5,028) Notes payable -- 4,000 481 Accrued liabilities and other payables 18,361 40,531 4,872 Income tax payable 9,342 (3,468) (417) Taxes other than income 20,970 (20,970) (2,520) Due to related companies 129,031 (34,854) (4,189) Due to shareholders 674 5,670 681 -------- -------- ------- Net cash used in operating activities (86,312) (39,057) (4,694) Cash flows from investing activities: Purchase of a subsidiary 22 -- (731) (88) Disposal of long term investments 263 5,561 668 Proceeds from disposal of fixed assets -- 115 14 Additions to fixed assets (153,213) (92,571) (11,126) -------- -------- ------- Net cash used in investing activities (152,950) (87,626) (10,532)
(Continued on next page) The accompanying notes form an integral part of these consolidated financial statements. F-6 SUNBASE ASIA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1994 AND DECEMBER 31, 1995 (continued) (AMOUNTS IN THOUSANDS)
1994 1995 1995 RMB RMB US$ --- --- --- Cash flows from financing activities: Proceeds from short term bank loans 440,213 518,573 62,328 Repayment of short term bank loans (360,344) (468,838) (56,351) Redemption of debentures (10,000) -- -- Proceeds from long term bank loans 68,424 54,289 6,525 Repayment of long term bank loans -- (12,043) (1,447) -------- -------- ------- Net cash provided by financing activities 138,293 91,981 11,055 -------- -------- ------- Net decrease in cash and cash equivalents (100,969) (34,702) (4,171) Cash and cash equivalents, at beginning of year 166,615 65,646 7,890 -------- -------- ------- Cash and cash equivalents, at end of year 65,646 30,944 3,719 ======== ======== ======= Income taxes paid 10,920 15,953 1,917 Interest paid (net of amount capitalized) 30,856 35,186 4,229 Non-cash transactions: Financing lease arrangements 14,590 15,873 1,908 Purchase of a subsidiary by issue of convertible stock -- 28,288 3,400 ======== ======== =======
The accompanying notes form an integral part of these consolidated financial statements. F-7 SUNBASE ASIA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1994 AND DECEMBER 31, 1995 (AMOUNTS IN THOUSANDS)
Common Preferred Contributed Retained Stock stock Surplus Reserves earnings Series A Series B RMB RMB RMB RMB RMB RMB Balance at December 31, 1993 (note 1) 99 44,533 -- 144,635 -- -- Reorganization expenses (note 21) -- -- -- 7,307 -- -- Net income -- -- -- -- -- 51,608 Appropriation to reserves (note 20) -- -- -- -- 13,011 (13,011) -- ------ ------- ------- ------ ------- Balance at December 31, 1994 99 44,533 -- 151,942 13,011 38,597 New issue (note 1) -- -- 28,288 -- -- -- Net income -- -- -- -- -- 54,095 Appropriation to reserves (note 20) -- -- -- -- 12,255 (12,255) -- ------ ------- ------- ------ ------- Balance at December 31, 1995 99 44,533 28,288 151,942 25,266 80,437 == ====== ====== ======= ====== ======
The accompanying notes form an integral part of these consolidated financial statements. F-8 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, unless otherwise stated and except number of shares and per share data) 1. ORGANIZATION AND PRINCIPAL ACTIVITIES Sunbase Asia, Inc. ("the Company") entered into a share exchange agreement ("Share Exchange Agreement") with Asean Capital Limited ("Asean Capital") on December 2, 1994. Pursuant to the agreement and certain subsequent changes thereto, as agreed between the Company and Asean Capital, and further to a board resolution of the Company on March 31, 1995, the Company issued 10,261,000 common stock shares, 36 shares of Series A convertible preferred stock and a US$5 million secured promissory note to Asean Capital in exchange for the entire issued share capital of China Bearing Holdings Limited ("China Bearing"). The Series A convertible preferred stock is convertible at the option of the holder at a conversion rate of 100,000 common stock shares per Series A share. As preferred shares, they also carry 500,000 votes per share and are entitled to the same dividend as the common stock shareholders on the basis as if the preferred shares had been converted to common stock shares at the conversion rate as noted above. The total number of common stock shares outstanding subsequent to this arrangement was 11,700,063. For the purpose of these financial statements, the Share Exchange Agreement and all subsequent amendments thereto were deemed to be effected as of December 31, 1993. This transaction has been treated as a recapitalization of China Bearing with China Bearing as the acquirer (reverse acquisition). The historical financial statements prior to December 2, 1994 are those of China Bearing. China Bearing is a holding company which was establishing to acquire a 100% interest in China International Bearing (Holdings) Company Limited ("China International"), a company then wholly-owned by Sunbase International (Holdings) Limited ("Sunbase International"), at a nominal consideration of HK$0.002 on March 8, 1994. China International was incorporated in Hong Kong on June 23, 1993 to act as the holding company of Harbin Xinhengli Development Co. Ltd. ("Harbin Xinhengli") and Harbin Sunbase Development Co. Ltd. ("Harbin Sunbase"), Sino-foreign equity joint ventures in the People's Republic of China ("China" or the "PRC") established on September 18, 1993 and January 28, 1993, respectively, and to acquire, in aggregate, a 51.6% interest in Harbin Bearing Company Limited ("Harbin Bearing"). China International has a 99.9% equity interest in Harbin Xinhengli and a 99.0% equity interest in Harbin Sunbase, which hold 41.6% and 10.0%, equity interests in Harbin Bearing. The aggregate cash consideration contributed by Harbin Xinhengli and Harbin Sunbase to Harbin Bearing was RMB 232.1 million for the acquisitions of the 51.6% interest in Harbin Bearing. Harbin Bearing is the successor to the manufacturing operations of Harbin Bearing General Factory (the "Predecessor" or "Bearing Factory"), a Chinese state-owned enterprise established in 1950. In connection with the restructuring of the Predecessor, Harbin Bearing was established on December 28, 1993 as a joint stock limited company under the Trial Measures on Share Companies and the Opinion on the Standardization of Joint Stock Companies promulgated by the State Council of China. F-9 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, unless otherwise stated and except number of shares and per share data) 1. ORGANIZATION AND PRINCIPAL ACTIVITIES (Continued) Pursuant to an agreement between the Predecessor and Harbin Bearing, the ball bearing manufacturing and sales businesses, together with certain assets and liabilities, were transferred to Harbin Bearing. Certain other assets and liabilities relating to the bearing business were transferred to Harbin Precision Machinery Manufacturing Company ("Harbin Precision"), and certain ancillary operations, businesses, facilities used to provide community services to employees of the factory and their families in Harbin were transferred to Harbin Bearing Holdings Company ("Harbin Holdings"). However, certain assets such as accounts receivable and construction in progress and certain liabilities such as the long term bank loan were not transferred to Harbin Bearing. Harbin Bearing will account for all new sales and subsequent collections effective from January 1, 1994 and assist the Predecessor in the collection of its outstanding accounts receivable prior to the reorganization. This service will be provided at no cost. Harbin Holdings is a separately established enterprise controlled by and under the administration of the Harbin Municipal Government and the industrial oversight of the Machine Bureau. Harbin Precision is wholly-owned by Harbin Holdings. Harbin Holdings received 33.3% of the new shares of Harbin Bearing in consideration for the net assets transferred thereto from the Predecessor. Details of the equity capital of Harbin Bearing are as follows:
Contribution to Registered Ownership Capital Percentage RMB' million Harbin Xinhengli and Harbin Sunbase 232.1 51.6% Harbin Holdings (in the form of assets) 150.0 33.3% Current employees of Harbin Bearing and others (in cash) 67.9 15.1% ----- ----- 450.0 100.0% ===== =====
The assets acquired and the liabilities assumed by Harbin Bearing from the Predecessor were revalued on December 31, 1993 at the then respective fair values which included certain fixed assets revalued by the State Administration of Assets Bureau. The book value of the net assets so transferred was RMB 150,000. After giving effect to the principal adjustments in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP") as explained in Note 2 below, the fair value of the net assets transferred to Harbin Bearing from the Predecessor was RMB 173,118. The total fair value of the net assets of Harbin Bearing after taking into account the cash received from the other investors totalled RMB 473,118. China International completed its acquisition of an effective interest of 51.4% interest in Harbin Bearing through Harbin Xinhengli and Harbin Sunbase on December 28, 1993. Harbin Holdings together with F-10 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, unless otherwise stated and except number of shares and per share data) 1. ORGANIZATION AND PRINCIPAL ACTIVITIES (Continued) some individual investors retained 48.4% and the remaining 0.2% which was held by the joint venture partners of Harbin Xinhengli and Harbin Sunbase. The following unaudited pro forma information for the years ended December 31, 1994 and 1993 has been prepared on the basis as if the acquisition of China Bearing and Harbin Bearing had occurred on January 1, 1993. The pro forma results for the year ended December 31, 1994 presented below are prepared after giving effect to the following pro forma adjustments: (a) Interest expense in respect of the US$5 million secured promissory note issued pursuant to the restructuring as detailed above; and (b) reversal of the reorganization expenses which had already been reflected in the pro forma results for the year ended December 31, 1993 on the basis as if the reorganization was completed on January 1, 1993. The pro forma results of operations have been prepared for comparative purposes only and do not purport to indicate the results of operations which would actually have occurred had the acquisitions been in effect on January 1, 1993 or which may occur in the future.
Year ended December 31, 1993 1994 RMB RMB (unaudited) Net sales 687,064 719,842 Net income 41,310 55,563 Earnings per common stock share 2.70 3.63
On December 29, 1995, the Company entered into a reorganization agreement ("Reorganization Agreement") with Southwest Products Company ("Southwest") and the shareholders of Southwest for the acquisition of 100% of the issued common stock of Southwest. Pursuant to the Reorganization Agreement, a wholly-owned subsidiary of the Company was incorporated for the purpose of merging with Southwest pursuant to a separate merger agreement. In connection with the merger, the Company issued an aggregate of 6,800 shares of Series B convertible preferred stock ("Series B stock") to the then shareholders of Southwest or their designates. At the option of the Series B stockholders, the stock may be redeemed at US$500 per Series B share by the Company from the proceeds of the next permanent equity offering, the net proceeds of which will be designated for such redemption. Any shares not so redeemed will automatically be converted into common stock shares at the rate of 100 common stock shares per Series B stock. If the aforesaid public offering or the redemption are F-11 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, unless otherwise stated and except number of shares and per share data) 1. ORGANIZATION AND PRINCIPAL ACTIVITIES (Continued) not effected within two years from date of issue of the Series B stock, the stock will automatically be converted into common stock at the rate of 100 common stock shares per Series B stock. As preferred shares, the shares carry 100 votes per share and are entitled to the same dividend as the common shareholders on the basis as if the preferred shares had been converted to common stock shares at the conversion rate as noted above. This transaction has been treated as a business combination and is accounted for under the purchase method of accounting. However, since the acquisition was consummated on December 31, 1995, the results of Southwest for the year then ended have not been consolidated into the Company but will accrue to the Company from January 1, 1996. Southwest is a manufacturer of spherical bearings and supplies its products to the aerospace, commercial aviation and other industries around the world. Its major customers are in the United States of America. Southwest also has an interest in a Shanghai Joint Venture. As a result of a lack of information available with respect to the financial condition of the Shanghai Joint Venture, management of the Company was unable to determine the fair value of the 28% equity interest in the Shanghai Joint Venture owned by Southwest. Accordingly, the Company did not allocate any portion of the Southwest purchase consideration to the investment in the Shanghai Joint Venture at December 31, 1995. The Company is attempting to obtain additional information, and to the extent that such additional information is obtained during 1996, the Company may subsequently determine to reallocate a portion of the purchase consideration to the investment in the Shanghai Joint Venture, with a commensurate reduction to goodwill. Such reallocation, if it occurs, would not have a material effect on the consolidated results of operations or financial position of the Company. The following unaudited pro forma information for the years ended December 31, 1995 and 1994 are prepared on the basis as if the acquisition of Southwest and China Bearing by the Company had occurred on January 1, 1994. The unaudited pro forma information for the year ended December 31, 1994 is presented after taking into account the effect of the following pro forma adjustments in respect of the acquisition of China Bearing and Southwest by the Company: (a) interest expense in respect of the US$5 million secured promissory note issued pursuant to the restructuring of the Company for the acquisition of China Bearing; (b) reversal of the reorganization expenses incurred for the aforesaid restructuring as if the reorganization were completed on January 1, 1993; and (c) amortization of goodwill and the effect of the increment of fair values on assets arising from acquisition of Southwest. The following pro forma financial information has been prepared for comparative purposes only and do not purport to indicate the results of operations which would actually have occurred had the F-12 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, unless otherwise stated and except number of shares and per share data) 1. ORGANIZATION AND PRINCIPAL ACTIVITIES (Continued) acquisitions and the reorganization been in effect on January 1, 1994 or which may occur in the future.
Year ended December 31, 1994 1995 RMB RMB (unaudited) Net sales 755,234 708,658 Net income 67,463 58,003 Pro forma earnings per common share 4.22 3.63
2. BASIS OF PRESENTATION The Company's first operating subsidiary, Harbin Bearing, was formed on December 28, 1993 and commenced operations on January 1, 1994. Accordingly, no consolidated statements of income and cash flows were prepared for the year ended December 31, 1993. These consolidated financial statements incorporate the results of operations of the Company and its subsidiaries (hereinafter referred to as the "Group") on the basis that the Group with all its present components had been so constituted during the two-year period ended December 31, 1995, except for Southwest, the acquisition of which was completed on December 31, 1995. These financial statements include the fair value of the net assets of Southwest at December 31, 1995. All material intra group transactions and balances have been eliminated on consolidation. The consolidated financial statements were prepared in accordance with U.S. GAAP. This basis of accounting differs from that used in the statutory and management accounts of Harbin Bearing which were prepared in accordance with the accounting principles and the relevant financial regulations applicable to joint stock enterprises as established by the Ministry of Finance of China ("PRC GAAP"). The principal adjustments made to conform the statutory accounts of Harbin Bearing to U.S. GAAP included the following: . Revenue recognition; . Provision for doubtful accounts receivable; . Provision for inventory obsolescence; . Valuation of inventories; . Accounting of assets financed under capital leases as assets of the Company together with the corresponding liabilities; and . Deferred taxation. F-13 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 2. BASIS OF PRESENTATION (Continued) The financial information has been prepared in Renminbi (RMB), the national currency of China. Solely for the convenience of the reader, certain elements of these financial statements have been translated into United States dollars prevailing at the People's Bank of China on December 31, 1995 which was US$1.00 = RMB8.32. No representation is made that the Renminbi amounts could have been, or could be, converted into United States dollars at that rate or any other certain rate on December 31, 1995. 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) Cash and bank balances Cash and bank balances include cash on hand and demand deposits with banks with an original maturity of three months or less. None of the Group's cash is restricted as to withdrawal or use. (b) Inventories Inventories are stated at the lower of cost, on a first-in, first- out basis, or market. Work-in-progress and finished goods include direct materials, direct labor and an attributable proportion of production overheads. (c) Fixed assets and depreciation Property, machinery and equipment are stated at cost less accumulated depreciation. Depreciation of property, machinery and equipment is computed using the straight-line method over the assets' estimated useful lives. The estimated useful lives of property, machinery and equipment are as follows: Buildings 20 years Machinery and equipment 8-10 years Motor vehicles 3 years Furniture, fixtures and office equipment 5 years (d) Construction in progress Construction in progress represents factory buildings, plant and machinery and other fixed assets under construction and is stated at cost. Cost comprises direct costs of construction as well as interest charges on borrowed funds. Capitalization of interest charges ceases when an asset is ready for its intended use. Construction in progress is transferred to fixed assets upon commissioning when it is capable of producing saleable output on a commercial basis, notwithstanding any delays in the issue of the relevant commissioning certificates by the appropriate PRC authorities. No depreciation is provided on construction in progress until the asset is completed and put into productive use. F-14 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) (e) Income taxes The income taxes reflect the accounting standards in Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes". (f) Foreign currency translation Foreign currency transactions are translated into Renminbi at the applicable floating rates of exchange quoted by the People's Bank of China, prevailing at the dates of the transactions. Monetary assets and liabilities denominated in foreign currencies are translated into Renminbi using the applicable exchange rates prevailing at the balance sheet date. The Company's share capital is denominated in United States Dollars and the reporting currency is Renminbi. For financial reporting purposes the United States Dollars share capital amounts have been translated into Renminbi at the applicable rates prevailing on the dates of receipt. (g) Capital leases Leases that transfer substantially all the rewards and risks of ownership of assets to the Group, other than legal title, are accounted for as capital leases. At the inception of a capital lease, the cost of the leased asset is capitalized at the present value of the minimum lease payments and recorded together with the obligation, excluding the interest element, to reflect the purchase and financing. Assets held under capital leases are included in fixed assets and depreciated over the estimated useful lives of the assets. The finance costs of such leases are charged to the profit and loss account so as to provide a constant periodic rate over the lease terms. Leases where substantially all the rewards and risks of ownership of assets remain with the leasing company are accounted for as operating leases. Rentals applicable to such operating leases are charged to the profit and loss account on the straight-line basis over the lease terms. (h) Goodwill Goodwill represents the excess of the consideration paid for the purchase of a subsidiary over the fair value of the net assets of businesses acquired and are being amortized over a 15-year period. The carrying value of goodwill is assessed on an ongoing basis. The measurement of possible impairment is based primarily on the ability to recover the balance of the goodwill from expected future operating cash flows on an undiscounted basis of the entity acquired. If the review indicates goodwill may be impaired, the carrying value of the goodwill is reduced. (i) Use of estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make F-15 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) estimates and assumptions that affect amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. 4. INCOME TAXES Sunbase Asia, Inc. was incorporated in the State of Nevada in the United States of America. The Company is subject to U.S. federal tax on its income. Nevada does not impose any tax on corporations organized under its laws. Southwest was incorporated in the State of California in the United States of America and is subject to U.S. federal tax on its income. China Bearing was incorporated under the laws of Bermuda and, under current Bermudan law, is not subject to tax on income or on capital gains. China Bearing has received an undertaking from the Ministry of Finance of Bermuda pursuant to the provisions of the Exempted Undertakings Tax Protection Act, 1966, as amended, that in the event that Bermuda enacts any legislation imposing tax computed on profits or income, including any dividend or capital gains withholding tax, or computed on any capital asset, gain or appreciation, or any tax in the nature of estate duty or inheritance tax, then the imposition of any such tax shall not be applicable to China Bearing or to any of its operations or the shares, debentures or other obligations of China Bearing, until March 28, 2016. This undertaking is not to be construed so as to (i) prevent the application of any such tax or duty to such persons as are ordinarily resident in Bermuda; or (ii) prevent the application of any tax payable in accordance with the provision of the Land Tax Act, 1967 or otherwise payable in relation to any land leased to China Bearing in Bermuda. China International was incorporated under the Hong Kong Companies Ordinance and under the current Hong Kong tax law, any income arising in and deriving from businesses carried on in Hong Kong will be subject to tax. No tax will be charged on dividends received and capital gains earned. Harbin Xinhengli and Harbin Sunbase are subject to Chinese income taxes at the applicable tax rates of 30% for Sino-foreign equity joint venture enterprises. Dividend income received is exempt from any Chinese income taxes. The applicable tax rate for joint stock limited enterprises in China is 33% which is levied on the taxable income as reported in the statutory accounts adjusted for taxation in accordance with the relevant income tax laws applicable to joint stock limited enterprises. Harbin Bearing, being a joint stock limited company registered in the Special Economic and Technological Development Zone in the Municipal City of Harbin, will normally be subject to a maximum income tax rate of 20%. Pursuant to the same income tax basis applicable to the Special Economic and Technological Development Zone, Harbin Bearing has been designated a high technology production enterprise and is entitled to a special income tax rate of 15%. F-16 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 4. INCOME TAXES (Continued) The Company has undertaken not to require China Bearing to make any distribution of dividends and the directors of Harbin Xinhengli and Harbin Sunbase have decided not to distribute any dividend income related to income earned for the year received from Harbin Bearing outside of China. As a result, deferred income taxes have not been accrued in the financial statements in respect of income distributions. The determination of the amount of the unrecognized deferred tax liability for temporary differences related to such investments in foreign subsidiaries is not practicable. The reconciliation of the effective income tax rates based on income before income taxes stated in the consolidated statement of income to the statutory income tax rate in China applicable to the Company's only operating subsidiary is as follows:
Year ended December 31, 1994 1995 Effect of - Statutory tax rate 15.0% 15.0% Permanent difference 2.0% 0.8% ---- ---- 17.0% 15.8% ==== ====
5. ACCOUNTS RECEIVABLE Accounts receivable comprise:
December 31, 1994 1995 RMB RMB Accounts receivable - trade 272,484 278,113 Less: Allowance for doubtful debts (11,300) (13,927) ------- -------- Accounts receivable, net 261,184 264,186 ======= ======== Movement of allowance for doubtful debts Balance as at January 1, - 11,300 Provided during the year 11,300 2,627 ------- -------- Balance as at December 31, 11,300 13,927 ======= ========
The accounts receivable of the Predecessor were not transferred to Harbin Bearing as part of the reorganization on formation of Harbin Bearing on December 28, 1993. However, Harbin Bearing will account for new sales and subsequent collections effective from January 1, 1994 and assist the Predecessor in the collection of its accounts receivable prior to the reorganization. F-17 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 6. INVENTORIES Inventories comprise:
December 31, 1994 1995 RMB RMB Raw materials 122,684 105,132 Work-in-progress 87,839 104,697 Finished goods 169,948 271,477 -------- -------- 380,471 481,306 Less: Allowance for obsolescence (19,016) (4,309) -------- -------- Inventories, net 361,455 476,997 ======== ======== Movement of allowance for obsolescence Balance as at January 1, 23,857 19,016 Provided during the year - 1,098 Obsolete inventories sold during the year (4,841) (15,805) -------- -------- Balance as at December 31, 19,016 4,309 ======== ========
7. FIXED ASSETS
December 31, 1994 1995 RMB RMB Buildings 71,644 68,725 Machinery and equipment 283,748 402,390 Motor vehicles 16,970 16,712 Furniture, fixtures and office equipment 4,240 5,110 Construction in progress 149,255 141,757 ------- ------- 525,857 634,694 Less: Accumulated depreciation (44,562) (80,608) ------- ------- 481,295 554,086 ======= =======
Total amount of interest capitalized during the year and included in the above fixed assets are RMB 10,411 (1994: RMB 1,334). The Group's buildings are located in PRC and the land on which the Group's buildings are situated is State-owned. F-18 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 7. FIXED ASSETS (Continued) The gross amounts of assets recorded under capital leases and the accumulated depreciation thereon are analyzed as follows:
1994 1995 RMB RMB Machinery and equipment 150,337 150,337 Motor vehicles 4,181 4,181 Furniture, fixtures and office equipment 927 927 -------- -------- 155,445 155,445 Less: Accumulated depreciation (20,371) (40,742) -------- -------- 135,074 114,703 ======== ========
8. DEFERRED ASSET
December 31, 1994 1995 RMB RMB Deferred asset comprises: Deferred valued added tax ("VAT") receivable 38,860 20,482 Less: Present value discount ( 3,131) ( 2,348) -------- -------- 35,729 18,134 ======== ========
This represents the deemed VAT receivable arising from the introduction of the new PRC VAT system on January 1, 1994. This asset was calculated and accounted for in accordance with governmental directions by applying the 14% VAT rate to certain inventory values as at December 31, 1993, with the effect of reducing the value of certain opening inventory of Harbin Bearing as at January 1, 1994 by the same amount. A detailed directive regarding the utilization of the deferred VAT receivable was issued in May 1995 by the Ministry of Finance and the State General Tax Bureau pursuant to which the Group will be permitted to offset the balance of RMB38,860 against its VAT payable within a period of five years starting from January 1, 1995. Accordingly, a discount has been applied using Harbin Bearing's average rate of borrowing over the estimated period of recovery. 9. LONG TERM INVESTMENTS Long term investments are stated at cost and represent investments in treasury bonds issued by the Chinese Government. The investments bear interest ranging from 3% to 8% per annum and are redeemable on maturity or otherwise prior thereto as advised by the government. The long term investments were pledged as one element of the security to the Group's bankers to secure a short term bank loan of RMB 418.4 million which was utilized to the extent of RMB 358 million. Other collateral includes the Group's fixed assets of RMB 137,782 and a third party guarantee from Harbin Holdings. F-19 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 10. GOODWILL The goodwill arises as a result of the acquisition of Southwest on December 31, 1995. Nor amortization was provided during the year as the acquisition was completed on December 31, 1995. 11. SHORT TERM BANK LOANS The short term bank loans bear interest at a weighted average rate of 14% and 11% per annum for the years ended December 31, 1995 and 1994, respectively, and are repayable within one year. 12. NOTES PAYABLE Included in the total amount was an amount of RMB 11,627 which represents a long term note payable to a bank. The Group is in the process of refinancing the note and accordingly the amount has been classified under current liabilities. 13. OBLIGATIONS AND COMMITMENTS (a) Obligations under capital leases Harbin Bearing leases machinery and equipment, furniture, fixtures and office equipment and motor vehicles from Harbin Precision, a company wholly-owned by Harbin Holdings, a separately established enterprise under the supervision and control of the Machine Bureau, which received 33.3% of the new shares of Harbin Bearing. These leases are accounted for as capital leases which have lease terms ranging from five years to eight years. The lease obligations for the machinery and equipment, furniture, fixtures and office equipment and motor vehicles have an implicit annual interest rate at 8.46%. The scheduled future minimum lease payments as of December 31, 1995 were as follows:
December 31, 1995 RMB Year ending December 31, 1996 27,183 1997 27,183 1998 27,183 1999 25,927 2000 25,927 2001 25,927 -------- Total minimum lease payments 159,330 Less: Amount representing interest (34,348) -------- Present value of minimum lease payments 124,982 Less: Current portion (17,269) -------- 107,713 ========
F-20 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 13. OBLIGATIONS AND COMMITMENTS(Continued) The lease rentals incurred during the year amounted to RMB27,183 (1994: RMB27,183), out of which RMB 11,310 (1994: RMB12,593) was the interest portion. (b) Other commitments As of December 31, 1995, the Group had outstanding commitment for capital expenditure of RMB 46,027 (US$5,532) (1994: RMB 91,500 (US$10,919)) and outstanding operating lease commitments expiring in 1998 in respect of buildings of approximately RMB 11,254 (US$ 1,353) (1994: RMB 15,004 (US$1,790)). 14. OTHER LOANS The loans are due to the employees of Harbin Bearing, are unsecured and bear interest at 15% per annum. The loans, together with the accumulated interest, were repaid in full subsequent to December 31, 1995. 15. SECURED PROMISSORY NOTE The secured promissory note (the "Note") was issued to Asean Capital Limited in connection with the Share Exchange Agreement as detailed in Note 1 and is secured by a continuing security interest in and to all of the Company's title and interest in the outstanding capital stock of China Bearing. The carrying value of the net assets of China Bearing represents all the consolidated net assets of the Company before taking into account the carrying value of the Note, the consolidated net assets of Southwest of RMB 16,144 and the goodwill arising on acquisition of Southwest of RMB 12,144. The Note is denominated in United States dollars, is repayable in full in United States dollars on December 31, 1996 and bears interest at 8% per annum. 16. LONG TERM BANK LOANS The long term bank loans are principally loans borrowed to finance the construction in progress. The loans bear interest ranging from 3.7% to 9.25% per annum and are not repayable within one year. 17. NUMBER OF SHARES/EARNINGS PER SHARE As detailed in Note 1 to the financial statements, the Company issued new shares in consideration for the acquisition of its interest in Southwest. The earnings per common stock share for the years ended December 31, 1994 and 1995, which excludes the results of Southwest, is calculated using the common stock and common stock equivalents, after assuming that all convertible preferred stocks except those issued in F-21 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 17. NUMBER OF SHARES/EARNINGS PER SHARE (Continued) connection with the acquisition of Southwest, have been converted into common stock, as if these shares had been outstanding throughout all periods presented. The pro forma earnings per common share for the years ended December 31, 1994 and 1995, which includes the results of Southwest, as stated in Note 1, is calculated by including all the convertible preferred stocks. 18. FOREIGN CURRENCY EXCHANGE The Chinese government imposes control over its foreign currency. Renminbi, the official currency in China, is not freely convertible. Prior to December 31, 1993, all foreign exchange transactions involving Renminbi had to be undertaken either through the Bank of China or other institutions authorized to buy and sell foreign exchange or at a swap center. The exchange rates used for transactions through the Bank of China and other authorized banks were set by the government from time to time whereas the exchange rates available at a swap center were determined largely by supply and demand. On January 1, 1994, the People's Bank of China introduced a managed floating exchange rate system based on the market supply and demand and proposed to establish a unified foreign exchange inter-bank market amongst designated banks. In place of the official rate and the swap centre rate, the People's Bank of China publishes a daily exchange rate for Renminbi based on the previous day's dealings in the inter-bank market. It is expected that swap centres will be phased out in due course. However, the unification of exchange rates does not imply the full convertibility of Renminbi into United States dollars or other foreign currencies. Payment for imported materials and the remittance of earnings outside of China are subject to the availability of foreign currency which is dependent on the foreign currency denominated earnings of the entity or allocated to the Company by the government at official exchange rates or otherwise arranged through a swap center with government approval. Approval for exchange at the exchange centre is granted to enterprises in China for valid reasons such as purchases of imported goods and the remittance of earnings. While conversion of Renminbi into United States dollars or other foreign currencies can generally be effected at the exchange centre, there is no guarantee that it can be effected at all times. 19. CONTRIBUTED SURPLUS As part of the reorganization of Sunbase Asia, Inc. on December 2, 1994 as detailed in Note 1 above, the entire share capital and contributed surplus of China Bearing were acquired by Sunbase Asia, Inc. The consideration for the shares in China Bearing on the basis that the reorganization took place on December 31, 1993 was as follows: F-22 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 19. CONTRIBUTED SURPLUS (Continued)
