-----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, OQjBge4kR8jPGpCAIYJwR1wEXvAx1T+TRNyo8Xo4Qi0gssYh3OIlyq5i9X8zc22Z 3+ZGVkhIyG6GxEVDSPIloA== 0000898430-98-002014.txt : 19980518 0000898430-98-002014.hdr.sgml : 19980518 ACCESSION NUMBER: 0000898430-98-002014 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980515 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: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-03132 FILM NUMBER: 98626269 BUSINESS ADDRESS: STREET 1: PO BOS 1028 CITY: MONROVIA STATE: CA ZIP: 91017-1028 BUSINESS PHONE: 8183580181 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-K 1 FORM 10-K 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, 1997 [_] 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 [_] No[X] 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. 1 As of March 31, 1998, 12,700,142 shares of Common Stock were outstanding. The aggregate market value of the outstanding stock of the Registrant held by non-affiliates on March 31, 1998 was $11,795,226. Documents incorporated by reference: None The total number of pages in this report is 88. The exhibit index is located on pages 83 through 86. 2 PART I. ITEM 1. BUSINESS. This Annual Report on Form 10-K contains forward-looking statements that involve risks and uncertainties. Actual results of the Company could differ materially from those statements. Factors that could cause or contribute to such differences include, but are not limited to, those factors discussed under the heading "FACTORS THAT MAY AFFECT FUTURE RESULTS" in ITEM 7 and elsewhere in this Report. SUNBASE ASIA 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 ("U.S."), Europe, Asia, South America and Africa. Harbin Bearing Company, Ltd. ("Harbin Bearing"), a majority-owned subsidiary of Sunbase Asia, is located in Harbin, China, and has been in business since 1950. Harbin Bearing has approximately 12,500 employees and operates out of facilities occupying in excess of two million square feet. Harbin Bearing is one of the five largest manufacturers of bearings in China in terms of sales revenue. Harbin Bearing manufactures and distributes a wide variety of precision and commercial-grade rolling element bearings in sizes ranging from 10 mm to 1,000 mm (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, and virtually any product that contains rotating or revolving parts. 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 mechanics and the use of sophisticated machine tools. On January 16, 1996 (effective December 29, 1995), the Company acquired Smith Acquisition Company, Inc. dba Southwest Products Company ("Southwest Products"), a bearing manufacturing company located in Los Angeles County, California, that has been in business since 1945. Southwest Products is an engineering-intensive company that designs and manufactures high-precision plain spherical bearings, rod-end bearings, bushings and push-pull controls for U.S., European and Asian aerospace and high technology commercial applications and the U.S. military. Spherical bearings are "ball and socket" mechanisms that allow for motion in three dimensions and which move loads from one plane to another. For flight critical applications, a spherical bearing must have extremely precise tolerances and it must be able to endure heavy loads without failure. Over 90% of Harbin Bearing's sales are made to the Original Equipment Manufacturers ("OEMs") and replacement markets in China. Based on low production costs in China and the on-going worldwide demand for bearings, management intends to develop a substantial export business to complement the Company's strong domestic position in the Chinese markets. Historically, Harbin Bearing's export sales have been made through trade intermediaries and by receiving customer orders that are placed directly to its offices in China. Subject to compliance 3 with U.S. export controls, Southwest Products will provide engineering and technical support to Harbin Bearing, and will market and distribute Harbin Bearing products internationally, focusing on exports of the products to the U.S. In addition, subject to compliance with U.S. export controls, Southwest Products will assist Harbin Bearing in implementing U.S. manufacturing methods, improving quality control procedures and in developing new products at Harbin Bearing's facilities in China. See ITEM 7, "FACTORS THAT MAY AFFECT FUTURE RESULTS." The following diagram shows the corporate structure of the Company and its affiliated companies as of December 31, 1997: 4 ------------------------------------- SUNBASE ASIA, INC. Common Stock trades on NASDAQ (Nevada Corporation) ------------------------------------- 100% 100% - ----------------------------------- ===================================== CHINA BEARING SOUTHWEST HOLDINGS LIMITED PRODUCTS (Bermuda Holding Company) COMPANY - ----------------------------------- (California corporation) 100% OPERATING COMPANY - ----------------------------------- ===================================== CHINA INTERNATIONAL BEARING HOLDINGS LIMITED (Hong Kong Holding Company) - ----------------------------------- 99% 99.9% - --------------------- ---------------------- HARBIN SUNBASE HARBIN XINHENGLI DEVELOPMENT DEVELOPMENT COMPANY LIMITED COMPANY LIMITED (PRC JV Holdings Co.) (PRC JV Holdings Co.) - --------------------- ---------------------- 10% 41.57% =============================================== HARBIN BEARING COMPANY, LTD (PRC Joint Stock Company) OPERATING COMPANY (note A) =============================================== (A) Sunbase Asia's effective ownership in Harbin Bearing is 51.43%. 5 COMPETITION Harbin Bearing's main competitors can be categorized into three principal groups: (i) a few very large national bearing manufacturers in China with a wide range of products; (ii) small local Chinese bearing production facilities that compete on a local basis by manufacturing small-sized, commodity-type bearings; and (iii) non-Chinese bearing manufacturers. Competition is principally based upon pricing considerations. Chinese Competition In China, there are five major bearing manufacturers. In terms of revenue reported by bearing manufacturers in China for 1996, the top five are Wafangdian Bearing Company Limited, Luoyang Bearing Group, Northwest Bearing Joint Stock Company, Harbin Bearing and Xiangyang Bearing Joint Stock Company. The balance of the PRC bearing industry is fragmented, comprised of a larger number of smaller bearing companies producing mostly lower grade bearings often on a local basis for use mostly as replacement bearings in the electrical appliance and agricultural equipment industries. PRC bearing manufacturers are often unable to produce bearings of such a high precision, consistency and durability as those produced by the leading multinational manufacturers. Contributory factors include the lower levels of capital expenditure in the PRC bearing industry, the greater labor intensive production processes and the relative lack of operational skills and training. According to a PRC bearing industry journal, local production is able to satisfy about 70 % of domestic demand in terms of type of products and 90 % in terms of quantity. Therefore, there is a surplus demand in China for certain higher grade bearings, especially in the road transport and railway sectors. In 1996, the PRC imported about $200 million of bearings (according to the China National Bearing Industry Association) in order to help satisfy the demand for higher grade bearings (including wheel hub bearing units for passenger vehicles and high-speed railway bearings) not generally available from PRC manufacturers, an increase of over some 250 % from 1990. This has led the PRC authorities to encourage foreign investment in higher grade bearing manufacturers and to demand a halt to approvals of foreign investment supporting the production of lower grade bearings. Bearings imported into the PRC are currently subjected to import tariffs ranging from 10 % to 17 %. If the PRC becomes a signatory of the World Trade Organization, the import tariff may be phased out, thus potentially increasing competition by foreign manufacturers. The PRC bearing industry's export target for the year 2000 is $350-400 million, including targets of $150 million to the U.S., $100 million to South East Asia and $100 million to Western Europe. It is estimated by the Chinese National Bearing Industry Association that about 900 million units of bearings were produced in 1995. Under the Ninth Five-Year Plan (1996-2000) a target bearing output of 1.2 to 1.3 billion units has been set. Pursuant to this Plan, the industry will establish priorities for developing bearings for motor vehicles, railway passenger trains, freight cars, engineering and agricultural machinery, metallurgy, mining, petrochemical machinery, machine tools, electric motors, bearings for export and high- efficiency special bearing equipment. 6 The potential for growth in the PRC bearing industry will be substantially dependent upon the performance of the PRC industrial sector and the economy in general. Since 1978, China has been pursuing economic reform policies in an effort to improve its industrial sector and revitalize its economy. Nevertheless, due to the recent financial crises hitting Asia, the central PRC government has implemented various policies to minimize the adverse effects upon the PRC economy. Such policies include closer supervision of the PRC banking system and tighter control over capital expenditures by PRC enterprises. These policies indirectly resulted in greater competition and will continue to have an adverse and significant impact on the performance of PRC bearing manufacturers. Competition in International Markets Worldwide sales of bearings are estimated at $40-45 billion, with approximately 75 % of the consumption within North America, Western Europe and Japan. The industry is extremely competitive. Although Harbin Bearing's main competitors are Eastern European manufacturers and manufacturers located in China, to a lesser extent, Harbin Bearing also competes with companies, such as Svenska Kugellager Fabriken (SKF), Fisher Aktien Gesellschast (FAG), New Technology Network (NTN), NSK, Timken, Torrington-Fafnir and Nippon Miniature Bearing (MINEBEA), who dominate this market. Management believes in the long term that, Harbin Bearing's competitive position should be enhanced to the extent Southwest Products is able to assist Harbin Bearing, in implementing U.S. manufacturing methods and quality control procedures and in developing new products may enhance Harbin Bearing's general competitive position. In addition, Harbin Bearing may be able to compete in market segments that demand products with higher precision levels and may more effectively penetrate those market segments that utilize commodity-type bearings. See ITEM 7, "FACTORS THAT MAY AFFECT FUTURE RESULTS". 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 1997, deep-groove bearings comprised approximately 57.8 % of Harbin Bearing's sales in revenue. Harbin Bearing specializes in and is the largest manufacturer of precision bearings in China. 7 Sales and 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 1997, approximately 30 % of Harbin Bearing's sales were made to OEMs in the machinery, transportation and electrical equipment industries representing, respectively, approximately 50 %, 7 % and 30 % of its total sales to OEMs. The remaining 13 % of sales were made to miscellaneous categories of OEM customers. Approximately 70 % of Harbin Bearing's sales in 1997 were made to distributors. Sales to related parties accounted for RMB 171,373,000 or 23.0 % in 1997, RMB 232,338,000 or 25.9 % in 1996 and RMB 103,111,000 or 15.3 % in 1995. These related parties are owned by the Harbin Municipal Government. Harbin Bearing has 11 sales offices in major cities in China, including Beijing, Shanghai and Guangzhou. These sales offices are established strategically for the purpose of increasing market share as well as widening the channel of sales. 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. As of December 31, 1997, Harbin Bearing's sales force consists of 126 sales personnel and 236 support personnel who are responsible for product promotion, marketing, after-sales services and technical support. Harbin Bearing sells its bearings in China and abroad under the "HRB" trademark. Harbin Bearing delivers its bearings by rail, truck, ocean freight and airfreight. Deliveries by truck are increasing due to improved highway networks and conditions. This substantially shortens delivery time over delivery by rail. 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". Due to the adverse market conditions in the PRC as influenced by the financial turmoil in Asia, Harbin Bearing has further enhanced its credit review procedures and has limited sales to customers where timely revenue collection could not be ascertained. Management believes the difficult market conditions will not improve in the foreseeable future. Management will continue to cautiously monitor sales in order to avoid sales that could produce negative growth for the year ahead. See ITEM 7, "FACTORS THAT MAY AFFECT FUTURE RESULTS". 8 Manufacturing/Engineering/New Product Development In the face of greater competition in the bearing industry, Harbin Bearing has been endeavoring to improve productivity and quality so as to control and reduce manufacturing cost in order to become more competitive. Harbin Bearing manufactures its products primarily for customer's specific orders. As far as the U.S. aerospace and automotive markets are concerned, Harbin Bearing has committed to consistently manufacture products with the quality required by these OEMs. Nevertheless, the original schedule for the implementation of system improvements to meet the various worldwide recognizable manufacturing standards such as ISO 9000 and QS 9000, the automotive quality standard at the Harbin Bearing facility has been extended for another two years to the year 2001. Any assistance from the U.S. in meeting such standards may be subject to U.S. export controls. Attainment of these quality control standards is a pre- requisite to compete for bidding from U.S. aerospace and automotive manufacturers. See ITEM 7, "FACTORS THAT MAY AFFECT FUTURE RESULTS." 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. 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 45 days 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. Workforce As of December 31, 1997, Harbin Bearing employed approximately 12,500 full- time personnel in the following areas: executive and administrative (650), sales and service (500), manufacturing and production (11,050), and research and development (300). Management believes that, in general, its relationship with the employees is good. The Harbin Municipal Government promulgated regulations which provide for the establishment of a pension fund program to which both employer and employees must contribute. Commencing with the second half of 1996, Harbin Bearing was required to contribute monthly an amount equivalent to 22 % of its employees' aggregate monthly income, and each employee was required to contribute each month an amount that is equivalent to 3 % of such employee's monthly income. 9 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, which has operated continuously since 1945, is located in a 5,110 square meter facility in Irwindale, California. Southwest Products 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, aviation, military and high tech commercial applications. Southwest Products employs 60 full-time personnel in the following areas: executive and administrative (5); sales and service (5); manufacturing (37) and engineering, research and development (13). The average length of employee tenure at Southwest Products is in excess of nine 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, military aircraft (including the B-2 Stealth Bomber, F- 117 Stealthfighter, F-15, F-16, F-18 and C-17), submarines, (Los Angeles Class, Seawolf and Centurion), and nuclear power plants. Southwest Products' bearings are used by Northrop Grumman, Lockheed Martin, NASA, all U.S. 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. Sales and Marketing Growth by Southwest Products is expected to come from sales of products for which Southwest Products is already qualified and from sales of new products for which Southwest Products must obtain qualification. Southwest Products believes that it presently has the most rapid delivery turnaround in the bearing industry, some six weeks shorter than the nearest competition and twelve weeks shorter than the industry average. The commercial aerospace industry continues to experience growth. Due to this growth and the downsizing that has occurred at many bearing manufacturers during the past few years, many spherical bearing manufacturers are unable to deliver products to the OEMs within acceptable time frames. Southwest Products has taken advantage of its position as the leader in terms of quick delivery with expedite fees for accelerated deliveries. 