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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________________
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Year ended December 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No. 33-3276-D
CHINA CONTINENTAL, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Utah 87-0431063
- ---------------------------------- ---------------------------------
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)
1801-1806 Hua Qin International Building, 340 Queen's Road Central, Hong Kong
-----------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant Telephone Number, Included Area Code: 011-852-2542-2612
Securities Registered Pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
------------------- -----------------------------------------
None None
Securities Registered Pursuant to Section 12(g) of the Act:
None
----------------
(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 .
--- ----
Check if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-B is not contained in this form and will not be contained, to the best of
registrant 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-KSB.
[X]
The issuer revenues for its most recent fiscal year were US$36,788,039.
At of December 31, 1998, 69,000,000 shares of common stock of the
Registrant were outstanding. As of such date, the aggregate market value of the
common stock held by non-affiliates, based on the closing bid price on the NASD
Bulletin Board, was approximately $36,788,039.
DOCUMENTS INCORPORATED BY REFERENCE
No annual reports to security holders, proxy or information statements, or
prospectuses filed pursuant to Rule 424(b) or (c) have been incorporated by
reference in this report. Annual Small Business Disclosure Format: Yes No X
TABLE OF CONTENTS
PART I Page
------
ITEM 1. DESCRIPTION OF BUSINESS....................... 3
ITEM 2. DESCRIPTION OF PROPERTIES..................... 7
ITEM 3. LEGAL PROCEEDINGS............................. 7
ITEM 4. SUBMISSION OF MATTERS TO A VOTE
OF SECURITY HOLDERS........................... 7
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS................... 7
ITEM 6. SELECTED FINANCIAL DATA....................... 9
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF
OPERATION..................................... 11
ITEM 7A QUANTITATIVE AND QUALIFICATION DISCLOSURE
ABOUT MARKET RISK............................. 15
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY
DATA ......................................... 15
ITEM 9 CHANGES IN AND DISAGREEMENTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE...................... 15
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE
REGISTRANT..................................... 16
ITEM 11. EXECUTIVE COMPENSATION......................... 16
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT ......................... 18
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED PARTY
TRANSACTION.................................... 18
ITEM 14 YEAR 2000 ISSUES............................... 19
PART IV
ITEM 15 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
REPORTINGS ON FORM 8-K......................... 20
SIGNATURES..................................... 21
INDEX TO CONSOLIDATED FINANCIAL
STATEMENTS..................................... F-1
2
PART 1
ITEM 1. DESCRIPTION OF BUSINESS
This Form 10-K contains forward -looking statements within the meaning of
Section 27A of the Securities Act of 1933 and section 21E of the Securities
Exchange Act of 1934. The Company's actual results could differ materially from
those set forth in the forward-looking statements. Certain factors that might
cause such a difference are discussed in the section entitled "Certain Factors
Affecting Future Operating Results" beginning on page 14 of this Form 10-K.
The Company
China Continental, Inc. (the "Company" or "CHCL") designs, installs and
sells plastic production lines on a turn-key basis, sells machinery and
equipment for the manufacture of plastic products and imports and resells raw
materials. The major portion of sales are to plastic manufacturers in the
People's Republic of China ("PRC" or "China"). The Company has completed over 74
turn-key projects throughout the PRC, varying in size from $300,000 to five
million United States dollars. Seven turn-key projects were completed during the
year under review with an average size of US$4.5 million. Typically turn-key
projects take four to eight months to complete, depending on size and
complexity. The installation and maintenance of production lines are handled
jointly by the original equipment manufacturers and the Company. The Company
became a US listed public company via a reverse merger in February 1995.
Market and Client Base
In the 1990's, the Company began to market fully automated production lines
to plastic product manufacturers in the PRC on a turn-key basis. The majority of
turn-key projects were sold to companies in the PRC.
Business Segments
The Company has three principal business segments:
Sale of turn-key plastic production lines;
Importer and reseller of raw materials;
Operation of a breeding center.
Sale of Turn-key Plastic Production Lines
In the 1990's, the Group began to market fully automated production lines
to plastic product manufacturers in the PRC on a turn-key basis. These turn-key
projects require the provision of services from the design of the engineering
configuration of the production lines to the supply and installation of the
machinery and equipment. The Company has completed 74 turn-key projects
throughout the PRC, varying in size from $300,000 to $5 million. The Company
also imports and resells raw materials and machinery and equipment to the
plastic manufacturers in the people's republic of China.
A typical turn-key project takes four to eight months to complete,
depending on its size and complexity. The design of a production line is based
on job specifications, such as the particulars of the plastic products, the
packaging format, the intended maximum production capacity and the layout of the
factory premises obtained from the customers. The installation and maintenance
of production lines are handled jointly by the original equipment manufacturers
and the Company. Test-runs of the turn-key production lines are conducted by the
engineers of the Company to ensure quality and the meeting of specified
requirements. Turn-key projects usually have warranty periods from six months to
one year during which repairs and maintenance are provided free of charge by the
Company.
3
Sale of Machinery and Equipment, Accessories, Spare Parts, Raw Materials and
Steel
Sale of machinery and equipment, accessories, spare parts, raw materials
and steel are conducted in conjunction with the sales of turn-key plastic
production lines.
Principal Suppliers
The Company acquires its machinery and plastic materials principally from
Nippon Polyurethane Industry Co., Ltd., Nihon Unipolymer Co., Ltd., Tomen
Corporation, Janson Co., Ltd. Vicson Iron Works Co., Ltd., Cheer Young Machinery
Works Co., Ltd., Mintop Development Limited, Wing Lee Hong and K S Plastics Inc.
Employees
As of December 31, 1998, the Company employed a sales and administrative
staff of 14 persons in Hong Kong and a technical staff of approximately 35
persons in the PRC.
Competition
The market for turn-key automated production lines in the plastic
manufacturing industry is fragmented in the PRC. The Company believes it is a
leading designer, installer and marketer of automated turn-key plastic
production lines in the PRC and it provides buyers with superior post
installation technical, engineering and quality control supports. To date, there
has been no significant price competition in this market, but price competition
may become a factor in the future.
Economic development in the People's Republic of China ("PRC" or "China")
Since 1953, the development of the PRC's economy has been characterized by
the adoption of the "Five Year Plans". Implementation of the plans is carried
out under the supervision of the State Planning Commission, which reports
directly to the State Council. The ninth Five Year Plan for national, economic
and social development for 1996-2000, along with a ten-year program which
extends to 2010, was adopted in 1996, by the Standing Committee of the NPC.
China's gross domestic product for 1998 grew at 7.8%, when compared with
the same period of the previous year Although this growth rate is 1.6% lower
than 1997 and 1996, it is still the highest in the world. According to the
United Nations forecast, total world Gross Domestic product growth in 1998 will
be 2.9% (3.1% for 1997), within which the developed countries will grow at 2.2%,
the developing countries at 5.0% and Eastern Europe at 3.0%. China will have the
highest growth rate at 7.8%
The total amount of investment in 1998 reached approximately RMB2,846
billion, a nominal growth rate of 19.6%, representing a real rate of 14.1%, and
the rate of investment of approximately 26.6%. The 1998 total investment
exceeded RMB3,000 billion for a nominal growth rate of 17.0% and a real growth
rate of 14.0% while the rate of investment remains constant at 27.0%. On the
whole, the nominal growth rate is lower than the average level of the past
years. However, due to the fall in inflation, the real investment growth rate
will not fall significantly. The situation where the investment growth rate is
higher than GDP growth rate will remain unchanged.
Fixed assets investment growth in 1998 exceeded 14.1 per cent, down from
15.1 per cent in 1997. The central government has approved 72 large and
medium-sized projects totaling a 1.36 trillion yuan investment. Feasibility
studies are being conducted for 320 others with a projected investment of 5.34
trillion yuan.
4
On the whole, it is believed that China will be able to maintain a
favorable combination of a high growth economy with low inflation in 1999.
FUTURE PROSPECT OF THE COMPANY
In the 1990s, the Company began to market on a turnkey basis fully
automated production lines to plastic product manufacturers in the People's
Republic of China ("PRC" or "China"). These turnkey projects require the
provision of services ranging from the design of the engineering configuration
of the production lines to the supply and installation of the machinery and
equipment. These businesses have been very rewarding to the Company because of
its high margins.
The company also owns a minority stake in Weifang Great Dragon Chemical
Fiber Company Limited which was purchased in April 1997 for a cash consideration
of US$8 million. The principal activity of the business is the production of
polyester tire cord fabrics and polyester/nylon canvasses. Polyester tire cord
fabrics are one of the main components in the manufacture of radial tires. At
present, radial tires come as original equipment on most passenger cars and
light trucks.
The recent upheaval of most Asian financial economies has been a critical
factor in the decision of the Company to re-examine its historical business and
to formulate a corporate discipline that would focus on long-term growth and
development.
In approaching the next millennium, it appears that food production is
still the paramount question despite the recent advances of scientific methods
in agriculture and animal husbandry. The global demand for food is expected to
be critical to continued growth, particularly in developing countries. The
Company feels that the challenge of providing food in the next century can only
be met through agricultural genetic engineering. Therefore, the goals of the
Company are to increase shareholders' value and to be involved in selected
emerging high-growth sectors, particularly in the provisions of technologies
utilized in agricultural genetics and farming in China.
The Company has researched and ascertained that there are tremendous
opportunities in the agricultural genetics industry in China and it plans to
concentrate and expand the Company's resources into this business segment. China
is an enormous, undeveloped, emerging market. Its population of 1.4 billion is
growing by approximately 15 million annually and needs its daily requirement of
food to sustain its growth, peace and prosperity.
Despite being the most populous nation and being the largest livestock
producer in the world, China lacks superior livestock and planting seed genetics
technology to sustain its agricultural industry. Unless new emphasis is placed
on optimizing the use of land and livestock, economic self-sufficiency will not
be achieved.
The Company believes it has identified a niche by initiating a multi-phase
program to enhance agricultural production in China through the provision of
agricultural genetics technology to support the Country's increasing demand of
food. The strong relationship that the Company enjoys with the Chinese
government and certain International partners will provide the Company with
strategic access to this development opportunity.
The Company has embarked on a livestock and genetic engineering joint
venture called Chengde Dafeng Agricultural and Animal Company Limited. The joint
venture includes the Feng Ning Manchuria Autonomous Region Agriculture Company
Limited and China Land Resources Development Bureau. The farm which is the basis
of this operation is located in Feng Ning Manchuria Autonomous County of
Northern Hebei Province in China.
5
The emphasis of the Company is to lead, focus and manage a selected high
growth emerging businesses within a specific growing industry group,
particularly in the provisions of technologies in agricultural genetics and
farming in China, and to generate from these businesses the potential of
significant returns. The Company believes opportunities exist for its growth in
the business of agricultural genetics and farming in China, particularly in
those areas that offer potential proprietary technology development and
potential market dominance.
The Company believes that there are a number of favorable factors that will
enable it to achieve its objectives, including:
The opportunity to lead the market in the agricultural genetics and farming
industry in China with the ability to make available the latest techniques
and know-how in genetics technology and farming;
The presence of dedicated management and staff with necessary expertise;
The unique location and availability of a significant plot of land; and
The strong support from its Chinese and international partners, ensuring
that it is in a position to exploit existing and future opportunities in
agricultural genetics.