RMB U.S.$ Common stock, paid up capital 99 12 Convertible preferred stock 44,533 5,314 Promissory note 42,250 5,042 Contributed surplus 144,635 17,260 ------- ------ Net asset value of China Bearing at December 31, 1993 231,517 27,628 ======= ======
The net assets of China Bearing were allocated first to the legal paid up capital at the par value of US$0.001 per share of 11,700,063 shares. The amount of net assets allocated to the convertible preferred stock was based on the total equivalent common shares attributable to the preferred stock. The remaining net assets were allocated to the contributed surplus. As more fully explained in note 21, reorganization expenses of RMB 7,307 were credited to contributed surplus pursuant to the Share Exchange Agreement in 1994. 20. DISTRIBUTIONS OF PROFIT AND APPROPRIATIONS TO RESERVES According to the relevant laws and regulations for joint stock limited enterprises and Harbin Bearing's articles of association, the distribution of profit by Harbin Bearing is based on the profits as reported in the statutory accounts after the following allocations and appropriations: (a) making up any accumulated losses; (b) transferring 10% of its profit after taxation, measured under PRC accounting standards, to the statutory surplus reserve; (c) transferring 5% to 10% of its profit after taxation, measured under PRC accounting standards, to a collective welfare fund; and (d) transferring a certain amount of its profit after taxation measured under PRC accounting standards to a discretionary surplus reserve. The following appropriations were made and are further described below:
Year ended December 31, 1994 1995 RMB RMB Statutory surplus reserve 8,674 8,170 Collective welfare fund 4,337 4,085 ------ ------ 13,011 12,255 ====== ======
F-23 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 20. DISTRIBUTIONS OF PROFIT AND APPROPRIATIONS TO RESERVES (Continued) The collective welfare fund must be used for capital expenditure on staff welfare facilities and cannot be used to finance staff welfare expenses. Such facilities for staff were and are owned by Harbin Bearing. The distributable retained earnings of the Group as of December 31, 1995, after taking into account of the above restrictions and appropriations and based on the PRC statutory accounts of Harbin Bearing, amounted to RMB 73,591. 21. REORGANIZATION EXPENSES The amount represents expenses related to the cost of the minority- owned 1,439,063 common stock (the "Shares") valued at the pro-rated net asset value of the Company on December 2, 1994, which approximated the fair value, pursuant to the Share Exchange Agreement detailed in Note 1, after accounting for relevant discounts relating to minority interest and the trading restrictions of the Shares. The value assigned to these shares is considered a cost of the restructuring of the Company and is charged to income and credited to contributed surplus. The proforma earnings per common stock for the year ended December 31, 1994 after excluding such non- recurring reorganization expenses is RMB 3.85. 22. NOTE TO THE CONSOLIDATED STATEMENTS OF CASH FLOWS Purchase of a subsidiary
December 31, 1995 RMB Net assets acquired: Cash and bank balance 18 Accounts receivable 1,690 Inventories 7,718 Other receivables 487 Fixed assets 29,611 Accounts payable ( 6,188) Notes payable ( 11,627) Accrued liabilities ( 4,816) -------- 16,893 Goodwill 12,144 -------- 29,037 ======== Satisfied by: Shares issued 28,288 Current account 749 -------- 29,037 ========
F-24 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 23. RELATED PARTY TRANSACTIONS AND ARRANGEMENTS During the year, the Group had transactions with several related parties. The major related party transactions are summarized as follows and described in further detail below:
Year ended December 31, Nature of transactions Notes 1994 1995 RMB RMB Revenue: Sales of products (a) 63,994 103,111 Leases of equipment Capital payments (b) 14,590 15,873 Expenses: Leases of equipment Finance charges (b) 12,593 11,310 Leases of buildings (c) 3,751 3,751 Land use rights (d) 2,508 2,508 Management and administrative services (e) 17,416 19,126 Trademark royalty fees (f) 3,599 3,362 Pension and retirement plan expenses (g) 16,769 18,394
(a) Significant sales to related companies Harbin Bearing made sales of RMB 42,855 (1994: RMB 46,578) and RMB 40,257 (1994: RMB 7,832) to Harbin Bearing Import & Export Company ("HBIE") and Xin Dadi Mechanical and Electrical Equipment Company ("Xin Dadi"), related companies owned by the Harbin Municipal Government, respectively, during the current year. As at December 31, 1995, the amounts of trade receivables from HBIE and Xin Dadi included under due from related companies were RMB 65,520 (1994: RMB 54,496) and RMB Nil (1994: RMB 9,164), respectively. An amount due to Xin Dadi is included in due to related companies as at December 31, 1995 at RMB 105,171, representing advance payment received in respect of future sales. (b) Leases of equipment Harbin Bearing has entered into an eight year lease agreement with Harbin Precision to lease machinery and equipment and a five year lease agreement with Harbin Precision to lease motor vehicles, furniture, fixtures and equipment related to the business at an initial annual rental of RMB 25,927 (US$3,116) and RMB 1,256 (US$151), respectively, from January 1, 1994 to December 31, 2001 and from January 1, 1994 to December 31, 1998, respectively. F-25 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 23. RELATED PARTY TRANSACTIONS AND ARRANGEMENTS (Continued) (c) Leases of Buildings Options to extend the leases and to purchase the leased assets have been granted to Harbin Bearing upon expiring of the initial leases. All these leases are treated as capital leases. Harbin Bearing has entered into a five year lease agreement with Harbin Precision to lease buildings related to the operation of Harbin Bearing with effect from January 1, 1994 at an initial annual rental of RMB 3,751 (US$451). The initial lease will expire on December 31, 1998 and Harbin Bearing has been granted an option to extend the lease at market rent for another five years. This lease is treated as an operating lease. (d) Land use rights The municipal government has allocated to Harbin Holdings the right to use the parcels of land on which Harbin Bearing's operations are conducted. Harbin Holdings has agreed to lease the land on which the main factory is situated to Harbin Bearing in return for an initial annual rental of RMB 2,508 (US$301) effective from January 1, 1994 subject to future adjustments in accordance with changes in government fees. (e) Management and administrative services agreements In 1994, Harbin Bearing and Harbin Holdings entered into a management and administrative services agreement. The agreement provides for the payment by Harbin Bearing of an annual fee of RMB 18,876 (US$2,269) (1994: RMB 17,160) in connection with services for medical, heating, education and other staff-related benefits provided by Harbin Holdings for a term of three years. The fees are subject to an annual 10% inflation adjustment. The costs of these services were previously fully paid by the Predecessor and have now been superseded by the above agreement. Agreements were also entered into by Harbin Bearing with Harbin Xinhengli and Harbin Sunbase, respectively, in respect of general management services to be provided by the joint ventures from January 1, 1994 to December 31, 1995 at an annual fee of RMB 150 (US$18) payable to each of the joint ventures. An agreement was entered into between China Bearing and Sunbase International, a majority shareholder of the Company, in respect of general management and administrative services at an annual fee of RMB 250 (US$30). In addition, China Bearing is to reimburse Sunbase International for administrative services rendered on behalf of China Bearing at cost. No additional administrative services were rendered by Sunbase International in the current year. (f) Trademark license Pursuant to a trademark license agreement, Harbin Holdings has granted Harbin Bearing the right to use the "HRB" trademark. Harbin Bearing is required to pay a royalty cost calculated on F-26 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 23. RELATED PARTY TRANSACTIONS AND ARRANGEMENTS (Continued) (f) Trademark license (Continued) an annual basis at 0.5% of the net sales of Harbin Bearing effective from January 1, 1994 to December 31, 2003 and at 0.3% of the net sales from January 1, 2004 to December 31, 2013. The trademark license can be transferred to Harbin Bearing thereafter upon mutual agreement between the two parties subject to the relevant laws in China. The trademark royalty paid by Harbin Bearing during the current year amounted to RMB 3,362 (1994: RMB 3,599). (g) Pension and retirement plan Pursuant to an agreement on December 31, 1993, Harbin Bearing will make an annual payment to Harbin Holdings as its contribution to the pension scheme for all staff retiring after December 28, 1993. Such annual payment should be made based on the standard contribution as required by government regulations calculated at 20% of salary. Harbin Holdings is then responsible for the entire pension payment to staff who have retired after December 28, 1993. Harbin Holdings has undertaken to bear all pension payments to staff who have retired before December 28, 1993. This agreement will only be effective on the condition that no compulsory rules and regulations are implemented in the future such that Harbin Bearing has to be directly responsible for any pension payments. The contribution to the pension scheme made by Harbin Bearing in the current year amounted to RMB 18,394 (1994: RMB 16,769). Management expects that the arrangements detailed in (b), (c) and (d) above will be renewed after the initial contract term. As described further in Note 1, the Company, in consideration for the purchase of its interest in China Bearing, exchanged common stock shares, preferred shares and assumed vendor financing from Asean Capital Limited. The vendor financing provided from Asean Capital is in the form of US$5,000 secured promissory note secured on the shares of China Bearing (see Note 15). A significant portion of the business undertaken by Harbin Bearing during the year has been effected with State-owned enterprises in China and on such terms as determined by the relevant Chinese authorities. 24. FINANCIAL INSTRUMENTS The carrying amount of the Company's cash and bank balances approximates their fair value because of the short maturity of those instruments. The carrying amounts of the Company's borrowings approximate their fair value based on the borrowing rates currently available for borrowings with similar terms and average maturities. F-27 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 25. SEGMENT DATA The Company operates mainly in the ball bearing industry in China, consequently, no segment reporting disclosures are required. 26. CONCENTRATION OF RISK Concentration of credit risk: Financial instruments that potentially subject the Group to a significant concentration of credit risk consist principally of cash deposits, trade receivables and amounts due from related companies. (a) Cash deposits The Group places its cash deposits with various PRC State-owned financial institutions. (b) Trade receivables The Company manufactures and sells general and precision ball bearings in diversified industries in China. The Company has long standing relationships with most of its customers and generally does not require collateral. There is no concentration of receivables in any one specific industry except for the outstanding receivable balance with a distributor, HBIE, which has a receivable balance of RMB 65,520 as at December 31, 1995. Current vulnerability due to certain concentrations: The Group's operating assets and primary source of income and cash flow is its interest in its subsidiary in the PRC. The value of the Group's interest in this subsidiary may be adversely affected by significant political, economic and social uncertainties in the PRC. Although the PRC government has been pursuing economic reform policies for the past 17 years, no assurance can be given that the PRC government will continue to pursue such policies or that such policies may not be significantly altered, especially in the event of a change in leadership, social or political disruption or unforeseen circumstances affecting the PRC's political, economic and social life. There is also no guarantee that the PRC government's pursuit of economic reforms will be consistent or effective. 27. SUBSEQUENT EVENT On January 2, 1996, the Company's board of directors adopted a stock option plan (the "Plan"). The Plan permits the directors to grant options to purchase an aggregate of up to 2,500,000 shares of the common stock of the Company. All incentive stock options will have option exercise prices per option share not less than the fair market value of a share of the common stock on the date the option is granted, except that in the case of incentive stock options granted to any person possessing more than 10% of the total combined voting power of all classes of stock of the Company or any F-28 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 27. SUBSEQUENT EVENT (Continued) affiliate of the Company, the price shall not be less than 110% of such fair market value. The Plan terminates on the earlier of the date on which no additional shares of common stock are available for issuance under the Plan or January 2, 2006. F-29 EX-3.5 2 THIRD AMENDED AND RESTATED CERT. OF DESIGNATION EXHIBIT 3.5 THIRD AMENDED AND RESTATED CERTIFICATE OF DESIGNATION ----------------------------------------------------- WHEREAS, the Board of Directors of this Corporation has previously authorized the issuance of Series B Preferred Stock and has filed a Certificate of Designation relating thereto with the Secretary of State of Nevada on December 14, 1994, which Certificate of Designation this Corporation has, by filing appropriate certificates, amended and restated on December 16, 1994 and on December 30, 1994, and corrected on January 3, 1995; WHEREAS, no shares of such Series B Preferred Stock have been issued; WHEREAS, the Board of Directors of this Corporation has filed a Certificate of Designation with the Secretary of State of Nevada on January 3, 1996 intending such Certificate to supersede, amend and restate all Certificates filed by this Corporation with respect to the Series B Preferred Stock. However, the Certificate filed on January 3, 1996 did not set forth such intentions; WHEREAS, the Board of Directors of this Corporation hereby determines that it is in the best interests of this Corporation that this Third Amended and Restated Certificate of Designation completely supersede, amend and restate all of the aforementioned Certificates with respect to the Series B Preferred Stock as follows: WHEREAS, the Articles of Incorporation of this Corporation, as amended, authorize this Corporation to issue 50,000,000 shares of preferred stock, par value $.001 per share; WHEREAS, the Articles of Incorporation of this Corporation, as amended, authorize the Board of Directors of this Corporation to determine the designations, powers, preferences, rights and limitations of such preferred stock, including the rights, if any, of the holders thereof with respect to voting, dividends, redemption, liquidation and conversion; WHEREAS, the Board of Directors of this Corporation has previously authorized the issuance of Series A Preferred Stock of this Corporation; WHEREAS, the Board of Directors hereby determines that it is in the best interests of this Corporation to designate 6,800 shares of Series B Preferred Stock upon the following terms and conditions: NOW, THEREFORE, BE IT RESOLVED, that the Board of Directors hereby fixes and determines the designation of, the number of shares constituting, and the powers, preferences, rights and limitations relating to, said Series B Preferred Stock, as follows: 1. Designation and Number of Shares. The designation of such series -------------------------------- of Preferred Stock is Series B Preferred Stock and the number of shares of such series is 6,800. 2. Dividend Rights. Each of the shares of the Series B Preferred --------------- Stock, on an "as-converted" and pro-rata basis, shall participate with the shares of the Common Stock of this Corporation in any dividends paid by this Corporation thereon. 3. Rights of Liquidation. Upon any voluntary or involuntary --------------------- liquidation, dissolution or winding up of the Corporation, the holders of Series B Preferred Stock shall 2 be entitled, before any distribution of assets shall be made to the holders of Common Stock or any other shares of the Corporation ranking junior to Series B Preferred Stock, to receive an amount equal to $500 per share of Series B Preferred Stock so held. After the full preferential liquidation amount has been paid to, or determined or set apart for, the holders of Series B Preferred Stock, the remaining assets shall be paid to the holders of all classes of Common Stock and other shares of the Corporation ranking junior to Series B Preferred Stock. In the event the assets of the Corporation, after being valued at the highest value permitted by law, are insufficient to pay the full preferential liquidation amount required to be paid to the holders of Series B Preferred Stock, the entire remaining assets shall be paid to the holders of Series B Preferred Stock on a pro-rate basis, and the holders of Common Stock and any other shares of the Corporation ranking junior to Series B Preferred Stock shall receive nothing. Neither the merger, consolidation or reorganization of the Corporation nor the sale, lease or conveyance of all or substantially all of the Corporation's assets shall be deemed a liquidation, dissolution or winding up of the Corporation within the meaning of this section. However, the Company shall notify the holders of the Series B Preferred Stock as to any such merger, consolidation or reorganization. 4. Rights Upon Reorganizations, Mergers; Consolidations or Sale of --------------------------------------------------------------- Assets. If at any time there shall be a capital reorganization of the - ------ Corporation's Common Stock (other than a stock dividend, combination or split provided for herein) or merger of the Corporation into another corporation, or the sale of the Corporation's properties and assets as, or substantially as, an entirety to any other person or entity, then, as part of such reorganization, merger or sale, lawful provision shall be made so that the holders of the Series B Preferred Stock shall thereafter be entitled to receive upon conversion of the Series B Preferred Stock, the number of shares of stock or other securities or property of the Corporation, or of the successor corporation resulting from such merger, to which the holders of the Common Stock deliverable upon conversion of the Series B Preferred Stock would have been entitled on such capital reorganization, merger or sale if the Series B Preferred Stock had been converted immediately before that capital reorganization, merger or sale to the end that the provisions of this Section 4 (including adjustment of the "Conversion Rate", defined below, then in effect and number of shares purchasable upon conversion of the Series B Preferred Stock) shall be applicable after that event as nearly equivalently as may be practicable. 3 5. Voting Rights. ------------- (a) Holders of Series B Preferred Stock will to the extent permitted by law be entitled to vote on matters submitted to a vote of shareholders of the Corporation as if the Series B Preferred Stock were converted into shares of Common Stock pursuant to the other provisions hereof on the record date for determining who is so entitled to receive notice of and vote upon any such matter, or, if no record was taken, the date as of which holders of Common Stock entitled to vote was determined. Notwithstanding the foregoing, each share of Series B Preferred Stock will be deemed convertible into 100 shares of Common Stock solely for purposes of determining voting rights until such share has been converted as provided below. (b) So long as any of the shares of Series B Preferred Stock are outstanding, the Corporation will not, without the affirmative vote or consent of the holders of at least fifty percent (50%) of the shares of Series B Preferred Stock (the holders of such shares voting or consenting separately as a class) at the time outstanding, given in person or by proxy, either in writing or by a resolution adopted at a meeting called for the purpose of amending, altering or repealing any of the provisions of the Corporation's Articles of Incorporation, By-laws or the resolution providing for the issuance of such shares, pass any stockholder resolution, including such action effected by merger or similar transaction in which the Corporation is the surviving corporation, if such amendment or resolution would affect adversely the preferences, special rights or powers of the shares of Series B Preferred Stock. 6. Redemption Rights. ----------------- (a) At the individual option of each holder of shares of Series B Preferred Stock, the Corporation shall redeem the number of shares of Series B Preferred Stock held by such holder that is specified in a request for redemption delivered to the Corporation by the holder on or prior to fifteen (15) days from the date that the Corporation notifies such holder of its intent to file a registration statement (the "Optional Registration Statement") with the Securities and Exchange Commission (the "Commission") for a public offering by the Corporation of the Common Stock of the Corporation with respect to which the applicable 4 registration statement designates that all or a portion of the proceeds thereof will be used to redeem the Series B Preferred Stock. The Corporation shall redeem such shares out of the proceeds of such public offering by paying in cash therefor $500 per share (as adjusted for any stock dividends, combinations or splits with respect to such shares) less the holder's pro rata share of the underwriter's commission for the sale in the public offering of that number of shares of Common Stock necessary to redeem the Series B Preferred Stock. (b) Application of Funds; Payment. If, on that date that is ----------------------------- twenty-one (21) business days after the date of closing of any public offering of the Corporation the net proceeds of which are designated to be used to redeem the Series B Preferred Stock (the "Redemption Date"), the funds necessary for such redemption shall have been irrevocably set aside by the Corporation, separate and apart from its other funds, for the pro rata benefit of the holders of the shares of Series B Preferred Stock so called for redemption, then notwithstanding that any certificate for the shares of Series B Preferred Stock so called for redemption shall not have been surrendered for cancellation by the Redemption Date, the shares represented thereby shall no longer be deemed outstanding, the right to receive any dividends thereon shall cease to accumulate from the Redemption Date, and all rights of the holders of the shares so called for redemption shall forthwith, after the Redemption Date, cease and terminate, excepting only the right of the holder thereof to receive the redemption price therefor, but without interest, upon surrender of the certificate or certificates evidencing such shares as provided in the notice of redemption. Any funds so set aside by the Corporation and unclaimed at the end of two (2) years from the Redemption Date shall revert to the general funds of the Corporation, after which reversion, the holders of such shares of Series B Preferred Stock so called for redemption shall look solely to the Corporation for payment of the redemption price. Any interest accrued on funds so deposited shall be paid to the party entitled to such funds. Notwithstanding the foregoing, if such funds become available or are paid to a public official pursuant to any abandoned property, escheat or similar law, the Corporation shall have no further obligation with respect to such funds or payment of the redemption proceeds to any former holder of such shares. 7. Conversion. The shares of Series B Preferred Stock shall be ---------- convertible into the Common Stock of the 5 Corporation, on and subject to the following terms and conditions: (a) The conversion rights set forth herein shall apply only as follows: (i) To the extent that a holder does not elect to redeem the shares of Series B Preferred Stock as provided in Section 6 above, the remaining Series B Preferred Stock shall be automatically converted, on the same date that the redemption price is paid to the redeeming holders, into one hundred (100) shares of Common Stock (as adjusted for any stock dividends, combinations or splits); (ii) If, by that date which is two (2) years after the date on which the shares of the Series B Preferred Stock are distributed to the holders (the "Two Year Date"), such holders have not been able to redeem their shares because Purchaser has not made a public offering, the net proceeds of which are designated to be used to redeem the Sunbase Preferred Shares, the holder's shares shall automatically convert into shares of the Common Stock of Purchaser as follows: On the first business day following the Two Year Date, each share shall automatically be converted into that number of shares of Common Stock of Purchaser that equals $500 divided by the lesser of (a) $5.00 ("Conversion Share Amount") or (b) the average closing price of the Common Stock of the Purchaser (subject to adjustment for stock dividends, combinations or splits). As used herein, the average closing price shall be computed by taking the then most recent 60 consecutive trading days where Purchaser's Common Stock has traded at a minimum volume of 2,000 shares per day for 45 of those 60 trading days. (b) In order to convert the shares of Series B Preferred Stock into shares of Common Stock, the holder thereof shall surrender at any office of the Corporation the certificate or certificates therefore, duly endorsed or assigned to the Corporation or in blank. Shares of Series B Preferred Stock shall be deemed to have been converted as provided herein notwithstanding the failure of any holder to surrender such holder's certificates, and the person or persons entitled to receive Common Stock issuable upon the effective date of such conversion 6 shall be treated for all purposes as the record holder or holders of such Common Stock at such time. As promptly as practicable on or after the effective date of conversion, the Corporation shall issue and shall deliver at said office a certificate or certificates for the number of full shares of Common Stock issuable upon such conversion. (c) In case the outstanding shares of Common Stock shall be subdivided or combined into a greater or smaller number of shares of Common Stock, then the rates of conversion set forth in subsections (a)(i) and (a)(ii) above (collectively, the "Conversion Rate") shall be adjusted as follows: (i) with regard to a conversion under subsection (a)(i) above, the number of shares of Common Stock issuable upon conversion of the shares of Series B Preferred Stock shall be proportionately increased in the event the shares of Common Stock are subdivided and proportionately decreased in the event the shares of Common Stock are combined; and (ii) with regard to a conversion under subsection (a)(ii) above, the Conversion Share Amount shall be proportionately decreased in the event the shares of Common Stock are subdivided and proportionately increased in the event the shares of Common Stock are combined. Any adjustment to the Conversion Rate shall become effective immediately after the opening of business on the day following the day upon which such subdivision or combination becomes effective. (d) Whenever the Conversion Rate is adjusted as herein provided: (i) the Corporation shall compute the adjusted Conversion Rate in accordance with these Resolutions and shall prepare a certificate signed by the Treasurer of the Corporation setting forth the adjusted Conversion Rate and showing in reasonable detail the facts upon which such adjustment is based, and such certificate shall forthwith be filed with the transfer agent or agents for the Series B Preferred Stock; and (ii) a notice stating that the Conversion Rate has been adjusted and setting forth the adjusted Conversion Rate shall forthwith be required, and as soon as practicable after it is required, such notice shall be mailed to the holders of record of the outstanding shares of the Series B Preferred Stock. 7 (e) The Corporation shall at all times reserve and keep available, free from preemptive rights, out of its authorized but unissued Common Stock, for the purpose of effecting the conversion of the shares of Series B Preferred Stock, the full number of shares of Common Stock then deliverable upon the conversion of all shares of Series B Preferred Stock then outstanding. (f) The Company will round-up any fractional shares of Common Stock that would otherwise be issued by the Corporation. (g) The Corporation will pay any and all taxes that may be payable in respect of the issue or delivery of shares of Common Stock on conversion of shares of the Series B Preferred Stock pursuant hereto. The Corporation shall not, however, be required to pay any tax which may be payable in respect of any transfer involved in the issue and delivery of shares of Common Stock in a name other than that in which the shares of the Series B Preferred Stock so converted were registered, and no such issue or delivery shall be made unless and until this person requesting such issue has paid to the Corporation the amount of any such tax, or has established, to the satisfaction of the Corporation, that such tax has been paid. (h) For the purpose of this Section 7, the term "Common Stock" shall include any stock of any class of the Corporation which has no preference in respect of dividends or of amounts payable in the event of any voluntary or involuntary liquidation, dissolution or winding up of the Corporation and which is not subject to redemption by the Corporation. However, shares issuable on conversion of shares of the Series B Preferred Stock shall include only shares of the class designated as Common Stock of the Corporation as the date hereof or shares of any class or classes resulting from any reclassification or reclassifications thereof and which have no preference in respect of dividends or of amounts payable in the event of any voluntary or involuntary liquidation, dissolution or winding up of the Corporation and which are not subject to redemption by the Corporation; provided that if at any time there shall be more than one such resulting class, the shares of each such class then so issuable shall be substantially in the proportion which the total number of shares of such class resulting from all such reclassifications bears to the total number of shares of all such classes resulting from all such reclassifications. 8 RESOLVED FURTHER, that the president or the Vice President and the Secretary or Assistant Secretary of the Corporation are each authorized to do or cause to be done all such acts or things and to make, execute and deliver or cause to be made, executed and delivered all such agreements, documents, instruments and certificates in the name and on behalf of the Corporation or otherwise as they deem necessary, desirable or appropriate to execute or carry out the purpose and intent of the foregoing resolutions. Each of the undersigned swears that the foregoing is true and accurate and that he has the authority to sign this document on behalf of the Corporation. IN WITNESS WHEREOF, we have executed this Certificate and duly affirm the foregoing as true under the penalties of perjury as of this ____ day of January, 1996. ______________________________ ______________________________ Roger Li, Vice President John Chong, Secretary 9 EX-10.17 3 KNOW-HOW CONTRACT EXHIBIT 10.17 K N O W - H O W C O N T R A C T FOR SELF-LUBRICATING SPHERICAL BEARINGS AND STEEL-TO-STEEL SPHERICAL BEARINGS CONTRACT NO. 92MMG-129(62)230US BEIJING DECEMBER 18, 1992 -2- CONTENTS PREAMBLE Section 1 DEFINITIONS Section 2 CONTENT AND SCOPE OF THE CONTRACT Section 3 PRICES Section 4 PAYMENT AND PAYMENT CONDITIONS Section 5 DELIVERY OF TECHNICAL DOCUMENTATION Section 6 MODIFICATION AND IMPROVEMENT OF TECHNICAL DOCUMENTATION Section 7 CHECKING AND INSPECTING Section 8 GUARANTEE AND CLAIMS Section 9 INFRINGEMENT Section 10 TAXES Section 11 ARBITRATION Section 12 FORCE MAJEURE Section 13 EFFECTIVENESS, TERMINATION AND MISCELLANEOUS Section 14 LEGAL ADDRESSES -3- ANNEXES Annex 1: TYPES AND SIZES OF CONTRACT PRODUCTS Annex 2: DELIVERY OF TECHNICAL DOCUMENTS Annex 3: TRAINING OF THE TECHNICAL PERSONNEL OF LICENSEE AT LICENSOR'S FACILITY Annex 4: TECHNICAL SERVICES OF EXPERTS SENT BY LICENSOR AT LICENSEE'S FACILITY Annex 5: CHECKING AND ACCEPTING OF THE CONTRACT PRODUCTS Annex 6: RESALE OF THE CONTRACT PRODUCTS Annex 7: SPECIMEN OF THE IRREVOCABLE LETTER OF GUARANTEE ISSUED BY LICENSEE'S BANK Annex 8: SPECIMEN OF THE IRREVOCABLE LETTER OF GUARANTEE ISSUED BY LICENSOR'S BANK -4- PREAMBLE This CONTRACT is signed in Beijing on December 18, 1992 by and between Southwest Products Co. 2240 Buena Vista Irwindale, CA 91706 The United States of America --hereinafter referred to as "LICENSOR"-- as the one party and Shanghai Hong Xing Bearing Factory 937, Zhong Shan (South 1) Road Shanghai 200023 People's Republic of China represented by China National Machinery Import & Export Corp. Er-Li-Gou, Xijiao, Beijing People's Republic of China --hereinafter referred to as "LICENSEE"-- as the one party whereas LICENSOR is disposing of valuable know-how and experience in the design, manufacture, sell, installation and technical service of self-lubricating spherical bearings, and whereas LICENSOR has the right and is willing to grant LICENSEE a license for the use of said know-how and experience, and whereas LICENSEE is desirous to acquire said know-how and experience from LICENSOR and to design, manufacture, sell, and export self-lubricating spherical bearings in accordance with LICENSOR's know-how and experience. the two parties entered into this CONTRACT under the terms and conditions as follows: -5- - ----------------------- 1.1 "KNOW-HOW" as used herein shall mean the technical knowledge and experience being in LICENSOR's possession at the effective date hereof with regard to the design, manufacture, marketing, installation, application and maintenance of the CONTRACT PRODUCTS. 