10 Southwest Products Proprietary Technology Southwest Products manufactures both metal-on-metal bearings and self- lubricating bearings, based on Southwest Products' design and 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 U.S. 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 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 formula 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 market for non- specialized bearings (standards market) by improving Southwest Products' international cost competitiveness. In late 1992, Southwest Products and HXBC signed a Technology Transfer Agreement through which Southwest Products licensed technology to the Shanghai Joint Venture and was to manage the Shanghai Joint Venture's manufacturing activities. Because the types of bearings covered by the Technology Transfer Agreement are restricted commodities covered by the U.S. Export Administration Regulations Commerce Control List, the transfer of technology relating to such bearings was subject to Southwest Products receiving from the U.S. Department of Commerce a Validated Export License ("License"), which permits the technology to be transferred by Southwest Products to the PRC, subject to specified conditions. The License was issued in February 1994 and expired in February of 1996; the Company has not yet attempted to renew the License. At this time the Company is unsure as to whether the U.S. Department of Commerce would renew the License. Additionally, the Company believes that HXBC has not complied with the terms of the Technology Transfer Agreement due to HXBC's failure to purchase requisite technology and machinery and equipment either from or through Southwest Products. Therefore, the Shanghai Joint Venture has not been fully capitalized. Additionally, due to this failure to fully capitalize the Joint Venture, the Company believes that the Shanghai Municipal government may not extend the Joint Venture License issued by the municipal government. Without an extension of the Joint Venture License, the Joint Venture would not be permitted to operate. Accordingly, the Joint Venture is not currently conducting any operations and the Company has no present plans to initiate Joint Venture operations. 11 OPERATING IN CHINA Because the production operations of the Company are based to a substantial extent in China, the Company is subject to rules and restrictions governing China's legal and economic system as well as general economic and political conditions in the 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 devaluation or the expropriation of private enterprises 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 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 control inflation. In 1995, China's overall inflation rate (retail price index) was some 15%, compared to 21 % in 1994 and 13% in 1993. However, after the implementation of strict monetary policies, the inflation rates were 6% and 8 % in 1996 and 1997 respectively. High inflation has in the past and may in the future cause the PRC government to impose controls on prices, or to take other actions which could inhibit economic activity in China, which in turn could affect demand for the Company's products. In view of the change in market conditions and greater competition, Harbin Bearing may unable 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, 12 remained fairly stable from 1994 to 1997 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). Foreign Exchange Control and Exchange rate Risks. Prior to January 1, 1994 the PRC had two exchange rates: the Official Rate and the Swap Centre Rate. On January 1, 1994 this dual foreign exchange system was abolished. The control on the purchase of foreign exchange is being relaxed. Pursuant to the PRC Foreign Exchange Control Regulations which came into effect on April 1, 1996, enterprises which require foreign exchange for current account transactions (such as trading activities) may purchase foreign exchange from designated banks subject to production of relevant supporting documents. The Administrative Regulations on the Settlement, Sale and Payment of Foreign Exchange, which came into force on July 1, 1996, set out the procedures for the purchase, sale and settlement of foreign exchange for current account transactions. In addition, these Regulations provide that foreign exchange required for the payment of dividends that are payable in foreign currencies under applicable regulations may be purchased from designated foreign exchange banks subject to the payment of taxes on such dividends and upon presentation of board resolutions authorizing the distribution of profits or dividends of the company concerned. Despite the relaxation of foreign exchange control over current account transactions, the approval of the State Administration for Foreign Exchange ("SAFE") is still required before a PRC enterprise may borrow in a foreign currency, provide any foreign exchange guarantee, make any investment outside the PRC or enter into any other capital account transaction which involves the purchase of foreign exchange. In general, all organizations and individuals within the PRC, including foreign investment enterprises ("FIEs"), are required to sell their foreign exchange earnings to designated banks in the PRC. FIEs, however, are permitted to retain a certain percentage of their foreign exchange earnings and the sums retained may be deposited into foreign exchange bank accounts maintained with designated banks. Despite the relaxation of foreign exchange control over current account transactions, Renminbi remains a currency which is not freely convertible into other currencies. There can be no assurance that shortages of foreign currency at the swap centres or designated banks will not restrict the Company's ability to obtain sufficient foreign currency to pay dividends to the shareholders of the Company or to meet other foreign currency requirements or that the Renminbi will not be subject to further devaluation. Currently, the Company is unable to hedge its U.S. Dollar-Renminbi exchange rate exposure in China because no financial institutions are authorized to engage in foreign currency transactions offering forward exchange contracts with respect to the 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 are affiliates of the Harbin Municipal Government. 13 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 of 51.43 % in Harbin Bearing. 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. In December 1994, the Company (which was then called Pan American Industries, Inc.) acquired a 51.43 % effective interest in Harbin Bearing by issuing to Asean Capital Limited ("Asean Capital") newly issued shares representing a controlling interest in the Company. All of the outstanding capital stock of Asean Capital is currently owned by Sunbase International. See ITEM 13, "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS." ITEM 2. PROPERTIES. HARBIN BEARING Harbin Bearing operates twelve finished product plants and thirteen auxiliary plants. With the exception of a newly relocated finished product plant in Daowaiqu of Limin Trade Development Zone, all of the Company's plants are located in four plant compounds in Harbin. The Harbin branch of the 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 are located. The site is approximately 540,000 square meters of which production facilities occupy approximately 290,000 square meters. Harbin Holdings has entered into a lease agreement with the Company for use of its buildings for five years commencing January 1, 1994. See ITEM 13, "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS." SOUTHWEST PRODUCTS Southwest Products leases a 5,110 square meter facility in Irwindale, California on a month to month basis at a monthly rent of $14,000. 14 ITEM 3. LEGAL PROCEEDINGS Foreign Investment Matters The Company is currently holding discussions with the Committee on Foreign Investment in the United States ("CFIUS"), an inter-agency committee of the United States Government, with respect to the Company's acquisition in January 1996 of Southwest Products Company ("Southwest"). CFIUS is conducting a review to determine if the ownership of Southwest by the Company poses a potential threat to the national security interests of the United States. If CFIUS determines that such a threat may exist, then it may recommend to the President of the United States that he order divestiture of Southwest by the Company. Alternatively, CFIUS may take no action or may propose that certain measures be taken by the Company to protect the national security interests of the United States as a condition of the Company continuing to own Southwest. At this time, it is premature to evaluate the likelihood of any action by CFIUS with respect to this matter. If the Company is required to divest its ownership of Southwest or significant restrictions on its ownership are imposed, the Company believes it has certain claims which it may bring against certain of its professional advisors who assisted it in connection with its acquisition of Southwest. However, no assurance can be given that any such claims by the Company would fully reimburse it for any loss it might realize upon a divestiture of Southwest or as a result of the imposition of conditions on its ownership. ITAR Regulations In December 1997, Southwest registered with the Office of Defense Trade Controls of the Department of State ("DTC") as a manufacturer of defense articles subject to regulation under the International Traffic in Arms Regulations ("ITAR"). Southwest had not previously been registered with DTC, although it appears that such registration was required. Southwest is currently reviewing its export history to determine if any of its exports may have been in violation of ITAR. In this regard, the Company is making voluntary disclosure to DTC and is cooperating fully with DTC in seeking to bring Southwest into full compliance with ITAR. If it is determined that Southwest violated ITAR in the past, it could be subjected to a variety of civil or criminal penalties. At this time, no proceedings related to any alleged non-compliance by Southwest with ITAR have been instituted or threatened. The Company believes that if any such proceedings are instituted, any sanctions which might be imposed would take into account the inadvertent nature of violations of ITAR by Southwest, if any, as well as the Company's voluntary disclosure to DTC with respect to this matter. However, no assurance can be given as to the outcome of any such proceedings. Employee Claim In 1996 the Company's subsidiary, Southwest Products, was a defendant in a lawsuit with an employee. The lawsuit was settled out of court in 1997. Except as disclosed above, the Company is not a party to, nor any of its property is subject to any material legal proceedings. 15 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. The following matters, which are described in greater detail in the Company's proxy statement, were submitted to a vote of the Company's security holders (shareholder's of record of the Company's voting stock at the close of business on October 15, 1997) at the Company's annual meeting held on December 15, 1997: 1. To elect a board of seven directors to serve until the next annual meeting of the Company's shareholders and until their successors have been elected and qualified; 2. To ratify the appointment of Ernst & Young as the Company's independent auditors for the year ending December 31, 1997; and 3. To transact such other business as may properly come before the meeting or any adjournment thereof. The following are the results of votes cast as reported at the Company's annual meeting on December 15, 1997.
Proposal #1 Election of Directors For Withheld - ----------- --------------------- --- -------- Gunter Gao 9,016,420 0 Billy Kan 9,016,420 0 William McKay 8,990,420 26,000 Philip Yuen 9,016,420 0 Ho Cho Hing (Franco) 9,016,420 0 Li Yuen Fai (Roger) 9,016,420 0 George Raffini 9,016,420 0 Proposal #2 To ratify Ernst & Young as the Company's independent - ----------- auditors for year 1997. For Against Abstain --- ------- ------- 9,016,420 0 0
16 PART II. ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS Commencing on February 9, 1996, the Company's Common Stock began trading on the National Market of NASDAQ under the symbol ASIA and changed symbol to SNBS effective January 30, 1998. 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 1996 - ----------- Quarter Ended March 31, 1996 7 7/8 6 1/32 Quarter Ended June 30, 1996 8 6 1/2 Quarter Ended September 30, 1996 7 3/4 6 1/8 Quarter Ended December 31, 1996 8 4 3/4 High Low Fiscal 1997 - ----------- Quarter Ended March 31, 1997 7 1/16 4 1/4 Quarter Ended June 30, 1997 6 1/2 4 1/4 Quarter Ended September 30, 1997 6 3 5/8 Quarter Ended December 31, 1997 3 7/8 2 7/8
The approximate number of record security holders of the Common Stock at December 31, 1998 was 1,641. The Company has paid no cash dividends on its Common Stock and has no present intention of paying cash dividends in the foreseeable future. Pursuant to the Convertible Debenture Agreement, no dividend payments can be made on a share of Common Stock that is greater than 20% of the Company's audited earnings per share (excluding any extraordinary item). 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 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 17 if the amount of such fund has reached 50 % of the company's registered capital. For 1997, Harbin Bearing contributed 10 % and 5 %, respectively, of after-tax profits as determined under Chinese accounting principles for such purposes. Distribution of dividends by Harbin Bearing to its shareholders are required to be in proportion to each shareholder's percentage interest in Harbin Bearing. In addition, distribution of dividends 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 the Company for the years ended December 31, 1995, 1996 and 1997. All U.S. dollar amounts have been converted from Renminbi based on the exchange rate on December 31, 1997 of U.S. $1.00 to each RMB 8.30 as quoted at the People's Bank of China.
OPERATING DATA 1995 1996 1997 1997 RMB RMB RMB US$ Net sales 672,359 889,706 741,696 89,361 Cost of sales (380,279) (546,918) (506,946) (61,076) Provisions on inventories (1,098) (1,415) (33,255) (4,007) Gross profit 290,982 341,373 201,495 24,278 Selling, general and administrative expense (110,375) (115,174) (89,117) (10,737) Interest expense, net (48,446) (57,173) (70,925) (8,545) Provisions on accounts receivable (2,627) (3,998) (17,040) (2,053) Other income - 16,640 - - Income before income taxes 129,534 181,668 24,413 2,943 Provision for income taxes (20,472) (27,792) (7,591) (915) Income before minority interests 109,062 153,876 16,822 2,028 Minority interests (54,967) (77,342) (21,006) (2,531) Net income/(loss) 54,095 76,534 (4,184) (503) BALANCE SHEET 1995 1996 1997 1997 RMB RMB RMB US$ Current assets 1,032,600 1,181,609 1,367,253 164,729 Working capital 306,288 404,618 307,461 37,043 Long-term debts 218,383 231,824 84,938 10,234 Minority interests 343,142 420,484 441,490 53,192 Shareholders' equity 330,565 443,184 439,000 52,890 Total assets 1,618,402 1,872,483 2,025,220 244,002
18 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS CONDITION AND RESULTS OF OF FINANCIAL OPERATIONS OVERVIEW The Company owns, through various subsidiaries and joint venture interests, a 51.43 % indirect ownership in Harbin Bearing. Harbin Bearing manufactures a wide variety of bearings in China for use in commercial, industrial and aerospace applications that are sold primarily in China and certain western countries, including the U.S. On January 16, 1996 (effective December 29, 1995), the Company acquired Southwest Products, which manufactures precision spherical bearings that are sold primarily to the aerospace and commercial aviation industries. The acquisition of Southwest Products has been accounted for under the purchase method of accounting. The results of Southwest Products have been included in the Company's consolidated results of operations commencing January 1, 1996. As a result of adverse market conditions in China primarily due to the financial crises in Asia, especially during the last quarter of 1997, the funds designated to Chinese stated-owned enterprises became even less available than in previous years and resulted in greater competition in the bearing industry. Under these circumstances, the operations of Harbin Bearing were adversely affected this year. Unless specifically stated in this ITEM 7, all RMB and U.S. Dollar amounts except per share information are in the thousands ('000). 19 RESULTS OF OPERATIONS RESULTS FOR 1997 COMPARED TO 1996
Year ended Year ended December 31, December 31, 1997 1996 RMB RMB --- --- Net sales 741,696 889,706 Cost of sales (506,946) (546,918) Provisions on inventories (33,255) (1,415) --------- -------- Gross profit 201,495 341,373 Gross profit percentage 27.2% 38.4% Selling expenses (19,520) (25,412) General and administrative expenses (69,597) (89,762) Interest expense (70,925) (57,173) Provisions on accounts receivable (17,040) (3,998) Other income - 16,640 --------- -------- Income before income taxes 24,413 181,668 Provision for income taxes (7,591) (27,792) --------- -------- Income before minority interests 16,822 153,876 Minority interests (21,006) (77,342) --------- -------- Net (loss)/income (4,184) 76,534 ========= ========