The Joint Venture project entails the importation of Boer goat embryos
through TeMania International Limited ("TMI"), a company based in Christchurch,
New Zealand, for implanting into local recipients. Superior genetics from South
Africa and New Zealand will be selected and collected for propagation in this
project. Once the first generation of offspring from embryo transfer has
matured, semen and embryos will be collected from the offspring for propagation
and distribution. Embryo transfer is a more economical and efficient way of
breeding superior livestock than importing live animals for breeding purposes.
TMI's involvement as a Technical Adviser will be to assist the Company in
establishing and initially managing a feedlot breeding center for Boer goats and
crossbred Boer goats, improving the genetic makeup of the domestic Chinese herd
through advanced semen extraction, artificial insemination and embryo transplant
techniques. TMI's participation will also introduce enhanced farm management
practices and technology, including nutritional expertise, animal husbandry
techniques and western farming practices proven to maximize efficiency in
livestock production and herd management.
The objectives of this project are to:
Support the Chinese Government's Grain Conservancy Policy for the
development of pasture fed animals such as sheep, goats and cattle as,
unlike pigs, they do not compete for grains with humans;
Produce superior breeding livestock to improve China's expanding livestock
population; and
Provide red meat for a population of 1.4 billion people.
The project will entail the marketing and sale of thoroughbred Breeding
livestock and superior breed semen & embryos to contract breeders and growers.
The contract breeders will be coordinated through municipal, provincial and
central governments. The Company intends to repurchase the offspring (the
Crossbreed) of the artificially bred livestock for feedloting and slaughter in
the Company's contract abattoir.
The project also involves sub-contracting an abattoir that will meet USDA,
EU, Japan, China and Halal health requirements, and sub-contracting a meat
packing plant equipped with tanning, fabricating and rendering facilities and
with the capacity to process approximately 500,000 head of sheep and goats and
40,000 head of cattle yearly. High quality brand products will then be
distributed in China and worldwide. The Company will also be involved in the
sale of feed, feed additives, minerals, vitamins, veterinary drugs and other
related items and the production and sale of milk, skin, hide, wool and
cashmere.
6
In summary, this project will propagate breeding livestock and, when
practicable, the Company will consider, setting up a seed division. The mission
of the seed division is to improve China agricultural production through quality
genetics. The seed industry is a rapidly developing industry undergoing
decentralizing government control and regulations. According to recent studies,
China's seed industry is facing pressure to improve yields to feed its
increasing human and livestock populations. China imports vegetable seeds,
potato seeds, turf seeds, oilseed and fruit seeds for planting and exports rice
planting seeds, soybeans, forage seeds, sugar beets and vegetable seeds to over
20 countries. At present, China is not a major world exporter of planting seeds
due to the lack of facilities, a distribution system, testing labs, technology
and machinery.
The Company believes that it has identified a niche by providing a program
to enhance agricultural production that will significantly improve the standard
of living in China, and by providing badly needed agricultural genetics to
support the increasing demand of food in China. With the strong relationship
with the Chinese and International partners, the Company will have access to
this development opportunity and is well positioned to take advantage of
existing and future opportunities.
The Company intends to maximise its substantial cash flow to enhance the
values of its venture businesses through effective management, operations and
development strategies. The Company believes opportunities exist for its growth
in the business of agriculture and farming in China and are confident of the
growth of the Company and its rewarding prospects.
ITEM 2. DESCRIPTION OF PROPERTIES
The Company principal administrative, marketing and technical facilities
are located in Hong Kong at 1801-1806, Hua Qin International Building, 340 Queen
Road Central. These premises are owned by the Company.
The farm of the Company is located in Chengde Feng Ning Manchuria
Autonomous Region, People's Republic of China. The farm is 51 % owned by the
Company.
ITEM 3. LEGAL PROCEEDINGS
The Company is not currently subject to any material pending legal
proceeding.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5. MARKET FOR REGISTRANT COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
Market Information
The Company's common stock trades on the OTC Electronic Bulletin Board and
is quoted under the symbol "CHCL", the following table sets forth the high and
low bid price per share for the Company common stock for each quarterly period.
7
1998 1997
------ ------
High Low High Low
------ ----- ------ -----
First Quarter 1.03 0.50 1.375 0.875
Second Quarter 1.156 0.563 1.0625 0.5625
Third Quarter 0.984 0.516 2.59375 0.5625
Fourth Quarter 1.00 0.50 1.71875 0.875
The quotation reflects the inter-dealer prices without retail markup,
markdown or commission and may not represent actual transactions.
Holders
As of September 28, 1999 there were approximately 278 holders of record.
Dividends
Since fiscal 1994, the Company has not declared or paid any cash dividends
on its Common Stock and does not expect to declare or pay any such dividend in
the foreseeable future.
8
ITEM 6. SELECTED FINANCIAL DATA
(In thousand United States dollars, except per share data)
The following table sets forth, for the periods and dates indicated,
selected consolidated financial and operating data for the Company. The
financial data was derived from the consolidated financial statements of the
Company and should be read in conjunction with the Company audited consolidated
financial statements in the Index to Financial Statements on page F-1 of this
report.
Year Nine Year Year Year
Ended Months Ended Ended Ended
Ended
Dec.31, Dec.31, Mar.31, Mar.31, Mar.31,
1998 1997 1997 1996 1995
--------- -------- --------- --------- ---------
Income Statement Data:
Automatic production lines $32,806 $18,815 $31,957 $34,897 $30,375
Raw materials 1,594 1,846 2,782 3,451 2,275
Breeding Center 2,388 0 0 0 0
Total Sales 36,788 20,661 34,759 38,348 32,650
Cost of Sale 14,284 8,335 14,290 15,228 15,639
Gross Profit 22,504 12,325 20,469 23,120 17,011
Depreciation and amortization (4,425) (57) (80) (64) (65)
Selling and administrative expenses (2,395) (510) (959) (1,249) (1,325)
(Provision for) Recovery of doubtful
accounts (681) 0 289 (1,217) (942)
Financial Income (Expenses), net (165) (57) (55) (73) 2
Other Income (Expenses), net 360 2,919 (595) (2,518) 523
Share of income / (losses) of
associated companies 103 144 0 (235) (347)
Reorganization expenses 0 0 0 0 (1,603)
Income before income tax 15,301 14,763 19,069 17,764 13,254
---------- --------- --------- --------- ---------
Income taxes 2,890 1,290 2,635 2,742 1,549
---------- --------- --------- --------- ---------
Income before minority interest 12,411 13,473 16,434 15,022 11,705
---------- --------- --------- --------- ---------
Loss allocated to minority interest 2,114 0 0 0 0
---------- --------- --------- --------- ---------
Income for the year 14,525 13,473 16,434 15,022 11,705
---------- --------- --------- --------- ---------
Net income per share 0.23 0.52 0.63 0.58 0.45
---------- --------- --------- --------- ---------
Weighted average shares outstanding 62,569 26,000 26,000 26,000 26,000
---------- --------- --------- --------- ---------
Balance Sheet Data at period end
Working capital (deficit) 30,699 (31,505) 55,784 (8,048) 19,910
---------- --------- --------- --------- ---------
Total Assets 253,684 218,776 73,282 53,773 33,343
---------- --------- --------- --------- ---------
Long-term Liabilities 1,261 0 0 21 209
---------- --------- --------- --------- ---------
Shareholders Equity 128,958 71,023 57,516 40,713 26,691
9
The Company changed its financial year end date to December 31, 1997. The
following table sets forth, for the periods and dates indicated, selected
consolidated financial and operating data for the Company. The financial data
was derived from the consolidated financial statements of the Company and should
be read in conjunction with the Company audited consolidated financial
statements in the Index to Financial Statements on page F-1 of this report. See
also Item 7, Management Discussion and Analysis of Financial Condition and
Results of Operation.
Year ended December 31,
1998 1997 1996
audited unaudited unaudited
------- --------- ---------
Income Statement Data
Automatic production lines $32,806 $21,759 $34,277
Raw materials 1,594 2,364 3,276
Breeding Center 2,388 0 0
Sales 36,788 24,123 37,553
Cost of Sale 14,284 8,042 14,072
Gross Profit 22,504 16,081 23,481
Depreciation and amortization (4,425) (73) (62)
Selling and administrative expenses (2,395) (556) (1,003)
(Provision for) Recovery of doubtful
accounts (681) 289 (1,217)
Financial Income (Expenses), net (165) (91) (116)
Other Income (Expenses), net 360 2,304 (2,512)
Share of income / (losses) of
associated companies 103 201 (220)
Income before income tax 15,301 18,155 18,351
-------- --------- ---------
Income taxes 2,890 2,683 2,736
-------- --------- ---------
Income before minority interest 12,411 15,472 15,615
-------- --------- ---------
Loss allocated to minority interest 2,114 0 0
-------- --------- ---------
Net income 14,525 15,472 15,615
-------- --------- ---------
Net income per share 0.23 0.60 0.60
-------- --------- ---------
Weighted average shares outstanding 62,569 26,000 26,000
-------- --------- ---------
Balance Sheet Data (At Year End)
Working capital 30,699 (31,505) 36,372
-------- --------- ---------
Total Assets 253,684 218,776 67,593
-------- --------- ---------
Long-term Liabilities 1,261 0 20
-------- --------- ---------
Shareholders Equity 128,958 71,023 54,372
-------- --------- ---------
10
ITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Twelve months ended December 31,1998 compared to the Twelve months ended
December 31,1997
Revenues
Revenues increased by US$12,665,000 or 52.50% to US$36,788,000 for the
twelve months ended December 31, 1998 from US$24,123,000 for the prior year.
This increase is principally attributable to an increase in the sale of turn-key
projects totaling US$11,000,000 and the sale of the breeding center totaling
US$2,388,000 which were partially offset by a decrease in the sale of raw
materials. The net increase reflects the continuous demand for the Company's
services.
Cost of revenues/sales
Cost of sales of turn-key projects includes the cost of the machinery
purchased and the salaries and wages paid to engineers and consultants. For the
year ended December 31, 1998, cost of sales as a percentage of revenue of
turn-key projects was 38.82%, an increase of 5.48% from the 34.34% for the prior
year. The increase is principally attributable to an increase in the cost of
materials..
Depreciation and Amortization
Depreciation and amortization expense increased by US$4,352,000 or 5,961%
to US$4,425,000 for the year ended December 31, 1998 from US$73,000 for the
prior year. The increase in depreciation expense is attributable to the
acquisition of the farm of which US$175,292,130 is being depreciated over a
period of 40 years.
Selling and administrative expenses
Selling and administrative expenses include salaries, commissions and other
direct employment costs paid to Company sales representatives and other
professionals. Selling and administrative expenses increased by US$1,839,000 or
330.76% to US$2,395,000 for the year ended December 31, 1998 compared to
US$556,000 for the prior year. The increase is principally attributable to
additional payments to various consultants and because of a higher volume of
corporate activity resulting from increased sales.
Provision for doubtful debts
The provision for doubtful accounts increased by US$970,000 or 235%
toUS$681,000 for the year ended December 31, 1998 compared with a recovery of
bad debts of US$289,000 for the prior year. The increase resulted from the
Company writing off of all receivables which had been outstanding for one year
or longer.
Financial Income (Expense) net
Financial income/(expense) net is interest earned on cash and cash
equivalents, less interest expense. Net financial expense increased by US$74,000
or 81.32% to US$(165,000) for the year ended December 31, 1998 from US$(91,000)
for the prior year. This increase is attributable to increase in borrowing by
the Company.