1.2 "CONTRACT PRODUCTS" as used herein shall mean self-lubricating spherical plain bearings as per MIL-B-81820 and steel to steel spherical bearings as per MIL-B-8976 with bore size from 3/16" to 2" which made by LICENSOR's KNOW-HOW of the type as described in Annex 1 hereto. 1.3 "TECHNICAL DOCUMENTATION" as used herein shall mean drawings and other documentation in respect of the CONTRACT PRODUCTS as specified in Annex 2 hereto. TECHNICAL DOCUMENTATION shall be, as available with LICENSOR, in English language and in British system. -6- SECTION 2 - CONTENT AND SCOPE OF THE CONTRACT - --------------------------------------------- 2.1 The content of CONTRACT is the transfer of LICENSOR's KNOW-HOW to LICENSEE with regard to the CONTRACT PRODUCTS by means of TECHNICAL DOCUMENTATION, Training and Technical Services as specified below, i.e., LICENSEE agreed to acquire from LICENSOR and LICENSOR agrees to make available to LICENSEE the KNOW-HOW. The types and technical specification of the CONTRACT PRODUCTS for self-lubricating spherical plain bearings and steel to steel spherical bearings will be set forth in Annex 2 hereto. 2.2 By this CONTRACT LICENSOR grants LICENSEE the exclusive, non-transferrable rights A. to design, manufacture and use the CONTRACT PRODUCTS in the People's Republic of China and B. to sell, supply the CONTRACT PRODUCTS in the People's Republic of China and worldwide with exception of the following countries within the validity period of the CONTRACT, for which LICENSOR is legally bound by agreements with third parties: EUROPE, MIDDLE EAST, NORTH AMERICA, JAPAN, TURKEY, AUSTRALIA, NEW ZEALAND, BRAZIL, ARGENTINA, VENEZUELA 2.3 LICENSOR shall supply to the LICENSEE the TECHNICAL DOCUMENTATION in the scope and at the terms and conditions as set forth in Annex 3 hereto. 2.4 LICENSOR shall train LICENSEE's technical personnel at LICENSOR's facilities in the KNOW-HOW of the CONTRACT PRODUCTS in the scope and at the terms and conditions as set forth in Annex 3 hereto. 2.5 LICENSOR shall send its technical experts to LICENSEE's factory for rendering Technical Services for assisting LICENSEE in the scope and at the terms and conditions as set forth in Annex 4 hereto. 2.6 The checking methods and requirements of the CONTRACT PRODUCTS will be set forth in Annex 5 hereto. -7- 2.7 LICENSOR shall supply to the LICENSEE components, materials and toolings for the manufacture of the CONTRACT PRODUCTS at reasonable prices in the scope at the terms and conditions to be agreed upon between LICENSEE and LICENSOR and to be set forth in separate contracts. 2.8 During the validity period of CONTRACT LICENSEE have the rights to export the CONTRACT PRODUCTS out of China with exception specified in subsection 2.2 and the LICENSOR has marketing rights for CONTRACT PRODUCTS out of China. 2.9 LICENSEE shall treat as strictly confidential and not disclose to any third party any information received orally, in writing or otherwise by LICENSOR under this CONTRACT during the validity period of the CONTRACT. 2.10 Neither party shall transfer this KNOW-HOW to any third party in LICENSEE's country during the currency of the CONTRACT. 2.11 LICENSOR agrees that during the validity period of the CONTRACT LICENSEE may mark the "Manufacture under license of SWPC" in the CONTRACT PRODUCTS which made under LICENSOR's design, technology and standards. 2.12 LICENSOR guarantees that the TECHNICAL DOCUMENTATION supplied by LICENSOR shall be the latest documentation being used by LICENSOR in its then current manufacturing. -8- SECTION 3 - PRICES - ------------------ 3.1 The total KNOW-HOW transfer fee to be paid by the LICENSEE to the LICENSOR pursuant to the content and scope of the CONTRACT as stipulated in section 2 is $900,000 (in words: Nine hundred thousand U.S. dollar). 3.2 The CONTRACT PRICE includes transportation and insurance cost for the TECHNICAL DOCUMENTATION provided by LICENSOR to LICENSEE. -9- SECTION 4 - PAYMENT AND PAYMENT CONDITIONS - ------------------------------------------ 4.1 All payments to be made under contract shall be effected in U.S. currency. The payments made by LICENSEE to LICENSOR shall be effected through the Bank of China, headquarters, Beijing. 4.2 All bank charges incurred inside the People's Republic of China shall be borne by the LICENSEE whereas the bank charges incurred outside the People's Republic of China shall be borne by the LICENSOR. 4.3 The KNOW-HOW transfer fee as per subsection 3.1 hereof shall be paid by LICENSEE to the LICENSOR in the following manner and rates: 4.3.1 Fifteen percent (15%) of the KNOW-HOW transfer fee, i.e., $135,000 (in words: One hundred and thirty-five thousand U.S. dollars) shall be paid by LICENSEE to LICENSOR not later than thirty (30) days from effective date of the contract always provided that the LICENSEE has received from LICENSOR the correct documents as follows: A. One photostat copy of a valid Export Licence issued by the relevant authority or of a letter stating that the said Export Licence is not required. B. Five copies of Commercial Invoice covering 15% (Fifteen percent) of the KNOW-HOW transfer fee. C. One original and one copy of a Sight Draft. D. One original and one copy of an Irrevocable Documentary Letter of Guarantee presented by LICENSOR to LICENSEE (see specimen under Annex 8 hereto). 4.3.1(A) When making the above payment, the Bank of China, headquarters, shall also open an Irrevocable Documentary Letter of Guarantee with one original and one copy in favour of the LICENSOR in the amount of $180,000 (in words: one hundred and eighty thousand U.S. dollars) (see specimen under Annex 7 hereto). -10- 4.3.2 Forty percent (40%) of the KNOW-HOW transfer fee, i.e. $360,000-- (in words: Three hundred and sixty thousand U.S. dollars) shall be paid by the LICENSEE to the LICENSOR within thirty (30) days after delivery of the technical documents as set forth in Annex 2 on presentation of the following documents: A. Five copies of the Commercial Invoice B. One original and one copy of a Sight Draft. C. Two photostat copies of the Airway Bill of Loading for complete Lot No. 1 of the TECHNICAL DOCUMENTATION according to the stipulations of section 2 hereof and one copy of the TECHNICAL DOCUMENTATION has been completely delivered. 4.3.3 Twenty-Five percent (25%) of the KNOW-HOW transfer fee, i.e. $225,000--(in words: Two hundred and twenty-five thousand U.S. dollar)--shall be paid by the LICENSEE to the LICENSOR within thirty (30) days after the Training has been completed by the LICENSOR to the LICENSEE according to the stipulations of Annex 3 on presentation of the following documents: A. Five copies of the Commercial Invoice B. One original and one copy of a Sight Draft. C. One original and one copy of the Certificate issued by the LICENSEE and the LICENSOR to the effect that Training has been completed. Half of the above fee will be paid after Training of the first group of personnel has been completed, balance paid after Training of the second group of personnel has been completed and payable against above mentioned documents. 4.3.4. Fifteen percent (15%) of the KNOW-HOW transfer fee, i.e. $135,000--(in words: One hundred and thirty-five thousand U.S. dollars)--shall be paid by the LICENSEE to the LICENSOR within thirty (30) days after check and acceptance of the CONTRACT PRODUCTS on presentation of the following documents: A. Five copies of the Commercial Invoice B. One original and one copy of a Sight Draft. C. One original and one copy of the Acceptance Certificate issued by U.S. Navy. The LICENSEE shall pay up this part of fee even if the LICENSEE has failed to submit CONTRACT PRODUCTS to the U.S. Navy to attempt to qualify under MIL-B-81820 for one year. (Counting from the date when the machinery has been checked and accepted). -11- 4.3.5 Five percent (5%) of the KNOW-HOW transfer fee, i.e. $45,000--(in words: forty-five thousand U.S. dollar)-- shall be paid by the LICENSEE to the LICENSOR within thirty (30) days after reception of the following documents, due twelve (12) months after the date when checking and accepting the CONTRACT PRODUCTS. A. Five copies of the Commercial Invoice B. One original and one copy of a Sight Draft. The LICENSEE shall pay up this part of fee due eighteen (18) months after the machinery has been checked and accepted even if the LICENSEE has failed to submit CONTRACT PRODUCTS to the U.S. Navy to a attempt to qualify under MIL-B-81820 for one year. (Counting from the day when the machinery had been checked and accepted). 4.4 The LICENSEE has the right to deduct the penalty and/or claims from any above mentioned payment, which LICENSEE is liable to pay according to the stipulations of this CONTRACT. -12- SECTION 5 - DELIVERY OF TECHNICAL DOCUMENTATION - ----------------------------------------------- 5.1 LICENSOR shall according to the delivery schedule and contents stipulated in Annex 2 hereto deliver the TECHNICAL DOCUMENTATION CIF Shanghai Airport. 5.2 The date stamped by Air Transportation Agency at Shanghai Airport shall be taken as the actual date of delivery. Upon receiving each lot of the TECHNICAL DOCUMENTATION, LICENSEE shall inform LICENSOR hereof by Fax immediately. 5.3 Within 48 (forty-eight) hours after despatch of each lot of the TECHNICAL DOCUMENTATION, LICENSOR shall notify LICENSEE by Fax of the CONTRACT number, number and date of Air Bill, item number of the TECHNICAL DOCUMENTATION, number of pieces, weight, flight number and expected date of arrival at destination, and shall airmail to LICENSEE 2 (two) copies of each of the Airway Bill and detailed list of the TECHNICAL DOCUMENTATION dispatched. 5.4 If the TECHNICAL DOCUMENTATION is lost or found to be short or damaged during the air transportation LICENSOR shall supply LICENSEE once again free of charge within 30 (thirty) days after the receipt by LICENSOR from LICENSEE of such written notice stating in detail all the lost or shortcoming or damaged TECHNICAL DOCUMENTATION without any delay. 5.5 The TECHNICAL DOCUMENTATION shall be packed in strong cases suitable for long distance transportation, numerous handlings, rain proof and moisture proof. 5.6 On the surface of each package of the TECHNICAL DOCUMENTATION the following items shall be marked in English: A. CONTRACT number 92 MMG-129(62)230US B. Consignee China National Machinery Import & Export Corp. Shanghai Hong Xing Bearing Factory C. Destination Shanghai D. Shipping Mark 92MMG-129(62)230US ------------------ SHANGHAI, CHINA E. Weight (Kg) F. Case, Piece number G. Consignee Code -13- 5.7 Inside the cases these shall be 2 (two) copies of a detailed packing list of the TECHNICAL DOCUMENTATION describing List of TECHNICAL DOCUMENTATION shipped with names and/or drawing numbers. -14- SECTION 6 - MODIFICATION AND IMPROVEMENT OF THE TECHNICAL DOCUMENTATION - ----------------------------------------------------------------------- 6.1 If the TECHNICAL DOCUMENTATION failed to meet the industry standards (such as Standards of design, material, technology, equipment and other conditions), LICENSOR shall have obligations to assist LICENSEE to amend the TECHNICAL DOCUMENTATION and confirm it in written form, so that LICENSEE can make qualified CONTRACT PRODUCTS. 6.2 Any modification and improvement made by either of the parties with regard to CONTRACT PRODUCTS during the validity period of this contract shall be sent to other party with no charge. 6.3 Inventions made by either of the parties with regard to CONTRACT PRODUCTS during the currency of this contract shall be property of the party whose employees made the respective invention. Such party may apply for respective rights. -15- SECTION 7 - CHECK AND ACCEPTANCE - -------------------------------- 7.1 Agreed upon between two parties, the CONTRACT PRODUCTS made according to the TECHNICAL DOCUMENTATION shall be checked and accepted jointly by both parties as set forth in Annex 5. 7.2 If the performance of the CONTRACT PRODUCTS meets the stipulations as specified in MIL-B-81820 through approval by the U.S. Navy, it will be considered as qualified. 7.3 If the technical features of the tested CONTRACT PRODUCTS fail to meet the requirements of technical specifications defined in Annex 5, both parties shall study and analyze the reasons, take action to eliminate defect in order to start the second feature test and verification. The CONTRACT PRODUCTS have to be approved by U.S. Navy with an issued acceptance Certification. 7.4 If any test failed due to problems with the TECHNICAL DOCUMENTATION and/or items and tools of the CONTRACT PRODUCTS delivered by LICENSOR, LICENSOR should send their technicians for another test and acceptance and all costs according to Annex 5 should be borne by LICENSOR. If the reason for test failure lies with LICENSEE, LICENSEE will bear all costs. 7.5 If the third test fails due to reasons of LICENSOR, it shall be settled according to Subsection 8.7. If the failure lies with LICENSEE, both parties will discuss how to execute the CONTRACT. -16- SECTION 8 - GUARANTEE AND CLAIMS - -------------------------------- 8.1 LICENSOR guarantees that the TECHNICAL DOCUMENTATION provided by LICENSOR shall be the latest documentation being used by LICENSOR in its then current manufacturing and provide any modification and improvement in the TECHNICAL DOCUMENTATION with regard to the CONTRACT PRODUCTS at no charge during the currency of this contract. 8.2 LICENSOR guarantees that the TECHNICAL DOCUMENTATION supplied by LICENSOR shall be completed, correct and legible as stipulated in Annex 2 to the CONTRACT. 8.3 If the TECHNICAL DOCUMENTATION does not meet the stipulations in subsection 8.2 hereof, LICENSOR shall deliver LICENSEE once again free of charge within thirty (30) days after the receipt of the written notice from LICENSEE stating in detail all the missing or incompleted or incorrect TECHNICAL DOCUMENTATION without any delay. 8.4 If LICENSOR fails to deliver the TECHNICAL DOCUMENTATION within the time defined in the CONTRACT, LICENSOR should pay a penalty of 0.5% per week, maximum 5% based on the amount of delayed objective. 8.5 LICENSOR will not be released from their obligations of continuing to deliver the TECHNICAL DOCUMENTATIONS if LICENSOR is fined according to subsection 8.4. 8.6 Warranty and claim concerning tools and material supplied by LICENSOR. LICENSEE shall forthwith inspect each delivery of tools and material supplied by LICENSOR and inform LICENSEE of any shortfall, damage, incompletion of faultiness within 90 days upon arrival at Shanghai, otherwise LICENSOR will be relieved from any claim resulting from any defect of delivered items. 8.7 If the LICENSOR hasn't delivered the TECHNICAL DOCUMENTS more than three (3) months as stipulated in Annex 2, LICENSEE is entitled to handle it according to subsection 8.8. -17- 8.8 If the third test fails due to reasons of LICENSOR, it shall be handled as follows: If the acceptance of tested CONTRACT PRODUCTS can't be reached, so that LICENSEE can't manufacture, and LICENSOR is not able to solve it, LICENSEE is entitled to cancel the CONTRACT. LICENSOR shall return all the payments plus 8% interest per annual to LICENSEE. -18- SECTION 9 - INFRINGEMENT - ------------------------ 9.1 LICENSOR assures that it is the legitimate owner of the KNOW-HOW to be supplied to LICENSEE according to the stipulations of the CONTRACT and that it is lawfully in a position to transfer the KNOW-HOW to LICENSEE. Should the use by LICENSEE of KNOW-HOW licensed according to this CONTRACT infringe any letters patent or other rights of any third party, then the LICENSOR shall be responsible for solving the problems arising with the third party and LICENSOR shall take responsibilities legally and economically. -19- SECTION 10 - TAXES - ------------------ 10.1 All taxes, customs and other duties in connection with the performance of the CONTRACT arising outside LICENSEE's country shall be borne by LICENSOR. 10.2 In the execution of the CONTRACT, any income made by LICENSOR within territory of P.R.C. shall be subject to taxation according to "the Sino-America Double Taxation agreement signed between P.R.C. and U.S.A.". This income tax will amount to 10% (ten percent) of every payment to be made by LICENSOR to LICENSEE. LICENSEE shall deduct this amount from every payment for Income Tax to be paid to the Chinese Taxation Bureau on behalf of LICENSOR. After taxation, LICENSEE shall send LICENSOR by registered airmail and without delay the original receipt issued by the said bureau. -20- SECTION 11 - ARBITRATION - ------------------------ 11.1 The two parties shall use their best endeavors to settle any disputes and/or misunderstandings arising from this CONTRACT in an amicable way. Where such settlement can't be reached the respective dispute and/or misunderstanding shall be submitted to the Arbitration Committee of the China Council for the Promotion of International Trade. 11.2 The decision of the arbitration shall be final and bonding upon both parties. 11.3 The costs of arbitration shall be borne by the losing party. 11.4 In the course of arbitration, the CONTRACT shall be continuously executed except the part which is under arbitration. -21- SECTION 12 - FORCE MAJEURE - -------------------------- 12.1 If either the contracting parties is prevented from the performance of the CONTRACT by natural disasters such as serious typhoon, fire, flood, heavy snow, earthquake, etc., war or by other occurences recognized as force majeure to the international practice agreed upon by both parties, the time for the performance of such contractual obligations of both parties prevented from the performance shall be extended by a period equal to the time lost due to force majeure. 12.2 The party prevented from performing the CONTRACT shall notify the other by cable or telex, within the shortest possible time, of the occurence of force majeure and, within fourteen (14) days, send the other party by registered airmail a certificate issued by the authorities concerned as the confirmation to the other party as soon as the incident of force majeure is eliminated and certify the elimination by registered airmail. 12.3 Neither of the parties shall claim compensation from the other party for its non-fulfillment of the contractual obligations due to the force majeure occurrence. 12.4 In the event that the occurrence of force majeure lasts over 120 (one hundred and twenty) days, both parties shall settle the matter of the performance of the CONTRACT through friendly consultation and reach an agreement as soon as possible. -22- SECTION 13 - EFFECTIVENESS, TERMINATION AND MISCELLANEOUS - --------------------------------------------------------- 13.1 The CONTRACT is signed by the representatives of both parties in Beijing. After signing the CONTRACT both parties shall apply to their respective Authorities for approval. The date of approval last obtained shall be taken as the date of effectiveness of the CONTRACT. Both parties shall exert their best efforts to obtain the approval within sixty (60) days and inform the other party by fax and thereafter confirm the same by letter. 13.2 The CONTRACT shall be valid for five (5) years from the date of effectiveness, and shall become null and void automatically upon the expiry of the validity period of the CONTRACT, unless otherwise agreed upon by both parties to continue term of the CONTRACT. 13.3 The CONTRACT is made out in English in 4 (four) copies, 2 (two) for each party. 13.4 Annexes 1 to 8 to the CONTRACT shall form an integral part of the CONTRACT, having the same effectiveness as the CONTRACT. 13.5 Should any of the contents of the CONTRACT be amended and supplemented, documents in written form shall be signed by the representatives of both parties after a negotiation held by the representatives of both parties and such documents shall form an integral part of the CONTRACT, having the same effectiveness. 13.6 For the execution of the CONTRACT, the correspondence between both parties shall be written in English. All formal notices shall be in written form, 2 (two) copies of each text airmailed as registered matter. 13.7 Any kind of termination of this CONTRACT shall not effect in any way the debts and relevant rights and liabilities between the two parties and the debtor shall be kept liable until he fully pays up his debts to the creditor after the termination of the CONTRACT. -23- 13.8 LICENSOR and LICENSEE agree that any performance by either party to this Agreement is solely dependent upon the parties hereto executing this KNOW-HOW CONTRACT, a Joint Venture Agreement between the parties hereto and an Equipment Purchase Agreement. All contracts must be approved by the parties hereto and all contracts must be approved by the Chinese Government and if not all three contracts are approved, neither party will be obligated to perform. LICENSOR will grant LICENSEE until September 30, 1993 to obtain the approval of the Chinese Government for KNOW-HOW CONTRACT, the Joint Venture Contract and the Equipment Purchase Contract. -24- SECTION 14 - LEGAL ADDRESSES - ---------------------------- LICENSOR: LICENSEE: SOUTHWEST PRODUCTS CO. Shanghai Hong Xing Bearing Factory 2240 Buena Vista 937, Zhong Shan (South 1) Road Irwindale, CA 91706 200023, Shanghai The United States of America People's Republic of China Phone: (818) 358-0181 Phone: (021) 433-6860 Telex: 182562 Telex: 4861 Telefax: (818) 303-6141 Telefax: (021) 431-1702 Signed by Signed by /s/ Signature not decipherable /s/ Signature in Chinese - ------------------------------ ------------------------------- represented by China National Machinery Import & Export Corp. Er-Li-Gou, Xijiao, Beijing People's Republic of China Post Code: 100044 Phone: (01) 849-5010 Telex: 22885 CMIEC CN Telefax: (01) 831-4137 Signed by /s/ Signature in Chinese ------------------------------- -25- Annex 1 Types and sizes of the contract products 1. Title: self-lubricating spherical plain bearings and steel-to-steel spherical plain bearings. 2. Names of the contract products: 2.1 MS14101 Bearings with plan, self-lubricating, self-aligning, low speed, narrow, grooved outer ring, -65 to 325 degrees F Dash No. 3, 4, 5, 5A, 6, 7, 8, 9, 10, 12, 14, 16 Total Types: 12 2.2 MS14103 Bearings with plain, self-lubricating, self-aligning, low speed, wide, grooved other ring, -65 to 325 degrees F Dash No. 3, 4, 5, 6, 7, 7A, 8, 9, 10, 12, 14, 16 Total Types: 12 2.3 MS14102 Bearings with plain, self-lubricating, self-aligning, low speed, wide, chamfered outer ring, -65 to 325 degrees F Dash No. 3, 4, 5, 6, 7, 8, 9, 10, 12, 14, 16 Total types: 11 2.4 MS14104 Bearings with plain, self-lubricating, self-aligning, low speed, narrow, chamfered outer ring, -65 to 325 degrees F Dash No. 3, 4, 5, 6, 7, 8, 9, 10, 12, 14, 16 Total types: 11 2.5 MIL-B-8976 MS-21154S GROOVED TYPE Dash No. 3, 4, 5, 6, 7, 8, 9, 10, 12, 14, 16 Total types: 11 -26- 2.6 MIL-B-8976 MS-21155S PLAIN TYPE Dash No. 3, 4, 5, 6, 7, 8, 9, 10, 12, 14, 16 Total types: 11 -27- Annex 2 Delivery of technology documents Due 45 days following execution of Agreement, Licensor shall provide licensee with at least four copies of the following documents: Item 1: Assembly and component blueprints for products list in Annex 1 attached hereto ("Products"). These blueprints will contain all relevant dimensions, types of material including liner material, types of heat treat, surface finish callouts, and other relevant data. Item 2: Loads, stress analysis, estimated performance, test criteria for the Products. Item 3: Manufacturing operation sheets for each of the Products, which operation sheets shall contain all relevant manufacturing processes necessary to manufacture the Products. Such processes may include rought blanking, face and turn, heat treats, grind, hone, polish and assembly. The manufacturing process shall contain technical processes. Item 4: Formula for liner material, including manufacturing and storage methods. Item 5: Drawings for tools and tooling used in manufacturing process as per item 3. Item 6: Provide the latest edition of America Military Standard: MIL-B-81820, MIL-B-81934, MIL-B-81935, MIL-B-197, MIL-B-8942, MIL-B-8976, MIL-P-116, MIL-I-6868, MIL-I-5606, MIL-H-6875, MIL-H-83282, MIL-L-7808, MIL-A- 8243, MIL-T-5624, MIL-S-5002, MIL-STD-105, MIL-STD-129, MIL-STD-130, MIL-STD-1599, QQ-C-320, QQ-P-416, QQ-P-35, TT-S-735, ANSI B46, C-794, MIL-I-45208, Boeing DI-9000 and comprehensive explanations of MIL-B- 81934, 81820, 81935 and standards with regard to material of the contract products as per item 1. -28- Item 7: Provide testing methods, names of testing tools and testing procedure which are required in component-manufacturing process as per item 3. Item 8: Provide inspection methods, name of instruments or machines and inspection procedure used to inspect the Products. Item 9: Quality control data: A MIL-I-45208 approved quality management manual, Statistical process control data. Item 10: Production control data. Item 11: Accounting system data. -29- Annex 3 Training of the technical personnel of licensee at licensor's facility Item 1: The technical personnel and employees of licensee will be trained in licensor's facility by licensor. Number: 15. Period: 25 working days/person. Training will consist of maintenance, repair and operation of all machinery, inserts, tools and tooling used in all manufacturing process as specified under item 3 of Annex 2. Training will also consist of maintenance and operation of all testing instruments and machines as per Item 6, 7 of Annex 2. Quality control. Item 2: Licensor shall designate qualified trainers to instruct the technical personnel of licensee as per Item 1. Item 3: Licensor shall give trainees comprehensive instruction in their respective positions. These instruction shall include: set up, operation, troubleshooting and regulation of instruments and machines, etc. Item 4: According to general practice of our country, the expenses of personnel sent by both parties shall be borne by sending party itself. -30- Annex 4 Technical services of experts sent by Licensor at Licensee's factory Item 1: Licensee agrees that Licensor send experts to Licensee's factory for technical services and instruction at mutually agreed upon times. The number of experts, period and times and training to be provided will be decided through consultation by two parties. Item 2: Content of technical services: 2.1: Instruction in the production of the Products. 2.2: Instruction in the set up of a proper room for preparation of MIL-B- 81820, 81934, 81935 liners. 2.3: Instruction in the establishment of a MIL-B-45208 quality control system. Assist Licensee in attempting qualify and maintain qualification under MIL-B-81820. 2.4: Instruction in establishing a functioning production control system. 2.5: Instruction in setting up an accounting system according to Licensor's accounting system requirements. Item 3: Period and person-times of technical services: Licensor shall send a bearing manufacturing expert to Licensee's factor for instruction as per Item 2.1, 2.2 for one to three months, which divided into four sections of period: installing and preparing of machinery, trail production, normal lot production and receptive inspection. Licensor shall send respective experts to assist Licensee as per Item 2.3, 2.4, 2.5. Item 4: According to general practice of our country, the expenses of personnel sent by both parties shall be borne by sending party itself. -31- Annex 5 Checking and Accepting of the contract products Item 1: After Licensor had installed and debugged the machinery, when the machinery is in good condition, Licensee will carry out checking and accepting the contract products. These products will be produced according to manufacturing methods provided by Licensor. Item 2: Select two kinds of products (including self-lubricating spherical plain bearing, steel-to-steel spherical bearings) with three different sizes options, which mean small size, middle size and large size. The detail size could be consulted by two parties. Then there are six (6) kinds of bearings. Item 3: The finished bearings will be inspected by inspection and sampling program under MIL-B-81820, 8976. In addition, it is essential to select a set of bearings from six kinds of bearings to carry out metallographical examination, hardness test and surface roughness test. Item 4: The material used in test parts will be provided by Licensor at Licensee's expense. Item 5: The contract products produced by Licensee shall be submitted to U.S. Navy for inspection only after these Products are approved for qualification testing submission by Licensor. If the products inspected prove to be qualified, the qualification fees shall be borne by Licensee. In case the products inspected fail to be qualified, the qualification fees shall be reimbursed to Licensee by Licensor, and Licensor shall pay all future qualification fees to the U.S. Navy until such time as the products are qualified. -32- Annex 6 Resale of the CONTRACT PRODUCTS Item 1: After the CONTRACT PRODUCTS made by LICENSEE has been approved by U.S. Navy, LICENSOR and LICENSEE shall use their best efforts to market the CONTRACT PRODUCTS outside of P.R.C. at a volume of 300,000 pieces per year at a total annual cost of $2,000,000.00. Item 2: The detail types and prices of the CONTRACT PRODUCTS for marketing will be decided by two parties' frank negotiations. Item 3: The CONTRACT PRODUCTS for marketing will be marked "Manufacture under license of SWPC" during the validity period of this CONTRACT. -33- Annex 7 SPECIMEN OF THE IRREVOCABLE LETTER OF GUARANTEE ISSUED BY LICENSEE'S BANK On December 18, 1992 a KNOW-HOW CONTRACT for Self-lubricating Spherical Bearings and Steel-to-Steel Spherical Bearings Number 92MMG-129(62)230US was signed by and between Southwest Products Company, hereafter referred to as LICENSOR and Shanghai Hong Xing Bearing Factory represented by China National Machinery Import & Export Corp., hereafter referred to as LICENSEE. The contract provides several payments by LICENSEE to LICENSOR, one of which is in the amount of $180,000 U.S. and is described in Section 4.3.1(A), 4.3.4 and 4.3.5 of the CONTRACT. We, at the request of LICENSEE, hereby open our irrevocable Letter of Guarantee in LICENSOR's favor in the amount of $180,000.00 and we hereby undertake with LICENSOR as follows: If LICENSEE has failed to pay LICENSOR the sum of $135,000 U.S., written notice of LICENSEE's failure to pay and we shall within five banking days following receipt of LICENSOR's notice pay to LICENSOR the sum of $135,000 with interest at the rate of 8% calculated from the date of LICENSEE's qualification under MIL-B-81820 by the U.S. Navy. If LICENSEE fails to manufacture and check CONTRACT PRODUCTS, as stated in Section 4.3.4, interest shall be calculated six months from the date when the machinery has been checked and accepted under a separate Equipment Purchase Agreement. If LICENSEE has failed to pay LICENSOR the sum of $45,000 pursuant to Section 4.3.5 of the CONTRACT, LICENSOR shall send us written notice of LICENSEE's failure to pay and we shall within five banking days following receipt of LICENSOR's notice, pay to LICENSOR the sum of $45,000 with interest at the rate of 8% calculated from the date of LICENSEE's qualification under MIL-B-81820 by the U.S. Navy. If LICENSEE fails to manufacture and check CONTRACT PRODUCTS as stated in Section 4.3.5, interest shall be calculated six months from the date when the machinery has been checked and accepted under a separate Equipment Purchase Agreement. -34- This Letter of Guarantee is valid for partial exercise. This Letter of Guarantee shall automatically reduce to 5% (Five percent) of total Contract value after 15% (Fifteen percent) of total Contract value specified in Section 4.3.4 is effected. This Letter of Guarantee is to be returned upon the expiration of our Guarantee and obligations thereunder. -35- Annex 8 SPECIMEN OF THE IRREVOCABLE LETTER OF GUARANTEE ISSUED BY LICENSOR'S BANK To: China National Machinery Import & Export Corp. Er-Li-Gou, Xijiao, Beijing People's Republic of China Re: Our Irrevocable Letter of Guarantee No. ___________ With reference to KNOW-HOW transfer CONTRACT No. _________ (hereafter referred to as the Contract) signed on December 18, 1992 between your Corp. and Southwest Products Company: 2240 Buena Vista Irwindale, CA 91706 The United States of America (hereafter referred to as LICENSOR), with Contract value amounting to $900,000 (Nine Hundred Thousand Dollars). We hereby undertake as follows: 1. Our liability under this Letter of Guarantee shall be limited to the advance payment of 15% (fifteen percent) of the Contract value, namely, i.e. $135,000 (One Hundred Thirty-five Thousand Dollars). 2. If LICENSOR has failed to deliver the documents listed in Annex 2 and if LICENSOR has failed to perform after receiving notice under Section 5.4 of the CONTRACT within the 30 (thirty) day period of 5.4, then LICENSEE may send written notice of LICENSOR's failure to fulfill its contractual obligations. Within 5 (five) banking days after receipt of your written notice stating in which way the LICENSOR has failed to fulfill its contractual obligations and demanding refund from LICENSOR due to non-delivery of Technical Documentation under Annex 2 to the Contract, we shall immediately and unconditionally refund to you the above-mentioned 15% (fifteen percent) of the KNOW-HOW transfer fee and pay you the interest at the rate of 8% (eight percent) per year counting from the date of effecting the advance payment to the date of the refunding. -36- 3. This Letter of Guarantee shall become effective as from the date when the advance payment is effected by you and shall remain valid until the 15th day after LICENSOR has delivered the Technical Documentation. 4. This Letter of Guarantee is to be returned upon the expiration of our guarantee and obligations thereunder. [Chinese Characters] CONTRACT AMENDMENT ADVICE ------------------------- [Chinese Characters]: [Chinese Characters]: Contra No.: 92MMG-129(62)23OUS Date: AUG. 24, 1993 ---------------------------------- -------------------------- 92MMG-129(62)23OUS [Chinese Characters]: ------------------------ Shipph Mark: SHANGHAI, CHINA [Chinese Characters]: ---------------------------------- ----------- [Chinese Characters]: Place Destination: SHANGHAI AIRPORT, CHINA [Chinese Characters]: ---------------------------- ----------- [Chinese Characters] This serves to notify that an amendment made on a parts of the contents of the above contract has been agreed upon by both parties; Please amend accordingly.