NET SALES Sales for the year ended December 31, 1997 decreased by RMB 148,010 or 16.6% to RMB 741,696 as compared to RMB 889,706 for the year ended December 31, 1996. The decrease in sales was due to the Company's continuing efforts to adjust to tightening credit conditions in the PRC. The Company has responded to such conditions by enhancing its credit review procedures and restricting sales to customers where collectability was uncertain. Moreover, stringent controls on capital expenditures by PRC enterprises by the Chinese government have also caused a decrease in the demand for the Company's products, which are used as components in machinery and equipment. Competition for the limited sales orders in the bearing market became greater in 1997. During 1997, there were no material price increases from the prior twelve month period. Sales for Harbin Bearing for the year ended December 31, 1997 decreased by RMB 156,784 or 18.4% to RMB 697,282 as compared to RMB 854,066 for the year ended December 31, 1996. The decrease was partially offset by an increase in sales for Southwest Products by RMB 8,774 or 24.6% to RMB 44,414 for the year ended December 31, 1997 as compared to RMB 35,640 for the year ended December 31, 1996. 20 COST OF SALES/PROVISIONS ON INVENTORIES/GROSS PROFIT Cost of sales for the year ended December 31, 1997 decreased to RMB 506,946 as compared to RMB 546,918 for the year ended December 31, 1996. Gross profit decreased by RMB 139,878 or 41.0% in 1997 as compared to 1996. Gross profit as a percentage of revenue also decreased from 38.4% in 1996 to 27.2% in 1997. The decrease in gross profit was mainly attributable to the decrease in sales caused by adverse market conditions in the PRC, which led to a plunge in units of bearings produced in 1997. The decrease in production output and an under-utilization of machinery and equipment capacity resulted in an increase in overhead absorption by each unit produced and an increase in the unit cost of goods sold. Also, there was no material change in selling prices during 1997 as compared to 1996. Furthermore, an additional provision for obsolete and slow moving inventory totalling RMB 33,255 was made in 1997, an increase of RMB 31,840 over that in 1996. SELLING EXPENSES Selling expenses for the year ended December 31, 1997 decreased by RMB 5,892 or 23.2% to RMB 19,520 as compared to RMB 25,412 for the year ended December 31, 1996. Selling expenses as a percentage of revenues improved slightly from 2.8% for 1996 to 2.6% for 1997. The decrease in selling expenses was primarily attributable to the decrease in royalty costs, packing expenses and government taxes in China as a result of the decrease in sales output. GENERAL AND ADMINISTRATIVE EXPENSES General and administrative expenses decreased by RMB 20,165 or 22.5% in 1997 as compared to 1996. General and administrative expenses as a percentage of revenues decreased from 10.1% to 9.4%. The decrease in general and administrative expenses was mainly attributable to tighter control over expenditures in view of the adverse market conditions. INTEREST EXPENSE Interest expense for the year ended December 31, 1997 increased by RMB 13,752 or 24.1% as compared to 1996. The increase in interest expense was attributable to the increase in bank loans during 1997 as compared to 1996 and the surge in Convertible Debentures interest. These increases were partially offset by an increase in interest income. The total amount of Convertible Debentures interest charged in 1997 was RMB 21,921 whereas the amount was RMB 4,078 in 1996. The substantial rise was due to a full year of convertible debenture interest for 1997 as compared to a charge of four months for 1996 and the increase in the interest accrual rate from 12% to 19.75% per annum (amounted to RMB 10,480) due to the Company's default on a condition of the Subscription Agreement governing the Convertible Debentures. PROVISIONS ON ACCOUNTS RECEIVABLE An increase in provision for bad debts for Harbin Bearing of RMB 17,040 in 1997 as compared to RMB 3,998 in 1996 was made to provide for the slow recovery of accounts receivable. The Company believes that the current economic situation in Asia will continue into the immediate future and the Company expects to continue to encounter difficulties in accounts receivable collections. 21 OTHER INCOME Last year other income was a gain on the sale of a short term investment in a subsidiary by China Bearing to a third party, which amounted to RMB 16.6 million. The only asset of the subsidiary was a residential property in Hong Kong, which was purchased in 1996. Net Income As a result of the aforementioned factors, net income decreased by RMB 80,718 or 105.5% to the net loss of RMB 4,184 for the year ended December 31, 1997 as compared to a net income of RMB 76,534 for the year ended December 31, 1996. 22 RESULTS FOR 1996 COMPARED TO 1995
Year ended Year ended December 31, December 31, 1996 1995 RMB RMB --- --- Net sales 889,706 672,359 Cost of sales (546,918) (380,279) Provisions on inventories (1,415) (1,098) --------- --------- Gross profit 341,373 290,982 Gross profit percentage 38.4% 43.3% Selling expenses (25,412) (18,942) General and administrative expenses (89,762) (91,433) Interest expense (57,173) (48,446) Provisions on accounts receivable (3,998) (2,627) Other income 16,640 - --------- --------- Income before income taxes 181,668 129,534 Provision for income taxes (27,792) (20,472) --------- --------- Income before minority interests 153,876 109,062 Minority interests (77,342) (54,967) --------- --------- Net income 76,534 54,095 ========= =========
NET SALES Sales (including RMB 35,640 from Southwest Products) for the year ended December 31, 1996 increased by RMB 217,347 or 32.3% as compared to the year ended December 31, 1995. Excluding the Southwest Products operations, sales increased by RMB 181,707 or 27.0% for the year ended December 31, 1996 as compared to a 6.6% decrease for the year ended December 31, 1995. The increase was due to: a. An increase in the domestic (Chinese) demand for bearings primarily in the automobile, motorcycle and machine-tooling industries. The Company continued its efforts to shift its product mix from small and medium sized bearings to higher margin medium and large sized bearings. This change has improved operational efficiency and established tighter credit control. b. A large sales order that was entered into with a major distributor in 1995, which is also a related party beneficially owned by the Harbin Municipal Government, was delivered in 1996 and therefore accounted for as a sale in 1996. 23 COST OF SALES/GROSS PROFIT Cost of sales (including RMB 26,529 from Southwest Products) for the year ended December 31, 1996 increased to RMB 546,918 as compared to RMB 380,279 for the year ended December 31, 1995. Gross profit increased by RMB 50,391 or 17.3% in 1996 compared to 1995. The increase in gross profit was attributable to the increase in sales. Gross profit as a percentage of revenue decreased from 43.3% in 1995 to 38.4% in 1996. The gross profit margin for 1995 was reported as 43.3% but would have been only 39.2% of revenue had there not been certain year end adjustments principally relating to the reversal of the inventory provision for obsolete inventories sold in 1995. SELLING EXPENSES Selling expenses (including RMB 4,855 from Southwest Products) for the year ended December 31, 1996 increased by RMB 6,470 or 34.2% to RMB 25,412 as compared to RMB 18,942 for the year ended December 31, 1995. The increase in selling expenses was primarily attributable to the inclusion of Southwest Products selling expenses in 1996 and the increase in royalty costs and government taxes in China as a result of the increase in sales. Selling expenses as a percentage of revenue remained constant at a rate of 2.8%. GENERAL AND ADMINISTRATIVE EXPENSES General and Administrative expenses (including RMB 10,490 from Southwest Products) decreased by RMB 1,671 or 1.8% in 1996 as compared to 1995. General and Administrative expenses as a percentage of revenues decreased from 13.6% to 10.1%. The decrease in General and Administrative expenses of RMB 12,161 after excluding RMB 10,490 from Southwest was mainly attributable to: a. A decrease in staff salaries, staff benefits and related insurance of RMB5,258 as compared to 1995. b. A decrease in compensation expense relating to the voluntary early retirement program at Harbin Bearing of RMB 5,173 (RMB 6,133 in 1995 to RMB 960 in 1996). INTEREST EXPENSE Interest expense (including RMB 3,039 from Southwest Products) for the year ended December 31, 1996 increased by RMB 8,727 or 18% as compared to 1995. The increase in interest expense was attributable to the inclusion of Southwest Products interest expense in 1996, the increase in the principal amount of bank loans during 1996 as compared to 1995 and the inclusion of RMB 4,078 of Convertible Debenture interest calculated at the rate of 12% per annum since August 23, 1996. OTHER INCOME This represents a gain on the sale of a short term investment in a subsidiary by China Bearing to a third party, which amounted to RMB 16.6 million. The only asset of the subsidiary was a residential property in Hong Kong, which was purchased during 1996. 24 NET INCOME As a result of the aforementioned factors, including the consolidation of Southwest Products operations effective January 1, 1996, net income increased by RMB 22,439 or 41.5% to RMB 76,534 for the year ended December 31, 1996 as compared to RMB 54,095 for the year ended December 31, 1995. LIQUIDITY AND CAPITAL RESOURCES OPERATING ACTIVITIES The Company's operations consumed cash resources of RMB 39,593 in 1997 as compared to RMB 105,768 generated from operating activities in 1996. The decrease in cash generated from operating activities was a result of the unsatisfactory market conditions which led to a decrease in sales and the slower recovery of trade receivables from customers whose businesses, in general, were not satisfactory in 1997. As of December 31, 1997, the Company's working capital had decreased to RMB 307,461 as compared to RMB 404,618 at December 31, 1996. Working capital at December 31, 1995 was RMB 306,288. The Company's current ratio was 1.29:1 as of December 31, 1997, 1.52:1 at December 31, 1996 and 1.42:1 at December 31, 1995. INVESTING ACTIVITIES Capital expenditures for 1997 of RMB 48,281 consisted of costs relating to the construction of new plant and machinery and renovation of existing facilities and equipment. They were financed primarily by internally generated funds, short-term and long-term bank loans. As of December 31, 1997, the Company had no outstanding capital expenditure commitments (December 31, 1996, RMB 32,448; December 31, 1995, RMB 46,027). FINANCING ACTIVITIES The Company has historically relied on both short-term and long-term bank loans from Chinese banks to support its operating and capital requirements. Short-term bank loans, which have terms ranging from three months to six months, are utilized to finance both operating and capital requirements and are renewed on a revolving basis. Long-term bank loans are utilized to fund capital expansion projects. During the year 1997, the net increase in bank loans (after deducting repayments) was RMB 87,692, which were utilized to fund the operations and a portion of capital expenditures. The Company believes that it will be able to continue to maintain and expand its bank borrowings under existing terms and conditions. In order to finance the Company's continuing operating and capital requirements, the Company has evaluated both debt and equity financing opportunities. During June 1996, the Company sold 1,000,000 shares of common stock at U.S. $5.00 per share, generating net proceeds of U.S. $4,347 (RMB 36,085). 25 Pursuant to a Subscription Agreement dated August 2, 1996, (the Subscription Agreement), among China Bearing, Asean Capital Limited, China International Bearing Holdings Limited, the Company and Southwest Products (collectively, the Sunbase Group); Glory Mansion Limited, Wardley China Investment Trust, MC Private Equity Partners Asia Limited and China Investissement 2000 (collectively the Investors), on August 23, 1996, China Bearing issued an aggregate of U.S. $11,500,000 principal amount of Convertible Debentures (the Convertible Debentures) to the Investors. Unless the Convertible Debentures have been converted, the Convertible Debentures are due and payable in August, 1999 (the Maturity Date). The Convertible Debentures bear interest at the higher rate of (i) 5% annum (net of withholding tax, if applicable) and (ii) the percentage of the dividend yield calculated by reference to dividing the annual dividend declared per share of Common Stock of the Company by the Conversion Price (as herein defined). Interest is payable quarterly. The Investors have the right to convert at any time the whole or any part of the principal amount of the Convertible Debentures into shares of the Common Stock of the Company. The Conversion Price (the Conversion Price) was initially U.S. $5.00 per share, subject to adjustment for (a) change in par value of the Common Stock, (b) issuance of shares by way of capitalization of profits or reserves, (c) capital distributions, (d) rights offering at a price which is less than the lower of the then market price or Conversion Price, (e) issuance of derivative securities where the total consideration per share initially received is less than the lower of the then market price or Conversion Price, (f) issuance of shares at a price per share which is less than the lower of the then market price or the Conversion Price and (g) if the cumulative audited earnings per common share for any two consecutive fiscal years commencing with the fiscal year ended December 31, 1996 and ending with the fiscal year ending December 31, 1998 are less than the specified projection of cumulative earnings per common share for such period. Due the Company's failure to achieve the projected cumulative audited earnings per common share of U.S.$1.79 for the two years ended December 31, 1997, the Conversion Price has been adjusted to U.S.$ 1.84 per share pursuant to the terms of the Subscription Agreement. The Convertible Debentures are required to be redeemed on the Maturity Date at the principal amount outstanding together with any accrued but unpaid interest together with an amount that would enable the Investors to yield an aggregate internal rate of return of 12% per annum on the cost of their investment. In addition, if any of the events of default specified in the Subscription Agreement occurs, the Convertible Debentures are automatically due and payable at the principal amount outstanding together with the accrued interest and an amount that would enable the Investors to yield an aggregate internal rate of return on their investment of 19.75% per annum. Events of default include breach of covenants after failure to cure after notice; failure to pay principal or interest; failure to pay indebtedness for borrowed money; bankruptcy, insolvency or unsatisfied judgements; failure to achieve earnings per common share of at least U.S. $0.55 for each fiscal year commencing January 1, 1996; and accounts receivable reaching a certain level in relationship to net sales. The obligations of China Bearing under the Subscription Agreement are guaranteed by the Company, Asean Capital Limited, China International Bearing Holdings Limited and Southwest Products. 26 Due to the failure of the Company in achieving the defined earnings per common share of U.S.$0.55 in 1997, an event of default had occurred Although the Convertible Debentures bear an interest charge at the rate of 5 % per annum, interest was being accrued at the rate of 19.75 % per annum to provide for the condition of the default. The outstanding Convertible Debentures have been classified as current liabilities as of December 31, 1997. In view of the inability of the Company and the guarantors to satisfy an immediate redemption of the Convertible Debentures, the Company intends to conduct negotiations with the Investors and will seek a rescheduling of the redemption payment. The Company believes that a workable solution could be made with the Investors in due course. No assurance can be given that such negotiations will result in a resolution that is favorable to the Company. See ITEM 7, "FACTORS THAT MAY AFFECT FUTURE RESULTS." A promissory note for U.S. $5,012 (RMB 41,600) (the Note) was issued to Asean Capital Limited (Asean) in connection with the Share Exchange Agreement (See ITEM 1. "ORGANIZATION OF COMPANY") and is secured by a continuing security interest in all of the Company's title and interest in outstanding capital stock of its wholly-owned subsidiary China Bearing. The Note is denominated in and is repayable in full in U.S. dollars, and bears interest at 8 % per annum. In connection with the issuance of convertible debentures Asean has undertaken that for so long as any of the debentures are outstanding, no amounts are to be repaid on the Note unless there is sufficient working capital and the repayment is made in accordance with the following schedule: Payment Period Amount - -------------- ------ August 1, 1996 to July 31, 1997 up to U.S.