11
Other income/(expenses)
Other income/(expenses) decreased by US$1,944,000 to US$360,000 for the
year ended December 31, 1998 from US$2,304,000 for the prior year. This decrease
is principally attributable to the lack of any gain on disposals of subsidiaries
such as the sale of Gain Whole Limited and Megaway Development Limited during
the year ended December 31, 1997.
Share of income/(losses) of associated companies
Other than Weifang Great Dragon Chemical Fibre Company Limited, the
associated Companies of the Company are principally operated on an break even
basis. The Company has no further obligation to support the associated companies
and the losses sustained by them. During 1997, the Company incurred diminution
in value from the remaining interest in associated companies which reduced their
carrying value to zero. Therefore, no share of post-acquisition losses was
provided for during the year ended March 31, 1997. The share of profit of the
associated companies represented merely the Company's share of the profit of
Weifang Great Dragon Chemical Fiber Company Limited for the year ended December
31, 1998 which totaled US$102,000.
Income taxes
Income taxes for the year ended December 31,1998 were US$2,890,000 or
18.88% of pretax income. This compares with US$2,683,000 or 14.77% of pretax
income for the prior year. The increase principally resulting from a charge back
of the income tax provision during the year ended December 31, 1997 which did
not occur in 1998 and that certain income derived during the year ended December
31, 1997 was considered as capital gain and therefore not subject to income tax.
Net Income
Net income decreased by US$947,000 or 6.12% to US$14,525,000 from
US$15,472,000 for the year ended December 31, 1997. The decrease can mainly be
accounted for by the increase in depreciation and selling expenses which were
partially offset by the increase in revenue.
1997 versus 1996
- ----------------
Revenues
Revenues decreased by US$13,430,000 or 35.76% to US$24,123,000 for the year
ended December 31, 1997 from US$37,553,000 for the prior year. This decrease was
principally attributable to a decrease in the sales of turn-key projects.
Management is shifting the emphasis from small scale to large scale projects as
it believes that the resources of the Company can best be utilized by
concentrating on the marketing and sale of large turn-key projects and obtaining
economies of scale thereon.
Cost of revenues/sales
Cost of sales of turn-key projects includes the cost of the machinery
purchased and the salaries and wages paid to engineers and consultants. For the
year ended December 31, 1997, cost of sales as a percentage of revenue on
turn-key projects was 33.34%, representing a decrease of 4.13% from 37.47% for
the prior year. The decrease can mainly be attributable to the devaluation of
most Asian currencies and a larger rebate obtained from suppliers.
12
Depreciation of Fixed Assets
Depreciation expense increased by US$11,000 or 17.74% to US$73,000 for the
year ended December 31, 1997 from US$62,000 for the prior year. The increase in
depreciation expense is the result of a change in accounting policies whereby
buildings are depreciated over the remaining period of the 50 year lease as
opposed to the useful life of the building utilized in prior years.
Selling and administrative expenses
Selling and administrative expenses include salaries, commissions and other
direct employment costs paid to the Company's sales representatives and other
professionals. Selling and administrative expenses decreased by US$447,000 or
44.56% to US$556,000 for the year ended December 31, 1997 from US$1,003,000 for
the prior year. This decrease was mainly due to management streamlining
operational procedures and increased budgetary control. Moreover, the Company
minimized its commission expenses by reducing commission to a major customer,
China Fujian Foreign Trade Holdings Limited and its auditing expense by
approximately US$100,000.
Provision for doubtful debts and diminution in value of investment
The provision for doubtful debts and diminution in value of investment
decreased by US$1,506,000 or 123% to a recovery of US$289,000 for the year ended
December 31, 1997 from a provision of US$1,217,000 for the prior year. This
decrease is attributable to a tightening of credit procedure and the recovery of
US$290,000, which had previously been reserved.
Financial Income (Expense) Net
Financial income /(expense) is interest earned on cash and cash
equivalents, less interest expense. Net financial expense decreased by US$25,000
or 21.55% to US$(91,000) for the year ended December 31, 1997 from US$(116,000)
for the prior year, This decrease is attributable to tighter controls on cash
and the curtailing of the bank loans.
Other income/(expenses)
Other income increased by US$4,816,000 or 191.7% to US$2,304,000 for the
year ended December 31, 1997 from US$(2,512,000) for the prior year. This
increase is principally attributable to a decrease of US$1,228,000 in write-offs
of short- term investments and the capital gain derived from the disposals of
the Company's subsidiaries, Gain Whole Limited and Megaway Development Limited.
Share of income/(losses)of associated companies
The associated Companies of the Company are principally operated on an
break even basis. The Company has not further obligation to support the
associated companies and the losses sustained by them. During 1997, the Company
incurred additional diminution in value from the remaining interest in
associated companies which reduced their carrying value to zero. Therefore, no
share of post-acquisition losses was provided for the year ended December 31,
1997. The share of the profit of the associated companies represented the
Company's share of the profit of Weifang Great Dragon Fiber Company Limited for
the year ended December 31, 1997 which totaled US$201,000.
13
Income taxes
Income taxes for the year ended December 31, 1997 were US$2,683,000 or
14.77% of pretax income. This compares with US$2,736,000 or 14.9% of pretax
income for the prior year. The effective tax rate remained fairly constant
throughout the two years under review.
Net income
Net income decreased by US$143,000 or 0.9% to US$15,472,000 from
US$15,615,000 for the year ended December 31, 1996. This decrease is principally
attributable to lower revenues which were substantially offset by reduced costs.
Liquidity and capital resources
At December 31, 1998, the Company had working capital of US$35,938,000,
including a cash balance of US$35,668,000. This compares to a deficit of working
capital of US$(26,324,000) and a cash balance of US$17,808,000 at December 31,
1997.
Net cash provided by operating activities increased to US$ 18,751,000 from
US$ 10,962,000 for the prior year. The cash provided by operating activities
consisted principally of US$14,382,000 of net income, an increase in
depreciation expenses, an increase in accounts payable and accrued liabilities,
and an increase in income tax payable. These were partially offset by an
increase in accounts receivable and the recording of minority interests.
Net cash used in investing activities totaled US$2,000 for the year ended
December 31, 1998 compared to US$ 15,034,000 for the nine months ended December
31, 1997. In both periods the Company had nominal purchase of fixed assets, but
in the prior period, the Company used US$52,000,000 to purchase 56.5% of the
equity of Wealthy Asia Limited. This was partially offset by the proceeds on
disposal of short- term investments.
Net cash used in financing activities totaled US$(891,000) for the year
ended December 31,1998. Net cash provided by financing activities consisted
principally of net repayments which were partially offset by advances of bank
overdrafts.
The Company business has historically been capital intensive. In most years
internally generated funds were sufficient to fund the Company operations and
finance its growth. While the cash generated from earnings and available lines
of credit has historically provided sufficient liquidity to meet ordinary
capital requirements. Management anticipates that cash generated from operations
combined with current working capital and available credit lines will provide
sufficient liquidity to meet ordinary capital requirements for the next twelve
months.
Impact of inflation
To date, the Company has not experienced any significant effect from
inflation. The Company's major expenses have been the cost of purchase of
machinery, salaries and related costs incurred principally for the turn-key
projects. The Company generally has been able to meet increases in costs by
raising prices of its products.
14
Certain Factors Affecting Certain Future Operating Results
a) Revised Corporate Business
In the past, the Company has been actively involved in the sale of turn-key
production lines, machinery and equipment, accessories, spare parts and raw
materials. The Company is now moving away from this line of business into the
provision of technology in agricultural genetics and farming in China. Because
of the Company's inexperience with this industry, there is no guaranty that its
future results will equal those of the past or that the Company will be
profitable in this industry.
b. Dependence on Strategic Relationship
The Company plans to conduct its future operations in the PRC with Feng
Ning Manchuria Autonomous Region Agriculture Company and China Resources
Development Bureau. Any deterioration of this strategic relationship could have
an adverse effect on the future operations and financial position of the
Company.
c. Country Risk
Substantially all of the Company operations are conducted in the PRC and
accordingly, the Company is subject to special considerations and significant
risks not typically associated with companies operating in North America and
Western Europe. These include the risks associated with the political, economic
and legal environments and foreign currency exchange, among others. The
Company's results may be affected by, among other things, changes in the
political and social conditions in the PRC and changes in government policies
with respect to laws and regulations, anti-inflation measures, currency
conversion and remittance abroad and rates and method of taxation. The PRC
government has implemented economic reform policies in recent years, and these
reforms may be refined or changed by the government at any time. It is possible
that a change in the PRC leadership could lead to changes in economic policy. In
addition, a substantial portion of the Company revenues is denominated in
Renminbi, which must be converted into other currencies before remittance
outside the PRC. Both the conversion of the Reminbi and other foreign currencies
and remittance of foreign currencies abroad require approval of the PRC
government.
ITEM 7A QUANTITATIVE AND QUALIFICATION DISCLOSURE ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements of the Company are annexed to this Report as pages
F2 through F-24. An index to such materials appears on page F-1.
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
15
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth the name and ages of the executive officers
of the Company and the position held by each.
Name Age Title
------ ----- -----------
Harry H.H. Ho 49 Chairman of the Board and Chief
Executive Officer
Jia Ji Shang 45 Vice-Chairman of the Board and
Director
Ji Jun Wu 60 Director
Kim Yong Soh 49 Director
Tan Sri (Dr.) M. Ghazali Shafie 61 Senior Advisor
Dr. Li Yan 44 Director
Chan Kwai Chiu 41 Director
Eric Ng 39 Secretary/Treasurer/Chief Financial
Officer and Director
Ian Macdonald 45 Advisor
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth all compensation paid or to be paid for
services rendered during the last three fiscal years by the Company to its chief
executive officers and the one remaining most highly paid executive officer who
earn more than $100,000 for the three fiscal years ended December 31,1998.
Name of Individuals Year Salary Bonus Others
--------------------- ------ -------- ------- --------
Chan Kwai Chiu 1997 155,870 12,990 129,366
Apr. 1,1997 to
Dec.31, 1997 116,900 9,742
1998 108,000 0
Wong Yuen Ki 1997 138,000 11,500 155,819
Apr. 1,1997 to
Dec.31, 1997 103,500 8,625
1998 0 0
No cash compensation was paid or accrued by the Company in excess of
$100,000 for any other executive officer. The Company does not provide
retirement, pension, profit sharing or similar benefit programs or plans to its
officers. The Company does not pay fees or other compensation to its directors
for attending meetings or special assignments.
16
EXECUTIVE OFFICERS OF THE REGISTRANT
The Company executive officers are as follows:
Mr. Harry H. H. Ho, is the Chairman and the Managing Director of the
Company. He holds a degree in business studies from the Nanyang University of
Singapore and a master degree in business administration from East Asia
University of Macau. He has in excess of 10 years of commercial experience in
international trade, particularly in food products. In 1989 he established the
Megaway Group whose business activities include food, shipping and financing
services. In the same year, he established Hua Tuo Guan in Singapore to offer
franchise services in Chinese medical and health food. Since 1990, Mr. Ho has
been involved in China Trade and has been involved in takeovers and
restructuring of a number of Chinese enterprises.
Mr. Jia Ji Shang is the Vice -Chairman and a Director of the Company. He
holds a degree in engineering from the Central Broadcast Television University
of the People's Republic of China. He has in excess of 16 years of commercial
experience and is closely associated with the high ranking officials in the
People's Republic of China.