- ---------------------------------------------------------------------------------------------- Contents Amended ----------------------------------- Item of Name of Reason for Contract Commodity Amendment Before Amendment After Amendment - ---------------------------------------------------------------------------------------------- SECTION 4.3.1 KNOW-HOW ACCORDING TO THE 4.3.1(A) TRANSFER FOR SELLER'S REQUEST 4.3.2 SELF-LUBRICATING 4.3.3 SPHERICAL DETAILS AS PER ATTACHMENT BEARINGS AND SECTION 13.8 STEEL TO STEEL SPHERICAL ANNEX 1 BEARINGS 7 - ---------------------------------------------------------------------------------------------- [Chinese Characters] [Chinese Characters] Buys: China National Machinery Sellers: SOUTHWEST PRODUCTS CO. Import & Export Corporation /s/ Signature in Chinese /s/ James ? Mancill Chairman
ATTACHMENT TO AMENDMENT OF CONTRACT NO. 92MMG-129(62)23OUS ========================================================== THE REVISED TEXT FOR ANNEX 7 BENEFICIARY: SOUTHWEST PRODUCTS COMPANY 2240 BUENA VISTA IRWINDALE, CA 91706 U.S.A. OUR REFERENCE NO: ADVISING BANK: RE: OUR IRREVOCABLE LETTER OF GUARANTEE NO. __________ WITH REFERENCE TO CONTRACT NO. 92MMG-129(62)23OUS (HEREINAFTER REFERRED TO AS THE CONTRACT) SIGNED ON DEC. 18, 1992 BETWEEN YOU (HEREINAFTER REFERRED TO AS THE SELLER) AND CHINA NATIONAL MACHINERY IMPORT AND EXPORT CORP. (HEREINAFTER REFERRED TO AS THE BUYER) CONCERNING KNOW-HOW TRANSFER FOR SELF-LUBRICATING SPHERICAL BEARING AND STEEL TO STEEL SPHERICAL BEARINGS AMOUNTING TO USD900,000.00 (SAY: US DOLLAR NINE HUNDRED THOUSAND ONLY). WE, BANK OF CHINA H.O., AT THE REQUEST OF THE BUYER, HEREBY ISSUE OUR IRREVOCABLE LETTER OF GUARANTEE NO. __________ IN FAVOR OF THE SELLER TO THE EXTENT OF USD180,000.00 (SAY: US DOLLAR ONE HUNDRED EIGHTY THOUSAND ONLY) EQUAL TO 20% (TWENTY PERCENT) OF THE TOTAL CONTRACT PRICE AND GUARANTEE THAT THE PAYMENTS WILL BE MADE BY THE BUYER ACCORDING TO THE TERMS AND CONDITIONS OF THE CONTRACT AND HEREBY UNDERTAKE WITH THE SELLER AS FOLLOWS: IN CASE THE SELLER FULFILLS THE ABOVE MENTIONED CONTRACT OBLIGATIONS AND PROVIDES THE DOCUMENTS ACCORDING TO THE STIPULATIONS OF CLAUSES SECTION 5 OF THE CONTRACT, BUT THE BUYER FAILS TO PAY THE ABOVE MENTIONED AMOUNTS PARTIALLY OR WHOLLY, THEN WE SHALL WITHIN 7 (SEVEN) WORKING DAYS AFTER RECEIPT OF THE SELLER'S WRITTEN NOTICE, PAY TO THE SELLER THE RELEVANT AMOUNTS OF CLAUSES SECTION 4.3.4 AND/OR 4.3.5 UNDER THE CONTRACT, PLUS SIMPLE INTEREST AT THE RATE OF 6% (SIX PERCENT) PER ANNUM, PROVIDED THAT THE BUYER CANNOT PROVE THAT THE DOCUMENTS THE SELLER PRESENTED ARE NOT IN CONFORMITY WITH THE STIPULATIONS OF THE CONTRACT. THE AMOUNT OF THE L/G SHALL BE AUTOMATICALLY DECREASED IN PROPORTION TO THE PAYMENTS MADE BY THE BUYER. THE L/G SHALL COME INTO FORCE UPON ITS ISSUING DATE AND SHALL REMAIN VALID UNTIL THE BUYER HAS MADE THE PAYMENT AS SPECIFIED IN CLAUSE SECTION 4.3.5 BUT NOT LATER THAN ____________________. THE L/G SHOULD BE RETURNED BACK TO OUR BANK WHEN IT BECOMES NULL AND VOID. ALL BANKING CHARGES INCURRED INSIDE OF CHINA WILL BE BORNE BY THE BUYER, AND ALL THE BANKING CHARGES INCURRED OUTSIDE OF CHINA WILL BE BORNE BY THE SELLER. ATTACHMENT TO AMENDMENT OF CONTRACT NO. 92MMG-129(62)23OUS ================================================================================ CONTENTS AMENDED ________________________________________________________________________________ BEFORE AMENDMENT AFTER AMENDMENT 1. SECTION 4.3.1 1. DELETE THE ORIGINAL SECTION 4.3.1/2 SECTION 4.3.2 NEW SECTION 4.3.1: 30 DAYS PRIOR TO THE DATE OF DELIVERY, THE LICENSEE SHALL OPEN AN IRREVOCABLE LETTER OF CREDIT WITH BANK OF CHINA, HEADOFFICE, BEIJING, IN FAVOR OF THE LICENSOR FOR 55% (FIFTY-FIVE PERCENT) OF 1. FIVE ORIGINALS OF COMMERCIAL INVOICE 2. ONE ORIGINAL AND ONE COPY OF A SIGHT DRAFT 3. TWO COPIES OF AIRWAY BILL MARKED "FREIGHT PREPAID" FOR COMPLETE LOT NO. 1 OF THE TECHNICAL DOCUMENTATION ACCORDING TO THE STIPULATIONS OF SECTION 2 HEREOF AND ONE COPY OF THE TECHNICAL DOCUMENTATION HAS BEEN COMPLETELY DELIVERED. AND ONE COPY OF DETAILED LIST OF TECHNICAL DOCUMENTS DISPATCHED 4. COPY OF FAX/TELEX TO THE LICENSEE ADVISING PARTICULARS OF SHIPMENT IMMEDIATELY AFTER SHIPMENT IS MADE 5. INSURANCE POLITY OR CERTIFICATE IN ONE ORIGINAL AND FOUR COPIES COVERING 110% OF INVOICE VALUE AGAINST ALL RISKS. ATTACHMENT TO AMENDMENT OF CONTRACT NO. 92MMG-129(62)23OUS ================================================================================ CONTENTS AMENDED ________________________________________________________________________________ BEFORE AMENDMENT AFTER AMENDMENT 2. SECTION 4.3.3 2. SECTION 4.3.2 3. SECTION 4.3.1(A) 3. SECTION 4.3.3 THE TEXT REVISED AS FOLLOWS: AFTER THE TRAINING HAS BEEN COMPLETED, THE LICENSEE SHALL OPEN AN IRREVOCABLE LETTER OF GUARANTEE THROUGH BANK OF CHINA, HEADOFFICE, BEIJING WITH ONE ORIGINAL AND ONE COPY IN FAVOR OF THE LICENSOR IN THE AMOUNT OF USD180,000.00 (IN WORDS: ONE HUNDRED AND EIGHTY THOUSAND U.S. DOLLARS, THE VALUE OF SECTION 4.3.4 + SECTION 4.3.5) (SEE REVISED SPECIMEN UNDER ANNEX 7 HERETO) 4. SECTION 13.8 4. THE LICENSOR WILL GRANT LICENSEE UNTIL/ BEFORE THE END OF DECEMBER, 1993 TO OBTAIN THE APPROVAL OF THE CHINESE GOVERNMENT FOR KNOW-HOW CONTRACT, THE JOINT VENTURE CONTRACT AND THE EQUIPMENT PURCHASE CONTRACT. 5. ANNEX 1 5. ANNEX 1 2.1-2.6 DASH NO. AND TOTAL TYPES WILL BE INCREASED AS FOLLOWS: 2.1 2.1 INCREASED DASH NO. 18,20,22,24,26,28,30,32 TOTAL TYPES: 12 TOTAL TYPES: 20 2.2 2.2 INCREASED DASH NO. 18,20,22,24,26,28,30,32 TOTAL TYPES: 12 TOTAL TYPES: 20 2.3 2.3 INCREASED DASH NO. 18,20,22,24,26,28,30,32 TOTAL TYPES: 11 TOTAL TYPES: 19 2.4 2.4 INCREASED DASH NO. 18,20,22,24,26,28,30,32 TOTAL TYPES: 11 TOTAL TYPES: 19 EX-10.18 4 CONTRACT FOR JOINT VENTURES CONTRACT FOR JOINT VENTURES USING CHINESE AND FOREIGN INVESTMENT Chapter 1 General Provisions In accordance with "The Law of the People's Republic of China on Joint Ventures Using Chinese and Foreign investment" and other relevant Chinese laws and regulations, Shanghai Hong Xing Bearing Factory and Smith Acquisition Company dba. Southwest Products Company, adhering to the principle of quality and mutual benefit and through friendly consultations, agree to jointly invest to set up a joint venture enterprise in Shanghai the People's Republic of China. The contract is worked out hereunder. Chapter 2 Parties to the Joint Venture Article 1 Parties of this contract are as follows: Shanghai Hong Xing Bearing Factory (hereinafter referred to as Party A), registered with Shanghai in China, and its legal address is at 937, Zhong Shan Nan Yi Road, Lu wan district, Shanghai, China. 1 Legal representative: Name: Hu Xie Juan Position: Director Nationality: China Smith Acquisition Company dba. Southwest Products Company (hereinafter referred to as Party B), a California corporation. Its legal address is at 2240 Buena Vista, Irwindale, CA 91706. Legal representative: Name: William Reed Mckay Position: President Nationality: America Chapter 3 Establishment of the Joint Venture Company Article 2 In accordance with "The Law of the People's Republic of China on Joint Ventures Using Chinese and Foreign Investment" and other relevant Chinese laws and regulations, both parties to the joint venture agree to set up Shanghai Southwest Bearing joint venture limited liability company (hereinafter referred to as the joint venture company). Article 3 The name of the joint venture company is Shanghai 2 Southwest Bearing Company Ltd. The name in foreign language is _____________. The legal address of the joint venture company, is at 937, Zhong Shan Nan Yi Road, Shanghai, China. All activities of the joint venture company shall be governed by the laws, decrees and pertinent rules and regulations of the People's Republic of China. Article 5 The organization form of the joint venture company, is a limited liability company. Each party to the joint venture company is liable to the joint venture company within the limit of _______ capital subscribed by it. The profits, risks and losses of the joint venture company shall be shared by the parties in proportion to their real contributions of the registered capital. 3 Chapter 4 Purpose, Scope and Scale of Production and Business Article 6 The purpose of the parties to the joint venture is in conformity with the enhancing of the economic cooperation and technical exchange, to improve the product quality, develop new products, and gain competitive position in the world market in quality and price by adopting advanced and appropriate technology and scientific management method, so as to raise economic results and ensure satisfactory economic benefits for each investor. Article 7 The productive and business scope of the joint venture company is to design, manufacture and sell spherical bearing products and related modified products. The spherical bearing products will consist of steel to steel and self-lubricating spherical and journal bearings. These bearings are standard, precision, for special uses. Provide maintenance service after the sale of the products; Study and develop new products and new liner material, 4 bonding technology. Article 8 The production scale of the joint venture company is as follows: 1. The production capacity after the joint venture is put into operation is 600,000 units per year for normal years. 2. The production scale and product varieties may be increased with the development of the production and operation. (see Feasibility Study Report) Chapter 5 Total Amount of Investment and Registered Capital Article 9 The total amount of investment of the joint venture company is $ 7,200,000. Article 10 Investment contributed by the parties is $3,600,000 which will be the registered capital of the joint venture company. Of which: Party A shall pay $ 2,600,000, accounting for 5 72.22%; Party B shall pay $ 1,000,000, accounting for 27.78%. Article 11 Both Party A and Party B will contribute the following as their investment: Party A: Technology: $900,000 (was imported for producing steel - to - steel and self - lubricating spherical bearings) Machines and Instruments: $1,100,000 Premises: $600,000 Party B: Cash: $800,000 Technology: $200,000 (for manufacturing and bonding self-lubricating liner) Note: Both Party A and Party B shall strictly comply with Technology Transfer Contract signed in Beijing On Dec. 18, 1992 (with Contract Amendment signed on Aug. 24, 1993) and a second Technology Transfer Contract which will be signed in Shanghai between the joint venture company and Party B in the future, and Machinery Contract. 6 Article 12 In accordance with Technology Transfer Contract and Machinery Contract, the registered capital of the joint venture company shall be paid in installments by Party A and Party B according to their respective proportion of their investment. Article 13 In case either party to the joint venture intends to assign all or part of his investment subscribed to a third party, written consent shall first be obtained from the other party to the joint venture, and approval from the examination and approval authority is required. When one party to the joint venture assigns all or part of his investment, the other party has preemptive right to acquire the assignment provided this preemptive right is not in violation of United States law or Chinese law. Chapter 6 Responsibilities of Each Party to the Joint Venture Article 14 Party A and Party B shall be respectively responsible for the 7 following matters: Responsibilities of Party A: Handling of applications for approval, registration, business license and other matters concerning the establishment of the joint venture company from relevant departments in charge in China; Processing for applying the right to the use of a site to the authority in charge of the land; Organizing the design and construction of the premises and other engineering facilities of the joint venture company; Provided technology, machinery and instrument, construction and premises in accordance with the stipulations in Article 11; Assisting the joint venture company for processing import customs declaration for buying technology from Party B and arranging the transportation within the Chinese territory; Assisting the joint venture company in purchasing or leasing equipment, materials, raw materials, articles for office use, means of transportation and communication facilities, etc; Assisting the joint venture company in contacting and settling the fundamental facilities such as water, electricity, transportation, etc; Assisting the joint venture company in recruiting Chinese 8 management personnel, technical personnel, workers and other personnel needed; Assisting foreign workers and staff in obtaining housing and in applying for the entry visa, work license and processing their travelling matters; Responsible for handling other matters entrusted by the joint venture company. Responsibilities for Party B: Providing cash in accordance with the stipulations in Article 11 under time limit as followings: At first, as first installment of contribution by Party B pay US $400,000 (four hundred thousand dollars) to the joint venture company in half a year upon the date of establishing the joint venture; At second, as second installment of contribution by Party B pay US $200,000 (two hundred thousand dollars) to the joint venture within one year upon the date of its establishing; At last, as third installment of contribution by Party B pay US $200,000 (two hundred thousand dollars) to the joint venture in one year and half a year upon the date of establishment of the joint 9 venture company. and responsible for shipping to a Chinese port technical documents, etc; Handling the matters entrusted by the joint venture company, such as selecting and purchasing machinery and equipment outside China; Providing needed technical personnel for installing, testing and trial production of the equipment, as well as technical personnel for production and inspecting; Training the technical personnel and workers of the joint venture company; Because Party B is the licensor, he shall be responsible for handling American technology export license and the stable production of qualified products of the joint venture company in the light of design capacity within the stipulated period, and meet the production quote; Responsible for other matters entrusted by the joint venture company. 10 Chapter 7 Transfer of Technology Article 15 Both Party A and Party B agree that a technology transfer agreement shall be signed between Party A, the joint venture company and Party B so as to obtain advanced production technology needed for realizing the production and operation purpose and the production scale stipulated in Chapter 4 in the contract, including products designing, technology of manufacturing, means of testing, liner materials prescription and bonding technology, quality standard and the training of personnel, etc. (see Technology Transfer Agreement signed in Beijing) Party B offers the following guarantees on the transfer of technology: 1. Party B guarantees that the overall technology such as the designing, technology of manufacturing, technological process, tests and inspecting of steel to steel spherical bearings, self-lubricating spherical bearings, rod end bearings, bushings provided to the joint venture company must be integrated, precise and reliable. It is to meet the requirement of the joint venture's operation purpose, and be able to obtain the standard of 11 production quality and production capacity stipulated in the contract. 2. Party B guarantees that he possesses the rights of the technology stipulated in this contract and the technology transfer agreement, Party B should the legitimate owner of the Technology. Should any legal prosecution caused by disputes of possession henceforth, it will be settled by Party B solely. So should any unsuccess of integrity and continuity arising from above in executing the Contract be brought about, Party B should bear relevant responsibility (refer to items regulated in Technology Transfer Contract), and Party B has the rights to transfer it under license to Party A and the joint venture company, and pledges that the provided technology should be truly most advanced among the same type of technology of Party B, the model, specification and quality of the equipment are excellent to meet the requirement of technological operation and practical usage; 3. Party B shall work out a detailed list of the provided technology and technological service at various stages as stipulated in the technology transfer agreement to be an appendix to the contract, and guarantee its performance; 4. The drawings, technological conditions and other detailed 12 information are part of the transferred technology and shall be offered on time. 5. Within the validity period of the technology transfer agreement, Party B shall provide the joint venture company with the improvement of the technology and the improved information and technological materials in time, and shall not charge separate fees; 6. Party B shall guarantee that technological personnel and the workers in the joint venture company can master all the technology transferred within the period stipulated in the technology transfer agreement. Article 17 In case Party B fails to provide equipment or technology in accordance with the stipulations in this contract and in the technology transfer agreement or in case any deceiving or concealing actions are found, Party B shall be responsible for compensating the direct losses to the joint venture company. Article 18 Within the duration of the joint venture company, the joint venture shall have the right to use, research and develop the 13 imported technology as stipulated in technology transfer contract signed between Party A, joint venture company and Party B. Both Party A and Party B shall guarantee to provide each other with the improvement of the technology and developed process, productive and designing information in time without extra charge. Chapter 8 Selling of Products Article 19 The products of the joint venture company will be sold both on Chinese market and on overseas market, the export part accounting for more than 90% of annual overall output of the joint venture, and less than 10% for domestic market. The parts will not be sold in violation of United States laws. Article 20 Products may be sold on overseas market through the following channels: The joint venture company may directly sell its products on the international market only to those areas not specified in Item 2.2 of the Technology Transfer Contract. 14 Party B will sell the products made by the joint Venture in the areas specified in Item 2.2 of the Technology Transfer Contract (executing as Article 9 in Articles of association). The amount sold will be no less than 300 to 540 thousand units per year. Party B will sell these products to Smith Acquisition Company dba Southwest Products Company ("Buyer" ). The price of the Products sold to Buyer shall be set by agreement of the General Manager and Deputy General Manager. The price shall be based upon the JV's cost to manufacture the Products plus a reasonable profit added thereto. The price established by the JV must be agreed upon and accepted by the Buyer in the form of a purchase order to be valid. The price shall basically at least not lower than the price as specified in annex of the Feasibility Study Report. Article 21 The joint venture's products to be sold in China may be sold directly by joint venture company to enterprises and commercial departments in China, but may not be sold in violation of United States laws. 15 Article 22 The trade mark of the joint venture's products will be decided by the board of the directors of the joint venture company (SW - SH for temporarily use). The joint venture company shall apply for the registration of the trade mark with the Trademark Office of the Administrative Authority for Industry and Commerce in China, the right of trademark shall be protected by law. The joint venture company shall enjoy an exclusive right to use the trademark. Should products made by the Joint Venture be sold outside of China, the Joint Venture company would have rights to use the trademark of Southwest Products Company, but it is necessary to mark the site of production in clear position. Chapter 9 The Board of Directors Article 23 The date of registration of the joint venture company shall be the establishment of the board of directors of the joint venture company. 16 Article 24 The board of directors are composed of six directors, of which four directors shall be appointed by Party A, two by Party B. The chairman of the board shall be appointed by Party A, and its vice - chairman by Party B. The term of office for the directors, chairman and vice-chairman is four years; Their term of office may be renewed if continuously appointed by the relevant party. Article 25 The highest authority of the joint venture company shall be its board of directors. It shall decide all major issues concerning the joint venture company. Unanimous approval shall be required before any decisions are made concerning major issues (See the Article 29 of Articles of Association). As for other matters, approval by more than half of member of the board of directors shall be required. Article 26 The chairman of the board is the legal representative of the joint venture company. Should the chairman be unable to exercise his responsibilities for some reason, he shall authorize 17 the vice - chairman or any other director the represent the joint venture company temporarily. Article 27 The board of directors shall convene at least one meeting every year. The meeting shall be called and presided over by the chairman of the board. The chairman may convene an interim meeting based on a proposal made by more than one-third of the total number of directors. Minutes of the meetings shall be placed on file. Chapter 10 Business Management Office Article 28 The joint venture company shall establish a management office which shall be responsible for its daily management. The management office shall have a general manager, appointed by Party B at the initial term; Two deputy general managers by Party A; After the first term, nomination will be decided upon by the unanimous agreement of the board of directors. The general manager and deputy general managers shall be invited by the board of directors whose term of office is four years. 18 Article 29 The responsibility of the general manager is to carry out the decisions of the board meeting and organize and conduct the daily management of the joint venture company. The deputy general managers shall assist the general manager in his work. Several department managers may be appointed by the management office, who shall be responsible for the works in various department respectively, handle the matters handed over by the general manager and deputy general managers and shall be responsible to them. Article 30 In case of graft or serious dereliction of duty on the part of the general manager and deputy general managers, the board of directors shall have the power to dismiss them at any time. Chapter 11 Purchase of Equipment Article 31 In its purchase of required raw materials, fuel, parts, means of transportation and articles for office use, etc., the joint venture company shall give first priority to purchase in China 19 where conditions are the same and the customer will accept Chinese raw material. Article 32 In case the joint venture company entrusts Party B to purchase equipment on overseas market, Party B shall invite persons appointed by Party A to take part in the purchasing and pay attention to the site conditions of Party A. Chapter 12 Preparation and Construction Article 33 During the period of preparation and construction, a preparation and construction office shall be set up under the board of directors. The preparation and construction office shall consist of five persons, among which four persons will be from Party A, one person from Party B. The preparation and construction office shall have one manager recommended by Party A, and one deputy manager by Party B. The manager and deputy manager shall be appointed by the board of directors. 20 Article 34 The preparation and construction office is responsible for the following concrete work: examining the designs of the project, signing project construction contract, organizing the purchasing and inspecting of relative equipment, materials, etc., working out the general schedule of project construction, compiling the expenditure plans, controlling project financial payments and final accounts of the project, drawing up managerial methods and keeping and filing documents, drawings, files and materials, etc., during the construction period of the project. Article 35 A technical group with several technical personnel appointed by Party A and Party B shall be organized. The group, under the leadership of the preparation and construction office, is in charge of the examination, supervision, inspection, testing, checking and accepting and performance checking for the project design, the quality of project, the equipment and materials and the imported technology. Article 36 After approved by both parties, the establishment, 21 remuneration and the expenses of the staff of the preparation and construction office shall be paid respectively by Party A and Party B with Party A paying its assigned personnel and Party B paying its delegate. Article 37 After having completed the project and finishing the turning over procedures, the preparation and construction office shall be dissolved upon the approval of the board of directors. Chapter 13 Labour Management Article 38 Labour contract covering the recruitment, employment, dismissal and resignation, wages, labour insurance, welfare, rewards, penalty and other matters concerning the staff and workers of the joint venture company shall be drawn up between the joint venture company and the Trade Union of the joint venture company as a whole or individual employees in accordance with the "Regulations of the People's Republic of China on Labour Management in Joint Ventures Using Chinese and Foreign Investment" and its implementation rules. 22 The labour contracts shall, after being signed, be filed with the local labour management department. Article 39 The appointment of high-ranking administrative personnel recommended by both parties, their salaries, social insurance, welfare and the standard of travelling expenses, etc., shall be decided by the meeting of the board of directors. Chapter 14 Taxes, Finance and Audit Article 40 Joint venture company shall pay taxes in accordance with the stipulations of Chinese laws and other relative regulations. Article 41 Staff members and workers of the joint venture company shall pay individual income tax according to the "Individual Income Tax Law of the People's Republic of China." Article 42 Allocations for reserve funds, expansion funds of the joint 23 venture company and welfare funds and bonuses for staff and workers shall be set aside in accordance with the stipulations in "The Law of the People's Republic of China on Joint Ventures Using Chinese and Foreign Investment." The annual proportion of allocations shall be decided by the board of directors according to the business situation of the joint venture company. Article 43 The fiscal year of the joint venture company shall be from January 1 to December 31. All vouchers, receipts, statistic statements and reports, account books shall be written in Chinese and English. Article 44 Financial checking and examination of the joint venture company shall be conducted by an auditor registered in China and reports shall be submitted to the board of directors and the general manager. In case Party B considers it is necessary to employ a foreign auditor registered in another country to undertake annual financial checking and examination, Party A shall give its consent. All the expenses thereof shall be borne by Party B. 24 Article 45 In the first three months of each fiscal year, the general manager shall prepare previous year's balance sheet, profit and loss statement and proposal regarding the disposal of profits, and submit them to the board of directors for examination and approval. Chapter 15 Duration of the Joint Venture Article 46 The duration of the joint venture company is 25 years. The establishment of the joint venture company shall start from the date on which the business license of the joint venture company is issued. An application for the extension of the duration, proposed by one party and unanimously approved by the board of directors, shall be submitted to the Shanghai Foreign Investment Commission six months prior to the expiry date of the joint venture. 25 Chapter 16 The Disposal of Assets After Expiration of the Duration Article 47 Upon the expiration of the duration or termination before the date of expiration of the joint venture, liquidation shall be carried out as per liquidated procedure stipulated in Regulations of Shanghai Municipality on Liquidation of Enterprises with Foreign Investment and according to the relevant laws. The liquidated assets shall be distributed in accordance with the proportion of investment contributed by Party A and Party B. Chapter 17 Insurance Article 48 Insurance policies of the joint venture company on various kinds of risks shall be underwritten with the People's Republic of China. Types, value and duration of insurance shall be decided by the board of directors in accordance with the stipulations of the insurance company in China. 26 Chapter 18 The Amendment, Alteration and Discharge of the Contract Article 49 The amendment of the contract or other appendices shall come into force after the written agreement is signed by Party A and Party B and approved by the original examination and approval authority. Article 50 In case of inability to fulfill contract or to continue operation due to heavy losses in successive years without any increased investment as a result of force majeure, the duration of the joint venture and the contract shall be terminated before the time of expiration after being unanimously agreed upon by the board of directors and approved by the original examination and approval authority. Article 51 Should the joint venture company be unable to continue its operations or achieve the business purpose stipulated in the contract due to the fact that one of the contracting parties fails to 27 fulfill the obligations prescribed by the contract and articles of association, or seriously violates the stipulations of the contract and articles of association, that party shall be deemed as unilaterally terminating the contract. The other party shall have the right to terminate the contract in accordance with the provisions of the contract after being approved by the original examination and approval authority as well as to claim damages. In case Party A and Party B of the joint venture company agree to continue the operation, the party who fails to fulfill the obligations shall be liable to the economic losses thus caused to the joint venture company. Chapter 19 Liabilities for Breach of Contract Article 52 Should either Party A or Party B fail to pay on schedule the contributions in accordance with the provisions defined in Chapter 5 of this contract, the breaching party shall pay to the other party 5% of the contribution starting from the first month after exceeding the time limit. Should the breaching party fail to pay after 3 months, 15% of the contribution shall be paid to the other party, who shall have the right to terminate the contract and 28 to claim damages to the breaching party in accordance with the stipulations in Article 53 of this contract. Article 53 Should all or part of the contract and its appendices be unable to be fulfilled owing to the fault of one party, the breaching party shall bear the responsibilities thus caused and compensate relevant economic losses. Should it be the fault of both parties, they shall bear their respective responsibilities and be liable to relevant economic losses according to actual situations. Chapter 20 Force majeure Article 54 Should either of the parties to the contract be prevented from executing the contract by force majeure, such as earthquake, typhoon, flood, fire and war and other unforeseen events, and their happening and consequences are unpreventable and unavoidable, the prevented party shall notify the other party by Fax without any delay, and within 15 days thereafter provide the detailed information of the events and a valid document for 29 evidence issued by the relevant public notary organization for explaining of the reason of its inability to execute or delay the execution of all or part of the contract. Both parties shall, through consultations, decide whether to terminate the contract or to exempt the part of obligations for implementation of the contract or whether to delay the execution of the contract according to the effects of the events on the performance of the contract. Chapter 21 Applicable Law Article 55 The formation of this contract, its validity, interpretation, execution and settlement of the disputes shall be governed by the related laws of the People's Republic of China. Chapter 22 Settlement of Disputes Article 56 Any disputes arising from the execution of, or in connection with, the contract shall be settled through friendly consultations between both parties. In case no settlement can be reached 30 through consultations, the disputes shall be submitted to Shanghai branch of the International Economic and Trade Arbitration Commission of the China Council for arbitration in accordance with its rules of procedure. The arbitral award is final and binding upon both parties. Article 57 During the arbitration, the contract shall be executed continuously by both parties except for matters in dispute. Chapter 23 Language Article 58 The contract shall be written in Chinese version and in English version. Both languages are equally authentic. In the event of any discrepancy between the two aforementioned versions, the Chinese version shall prevail. 31 Chapter 24 Effectiveness of the Contract and Miscellany Article 59 The appendices drawn up in accordance with the principles of this contract are integral part of this contract, including: the project agreement, the technology transfer agreement, the sales agreement . . . . Article 60 The contract and its appendices shall come into force beginning from the date of approval by Shanghai Mechanical & Electrical Industrial Administration Bureau. Article 61 The technology transfer contract signed in Beijing between Party A and Party B will be signed in Shanghai between the joint venture company and Party B, the machinery purchasing contract with which the joint venture company entrusts Party B to purchase equipment on overseas market are all appendices of this contract. 32 If there are some contradictions among above mentioned contracts, this contract shall prevail. Article 62 Should notices in connection with any party's rights and obligations be sent by either Party A or Party B by telegram or telex, etc., the written letter notices shall be also required afterwards. The legal addresses of Party A and Party B listed in this contract shall be the posting addresses. Article 63 The contract is signed in Shanghai of China by the authorized representatives of both parties on March 21, 1994. For Party A For Party B (Signature) (Signature) 33 EX-10.19 5 ARTICLES OF ASSOCIATION FOR JOINT VENTURES EXHIBIT 10.19 ARTICLES OF ASSOCIATION FOR JOINT VENTURES USING CHINESE AND FOREIGN INVESTMENT SHANGHAI, CHINA 18 MARCH, 1994 ARTICLES OF ASSOCIATION FOR JOINT VENTURES USING CHINESE AND FOREIGN INVESTMENT CHAPTER I GENERAL PROVISIONS ARTICLE 1 In accordance with "The Law of the People's Republic of China on Joint Ventures Using Chinese and Foreign Investment" and the contract, in which two parties agree on setting up Shanghai Southwest Bearing joint venture company Ltd. (hereinafter referred to as the joint venture company), signed by Shanghai Hong Xing Bearing Factory (hereinafter referred to as Party A and Smith Acquisition Company dba. Southwest Products Company of U.S.A. (hereinafter referred to as Party B) in Shanghai, China, the articles of association hereby is formulated. ARTICLE 2 The name of the joint venture company is Shanghai Southwest Bearing Company Ltd. The name in Chinese language is ______________. . 1 . The legal address of the joint venture company is at 937, Zhong Shan Nan Yi Road, Shanghai China. ARTICLE 3 The names and legal addresses of the parties to the joint venture are as follows: Party A: Shanghai Hong Xing Bearing Factory at 937, Zhong Shan Nan Yi Road, Shanghai, China Party B: Smith Acquisition Company dba. Southwest Products Co. of U.S.A. at 2240, Buena Vista, Irwindale, CA 91706, America ARTICLE 4 The joint venture company is a limited liability company. ARTICLE 5 The joint venture company has the status of a legal person and is subject to the jurisdiction and protection of China's laws concerned. All its activities shall be governed by Chinese laws, decrees and other pertinent rules and regulations. . 2 . CHAPTER II PURPOSE AND SCOPE OF BUSINESS ARTICLE 6 The purpose of the joint venture is to produce and sell spherical bearing products as stipulated in the Contract for Joint Venture, to develop new liner material and bonding technology, and to reach world class level for obtaining satisfactory economic benefits for the parties to the joint venture company. ARTICLE 7 The business scope of the joint venture company is to design, manufacture and sell spherical bearing products and related modified products, machines; provide after sale-services. ARTICLE 8 The scale of production of the joint venture company is as follows: First year: 100,000 units Second year: 500,000 units Third year: 600,000 units . 3 . ARTICLE 9 The joint venture company may sell its products on the Chinese domestic market and on the international market, its selling proportion based on annual total output is as following: First year: 100% Second Year: 90% for export; 10% for the domestic market Third Year: more than 90% for export; remaining for the domestic market. CHAPTER III THE TOTAL AMOUNT OF INVESTMENT AND REGISTERED CAPITAL ARTICLE 10 The total amount of investment of the joint venture company is $4,600,000. Its registered capital is $7,200,000. . 4 . ARTICLE 11 The investment contributed by each party is as follows: PARTY A: Investment subscribed is $2,600,000, accounting for 72.22% of the registered capital, among which, Technology: $900,000 (was imported for producing steel to steel and self-lubricating spherical bearings) Machines and Instruments: $1,100,000 Premises: $600,000 PARTY B: Investment subscribed is $1,000,000, accounting for 27.78% of the registered capital, among which, Cash: $800,000 Technology: $200,000 (for manufacturing and bonding self- lubricating liner) ARTICLE 12 The parties to the joint venture shall pay in all the investment subscribed according to the time limit stipulated in the contract. . 5 . ARTICLE 13 After the investment is paid by the parties to the joint venture, an accountant who had been registered in China, agreed upon by both parties invited by the joint venture company shall verify it and provide a certificate of verification. According to this certificate, the joint venture shall issue an investment certificate which includes the following items: name of the joint venture; date of the establishment of the joint venture; names of the parties and the investment contributed; date of the contribution of the investment; and the date of issuance of the investment certificate. ARTICLE 14 Within the term of the joint venture, the joint venture company shall not reduce its registered capital. ARTICLE 15 Should one party assign all or part of its investment subscribed, written consent shall be obtained from the other party of the joint venture. When one party assigns investment, the other party has preemptive right. Such . 6 . assignment shall not be in violation of United States or Chinese law. ARTICLE 16 Any increase or assignment of the registered capital of the joint venture company shall be unanimously approved by the board of directors and submitted to the original examination and approval authority for approval. The registration procedures for changes shall be dealt with at the original registration and administration office. CHAPTER IV THE BOARD OF DIRECTORS ARTICLE 17 The joint venture shall establish the board of directors which is the highest authority of the joint venture company. ARTICLE 18 The board of directors shall decide all major issues concerning the joint venture company. Its functions and powers are as follows: . 7 . _____ deciding and approving the important reports submitted by the general manager (for instance: production plan, annual business report, funds, loans, etc.,); _____ approving annual financial reports, budget of receipts and expenditures, distribution plan of annual profits; _____ adopting major rules and regulations of the company; _____ deciding to set up branches; _____ amending the parties of association of the company; _____ discussing and deciding the termination of production, termination of the company or merging with another economic organization; _____ deciding the engagement of high-rank officials such as the general manager, chief engineer, treasurer, auditor, etc.; _____ being in charge of expiration of the company and the liquidation matters upon the expiration of the joint venture company; _____ other major issues which shall be decided by the board of directors. . 8 . ARTICLE 19 The board of directors shall consist of six directors, of which four directors shall be appointed by Party A, two by Party B. The term of office for the directors is four years and may be renewed. ARTICLE 20 Chairman of the board shall be appointed by Party A and vice chairman of the board by Party B. ARTICLE 21 When appointing and replacing directors, a written notice shall be submitted to the board. ARTICLE 22 The board of directors shall convene one meeting every year. The chairman may convene an interim meeting based on a proposal made by more than one-third of the total number of directors. ARTICLE 23 The board meeting will be held in principle on the . 