$2,000,000 plus accrued interest August 1, 1997 to July 31, 1998 up to U.S.$1,500,000 plus accrued interest August 1, 1998 to July 31, 1999 up to U.S.$1,500,000 plus accrued interest Pursuant to the above described repayment schedule, a principal payment of U.S.$2,010 (RMB 16,700) was made on September 10, 1996. The directors do not envisage any other repayments being made in the foreseeable future. The Company anticipates that its cash flow from operations, combined with cash and cash equivalents, bank lines of credit and other external sources of debt and equity financing, should be adequate to finance the Company's operating and debt service requirements for the foreseeable future. Nevertheless, due to the recent financial turmoil in Asia and the default on the Convertible Debentures, management will cautiously and closely monitor the funding position of the Company. Inflation and Currency Matters In recent years, the Chinese economy has experienced periods of rapid economic growth as well as high rates of inflation, which in turn has resulted in periodic adoption by the Chinese government of various corrective measures designed to regulate growth and contain inflation. During the year ended December 31, 1997, the general inflation rate in the PRC was under control and was below 10 % on an average basis. Since 1993, the Chinese government has implemented and maintained an economic program designed to control inflation, which has 27 resulted in the tightening of working capital available to Chinese business enterprises. The success of the Company depends in substantial part on the continued growth and development of the Chinese economy. The Company continually monitors the effects of inflation. In view of the change in market conditions and increased competition, the Company may be unable to raise its prices to shift a portion of the inflated costs to the customers. The price of bearing steel, the major raw material used by the Company, remained fairly stable during 1996 and 1997. The major impact of inflation was on labor cost due to increases in employee wages. However, the Company could manage to offset the effects of inflation through improved operational efficiency. Foreign operations are subject to certain risks inherent in conducting business abroad, including price and currency exchange controls, and fluctuations in the relative value of currencies. Changes in the relative value of currencies occur periodically and may, in certain instances, materially affect the Company's results of operations. The Company conducts most of its business in China and, accordingly, the sale of its products is settled primarily in RMB. As a result, devaluation of the RMB against the U.S. Dollar, could have a material adverse effect upon the results of operations and financial position of the Company. Although prior to 1994 the RMB experienced significant devaluation against the U.S. Dollar, the RMB has remained fairly stable from 1994 to present. The unified exchange rate was U.S. $1.00 to RMB 8.65 at December 31, 1993, RMB 8.45 at December 31, 1994, RMB 8.32 at December 31, 1995, RMB 8.3 at December 31, 1996 and RMB 8.3 at December 31, 1997. The People's Bank of China has declared its intention not to devalue the RMB. However, it is possible that competitive pressures resulting from the significant devaluation of other Asian currencies will ultimately force the Government of China to reconsider its position on devaluation of the RMB. FACTORS THAT MAY AFFECT FUTURE RESULTS Liquidity The Company's operations used cash resources of RMB 39,593 in 1997 as compared to RMB 105,768 generated from operating activities in 1996. In addition, during 1997, the net increase in bank loans was RMB 87,692 and the increase in accounts receivable-trade was RMB 183,649. The economic conditions in Asia and liquidity constraints in China may adversely affect the Company's operations and the collectability of its accounts receivable. Continuation of these trends could impair the Company's liquidity. Accounts Receivable Accounts receivable-trade increased by RMB 183,649 or 55.4% in 1997. The balance in the allowance for doubtful accounts also increased by RMB 17,040 or 95.1%. As credit remains tight in China, collection of outstanding accounts receivable may become more difficult. The Company has further enhanced its credit review procedures and has limited its sales to customers where collectability was uncertain. The Company is unable to predict how the current economic conditions and the credit tightening policy of the Chinese government will effect the Company's collection of accounts receivable. 28 Potential Acceleration of Convertible Debentures The Company's failure to earn U.S. $0.55 per share in 1997 constitutes a default under the Subscription Agreement of which U.S. $11,500 is outstanding. As a result, the holders of the Convertible Debentures have a right to accelerate the payment of all amounts due under the Subscription Agreement. The Company believes that an equitable resolution may be reached with the holders of the Convertible Debentures. However, no asurances can be given in this regard and any acceleration would have a severe negative effect on the liquidity of the Company. Potential Changes in the Economy of China The economy of the People's Republic of China has experienced significant growth in the past decade. Much of this growth has been a result of governmental policies which have encouraged substantial private economic activity. The continuation of growth in China is now subject to a number of uncertainties including, without limitation, a continuation of governmental policies favoring private enterprise (see below), continued success in maintaining a moderate rate of inflation, the ability of China to remain competitive with other Asian countries that have experienced significant devaluation of their currencies during the past year, resolution of liquidity problems affecting the Chinese banking system and economy as a whole and the maintenance of uninterrupted trading relationships with the United States and other major trading partners. In the event that negative developments in these or other areas result in a slowdown or decline in the economy of China, then it is likely that the future results of operations of the Company will be adversely effected. Political and Regulatory Considerations in China Although the government of China has been pursuing economic reform policies for over a decade, there can be no assurances that such policies will continue. Any change in such policies could have a substantial adverse effect on the economic growth of China which would likely diminish the market for the Company's products in China. Moreover, changes in the laws or regulations governing business operations, restrictions on foreign ownership of Chinese companies, exchange controls, changes in the tax laws or restrictions on the repatriation of profits could be imposed in a manner which would result in negative consequences to the Company and its interest in Harbin. U.S. Regulatory Matters The Committee on Foreign Investment in the United States ("CFIUS") is currently reviewing the Company's acquisition of Southwest Products in 1996 and the Company is currently in discussions with the Department of State regarding compliance with the International Traffic in Arms Regulation ("ITAR"). As a result of these proceedings, adverse actions could be taken against the Company including, without limitation, an order requiring it to divest Southwest, imposition of restrictions on the Company's access to technology from Southwest or civil or criminal sanctions for alleged violations of ITAR. At this time, it is premature to assess the potential outcome of these proceedings or the consequences, if any, for the Company and its future operations. 29 Failure to Qualify HRB to Automotive and Aerospace Quality Standards To date Harbin Bearing has been unable to establish procedures that would enable it to qualify to international quality standards, generally accepted automotive quality standards or aerospace quality standards. Such failure has resulted in Harbin Bearing's inability to capture orders from the U.S. automotive and aerospace industries. At present, the Company's has temporarily suspended the active program at Harbin Bearing that would enable Harbin Bearing to qualify to these standards. If the program is not restarted, it is unlikely that Harbin Bearing would be in a position to capture any significant orders from either the U.S. automotive or aerospace sectors. The Company does not anticipate completing such a program until the year 2001. Failure to qualify Harbin Bearing will constrain the Company's future growth. Ability to Remain Competitive The Company's ability to remain competitive depends in significant part on its ability to fund research and development, introduce new products and retain key personnel for these functions. Some of the Company's competitors have substantially greater resources available for these purposes. To the extent that the Company does not generate adequate cash flow or obtain other financing to fund product development, the Company's competitive position will probably be adversely effected, which may result in a loss of sales or lower productivity. Risk of Technological Obsolecense The Company's products may become obsolete as a result of new technologies or new developments affecting the bearing industry. The Company's ability to remain competitive will depend to a large extent upon its ability to anticipate and stay abreast of new technological developments. Some of the Company's competitors outside China have substantially greater resources dedicated to product development activities. Any failure of the Company to maintain its technological edge could result in reduced sales and profitability. Southwest Products Company Environmental Issues Southwest occupies property that has been the subject of environmental remediation mandated by the County of Los Angeles. Remediation took place in 1993 and again in 1997. Employees of the lessor for the property have informed Southwest that they believe that the remediation has been successfully completed and that the lessor anticipates getting approval from the State of California for the remediation that has been conducted. Employees for the lessor have indicated that they expect that as a result of the approval this environmental issue will be finally and favorably resolved. Southwest does not believe that it has any liability regarding this issue. However, no assurance can be given in this regard. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements are set forth on page 43. 30 Certain unaudited quarterly financial information is set forth in the following table:
Net Gross Net Net Sales Profit Income Income Per Share (Thousands of RMB, except per share data.) (Exchange rate at 12/31/97: RMB 8.30 to $1) RMB RMB RMB RMB 1997 First Quarter 241,217 93,849 16,918 1.00 Second Quarter 244,626 96,169 17,778 1.05 Third Quarter 160,823 62,551 10,076 0.59 Fourth Quarter 95,030 (51,074) (48,956) (2.88) RMB RMB RMB RMB 1996 First Quarter 216,080 83,191 16,065 1.00 Second Quarter 249,609 96,581 16,817 1.04 Third Quarter 259,271 100,438 21,034 1.23 Fourth Quarter 164,746 61,163 22,618 1.31
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Not Applicable 31 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 42 1994 Billy Kan 46 1996 William McKay 43 1996 (Roger) Li Yuen Fai 37 1994 George Raffini 41 1996 Philip Yuen 61 1996 (Franco) Ho Cho Hing resigned as a director of the Company effective from January 1, 1998. B. EXECUTIVE OFFICERS Name Age Office First Elected - ---- --- ------ ------------- Gunter Gao 42 Chairman 1994 Billy Kan 46 Vice Chairman 1996 William McKay 43 Chief Executive 1996 Officer and President (Roger) Li Yuen Fai 37 Vice President and 1994 Chief Financial Officer (Davis) Lai Kwan Fai 34 Corporate Secretary 1996
GUNTER GAO, CHAIRMAN AND DIRECTOR, 42. 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, steel and retail. Mr. Gao is also the Chairman of the Board of Sunbase Asia. Mr. Gao is responsible for the overall strategy of the Company. Mr. Gao is actively and directly involved in all operational and strategic transactions. During the 1980's, 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 the Chinese 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 32 Advisor to several Chinese municipal and provincial governments, including the governments of Tianjin, Hebei, Shaanxi, Xinjiang and Harbin. In addition, Mr. Gao is the deputy director of the Sino-Foreign Entrepreneurs Cooperative Committee. BILLY KAN, VICE CHAIRMAN AND DIRECTOR, 46. Mr. Kan has been the Vice Chairman and a director of Sunbase Asia since the beginning of 1996 and the Chairman of the Board of Southwest Products since 1996. Mr. Kan reports to the Board of Directors and serves as the communications and support link in various parts of the world, while maintaining overall control of the Company's operations. Mr. Kan holds a Bachelor of Science Degree from the University of East Anglia, an 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, 43. Mr. McKay has been the Chief Executive Officer, President and a Director of Sunbase Asia since 1996 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 in China. Mr. McKay is responsible for the day-to-day operations of the Company in such areas of product development, marketing and general operations. Prior to joining Southwest Products, Mr. McKay practiced law, specializing in the areas of business and real estate. Mr. McKay holds a Juris Doctorate Degree, Master 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, CHIEF FINANCIAL OFFICER, VICE-PRESIDENT AND DIRECTOR, 37. Mr. Li has been the Chief Financial Officer and a Director of Sunbase Asia since 1994. 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. GEORGE RAFFINI, DIRECTOR, 41. Mr. Raffini is the Managing Director of HSBC Private Equity Management Limited with responsibility for managing the investment process for projects and regional private equity investment funds with total capital under management of over $500 million. Mr. Raffini received his Bachelor of Science Degree from The American University, a diploma in Political and Economic Affairs from the Institut D' etudes Politiques, Paris, France, a Master Degree in International Affairs from Columbia University and a MBA from Harvard University. Mr. Raffini is the nominee of certain of the investors of the Convertible Debentures. PHILIP YUEN, DIRECTOR, 61. Mr. Yuen is a solicitor of the Supreme Court of Hong Kong. He became a practicing solicitor in 1962 and founded the solicitors' firm of Yung, Yu, Yuen & Co. in 1965. He is currently the managing partner of his firm. He has over 30 years experience in legal practice. Mr. Yuen has been a member of The National Committee of the Chinese People's Political Consultative Conference since 1983 and has been a member of the China International Economic and Trade Arbitration Commission for the past 16 years. Mr. Yuen has established extensive relationships with businesses in the PRC and is also a non-executive 33 director of Tsingtao Brewery Company Limited, Henderson Development Company Limited, Henderson (China) Investment Company Limited and Melbourne Enterprises Limited, all of which are listed on The Stock Exchange of Hong Kong Limited. KEY MANAGEMENT ZHANG ZHENG BIN, GENERAL MANAGER, 50. Mr. Zhang was appointed the General Manager of Harbin Bearing in 1997 and is responsible for the day-to-day operations as well as sales and marketing of Harbin Bearing. Mr. Zhang has been a high ranking employee of Harbin Bearing for over 11 years in a variety of senior management positions. Mr. Zhang holds a degree in Engineering from Harbin Polytechnic University. (CHARLIE) TANG CHAK LAM, ASSISTANT TO THE CHIEF FINANCIAL OFFICER, 36. Mr. Tang has been the assistant to the Chief Financial Officer since November 1996. Mr. Tang is a fellow member of the Association of Chartered Certified Accountants and a certified public accountant in Hong Kong. Prior to joining Sunbase Asia, Mr. Tang was the head of accounting and finance of the China division of the Lippo Group, a large conglomerate listed on The Stock Exchange of Hong Kong Limited. Mr. Tang also has extensive audit experience and was employed by Coopers & Lybrand for more than 8 years. (HARRIS) LAU KWOK KEI, CHIEF ACCOUNTING OFFICER, 33. Mr. Lau has been the Chief Accounting Officer of Sunbase Asia since February 1998. Mr. Lau has over 7 years of work experience in the accounting and auditing profession and was previously employed by the international accounting firm of Deloitte Touche Tohmatsu from 1995 to 1997. TODD STOCKBAUER, CHIEF FINANCIAL OFFICER, 35. Mr. Stockbauer has been employed as the Chief Financial Officer 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 with an emphasis in Accounting from the University of California at Santa Barbara and is a Certified Public Accountant in the State of California. JOHN LEONIAK, CHIEF ENGINEER, 61. Mr. Leoniak has been the Chief Engineer at Southwest Products since 1991. As Chief Engineer, Mr. Leoniak supervises Southwest Products' engineering. 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 Degree in Mechanical Engineering from the Polytechnic Institute of Brooklyn. (DAVIS) LAI KWAN FAI, CORPORATE SECRETARY, 34. Mr. Lai has been the Corporate Secretary of Sunbase Asia since 1996. Mr. Lai holds a Master of Arts Degree in Economics and Finance from the University of Leeds in the United Kingdom. 34 ITEM 11. EXECUTIVE COMPENSATION. MANAGEMENT COMPENSATION SUMMARY COMPENSATION TABLE The following table sets forth information regarding compensation for services in all capacities paid or accrued for the fiscal years indicated by the Company to its Chief Executive Officer and the only other executive officer whose compensation exceeded U.S.$100,000 in 1997:
Annual Compensation --------------------------------------------- Name Long- Principal All other Term Position Year Salary Bonus Compensation Compensation - --------- ---- ------ ----- ------------ ------------ (US$) (US$) (US$) (US$) B.Kan/ 1997 209,677 - - - Vice Chairman, 1996 111,804 - - - Director 1995 - - - - W.R.McKay/ 1997 285,000 - 651 - CEO, President, 1996 284,327 - 1,181 - Director 1995 - - - -
OPTION GRANTS IN 1997 No stock options were granted in 1997. AGGREGATE OPTION EXERCISES IN 1997 AND OPTION VALUES AS OF DECEMBER 31, 1997 The value of options exercised by the named executive officers in 1997 and the value of unexercised options at December 31, 1997 are set forth below:
Number of Value of Exercisable/ Exercisable/ Unexercised Unexercised Options at In-the-Money 12/31/97 Options at Shares 12/31/97 Acquired on Value Exercisable/ Exercisable/ Name Exercise Realized Unexercisable Unexercisable - ---- -------- -------- ------------- ------------- B. Kan 0 0 400,000 / 0 / 0 0 200,000 W. R. McKay 0 0 160,000 / 0 / 0 0 640,000
35 The value of unexercised in-the-money options is determined by using the difference between the exercise price and the average bid price at December 31, 1997. 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 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. 36 On July 1, 1996, the Compensation Committee of the Company granted stock options to the following individuals on the following terms:
Exercise Price/Share Number of Shares per Option Holder Vesting Schedule (U.S.) Option Rights - ------------- ---------------- ------ ------------- Billy Kan January 16, 1996 6.375 200,000 January 16, 1997 6.375 200,000 January 16, 1998 6.375 200,000 ------- 600,000 ------- Roger Li January 16, 1996 6.375 200,000 January 16, 1997 6.375 200,000 January 16, 1998 6.375 200,000 ------- 600,000 ------- Dickens Chang January 16, 1996 6.375 15,000 January 16, 1997 6.375 15,000 January 16, 1998 6.375 20,000 ------- 50,000 -------
Mr. Dickens Chang terminated employment with the Company on February 28, 1998. In accordance with the terms of his options granted, all unexercised options and unvested options of Mr. Chang expired automatically. EMPLOYMENT AGREEMENTS 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 for a term of five years. 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 $225,000), based upon an annual review of Mr. McKay's performance. In addition to the base salary, the Board of Directors of Sunbase Asia may, at its sole discretion, pay Mr. McKay a bonus for any particular year of his employment. On January 16, 1996, in connection with the execution of the Agreement, Sunbase Asia, Southwest Products and Mr. McKay entered into a Confidentiality and Non-Competition Agreement pursuant to which Mr. McKay agrees to keep certain information of Sunbase Asia, Southwest Products and their affiliates confidential, and is prohibited from competing with Sunbase Asia, Southwest Products and their affiliates during the term of the Agreement. 37 Pursuant to the terms of an Employment Agreement between the Company and Mr. Kan dated August 1, 1996, Mr. Kan is employed as the Vice Chairman of the Board of Directors or such other capacity of an equivalent status as the Company may reasonably require. The term of the employment commenced August 1, 1996 and continues until terminated by either party giving to the other not less than 12 months prior notice. Mr. Kan's duties include the development, marketing and promotion of the products of the Company as may be required by the Board of Directors. Mr. Kan is to exercise such powers and functions and perform such duties in relation to the business of the Company as may from time to time be assigned to him by the Board. Mr. Kan will be paid a salary of HK$ 1,625,000 per annum subject to review by the Board on an annual basis. Mr. Kan is also entitled to stock options. See "Management Compensation - Stock Options Plan". ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The following table sets forth, as of March 31, 1998, the stock ownership of all persons known to own beneficially five % (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 Percent Name and Beneficial of Beneficial of Address Ownership (1) Class (2) Ownership (1) Class (3) - -------- ------------- --------- ------------- --------- Asean Capital 12,339,900 (4) 72.7% 26,739,900 (5) 85.2% Gunter Gao 12,339,900 (4)(6) 72.7% 26,739,900 (5)(6) 85.2% Chairman and Director Glory Mansion Limited ("GML") 3,260,870 (7) 16.1% 3,260,870 (7) 9.4% Wardley China Investment Trust ("Wardley") 1,086,960 (8) 6.0% 1,086,960 (8) 3.4% Private Equity Management BVI Limited 3,260,870 (9) 6.1% 3,260,870 (9) 9.4% Billy Kan Vice Chairman and Director 620,000 (10) 3.5% 620,000 (10) 1.9% William McKay Chief Executive Officer, President and Director 328,500 (11) 1.9% 328,500 (11) 1.0% Li Yuen Fai (Roger) Chief Financial Officer, Vice President and Director 600,000 (12) 3.4% 600,000 (12) 1.9%
38 Lai Kwan Fai (Davis) Corporate Secretary * * * * Philip Yuen * * * * Director George Raffini (13) * * * * Director Sunbase International 12,339,900 (14) 72.7% 26,739,900 (14) 85.2% (Holdings) Limited The New China Hong Kong Limited 1,371,100 8.1% 1,371,100 4.4% All directors and executive 13,888,400 (17) 75.0% 28,288,400 (17) 85.9% officers of the Company as a Group, 7 persons
_________________________ * 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 shared investment power with respect to a security (i.e., the power to dispose of, or to direct the disposition of a security). (2) This percentage is determined on the basis of 16,980,142 shares of Common Stock calculated as follows: (a) 12,700,142 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, plus, with respect to each named person, the number of shares of Common Stock, if any, which person has the right to exercise or otherwise acquire within sixty days, but otherwise excludes shares of Common Stock issuable pursuant to conversion of the Convertible Debentures, warrants and options. (3) This percentage is determined on the basis of an aggregate of 31,380,142 voting rights calculated as follows: (a) 12,700,142 rights from Common stock outstanding; (b) 18,000,000 rights from the Series A Preferred Stock; and (c) 680,000 rights from the Series B Preferred Stock, plus, with respect to each named person, the number of shares of Common Stock, if any, which such person has the right to exercise or otherwise acquire within sixty days, but otherwise excludes shares of Common Stock issuable pursuant to conversion of the Convertible Debentures, warrants and options. (4) Consists of 8,739,900 outstanding shares of Common Stock and 3,600,000 shares of Common Stock issuable upon the conversion of the Series A Preferred Stock. (5) Consists of 8,739,900 voting rights held by way of Asean Capital's ownership of 8,739,900 shares of Common Stock and 18,000,000 voting rights held by way of Asean Capital's ownership of 36 shares of Series A Preferred Stock. Pursuant to the terms of the Convertible Debentures, Asean Capital is prohibited from exercising the super majority votes of the Series A Preferred Stock. 39 (6) Includes shares of Sunbase Asia Common Stock and Series A 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 all 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. (7) Consists of shares issuable upon conversion of the Convertible Debentures at an initial exercise price of $1.84 per share. GML is the record owner of $6,000,000 in principal amount of Convertible Debentures. (8) Consists of shares issuable upon conversion of the Convertible Debentures at an initial exercise price of $1.84 per share. Wardley is the record owner of $2,000,000 in principal amount of Convertible Debentures. (9) PEM, as the general partner of the HSBC Private Equity Fund, L.P.("HSBC"), the parent of GML, shares voting power and has sole investment power over shares of Common Stock issuable to GML upon conversion of the Convertible Debentures. (10) Includes 600,000 shares of Common Stock issuable upon exercise of currently exercisable stock options granted to Mr. Kan, See "Management Stock Option Plan." (11) Includes 320,000 shares of Common Stock issuable upon exercise of currently exercisable stock options granted to Mr. McKay (See "Management Stock Option Plan"), but does not include any shares issuable upon conversion of 18 shares of Series B Preferred Stock owned by Mr. McKay. (12) Consists of 600,000 shares of Common Stock issuable upon exercise of currently exercisable stock options granted to Mr. Li. See "Management Stock Option Plan.". (13) Does not include any shares issuable upon conversion of the Convertible Debentures owed by GML and Wardley. Mr. Raffini is an employee of HSBC and the nominee of GML and Wardley to the Board of Directors. (14) Consists of 8,739,000 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 100%. (15) Consists of 8,739,000 voting rights held by way of Asean Capital ownership of 8,739,000 shares of Common Stock and 18,000,000 voting rights held by way of Asean Capital's ownership of 36 shares of Series A Preferred Stock. (16) See (4), (5), (6), (10), (11), (12), and (13) above (17) The address of Dr. Gao and Messrs, Kan, Li, and Lai is 19/F. First Pacific Bank Centre, 51-57 Gloucester Road, Wanchai, Hong Kong. The address of GML, Wardley, PEM and Mr. Raffini is 3 Garden Road, Hong Kong. The address of New China Hong Kong is 25/F. Bank of China Tower, 1 Garden Road, Hong Kong. The address of Mr. Yuen is 11/F., Wing Lung Bank Building., 45 Des Voeus Road, Hong Kong. The address of Mr. McKay is 2240 Buena Vista, Irwindale, California 91010. 40 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. As discussed above (See ITEM 1 "BUSINESS ORGANIZATION OF THE COMPANY"), an effective 51.43 % in Harbin Bearing was acquired at the end of 1993 by the 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 51.57 % 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 41.57 % 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 presently owns all of the capital stock. As set forth above, in December 1994, Asean Capital transferred all of its interest in China Bearing to the Company. 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 RMB 27,183,000 (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. Harbin Bearing and Harbin Holdings have entered into a lease covering plants and buildings used in Harbin Bearing's business which were not contributed to Harbin Bearing in the restructuring (the "Plant Lease"). The Plant Lease provides for annual rent payments of RMB 3,751,000 (US$ 452,000). 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 RMB 2,508,000 (US$ 302,000) per annum, effective January 1, 1994 subject to future adjustments in accordance with changes in government fees. 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 41 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 % (22 % effective July 1, 1996) 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 service 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. The management and administrative service agreement was expired on December 31, 1996. 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, 1996 at an annual fee of RMB 150,000 (U.S.$18,000) payable to each of the joint venture companies. 42 INDEX TO FINANCIAL STATEMENTS
Pages ----- SUNBASE ASIA, INC. AND SUBSIDIARIES: Report of Independent Auditors 44 Consolidated Balance Sheets as of December 31, 1996 45-46 and December 31, 1997 Consolidated Statements of Income for the years ended December 31, 1995, December 31, 1996 and December 31, 1997 47-48 Consolidated Statements of Cash Flows for the years ended December 31, 1995, December 31, 1996 and December 31, 1997 49-51 Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1995, December 31, 1996 and December 31, 1997 52 Notes to Consolidated Financial Statements 53-82
43 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, 1997 and 1996 and the related statements of income, cash flows and changes in shareholders' equity for each of the three years in the period ended December 31, 1997. 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, 1997 and 1996, and the consolidated results of their operations and cash flows for each of the three years in the period ended December 31, 1997, in conformity with accounting principles generally accepted in the United States of America. /s/ Ernst & Young Hong Kong 13 May 1998 44 SUNBASE ASIA, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1996 AND DECEMBER 31, 1997 (Amounts in thousands, except number of shares and per share data)
Notes 1996 1997 1997 RMB RMB US$ --- --- --- ASSETS Current assets Unrestricted cash and bank balances 48,489 39,343 4,830 Deposit with a financial institution 23,750 23,750 2,771 Restricted cash and bank balance 5 15,189 - - Accounts receivable, net 6 313,791 480,400 57,880 Notes receivable 15,212 6,190 746 Inventories, net 7 476,409 477,217 57,496 Other receivables 70,075 40,330 4,859 Receivable from disposal of an investment 13,419 - - Due from related companies 24 205,275 300,023 36,147 --------- --------- ------- Total current assets 1,181,609 1,367,253 164,729 Fixed assets 8 656,071 631,812 76,122 Deferred assets 9 22,204 14,383 1,733 Long term investments 10 1,012 1,012 122 Goodwill 11 11,587 10,760 1,296 --------- --------- ------- Total assets 1,872,483 2,025,220 244,002 ========= ========= =======
continued/... The accompanying notes form an integral part of these consolidated financial statements. 45 SUNBASE ASIA, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1996, AND DECEMBER 31, 1997 (continued) (Amounts in thousands, except number of shares and per share data)
Notes 1996 1997 1997 RMB RMB US$ --- --- --- LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities Short term bank loans 12 358,847 435,403 52,458 Long term bank loans, current portion 16 98,641 140,772 16,960 Accounts payable 151,971 115,646 13,933 Notes payable 2,800 - - Interest payable on convertible debentures 15 2,882 20,035 2,414 Accrued liabilities and other payables 52,662 111,501 13,434 Short term obligations under capital leases 13 18,788 20,441 2,463 Secured promissory note 1,14 12,450 12,450 1,500 Income tax payable 4 38,368 50,392 6,071 Taxes other than income 25,225 38,972 4,696 Due to related companies 14,357 18,730 2,257 Convertible debentures 15 - 95,450 11,500 --------- --------- ------- Total current liabilities 776,991 1,059,792 127,686 Long term bank loans 16 35,000 4,005 483 Long term obligations under capital leases 13 88,924 68,483 8,251 Secured promissory note 1,14 12,450 12,450 1,500 Convertible debentures 15 95,450 - - Minority interests 420,484 441,490 53,192 --------- --------- ------- 1,429,299 1,586,220 191,112 Shareholders' equity: Common Stock, par value US$0.001 each, 50,000,000 shares authorized; 12,700,142 (1996: 12,700,109) issued, and fully paid-up 19 107 107 13 Preferred Stock, par value US$0.001 each, 25,000,000 shares authorized; Convertible Preferred Stock - Series A; 36 shares issued and outstanding 1,19 44,533 44,533 5,365 Convertible Preferred Stock - Series B; 6,800 shares issued and outstanding 1 28,288 28,288 3,408 Contributed surplus 19 188,019 188,019 22,653 Reserves 20 27,866 27,971 3,370 Retained earnings 154,371 150,082 18,081 --------- --------- ------- Total shareholders' equity 443,184 439,000 52,890 --------- --------- ------- Total liabilities and shareholders' equity 1,872,483 2,025,220 244,002 ========= ========= =======
The accompanying notes form an integral part of these consolidated financial statements. 46 SUNBASE ASIA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1995, DECEMBER 31, 1996 AND DECEMBER 31, 1997 (Amounts in thousands, except number of shares and per share data)