Mr. Ji Jun Wu, is a Director of the Company and is the President of China
operation of the Megaway Group. He has in excess of 40 years of commercial
experience. Since the establishing of the open economy by the PRC in 1980 he has
been instrumental in the establishment of more than ten foreign investments and
joint ventures in the PRC, including such international companies as Motorola,
NEC, IBM, AT&T, Samsung and Yamaha. In addition, he has served as an official
Chinese representative. Because of his work and achievements, he was honored by
the City of Houston, Texas, USA as an honorable citizen.
Mr. Kim Yong SOH is a non executive director of the Company. He holds an
honors degree in system and engineering from Nanyang University of Singapore and
a master degree in system and engineering from the University of Singapore. He
has in excess of ten years of commercial experience, working with international
companies such as Siemens, SGS Thomson, Deltron Automatics Systems and Texas
Instruments National Semiconductors. In 1992 he established Right Holdings
Limited in Singapore, a company engaged in property development, building
construction, tourism, electronic components and general investments.
Tan Sri (Dr.) M. Ghazali SHAFIE is a former minister in the government of
Malaysia. He is the Senior Advisor of the Company. He was the Chairman of
Rolls-Royce Southeast Asia Advisory Board from 1987-1990, a consultant to the
World Bank Economic Development Institute (EDI), and the Chairman of
Commonwealth Obaerver Group for Bangladesh Parliamentary Elections. At present,
he is a Senior Consultant to the United Nations Centre on Transnational
Cooperation (UNCTC).
Dr. Li Yan, graduated from Massachusetts Institute of Technology, with a
degree in Biochemistry and is the Technical Director of the Company. She is
responsible for research and development of technologies in agricultural
genetics. She has in excess of 10 years of experience in the research and
development of agricultural genetics and has received honors for outstanding
achievements for her research works.
Mr. Chan Kwai Chiu is a director of the Company. Mr. Chan has in excess of
16 years experience in the plastic products industry, including 10 years
experience in the design, installation and management of plastic related
production lines. His high level relationships with government planning agencies
commissioned for free enterprise projects in China at the provincial level, and
with the authorities of the "city" level planning agencies, have contributed
significantly to the business of the Company.
17
Mr. Eric Ng joined the Company in 1992 as Chief Financial Officer and
Secretary of the Company and is responsible for the financial strategy of the
Company. Prior to joining the Company he was a manager at KPMG Peat Marwick Hong
Kong, a member of the Chartered Association of Certified Accountants and a
manager of Dynamic Holdings Limited (a listed company in Hong Kong). During his
tenure at KPMG Peat Marwick, he was responsible for numerous merger and
acquisitions of listed companies in Hong Kong. He has in excess of 10 years
experience in auditing, finance and administration.
Mr. Ian Macdonald is a Technical Adviser to the Company. He is a recognized
international authority on goat, deer and sheep reproduction with in excess of
15 years of experience in the Advanced Animal Breeding and Genetics fields.
Through his company in New Zealand, he is engaged in custom semen and embryo
collection services to augment client merchandising abilities both domestically
and internationally. In the early 1980's, when goat semen and embryo collection
technology was in its infancy, Ian Macdonald was in charge of training in excess
of 300 Artificial Insemination technicians specifically for goat reproduction.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth as of September 20, 1999 the number of
shares of the Company's Common Stock known to be held by the Executive Officers
and Directors, individually, and as a group, and by beneficial owners more than
five percent of the Company Common Stock.
Amount and Nature of
Beneficial Ownership
Name and Address (1) of Beneficial Owner Shares Percentage of Class
- ---------------------------------------- ----------------------- --------------------
Chan Kwai Chiu 9,100,000 13.18%
Charter Score Development Limited 1,000,000 1.45%
Land Cheer Investment Limited 2,600,000 3.77%
Allington International Inc. 18,190,000 26.36%
All officers and directors as a group (one) 30,890,000 44.76%
(1) Address for all persons and entities is 1801-1806 Hua Qin International
Building, 340 Queen Road Central, Hong Kong.
ITEM.13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company amounts due from/(to) directors and related companies owned
and/or controlled by a director, Chan Kwai Chiu, are unsecured, interest-free
and are repayable on demand.
In the normal course of business, some of the companies are engaged in the
"set-up" of automatic production lines on a turn-key basis for its joint
ventures. In addition, the companies also arrange for the sale of raw materials
to these joint ventures. Amounts of revenues from the sales of raw materials to
these joint ventures are summarized as follows:
18
Year Ended Year Ended
March 31, April 1, 1997 to December 31,
1997 December 31,1997 1998
Sales to joint ventures:
Raw materials US$2,548,484 US$1,594,473 US$1,542,354
The unrealized profits arising from these transactions were eliminated in the
consolidated financial statements to the extent of the Company interest in these
joint ventures.
During the year ended March 31, 1997, HK$17,935,678 of trade accounts
payable were paid directly by directors on behalf of the Company and
HK$21,625,232 of trade accounts receivable were received directly by directors.
The net activity of these transactions was posted to the amounts due to
directors in the accompanying consolidated balance sheets.
On April 2, 1997, the Group acquired a 30% interest in Megaway Development
Limited. The principal asset of Megaway Development Limited is a 60% interest in
Weifang Great Dragon Chemical Fibre Company Limited whose principal activity is
the manufacture of polyester tyre cord fabrics, and polyester/nylon canvas.
Megaway Development Limited was acquired in exchange for a trade receivable from
CFFTC in the amount of HK$65,031,120 (US$8,415,000).
On December 23, 1997, Sun's International Holdings Limited acquired a 56.5%
interest in Wealthy Asia Limited (WAL) for US$52,000,000 (HK$403,364,486) in
cash from Mr. Brian Ko. WAL had simultaneously acquired 100% of Megaway
Agriculture Co. Ltd. (Megaway) from Mr. Harry Ho for US$92,000,000
(HK$713,644,828) in cash of US$9,200,000 at closing, with the remainder in the
form of a verbal receivable which was subsequently settled through payment of
US$ 72,900,000 in cash on December 31, 1997 and receipt of 9,900,000 newly
issued shares of China Continental, Inc. common stock on March 18, 1998.
On February 10, 1998 Sun's International acquired the remaining 43.5%
interest in WAL from Mr. Brian Ko via the issuance of an additional 40,000,000
shares of stock in China Continental, Inc. of which 9,900,000 shares were issued
directly to Megaway Resort Development Limited, a company owned by Mr. Harry Ho.
The principal asset of Megaway is a 51% interest in Changde Dafeng
Agriculture and Animal Husbandry Ltd. (Changde), a Sino-Singapore joint venture
incorporated in the People's Republic of China on December 3, 1997. Mr. Ho,
through his prior ownership of Megaway, was an original party to the joint
venture, with the remaining 49% interest being held by entities associated with
the Chinese government. Changde has been established to run a breeding center to
propagate Boer goats and other livestock breeds. Changde's principal asset is
20,000 hectares or 49,400 acres of grassland located approximately 250
kilometers north of Beijing, in the People's Republic of China. Based upon an
independent appraisal dated July 30, 1998 by American Appraisal Hong Kong
Limited, the value of 100% of Changde is US$181,000,000 (HK$1,402,750,000) as of
December 31, 1997, resulting in a minority interest of the Company of
HK$685,039,110 as of December 31, 1997.
ITEM 14. YEAR 2000 ISSUE
Many computers were not designed to handle any dates beyond the year 1999
and, therefore, computer hardware and software will need be modified prior to
the year 2000 in order to remain functional; this is the so called "Year 2000"
problem. The Company does not believe it has material exposure with respect to
Year 2000 issues. The Company currently utilizes commercially produced hardware
and software packages that were purchased to be Year 2000 complaint. The Company
does not rely on any one supplier or vendor for its goods and services, so the
failure of any supplier or vendor with the Year 2000 problems to convert its
systems on a timely basis should not have a material effect on the Company's
business, financial condition and result of operations. Software and hardware ,
such as telecommunication and office automation systems, that facilitates
operations of the Company's location and corporate headquarters comprise the
Company's primary non-IT systems and were likewise purchased or upgraded to be
Year 2000 complaint.
19
Additionally, the Company is currently communicating with its significant
customers to determine the extent to which the Company may be vulnerable to
their failure to remedy their own Year 2000 issues. The Company anticipates that
it will complete this investigation by October 1999, at which time it will
assess and need to formulate any necessary contingency plans to deal with Year
2000 issues to customers, if any. Although the Company's IT and non-IT systems
were represented as being Year 2000 complaint when purchased or upgraded, there
can be no guarantee that the Company, its customers or other third party
business associates will not experience Year 2000 compliance difficulties which
could have a material adverse effect on the Company's business, results of
operation and financial condition.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 27.1 Financial Data Schedule.
(b) Report on Form 8-K
None
20
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CHINA CONTINENTAL, INC.
By: /s/ Harry H.H.Ho
-------------------------------------
Harry H.H. Ho
Chairman of the Board and Chief Executive Officer
Dated: September 30, 1999
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.
Signatures Titles Date
- ---------- ------------- ---------
/s/ Harry H.H. Ho
- -------------------
Harry H.H. Ho Chairman of the Board and Chief
Executive Officer September 30, 1999
/s/s Jia Ji Shang
- --------------------
Jia Ji Shang Vice- Chairman and Director September 30, 1999
/s/ Ji Jun Wu
- --------------------
Ji Jun Wu Director September 30, 1999
/s/ Kim Yong Soh
- --------------------
Kim Yong Soh Director September 30, 1999
/s/ Dr. Li Yan
- --------------------
Dr. Li Yan Technical Director September 30, 1999
/s/ Chan Kwai Chiu
- --------------------
Chan Kwai Chiu Director September 30, 1999
/s/ Eric Ng
- --------------------
Eric Ng Secretary/Treasurer/
Chief Financial Officer and Director September 30, 1999
CHINA CONTINENTAL, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Pages
-------
Report of independent auditors F-2
Consolidated statements of income F-3
Consolidated statements of changes in stockholders' equity F-4
Consolidated balance sheets F-5
Consolidated statements of cash flows F-7 to F-8
Notes to consolidated financial statements F-9 to F-28
F-1
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and the Stockholders
China Continental, Inc.
We have audited the accompanying consolidated balance sheets of China
Continental, Inc. (the "Company") and subsidiaries (collectively the "Group") as
of December 31, 1997 and December 31, 1998, and the related consolidated
statements of income, changes in stockholders' equity and cash flows for the
year ended March 31, 1997, nine months ended December 31, 1997 and year ended
December 31, 1998. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards
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 consolidated financial statements referred to above, present
fairly, in all material respects, the consolidated financial position of China
Continental, Inc. and subsidiaries as of December 31, 1997 and December 31,
1998, and the consolidated results of their operations and their cash flows for
the year ended March 31, 1997, nine months ended December 31, 1997 and year
ended December 31, 1998, in conformity with generally accepted accounting
principles in the United States of America.
As described in Note 11, the Company entered into certain transactions during
1997-1999, ultimately with its current chairman and chief executive officer.
These transactions have significantly impacted the Company's business plan,
liquid assets and common stockholder ownership interests. Appropriate
disclosures have been made and our opinion is not qualified in this respect.