9 . location of the company. ARTICLE 24 The board meeting will be called and presided over by the chairman. Should the chairman be absent, the vice chairman shall call and preside over the board meeting. ARTICLE 25 The chairman shall give each director a written notice 30 days before the date of the board meeting. The notice shall cover the agenda, time and place of the meeting. ARTICLE 26 Should a director be unable to attend the board meeting, he may present a proxy in written form to the board. In case the director neither attends nor entrusts other to attend the meeting, he will be regarded as abstention. ARTICLE 27 The board meeting requires a quorum of at least two-thirds of the total number of directors. When the quorum is less than two-thirds, the decisions adopted by . 10 . the board meeting are invalid; Each board decision must be approved by at least one board member appointed by Party B. ARTICLE 28 Detailed written records shall be made for each board meeting and signed by all the attending directors or by the attending proxy. The record shall be made in Chinese and English, and shall be filed with the company. ARTICLE 29 The following issues shall be unanimously agreed upon by the board of directors: _____ amending the articles of association of the joint venture company; _____ increasing and assignment the registered capital of the joint venture company; _____ deciding annual plan of production and selling, financial budget and final account; _____ deciding distribution plan of annual profits, use and distribution proportion of reserve funds, expansion funds of the joint venture company, welfare funds and . 11 . bonuses for staff and workers. _____ appointing and removing of the general manager and deputy general managers; _____ merging with other economic organization; _____ terminating and disbanding the joint venture company; _____ liquidation organization and plan of the joint venture company, ARTICLE 30 The other important issues shall be passed by more than half of the total number of directors, but must be approved by at least one director appointed by Party B. CHAPTER V BUSINESS MANAGEMENT ORGANIZATION ARTICLE 31 The joint venture company shall establish a management organization. It consists of production, technology, marketing, finance and administration offices, etc. ARTICLE 32 . 12 . The joint venture company shall have one general manager and two deputy general managers who are engaged by the board of directors. The first general manager shall be recommended by Party B; After the first term, recommendation will be decided upon negotiation of the board of directors. Deputy general managers shall be recommended by Party A, and approved by the general manager. ARTICLE 33 The general manager is directly responsible to the board of directors. He shall carry out the decisions of the board of directors, organize and conduct the daily production, technology and operation and management of the joint venture company. The deputy general managers shall assist the general manager in his work and act as the agent of the general manager during his absence and exercise the functions of the general manager. ARTICLE 34 Decision on the major issues concerning the daily work of the joint venture company shall be signed jointly by the general manager and deputy general managers, then the . 13 . decisions shall come into effect. Issues which need co-signatures shall be specifically stipulated by the board of directors. ARTICLE 35 The term of office for the general manager and deputy general managers shall be four years. After the initial term, the general manager and the deputy general managers should continue to be nominated by the same parties as originally stipulated, and be approved by the board of directors. ARTICLE 36 At the invitation of the board of directors, the chairman, vice- chairman or directors of the board may concurrently be the general manager, deputy general managers or other high-ranking personnel of the joint venture company. ARTICLE 37 The general manager or deputy general managers shall not hold posts concurrently as general manager or deputy . 14 . general managers of other economic organizations in commercial competition with their own joint venture company. ARTICLE 38 The joint venture company shall have one chief engineer, one treasurer and one auditor engaged by the board of directors and approved by the general manager. ARTICLE 39 The general engineer, treasurer and auditor shall be under the leadership of the general manager. The treasurer shall exercise leadership in financial and accounting affairs, organize the joint venture company to carry out overall business accounting and implement the economic responsibility system. The auditor shall be in charge of the auditing work of the joint venture company, examine and check the financial receipts and expenditure and the accounts, and submit written reports to the general manager and the board of directors. . 15 . ARTICLE 40 The general manager, deputy general manager, chief engineer, treasurer, auditor and the other high-ranking personnel who wish to quit the job with the joint venture shall submit their written resignation to the board of directors in advance. In case any one of the above-mentioned persons conduct graft or serious dereliction of duty, they may be dismissed at any time upon the decision of the board. Those who violate the criminal law shall be under criminal sanction. CHAPTER IV FINANCE AND ACCOUNTING ARTICLE 41 The finance and accounting of the joint venture company shall be handled in accordance with the "Stipulations of the Finance and Accounting System of the Joint Ventures Using Chinese and Foreign Investment formulated by the Ministry of Finance of the People's Republic of China. . 16 . ARTICLE 42 The fiscal year of the joint venture company shall coincide with the calendar year, i.e. from January 1 to December 31 on the Gregorian calendar. ARTICLE 43 All vouchers, account books, statistic statements and reports of the joint venture company shall be written in Chinese and English. ARTICLE 44 The joint venture company adopts RMB as its accounts keeping unit. The conversion of RMB into other currency shall be in accordance with the exchange rate of the converting day published by the State Administration of Exchange Control of the People's Republic of China. ARTICLE 45 The joint venture company shall open accounts in RMB and foreign currency with the Bank of China or other banks agreed by the Bank of China. . 17 . ARTICLE 46 The accounting of the joint venture company shall adopt the internationally used accrual basis and debit and credit accounting system in their work. ARTICLE 47 The following items shall be covered in the financial accounts books: 1. The amount of overall cash receipts and expense of the joint venture company; 2. All material purchasing and selling of the joint venture company; 3. The registered capital and debts situation of the joint venture company; 4. The time of payment, increase and assignment of the registered capital of the joint venture company. 5. Other financial information deemed necessary by the general manager to assist him in performing his duties. ARTICLE 48 The joint venture company shall work out the statement . 18 . of assets and liabilities and losses and gains accounts of the past year in the first three months of each fiscal year, and submit to the board meeting for approval after being examined and signed by the auditor. ARTICLE 49 Parties to the joint venture have the right to invite an auditor to undertake annual financial check and examination at their own expense. The joint venture company shall provide convenience for checking and examination. ARTICLE 50 The depreciation period for the fixed assets of the joint venture company shall be decided by the board of directors in accordance with the Rules for the Implementation of the Income Tax Law of the People's Republic of China Concerning Joint Venture with Chinese and Foreign Investment. ARTICLE 51 All matters concerning foreign exchange shall be handled in accordance with the "Provisional Regulations for . 19 . Exchange Control of the People's Republic Of China", and other pertaining regulations as well as the stipulations of the joint venture contract. CHAPTER VI PROFITS SHARING ARTICLE 52 The joint venture company with unanimous approval of the board of directors will draw reserve funds, expansion funds and bonuses and welfare funds for staff and workers after payment of taxes. The proportion of allocation is decided by the board of directors. ARTICLE 53 After paying the taxes in accordance with law and drawing the various funds, the remaining profits will be distributed according to the proportion of each party's investment in the registered capital. At the beginning period of the joint venture company, profits will be distributed by RMB currency. ARTICLE 54 . 20 . The joint venture company shall distribute its profits each year. The profit distribution plan and the amount of profit distributed to each party shall be published within the first three months following each fiscal year. ARTICLE 55 The joint venture company shall not distribute profits unless the losses of previous fiscal year have been made up. Remaining profit from previous year can be distributed together with that of the current year. CHAPTER VIII STAFF AND WORKERS ARTICLE 56 The employment, recruitment, dismissal and resignation of the staff and workers of the joint venture company and their salary, welfare benefits, labour insurance, labour protection, labour discipline and other matters shall be handled according to the "Regulations of the People's Republic of China on Labour Management in Joint Ventures Using Chinese and Foreign Investment" and its implementation rules. . 21 . ARTICLE 57 The required staff and workers to be recruited by the joint venture company will be recommended by the local labour department or the joint venture will do so through public selection examinations and employ those who are qualified with the consent of the labour department. ARTICLE 58 The joint venture company has the right to take disciplinary actions, record a demerit and reduce salary against those staff members and workers who violate the rules and regulations of the joint venture company and labour discipline. Those with serious cases may be dismissed. Discharging of workers shall be filed with the labour and personnel department in the locality. ARTICLE 59 The salary treatment of the staff and workers shall be set by the board of directors according to the specific situation of the joint venture, with reference to pertaining stipulations of China, and shall be specified in detail in . 22 . the labour contract. The salary of the staff and workers shall be increased correspondingly with the development of production and the raising of the ability and technology of the staff and workers. ARTICLE 60 Matters concerning the welfare funds, bonuses, labour protection and labour insurance, etc. shall be stipulated in various rules by the joint venture company to ensure that the staff and workers go in for production and work under normal conditions. CHAPTER IX TRADE UNION ORGANIZATION ARTICLE 61 The staff and workers of the joint venture company have the right to establish trade union organization and carry out activities in accordance with the stipulations of the Trade Union Law of the People's Republic of China". ARTICLE 62 . 23 . The trade union in the joint venture company representative of the interests of the staff and workers. The tasks of the trade union are: to protect the democratic rights and material interests of the staff and workers pursuant to the law; to assist the joint venture company to arrange and make rational use of welfare funds and bonuses; to organize professional, scientific and technical studies, carry out literary, art and sports activities; and educate staff and workers to observe labour discipline and strive to fulfil the economic tasks of the joint venture company. ARTICLE 63 The trade union of the joint venture company shall sign labour contracts with the joint venture company on behalf of the staff and workers, and supervise the implementation of the contracts. ARTICLE 64 Persons in charge of the trade union of the joint venture company have the right to attend as nonvoting members and to report the opinions and demands of staff and workers to meetings of the board of directors held to . 24 . discuss issues such as development plans, production and operational activities of the joint venture. ARTICLE 65 The trade union shall take part in the mediation of disputes arising between the staff and workers and the joint venture company. ARTICLE 66 The joint venture company shall allot an amount of money totalling 2% of all the salaries of the staff and workers of the joint venture company as trade union's funds, which shall be used by the trade union in accordance with the "Managerial Rules for the Trade Union Funds" formulated by the All China Federation of Trade Unions. CHAPTER X DURATION, TERMINATION AND LIQUIDATION ARTICLE 67 The duration of the joint venture company shall be 25 years, beginning from the day when business license is issued. . 25 . ARTICLE 68 An application for the extension of duration shall, proposed by both parties and approved at the board meeting, be submitted to the original examination and approval authority six months prior to the expiry date of the joint venture. Only upon its approval may the duration be extended, and the joint venture company shall go through registration formalities for the alteration at the original registration office. ARTICLE 69 The joint venture may be terminated before its expiration in case the parties to the joint venture agree unanimously that the termination of the joint venture is for the best interests of the parties. To terminate the joint venture before the term expires shall be decided by the board of directors through a plenary meeting, and it shall be submitted to the original examination and approval authority for approval. ARTICLE 70 . 26 . [MISSING PAGE 27] . 27 . priority from the existing assets of the joint venture company. ARTICLE 74 The remaining property after the clearance of debts of the joint venture company shall be distributed between the parties to the joint venture according to the proportion of each party's investment in the registered capital. ARTICLE 75 On completion of the liquidation, the joint venture company shall submit a liquidation report to the original examination and approval authority, go through the formalities for nullifying its registration in the original registration office and hand in its business license, and at the same time, make an announcement to the public. ARTICLE 76 After winding up of the joint venture company, its account books shall be left in the care of the Chinese participant. . 28 . ARTICLE 77 Following are the rules and regulations formulated by the board of directors of the joint venture company. 1. Management regulations, including the powers and functions of the managerial branches and its working rules and procedures; 2. Rules for the staff and workers; 3. Rules to keep secret; 4. System of labour and salary; 5. System of work attendance record, promotion and awards and penalty for staff members and worker's; 6. Detailed rules of staff and worker's welfare; 7. Financial system; 8. Liquidation procedures upon the dissolution of the joint venture company; 9. Other necessary rules and regulations; . 29 . CHAPTER XII SUPPLEMENTARY ARTICLES ARTICLE 78 The amendments to the Articles of Association shall be unanimously agreed on and decided by the board of directors and submitted to the original examination and approval authority for approval. ARTICLE 79 The Articles of Association is written in Chinese language and English language. Both languages shall be equally authentic. In the event of any discrepancy between the two above mentioned versions, the Chinese version shall prevail. ARTICLE 80 The Articles of Association shall come into effect upon the approval by the Shanghai Foreign Investment Commission. The same applies in the event of amendments. ARTICLE 81 . 30 . The Articles of Association is signed in Shanghai of China by the authorized representatives of both parties on March 21, 1994. For Party A For Party B (Signature) (Signature) [Signature appears here] [Signature appears here] . 31 . EX-10.20 6 AGREEMENT AND PLAN OF REORGANIZATION AND MERGER EXHIBIT 10.20 AGREEMENT AND PLAN OF REORGANIZATION AND MERGER Among SUNBASE ASIA, INC. as Purchaser SMITH ACQUISITION COMPANY, INC. d/b/a SOUTHWEST PRODUCTS COMPANY as the Company and THOSE PERSONS SET FORTH ON THE SIGNATURE PAGES OF THIS AGREEMENT as the Shareholders Dated: As of December 29, 1995 AGREEMENT AND PLAN OF REORGANIZATION AND MERGER THIS AGREEMENT AND PLAN OF REORGANIZATION AND MERGER, dated and deemed effective by the parties hereto as of December 29, 1995, is made and entered into by and among Sunbase Asia, Inc., a Nevada corporation ("Purchaser"); those persons set forth on the signature pages of this Agreement (collectively, the "Shareholders" and individually, a "Shareholder"); and Smith Acquisition Company, Inc., a California corporation, d/b/a Southwest Products Company (the "Company") with reference to the following: A. Prior to the conversion described below, the Shareholders own the number of issued and outstanding shares of the (a) no par value common stock and (b) the no par value preferred stock (the "Southwest Preferred Shares") of the Company together with the principal amount of Subordinated Debt (the "Subordinated Debt") set forth opposite the applicable Shareholder's name on Schedule 5.3. B. The Shareholders intend to recapitalize the Company so that immediately prior to the consummation of this transaction all of the Southwest Preferred Shares and the Subordinated Debt will be converted to Southwest Common Stock. C. The respective directors of Purchaser and the Company and the Shareholders have determined that it is in the best interests of the Company, Purchaser and the Shareholders for the Company to be merged with a California corporation to be created by Purchaser ("Newco") upon the terms and conditions set forth in this Agreement. D. Pursuant to this Agreement, the Shareholders are hereby approving the merger of the Company and Newco. NOW, THEREFORE, in consideration of the mutual promises and covenants set forth herein, the parties hereby agree as follows: ARTICLE I --------- DEFINITIONS ----------- When used in this Agreement, the following terms shall have the respective meanings set forth below: "Affiliate" shall mean, with respect to any Person, (i) a Person directly or indirectly controlling, controlled by or under common control with such Person; (ii) a Person owning or controlling 10% or more of the outstanding voting securities of such Person; or (iii) an officer, director or partner of such Person. When the Affiliate is an officer, director or partner of such Person, any other Person for which the Affiliate acts in that capacity shall also be considered an Affiliate. For these purposes, control means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a Person, whether by the ownership of voting securities, by contract or otherwise. "Agreement" shall mean this Agreement and Plan of Reorganization and Merger, including all exhibits and schedules thereto, as the same may hereafter be amended, modified or supplemented from time to time. "Authority" shall mean any governmental, regulatory or administrative body, agency or authority, any court of judicial authority, any arbitrator or any public, private or industry regulatory authority, whether international, national, Federal, state or local. "Business" shall mean the manufacture, assembly and sale of bearing products. "Closing" shall have the meaning specified in Section 3.1 hereof. "Closing Date" shall mean the date upon which the Closing occurs. "Code" shall mean the Internal Revenue Code of 1986, as the same may hereafter be amended from time to time. Any reference to a specific section of the Code shall refer to the cited provision as the same may be subsequently amended from time to time, as well as to any successor provision(s). "Company" shall mean Smith Acquisition Company, Inc. d/b/a Southwest Products Company, a California corporation. "Company Documents" shall mean this Agreement and all other agreements, instruments and certificates to be executed by the Company in connection with this Agreement. "Contracts and Other Agreements" shall mean all contracts, agreements, warranties, guaranties, indentures, bonds, options, leases, subleases, easements, mortgages, plans, collective bargaining agreements, licenses, commitments or binding arrangements of any nature whatsoever, express or implied, written or unwritten, and all amendments thereto, entered into or binding upon the applicable party or to which the property of the applicable party may be subject. 2 "Effective Time" shall have the meaning specified in Section 2.1 hereof. "Knowledge" shall mean, (i) with respect to any Shareholder who is not a director, the actual knowledge of such person, and the Knowledge that such person would have acquired by attending all of the meetings of the Board of Directors of the Company and by reviewing all of the corporate minutes therefor, (ii) with respect to any Shareholder who is also a director of Southwest, the actual knowledge of each such person, the knowledge that such person would have acquired upon reasonable inquiry, and the Knowledge that such person would have acquired by attending all of the meetings of the Board of Directors of the Company and by reviewing all of the corporate minutes therefor, and (iii) with respect to the Company, the actual knowledge of each of its directors, executive officers and key employees, the knowledge that each such person would have acquired upon diligent inquiry and the knowledge that is imputed to each such person and/or the Company by operation of Law. "Labor Agreements" shall mean, collectively, (i) all employment agreements, collective bargaining agreements or other labor agreements to which the Company is a party or by which its properties is bound; (ii) all pension, profit sharing, deferred compensation, bonus, stock option, stock purchase, savings, retainer, consulting, non-competition, retirement, welfare or incentive plans or contracts (including ERISA Plans) to which the Company is a party or by which its properties is bound; and (iii) all plans or agreements under which "fringe benefits" (including, but not limited to, hospitalization plans or programs, medical insurance, vacation plans or programs, sick plans or programs and related benefits) are afforded to any employees of the Company. "Law" shall mean any law, statute, regulation, ordinance, requirement, or other binding action or requirement of an Authority. "Licenses and Permits" shall mean all licenses and permits issued to the Company or in which the Company has any interest (including the right to use). "Lien or Other Encumbrance" shall mean any lien, pledge, mortgage, security interest, lease, charge, conditional sales contract, option, restriction, reversionary interest, right of first refusal, voting trust arrangement, preemptive right, claim under bailment or storage contract, easement or any other adverse claim or right whatsoever. "Losses" shall have the meaning specified in Section 12.1 hereof. 3 "Material Adverse Change" or "Material Adverse Effect" or other similar phrase including the word "material" with respect to the condition (financial or otherwise), assets, liabilities, Business, operations or prospects of the Company shall mean any adverse change or effect or potential adverse change or effect, or any series thereof, involving more than Fifty Thousand Dollars ($50,000) in the aggregate. "Merger" shall have the meaning specified in Section 2.1 hereof. "Newco" shall have the meaning specified in Recital C above. "Non-Competition Agreement" shall mean the agreement of William McKay referred to in Section 7.6 hereof. "Order" shall mean any decree, order, judgment, writ, award, injunction, rule or consent of or by an Authority. "Outside Date" shall have the meaning specified in Section 3.1 hereof. "Person" shall mean any entity, corporation, company, association, joint venture, joint stock company, partnership, trust, organization, individual (including personal representatives, executors and heirs of a deceased individual), nation, state, government (including agencies, departments, bureaus, boards, divisions and instrumentalities thereof), trustee, receiver or liquidator. "Purchaser Financial Statements" shall mean the audited (a) consolidated balance sheets of Purchaser as of December 31, 1993 and December 31, 1994; (b) the consolidated statement of income for the years ended December 31, 1993 and December 31, 1994; (c) consolidated statement of cash flows for the years ended December 31, 1993 and December 31, 1994; and (d) consolidated statements of changes in shareholder's equity for the years ended December 31, 1993 and December 31, 1994, including all notes thereto. "Property Rights" shall have the meaning specified in Section 5.9 hereof. "Purchaser Documents" shall mean this Agreement and all other agreements, instruments and certificates to be executed and delivered by Purchaser in connection with this Agreement. 4 "Securities Act" shall have the meaning specified in Section 4.9 hereof. "Shareholder Documents" shall mean this Agreement and all other agreements, instruments and certificates to be executed and delivered by the Shareholders in connection with this Agreement. "Southwest Financial Statements" shall mean the unaudited balance sheets as of June 30, 1995 and June 30, 1994 and the unaudited statements of income and statements of cash flow of the Company, for the twelve month periods then ended, including all notes thereto, and the unaudited balance sheets as of September 30, 1995 and the unaudited statements of income and statements of cash flow of the Company, for the three month period then ended, including all notes thereto. "Southwest Common Stock" shall mean any issued and outstanding shares of the common stock of the Company. "Southwest Preferred Shares" shall have the meaning specified in Recital A above. "Southwest Shares" shall mean all of the issued and outstanding shares of the common stock of the Company after conversion of the Southwest Preferred Shares and the Subordinated Debt, and the exercise or cancellation of all outstanding options. "Subordinated Debt" shall have the meaning specified in Recital A above. "Subsidiary" shall mean each corporation, partnership, joint venture, trust or other entity in which the Company has, directly or indirectly, an equity interest representing 10% or more of the capital stock thereof or other equity interest therein. "Subsidiary Merger Agreement" shall have the meaning specified in Section 2.1 hereof. "Sunbase Preferred Shares" shall have the meaning specified in Section 2.1 hereof. "Sunbase Shares" shall have the meaning specified in Section 4.9 hereof. "Taxes" shall mean, collectively, all taxes, including without limitation, income, gross receipts, net proceeds, alternative, add-on, minimum, ad valorem, value added, turnover, sales, use, property, personal property (tangible and intangible), stamp, leasing, excise, duty, 5 franchise, transfer, license, withholding, payroll, employment, fuel, excess profits, environmental, occupational, interest equalization, windfall profits and severance taxes, and all other like charges imposed by an Authority. "Tax Returns" shall mean, collectively all Federal, state, foreign and local tax reports, returns, information returns and other related documents required to be filed with any relevant taxing Authority. ARTICLE II ---------- SUBSCRIPTION OF NEW ISSUE SHARES AND SALE ----------------------------------------- AND PURCHASE OF SHARES ---------------------- 2.1 The Merger. Subject to the terms and conditions of this Agreement ---------- Newco shall be merged into the Company (with the Company being the surviving corporation of the merger) in accordance with the applicable provisions of the California Corporations Code (the "Merger") pursuant to the Agreement of Merger attached to this Agreement as Schedule 2.1 (the "Subsidiary Merger Agreement"). The Merger shall be effective when the Subsidiary Merger Agreement shall have been filed with the Secretary of State of the State of California. When used in this Agreement, the term "Effective Time" shall mean the time of filing of the Subsidiary Merger Agreement with the Secretary of State. The authorized and issued capital stock of Newco, all of which shall be owned by Purchaser immediately prior to the Effective Time, at the Effective Time, pursuant to the Subsidiary Merger Agreement and without any further action on the part of Purchaser, shall be converted into one share of the common stock of the Company (the "Surviving Stock"). Each outstanding stock certificate which prior to the Effective Time represented shares of capital stock of Newco automatically and for all purposes shall be deemed to represent the number of shares of the Company into which the shares of capital stock of Newco represented by such certificate have been converted as provided herein. At the Effective Time, all of the Southwest Shares shall be converted into and become the right to receive an aggregate of six thousand three hundred (6,300) shares of Series B Convertible Preferred Stock (the "Sunbase Preferred Shares") of Purchaser to be distributed to the Shareholders in accordance with Schedule 5.3. The terms of the Sunbase Preferred Shares shall be set forth on Schedule 2.1 and will include the following: (a) Each of the Sunbase Preferred shares, on an "as-converted" and pro-rata basis, shall participate with the shares of the common stock of Purchaser in any dividends paid by Purchaser thereon. 6 (b) Each holder of the Sunbase Preferred Shares shall be entitled to the number of votes equal to the number of shares of common stock of Purchaser into which such Shares could be converted under 2.1(c) below and shall have voting rights and powers equal to the voting rights and powers of the common stock (voting together with the common stock as a single class), except that any action to be taken by Purchaser which would adversely affect the rights of the holders of the Sunbase Preferred Shares shall require the approval of a majority in interest of such holders; (c) At the option of each holder, the shares owned by such holder may be redeemed from the proceeds of the next public offering of Purchaser, the net proceeds of which are designated to be used to redeem the Sunbase Preferred Shares. Purchaser shall provide to each holder (i) notice of its intention to file a registration statement with the Securities and Exchange Commission with respect to a public offering of its shares and (ii) a copy of Purchaser's most recent reports and registration statements filed with the SEC. In the event that such holder elects to redeem such holder's Sunbase Preferred Shares, such holder shall provide notice to Purchaser within 15 days from the date of the notice from Purchaser. The per share redemption price shall be $500 less the pro rata portion of the underwriter's commission with respect to the public offering. By way of example, if the redemption price otherwise payable to such holder is $400,000 and the underwriter's commission is 10%, Purchaser shall pay the redeeming holder $360,000. The redemption price payable to the redeeming holders shall be paid by Purchaser to such holders within twenty (20) business days after the closing of any public offering (as described herein) made by Purchaser. In the event that a holder elects not to have such holder's Sunbase Preferred Shares so redeemed, each Share not redeemed shall, on the same date that the redemption price is paid to the redeeming holders, be automatically converted into 100 shares of the common stock of Purchaser. The per share redemption price and the number of shares of common stock to be issuable upon conversion shall be subject to adjustment in the event of stock dividends, combinations or splits with respect to the common stock. (d) If, by that date which is two (2) years after the date on which the Sunbase Preferred Shares are distributed to the holders (the "Two Year Date"), such holders have not been able to redeem their Sunbase Preferred Shares because Purchaser has not made a public offering, the net proceeds of which are designated to be used to redeem the Sunbase Preferred Shares, the holder's Sunbase Preferred Shares shall automatically convert into shares of the common stock of Purchaser as follows: On the first business day following the Two Year Date, each Sunbase Preferred Share 7 shall automatically be converted into that number of shares of common stock of Purchaser that equals $500 divided by the lesser of (a) $5.00 or (b) the average closing price of the common stock of the Purchaser (subject to adjustment for stock dividends, combinations or splits). As used herein, the average closing price shall be computed by taking the then most recent 60 consecutive trading days where Purchaser's common stock has traded at a minimum volume of 2,000 shares per day for 45 of those 60 trading days. 2.2 Transfer Taxes. The Shareholders shall be solely responsible for -------------- the payment of any and all Taxes, impositions, liens, levies, assessments and similar charges incident to or incurred as a result of the transfer of the Southwest Shares pursuant to the Merger contemplated herein. ARTICLE III ----------- CLOSING ------- 3.1 Time and Place. Subject to the provisions of Sections 11.1 and -------------- 11.2 hereof, the Closing (the "Closing") shall take place at the offices of Loeb and Loeb, 1000 Wilshire Boulevard, Suite 1800, Los Angeles, California 90017, no later than January 19, 1996 (the "Outside Date"). 3.2 Transactions at the Closing. At the Closing, the following shall --------------------------- occur: 3.2.1 Pursuant to the Merger, the Shareholders shall receive certificates representing the Sunbase Preferred Shares; 3.2.2 Pursuant to the Merger, the Southwest Shares will be automatically converted into Sunbase Preferred Shares, and the Shareholders shall surrender all of the certificates evidencing the Southwest Shares for conversion into Sunbase Preferred Shares; 3.2.3 The Company shall deliver to Purchaser the opinion of counsel referred to in Section 9.5 hereof; 3.2.4 Purchaser shall deliver to the Company and the Shareholders the opinion of counsel referred to in Section 10.6 hereof; 3.2.5 All of the directors of the Company other than William McKay shall deliver the resignations referred to in Section 7.5 hereof; 3.2.6 William McKay shall deliver the Non-Competition Agreement referred to in Section 7.6 hereof; 8 3.2.7 The Company and Purchaser on the one hand and, on the other hand, William McKay, shall execute and deliver counterpart copies of the employment agreement referred to in Section 8.3 hereof; 3.2.8 The Company shall provide to Purchaser a certificate of good standing with respect to its jurisdiction of formation and each other jurisdiction in which the Company has qualified to do business; and 3.2.9 The Company shall deliver to Purchaser any and all other assignments, documents, instruments and conveyances requested by Purchaser or necessary to effect the consummation of the transactions contemplated by this Agreement. The foregoing transactions shall be deemed to occur simultaneously at the Closing. ARTICLE IV ---------- REPRESENTATIONS AND WARRANTIES OF THE ------------------------------------- SHAREHOLDERS REGARDING THE SOUTHWEST SHARES AND THEIR STATUS ------------------------------------------------------------ Each Shareholder, individually, represents and warrants to Purchaser that: 4.1 Title to Southwest Shares. Such Shareholder has good and ------------------------- marketable title to the Southwest Shares, which are free and clear of all Liens or Other Encumbrances excepting only such restrictions upon transfer, if any, as may be imposed by federal or state securities Laws. 4.2 Authority to Execute and Perform Agreements. Such ------------------------------------------- Shareholder has the full right, power and authority to enter into, execute and deliver this Agreement and all other Shareholder Documents. 4.3 Due Authorization; Enforceability. Such Shareholder has --------------------------------- taken all actions necessary to authorize such Shareholder to enter into and perform said Shareholder's obligations under this Agreement and all other Shareholder Documents. This Agreement is, and as of the Closing Date the other Shareholder Documents will be, the legal, valid and binding obligations of such Shareholder, enforceable in accordance with their respective terms. 4.4 No Violation of Order or Law. Such Shareholder is not a ---------------------------- party to, subject to or bound by any Law or Order which would prevent the execution or delivery of this Agreement by such Shareholder or the performance by such Shareholder of such Shareholder's obligations hereunder. 9 4.5 Adverse Agreements; Consents. Neither the execution or ---------------------------- delivery by such Shareholder of this Agreement or any other Shareholder Document nor the consummation by such Shareholder of the transactions contemplated herein or therein require the consent of any Person except, as applicable, the consent of each Shareholder's spouse, which consent shall be given by such spouse substantially in the form which is attached hereto as Schedule 4.5. 4.6 Securities Laws. Such Shareholder has obtained all necessary --------------- permits and other authorizations or Orders of exemption as may be necessary or appropriate under any and all applicable state securities Laws with respect to the transactions contemplated herein, except that no such representation or warranty is made with respect to the issuance by Purchaser of the Sunbase Preferred Shares or the Sunbase Shares. 4.7 No Adverse Litigation. To such Shareholder's Knowledge, such --------------------- Shareholder is not a party to any pending or threatened litigation which seeks to enjoin or restrict such Shareholder's own ability to sell or transfer his Southwest Shares hereunder, nor is any such litigation threatened against such Shareholder. Furthermore, to such Shareholder's Knowledge, there is no litigation pending or threatened against such Shareholder which, if decided adversely to such Shareholder, could adversely affect such Shareholder's ability to consummate the transactions contemplated herein. 4.8 No Broker. No broker or finder has acted for such --------- Shareholder in connection with this Agreement or the transactions contemplated herein, and no broker or finder is entitled to any brokerage or finder's fees or other commissions in respect of such transactions based in any way upon agreements, arrangements or understandings made by or on behalf of such Shareholder. 4.9 Investment Capacity. Each of the Shareholders understands ------------------- and agrees that (a) the Sunbase Preferred Shares to be issued to the Shareholders and the shares of Purchaser's Common Stock issuable upon conversion of the Sunbase Preferred Shares (together with the Sunbase Preferred Shares, the "Sunbase Shares") will not have been registered under the Securities Act of 1933, as amended (the "Securities Act") or the securities laws of any state, based upon an exemption from such registration requirements under the Securities Act; (b) the Sunbase Shares are and will be "restricted securities", as said term is defined in Rule 144 of the Rules and Regulations promulgated under the Securities Act; (c) the Sunbase Shares may not be sold or otherwise transferred unless they have been first registered under the Securities Act and applicable state securities 10 laws, or unless exemptions from such registration provisions are available with respect to said resale or transfer; (d) except as expressly set forth herein, Purchaser is under no obligation to register the Sunbase Shares under the Securities Act or any state securities laws, or to take any action and make any exemption from such registration provisions available; and (e) Purchaser is relying on the representation by each Shareholder (which is herein being made) that such Shareholder has such knowledge and experience in financial or business matters that such Shareholder is capable of evaluating the merits and risks involved in the investment in the Sunbase Preferred Shares and is able to bear the economic risk and complete loss of such Shareholder's investment. 4.10 Status of Shareholders; Receipt of Documentation. The ------------------------------------------------ Shareholders acknowledge that they have received a copy of the following documents of Purchaser: Form 10-K for the transition period from July 1, 1994 to December 31, 1994; Form 10-Q for the quarter ended March 31, 1995; Form 10-Q for the quarter ended June 30, 1995; From 10-Q for the quarter ended September 30, 1995; Form 8-K as of December 22, 1994; and Form 8-K/A as of December 22, 1994 and any other reports and registration statements filed by Purchaser with the SEC after December 31, 1994. Each Shareholder has been furnished with such information and documents pertaining to Purchaser as such Shareholder has requested, and has been given the opportunity to meet with officials of Purchaser and to have such persons answer questions regarding Purchaser's affairs and condition. Each Shareholder has substantial experience in business and financial matters and in making investments of the type contemplated by this Agreement; is capable of evaluating the merits and risks of the acquisition of the Sunbase Preferred Shares; and is able to bear the economic risks of such Shareholder's investment. 4.11 Waiver of Appraisal Rights. Each of the Shareholders hereby -------------------------- waives any right to require appraisal or to otherwise exercise any other rights pursuant to Chapter 13 of the California Corporations Code. 4.12 Issuance of Sunbase Preferred Shares to Third Parties. Each ----------------------------------------------------- of the Shareholders understands and agrees that in connection with the loan described in Section 9.8 below, 500 Sunbase Preferred Shares will be issued to certain third parties as incentive for such third parties to make a loan to the Company. Because Sunbase will issue a total of 6,800 Sunbase Preferred Shares in connection with the Merger, and based on the issuance of 500 Sunbase Preferred Shares to such certain parties, the Shareholders will receive a total of 6,300 Sunbase Preferred Shares, as set forth in Section 2.1 above. 