Notes 1995 1996 1997 1997 RMB RMB RMB US$ --- --- --- --- Net sales to - third parties 24 569,248 657,368 570,323 68,714 - related parties 23 103,111 232,338 171,373 20,647 ------- ------- ------- ------ 672,359 889,706 741,696 89,361 Cost of sales - third parties 24 (365,564) (530,373) (491,153) (59,173) - related parties 23 (14,715) (16,545) (15,793) (1,903) ------- ------- ------- ------ 24 (380,279) (546,918) (506,946) (61,076) Provisions on inventories (1,098) (1,415) (33,255) (4,007) ------- ------- ------- ------ Gross profit 290,982 341,373 201,495 24,278 Selling, general and administrative expenses - third parties (83,908) (85,027) (82,244) (9,909) - related parties 23 (26,467) (30,147) (6,873) (828) ------- ------- ------- ------ (110,375) (115,174) (89,117) (10,737) Interest expense - third parties (33,816) (44,354) (60,655) (7,308) - related parties 23 (14,630) (12,819) (10,270) (1,237) ------- ------- ------- ------ (48,446) (57,173) (70,925) (8,545) Provisions on accounts receivable (2,627) (3,998) (17,040) (2,053) Other income 21 - 16,640 - - ------- ------- ------- ------ Income before income taxes 129,534 181,668 24,413 2,943
continued/... The accompanying notes form an integral part of these consolidated financial statements 47 SUNBASE ASIA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1995, DECEMBER 31, 1996 AND DECEMBER 31, 1997 (Amounts in thousands, except number of shares and per share data)
Notes 1995 1996 1997 1997 RMB RMB RMB US$ --- --- --- --- Income before income taxes (continued) 129,534 181,668 24,413 2,943 Provision for income taxes: 4 - Current (20,472) (27,792) (7,591) (915) - Deferred - - - - ------ ------- ------ ------ (20,472) (27,792) (7,591) (915) ------ ------- ------ ------ Income before minority interests 109,062 153,876 (16,822 2,028 Minority interests (54,967) (77,342) (21,006) (2,531) ------ ------- ------ ------ Net income/(loss) 54,095 76,534 (4,184) (503) ======= ======= ====== ====== Net income/(loss) per common share: Basic 17 4.62 6.24 (0.33) (0.04) ======= ======= ====== ====== Diluted 17 3.54 4.62 (0.33) (0.04) ======= ======= ====== ======
The accompanying notes form an integral part of these consolidated financial statements. 48 SUNBASE ASIA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, DECEMBER 31, 1996 AND DECEMBER 31, 1997 (Amounts in thousands)
1995 1996 1997 1997 RMB RMB RMB US$ --- --- --- --- Cash flows from operating activities: Net income/(loss) 54,095 76,534 ( 4,184) ( 503) Adjustments to reconcile income to net cash provided by operating activities: Minority interests 54,967 77,342 21,006 2,531 Depreciation 44,447 62,872 70,738 8,521 Loss/(gain) on disposal of fixed assets 4,829 ( 670) 1,283 155 Amortization of goodwill - 847 827 100 Exchange difference on secured- promissory note ( 650) - - - Amortization of present value discount on deferred asset ( 783) ( 783) ( 783) ( 94) Amortization of deferred debenture issue expenses - 446 1,318 159 Decrease/(increase) in assets: Accounts receivable ( 1,312) ( 49,605) ( 166,609) ( 20,074) Notes receivable ( 107,824) 10,544 9,022 1,087 Inventories ( 25,756) 588 ( 808) ( 97) Prepaid VAT ( 40,429) 40,429 - - Other receivables ( 21,086) ( 12,866) 29,745 3,584 Due from related companies 32,994 ( 20,310) ( 56,657) ( 6,826) Increase/(decrease) in liabilities: Accounts payable ( 41,836) 35,766 ( 36,325) ( 4,377) Notes payable 4,000 ( 12,827) ( 2,800) ( 337) Interest payable on convertible debentures - 2,882 17,153 2,067 Accrued liabilities and other payables 40,531 ( 37,446) 58,839 7,089 Income tax payable ( 3,468) 32,494 12,024 1,448 Taxes other than income ( 2,592) 25,225 21,033 2,533 Due to related companies ( 34,854) ( 114,567) ( 14,415) ( 1,737) Due to shareholders 2,350 ( 11,127) - - ------ ------- ------ ------ Net cash provided by/(used in) operating activities ( 42,377) 105,768 ( 39,593) ( 4,771)
continued/... The accompanying notes form an integral part of these consolidated financial statements. 49 SUNBASE ASIA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, DECEMBER 31, 1996 AND DECEMBER 31, 1997 (Amounts in thousands)
1995 1996 1997 1997 Notes RMB RMB RMB US$ --- --- --- --- Cash flows from investing activities: Purchase of a subsidiary 1,22 ( 731) - - - Increase in deposit with a financial institution ( 23,750) - - - Increase/(decrease) restricted bank deposit - ( 15,189) 15,189 1,830 Disposal of long term investments 5,561 426 - - Proceeds from disposal of fixed assets 115 3,243 525 63 Additions of goodwill - ( 290) - - Additions to fixed assets ( 92,571) ( 167,430) ( 48,287) ( 5,818) Receivable from disposal of an investment - ( 13,419) 13,419 1,617 Increase in due from related companies - ( 47,886) ( 38,091) ( 4,589) ------- ------- ------ ------ Net cash used in investing activities ( 111,376) ( 240,545) ( 57,245) ( 6,897) ------- ------- ------ ------ Cash flows from financing activities: Proceeds from short term bank loans 518,573 701,710 665,373 9,224 Repayment of short term bank loans ( 468,838) ( 597,988) ( 588,817) - Repayment of other loans - ( 33,810) - - Repayment of secured promissory note - ( 16,700) - - Proceeds from issuance of convertible debentures - 95,450 - - Proceeds from sales of common stock, net of costs - 36,085 - - Proceeds from long term bank loans 54,289 1,283 11,136 1,342 Repayment of long term bank loans ( 12,043) - - - Advance from/(repayment to) shareholders 3,320 ( 6,225) - - Debenture issue expense - ( 3,733) - - ------- ------- ------ ------ Net cash provided by financing activities 95,301 176,072 87,692 10,566 ------- ------- ------ ------ Net increase/(decrease) in cash and cash equivalents ( 34,702) 41,295 ( 9,146) ( 1,102) Cash and cash equivalents, at beginning of year 41,896 7,194 48,489 5,932 ------- ------- ------ ------ Cash and cash equivalents, at end of year 7,194 48,489 39,343 4,830 ======= ======= ====== ======
continued/... The accompanying notes form an integral part of these consolidated financial statements. 50 SUNBASE ASIA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, DECEMBER 31, 1996 AND DECEMBER 31, 1997 (Amounts in thousands)
1995 1996 1997 1997 Notes RMB RMB RMB US$ --- --- --- --- Income taxes paid 15,953 - - - Interest paid (net of amounts capitalized) 35,186 51,835 64,748 7,801 Non-cash transactions: Financing lease arrangements 15,873 17,270 18,788 2,263 Purchase of a subsidiary by issue of convertible stock 28,288 - - - ====== ====== ====== =====
The accompanying notes form an integral part of these consolidated financial statements. 51 SUNBASE ASIA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1995, DECEMBER 31, 1996 AND DECEMBER 31, 1997 (Amounts in thousands)
Common Preferred Contributed Retained stock stock surplus Reserves earnings Total Series A Series B RMB RMB RMB RMB RMB RMB RMB Balance at December 31, 1994 99 44,533 - 151,942 13,011 38,597 248,182 New issue (note 1) - - 28,288 - - - 28,288 Net income - - - - - 54,095 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 80,437 330,565 New issue (note 1) 8 - - 36,077 - - 36,085 Net income - - - - - 76,534 76,534 Appropriation to reserves (note 20) - - - - 2,600 ( 2,600) - --- ------ ------ ------- ------ ------- ------- Balance at December 31, 1996 107 44,533 28,288 188,019 27,866 154,371 443,184 Net loss - - - - - ( 4,184) ( 4,184) Appropriation to reserves (note 20) - - - - 105 ( 105) - --- ------ ------ ------- ------ ------- ------- Balance at December 31, 1997 107 44,533 28,288 188,019 27,971 150,082 439,000 === ====== ====== ======= ====== ======= =======
The accompanying notes form an integral part of these consolidated financial statements. 52 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 Share Exchange 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"). This transaction has been treated as a recapitalization of China Bearing with China Bearing as the acquirer (reverse acquisition). 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. In 1997, 33 (1996: 46) common stock shares were issued from a reverse stock split. China Bearing is a holding company which was established to acquire a 100% interest in China International Bearing (Holdings) Company Limited ("China International"). China International was incorporated in Hong Kong 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 to acquire, in aggregate, a 51.6% interest in Harbin Bearing Company Limited ("Harbin Bearing") which is a joint stock limited company established in China under the Trial Measures on Share Companies and the Opinion on the Standardization of Joint Stock Companies promulgated by the State Council of China and the successor to the manufacturing operations of Harbin Bearing General Factory, a Chinese state-owned enterprise established in 1950. On December 29, 1995, the Company entered into a reorganization agreement ("Reorganization Agreement") with Southwest Products Company ("Southwest"), a company incorporated in the United States of America, 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 53 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) 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 not effected within two years from the 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 after expiry of the two-year period. 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 in 1995. 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. The following unaudited pro forma consolidated financial information for the years ended December 31, 1995 are prepared on the basis as if the acquisition of Southwest by the Company had occurred prior to January 1, 1996. The following pro forma consolidated financial information has been prepared for comparative purposes only and does not purport to indicate the results of operations which would actually have occurred had the acquisition and the reorganization been in effect on January 1, 1995 or which may occur in the future.
Year ended December 31, 1995 RMB (unaudited) Net sales 708,658 Net income 58,003 Pro forma earnings per common share: Basic 4.96 Diluted 3.79
54 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) 2. BASIS OF PRESENTATION These consolidated financial statements incorporate the results of operations of the Company and its subsidiaries (hereinafter referred to as the "Group") for the three year period ended December 31, 1997, except for Southwest, the acquisition of which was completed on 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. 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, 1997 which was US$1.00 = RMB8.30. 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, 1997. 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. 55 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) 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) (b) Inventories Inventories are stated at the lower of cost, on a first-in, first-out basis, or market value. 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 3-5 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. (e) Income taxes The income taxes reflect the accounting standards in Statement of Financial Accounting Standards No.109, "Accounting for Income Taxes". 56 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) (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 is being amortized over a fifteen year period. The carrying value of goodwill is assessed on an on-going basis. (i) Stock Options As the Company has elected to follow the accounting method under APB25, accounting for stock based compensation is based on the intrinsic value method. The compensation cost to record is based on the difference between the fair value of the share and the exercise price at the time both the number of options the employee is entitled to receive and the exercise price is known. This compensation cost is recognized over the period the employee performs the related services. 57 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) (j) Use of estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. (k) Impact of recently issued accounting standard In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"), to establish new rules for the reporting and display of comprehensive income and its components. However, adoption of SFAS 130 in 1998 will have no impact on the Company's consolidated net income or shareholders' equity. In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131"), to establish standards for the way public business enterprises report information about operating segments. The Company has not completed the assessment of SFAS No. 131. However, it is considered that additional disclosure is not applicable as the Group only operates in the business of manufacturing and sales of ball bearings. SFAS 131 is effective for financial statements for fiscal year beginning after December 15, 1997 and will be adopted in 1998. 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 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 by China Bearing from the joint venture enterprises received is exempt from any Chinese income taxes. 58 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 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. Income of Harbin Bearing, being a joint stock limited company registered in the Special Economic and Technological Development Zone in the Municipal City of Harbin, is normally 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%. 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 undistributed earnings of the Chinese subsidiaries of the Group amounted to RMB210,425 at December 31, 1997. The determination of the amount of the deferred income tax liability 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 major operating subsidiary is as follows:
Year ended December 31, 1995 1996 1997 Effect of - statutory tax rate 15.0% 15.0% 15.0% Permanent difference 0.8% 0.3% 16.0% ---- ---- ---- 15.8% 15.3% 31.0% ==== ==== ====
The permanent differences arise from losses generated by the subsidiaries which are exempted from tax. At December 31, 1997, Southwest had unutilized pre-acquisition net operating losses of RMB2,025 (US$244) ((1996: RMB3,071 US$370)). Pursuant to Internal Revenue Code Section 382 of the United States of America (IRC Section 382), the annual utilization of pre-acquisition net operating losses' carry forwards is limited to approximately RMB1,627 (US$196) ((1996: RMB1,627 US$196)). No deferred tax asset was recognized on these pre-acquisition losses in the allocation of the purchase price. In addition, Southwest has post-acquisition net operating losses of RMB15,148 (US$1,825) ((1996: RMB11,620 US$1,400)) generated from domestic sources, expiring through 2010, which is not subject to IRC Section 382 limitation. The deferred tax asset of RMB5,901 (US$711) ((1996: RMB2,639 US$318)) arising from such net operating losses has not been provided for in the financial statements. 59 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 5. RESTRICTED CASH AND BANK BALANCE At December 31,1997, there were no restricted cash and bank balances held by the Group. At December 31, 1996, a United States dollars time deposit US$1,830 (RMB15,189) was pledged to a bank to secure banking facilities granted to the Group. 6. ACCOUNTS RECEIVABLE
Accounts receivable comprise: December 31, 1996 1997 RMB RMB Accounts receivable - trade 331,716 515,365 Less: Allowance for doubtful debts ( 17,925) ( 34,965) ------- ------- Accounts receivable, net 313,791 480,400 ======= ======= December 31, 1995 1996 1997 RMB RMB RMB Movement of allowance for doubtful debts Balance as at January 1, 11,300 13,927 17,925 Provided during the year 2,627 3,998 17,040 ------ ------ ------ 13,927 17,925 34,965 Less: Allowance utilized during the year - - - ------ ------ ------ Balance as at December 31, 13,927 17,925 34,965 ====== ====== ======
60 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 7. INVENTORIES Inventories comprise:
December 31, 1996 1997 RMB RMB Raw materials 102,856 92,039 Work in progress 121,847 141,214 Finished goods 257,121 282,634 ------- ------- 481,824 515,887 Less: Provision (5,415) (38,670) ------- ------- Inventories, net 476,409 477,217 ======= ======= December 31, 1995 1996 1997 RMB RMB RMB Movement of inventory provision Balance as at January 1, 19,016 4,309 5,415 Provided during the year 1,098 1,415 33,255 Obsolete inventories sold during the year (15,805) (309) - ------ ----- ------ Balance as at December 31, 4,309 5,415 38,670 ====== ===== ======
61 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 8. FIXED ASSETS
December 31, 1996 1997 RMB RMB Buildings 71,151 71,151 Machinery and equipment 492,493 576,892 Motor vehicles 18,650 18,249 Furniture, fixtures and office equipment 6,553 24,283 Construction in progress 206,433 147,298 ------- ------- 795,280 837,873 Less: Accumulated depreciation (139,209) (206,061) ------- ------- 656,071 631,812 ======= =======
The total amount of interest capitalized during the year and included in the above fixed assets is RMB18,207 (1996: RMB19,473 and 1995: RMB10,411). The Group's buildings are located in the PRC and the land on which the Group's buildings are situated is State-owned. The gross amounts of assets recorded under capital leases and the accumulated depreciation are analyzed as follows:
1996 1997 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 (61,114) (80,091) ------- ------- 94,331 75,354 ======= =======
62 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 9. DEFERRED ASSETS
December 31, 1996 1997 RMB RMB Deferred valued added tax ("VAT") receivable 38,860 38,860 Less: Offset against VAT payable (18,378) (25,664) ------ ------ 20,482 13,196 Less: Present value discount (1,565) (782) ------ ------ 18,917 12,414 ------ ------ Deferred debenture issue expenses 3,733 3,733 Less: Amortization (446) (1,764) ------ ------ 3,287 1,969 ------ ------ 22,204 14,383 ====== ======