Chicago, Illinois
September 24, 1999
F-2
CHINA CONTINENTAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
For the year ended March 31, 1997, the nine
months ended December 31, 1997 and the
year ended December 31, 1998
Nine months
Year ended ended
March 31, December 31, Year ended December 31,
1997 1997 1998 1998
Notes HK$ HK$ HK$ US$
SALES
Related parties 18 19,699,783 12,357,168 11,953,242 1,542,354
Others 248,984,457 147,762,121 273,154,057 35,245,685
--------------- -------------- ---------------- ----------------
268,684,240 160,119,289 285,107,299 36,788,039
COST OF SALES (110,460,697) (64,600,231) (110,702,213) (14,284,157)
------------------ -------------- ---------------- -----------------
GROSS PROFIT 158,223,543 95,519,058 174,405,086 22,503,882
DEPRECIATION AND AMORTIZATION (620,313) (442,894) (34,296,686) (4,425,379)
SELLING AND ADMINISTRATIVE
EXPENSES (7,413,213) (3,958,938) (18,558,469) (2,394,641)
(PROVISION FOR) RECOVERY OF
DOUBTFUL DEBTS 2,238,844 - (5,280,608) (681,369)
FINANCIAL INCOME/(EXPENSES),
NET 4 (425,759) (442,851) (1,275,217) (164,544)
OTHER INCOME/(EXPENSES), NET 5 (4,597,305) 22,625,018 2,789,505 359,936
SHARE OF GAINS OF
ASSOCIATED COMPANIES 10 - 1,113,459 795,995 102,709
---------------- --------------- --------------- --------------
INCOME BEFORE INCOME TAXES 147,405,797 114,412,852 118,579,606 15,300,594
INCOME TAXES 6 (20,372,118) (10,000,694) (22,399,318) (2,890,235)
---------------- ---------------- ---------------- --------------
INCOME BEFORE MINORITY INTEREST 127,033,679 104,412,158 96,180,288 12,410,359
LOSS ALLOCATED TO
MINORITY INTEREST - - 16,388,692 2,114,671
---------------- ---------------- ---------------- --------------
NET INCOME 127,033,679 104,412,158 112,568,980 14,525,030
EARNINGS PER SHARE 3(j), 11 4.89 4.02 1.80 0.23
The accompanying notes are an integral part of these consolidated
financial statements.
F-3
CHINA CONTINENTAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the year ended March 31, 1997,
the nine months ended December 31, 1997
and the year ended December 31, 1998
Additional
Share paid-in Retained
capital capital earnings Total
Notes HK$ HK$ HK$ HK$
Balance at April 1, 1996 202,800 13,356,985 304,002,387 317,562,172
Net income - - 127,033,679 127,033,679
-------------- -------------- --------------- ----------------
Balance at March 31, 1997 202,800 13,356,985 431,036,066 444,595,851
Net income - - 104,412,158 104,412,158
-------------- -------------- --------------- ----------------
Balance at December 31, 1997 202,800 13,356,985 535,448,224 549,008,009
Issuance of 40,000,000 shares
on February 10, 1998 at
US$1.00 per share 11 309,200 309,326,204 - 309,635,404
Issuance of 1,400,000 shares
on August 12, 1998 at
US$.50 per share 21 10,822 5,400,178 - 5,411,000
Issuance of 1,600,000 shares
on September 30, 1998 at
US$.42 per share 21 12,368 5,250,737 - 5,263,105
Assumption of liabilities
on December 31, 1998 and
contribution to capital 21 - 17,534,193 - 17,534,193
Net income - - 112,568,980 112,568,980
-------------- --------------- --------------- ---------------
Balance at December 31, 1998 535,190 350,868,297 648,017,204 999,420,691
============== =============== =============== ===============
The accompanying notes are an integral part of these consolidated
financial statements.
F-4
CHINA CONTINENTAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1997 and December 31, 1998
December31, December 31,
1997 1998 1998
Notes HK$ HK$ US$
ASSETS
CURRENT ASSETS
Cash and bank balances 138,010,916 276,424,018 35,667,615
Trade receivables, net of provisions of
HK $8,602,321 and HK$0 at
December 31, 1997 and 1998,
respectively 7, 17 36,420,762 72,002,050 9,290,587
Prepayments, deposits and other
receivables, net of provisions of
HK$4,898,213 and HK$0 at
December 31, 1997 and 1998,
respectively 8 5,018,294 4,747,901 612,632
Amounts due from related companies 18 34,111,911 33,445,247 4,315,516
--------------- --------------- -------------
TOTAL CURRENT ASSETS 213,561,883 386,619,216 49,886,350
FIXED ASSETS 9 3,486,981 3,155,880 407,210
INTERESTS IN ASSOCIATED
COMPANIES 10 69,053,638 66,618,081 8,595,882
LAND LEASE RIGHTS, net of
accumulated amortization of
HK$0 and HK$33,962,849 at
December 31, 1997 and 1998,
respectively 11 1,358,514,000 1,324,551,151 170,909,826
AMOUNTS DUE FROM DIRECTORS 18 39,525,000 40,604,397 5,239,277
OTHER ASSETS 19 7,000,000 5,000,000 645,161
----------------- ----------------- ---------------
TOTAL ASSETS 1,691,141,502 1,826,548,725 235,683,706
============= ============= ===========
The accompanying notes are an integral part of these consolidated
financial statements.
F-5
CONSOLIDATED BALANCE SHEETS CONT'D
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Bank overdrafts 12 3,814,245 3,886,228 501,449
Bank import loans 12 10,478,535 3,588,515 463,034
Secured bank loan 12 9,984,864 119,171 15,377
Income taxes payable 73,707,403 96,487,847 12,450,045
Amounts due to directors 18 8,604,953 10,677,359 1,377,724
Amounts due to related parties 18 315,483,063 4,992,059 644,136
Accounts payable and accrued liabilities 35,021,320 28,950,400 3,735,535
--------------- --------------- -------------
TOTAL CURRENT LIABILITIES 457,094,383 148,701,579 19,187,300
LONG-TERM LIABILITIES
Secured bank loan 12 - 9,776,037 1,261,424
---------------- ---------------- --------------
TOTAL LIABILITIES 457,094,383 158,477,616 20,448,724
---------------- ---------------- --------------
MINORITY INTEREST 11 685,039,110 668,650,418 86,277,473
---------------- ---------------- --------------
STOCKHOLDERS' EQUITY
Common stock, par value US$0.001 per share:
Authorized:
1,000,000,000 shares;
Issued and outstanding:
26,000,000 and 69,000,000 shares
as of December 31, 1997 and 1998,
respectively 202,800 535,190 69,057
Additional paid-in capital 13,356,985 350,868,297 45,273,329
Retained earnings 535,448,224 648,017,204 83,615,123
--------------- --------------- ---------------
TOTAL STOCKHOLDERS'
EQUITY 549,008,009 999,420,691 128,957,509
----------------- ----------------- ---------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY 1,691,141,502 1,826,548,725 235,683,706
F-6
CHINA CONTINENTAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the year ended March 31, 1997, the nine months
ended December 31, 1997 and the year ended
December 31, 1998
Nine Months
Year ended ended Year ended
March 31, December 31, December 31,
1997 1997 1998 1998
HK$ HK$ HK$ US$
------------ ------------- ------------- ------------
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net income 127,033,679 104,412,158 112,568,980 14,525,030
Adjustments to reconcile net income to
net cash provided by operating
activities:
Gains on disposal of fixed assets (163,204) (350,800) - -
Depreciation and amortization 620,313 442,894 34,296,686 4,425,379
Provision for doubtful debts and
diminution in values of
investments and associated companies 869,710 - 5,280,608 681,369
Share of gains of associated
companies - (1,113,459) (795,995) (102,709)
Gains on disposal of short-term
investments - (18,731,775) - -
Loss allocated to minority interest - - (16,388,692) (2,114,670)
Sock issued for public relation services - - 5,411,000 698,193
(Increase)/decrease in assets:
Trade receivables and long-term receivable (13,182,571) (674,702) (36,167,309) (4,666,750)
Prepayments and deposits (307,547) (1,635,998) (598,127) (77,178)
Amounts due from related companies (887,809) (6,143,407) (2,186,764) (282,163)
Amounts due from associated companies (702,335) (616,905) 262,249 33,839
Amounts due from directors - - (2,102,195) (271,251)
(Decrease)/increase in liabilities:
Amounts due to directors 9,988,570 2,562,096 8,712,447 1,124,187
Amounts due to related parties 199,772 - (724,021) (93,422)
Accounts payable and accrued liabilities 13,690,462 (2,621,277) 14,974,220 1,932,157
Income taxes payable 18,455,771 9,428,109 22,780,444 2,939,412
--------------- -------------- --------------- --------------
Net cash provided by
operating activities 155,614,811 84,956,934 145,323,531 18,751,423
--------------- -------------- --------------- --------------
The accompanying notes are an integral part of these consolidated
financial statements.
F-7
CHINA CONTINENTAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
For the year ended March 31, 1997, the nine months
ended December 31, 1997 and the year ended December 31, 1998
Nine months
Year ended ended Year ended
March 31, December 31, December 31,
1997 1997 1998 1998
HK$ HK$ HK$ US$
CASH FLOWS FROM
INVESTING ACTIVITIES
Purchase of land lease rights - (403,364,486) - -
Purchase of fixed assets (15,080) (14,856) (2,736) (353)
Proceeds from disposal of fixed assets - 530,000 - -
Proceeds from disposal of short-term
investments - 286,331,775 - -
-------------- -------------- --------------- ----------------
Net cash used in
investing activities (15,080) (116,517,567) (2,736) (353)
-------------- -------------- --------------- ----------------
CASH FLOWS FROM
FINANCING ACTIVITIES
Net repayments under
bank import loans 2,389,290 2,415,365 (6,890,020) (889,035)
Net repayments of bank loans (1,478,799) - (89,656) (11,568)
Advances (repayments) of bank overdrafts (676,889) 3,814,245 71,983 9,288
--------------- -------------- --------------- -------------
Net cash provided by /(used in)
financing activities 233,602 6,229,610 (6,907,693) (891,315)
--------------- -------------- --------------- -------------
NET INCREASE/(DECREASE) IN
CASH AND BANK BALANCES 155,833,333 (25,331,023) 138,413,102 17,859,755
Cash and bank balances, at beginning
of period 7,508,606 163,341,939 138,010,916 17,807,860
--------------- --------------- --------------- -------------
Cash and bank balances, at end of period 163,341,939 138,010,916 276,424,018 35,667,615
=============== =============== =============== =============
SUPPLEMENTARY CASH FLOWS
DISCLOSURES:
Interest paid 469,392 488,704 1,275,217 164,544
=============== =============== =============== =============
Income taxes paid 2,079,551 572,585 256,629 33,113
=============== =============== =============== =============
The accompanying notes are an integral part of these consolidated
financial statements.
F-8
CHINA CONTINENTAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND PRINCIPAL ACTIVITIES
China Continental, Inc. (the "Company") was incorporated in the state of
Utah, in the United States of America, and its principal activity is a 100%
investment in Sun's International Holdings Limited (Sun's International), a
holding company for investments in operating companies. Sun's International
was incorporated under the laws of the British Virgin Islands.
Subsequent to March 31, 1997, the Company elected to change its fiscal
year-end to December 31.
The consolidated financial statements include the accounts of the Company
and Sun's International and its wholly owned subsidiaries, Billion Pearl
Investments Limited, High Glad Industries Limited (dormant), Prime Hill
Investment Limited (dormant), Prime View Industrial Limited (dormant),
Danbury Inc., Winkler Holdings Inc. (dormant), Cathay Mercantile (Overseas)
Limited (Disposed of in December, 1997; See Note 11), Gain Whole Limited
(Disposed of in August, 1997; See Note 11), Megaway Resort Development
Limited (Acquired and disposed of in August, 1997, and December, 1997,
respectively; See Note 11) and its majority owned subsidiary, Wealthy Asia
Limited (56.5% owned until February 10, 1998 at which time the remaining
43.5% was acquired, and which had no operating activity for 1997)
(hereinafter collectively together with the Company referred to as the
"Group").