11 ARTICLE V --------- REPRESENTATIONS, WARRANTIES AND COVENANTS ----------------------------------------- RELATING TO THE COMPANY ----------------------- The Company and, to their Knowledge, each of the Shareholders, hereby severally represent, warrant and covenant to Purchaser as follows: 5.1 Organization, Standing, Etc. of the Company. The Company is ------------------------------------------- a corporation duly organized, validly existing and in good standing under the laws of the State of California and has all requisite corporate power and authority to carry on its business as currently conducted and to own or lease and to operate the properties that it now owns or leases. The Company is duly qualified and in good standing to do business as a foreign corporation in the jurisdictions described in Schedule 5.1. Except as set forth in Schedule 5.1, there are no other states or jurisdictions in which the character or location of the properties owned or leased by it, or the conduct of its business, make such qualification necessary or where the failure to so qualify and be in good standing would have a material adverse effect on the Company's financial condition or results of operation. Copies of the Company's Articles of Incorporation and all amendments thereto, and of the Company's Bylaws as amended to date, have been furnished to Purchaser and are complete and correct. 5.2 No Violation. Neither the execution and delivery of this ------------ Agreement or the Subsidiary Merger Agreement and all other Company Documents nor the consummation of the transactions contemplated herein and therein will (a) violate any provision of the Articles of Incorporation or Bylaws of the Company; (b) violate, conflict with, or constitute a default under any material Contract or Other Agreement or other instrument to which the Company is a party or by which it or its property is bound; (c) except as set forth in Schedule 5.2, require the consent of any party to any material Contract or Other Agreement to which the Company is a party by which it or its property is bound; or (d) violate any Laws or Orders to the which the Company or its property is subject. 5.3 Capitalization. Immediately prior to the Closing, the -------------- authorized capital stock of the Company will consist of ten million (10,000,000) shares of no par value Common Stock of which 9,450,000 shares are issued and outstanding. Schedule 5.3 sets forth a true, correct and complete list of the shareholders of the Company, and (i) prior to conversion, the number of shares of Common Stock and Southwest Preferred Shares issued and outstanding, together with the principal amount and holders of the 12 Subordinated Debt and (ii) after conversion, the number of the Southwest Shares. Except as set forth on such Schedule, there are no options, warrants, calls or rights of any kind to purchase or otherwise acquire, and no securities are convertible into, the capital stock of Company, and there are no other agreements of any kind or character obligating the Company to issue, transfer or sell any of its capital stock authorized or outstanding or to register any such stock with any securities agency. There is no personal liability, and there are no preemptive or similar rights, attached to the Company's Common Stock or Preferred Stock. The Southwest Shares have been duly authorized and are fully paid and non-assessable. 5.4 Authority for Agreement. The Company has all requisite ----------------------- power and authority to enter into this Agreement and the Subsidiary Merger Agreement, to perform its obligations hereunder and to consummate the transactions contemplated hereby. This Agreement constitutes or will constitute, as the case may be, the legal, valid and binding obligation of the Company, enforceable against the Company in accordance with its terms. The execution and delivery of this Agreement and the Subsidiary Merger Agreement and the consummation of the transactions contemplated hereby will not conflict with, or result in any violation of or default under, any provision of any mortgage, indenture, lease, agreement or other instrument, or any permit, concession, grant, franchise, license, Order or Law, applicable to the Company or any of its properties. 5.5 Consents. No consent, license, approval, order or -------- authorization of, or registration, filing or declaration with, any Authority is required to be obtained or made, and no consent of any third party is required to be obtained, by the Company in connection with the execution, delivery or performance of this Agreement or the Subsidiary Merger Agreement, or the consummation of any other transactions contemplated hereby or thereby. 5.6 Financial Statements. The Southwest Financial Statements -------------------- which are attached hereto as Schedule 5.6, were prepared in accordance with generally accepted accounting principles applied on a consistent basis during the periods involved (except as may be otherwise indicated in the notes thereto), and fairly present the financial position of the Company as of the dates thereof and the results of its operations and changes in financial position for the periods then ended. 5.7 Subsidiaries. Except as set forth on Schedule 5.7, the ------------ Company has no Subsidiaries and does not own, directly or indirectly, any capital stock of, or have 13 any direct or indirect equity or ownership interest in the business of, any corporation or entity. 5.8 Litigation. Except as set forth on Schedule 5.8 hereto, ---------- there is no action, proceeding, investigation or inquiry whatsoever pending, or, to the Company's or Shareholders' Knowledge, threatened, affecting the Company or its assets or which questions the validity of this Agreement. 5.9 Trademarks, Trade Names, Patents, Etc. Schedule 5.9 hereto -------------------------------------- contains a complete and correct list and description of trademarks, trade names, copyrights, patents and all applications therefor, and other similar intellectual property rights used or held for use by the Company (the "Property Rights"). To the best of the Company's Knowledge, the Company owns or has the right to use all of the Property Rights which are material to the Business of the Company and to continue to do so after the Closing on substantially the same basis. None of the Property Rights violates any laws, statutes, ordinances or regulations, or infringes upon or violates any rights of others, or is being infringed by others. The Company has not received any notice or claim that any Property Right is not valid or enforceable by its owner or that there has been any infringement of any copyright, patent or other property right of any third party by the Company. 5.10 Employees. Schedule 5.10 hereto contains a complete and --------- correct list of the names of all current employees, consultants and commission agents of the Company together with compensation earned during the twelve months ended June 30, 1995 (including any bonuses and commissions and fringe benefits not generally available to the Company's employees). For employees, consultants and commission agents hired or retained since June 30, 1995, Schedule 5.10 sets forth the rate of compensation. To the Company's Knowledge, the Company is in compliance in all material respects with all applicable Laws respecting employment and employment practices, terms and conditions of employment and wages and hours. There are no pending or, to the Company's Knowledge, threatened, labor negotiations, work stoppages or work slow downs involving or affecting the Company or its Business, and no union representation questions exist, and there are no organizing activities, in respect of any of the employees of the Company. 5.11 Contracts. Schedule 5.11 attached hereto contains a --------- complete and correct list as of the date hereof of all Contracts and other Agreements to which the Company is a party or by which it or any of its property is bound which are material to the Company, its assets or its financial condition. Except as disclosed on Schedule 5.11A, (a) 14 all Contracts and other Agreements are in full force and effect and unimpaired by any defaults, acts or omissions of the Company and, based on the Company's Knowledge, unimpaired by any defaults, acts or omissions of any party thereto; and (b) no approval or consent of any party to such Contracts and Agreements is required in connection with the consummation of the transactions contemplated hereby. 5.12 Transactions with Interested Persons. Except as set forth ------------------------------------ on Schedule 5.12, no officer, director or employee (or spouse or any child thereof) of the Company owns, directly or indirectly, on an individual or joint basis, any material interest in, or serves as an officer, director or employee of, any customer, competitor or supplier of the Company or any person or entity which has a contract or arrangement with the Company (including without limitation leases, as lessor, of real property or personal property). 5.13 Bank Accounts. Attached hereto as Schedule 5.13 is a ------------- complete and correct list of each bank or other financial institution in which the Company has an account or safe deposit or lock box, the account or box number, as the case may be, and the name of every person authorized to draw thereon or having access thereto. 5.14 Compliance with Other Instruments or Laws. To the best of ----------------------------------------- the Company's Knowledge, the operations of the Company are in material compliance with all Laws applicable to the operation of the Company's business. Schedule 5.14 hereto lists all material permits, concessions, grants, franchises, licenses and other governmental authorizations or approvals applicable to the operation of the Business. 5.15 Environmental Matters. Except as disclosed in the Phase I --------------------- Environmental Site Assessment and Limited Phase II Subsurface Investigation Report dated April 7, 1995, prepared by Converse Environmental West, and notwithstanding the introduction paragraph to this Article V, based on the actual knowledge of both the Shareholders and the Company: (i) the operations of the Company comply in all respects with all applicable federal, state and local environmental, health and safety statutes and regulations; (ii) none of the operations of the Company involves the unlawful generation, transportation, treatment or disposal of hazardous waste, as defined under 40 C.F.R. Parts 260- 270 or any state equivalent, the Company has not disposed of any hazardous waste or substance by placing it in or on the ground of any premises owned, leased or used by the Company, and no underground storage tanks or surface impoundments are on any of the premises of the Company; (iii) no lien in favor of any Governmental Authority for (a) any liability 15 under federal or state environmental laws or regulations, or (b) damages arising from or costs incurred by such Governmental Authority in response to a release of a hazardous or toxic waste, substance or constituent, or other substance, into the environment, has been filed or attached to any premises of the Company, and the Company has no contingent liability in connection with any release of any hazardous or toxic waste, substance or constituent, or other substance, into the environment, (iv) none of the operations of the Company is subject to any judicial or administrative proceeding alleging the violation of any federal, state or local environmental, health or safety statute or regulation, and none of the operations of the Company is the subject of any federal or state investigation evaluating whether any remedial action is needed to respond to a release of any hazardous or toxic waste, substance or constituent, or any other substance, into the environment. 5.16 Broker's Commissions. No broker is entitled to any -------------------- brokerage or finder's fee or other commission or fee from the Company as a direct or indirect consequence of any commitment or other arrangement made on behalf of the Company in connection with the transactions contemplated by this Agreement. 5.17 Tax Returns and Payments. Except as set forth on Schedule ------------------------ 5.17, all Tax Returns or appropriate extensions therefor of the Company have been duly, properly and timely filed, and, to the best of the Company's Knowledge, all Taxes which have become due and payable have been paid in full. Complete and accurate copies of all Tax Returns for the taxable years ended February 28, 1993 and February 28, 1994 have been delivered to Purchaser. Except as set forth on Schedule 5.17, neither the Internal Revenue Service nor any other Tax Authority is now asserting or, to the best Knowledge of the Company, threatening to assert against the Company a deficiency or claim for additional Taxes or interest thereon or penalties in connection therewith. 5.18 Disclosure. The representations and warranties contained in ---------- this Agreement and the information contained in the Schedules and the certificates required to be delivered pursuant hereto in connection with the transactions contemplated hereby are true and correct in all material respects and do not omit to state any material fact necessary to make the statements contained therein not misleading. 5.19 Liabilities. Except as set forth on Schedule 5.19, the ----------- Company does not have any material liability or obligation, whether accrued, absolute, contingent or otherwise, which (a) has not been reflected in the Southwest 16 Financial Statements, or (b) has not been incurred since June 30, 1995 in the ordinary course of business or in connection with the transactions contemplated by this Agreement. 5.20 Insurance. Schedule 5.20 contains a complete and accurate --------- list of all policies of fire, liability, workmen's compensation, health, key man and other forms of insurance currently in effect with respect to the Company and the Business, true copies of which have heretofore been delivered to Purchaser. 5.21 ERISA. ----- (i) Plans. Schedule 5.21 lists each "employee pension ----- benefit plan" of the Company (collectively called "Pension Plans" and severally called a "Pension Plan"), as such term is defined in Section 3(2) of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), and each "employee welfare benefit plan" (collectively called "Welfare Plans" and severally called a "Welfare Plan") of the Company as such term is defined in Section 3(1) of ERISA, which is maintained by the Company or to which it contributes or is obligated or required to contribute or has been terminated by the Company. The Pensions Plans and Welfare Plans are hereinafter sometimes collectively referred to as the "Plans" and severally referred to as a "Plan". At present and during the past five years, the Company has neither sponsored, participated in, nor contributed to: (i) any defined benefit plans to which Section 4021 of ERISA applies that would create a liability under Title IV of ERISA and/or (ii) any "multi-employer plan" as defined in Section 3(37) of ERISA. (ii) Qualification. Each Pension Plan and the trust (if any) ------------- forming a part thereof has been determined by the Internal Revenue Service ("IRS") to be qualified under Section 401(a) of the Code, except with respect to changes in federal law resulting from the Tax Reform Act of 1986 and subsequent revenue acts, and is exempt from taxation under Section 501(a) of the Code, and to the Knowledge of the Company, nothing has occurred since the date of such determination which would severally affect such qualification. (iii) Compliance with Law and Plan. All Plans are now and ---------------------------- have at all times been established, maintained and operated in all material respects in accordance with all applicable Law (including, but not limited to ERISA and the Code and for health plans all COBRA requirements) and the Plan documents. All plan fiduciaries and plan officials are bonded as required. 17 (iv) Contributions; Benefit. The Company has paid in full ---------------------- all amounts which are required to have been paid by it on or prior to the date hereof as contributions to any of the Pension Plans. All contributions, premiums, charges or obligations to each Welfare Plan have been complete and timely made or will be made prior to the Closing Date. The amount of each payment to each Plan is sufficient to provide for all benefits earned or promised and other liabilities accrued under each Plan through the Closing Date. For each non-funded Plan, the Company has established reserves on its books to provide for the benefits earned and other liabilities accrued under each Plan through the Closing Date in amounts sufficient to provide for such benefits. No funds held or under the control of the Company would be deemed plan assets. 5.22 Compliance With Securities Laws. The Company is, and at all ------------------------------- times since its inception has been, in compliance in all material respects with all federal and state securities statutes, orders, rules and regulations (including without limitation statutes, orders, rules and regulations pertaining to any purchase or sale of the capital stock of the Company and any private offering of securities of the Company under Regulation D of the Securities Act) applicable to it or to the operation of the Business. The Company has no basis to expect, nor has it received, during the five-year period prior to the date hereof, any order, notice or other communication from any federal or state agency administering or enforcing the federal and state securities laws of any alleged, actual or potential violation and/or failure to comply with any such statute, order, rule or regulation. 5.23 Inventories. All inventories shown on the Southwest ----------- Financial Statements and all inventories existing as of the date hereof consisted of, and consist of, items of a quality and quantity usable and saleable in the ordinary course of the Business without markdown or discount; were, and are, merchantable and fit for the particular purpose, except for obsolete and slow-moving items and items below standard quality (which in any event did not, and do not, exceed normal commercial standards and amount), all of which had been, and have been, written down on the books of the Company to the lower of cost or net realizable market value or had been, and have been, provided for by adequate reserves. The amounts of the inventories shown on the Southwest Financial Statements were based on quantities determined by physical count or measurement, taken on the date of the applicable balance sheet, and valued at the lower of cost (determined on a first-in, first-out basis) or market value and on a basis consistent with that of prior years. 18 ARTICLE VI ---------- REPRESENTATIONS, WARRANTIES AND COVENANTS OF PURCHASER ------------------------------------------------------ Purchaser represents, warrants and covenants to the Company and the Shareholders as follows: 6.1 Organization, Standing, Etc. of the Company. Purchaser is a ------------------------------------------- corporation duly organized, validly existing and in good standing under the laws of the State of Nevada and has all requisite corporate power and authority to carry on its business as currently conducted and to own or lease and to operate the properties that it now owns or leases. Purchaser is duly qualified and in good standing to do business as a foreign corporation in those states and jurisdictions where the failure to so qualify would have a material adverse effect on Purchaser's financial condition or the results of its operations. Copies of Purchaser's Articles of Incorporation and all amendments thereto, and of Purchaser's Bylaws as amended to date, have been furnished to the Company and the Shareholders and are complete and correct. 6.2 Authority for Agreement. Purchaser has all requisite power ----------------------- and authority to enter into this Agreement and the Subsidiary Merger Agreement, to perform its obligations hereunder and to consummate the transactions contemplated hereby. This Agreement constitutes the legal, valid and binding obligation of Purchaser, enforceable against Purchaser in accordance with its terms. The execution and delivery of this Agreement and the Subsidiary Merger Agreement and the consummation of the transactions contemplated hereby will not conflict with, or result in any violation of or default under, any provision of any mortgage, indenture, lease, agreement or other instrument, or any permit, concession, grant, franchise, license, Order or Law, applicable to Purchaser or any of its properties. 6.3 No Violation. Neither the execution and delivery of this ------------ Agreement and the Purchaser Documents nor the consummation of the transactions contemplated herein and therein will (a) violate any provision of the Articles of Incorporation or bylaws of Purchaser; (b) violate, conflict with, or constitute a default under any material Contract or Other Agreement or other instrument to which Purchaser is a party or by which it or its property is bound; (c) require the consent of any party to any material Contract or Other Agreement to which Purchaser is a party or by which it or its property is bound; or (d) violate any Laws or Orders to which Purchaser or its property is subject. 6.4 Litigation. There is no action, proceeding, investigation ---------- or inquiry pending or, based on the actual 19 knowledge of the Purchaser, threatened, that materially affects Purchaser, its Affiliates or its assets, or that questions the validity of this Agreement. 6.5 Contracts. All Contracts and other Agreements to which --------- Purchaser is a party are in full force and effect and unimpaired by any defaults, acts or omissions of Purchaser and no approval or consent of any party to such Contracts and Agreements is required in connection with the consummation of the transactions contemplated hereby. Without limiting the generality of the foregoing, there are no provisions in Purchaser's Articles of Incorporation or Bylaws, or in any Contracts or other Agreements to which Purchaser is a party, which would prevent Purchaser from redeeming the Sunbase Preferred Shares, nor will Purchaser amend such Articles (including a reincorporation) or Bylaws, or enter into any Contract or other Agreement, the effect of which would prevent the redemption of the Sunbase Preferred Shares by Purchaser. In addition, based on Purchaser's actual knowledge, Purchaser's joint venture contract with Shanghai Hong Xing Bearing Factory, dated March 18, 1994 is unimpaired by any defaults, acts or omissions of Shanghai Hong Xing Bearing Factory. 6.6 Approvals. All consents, approvals, authorizations and --------- other requirements prescribed by any Law or Order, including, but not limited to, those relating to federal and state securities laws with respect to the issuance of the Sunbase Preferred Shares, which must be obtained or satisfied by Purchaser and which are necessary for the execution and delivery by Purchaser of this Agreement and all other Purchaser Documents, and the consummation of the transactions contemplated in this Agreement will be obtained and satisfied prior to Closing. 6.7 SEC Filings. Since January 1, 1995, Purchaser has timely ----------- filed and, as required by Section 13 of the Exchange Act, will continue to timely file, all the required forms, reports and other documents with the Securities and Exchange Commission. As of the date hereof, and at the Effective Time, all reports, forms and other documents so filed do not, and will not, contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. 6.8 No Adverse Change. Except as may be disclosed in the SEC ----------------- filings described in Section 6.7 above, there has not been any material adverse change in the assets, or existing or prospective financial condition of Purchaser since December 31, 1994. 20 6.9 Sunbase Financial Statements. The Sunbase Financial ---------------------------- Statements were prepared in accordance with generally accepted accounting principles applied on a consistent basis during the periods involved (except as may otherwise be indicated in the notes thereto) and fairly present the financial position of Purchaser as of the dates thereof and the results of operations and changes in financial position for the periods then ended. 6.10 Investment Representation. Purchaser is acquiring the ------------------------- Southwest Shares for investment purposes only and not with a view to any distribution or resale thereof. 6.11 Sunbase Preferred Shares. At the Closing, the Sunbase ------------------------ Preferred Shares and, at the time of their issuance pursuant to Article II hereof, the Sunbase Shares, shall be duly authorized, validly issued, fully paid and non-assessable. 6.12 No Broker. Except for Millennium Capital Partners, Ltd., no --------- broker, finder, agent or similar intermediary has acted for or on behalf of Purchaser in connection with this Agreement or the transactions contemplated hereby, and no broker, finder, agent or similar intermediary is entitled to any broker's, finder's, or similar fee or other commission in connection therewith based on any agreement, arrangement or understanding with Purchaser or any action taken by Purchaser. 6.13 Formation of Newco. As soon as practicable after execution ------------------ of this Agreement, Purchaser shall cause Newco to be formed, all of the stock of which will be held by Purchaser. 6.14 Capitalization. The authorized capital stock of Purchaser -------------- consists of 50,000,000 shares of Common Stock with a par value of $.001 of which 11,700,063 shares are issued and outstanding and 25,000,000 of Preferred Stock with a par value of $.001 of which 36 shares of Series A Preferred Stock are issued and outstanding. Except as set forth on Schedule 6.14, there are no options, warrants, calls or rights of any kind to purchase or otherwise acquire, and no securities are convertible into, the capital stock of Purchaser, there are no other agreements of any kind or character obligating Purchaser to issue, transfer or sell any of its capital stock authorized or outstanding and there is no personal liability, and there are no preemptive or similar rights, attached to Purchaser's Common Stock or Preferred Stock. 21 ARTICLE VII ----------- COVENANTS AND AGREEMENTS OF THE PARTIES --------------------------------------- EFFECTIVE PRIOR TO CLOSING -------------------------- 7.1 Corporate Examinations and Investigations. Prior to the ----------------------------------------- Closing Date, Purchaser shall be entitled, through its employees and representatives, to make such investigations of the property and plant and such examination of the books, records and financial condition of the Company as Purchaser may request. In order that Purchaser may have the full opportunity to do so, the Company and the Shareholders shall furnish Purchaser and its representatives during such period with all such information concerning the affairs of the Company as Purchaser or such representatives may request and cause the Company's officers, employees, consultants, agents, accountants and attorneys to cooperate fully with Purchaser or such representatives in connection with such review and examination and to make full disclosure of all information and documents reasonably requested by Purchaser and/or such representatives. Any such investigations and examinations shall be conducted at reasonable times and under reasonable circumstances. 7.2 Cooperation; Consents. Prior to the Closing Date, each --------------------- party shall cooperate with the other to the end that the parties shall (i) in a timely manner make all necessary filings with, and conduct negotiations with, all Authorities and other Persons the consent or approval of which, or a license or permit from which, is required for the consummation of the transactions contemplated by this Agreement and the Subsidiary Merger Agreement and (ii) provide to each other party such information as the other party may reasonably request in order to enable it to prepare such filings and to conduct such negotiations. Without limiting the foregoing, Purchaser shall cause Newco to take all actions necessary to execute and file the Subsidiary Merger Agreement and to effect all transactions contemplated of Newco by this Agreement. The parties shall also use their respective best efforts to expedite the review process and to obtain all such necessary consents, approvals, licenses and permits as promptly as practicable. To the extent permitted by Law, the parties shall request that each Authority or other Person whose review, consent or approval is requested treat as confidential all information which is submitted to it. 7.3 Conduct of Business. From the date hereof through the ------------------- Closing Date, the Company and Purchaser shall conduct their respective businesses and operations in such a manner so that the representations and warranties contained in Article V hereof shall continue to be true and correct as 22 of the Closing Date as if made at and as of the Closing Date. 7.4 Preservation of Business. From the date hereof through the ------------------------ Closing Date, the Company and Purchaser shall conduct their respective Businesses only in the ordinary course and consistent with prior practices and shall use their best efforts to (a) maintain their respective existences and business organizations; (b) maintain their respective relationships with customers and suppliers; (c) preserve their respective goodwill; and (d) satisfy their respective obligations to their creditors and suppliers. Without limiting the generality of the foregoing, the Company shall not, unless Purchaser shall otherwise agree in writing or as otherwise expressly provided herein, directly or indirectly, do any of the following: (i) amend its Articles of Incorporation or Bylaws; (ii) authorize for issuance, issue, sell, deliver or agree to commit to issue, sell or deliver any shares of any class of its capital stock or any securities convertible into shares of any class of its capital stock; (iii) split, combine or reclassify any shares of its capital stock; declare, set aside or pay any dividend or other distribution in respect of its capital stock; or purchase, redeem or otherwise acquire any shares of its capital stock; (iv) except for the loan described in Section 9.8 below, create, incur or assume any debt or assume, guarantee, endorse or otherwise become liable for the obligations of any person or make any loans, advances or capital contributions to, or investments in, any other person; and (v) except in the ordinary course of business consistent with past practices, sell, transfer, mortgage or otherwise dispose of or encumber any properties. 7.5 Resignations. On or prior to the Closing Date, all of the ------------ directors of the Company except William McKay shall resign, in writing, as directors of the Company, and the designees of Purchaser shall be elected to the Board of Directors of the Company, all effective as of the Closing Date. 7.6 Non-Competition. On or prior to the Closing Date, William --------------- McKay shall execute and deliver to the Company a Non-Competition Agreement in form and substance reasonably satisfactory to Purchaser. 23 7.7 No Solicitation or Negotiation. Unless and until this ------------------------------ Agreement is terminated, neither the Company nor any of the Shareholders shall, nor shall they cause, suffer or permit the directors, officers, employees, representatives, agents, investment bankers, advisors, accountants or attorneys of the Company or the Shareholders to, directly or indirectly, solicit or negotiate any offer for the sale of the Company's assets or stock. 7.8 Update of Representations and Warranties. Each party hereto ---------------------------------------- shall promptly notify the other party in writing of any changes to such party's representations and warranties contained herein which occurred during the period between the date hereof and the Closing Date. The obligation contained in this Section 7.9 is not intended to nor shall it diminish such party's obligation with respect to the completeness and correctness of such party's representations and warranties made as of the date hereof. ARTICLE VIII ------------ CONDITIONS PRECEDENT TO THE OBLIGATION -------------------------------------- OF EACH PARTY TO CLOSE ---------------------- The obligation of the Shareholders, the Company and Purchaser to consummate the transactions contemplated herein shall be subject to the fulfillment, at or prior to the Closing, of all of the conditions set forth below in this Article VIII. 8.1 No Action or Proceeding. No action, suit or proceeding ----------------------- shall have been instituted or be pending before any court or governmental body seeking to challenge or restrain the transactions contemplated herein which presents a substantial risk that such transactions will be restrained or that either party hereto may suffer material damages or other relief as a result of consummating such transactions. 8.2 Governmental Approvals. Any and all permits and approvals ---------------------- from any Authority required for the lawful consummation of the transactions contemplated herein shall have been obtained. 8.3 Employment Agreements. The Company and Purchaser, on the --------------------- one hand, and William McKay, on the other hand, shall have entered into an employment agreement covering certain tasks to be performed by William McKay on behalf of the Company and the Purchaser. 24 ARTICLE IX ---------- CONDITIONS PRECEDENT TO THE OBLIGATION -------------------------------------- OF PURCHASER TO CLOSE --------------------- The obligation of Purchaser to consummate the transactions contemplated herein shall be subject to the fulfillment, at or before the Closing Date, of all of the conditions set forth below in this Article IX. 9.1 Representations and Warranties. The representations and ------------------------------ warranties of the Shareholders and the Company contained in this Agreement, in any Company Document and in any Shareholder Document shall be true on and as of the Closing Date with the same force and effect as though made on and as of the Closing Date, and at the Closing each Shareholder and the Company shall each have delivered to Purchaser a certificate to such effect signed by such Shareholder and the President of the Company (as to his best Knowledge and solely in his capacity as President), as appropriate, and addressed to Purchaser. 9.2 Performance of Covenants. Each of the obligations of each ------------------------ Shareholder to be performed by such Shareholder and each obligation of the Company to be performed by it on or before the Closing Date pursuant to the terms of this Agreement shall have been duly performed on or before the Closing Date, and at the Closing each Shareholder and the Company shall have delivered to Purchaser a certificate attesting to such performance signed by such Shareholder and the President of the Company (as to his Knowledge and solely in his capacity as President), as appropriate, and addressed to Purchaser. 9.3 Third-Party Consents. Except as set forth in Schedule -------------------- 5.11A, all consents, permits and approvals from Authorities and from parties to any Contract or Other Agreement listed in Schedule 5.11 which may be required in connection with the consummation of the transactions contemplated hereby or the continuance of such Contract or Other Agreement after the Closing Date shall have been obtained by the Company upon terms and conditions satisfactory to Purchaser. 9.4 No Adverse Change. Except for liabilities incurred in the ----------------- ordinary course of business and consistent with past practice, there shall not have occurred between the date hereof and the Closing Date any Material Adverse Change in the condition (financial or otherwise), assets, liabilities (whether absolute, accrued, contingent or otherwise) of the Company, the Business or in the ability of the Shareholders or the Company to consummate the transactions contemplated herein. 25 9.5 Opinion of Counsel to the Company. Purchaser shall have --------------------------------- received the favorable opinion of Bruck & Perry, counsel to the Company, dated as of the Closing Date, addressed to Purchaser, in form and substance satisfactory to Purchaser's counsel, to the substantial effect that: 9.5.1 The Company is duly organized, validly existing and in good standing under the Laws of California and has all requisite power to own, lease and operate its assets, properties and Business as now conducted. 9.5.2 The Company has the full right, power and authority required to enter into, execute and deliver this Agreement and the other Company Documents in connection herewith and to perform fully its obligations hereunder and thereunder. 9.5.3 This Agreement and the other Company Documents have been duly and validly authorized, executed and delivered by the Company, and constitute the legal, valid and binding obligations of the Company executing the same, enforceable in accordance with their respective terms, except as such enforceability may be limited by (i) bankruptcy, insolvency, reorganization, moratorium or similar Laws now or hereafter in effect relating to or limiting creditors' rights generally, and (ii) general principles of equity (whether considered in an action in equity or at law) which provide, among other things, that the remedies of specific performance and injunctive and other forms of equitable relief are subject to equitable defenses and to the discretion of the court before which any proceedings therefor may be brought. 9.5.4 Neither the execution and delivery of this Agreement and the Company Documents, nor the consummation of the transactions contemplated hereby and thereby will (i) violate any provision of the Articles of Incorporation, bylaws, or other charter documents of the Company; or (ii) to the best knowledge of such counsel after diligent inquiry, violate, or constitute a default under, or permit the termination or acceleration of the maturity of, any material indebtedness of the Company except as described in Schedule 5.2. 9.5.5 The Southwest Shares have been duly authorized, validly issued and are fully paid and non-assessable. As to any matter contained in such opinion which involves the Laws of a jurisdiction in which such counsel is not admitted to practice, such counsel may rely upon the opinion of local counsel of established reputation satisfactory to Purchaser. Any such opinion may expressly rely as to 26 matters of fact upon certificates furnished by appropriate officers of the Company or appropriate governmental officials. 9.6 Southwest Shares. Immediately prior to the Closing, the ---------------- Southwest Shares shall represent all of the outstanding shares of the capital stock of the Company on a fully diluted basis. 9.7 Derivative Securities. All existing Subordinated Debt, --------------------- Preferred Shares and outstanding options and warrants shall have been converted, exercised or cancelled by the holder thereof on or prior to the Closing Date so no other shares of capital stock other than the Southwest Shares shall be outstanding or issuable pursuant to exercise or conversion and the Subordinated Debt shall have been extinguished. 9.8 Shareholder Loan. One or more of the Shareholders and ---------------- certain third parties shall have made a loan to the Company in the aggregate amount of Five Hundred Thousand Dollars ($500,000) on the terms and conditions set forth in Schedule 9.8. The loan shall be repaid on the earlier of (i) one (1) year from the Closing Date or (ii) that date on which Purchaser receives proceeds of at least Two Million Dollars ($2,000,000) from a placement or offering of securities of Purchaser after the Closing Date. The Company's obligation to repay the loan to such Shareholders shall be guaranteed by Purchaser. 9.9 Foothill Consent. Foothill Capital Corporation ("Foothill") ---------------- shall have consented to the transactions contemplated herein, waived any right to accelerate any obligation owed by the Company to Foothill as a result of the Merger, and provided to Purchaser written confirmation as to the status of the loan made by Foothill to Southwest in such form and substance as Purchaser, at its sole discretion, deems acceptable. 9.10 Delivery of Southwest Shares. Each of the Shareholders ---------------------------- shall have surrendered all of the Southwest Shares owned by such Shareholder for conversion into Sunbase Preferred Shares. ARTICLE X --------- CONDITIONS PRECEDENT TO THE OBLIGATION -------------------------------------- OF THE SHAREHOLDERS AND THE COMPANY TO CLOSE -------------------------------------------- The obligation of the Shareholders and the Company to consummate the transactions contemplated herein shall be subject to the fulfillment, at or before the Closing Date, of all the conditions set forth below in this Article X. 27 10.1 Representations and Warranties. The representations and ------------------------------ warranties of Purchaser contained in this Agreement and in any Purchaser Document shall be true on and as of the Closing Date with the same force and effect as though made on and as of the Closing Date, and at the Closing Purchaser shall have delivered to the Shareholders a certificate to such effect signed by the Chief Financial Officer of Purchaser. 10.2 Performance of Covenants. Each of the obligations of ------------------------ Purchaser to be performed by it on or before the Closing Date pursuant to the terms of this Agreement shall have been duly performed on or before the Closing Date, and at the Closing, Purchaser shall have delivered to Shareholders a certificate to such effect signed by the Chief Financial Officer of Purchaser. 