Deferred VAT receivable arose from the introduction of the new PRC VAT system on January 1, 1994. This asset was calculated and accounted for in accordance with governmental directive 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 inventories 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 is 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 borrowing rate over the estimated period of recovery. Deferred debenture issue expenses represented costs incurred for the issue of convertible debentures on August 23, 1996. The total amount of deferred expenses incurred of RMB3,733 are being amortized over the terms of the debentures of three years. 10. LONG TERM INVESTMENTS Long term investments are stated at cost and represent investments in unlisted 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. 63 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 11. GOODWILL Goodwill comprised:
1996 1997 RMB RMB Balance at beginning of year 12,144 11,587 Addition 290 - ------ ------ 12,434 11,587 Less: Amortization (847) (827) ------ ------ 11,587 10,760 ====== ======
The goodwill arose as a result of the acquisition of Southwest on December 31, 1995. The addition in 1996 represented a legal fee in respect of the acquisition completed in 1995. 12. SHORT TERM BANK LOANS The short term bank loans bear interest at a weighted average rate of 12.5% and 10.824% per annum for the years ended December 31, 1996 and 1997, respectively, and are repayable within one year. 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 Machinery Manufacturing Company ("Harbin Precision"), a company wholly-owned by Harbin Bearing Holdings Company ("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. 64 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 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 non-cancelable future minimum lease payments as of December 31, 1997 were as follows:
December 31, 1997 RMB Year ending December 31, 1998 27,183 1999 25,927 2000 25,927 2001 25,927 ------ Total minimum lease payments 104,964 Less: Amount representing interest (16,040) ------ Present value of minimum lease payments 88,924 Less: Current portion (20,441) ------ 68,483 ====== (b) Obligations under operating leases Non-cancelable operating leases commitments payable in the five years are as follows: December 31, 1997 RMB Year ending December 31, 1998 6,259 1999 2,508 2000 2,508 2001 2,508 2002 2,508 ----- 16,291 ======
The lease rentals recorded as expenses in respect of operating leases during the year amounted to RMB6,259 (1996:RMB6,259; 1995: RMB6,259). 65 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 Company has an option to extend the terms of the current operating lease in respect of the buildings which will expire on December 31, 1998, for another five years at market rent. The current annual rental of the building is RMB3,751 (US$452). As of December 31, 1997, the Group had no outstanding commitments for capital expenditure. 14. SECURED PROMISSORY NOTE The secured promissory note (the "Note") was issued in 1995 to Asean Capital in connection with the Share Exchange Agreement as detailed in Note 1 and was 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 Note is denominated in United States dollars and bears interest at 8% per annum. Pursuant to a subscription agreement dated August 2, 1996 entered into between the Company, certain of its subsidiaries, the convertible debentures holders and Asean Capital (the "Subscription Agreement") as more fully described in Note 15 below, Asean Capital has made an irrevocable and unconditional undertaking that it will not demand repayment of the Note unless the Company has sufficient cash flows for working capital, debt repayment and capital expenditure for the ensuing twelve month period and the repayment will only be made according to the repayment schedule defined in the Subscription Agreement. (RMB24,900 (US$3,000)) is repayable in two installments during the twelve month periods ending July 31, 1998 and July 31, 1999. No repayment was made in the current year. 15. CONVERTIBLE DEBENTURES These represent US$11,500 convertible debentures ("Convertible Debentures") issued by China Bearing to certain institutional investors on August 23, 1996 pursuant to a Subscription Agreement dated August 2, 1996. Unless the Convertible Debentures have been converted, they are due and payable in August 1999 (the "Maturity Date"). The investors have the right to convert at any time, in whole or in part, the principal amount of the debenture into 2,300,000 shares of the common stock of the Company based on the initial conversion price (the "Conversion Price") of US$5.00 per share, subject to certain adjustments in relation to the capital structure, changes to profits and reserves of the Company. 66 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 15. CONVERTIBLE DEBENTURES (continued) Pursuant to one of the conditions set out in the Subscription Agreement, if and whenever the cumulative audited earnings per share, the calculation of which is defined in the Subscription Agreement (the "defined EPS"), for any two consecutive financial years from year ended December 31, 1996 to 1998 are less than the corresponding management's projection of cumulative EPS for such years as set out in the Subscription Agreement, the Conversion Price shall be adjusted in accordance with the formula as stated in the Subscription Agreement. In the current year, due to the Company's failure to achieve the projected cumulative EPS of US$1.79 for the two years ended 31 December 1997, the Conversion Price has been adjusted to US$1.84 per share. The Convertible Debentures bear interest at the rate of the higher of (i) 5% per annum (net of withholding tax, if applicable) and (ii) the percentage of the dividend yield calculated by reference to dividing the annual dividend declared per share of common stock of the Company by the Conversion Price. The Convertible Debentures are required to be redeemed on the Maturity Date at their principal amount then outstanding together with any accrued but unpaid interest together with an amount that would enable the investors to yield an aggregate internal rate of return ("IRR") of 12% per annum on the cost of their investment. As a result, interest has been accrued in the financial statements for the year ended December 31, 1996 at the rate of 12% per annum. Pursuant to the Subscription Agreement, in the event that an adjustment of the Conversion Price as described above occurs, and such adjustment would result in the number of shares that would have been issued to the investors in aggregate had conversion immediately taken place to exceed 20% of the total issued share capital of the Company (including also for this purpose such number of shares that would have been issued upon conversion of all of the Convertible Debentures), that portion of the Convertible Debenture(s) representing the excess of such shares over such 20% ("the Excess") shall, at the option of the relevant investors, be redeemed by the Company at its principal amount outstanding together with any accrued but unpaid interest calculated up to and including the date of payment together with an amount that would enable the investors to yield in aggregate an IRR of 19.75% per annum. In the occurrence of any event of default as defined in the Subscription Agreement, the Convertible Debentures shall automatically become immediately due and payable in full by the Company at its principal amount outstanding together with the accrued but unpaid interest together with an amount that would enable the investors to yield an aggregate IRR on their investment of 19.75% per annum unless the Company shall have received a notice from any of the investors to specify the number of Convertible Debentures that they wish to redeem, in which case the amount payable shall only be limited to the specified amount. Due to the failure of the Company to achieve the defined EPS of US$0.55 in the current year, being an event of default stipulated in the Subscription Agreement, although the Convertible Debentures bear a face rate of interest of 5% per annum interest is accrued on these Convertible Debentures at the rate of 19.75% per annum from the date of inception up to December 31, 1997 and the outstanding amount of Convertible Debentures has been classified as current liabilities as at December 31, 1997. 67 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 15. CONVERTIBLE DEBENTURES (continued) The obligations of China Bearing under the Convertible Debentures are guaranteed by the Company, Asean Capital Limited, China International Bearing Holding Limited and Southwest Products Company (hereinafter collectively referred to as the "Guarantors"). The Guarantors have given certain negative pledges over the creation of securities interest for as long as any of the Convertible Debentures remain outstanding. 16. LONG TERM BANK LOANS Long term bank loans are principally loans borrowed to finance the construction in progress. The loans are unsecured, bear fixed interest rates ranging from 3.7% to 9.25% per annum. Current portion of the loans, repayable in 1998, together with the overdue portion of the current portion of the long term loans carried forward from last year, are included in current liabilities. The long term portion of the loans are repayable in 1999. 17. NUMBER OF SHARES/EARNINGS PER SHARE In 1997, the Financial Accounting Standards Board issued Statement No. 128, "Earnings per Share" ("SFAS 128"). SFAS 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. All earnings per share amounts for all periods have been presented and, where appropriate, restated to conform to SFAS 128 requirements. The exercise of outstanding warrants is not included as part of the assumption in the calculation of diluted earnings per share as the share price of the Company for all periods ended December 31, 1995, 1996 and 1997 was lower than the exercise prices. 68 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) The computations of basic and diluted earnings/loss per shares are as follows:
Year ended December 31, 1995 1996 1997 RMB RMB RMB Basic Net income/(loss), as reported 54,095 76,534 (4,184) ========== ========== ========== Weighted average number of common shares outstanding: Share of common shares outstanding on January 1, 11,700,063 11,700,063 12,700,109 Shares issued as a result of reverse stock split - 46 33 1,000,000 common shares issued on June 10, 1996 - 558,904 - ---------- ---------- ---------- Total weighted average number of common shares outstanding 11,700,063 12,259,013 12,700,142 ========== ========== ========== Earnings/(loss) per share 4.62 6.24 (0.33) ========== ========== ==========
69 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data)
Year ended December 31, 1995 1996 1997 RMB RMB RMB Diluted Net income/(loss), as reported 54,095 76,534 (4,184) Add after tax interest expenses applicable to Convertible Debentures - 4,078 - ---------- ---------- ---------- 54,095 80,612 (4,184) ========== ========== ========== Weighted average number of common shares outstanding: Share of common shares outstanding on January 1, 11,700,063 11,700,063 12,700,109 Shares issued as a result of reverse stock split - 46 33 1,000,000 common shares issued on June 10, 1996 - 558,904 - ---------- ---------- ---------- Total weighted average number of common shares outstanding 11,700,063 12,259,013 12,700,142 Common share issuable assuming conversion of the Convertible Preferred Shares Series A 3,600,000 3,600,000 - Series B - 680,000 - Common shares issuable assuming conversion of the Convertible Debentures on August 23,1996 - 812,876 - Common shares issuable assuming exercise of stock options, reduced by the number of shares which could have been purchased with the proceeds from exercise of such stock options - 102,017 - ---------- ---------- ---------- Total weighted average number of common shares and common shares equivalents outstanding 15,300,063 17,453,906 12,700,142 ========== ========== ========== Earnings per share 3.54 4.62 (0.33) ========== ========== ==========
70 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) The diluted loss per share for 1997 is the same as the basic loss per share as there was an anti-dilution effect which reduces the loss per share. The calculation which resulted in such an anti-dilution was based on the assumptions that the conversion rights under the Convertible Debentures had been fully exercised, at the adjusted exercise price as stated in note 15, and the redemption of preferred shares, both on January 1, 1997. On this basis, the net income calculated by adding back the interest expenses on the Convertible Debentures net of income tax is RMB17,746. As a result of the aforesaid, an anti-dilution effect was resulted and therefore the diluted loss per share was the same as the basic loss per share. 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 interbank market amongst designated banks. In place of the official rate and the swap center rate, the People's Bank of China publishes a daily exchange rate for Renminbi based on the previous day's dealings in the interbank market. However, the unification of exchange rates does not imply the full convertibility of Renminbi into United States dollars or other foreign currencies. Payments 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 center is granted to enterprises in China for valid reasons such as purchases of imported goods and the remittance of earnings. While the conversion of Renminbi into United States dollars or other foreign currencies can generally be effected at the exchange center, there is no guarantee that it can be effected at all times. 19. CONTRIBUTED SURPLUS The respective features of common stock and convertible preferred stock are detailed in Note 1 to the financial statements. 71 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) On June 10, 1996, the Company issued an additional 1,000,000 shares of common stock with a par value of RMB 0.0083 (US$0.001) at RMB 41.5 (US$5.00) per share. Total share premium on the new issue of shares amounted to RMB36,077 after deducting the direct expenses arising on the issue of these shares of RMB5,415 from the gross premium of RMB41,492. 20. DISTRIBUTION OF PROFITS 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 profits by Harbin Bearing is based on the profits as reported in its statutory accounts prepared under PRC GAAP after the following allocations and appropriations: (a) making up any accumulated losses; (b) transferring 10% of its profit after taxation to the statutory surplus reserve; (c) transferring 5% to 10% of its profit after taxation to a collective welfare fund; and (d) transferring a certain amount of its profit after taxation to a discretionary surplus reserve. The following appropriations were made and are further described below:
Year ended December 31, 1995 1996 1997 RMB RMB RMB Statutory surplus reserve 8,170 1,733 70 Collective welfare fund 4,085 867 35 ------ ----- --- 12,255 2,600 105 ====== ===== ===
The collective welfare fund must be used for capital expenditure on staff welfare facilities. Such facilities are for staff use, but are owned by Harbin Bearing. The distributable retained earnings of the Group as of December 31, 1997, after taking into account the above restrictions and appropriations and based on the PRC statutory accounts of Harbin Bearing, amounted to RMB73,260. The reserves retained in the Chinese subsidiaries of the Group amounted to RMB27,971 (1996: RMB27,866). 72 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 21. OTHER INCOME In 1996, other income represented a gain on the sale of investment in a subsidiary by China Bearing to a third party amounting to RMB16.6 million. The only asset of the subsidiary was a residential property in Hong Kong which was purchased during that year. No such income was earned in 1997. 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 =======
73 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 a number of 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 1995 1996 1997 RMB RMB RMB RMB Revenue: Sales of products (a) 103,111 232,338 171,373 Interest income (b) - - 2,547 ======= ======= ======= Capital expenditure: Leases of equipment capital payments (c) 15,873 17,270 18,788 Leases of buildings (d) 3,751 3,751 3,751 Land use rights (e) 2,508 2,508 2,508 ======= ======= ======= Expenses: Management and administrative services (f) 19,126 21,705 - Trademark royalty fees (g) 3,362 4,306 2,924 Pension and retirement plan expenses (h) 18,394 20,681 19,742 Finance charges on leases of equipment (c) 11,310 9,914 8,395 Interest on promissory note (i) 3,320 2,905 1,875 ======= ======= =======
(a) Significant sales to related companies Harbin Bearing made sales of RMB91,287 (1996: RMB14,549; 1995: RMB42,855) and RMB80,086 (1996: RMB203,442; 1995: RMB40,257) 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, 1997, the amounts of trade receivables from HBIE, Xin Dadi and other related companies included in the amounts due from related companies were as follows.