Danbury Inc. is primarily engaged in the sale of automatic production lines
on a turn-key basis and related consulting fees to various customers in the
People's Republic of China (the "PRC"). This company, along with certain
dormant companies, has also made investments in PRC enterprises through the
formation of associated companies with various PRC parties. Billion Pearl
Investments Limited is primarily an importer and reseller of raw materials
to an associated company. Wealthy Asia Limited, through a wholly owned
subsidiary, owns 51% of a joint venture known as Chengde Dafeng Agriculture
and Animal Husbandry Co., Ltd., which has been established to run a
breeding center to propagate Boer goats and other livestock breeds. See
Note 11.
F-9
CHINA CONTINENTAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. BASIS OF PRESENTATION
The consolidated financial statements are prepared in accordance with
generally accepted accounting principles in the United States of America
("US GAAP"). This basis of accounting differs from that used in the
statutory financial statements of the subsidiaries in Hong Kong which are
prepared in accordance with the accounting principles generally accepted in
Hong Kong.
The following material adjustments were made to present the consolidated
financial statements to conform with US GAAP:
- reversal of the revaluation surplus, and the related depreciation,
arising from the revaluation of leasehold land and buildings.
3. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES
(a) Basis of consolidation
----------------------
The consolidated financial statements of the Company include the
accounts of the Company and its wholly and majority owned
subsidiaries. All material intercompany balances and transactions have
been eliminated on consolidation.
(b) Associated companies
--------------------
An associated company is a company, not being a subsidiary, over which
the Group is in a position to exercise significant influence.
The Group's share of the post-acquisition results of associated
companies is included in the consolidated statements of income under
the equity method of accounting. The Group's interests in associated
companies are stated in the consolidated balance sheets at cost plus
the Group's share of the associated companies' post- acquisition
results and capital transactions, less any provisions for other than
temporary diminutions in values.
F-10
CHINA CONTINENTAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (continued)
(c) Cash and cash equivalents
-------------------------
The Group considers cash and cash equivalents to include cash on hand
and demand deposits with banks with original term to maturity of three
months or less at the date of acquisition.
At December 31, 1997 and 1998, cash and cash equivalents included
foreign currency deposits equivalent to HK$135,755,488 (US$17,516,837)
and HK$275,138,120 (US$35,501,693), respectively.
(d) Fixed assets and depreciation
-----------------------------
Fixed assets are stated at cost less accumulated depreciation.
Depreciation of fixed assets is calculated on the straight-line basis
to write off the cost less estimated residual value of each asset over
its estimated useful life. The principal annual rates used for this
purpose are as follows:
Leasehold land and buildings 2.0%
Furniture and fixtures 20%
Office equipment 20%
Motor vehicles 20%
(e) Land lease rights and amortization
----------------------------------
Land lease rights in Mainland China are stated at cost less
accumulated amortization. Amortization of land lease rights is
calculated on the straight-line basis over the lesser of its estimated
useful life or the lease term. The principal annual rate used for this
purpose is 2.5%.
(f) Income taxes
------------
Income taxes are determined under the liability method as required by
Statement of Financial Accounting Standard No. 109, "Accounting for
Income Taxes".
(g) Foreign currency translation
-----------------------------
Foreign currency transactions denominated in foreign currencies are
translated into Hong Kong dollars ("HK$") at the respective applicable
rates of exchange. Monetary assets and liabilities denominated in
foreign currencies are translated into HK$ at the applicable rate of
exchange at the balance sheet date. The resulting exchange gains or
losses are credited or charged to the statements of income.
Translation of amounts from HK$ into United States dollars ("US$") for
the convenience of the reader has been made at the single rate of
exchange on December 31, 1998 of US$ 1.00 : HK$7.75. No representation
is made that the HK$ amounts could have been, or could be, converted
into US$ at that rate on December 31, 1998 or at any other date.
F-11
CHINA CONTINENTAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (continued)
The associated companies maintain their books and accounting records in
Renminbi (the "RMB"). For the purpose of accounting for the Group's
attributable interests in the net assets and results of the joint ventures,
the RMB financial statements of the associated companies were translated
into HK$ using the current rate method whereby all assets and liabilities
are translated into HK$ at the applicable rate of exchange prevailing at
the balance sheet date as quoted by the People's Bank of China. Income and
expense items were translated at the average rates as quoted by the
People's Bank of China.
(h) Revenue recognition
-------------------
Revenue from the sale of machinery and equipment and raw materials is
recognized when the merchandise is delivered to the customer.
Revenue from the sale of the production line on a turn-key basis,
which is normally completed within a period of eight to twelve months,
is recognized in full in the year when the installation of the
production line is completed. The installation of a production line is
considered complete when all the significant costs have been incurred
and all the machinery and equipment for the production line have been
delivered and installed.
Revenue for design, training and consultancy services is recognized
when the service is rendered.
(i) Retirement benefits
-------------------
The Group participates in a defined contribution retirement plan
administered by an insurance company (the "Retirement Plan"). All
staff (except for PRC staff and directors of the Company) covered
under the Retirement Plan are entitled to a monthly pension, borne by
the insurance company, upon their retirement equal to a fixed
proportion of their ending salary amount as at their retirement. The
Group is required to make contributions to the Retirement Plan at a
rate of 5% of the salaries of its existing staff, and is not
responsible for any payments beyond the contributions to the
Retirement Plan as noted above. The retirement benefit contributions
are charged to the statements of income as services are provided.
Contributions made to the Retirement Plan during the year ended March
31, 1997, the nine months ended December 31, 1997 and the year ended
December 31, 1998, were HK$32,375, HK$47,504 and HK$57,546
respectively.
(j) Earnings per share
------------------
Effective December 31, 1997, the Company adopted Statement of
Financial Accounting Standard ("SFAS") No. 128, "Earnings Per Share",
which requires the Company to change the method used to compute
earnings per share ("EPS") and to restate all prior periods presented.
The presentation of primary and fully diluted EPS has been replaced
with basic and diluted EPS, respectively. Basic earnings per share is
computed using the weighted average number of common shares
outstanding during the period. The computation of diluted earnings per
share would include the dilutive effect of securities that could be
exercised or converted into common stock. The Company has not entered
into any transactions that would have a dilutive effect upon EPS.
The weighted average number of shares outstanding during the year
ended March 31, 1997, the nine months ended December 31, 1997 and the
year ended December 31, 1998 was 26,000,000, 26,000,000 and
62,568,767, respectively.
F-12
CHINA CONTINENTAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES (continued)
(k) Segment reporting
-----------------
In December 1998, the Company adopted SFAS No. 131, "Disclosures About
Segments of an Enterprise and Related Information". The adoption of
this standard requires that reportable segments are reported
consistent with how management assesses segment performance. This
statement requires disclosure of certain information by reportable
segment, geographic area and major customer. See Note 20, "Segment
Information," for further information. As a result, the Company will
separately report information on the following three operating
segments : automatic production lines on a turn-key basis, raw
material importer and reseller and breeding center operations. In
determining the operating income of each segment, certain general and
corporate expenses are not allocated to operating segments.
(l) Use of estimates
---------------
The preparation of consolidated financial statements in conformity
with US GAAP requires management to make estimates and assumptions
that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from
those estimates.
(m) Reclassification
----------------
Certain balances in the prior years have been reclassified to conform
to the presentation used in the current year.
F-13
CHINA CONTINENTAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. FINANCIAL INCOME/(EXPENSES), NET
Nine months
Year ended ended Year ended
March 31, December 31, December 31,
1997 1997 1998
HK$ HK$ HK$
Interest income 149,011 114,219 157,629
Interest expense (469,392) (488,704) (1,359,620)
Bank charges (105,378) (68,366) (73,226)
----------- ----------- -------------
(425,759) (442,851) (1,275,217)
=========== =========== =============
5. OTHER INCOME/(EXPENSES), NET
Nine months
Year ended ended Year ended
March 31, December 31, December 31,
1997 1997 1998
HK$ HK$ HK$
Commission and miscellaneous income 369,836 3,736,733 3,615,700
Foreign exchange gains/(losses), net 446,139 (194,290) (826,195)
Associated companies written off (4,236,040) - -
Short-term investments written off (1,177,240) - -
Gains on disposal of short-term investments
Cathay (Note 11) - 10,434,579 -
Gain/Megaway (Note 11) - 7,688,000 -
Other - 609,196 -
Gains on disposal of fixed assets - 350,800 -
------------- ------------- ------------
(4,597,305) 22,625,018 2,789,505
============= ============= ============
F-14
CHINA CONTINENTAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. INCOME TAXES
The companies in the Group operate in several jurisdictions and are subject
to taxes in those jurisdictions. Details of the related provision for
income taxes are as follows:
Nine months
Year ended ended Year ended
March 31, December 31, December 31,
1997 1997 1998
HK$ HK$ HK$
Income/(loss) before income taxes:
Hong Kong 507,446 177,843 (6,332,226)
PRC 146,898,351 114,235,009 124,911,832
--------------- --------------- ---------------
147,405,797 114,412,852 118,579,606
Income tax provision:
Current:
Hong Kong (169,634) (2,157,306) 102,270
PRC 20,704,956 12,158,000 22,297,048
------------- ------------- -------------
20,535,322 10,000,694 22,399,318
Deferred (163,204) - -
------------- ------------- -------------
20,372,118 10,000,694 22,399,318
============= ============= =============
It is management's intention to reinvest all the income attributable to the
Company earned by its operations outside the United States. Accordingly, no
United States corporate income taxes have been provided in these financial
statements.
Under the current law of the British Virgin Islands, any dividends the
Group will distribute in the future, and capital gains arising from the
Group's investments are not subject to income tax in the British Virgin
Islands.
Those companies carrying on business in Hong Kong are subject to Hong Kong
profits tax on their income arising in or derived from Hong Kong after
adjusting for income and expense items which are not assessable or
deductible for profits tax purposes. As such, current income taxes are
calculated at a statutory tax rate of 16.5% on their estimated taxable
income for the year.
Companies with operations in the PRC are also subject to PRC income tax for
income on services rendered therein. The applicable effective tax rate for
income derived from services rendered in that jurisdiction is approximately
8.5%.
At December 31, 1997 and December 31, 1998, income tax payables included
foreign currency payables equivalent to HK$73,483,206 (US$9,481,704) and
HK$96,487,847 (US$12,450,045), respectively.
F-15
CHINA CONTINENTAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. INCOME TAXES (continued)
A reconciliation between the actual income tax expense and income taxes
computed by applying the statutory Hong Kong tax rates to the income before
income taxes is as follows:
Nine months
Year ended ended Year ended
March 31, December 31, December 31,
1997 1997 1998
HK$ HK$ HK$
Statutory Hong Kong tax rates
16.5% 16.5% 16.5%
Computed expected tax expense 24,321,957 18,878,121 19,565,635
(Decrease) increase resulting from PRC tax
at a different composite tax rate (4,587,807) (7,699,316) 944,644
Adjustments for expense items which are not
deductible for profits tax purposes:
Share of (gain) loss in and provisions for diminutions
in values of associated companies 326,135 (94,644) (63,680)
Other provisions - 2,154,306 1,952,719
Disposal of short-term investments - (3,090,743) -
Others 311,833 (147,030) -
------------- ------------- -------------
20,372,118 10,000,694 22,399,318
============= ============= =============
F-16
CHINA CONTINENTAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. INCOME TAXES (continued)
Undistributed earnings of the Company's non-U.S. subsidiaries amounted to
approximately HK$632,000,000 at December 31, 1998. Because those earnings
are considered to be indefinitely invested, no provision for United States
corporate income taxes on those earnings has been provided. Upon
distribution of those earnings in the form of dividends or otherwise, the
Company would be subject to United States corporate income taxes.