10.3 Authority. All actions required to be taken by, or on the --------- part of, Purchaser to authorize the execution, delivery and performance of this Agreement, and the consummation of the transactions contemplated hereby shall have been duly and validly taken by Purchaser's Board of Directors. 10.4 No Adverse Change. Except as may be disclosed in the SEC ----------------- filings described in Section 6.7 above, there has not been any material adverse change in the assets, or existing or prospective financial condition of Purchaser, since December 31, 1994. Furthermore, except for liabilities incurred in the ordinary course of business and consistent with past practice, there shall not have occurred between the date hereof and the Closing Date any material adverse change in the condition (financial or otherwise), assets, liabilities (whether absolute, accrued, contingent or otherwise) of Purchaser, its business, or in the ability of Purchaser to consummate the transactions contemplated herein. 10.5 Third-Party Consents. Except as set forth in Schedule 10.5, -------------------- all consents, permits and approvals from Authorities and from parties to any Contract or Other Agreement which may be required in connection with the consummation of the transactions contemplated hereby or the continuance of such Contract or Other Agreement after the Closing Date shall have been obtained by Purchaser upon terms and conditions satisfactory to the Company. 10.6 Opinion of Counsel to Purchaser. The Shareholders and the ------------------------------- Company shall have received the favorable opinion of Loeb and Loeb, counsel to Purchaser, dated as of the Closing Date, addressed to the Company, in form and substance satisfactory to the Company's counsel, to the substantial effect that: 28 10.6.1 Purchaser is a corporation duly incorporated, validly existing and in good standing under the Laws of the State of Nevada. 10.6.2 Purchaser has all requisite power, authority and approval required to enter into, execute and deliver this Agreement and the Purchaser Agreements and to perform fully Purchaser's obligations hereunder and thereunder. 10.6.3 This Agreement and all Purchaser Documents have been duly and validly authorized, executed and delivered by Purchaser and constitute the legal, valid and binding obligations of Purchaser, enforceable in accordance with their respective terms, except as such enforceability may be limited by (i) bankruptcy, insolvency, reorganization, moratorium or similar Laws now or hereafter in effect relating to or limiting creditors' rights generally, and (ii) general principles of equity (whether considered in an action in equity or at law) which provide, among other things, that the remedies of specific performance and injunctive and other forms of equitable relief are subject to equitable defenses and to the discretion of the court before which any proceedings therefor may be brought. 10.6.4 At the time of Closing, the Sunbase Preferred Shares will be duly authorized, validly issued, fully paid and non-assessable. As to any matter contained in such opinion which involves the Laws of a jurisdiction in which such counsel is not admitted to practice, such counsel may rely on the opinion of local counsel of established reputation satisfactory to the Shareholders. Any such opinion may rely as to matters of fact upon certificates furnished by appropriate officers of Purchaser or appropriate governmental officials. 10.7 Capital Contribution. As soon as reasonably practicable -------------------- after the Closing, Purchaser shall make a capital contribution or loan of an aggregate of $2,500,000 to the Company, which contribution or loan shall be applied in part as follows: Foothill Capital Corporation long term debt payoff: $1,095,000; Foothill Capital Corporation note payoff: $336,307; Southwest Working Capital: $1,000,000 ARTICLE XI ---------- TERMINATION; REMEDIES --------------------- 11.1 Termination Without Default. In the event that as of the --------------------------- Outside Date, any event or state of facts not constituting a default by the Company or the Shareholders, on the one hand, or Purchaser, on the other hand, shall 29 exist, which event or state of facts constitutes a failure of the conditions precedent for such party's benefit, the party for whose benefit such condition precedent is imposed hereby shall have the right, at its sole option, to terminate this Agreement without liability to the other party. Such right may be exercised by Purchaser, on the one hand, or the Company and the Shareholders, on the other hand, as the case may be, by giving written notice to the other, specifying the event or state of facts giving rise to such right of termination. 11.2 Termination Upon Default. Either Purchaser, on the one ------------------------ hand, or the Company or the Shareholders, on the other hand, may terminate this Agreement by giving notice to the other prior to the Closing Date, without prejudice to any rights or obligations it may have, if the other party has materially failed in the due and timely performance of any of its covenants or agreements herein contained or there shall have been a material breach of the other's warranties and representations herein contained. In any such event the party who is not guilty of the breach may, in addition to all of its other rights and remedies, recover from the party responsible for the breach all losses incurred. 11.3 Specific Performance. The parties acknowledge that the -------------------- Southwest Shares are unique and cannot be obtained by Purchaser except from the Shareholders, and for that reason, among others, Purchaser will be irreparably damaged in the absence of the consummation of this Agreement. Therefore, in the event of any breach by the Shareholders or the Company of this Agreement, Purchaser shall have the right, at its election, to obtain an Order for specific performance of this Agreement, without the need to post a bond or other security, to prove any actual damage or to prove that money damages would not provide an adequate remedy. 11.4 Attorneys' Fees. If any Shareholder, the Company or --------------- Purchaser shall bring an action against the other by reason of any alleged breach of any covenant, provision or condition hereof, or otherwise arising out of this Agreement, the unsuccessful party shall pay to the prevailing party all attorneys' fees and costs actually incurred by the prevailing party, in addition to any other relief to which it may be entitled. If more than one Person is a party adverse to Purchaser in any such action, however, such Persons shall designate one counsel to represent all of them in the action and, if Purchaser is not the prevailing party, Purchaser shall be required to pay the attorneys' fees of such one counsel only. As used in this Section 11.4 and elsewhere in this Agreement, "actual attorneys' fees" or "attorneys' fees actually incurred" means the full and actual cost of any legal services actually performed in 30 connection with the matter for which such fees are sought calculated on the basis of the usual fees charged by the attorneys performing such services, and shall not be limited to "reasonable attorneys' fees" as that term may be defined in statutory or decisional Authority. ARTICLE XII INDEMNIFICATION --------------- 12.1 Indemnification by the Shareholders and the Company. Each --------------------------------------------------- of the Shareholders and the Company hereby agrees to severally indemnify and hold Purchaser harmless from and against any and all losses, obligations, deficiencies, liabilities, claims, costs and expenses (collectively, "Losses"), (including, without limitation, the amount of any settlement entered into pursuant hereto and all reasonable legal and other expenses incurred in connection with the investigation, prosecution or defense of the matter) caused by, arising out of, relating to, resulting or occurring from or in connection with the breach of any representation, warranty or covenant made by the Company or each such Shareholder in this Agreement or in any of the Company Documents or Shareholder Documents. Notwithstanding the foregoing, the liability of any Shareholder hereunder shall not exceed an amount in excess of an amount determined by multiplying the amount of the Loss by such Shareholder's pro rata share of the Southwest Shares as of the Closing, and no Shareholder shall be liable hereunder for any breach of any representation, warranty or covenant made by the Company or any other Shareholder. Further, the Company shall not be liable hereunder for any breach of any representation, warranty or covenant of any Shareholder relating to the Southwest Shares. Notwithstanding anything herein to the contrary, no Shareholder shall be liable hereunder for an amount in excess of the number of Sunbase Shares received by such Shareholder multiplied by $500. Notwithstanding the foregoing, the Shareholders and the Company shall only be required to indemnify Purchaser if, on a cumulative and aggregate basis, the amount of Losses described in this Section 12.1 exceeds $50,000. However, if the cumulative and aggregate amount of such Losses exceeds $50,000, all of the Losses shall be subject to indemnification hereunder by the Shareholders and the Purchaser. The Shareholders may satisfy any obligation to indemnify Purchaser hereunder by (i) paying Purchaser the amount due Purchaser hereunder in cash, (ii) assigning to Purchaser that number of Sunbase Preferred shares owned by the Shareholders which, when multiplied by $500 equals the amount due Purchaser hereunder or (iii) assigning to Purchaser that number of shares of the common stock of Purchaser owned by the Shareholders which, when multiplied by $5, equals the amount due Purchaser hereunder. 31 12.2 Indemnification by Purchaser. Purchaser hereby agrees to ---------------------------- indemnify and hold each of the Shareholders harmless from and against any and all Losses (including, without limitation, the amount of any settlement entered into pursuant hereto and all reasonable, legal and other expenses incurred in connection with the investigation, prosecution or defense of the matter) caused by, arising out of, relating to, or resulting or occurring from or in connection with the breach of any representation, warranty or covenant made by Purchaser in this Agreement or in any of the Purchaser Documents. Notwithstanding the foregoing, Purchaser shall only be required to indemnify the Shareholders if, on a cumulative and aggregate basis, the amount of Losses described in this Section 12.2 exceeds $50,000. However, if the cumulative and aggregate amount of the Losses exceeds $50,000, all of the Losses shall be subject to indemnification hereunder by Purchaser. 12.3 Notice to Indemnifying Party. If any party hereto (the ---------------------------- "Indemnified Party") receives notice of any claim or other commencement of any action or proceeding with respect to which any other party (the "Indemnifying Party") is obligated to provide indemnification pursuant to Sections 12.1 or 12.2 above, the Indemnified Party shall promptly give the Indemnifying Party written notice thereof which notice shall specify, if known, the amount or an estimate of the amount of the liability arising therefrom. Such notice shall be a condition precedent to any liability of the Indemnifying Party for indemnification hereunder. The Indemnified Party shall not settle or compromise any claim by a third party for which it is entitled to indemnification hereunder, without the prior written consent of the Indemnifying Party, unless suit shall have been instituted against it and the Indemnifying Party shall not have taken control of such suit after notification thereof as provided in Section 12.4 below. 12.4 Defense by Indemnifying Party. In connection with any claim ----------------------------- giving rise to indemnity hereunder resulting from or arising out of any claim or legal proceeding by a person who is not a party to this Agreement, the Indemnifying Party at its sole cost and expense may, upon written notice to the Indemnified Party, assume the defense of any such claim or legal proceeding using counsel of its choice (subject to the approval of the Indemnified Party, which approval may not be unreasonably withheld or delayed) if it acknowledges to the Indemnified Party in writing its obligations to indemnify the Indemnified Party with respect to all elements of such claim. The Indemnified Party shall be entitled to participate in (but not control) the defense of any such action, with its counsel and at its own expense; provided, however, that if the Indemnified Party, in its sole discretion, determines that there exists a conflict of 32 interest between the Indemnifying Party and the Indemnified Party, the Indemnified Party shall have the right to engage separate counsel, the reasonable costs and expenses of which shall be paid by the Indemnifying Party, but in no event shall the Indemnified Party be liable to pay for the costs and expenses of more than one such separate counsel. If the Indemnifying Party does not assume the defense of any such claim or litigation resulting therefrom, the Indemnified Party may defend against such claim or litigation, after giving notice of the same to the Indemnifying Party, on such terms as the Indemnified Party may deem appropriate, and the Indemnifying Party shall be entitled to participate in (but not control) the defense of such action, with its counsel and at its own expense. Notwithstanding the foregoing, however, Purchaser shall in all cases be entitled to control the defense of any such action if it (i) may result in injunctions or other equitable remedies in respect of Purchaser; (ii) may result in liabilities which would not be fully indemnified hereunder; or (iii) may have an adverse impact on the financial condition of Purchaser even if the Company and/or the Shareholders pay all indemnification amounts in full. 12.5 Reliance Upon Representations and Warranties. The -------------------------------------------- representations and warranties contained in this Agreement shall be considered to have been relied upon by the Company, the Shareholders or Purchaser, as the case may be, and shall survive until and through that date which is one (1) year after the Closing Date. ARTICLE XIII ------------ EXPENSES; CONFIDENTIALITY ------------------------- 13.1 Expenses of Sale. Each party hereto shall bear such party's ---------------- direct and indirect expenses incurred in connection with the negotiation and preparation of this Agreement and the consummation and performance of the transactions contemplated herein. 13.2 Confidentiality. Subject to any obligation to comply with --------------- (i) any Law (ii) any rule or regulation of any Authority or securities exchange or (iii) any subpoena or other legal process to make information available to the Persons entitled thereto, whether or not the transactions contemplated herein shall be concluded, all information obtained by any party about any other, and all of the terms and conditions of this Agreement, shall be kept in confidence by each party, and each party shall cause its shareholders, directors, officers, employees, agents and attorneys to hold such information confidential. Such confidentiality shall be maintained to the same degree as such party maintains its own confidential information and shall be 33 maintained until such time, if any, as any such data or information either is, or becomes, published or a matter of public knowledge; provided, however, that the foregoing shall not apply to any information obtained by Purchaser through its own independent investigations of the Company or received by Purchaser from a third party not under any obligation to keep such information confidential nor to any information obtained by Purchaser which is generally known to others engaged in the trade or business of the Company; and provided, further, that from and after the Closing, Purchaser shall be under no obligation to maintain confidential any such information concerning the Company. If this Agreement shall be terminated for any reason, each party shall return or cause to be returned to the other all written data, information, files, records and copies of documents, worksheets and other materials obtained by such party in connection with the transactions contemplated herein. 13.3 Publicity. No publicity release or announcement concerning --------- this Agreement or the transactions contemplated herein shall be issued without advance written approval of the form and substance thereof by Purchaser and the Company; provided, however, that such restrictions shall not apply to any disclosure required by regulatory Authorities, applicable Law or the rules of any securities exchange which may be applicable. ARTICLE XIV ----------- NOTICES ------- 14.1 Notices. All notices, requests and other communications ------- hereunder shall be in writing and shall be delivered by courier or other means of personal service (including by means of a nationally recognized courier service or professional messenger service), or sent by telex or telecopy or mailed first class, postage prepaid, by certified mail, return receipt requested, in all cases, addressed to: Purchaser: Sunbase Asia, Inc. 19/F., First Pacific Bank Centre 51-57 Gloucester Road Wanchai, Hong Kong Attention: Roger Li Telecopy No. 011-852-2865-4293 34 With a copy to: David L. Ficksman, Esq. Loeb and Loeb 1000 Wilshire Boulevard, Suite 1800 Los Angeles, California 90017 Telecopy No. (213) 688-3460 Each Shareholder: To the address set forth below each Shareholder's signature block. Company: Southwest Products Company 2240 Buena Vista Street Irwindale, California 91706 Attention: William McKay, President Telecopy No. (818) 303-6141 With a copy to: Daniel K. Donahue, Esq. Bruck & Perry A Professional Corporation One Newport Place Newport Beach, California 92660 Telecopy No. (714) 955-0835 All notices, requests and other communications shall be deemed given on the date of actual receipt or delivery as evidenced by written receipt, acknowledgement or other evidence of actual receipt or delivery to the address specified above. In case of service by telecopy, a copy of such notice shall be personally delivered or sent by registered or certified mail, in the manner set forth above, within three (3) business days thereafter. Any party hereto may from time to time by notice in writing served as set forth above designate a different address or a different or additional Person to which all such notices or communications thereafter are to be given. ARTICLE XV ---------- MISCELLANEOUS ------------- 15.1 Further Assurances. Each of the parties shall use its ------------------ reasonable and diligent best efforts to proceed promptly with the transactions contemplated herein, to 35 fulfill the conditions precedent for such party's benefit or to cause the same to be fulfilled and to execute such further documents and other papers and perform such further acts as may be reasonably required or desirable to carry out the provisions hereof and the transactions contemplated herein. Without limiting the generality of the foregoing, the Shareholders shall use their best efforts to cause the Company to fulfill its covenants hereunder prior to the Closing. 15.2 Modifications and Amendments; Waivers and Consents. At any -------------------------------------------------- time prior to the Closing Date or termination of this Agreement, Purchaser, on the one hand, and the Company and the Shareholders, on the other hand, may, by written agreement: (a) extend the time for the performance of any of the obligations or other acts of the other parties hereto; (b) waive any inaccuracies in the representations and warranties made by the other parties contained in this Agreement or any other agreement or document delivered pursuant to this Agreement; and (c) waive compliance with any of the covenants or agreements of the other parties contained in this Agreement. However, no such waiver shall operate as a waiver of, or estoppel with respect to, any subsequent or other failure. Whenever this Agreement requires or permits a waiver or consent by or on behalf of any party hereto, such waiver or consent shall be given in writing. 15.3 Entire Agreement. This Agreement (including any exhibits ---------------- and schedules hereto, which are hereby incorporated herein by this reference) and the agreements, documents and instruments to be executed and delivered pursuant hereto or thereto shall embody the final, complete and exclusive agreement among the parties with respect to the exchange of the Southwest Shares for Sunbase Preferred Shares and related transactions; shall supersede all prior agreements, understandings and representations written or oral, with respect thereto; and may not be contradicted by evidence of any such prior or contemporaneous agreement, understanding or representation, whether written or oral. 15.4 Governing Law and Venue. This Agreement is to be governed ----------------------- by and construed in accordance with the Laws of the State of California applicable to contracts made and to be performed wholly within such State, and without regard to the conflicts of laws principles thereof. 36 15.5 Binding Effect. This Agreement and the rights, covenants, -------------- conditions and obligations of the respective parties hereto and any instrument or agreement executed pursuant hereto shall be binding upon the parties and their respective successors, assigns and legal representatives. Neither this Agreement, nor any rights or obligations of any party hereunder, may be assigned by Purchaser, the Company or the Shareholders without the prior written consent of the other parties hereto; provided, however, that prior to or following the Closing, this Agreement and any rights and obligations of Purchaser hereunder, and under any Purchaser Document may, without the prior written consent of the Company and Shareholders, be assigned and delegated by Purchaser to any Affiliate of Purchaser and following the Closing, this Agreement and any rights and obligations of Purchaser hereunder and under any Purchaser Document may also be assigned and delegated by Purchaser, without the prior written consent of the Company and the Shareholders, to any successor-in-interest of Purchaser to the Sunbase Shares; provided, however, that no delegation by Purchaser of any such obligation shall relieve Purchaser of liability therefor. 15.6 Counterparts. This Agreement may be executed simultaneously ------------ in any number of counterparts, each of which shall be deemed an original but all of which together shall constitute one and the same instrument. In making proof of this Agreement it shall not be necessary to produce or account for more than one counterpart. 15.7 Section Headings. The section headings of this Agreement ---------------- are for convenience of reference only and shall not be deemed to alter or affect any provision hereof. 15.8 Gender, Tense, Etc. Where the context or construction ------------------- requires, all words applied in the plural shall be deemed to have been used in the singular, and vice versa; the masculine shall include the feminine and neuter, and vice versa; and the present tense shall include the past and future tense, and vice versa. 15.9 Severability. In the event that any provision or any part ------------ of any provision of this Agreement shall be void or unenforceable for any reason whatsoever, then such provision shall be stricken and of no force and effect. However, unless such stricken provision goes to the essence 37 of the consideration bargained for by a party, the remaining provisions of this Agreement shall continue in full force and effect, and to the extent required, shall be modified to preserve their validity. 15.10 Third-Party Rights. Nothing in this Agreement, whether ------------------ express or implied, is intended to confer any rights or remedies under or by reason of this Agreement on any Persons other than the parties to it and their respective successors and assigns, nor is anything in this Agreement intended to relieve or discharge the obligation or liability of any third Persons to any party to this Agreement, nor shall any provision give any third Persons any right of subrogation over or action against any party to this Agreement. 15.11 Construction. The language in all parts of this Agreement ------------ shall in all cases be construed simply, according to its fair meaning, and not strictly for or against any of the parties hereto. Without limitation, there shall be no presumption against any party on the ground that such party was responsible for drafting this Agreement or any part thereof. IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement as of the day and year first above written. PURCHASER Sunbase Asia, Inc. By: -------------------------------- Its: ---------------------------- THE COMPANY Smith Acquisition Company, Inc. d/b/a Southwest Products Company By: -------------------------------- Its: ---------------------------- 38 SHAREHOLDERS: ----------------------------------- Badr Al-Aiban c/o Delta International P.O. Box 6782 Jeddah, 2145 Saudi Arabia ----------------------------------- Gary Awad 1800 Austin Parkway, Apt. #1104 Sugar Land, Texas 77479 ----------------------------------- J. Thomas Chess 500 Columbia Street Pasadena, California 91030 ----------------------------------- John Coman 216 Fairhills Drive San Rafael, California 94901 ----------------------------------- William R. McKay 777 South Woodward Boulevard Pasadena, California 91107 ----------------------------------- James McN. Stancill 3642 Mountain View Avenue Pasadena, California 91107 ----------------------------------- Tom Naygrow c/o Steven J. Orlando 1805 Parliament Circle Carmichael, California 95608 39 ----------------------------------- Dick Orfalea 1235 North Louise Street Glendale, California 91207 ----------------------------------- Steven J. Orlando 1805 Parliament Circle Carmichael, California 95608 ----------------------------------- Carol Orlando c/o Steven J. Orlando 1805 Parliament Circle Carmichael, California 95608 RJN Enterprises By: ------------------------------- Its: ---------------------------- c/o Steven J. Orlando 1805 Parliament Circle Carmichael, California 95608 ---------------------------------- Frank Brothers 128 DeForest Road Wilton, Connecticut 06397 ---------------------------------- David C. Lutz 8807 Fox Briar Lane Boerne, Texas 78006-5585 40 ---------------------------------- Cameron McKay 505 East Plaza Serena Ontario, California 91764 ---------------------------------- Ernst Renezeder 1603 Hanging Rock Avenue Montebello, California 90640 ---------------------------------- Todd Stockbauer 16701 Algonquin Street, #308 Huntington Beach, California 92649 41 EX-10.21 7 EMPLOYMENT AGREEMENT DATED 01/16/96 EXHIBIT 10.21 EMPLOYMENT AGREEMENT -------------------- This Employment Agreement ("Agreement") is entered into as of January 16, 1996, by and between, on the one hand, Sunbase Asia, Inc., a Nevada corporation ("Sunbase") and Smith Acquisition Company, Inc. d/b/a/ Southwest Products Company, a California corporation ("Southwest") and, on the other hand, William R. McKay, an individual ("Employee"), with respect to the following facts: A. Pursuant to that certain Agreement and Plan of Reorganization and Merger, dated December 29, 1995, by and among Sunbase, Southwest and certain shareholders of Southwest (including, but not limited to, Employee) Southwest is being merged with a subsidiary of Sunbase, whereby Southwest will be the surviving corporation. B. Southwest and Sunbase desire to employ Employee as President and Chief Executive Officer of Southwest and Sunbase. C. Employee desires to be so employed. NOW, THEREFORE, in consideration of the premises and mutual promises set forth herein, the parties hereto hereby agree as follows: 1. Term of Employment. Southwest and Sunbase hereby employ ------------------ Employee and Employee accepts such employment commencing on the date first set forth above and terminating on that date which is five (5) years therefrom, unless sooner terminated as provided herein. 2. Services to be Rendered. ----------------------- 2.1 Duties. Employee shall be employed to serve as President and ------ Chief Executive Officer of Southwest and in such other executive capacities as the Board of Directors of Southwest (the "Board") may, in its sole discretion, determine from time to time. Employee shall also serve, without any additional salary or compensation, as President and Chief Executive Officer of Sunbase and shall, if requested by the Board, provide services as an officer to any parent or subsidiary of Southwest or Sunbase, or any company into which Southwest may be merged, and any parent or subsidiary thereof (individually, a "Related Entity"), provided that the business of any such Related Entity is related to the manufacture, distribution or sale of bearing products. Employee shall have the responsibilities, duties and powers customarily associated with such positions and shall perform such duties pertaining to the business of Southwest, Sunbase or any Related Entity as the Board may from time to time direct. Employee hereby consents to serve as a director of Southwest, Sunbase or any Related Entity without any additional salary or compensation, if requested to do so by the Board. Employee shall be subject to the policies and procedures generally applicable to senior executive employees of Southwest to the extent the same are not inconsistent with any term of this Agreement. Employee's principal place of employment shall be located within the County of Los Angeles, State of California. 2.2 Exclusive Services. Employee shall at all times faithfully, ------------------ industriously and to the best of his ability, experience and talents, perform all of the duties that may be assigned to him hereunder and shall devote such time to the performance of these duties as may be customary, necessary or appropriate therefor. Employee shall be available on a full time basis to perform the duties assigned to him hereunder; provided, however, that Employee may devote time to personal and family investments and charitable and philanthropic activities to the extent that such investments and activities do not conflict with the business of Southwest, Sunbase or any Related Entity. The existence of such a conflict shall be determined in good faith by the Board. 3. Compensation and Benefits. Southwest shall pay the compensation ------------------------- and provide the benefits which are set forth below to Employee during the term hereof, and Employee shall accept the same as full and complete payment for all services rendered by Employee to, or for the benefit of, Southwest, Sunbase or any Related Entity: 3.1 Salary. A base salary ("Base Salary") of Two Hundred Eighty- ------ Five Thousand Dollars ($285,000) per annum. The Base Salary shall be payable in accordance with the then current payroll practices of Southwest which Southwest may, in its sole discretion, change from time to time. McKay's Base Salary shall be reviewed annually, as soon as the relevant financial information is available for, as applicable, Southwest, Sunbase and the Related Entities, but in no event later than four (4) months after the end of each fiscal year of Southwest, by the Board or by a compensation committee (the "Compensation Committee") which is established by the Board, provided that the Compensation Committee is established to review the compensation of all senior officers. As a result of such review, the Base Salary may be increased or, if based on United States generally accepted accounting principles, Southwest has failed to generate a positive net operating income for the immediately preceding year, decreased, at the sole discretion of the Board or the Compensation Committee, 2 provided that the following review procedures are followed by the Board or the Compensation Committee, as applicable. (a) Decrease of Salary. In reviewing the performance of Employee ------------------ with respect to decreasing the Base Salary, the Board or the Compensation Committee shall exclusively evaluate whether Southwest has generated a positive net operating income for the relevant fiscal year based solely on Southwest's sales of those products that are manufactured by Southwest. The Board or the Compensation Committee shall exclude from the calculation of Southwest's net operating income: (i) any payments of principle or interest made by Southwest to Foothill Capital Corporation, as a result of Sunbase failing to make a capital contribution to Southwest as required under Section 10.7 of the Agreement and Plan of Reorganization and Merger, dated December 29, 1995, by and among Sunbase, Southwest and certain shareholders of Southwest, (ii) any payments of interest made by Southwest to Sunbase as a result of Sunbase making a capital contribution to Southwest in the form of debt, (iii) any payments of income tax made by Southwest and (iv) any costs, expenses or losses that would normally and reasonably be attributed to, and any revenue that is generated by, Sunbase or any Related Entity, including, but not limited to, any revenue, costs, expenses or losses relating to the distribution or marketing of products of Hong Xing Bearing Company or Harbin Bearing Company Limited. Should any such revenues, costs, expenses or losses be attributed to Southwest for purposes of cost allocation, accounting or any other reason, for purposes of this Section 3.1 only, the financial statements of Southwest shall be adjusted so that they exclusively reflect the performance of Southwest as provided above, to the exclusion of any such revenue, costs, expenses or losses. (b) Increase of Salary. In reviewing the performance of Employee ------------------ with respect to increasing the Base Salary, the Board or the Compensation Committee shall evaluate the profitability of Southwest and may, in addition and at its sole discretion, evaluate the profitability of Sunbase and any Related Entity. (c) Minimum Base Salary. In no event shall the Board decrease the ------------------- Base Salary to an amount less than Two Hundred Twenty-Five Thousand Dollars ($225,000). (d) Change in Base Salary. If the Board or the Compensation --------------------- Committee increases the Base Salary at any time other than before the first payment of Base Salary normally due in any year hereunder, Southwest shall make a lump sum payment to Employee at the time of 3 such increase, in an amount equal to the difference between (i) the total amount of Base Salary that Employee would have been paid if the Base Salary, as so increased, had been paid from the beginning of such year to the date on which the Base Salary is actually increased and (ii) the amount of Base Salary actually paid for such period. In addition, Southwest shall equally increase the remaining payments of the Base Salary on a go-forward basis so that the total Base Salary paid for such year equals the total amount of the Base Salary as increased. If the Board or the Compensation Committee decreases the Base Salary for any year hereunder, Southwest shall, at the time it decreases the Base Salary and on a go-forward basis, equally decrease all remaining payments of the Base Salary for such year so that the total Base Salary paid to Employee for such year is equal to the total Base Salary as so decreased. If Employee's Base Salary is decreased hereunder for any fiscal year, and Southwest generates a positive net operating income in the subsequent year, Employee's Base Salary shall be increased to, at a minimum, Two Hundred Eighty-Five Thousand Dollars ($285,000) for the year following such subsequent year. (e) Effect of Employee's Death or Disability on Base Salary. If ------------------------------------------------------- Employee dies or, as defined in Section 7.1 below, becomes totally disabled, Southwest shall continue to pay Employee or Employee's heirs, successors or assigns the Base Salary for a period of six (6) months, commencing on the date that Employee dies or becomes totally disabled. 3.2 Bonus. At the end of each fiscal year of Southwest, the Board ----- of Directors of Sunbase (the "Sunbase Board") shall review Employee's performance for such fiscal year and, in addition to the Base Salary, may choose to pay Employee, at the sole discretion of the Sunbase Board, a bonus for the relevant fiscal year. Any payment hereunder to Employee of a bonus in any particular year shall not obligate Sunbase or Southwest to pay Employee a bonus in any other year. In reviewing the performance of Employee with respect to paying Employee a bonus, the Sunbase Board shall review the performance and profitability of Southwest, Sunbase and any Related Entity to which Employee provides services hereunder. 3.3 Stock Options. Sunbase shall grant Employee, under the 1995 ------------- Sunbase Asia, Inc. Stock Option Plan, options to purchase shares of the common stock of Sunbase ("Options"). The principal terms of the Options are set forth below and all of the terms of the Options are set forth in a stock option agreement (a copy of which is attached hereto as Exhibit A and incorporated herein by this 4 reference). Concurrent with the due execution of this Agreement, Sunbase shall issue Employee eight hundred thousand (800,000) Options, each of which will entitle Employee the right to purchase from Sunbase one (1) share of the common stock of Sunbase. The right to purchase such shares, at the respective price per share as set forth below, will vest in Employee at the rate of one hundred sixty thousand (160,000) Options per each full year during which Employee remains employed by Employer, with the first year period commencing as of the date first set forth above. Employee may exercise the Options that have vested and purchase shares of the common stock of Sunbase, at the following prices:
Exercise Price of Full Years of Options that Vest Employment After Each Such Year --------------- -------------------- One $ 6.65 Two $ 7.75 Three $ 9.25 Four $10.75 Five $12.75