1996 1997 RMB RMB HBIE 49,792 127,365 Xin Dadi 107,597 86,681 ------- ------- 157,389 214,046 ======= =======
74 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) (b) Advances to related companies Apart from the trade receivable balances due from related companies as disclosed in note 23(a) above, advances which are non-trading in nature were made to other related companies as at December 31, 1997, as follows:
1996 1997 RMB RMB Sunbase Resources Limited ("Sunbase Resources") - 38,824 Sunbase Construction and Development 45,450 45,450 Harbin Precision 1,150 1,150 Other related companies 1,286 553 ------ ------ 47,886 85,977 ====== ======
Sunbase Resources is a related company of the Group in which the directors and/or shareholders have a beneficial interest. Sunbase Construction and Development is a joint venture established in the PRC of which Sunbase International Holding Limited, another related Company of the Group, has equity interests. Other related companies are owned by the Harbin Municipal Government. The above balances are unsecured, repayable within one year and interest- free except for the balance due from Sunbase International. Pursuant to an agreement dated 1 January 1997 between the Company and Sunbase Resources, interest was charged on the average balance at a rate of 10% per annum. Total income earned in respect of such balances was RMB2,547 for the year ended December 31, 1997. (c) 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 RMB25,927 (US$3,124) and RMB1,256 (US$151), from January 1, 1994 to December 31, 2001 and from January 1, 1994 to December 31, 1998, respectively. Options to extend the leases and to purchase the leased assets have been granted to Harbin Bearing upon expiry of the initial leases. All these leases are treated as capital leases. (d) Leases of buildings 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 RMB3,751 (US$452). 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. 75 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) (e) 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 RMB2,508 (US$302) effective from January 1, 1994 subject to future adjustments in accordance with changes in the government fees. (f) 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 RMB18,876 and RMB20,764 for the financial years ended December 31, 1995 and 1996 respectively 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. In 1997, no such fees were paid as the agreement expired in December 31, 1996. Agreements were also entered into by Harbin Bearing with Harbin Xinhengli and Harbin Sunbase, in respect of general management services to be provided by the joint ventures from January 1, 1994 to December 31, 1996 at an annual fee of RMB150 (US$18) payable to each of the joint ventures. An agreement was entered into between China Bearing and Sunbase International, in respect of general management and administrative services at an annual fee of RMB250 (US$30) for the year ended 1995. No such management fees were paid for the year ended December 31, 1996 and 1997. In addition, China Bearing is to reimburse Sunbase International for administrative services rendered on behalf of China Bearing at cost. The Company paid a total amount of RMB Nil (1996: RMB941) to Sunbase International (Holdings) Limited ("Sunbase International") for a reimbursement of the expenses incurred on the Company's behalf. (g) 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 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 and subject to the relevant laws in China. The trademark royalty paid by Harbin Bearing during 1995, 1996 and 1997 amounted to RMB3,362, RMB4,306, RMB2,924, respectively. 76 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) (h) Pension and retirement plan Pursuant to an agreement on December 31, 1993, Harbin Bearing is required to 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 is based on the standard contribution as required by government regulations calculated at 20% of salary up to the period ended June 30, 1996 and at 22% with effective from July 1, 1996. 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 was entered into on the condition that no compulsory rules and regulations are implemented by the government such that Harbin Bearing has to be directly responsible for any pension payments. The contributions to the pension scheme made by Harbin Bearing in 1995, 1996 and 1997 amounted to RMB18,394, RMB20,681 and RMB19,742, respectively. (i) Interest on promissory note As described further in Note 1, in consideration for the purchase of its interest in China Bearing, the Company issued common shares and preferred shares to, and assumed vendor financing from Asean Capital Limited. The vendor financing provided by Asean Capital was in the form of a US$5,000 secured promissory note which is secured on the shares of China Bearing (See Note 14). For the year ended 1996, US$2,000 was repaid and interest was payable on the remaining balance of US$3,000. The promissory note was issued to Asean Capital in connection with the Share Exchange Agreement as detailed in Note 1 and bears interest at 8% per annum. Management expects that the arrangements detailed in (b), (c) and (d) above will be renewed after the initial contract term. 24. OPERATIONS WITH STATE-OWNED ENTERPRISES Harbin Bearing is owned as to 33% by Harbin Holdings which is a separately established enterprise controlled by and under the administration of the Harbin Municipal Government. Substantially all 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. 77 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 25. 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 fair value of the Group's bank borrowings based on the interest rates currently available for borrowings with similar terms and average maturities approximates the carrying amount of these bank borrowings. The fair value of the secured promissory note and the convertible debentures are not determinable. 26. SEGMENT DATA The Group mainly operates in the ball bearing industry in China through Harbin Bearing, its 51% subsidiary, which generated 100% of the Group's net sales in 1995. During 1996 and 1997, the Group also operated in the ball bearing industry in the United States of America through Southwest Products, its wholly-owned subsidiary, which generated less than 10% of the Group's net sales in these years. 27. CONCENTRATION OF RISK Concentration of credit risk: Financial instruments that are 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 to 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 balances with two related companies, HBIE and Xin Dadi which have receivable balances of RMB127,365 and RMB86,681, respectively, as at December 31, 1997. 78 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 27. CONCENTRATION OF RISK (continued) (c) Current vulnerability due to certain concentrations: The Group's operating assets and primary source of income and cash flow is its interest in its subsidiaries in the PRC. The value of the Group's interest in these subsidiaries 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 18 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. 28. FOREIGN INVESTMENTS MATTERS The Company is currently holding discussions with the Committee on Foreign Investment in the United States ("CFIUS"), an inter-agency committee of the United States Government, with respect to the Company's acquisition in January 1996 of Southwest Products Company ("Southwest"). CFIUS is conducting a review to determine if the ownership of Southwest by the Company poses a potential threat to the national security interests of the United States. If CFIUS determines that such a threat may exist, then it may recommend to the President of the United States that he order divestiture of Southwest by the Company. Alternatively, CFIUS may take no action or may propose that certain measures be taken by the Company to protect the national security interests of the United States as a condition of the Company continuing to own Southwest. At this time, it is premature to evaluate the likelihood of any action by CFIUS with respect to this matter. If the Company is required to divest its ownership of Southwest or significant restrictions are imposed, the Company believes it has certain claims which it may bring against certain of its professional advisors who assisted it in connection with its acquisition of Southwest. However, no assurance can be given that any such claims by the Company would fully reimburse it for any loss it might realize upon a divestiture of Southwest or as a result of the imposition of conditions on its ownership. 79 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 29. STOCK OPTION PLAN 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 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 the exercise price of 160,000 options granted to an executive, was lower than the market value of the common stock on the date the option was granted. If in case of incentive stock options granted to any person possessing more that 10% of the total combined voting power of all classes of stock of the Company or any affiliate of the Company, the price may not be less than 110% of such fair market value. The Plan terminates on the earlier of either the date on which no additional shares of common stock are available for issuance under the Plan, or January 2, 2006. On July 1, 1996, the Compensation Committee of the Company granted 1,250,000 stock options to three executives, including two directors of the Company, on the following terms:
Exercise price/Share Number of Shares Vesting schedule US$ per option rights ---------------- --- ----------------- January 16, 1996 6.375 415,000 January 16, 1997 6.375 415,000 January 16, 1998 6.375 420,000 -------- 1,250,000 =========
80 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 29. STOCK OPTION PLAN (continued) Pursuant to the Plan and in accordance with the provisions of an employment agreement entered into between the Company and a director, the Company granted, on January 16, 1996, 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 the beneficiary to be, and will be treated as, an incentive stock option. The beneficiary may exercise the options that have vested and purchase shares of the common stock as follows:
Exercise price of the option vest Number of after each such year shares Vesting schedule US$ exercisable ---------------- --- ----------- January 16, 1997 6.65 160,000 January 16, 1998 7.75 160,000 January 16, 1999 9.25 160,000 January 16, 2000 10.75 160,000 January 16, 2001 12.45 160,000 ----- -------- 800,000 ========
As at December 31, 1997, none of the vested options have been exercised. Subsequent to the balance sheet date, the options granted to one of the Company's executives were withdrawn as that employee terminated his employment with the Company at that date. Pro forma information regarding net income and earnings per share is required by SFAS 123, and has been determined as if the Company had accounted for its stock options under the fair value method of that statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for the date of grant in 1996: Interest rate on United States treasury bonds; no dividend yield; volatility factors of the expected market price of the company's common stock of 87%; and a weighted-average expected life of the options of 3 to 5 years. The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require of the input of highly subjective assumptions including the expected stock price volatility. Because the Company's stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock options. 81 SUNBASE ASIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except number of shares and per share data) 29. STOCK OPTION PLAN (continued) For the purposes of pro forma disclosures, the estimated fair value of the options is amortized to write off the amount over the options' vesting period. The Company's pro forma information is as follows:
Year ended December 31, 1996 1997 RMB RMB Pro forma net income/(loss) 24,828 ( 69,270) ====== ======== Pro forma earnings/(loss) per share: Basic 2.03 ( 5.45) ====== ======== Diluted 1.41 ( 5.45) ====== ========
The Company's stock option activities and related information for the years ended December 31, 1996 and 1997 are summarized as follows:
1996 1997 Exercise Exercise Options price Options price US$ US$ Outstanding at beginning of year - - 2,050,000 6.967 Granted 2,050,000 6.967* - - Exercised - - - - Forfeited - - - - ---------- -------- ---------- ------- Outstanding at end of year 2,050,000 6.967 2,050,000 6.967 ========== ======== ========== =======
* Exercise price was presented at the weighted average basis after discounting such future price. 30. SERIES A WARRANTS The Company has outstanding 10,392,167 Series A Warrants (the "Warrants") in issue, which are stand alone instruments and are not attached to other financial instruments. These Warrants are issued without a consideration. The warrant holders are entitled to exchange 70 Warrants for one share of common stock at an exercise price of US$175. No such rights have been exercised during the year. The Warrants expire on June 30, 1998. 82 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 43 Report of Independent Auditors 44 Consolidated Balance Sheets as of 45-46 December 31, 1996 and December 31, 1997 Consolidated Statements of Income for the 47-48 years ended December 31, 1995, December 31, 1996 and December 31, 1997 Consolidated Statements of Cash Flows for the 49-51 years ended December 31, 1995 December 31, 1996 and December 31, 1997 Consolidated Statements of Changes in 52 Shareholders' Equity for the years ended December 31, 1995, December 31, 1996 and December 31, 1997 Notes to Consolidated Financial Statements 53-82
(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. 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 International. (1) 2.2 Asset Transfer and Assumption Agreement dated December 16, 1994, between the Company and Valley Financial Corporation. (I) 83 (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 Designation for Series B Preferred Stock. (4) (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) 10.4 Joint Venture Contract between China International 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 84 to Harbin Bearing. (3) 10.10 Pension Fund Aggregation Agreement between 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) 10.16 Ancillary and Transportation Equipment Lease Agreement between Harbin Precision and Harbin Bearing. (3) 10.17 Agreement and Plan of Reorganization and Merger dated as of December 29, 1995 among the Company, Southwest Products and the shareholders of Southwest Products. (4) 10.18 Employment Agreement dated as of January 16, 1996 between the Company, Southwest Products and William McKay. (4) 10.19 1995 Stock Option Plan. (5) 10.20 Form of Registration Rights Agreement relating to the Private Placement Shares. (5) 10.21 Employment Agreement dated as of August 1, 1996 between the Company and Billy Kan. (5) 10.22 Subscription Agreement (together with Form of Debentures and Guaranty) dated August 2, 1996 among China Bearing, Asean Capital, China International Bearing Holdings Limited, the Company, Southwest Products, Glory Mansion, Wardley China Investment Trust, MC Private Equity Partners Asia Limited and Chine Investissement 2000 (5) 21 Subsidiaries of the Company 27 Financial Data Schedule 85 (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. (4) Filed with the Company's Form 10-K, dated May 3, 1996 and incorporated by reference herein. (5) Filed with the Company's Form S-1, dated October 23, 1996 and incorporated by reference herein. (6) Filed with the Company's Form 10-K, dated April 4, 1997 and incorporated by reference herein. 86 SIGNATURES In accordance with Section 13 of 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 15, 1998 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 13, 1998 By: /s/ Gunter Gao -------------------------------------- Gunter Gao, Chairman Date: May 13, 1998 By: /s/ Billy Kan -------------------------------------- Billy Kan, Vice Chairman, Director Date: May 15, 1998 By: /s/ William McKay -------------------------------------- William McKay, Chief Executive Officer, President and Director Date: May 13, 1998 By: /s/ (Roger) Li Yuen Fai -------------------------------------- (Roger) Li Yuen Fai, Vice President, Chief Financial Officer and Director Date: By: /s/ -------------------------------------- George Raffini, Director Date: May 13, 1998 By: /s/ Philip Yuen -------------------------------------- Philip Yuen, Director Date: May 13, 1998 By: /s/ Harris Lau -------------------------------------- Harris Lau, Chief Accounting Officer 87 EX-21 2 SUBSIDIARIES OF THE COMPANY EXHIBIT 21 The Company's subsidiaries are:
Effective Percentage Name of Subsidiary Ownership Place of Incorporation - ------------------ ----------- ---------------------- CHINA BEARING 100% Bermuda HOLDINGS LIMITED CHINA INTERNATIONAL 100% Hong Kong BEARING HOLDINGS LIMITED HARBIN SUNBASE 99% People's Republic of China DEVELOPMENT COMPANY LIMITED HARBIN XINHENGLI 99.9% People's Republic of China DEVELOPMENT COMPANY LIMITED HARBIN BEARING 51.43% People's Republic of China COMPANY LIMITED SMITH ACQUISITION COMPANY, 100% California INC. dba SOUTHWEST PRODUCTS COMPANY
88 EX-27 3 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS CONTAINED IN THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE ANNUAL PERIOD ENDED DECEMBER 31, 1997, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS 1,000 12-MOS DEC-31-1997 JAN-01-1997 DEC-31-1997 7,601 0 99,632 0 57,496 164,729 76,122 0 244,002 127,686 0 0 8,773 13 44,104 244,002 89,361 89,361 65,083 65,083 0 0 8,545 2,943 915 (503) 0 0 0 (503) 0.04 0.04
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