Unrecognized deferred United States corporate income tax in respect of
these undistributed earnings at December 31, 1998 was approximately
HK$215,000,000.
7. TRADE RECEIVABLES, NET
As of December 31, As of December 31,
1997 1998
HK$ HK$
Trade receivables 45,023,083 72,002,050
Less: Provision for doubtful debts (8,602,321) -
------------- -------------
Trade receivables, net 36,420,762 72,002,050
============ ==============
Movements in provision for doubtful debts:
Balance at beginning of year 8,602,321 8,602,321
Write-off against specifically reserved receivables* - (8,602,321)
------------ -------------
Balance at December 31 8,602,321 -
============ =============
* In 1998, management determined that it should expend no further effort in
the collection of certain fully reserved receivables. It has therefore
written off the allowance against these receivables.
8. PREPAYMENTS, DEPOSITS AND OTHER RECEIVABLES, NET
As of December 31, As of December 31,
1997 1998
HK$ HK$
Prepayments, deposits and other receivables 9,916,507 4,747,901
Less: Provision for doubtful debts (4,898,213) -
------------ ------------
Prepayments, deposits and other receivables, net 5,018,294 4,747,901
Movements in provision for doubtful debts:
Balance at beginning of year 4,898,213 4,898,213
Write-off against specifically reserved receivables* - (4,898,213)
------------ ------------
Balance at December 31 4,898,213 -
============ ============
* In 1998, management determined that it should expend no further effort in
the collection of certain fully reserved receivables. It has therefore
written off the allowance against these receivables.
F-17
CHINA CONTINENTAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. FIXED ASSETS
As of December 31, As of December 31,
1997 1998
HK$ HK$
Cost:
Leasehold land and buildings, located in Hong Kong (1) 4,239,231 4,239,231
Furniture and fixtures 700,826 700,826
Office equipment 600,749 603,484
Motor vehicles 1,244,030 1,244,030
------------ ------------
6,784,836 6,787,571
Less: accumulated depreciation (3,297,855) (3,631,691)
------------ ------------
Net book value 3,486,981 3,155,880
============ ============
(1) Pledged to the Company's banker to secure facilities (See Note 16).
10. INTERESTS IN ASSOCIATED COMPANIES
As of December 31, As of December 31,
1997 1998
HK$ HK$
Unlisted investments, at cost 73,145,120 73,145,120
Share of post-acquisition gains, net 1,113,459 1,909,454
Write off for diminutions in values (8,114,000) (8,114,000)
------------- -------------
66,144,579 66,940,574
Due from (to) associated companies, net 2,909,059 (322,493)
------------- -------------
69,053,638 66,618,081
============= =============
Movement in provisions for diminutions in values:
Balance at beginning of year 6,793,565 8,114,000
Provisions for diminutions in value 1,320,435 -
------------ ------------
Balance at December 31 8,114,000 8,114,000
============ ============
F-18
CHINA CONTINENTAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. INTERESTS IN ASSOCIATED COMPANIES (continued)
During the year ended March 31, 1997, the Company incurred additional
diminutions in value in the remaining interests in associated companies
which reduced the carrying value to zero. Therefore, no further share of
post-acquisition losses has been provided for during the nine months ended
December 31, 1997 or the year ended December 31, 1998. The Group's share of
the post-acquisition gains of associated companies was HK$1,113,459 and
HK$795,995 for the nine months ended December 31, 1997 and the year ended
December 31, 1998, respectively. The amounts due from associated companies
are deemed to be collectible as of December 31, 1998.
Details of the associated companies at December 31, 1998 were as follows:
Country of
registration Group's
and effective
Name operations holding Principal activities
%
Panyu Panyi Chemical Industry PRC 30 Manufacturing and sale
& Commerce Co., Ltd. of PU resin
Shan Dong Linyi Modern PRC 35 Manufacturing and sale
Decorating Materials Co., Ltd. of PVC floor tiles
Zhengzhou ZZZ Prime Hill PRC 20 Manufacturing and sale
Floppy Disk Co., Ltd. of computer floppy disks
Megaway Development
Limited (Acquired in April, 1997; Western Holding company for company
See Note 11) Samoa 30 manufacturing polyester products
11. ACQUISITIONS AND DISPOSITIONS
Pursuant to a sales and purchase agreement dated December 20, 1996, Sun's
International, a wholly owned subsidiary of the Group, acquired from a
third party a 100% equity interest in Cathay Mercantile (Overseas) Limited
("Cathay") for a consideration of HK$130 million. There was no cash
movement involved in this transaction. Cathay was purchased by netting off
the other receivable, long-term receivable, amount due from a director and
amount due from a related company of HK$56,572,640, HK$68,333,334,
HK$4,280,000 and HK$814,026, respectively.
Cathay's principal activity was investment holding and Cathay, through its
65.055%-owned Hong Kong incorporated subsidiary, Fast Pulse Investment
Limited, held a 70% interest in a Sino-foreign cooperative joint venture
engaging in property development in Beijing, the PRC.
Based on a review of the fair value of the interest in Cathay, primarily
based on a valuation report on the land, the title of which was transferred
to the joint venture, performed by an independent professional valuer, a
provision in the amount of HK$17,000,000 was made to reduce the carrying
value of the other receivable to its estimated fair value of HK$113,000,000
as of March 31, 1996. As of March 31, 1997, the estimated fair value of the
interest in the property of HK$113,000,000 was reclassified to short-term
investments in the accompanying consolidated balance sheet. On December 23,
1997, Sun's International sold the 100% interest in Cathay for a
consideration of approximately HK$123,435,000.
F-19
CHINA CONTINENTAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. ACQUISITIONS AND DISPOSITIONS (continued)
On April 2, 1997, the Group acquired a 30% interest in Megaway Development
Limited, a company owned by Mr. Harry Ho. Mr. Ho has become the chairman
and chief executive officer of the Company. The principal asset of Megaway
Development Limited is a 60% interest in Weifang Great Dragon Chemical
Fibre Company Limited whose principal activity is the manufacture of
polyester tyre cord fabrics, and polyester/nylon canvas. Megaway
Development Limited was acquired in exchange for a trade receivable from
China (Fujian) Foreign Trade Centre Holdings Company ("CFFTC") in the
amount of HK$65,031,120.
On June 21, 1996, Sun's International obtained a 100% interest in Gain
Whole Limited for a consideration of US$20,000,000 (HK$154,600,000) as a
partial settlement for the same amount of the debt due from CFFTC, a major
customer of the Group. The principal asset of Gain Whole Limited was a
certificate of deposit for an amount of US$20,000,000 (HK$154,600,000) with
an authorized financial institution in the PRC. The certificate of deposit
was valued at cost, which approximated market and was classified as a
short-term investment in the accompanying consolidated balance sheet as of
March 31, 1997.
On August 28, 1997, Sun's International sold its 100% interest in Gain
Whole Limited for a consideration of a 100% interest in Megaway Resort
Development Limited, a company owned by Mr. Harry Ho and incorporated in
the British Virgin Islands. The principal asset of Megaway Resort
Development Limited is a 75% interest in Da Yu Edible Oil Co. Ltd., a Sino
Singapore joint venture incorporated in the PRC. On December 3, 1997, the
Group sold the 100% interest in Megaway Resort Development Limited for a
consideration of US$21,000,000 (HK$162,288,000).
On December 23, 1997, Sun's International acquired a 56.5% interest in
Wealthy Asia Limited (WAL) for US$52,000,000 (HK$403,364,486) in cash from
Mr. Brian Ko. WAL had simultaneously acquired 100% of Megaway Agriculture
Co. Ltd. (Megaway) from Mr. Harry Ho for US$92,000,000 (HK$713,644,828),
with a cash payment of US$72,800,000 which was settled on December 31, 1997
and a verbal agreement to remit the remainder at some future date. The
remainder was settled on March 18, 1998 through the receipt of 9,900,000
newly issued shares of China Continental, Inc. common stock.
The following amounts represent the initial recording of this transaction:
Asset (Liability) HK$
Land lease rights 1,358,514,000
Due from Harry Ho 39,525,000
Due to Brian Ko (309,635,404)
Minority Interest (685,039,110)
----------------
Cash Paid 403,364,486
On February 10, 1998, Sun's International acquired the remaining 43.5%
interest in WAL from Mr. Brian Ko via the issuance of an additional
40,000,000 shares of stock in China Continental, Inc. of which 9,900,000
shares were issued directly to Megaway Resort Development Ltd., a company
owned by Mr. Harry Ho and incorporated in Western Samoa.
F-20
CHINA CONTINENTAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. ACQUISITIONS AND DISPOSITIONS (continued)
The principal asset of Megaway is a 51% interest in Chengde Dafeng
Agriculture and Animal Husbandry Co., Ltd. (Chengde), a Sino-Singapore
joint venture incorporated in the PRC on December 3, 1997. Mr. Ho, through
his prior ownership of Megaway, was an original party to the joint venture,
with the remaining 49% interest being held by entities associated with the
Chinese government. Chengde has been established to run a breeding center
to propagate Boer goats and other livestock breeds. Chengde's principal
asset is 20,000 hectares or 49,400 acres of grassland located approximately
250 kilometers north of Beijing, in the PRC. Based upon an independent
appraisal dated July 30, 1998 by American Appraisal Hongkong Limited, the
value of 100% of Chengde is US$181,000,000 (HK$1,402,750,000) as of
December 31, 1997.
Had the 40,000,000 shares of common stock been outstanding throughout the
periods presented, earnings per share would have been HK$1.92 and HK$1.58
for the year ended March 31, 1997 and the nine months ended December 31,
1997, respectively.
12. BANK LOANS
The import loans with banks carry interest at 1% above the Hong Kong prime
lending rate (weighted average of 8.9% and 10.9% per annum as of December
31, 1997 and December 31, 1998, respectively). The import loans are usually
repaid in three to six months, which is in accordance with the terms of the
agreement.
The bank overdrafts carry interest at 3% above the Hong Kong prime lending
rate (weighted average of 11.9% and 12.9% per annum as of December 31, 1997
and December 31, 1998, respectively).
During October 1997, the Company borrowed and in turn loaned HK$9,984,864
to a company owned by a director, Mr. Chan Kwai Chiu, in conjunction with
his purchase of a personal residence. The mortgage loan is secured by the
residence and other properties owned by Mr. Chan Kwai Chiu with a cost of
HK$17,800,000. The balance remaining as of December 31, 1998 is
HK$9,895,208 and is payable as follows:
HK$
------------
1999 119,171
2000 131,081
2001 143,734
2002 157,607
2003 172,820
2004 189,502
Remaining years 8,981,293
------------
9,895,208
Less current portion (119,171)
------------
9,776,037
F-21
CHINA CONTINENTAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. CONCENTRATION OF CREDIT RISKS
Financial instruments which potentially subject the Group to a
concentration of credit risk principally consist of cash deposits, trade
receivables, long-term receivable and the amounts due from and to directors
and related companies.
(i) Cash deposits
The Group places its cash deposits with an international bank. See
Note 17.