(a) Expiration of Options. All unexercised Options shall expire on --------------------- that date which is six (6) years after the date on which such Options have vested. (b) Effect of Employee's Death or Disability on Options. If, on --------------------------------------------------- the date that Employee dies or, as defined in Section 7.1 below, becomes totally disabled, Employee has completed one hundred eighty-three (183) or more days of employment for the relevant year, then in addition to any Options that have vested in any previous year(s) of employment hereunder, the amount of one hundred sixty thousand (160,000) Options will be deemed vested in Employee as if Employee had remained employed for the full year. If, on the date that Employee dies or becomes totally disabled Employee has completed one hundred eighty-two (182) or less days of employment for the relevant year, then, in addition to any Options that have vested in Employee for any previous year(s) of employment hereunder, the amount of eighty thousand (80,000) Options shall be deemed vested in Employee. Any Options that have vested as of the date that Employee dies may be exercised by Employee's estate, heirs, successors or assigns, prior to such Options' expiration as described in Section 3.3(a) above. If Employee becomes totally disabled, Employee, or, if necessary, Employee's assigns, may exercise any Options which have vested as of the date on which Employee becomes so disabled prior to such Options' expiration as described in Section 3.3(a) above. 5 (c) Effect of Employee's Termination. If Employee is terminated -------------------------------- pursuant to Section 7.2 below, all unexercised Options shall expire on that date which is ninety (90) days after the date of such termination; provided, however, that notwithstanding Section 3.3 (e) below, upon Employee's written request, at any time during the two-week period that commences on the date that Employee is terminated pursuant to Section 7.2 below and, provided that such a registration statement is not already in effect, Sunbase shall file a Form S-8 Registration Statement with the Securities and Exchange Commission covering that amount of shares of the common stock of Sunbase which are issued to Employee hereunder. Provided that Employee requests that the Form S-8 Registration Statement be so filed in accordance with the foregoing, Sunbase shall file the Form S-8 Registration Statement by such date, or toll the ninety (90) day period set forth above for such amount of time, so that Employee has no less than thirty (30) days to sell the common stock of Sunbase while the Form S-8 Registration Statement is in effect. (d) Effect of Employee's Improper Termination of This Agreement. ----------------------------------------------------------- If Employee resigns or terminates this Agreement for any reason other than based on a material breach hereof by Southwest or Sunbase, all unexercised Options shall expire immediately. (e) Registration Rights and Holding Period. Upon Employee's -------------------------------------- written request, at any time during the eight (8) year period that commences two (2) years after the date first set forth, Sunbase shall file with the Securities and Exchange Commission a Form S-8 Registration Statement covering that amount of shares of the common stock of Sunbase which are issued to Employee hereunder. Notwithstanding the foregoing, Employee shall not resell any shares of the common stock underlying the Options that are issued to Employee hereunder for a holding period of one (1) year, which period shall commence on the date that the right to exercise the Options with respect to such shares vests in Employee. 3.5 Benefits and Vacation. Employee shall be entitled to --------------------- participate in benefits under Southwest's benefit plans and arrangements made available by Southwest to its senior officers, subject to and on a basis consistent with the terms, conditions and overall administration of such plans and arrangements. Southwest shall have the right to amend or delete any such benefit plan or arrangement made available by Southwest to its senior officers. Employee shall be entitled to the number of paid vacation days in each calendar year determined by Southwest from time to time 6 for its senior officers which, at a minimum, shall be twenty-eight (28) days per year, provided that Employee shall not take more than fourteen (14) such days sequentially at any given time. Employee shall also be entitled to all paid holidays given to Southwest's senior officers. 3.6 Automobile Expense. During the term of this Agreement, ------------------ Southwest shall pay to Employee the amount of Fifteen Thousand Dollars ($15,000) per annum as reimbursement for any and all costs and expenses which Employee incurs in connection with the purchase or lease, operation and maintenance of an automobile. The foregoing reimbursement does not include costs and expenses incurred by employee in connection with Employee's renting of automobiles, as necessary or appropriate to satisfy Employee's obligations hereunder. 3.7 Expenses. Southwest shall reimburse Employee for reasonable -------- out-of-pocket expenses incurred by Employee in connection with the business of Southwest, Sunbase and any Related Entity and the performance of Employee's duties hereunder, subject to (i) such policies as the Board may from time to time establish and (ii) Employee furnishing Southwest with documentation in the form of receipts satisfactory to Southwest substantiating such expenses. 3.8 Withholding and Other Deductions. All compensation payable and -------------------------------- benefits provided to Employee hereunder shall be subject to such deductions as Southwest is from time to time required to make pursuant to law, governmental regulation or order. 4. Representations and Warranties of Employee. Employee represents ------------------------------------------ and warrants to Southwest that Employee is not a party to any contract or subject to any restriction or obligation which is inconsistent with the execution of this Agreement, the performance of his duties hereunder or any other interest of Southwest, Sunbase or any Related Entity, and that Employee is fully physically and mental able and competent to performance his duties hereunder. 5. Confidential Information. Employee acknowledges that the nature ------------------------ of Employee's engagement hereunder is such that Employee will have access to "Confidential Information" (as defined below) which is of great value and that except for such engagement, Employee would not otherwise have access to the Confidential Information. During the term of this Agreement, Employee shall keep all Confidential Information in confidence and shall not disclose any of the same to any other person, except (i) the personnel of 7 Southwest or Sunbase with a need to know and (ii) other persons designated in writing by the Board. Employee shall not cause, suffer or permit the Confidential Information to be used for the gain or benefit of any party outside of Southwest or Sunbase or for Employee's personal gain or benefit outside the scope of Employee's employment hereunder. The term "Confidential Information" as used herein means all information or material not generally known other than by the personnel of Southwest or Sunbase which (i) gives Southwest or Sunbase a competitive business advantage or the opportunity of obtaining such advantage, or the disclosure of which could be detrimental to the interests of Southwest or Sunbase; (ii) is owned by Southwest or Sunbase or in which Southwest or Sunbase has an interest and (iii) is either marked "Confidential Information," "Proprietary Information" or the like or is known or should be known by Employee to be considered confidential and proprietary by Southwest or Sunbase. NOTWITHSTANDING THE ABOVE, HOWEVER, NO INFORMATION CONSTITUTES CONFIDENTIAL INFORMATION IF IT IS GENERIC INFORMATION OR GENERAL KNOWLEDGE WHICH EMPLOYEE WOULD HAVE LEARNED IN THE COURSE OF SIMILAR EMPLOYMENT ELSEWHERE IN THE TRADE OR IF IT IS OTHERWISE PUBLICLY KNOWN AND IN THE PUBLIC DOMAIN. 6. Insurance. Southwest shall have the right to take out life, --------- health, accident, "key-man" or other insurance covering Employee, in the name of Southwest and at Southwest's expense in any amount deemed appropriate by Southwest. Employee shall assist Southwest in obtaining such insurance, including, but not limited to, submitting to any required examinations and providing information and data which are required by insurance companies. 7. Termination. ----------- 7.1 Death or Total Disability of Employee. If Employee dies or ------------------------------------- becomes totally disabled during the term of this Agreement, this Agreement and Employee's employment hereunder shall automatically terminate. For purposes of this Section 7.1, Employee shall be deemed totally disabled if Employee becomes physically or mentally incapacitated or disabled or otherwise unable fully to discharge Employee's duties hereunder for any period of ninety (90) consecutive calendar days or for one hundred twenty (120) calendar days in any one hundred eighty (180) calendar-day period. 7.2 Termination for Cause. Employee's employment hereunder may be --------------------- terminated immediately by Southwest for cause. For purposes of this Section 7.2, the term "cause" means the occurrence of any of the following events: 8 (a) Employee's breach of any of the covenants contained in Section 5 above; (b) Employee's conviction by, or entry of a plea of guilty or nolo contendere in, a court of competent and final jurisdiction for any crime which results in the imprisonment of Employee in a federal or state penitentiary; (c) Employee's willful failure or refusal to perform Employee's duties as required by this Agreement provided that Employee does not cure such failure or refusal to perform within four (4) weeks of written notice thereof by Southwest; (d) Employee's gross negligence or material violation of any duty of loyalty to Southwest, Sunbase or any Related Entity provided that Employee does not cure such negligence or violation within four (4) weeks of written notice thereof by Southwest; or (e) Employee's breach of any other provision of this Agreement, provided that prior to termination of Employee's employment pursuant to this subsection (e), Employee shall have first received written notice from the Board stating with specificity the nature of such breach and affording Employee four (4) weeks to correct the alleged breach. Notwithstanding the foregoing Section 7.2, Employee's refusal to disclose to any person or entity information concerning or relating to the business or technology of Sunbase, Southwest or any Related Entity, which would constitute a violation of applicable law, will not, based solely on such refusal, constitute "cause" as such term is used herein or otherwise be deemed a breach of this Agreement. 7.3 Dissolution of Southwest. Southwest or Sunbase can immediately ------------------------ terminate this Agreement, and Employee's employment hereunder, if Southwest is dissolved or ceases to conduct business for any reason whatsoever; provided, however, that upon such termination Southwest shall pay Employee an amount equal to twelve (months) of Employee's Base Salary, based on the amount of the Base Salary at the time of such termination. 7.4 Return of Property. If this Agreement is terminated for any ------------------ reason, Southwest shall have the right to require Employee to vacate his offices prior to the effective date of such termination and to cease all 9 activities on Southwest's and Sunbase's behalf. Upon the termination of his employment, Employee shall immediately surrender to Southwest all lists, books and records relating to the business of Southwest, Sunbase and any Related Entity and all other property belonging to Southwest, Sunbase or any Related Entity, it being distinctly understood that all such lists, books and records, and other documents are the property of Southwest, Sunbase or any Related Entity. 8. General Relationship. Employee shall be an employee of -------------------- Southwest within the meaning of all federal, state and local laws and regulations including, but not limited to, laws and regulations governing unemployment insurance, workers' compensation, industrial accident, labor and taxes. 9. Miscellaneous. ------------- 9.1 Modification; Prior Claims. This Agreement sets forth -------------------------- the entire understanding of the parties with respect to the subject matter hereof, supersedes all existing agreements between them concerning such subject matter, and may be modified only by a written instrument duly executed by each party. Employee hereby waives any claims that may exist on the date hereof arising from his prior employment with Southwest, other than for compensation payable or reimbursement of reasonable expenses, all as incurred in the ordinary course of business. 9.2 Assignment. The rights and obligations of Southwest under this ---------- Agreement may, without the consent of Employee, be assigned by Southwest or Sunbase (i) to any person, firm, corporation or other entity which, whether by purchase, merger or otherwise, directly or indirectly, acquires or controls all or substantially all of the assets or business of Southwest, or (ii) to any Related Entity provided that the business of such assignee is related to the manufacture, distribution or sale of bearing products. The rights and obligations of Employee under this Agreement cannot be assigned. 9.3 Third-Party Beneficiaries. Other than as expressly set forth in ------------------------- this Agreement, this Agreement does not create and shall not be construed as creating any rights enforceable by any person or entity not a party to this Agreement . 9.4 Waiver. The failure of either party hereto at any time to ------ enforce performance by the other party of any provision of this Agreement shall in no way affect such party's rights thereafter to enforce the same, nor 10 shall the waiver by either party of any breach of any provision hereof be deemed to be a waiver by such party of any other breach of the same or any other provision hereof. 9.5 Section Headings. The headings of the sections in this ---------------- Agreement are inserted solely for the convenience of the parties and are not a part of, and are not intended to govern, limit or aid in the construction of any term or provision hereof. 9.6 Notices. All notices, requests and other communications ------- hereunder shall be in writing and shall be delivered by courier or other means of personal service, sent by telex or telecopy or mailed first class, postage prepaid, by certified mail, return receipt requested, addressed as follows: Southwest: Smith Acquisition Company d/b/a Southwest Products Company 2240 Buena Vista Street Irwindale, CA 91706 Facsimile: (818) 303-6141 Attention: William R. McKay Sunbase: Sunbase Asia, Inc. 19/F, First Pacific Bank Centre 51-57 Gloucester Road Wanchai, Hong Kong Facsimile: 011-852-2865-4293 Attention: Mr. Roger Li Employee: William R. McKay 777 South Woodward Boulevard Pasadena, CA 91107 Facsimile: (818) 405-0189 All notices, requests and other communications shall be deemed given on the date of actual receipt or delivery as evidenced by written receipt, acknowledgement or other evidence of actual receipt or delivery to the address. In case of service by telecopy, a copy of such notice shall be personally delivered or sent by registered or certified mail, in the manner set forth above, within three (3) business days thereafter. Any party hereto may from time to time by notice in writing served as set forth above desig- 11 nate a different address or a different or additional person to which all such notices or communications thereafter are to be given. 10. Severability. All sections, clauses and covenants contained in ------------ this Agreement and portions thereof are severable, and in the event any of them shall be held to be invalid by a court of competent jurisdiction, this Agreement shall be interpreted as if such invalid sections, clauses or covenants or portions thereof were not contained herein or, if appropriate or reasonable, such court shall have the power to modify such section, clause or covenant or portion thereof and, in its so modified form, such section, clause or covenant shall then be deemed valid and enforceable. 10.1 Governing Law and Venue. This Agreement shall be governed by ----------------------- and construed in accordance with the laws of the State of California applicable to contracts made and to be performed wholly within such State, and without regard to the conflicts of laws principles thereof. Any suit brought hereon shall be brought in the State or Federal courts located in the County of Los Angeles, State of California, the parties hereto hereby waiving any claim or defense that such forum is not convenient or proper. Each party hereto hereby agrees that any such court shall have in personam jurisdiction over it and consents to service of process in any manner authorized by California law. 10.2 Attorneys' Fees. If any legal action, arbitration or other --------------- proceeding is brought for the enforcement of this Agreement, or because of any alleged dispute, breach, default or misrepresentation in connection with this Agreement, the successful or prevailing party shall be entitled to recover reasonable attorneys' fees and other costs it incurs in such action or proceeding, in addition to any other relief to which it may be entitled. 10.3 Gender and Tense. Where the context so requires, the use of the ---------------- masculine gender shall include the feminine and/or neuter genders and the singular shall include the plural, and vice versa. 10.4 Counterparts. This Agreement may be executed in one or more ------------ counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same Agreement. 12 10.5 Construction. The rule of construction that any ambiguity in ------------ an agreement be construed against such agreement's drafter shall apply to this Agreement. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed as of the date hereinabove set forth. Sunbase Asia, Inc. ----------------------------------- William R. McKay By: ---------------------------------- Name: -------------------------------- Title: ------------------------------- Smith Acquisition Company, Inc. d/b/a Southwest Products Company By: ---------------------------------- Name: -------------------------------- Title: ------------------------------- 13 EX-10.22 8 SUNBASE ASIA, INC. 1995 STOCK OPTION PLAN EXHIBIT 10.22 SUNBASE ASIA, INC. ------------------ 1995 STOCK OPTION PLAN ---------------------- 1. ESTABLISHMENT, PURPOSE AND DEFINITIONS. -------------------------------------- (a) The 1995 Stock Option Plan (the "1995 Option Plan") of Sunbase Asia, Inc., a Nevada corporation (the "Company"), is hereby adopted. The 1995 Option Plan shall provide for the issuance of incentive stock options ("ISOs") and nonqualified stock options ("NSOs"). (b) The purpose of this 1995 Option Plan is to promote the long- term success of the Company by attracting, motivating and retaining key executives, consultants and directors (the "Participants") through the use of competitive long-term incentives which are tied to stockholder value. The 1995 Option Plan seeks to balance Participants' and stockholder interests by providing incentives to the Participants in the form of stock options which offer rewards for achieving the long-term strategic and financial objectives of the Company. (c) The 1995 Option Plan is intended to provide a means whereby Participants may be given an opportunity to purchase shares of Stock of the Company pursuant to (i) options which may qualify as ISOs under Section 422 of the Internal Revenue Code of 1986, as amended (the "Internal Revenue Code"), or (ii) NSOs which may not so qualify. (d) The term "Affiliates" as used in this 1995 Option Plan means parent or subsidiary corporations, as defined in Section 424(e) and (f) of the Code (but substituting "the Company" for "employer corporation"), including parents or subsidiaries which become such after adoption of the 1995 Option Plan. 2. ADMINISTRATION OF THE PLAN. -------------------------- (a) The 1995 Option Plan shall be administered by the Compensation Committee (the "Committee") appointed by the Board of Directors of the Company from time to time (the "Board"). (b) The Committee shall consist entirely of directors qualifying as "disinterested persons" as such term is defined in Rule 16b-3 promulgated by the Securities and Exchange Commission (the "Committee"). The Committee shall consist of at least two Disinterested Directors. Members of the Committee shall serve at the pleasure of the Board. None of the members of the Committee shall receive, while serving on the Committee, a grant or award of equity securities under (i) the 1995 Option Plan or (ii) any other plan of the Company or its Affiliates under which the participants are entitled to acquire Stock (including restricted Stock), stock options, stock bonuses, related rights or stock appreciation rights of the Company or any of its Affiliates, other than pursuant to transactions in any such other plan which do not disqualify a director from being a disinterested person under Rule 16b-3. (c) The Committee may from time to time determine which employees of the Company or its Affiliates or other individuals or entities (each an "option holder") shall be granted options under the 1995 Option Plan, the terms thereof (including without limitation determining whether the option is an incentive stock option and the times at which the options shall become exercisable), and the number of shares of Stock for which an option or options may be granted. (d) If rights of the Company to repurchase Stock are imposed, the Board or the Committee may, in its sole discretion, accelerate, in whole or in part, the time for lapsing of any rights of the Company to repurchase shares of such Stock or forfeiture restrictions. (e) If rights of the Company to repurchase Stock are imposed, the certificates evidencing such shares of Stock awarded hereunder, although issued in the name of the option holder concerned, shall be held by the Company or a third party designated by the Committee in escrow subject to delivery to the option holder or to the Company at such times and in such amounts as shall be directed by the Board under the terms of this 1995 Option Plan. Share certificates representing Stock which is subject to repurchase rights shall have imprinted or typed thereon a legend or legends summarizing or referring to the repurchase rights. (f) The Board or the Committee shall have the sole authority, in its absolute discretion, to adopt, amend and rescind such rules and regulations, consistent with the provisions of the 1995 Option Plan, as, in its opinion, may be advisable in the administration of the 1995 Option Plan, to construe and interpret the 1995 Option Plan, the rules and regulations, and the instruments evidencing options granted under the 1995 Option Plan and to make all other determinations deemed necessary or advisable for the administration of the 1995 Option Plan. All decisions, determinations and interpretations of the Committee shall be binding on all option holders under the 1995 Option Plan. 2 3. STOCK SUBJECT TO THE PLAN. ------------------------- (a) "Stock" shall mean Common Stock of the Company or such stock as may be changed as contemplated by Section 3(c) below. Stock shall include shares drawn from either the Company's authorized but unissued shares of Common Stock or from reacquired shares of Common Stock, including without limitation shares repurchased by the Company in the open market. (b) Options may be granted under the 1995 Option Plan from time to time to eligible persons to purchase an aggregate of up to 2.5 million shares of Stock. Stock options awarded pursuant to the 1995 Option Plan which are forfeited, terminated, surrendered or cancelled for any reason prior to exercise shall again become available for grants under the 1995 Option Plan (including any option cancelled in accordance with the cancellation regrant provisions of Section 6(f) herein). (c) If there shall be any change in the Stock subject to the 1995 Option Plan, including Stock subject to any option granted hereunder, through merger, consolidation, recapitalization, reorganization, reincorporation, stock split, reverse stock split, stock dividend, combination or reclassification of the Company's Stock or other similar events, an appropriate adjustment shall be made by the Committee in the number of shares and/or the option price with respect to any unexercised shares of Stock. Consistent with the foregoing, in the event that the outstanding Stock is changed into another class or series of capital stock of the Company, outstanding options to purchase Stock granted under the 1995 Option Plan shall become options to purchase such other class or series and the provisions of this Section 3(c) shall apply to such new class or series. (d) The Company may grant options under the 1995 Option Plan in substitution for options held by employees of another company who become employees of the Company as a result of merger or consolidation. The Company may direct that substitute options be granted on such terms and conditions as deemed appropriate by the Board or the Committee. (e) The aggregate number of shares of Stock approved by the 1995 Option Plan may not be exceeded without amending the 1995 Option Plan and obtaining stockholder approval within twelve months of such amendment. 3 4. ELIGIBILITY. ----------- Persons who shall be eligible to receive stock options granted under the 1995 Option Plan shall be those individuals and entities as the Committee in its discretion determines should be awarded such incentives given the best interests of the Company; provided, however, that (i) ISOs may only be granted to employees of the Company and its Affiliates and (ii) any person holding capital stock possessing more than 10% of the total combined voting power of all classes of Stock of the Company or any Affiliate shall not be eligible to receive ISOs unless the exercise price per share of Stock is at least 110% of the fair market value of the Stock on the date the option is granted. 5. EXERCISE PRICE FOR OPTIONS GRANTED UNDER THE PLAN. ------------------------------------------------- (a) All ISOs will have option exercise prices per option share not less than the fair market value of a share of the Stock on the date the option is granted, except that in the case of ISOs granted to any person possessing more than 10% of the total combined voting power of all classes of stock of the Company or any Affiliate the price shall be not less than 110% of such fair market value. The price of ISOs or NSOs granted under the 1995 Option Plan shall be subject to adjustment to the extent provided in Section 3(c) above. (b) The fair market value on the date of grant shall be determined based upon the closing price on an exchange on that day or, if the Stock is not listed on an exchange, on the average of the closing bid and asked prices in the Over the Counter Market on that day. 6. TERMS AND CONDITIONS OF OPTIONS. ------------------------------- (a) Each option granted pursuant to the 1995 Option Plan shall be evidenced by a written stock option agreement (the "Option Agreement") executed by the Company and the person to whom such option is granted. The Option Agreement shall designate whether the option is an ISO or an NSO. (b) The term of each ISO and NSO shall be no more than 10 years, except that the term of each ISO issued to any person possessing more than 10% of the voting power of all classes of stock of the Company or any Affiliate shall be no more than 5 years. Subsequently issued options, if Stock becomes available because of further allocations or the lapse of previously outstanding options, will extend for terms determined by the Board or the Committee but in no event shall an ISO be exercised after the expiration of 10 years from the date of its grant. 4 (c) In the case of ISOs, the aggregate fair market value (determined as of the time such option is granted) of the Stock to which ISOs are exercisable for the first time by such individual during any calendar year (under this 1995 Option Plan and any other plans of the Company or its Affiliates if any) shall not exceed the amount specified in Section 422(d) of the Internal Revenue Code, or any successor provision in effect at the time an ISO becomes exercisable. (d) The Option Agreement may contain such other terms, provisions and conditions regarding vesting, repurchase or other provisions as may be determined by the Committee. To the extent such terms, provisions and conditions are inconsistent with this 1995 Option Plan, the specific provisions of the Option Agreement shall prevail. If an option, or any part thereof, is intended to qualify as an ISO, the Option Agreement shall contain those terms and conditions which the Committee determine are necessary to so qualify under Section 422 of the Internal Revenue Code. (e) The Committee shall have full power and authority to extend the period of time for which any option granted under the 1995 Option Plan is to remain exercisable following the option holder's cessation of service as an employee, director or consultant, including without limitation cessation as a result of death or disability; provided, however, that in no event shall such option be exercisable after the specified expiration date of the option term. (f) The Committee shall have full power and authority to effect at any time and from time to time, with the consent of the affected option holders, the cancellation of any or all outstanding options under the 1995 Option Plan and to grant in substitution new options under the 1995 Option Plan covering the same or different numbers of shares of Stock with the same or different exercise prices. (g) As a condition to option grants under the 1995 Option Plan, the option holder agrees to grant the Company the repurchase rights as Company may at its option require and as may be set forth in a separate repurchase agreement. (h) Any option granted under the 1995 Option Plan may be subject to a vesting schedule as provided in the Option Agreement and, except as provided in this Section 6 herein, only the vested portion of such option may be exercised at any time during the Option Period. All rights to exercise any option shall lapse and be of no further effect whatsoever immediately if the option holder's service as an employee is terminated for "Cause" (as hereinafter defined) or if the option holder voluntarily terminates the option holder's service as an employee. The unvested portion of the option will lapse and be of no further 5 effect immediately upon any termination of employment of the option holder for any reason. In the remaining cases where the option holder's service as an employee is terminated by the employee voluntarily or due to death, permanent disability, or is terminated by the Company (or its affiliates) without Cause at any time, the vested portion of the option will extend for a period of three (3) months following the termination of employment and shall lapse and be of no further force or effect whatsoever only if it is not exercised before the end of such three (3) month period. "Cause" shall be defined in an Employment Agreement between Company and option holder and if none there shall be "Cause" for termination if (i) the option holder is convicted of a felony, (ii) the option holder engages in any fraudulent or other dishonest act to the detriment of the Company, (iii) the option holder fails to report for work on a regular basis, except for periods of authorized absence or bona fide illness, (iv) the option holder misappropriates trade secrets, customer lists or other proprietary information belonging to the Company for the option holder's own benefit or for the benefit of a competitor, (v) the option holder engages in any willful misconduct designed to harm the Company or its stockholders, or (vi) the option holder fails to perform properly assigned duties. (i) No fractional shares of Stock shall be issued under the 1995 Option Plan, whether by initial grants or any adjustments to the 1995 Option Plan. 7. USE OF PROCEEDS. --------------- Cash proceeds realized from the sale of Stock under the 1995 Option Plan shall constitute general funds of the Company. 8. AMENDMENT, SUSPENSION OR TERMINATION OF THE PLAN. ------------------------------------------------ (a) The Board may at any time suspend or terminate the 1995 Option Plan, and may amend it from time to time in such respects as the Board may deem advisable provided that (i) such amendment, suspension or termination complies with all applicable state and federal requirements and requirements of any stock exchange on which the Stock is then listed, including any applicable requirement that the 1995 Option Plan or an amendment to the 1995 Option Plan be approved by the stockholders, and (ii) the Board shall not amend the 1995 Option Plan to increase the maximum number of shares of Stock subject to ISOs under the 1995 Option Plan or to change the description or class of persons eligible to receive ISOs under the 1995 Option Plan without the consent of the stockholders of the Company sufficient to approve the 1995 Option Plan in the first instance. The 1995 Option Plan shall terminate on the earlier of (i) January 2, 2006 or (ii) the date on which no additional shares of Stock are available for issuance under the 1995 Option Plan. 6 (b) No option may be granted during any suspension or after the termination of the 1995 Option Plan, and no amendment, suspension or termination of the 1995 Option Plan shall, without the option holder's consent, alter or impair any rights or obligations under any option granted under the 1995 Option Plan. (c) The Committee, with the consent of affected option holders, shall have the authority to cancel any or all outstanding options under the 1995 Option Plan and grant new options having an exercise price which may be higher or lower than the exercise price of cancelled options. (d) Nothing contained herein shall be construed to permit a termination, modification or amendment adversely affecting the rights of any option holder under an existing option theretofore granted without the consent of the option holder. 9. ASSIGNABILITY OF OPTIONS AND RIGHTS. ----------------------------------- Each option granted pursuant to this 1995 Option Plan shall, during the option holder's lifetime, be exercisable only by the option holder, and neither the option nor any right to purchase Stock shall be transferred, assigned or pledged by the option holder, by operation of law or otherwise, other than by will upon a beneficiary designation executed by the option holder and delivered to the Company or the laws of descent and distribution. 10. PAYMENT UPON EXERCISE. --------------------- Payment of the purchase price upon exercise of any option or right to purchase Stock granted under this 1995 Option Plan shall be made by giving the Company written notice of such exercise, specifying the number of such shares of Stock as to which the option is exercised. Such notice shall be accompanied by payment of an amount equal to the Option Price of such shares of Stock. Such payment may be (i) cash, (ii) by check drawn against sufficient funds, (iii) by delivery to the Company of the option holder's promissory note, (iv) such other consideration as the Committee, in its sole discretion, determines and is consistent with the 1995 Option Plan's purpose and applicable law, or (v) any combination of the foregoing. Any Stock used to exercise options to purchase Stock (including Stock withheld upon the exercise of an option to pay the purchase price of the shares of Stock as to which the option is exercised) shall be valued in accordance with procedures established by the Committee. Any promissory note used to exercise options to purchase Stock shall be a full recourse, interest-bearing obligation secured by Stock in the Company being purchased and containing such terms as the Committee shall determine. If a promissory note is used to exercise 7 options the option holder agrees to execute such further documents as the Company may deem necessary or appropriate in connection with issuing the promissory note, perfecting a security interest in the stock purchased with the promissory note and any related terms the Company may propose. Such further documents may include, without limitation, a security agreement and an assignment separate from certificate. If accepted by the Committee in its discretion, such consideration also may be paid through a broker-dealer sale and remittance procedure pursuant to which the option holder (I) shall provide irrevocable written instructions to a designated brokerage firm to effect the immediate sale of the purchased Stock and remit to the Company, out of the sale proceeds available on the settlement date, sufficient funds to cover the aggregate option price payable for the purchased Stock plus all applicable Federal and State income and employment taxes required to be withheld by the Company in connection with such purchase and (II) shall provide written directives to the Company to deliver the certificates for the purchased Stock directly to such brokerage firm in order to complete the sale transaction. 11. WITHHOLDING TAXES. ----------------- (a) Shares of Stock issued hereunder shall be delivered to an option holder only upon payment by such person to the Company of the amount of any withholding tax required by applicable federal, state, local or foreign law. The Company shall not be required to issue any Stock to an option holder until such obligations are satisfied. (b) The Committee may, under such terms and conditions as it deems appropriate, authorize an option holder to satisfy withholding tax obligations under this Section 11 by surrendering a portion of any Stock previously issued to the option holder or by electing to have the Company withhold shares of Stock from the Stock to be issued to the option holder, in each case having a fair market value equal to the amount of the withholding tax required to be withheld. 12. RATIFICATION. ------------ This 1995 Option Plan and all options issued under this 1995 Option Plan shall be void unless this 1995 Option Plan is or was approved or ratified by (i) the Board; and (ii) a majority of the votes cast at a stockholder meeting at which a quorum representing at least a majority of the outstanding shares of Stock is (either in person or by proxy) present and voting on the 1995 Option Plan within twelve months of the date this 1995 Option Plan is adopted by the Board. No ISOs shall be exercisable prior to the date such stockholder approval is obtained. 8 13. CORPORATE TRANSACTIONS. ---------------------- (a) For the purpose of this Section 13, a "Corporate Transaction" shall include any of the following stockholder-approved transactions to which the Company is a party: (i) a merger or consolidation in which the Company is not the surviving entity, except for a transaction the principal purpose of which is to change the State of the Company's incorporation; (ii) the sale, transfer or other disposition of all or substantially all of the assets of the Company in liquidation or dissolution of the Company; or (iii) any reverse merger in which the Company is the surviving entity but in which beneficial ownership of securities possessing more than fifty percent (50%) of the total combined voting power of the Company's outstanding securities are transferred to holders different from those who held such securities immediately prior to such merger. (b) Upon the occurrence of a Corporate Transaction, if the surviving corporation or the purchaser, as the case may be, does not assume the obligations of the Company under the 1995 Option Plan, then irrespective of the vesting provisions contained in individual option agreements, all outstanding options shall become immediately exercisable in full and each option holder will be afforded an opportunity to exercise their options prior to the consummation of the merger or sale transaction so that they can participate on a pro rata basis in the transaction based upon the number of shares of Stock purchased by them on exercise of options if they so desire. To the extent that the 1995 Option Plan is unaffected and assumed by the successor corporation or its parent company a Corporate Transaction will have no effect on outstanding options and the options shall continue in effect according to their terms. (c) Each outstanding option under this 1995 Option Plan which is assumed in connection with the Corporate Transaction or is otherwise to continue in effect shall be appropriately adjusted, immediately after such Corporate Transaction, to apply and pertain to the number and class of securities which would have been issued to the option holder in connection with the consummation of such Corporate Transaction had such person exercised the option immediately prior to such Corporate Transaction. Appropriate adjustments shall also be made to the option price payable per share, provided the aggregate option price payable for such securities shall remain the same. In addition, the class and number of securities available for issuance under this 1995 9 Option Plan following the consummation of the Corporate Transaction shall be appropriately adjusted. (d) The grant of options under this 1995 Option Plan shall in no way affect the right of the Company to adjust, reclassify, reorganize or otherwise change its capital or business structure or to merge, consolidate, dissolve, liquidate or sell or transfer all or any part of its business or assets. 14. LOANS OR GUARANTEE OF LOANS. --------------------------- (a) The Committee may, in its discretion, assist any option holder in the exercise of options granted under this 1995 Option Plan, including the satisfaction of any Federal and State income and employment tax obligations arising therefrom by (i) authorizing the extension of a loan from the Company to such option holder, (ii) permitting the option holder to pay the exercise price for the Stock in installments over a period of years or (iii) authorizing a guarantee by the Company of a third party loan to the option holder. The terms of any loan, installment method of payment or guarantee (including the interest rate and terms of repayment) will be upon such terms as the Committee specifies in the applicable option or issuance agreement or otherwise deems appropriate under the circumstances. Loans, installment payments and guarantees may be granted with or without security or collateral (other than to option holders who are not employees, in which event the loan must be adequately secured by collateral other than the purchased Stock). However, the maximum credit available to the option holder may not exceed the exercise or purchase price of the acquired shares of Stock plus any Federal and State income and employment tax liability incurred by the option holder in connection with the acquisition of such shares of Stock. (b) The Committee may, in its absolute discretion, determine that one or more loans extended under this financial assistance program shall be subject to forgiveness by the Company in whole or in part upon such terms and conditions as the Committee may deem appropriate. 15. REGULATORY APPROVALS. -------------------- The obligation of the Company with respect to Stock issued under the Plan shall be subject to all applicable laws, rules and regulations and such approvals by any governmental agencies or stock exchanges as may be required. The Company reserves the right to restrict, in whole or in part, the delivery of Stock under the Plan until such time as any legal requirements or regulations have been met relating to the issuance of Stock, to their registration or qualification under the Securities Exchange Act of 1934, if applicable, or any 10 applicable state securities laws, or to their listing on any stock exchange at which time such listing may be applicable. 16. NO EMPLOYMENT/SERVICE RIGHTS. ---------------------------- Neither the action of the Company in establishing this 1995 Option Plan, nor any action taken by the Board or the Committee hereunder, nor any provision of this 1995 Option Plan shall be construed so as to grant any individual the right to remain in the employ or service of the Company (or any parent, subsidiary or affiliated corporation) for any period of specific duration, and the Company (or any parent, subsidiary or affiliated corporation retaining the services of such individual) may terminate or change the terms of such individual's employment or service at any time and for any reason, with or without cause. 17. MISCELLANEOUS PROVISIONS. ------------------------ (a) The provisions of this 1995 Option Plan shall be governed by the laws of the State of Nevada, as such laws are applied to contracts entered into and performed in such State, without regard to its rules concerning conflicts of law. (b) The provisions of this 1995 Option Plan shall inure to the benefit of, and be binding upon, the Company and its successors or assigns, whether by Corporate Transaction or otherwise, and the option holders, the legal representatives of their respective estates, their respective heirs or legatees and their permitted assignees. (c) The option holders shall have no divided rights, voting rights or any other rights as a stockholder with respect to any options under the 1995 Option Plan prior to the issuance of a stock certificate for such Stock. (d) If there is a conflict between the terms of any employment agreement pursuant to which options under this Plan are to be granted and the provisions of this Plan, the terms of the employment agreement shall prevail. 11 EX-27 9 FINANCIAL DATA SCHEDULE
5 1,000 YEAR DEC-31-1995 JAN-01-1995 DEC-31-1995 3,719 0 31,753 0 57,331 124,110 66,597 0 194,520 87,298 0 0 8,752 12 30,967 194,520 80,812 80,812 45,838 59,420 0 0 5,822 15,570 2,461 13,109 0 0 0 6,502 0 0.42
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