(ii) Trade receivables
As of December 31, 1997 and 1998, approximately 18% and 0%,
respectively, of the trade receivable balance was due from China
(Fujian) Foreign Trade Centre Holdings Company, a Chinese Government
controlled company.
(iii) Amounts due from related companies (See Note 18)
At December 31, 1997, approximately 34%, 24% and 21% of the amounts
due from related companies were due from New Skyland Industrial Ltd.,
Billion Pearl International Limited and New Skyland International
Ltd., respectively.
At December 31, 1998, approximately 24%, 18% and 46% of the amounts
due from related companies were due from New Skyland Industrial Ltd.,
Billion Pearl International Limited and New Skyland International
Ltd., respectively.
The Group does not have the policy of requiring collateral.
(iv) Amounts due from and to directors (See Notes 11 and 18)
14. FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of financial instruments are set out as follows:
(i) Cash deposits
The cash deposits are stated at cost which approximates market value.
(ii) Trade receivables, other receivables and amounts due from directors
and related companies
Trade receivables, other receivables and the amounts due from related
companies and directors are stated at their book value less provision
for doubtful debts, which approximates the fair value.
(iii) Bank import loans
The carrying amount of short-term bank loans approximates the fair
value because of the short maturity of these instruments.
(iv) Accounts payable and amounts due to related companies and directors
are stated at their book value which approximates their fair value.
F-22
CHINA CONTINENTAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. CURRENT VULNERABILITY DUE TO CERTAIN CONCENTRATIONS
The Group's operations are conducted in Hong Kong and the PRC. Accordingly,
the Group's business, financial condition and results of operations may be
influenced by the political, economic and legal environments in Hong Kong
and the PRC, and by the general state of the Hong Kong and the PRC
economies.
Effective July 1, 1997, sovereignty over Hong Kong was transferred from the
United Kingdom to the PRC, and Hong Kong became a Special Administrative
Region of the PRC (a "SAR"). As provided in the Basic Law of the Hong Kong
SAR of the PRC, the Hong Kong SAR will have full economic autonomy and its
own legislative, legal and judicial systems for 50 years. The Group's
management does not believe that the transfer of sovereignty over Hong Kong
has had an adverse impact on the Company's financial and operating
environment. There can be no assurance, however, that changes in political
or other conditions will not result in such an adverse impact.
The Group's operations in the PRC are subject to special considerations and
significant risks not typically associated with companies in North America
and Western Europe. These include risks associated with, among others, the
political, economic and legal environments and foreign currency exchange.
The Group's results may be adversely affected by changes in the political
and social conditions in the PRC, and by changes in governmental policies
with respect to laws and regulations, anti-inflationary measures, currency
conversion and remittance abroad, and rates and methods of taxation, among
other things.
Currently, a large proportion of the Group's revenue comes from the sale of
automatic production lines on a turn-key basis with companies in the PRC
(See Note 20). As such, those revenues are vulnerable to an increase in the
level of competition from overseas and domestic suppliers and a change in
the supply and demand relationship with those customers.
16. BANKING FACILITIES
The Group had banking facilities of approximately HK$33,180,000 for
mortgages, overdrafts and trade finance. Unused facilities as of December
31, 1998 amounted to approximately HK$25,600,000.
The banking facilities of the Group were secured by:
i. mortgages over the Group's leasehold land and buildings with a net
book value of approximately HK$3,172,000.
ii. lien on a subsidiary's fixed deposits totaling HK$2,000,000.
iii. personal guarantee by a director, Chan Kwai Chiu, up to HK$21,000,000.
iv. mortgages over properties held by a director, Chan Kwai Chiu, with
purchase cost of approximately $17,800,000.
F-23
CHINA CONTINENTAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
17. FOREIGN CURRENCY EXCHANGE
The Group has substantial transactions with customers and significant
investments in associated companies in the PRC. Both the customers and the
associated companies may settle their debts and distribute their dividends
outside the PRC. The remittances are subject to control because RMB is not
freely convertible into foreign currencies. The majority of the Company's
bank balances as of December 31, 1997 and 1998 were in RMB. The amount of
debts due from customers in the PRC subject to control amounted to
HK$35,191,812 and HK$71,309,250 at December 31, 1997 and 1998,
respectively.
On January 1, 1994, the PRC government introduced a single rate of exchange
as quoted daily by the People's Bank of China (the "Unified Exchange
Rate").
The quotation of the exchange rates does not imply free convertibility of
RMB into Hong Kong dollars or other foreign currencies. All foreign
exchange transactions continue to take place either through the Bank of
China or other banks authorized to buy and sell foreign currencies at the
exchange rates quoted by the People's Bank of China. Approval of foreign
currency payments by the Bank of China or other institutions requires
submitting a payment application form together with suppliers' invoices,
shipping documents and signed contracts.
18. ADDITIONAL RELATED PARTY BALANCES AND TRANSACTIONS
The Group's amounts due from/(to) directors and related companies owned
and/or controlled by a director, Chan Kwai Chiu, are unsecured,
interest-free and are repayable on demand. See also Note 12.
In the normal course of business, some of the companies in the Group are
engaged in the set-up of automatic production lines on a turn-key basis for
its associated companies. Other than the above-mentioned transactions, the
companies also arrange for the sale of raw materials to these associated
companies. Amounts of revenues from the sales of raw materials to these
associated companies are summarized as follows:
Nine months
Year ended ended Year ended
March 31, December 31, December 31,
1997 1997 1998
HK$ HK$ HK$
Sales to associated companies:
Raw materials 19,699,783 12,357,168 11,953,242
========== ========== ==========
Any unrealized profits arising from these transactions were eliminated in the
consolidated financial statements to the extent of the Group's interests in
these associated companies.
F-24
CHINA CONTINENTAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
19. CONTINGENCIES AND COMMITMENTS
During 1998 the Company entered into an agreement with an unrelated entity
to provide public relations and promotional services for the Company. In
accordance with the agreement the entity is to be issued stock for all
services provided. A portion of the agreement is contingent upon the firm's
ability to raise capital and obtain a listing for the Company on certain
stock exchanges in the United States. Attainment of these goals could
result in the issuance of up to an additional to 1.6 million shares of
common stock to the firm. See Note 21.
The Group had contracts with a related company controlled by Mr. Chan Kwai
Chiu in the PRC to purchase office premises to be developed by the related
company for HK$21,700,000. At December 31, 1998, HK$5,000,000, which was
grouped under other assets, had been paid as a deposit for the purchase
with the remainder being payable upon receipt of the title certificates for
the office premises.
20. SEGMENT INFORMATION
The Company performs in the three following operating segments : Automatic
production lines on a turn-key basis, raw materials and breeding center
operations. In determining the operating income of each segment, certain
other expenses such as income taxes, administrative, financial, other
(income) expense and shares of gains of associated companies are not
allocated to operating segments.
The following table reflects the results of the segments consistent with
the Company's management system.
Nine Months
Year ended ended Year ended
March 31, December 31, December 31,
1997 1997 1998
HK$ HK$ HK$
Sales
Automatic production lines 247,666,944 145,436,500 254,247,430
Raw materials 21,017,296 14,682,789 12,353,242
Breeding center - - 18,506,627
--------------- --------------- ---------------
Total sales 268,684,240 160,119,289 285,107,299
=============== =============== ===============
Operating Income (Loss)
Automatic Income 156,020,592 91,605,000 160,358,850
Raw Income 1,058,501 5,368,427 1,689,518
Breeding - - (30,651,824)
--------------- --------------- ---------------
Total operating income 157,079,093 96,973,427 131,396,544
Less : General corporate expenses 4,650,232 5,856,201 15,127,221
Financial expense 425,759 442,851 1,275,217
Other (income) expense 4,597,305 (22,625,018) (2,789,505)
Share of gains of associated
companies - (1,113,459) (795,995)
--------------- --------------- ---------------
Income before income taxes 147,405,797 114,412,852 118,579,606
=============== =============== ===============
F-25
CHINA CONTINENTAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
20. SEGMENT INFORMATION (continued)
Operating Segment Data
Identifiable Capital Depreciation
Assets Expenditures & amortization
HK$ HK$ HK$
Year ended March 31, 1997:
Automatic production lines 260,872,259 - -
Raw materials 2,579,789 -
Breeding center - - -
Other - 15,080 620,313
--------------- ------------ ----------
263,452,048 15,080 620,313
--------------- ------------ ----------
Nine months ended December 31, 1997:
Automatic production lines 170,354,856 - -
Raw materials 3,467,445 -
Breeding center 1,358,514,000 403,364,486 -
Other - 14,856 442,894
---------------- ----------------- ----------
1,532,336,301 403,379,342 442,894
---------------- ----------------- ----------
Year ended December 31, 1998:
Automatic production lines 346,447,370 - -
Raw materials 728,610 - -
Breeding center 1,327,305,671 - 33,962,849
Other - 2,736 333,837
---------------- ----------------- --------------
1,674,481,651 2,736 34,296,686
---------------- ----------------- --------------
Reconciliation to Total Assets As Reported
Nine months
Year ended ended Year ended
March 31, December 31, December 31,
1997 1997 1998
HK$ HK$ HK$
ASSETS :
Total reportable segments - identifiable assets 263,452,048 1,532,336,301 1,674,481,651
Unallocated amounts:
Cash 71,590 13,896 8,096
Prepayments, deposits and other receivables 271,577,777 5,613,775 3,235,373
Due from related parties 17,983,640 73,636,911 74,049,644
Plant and other property and equipment 4,094,219 3,486,981 3,155,880
Interests in associated companies 2,292,154 69,053,638 66,618,081
Other 7,000,000 7,000,000 5,000,000
-------------- ----------------- -----------------
Total Consolidated Assets 566,471,428 1,691,141,502 1,826,548,725
============== ================= =================
F-26
CHINA CONTINENTAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
20. SEGMENT INFORMATION (continued)
Substantially all of the Group's activities consist of assembling and sales
of production lines on a turn-key basis. Substantially all the Group's
sales are made to customers in the PRC. The sales to other customers
consist of sales relating to the raw materials and breeding center
segments.
Sales by Major Customers
Sales
-------------------------------------------------
Nine months Accounts
Year ended ended Year Ended Receivable
March 31, December 31, December 31, December 31,
HK$ HK$ HK$ HK$
----------- --------------- -------------- ---------------
China (Fujian) Foreign Trade
Centre Holdings Company ("CFFTC") 30,842,448 - - -
Kin Heng Xin Investment &
Development Company Limited 128,292,528 85,870,000 83,414,430 42,445,430
Shenzhen San Gao Enterprises
Company Limited (Shenzhen) 88,531,968 59,566,500 88,276,600 28,863,820
Chit Tat Industrial Development Limited - - 82,556,400 -
Others 21,017,296 14,682,789 30,859,869 692,800
--------------- --------------- --------------- --------------
268,684,240 160,119,289 285,107,299 72,002,050
=============== =============== =============== ==============
21. ADDITIONAL NON-CASH TRANSACTIONS
1997
----
During the year ended March 31, 1997, HK$17,935,678 of trade accounts
payable were paid directly by directors on behalf of the Company and
HK$21,625,232 of trade accounts receivable were received directly by
directors. The net activity of these transactions was posted to the amounts
due to directors in the accompanying consolidated balance sheets.
1998
----
On August 12, 1998, 1,400,000 shares of stock were issued in exchange for
public relation services. The stock was issued at US$.50 per share, which
approximates trading value at that date. Total public relation service
expense recorded in relation to this transaction was HK$5,411,000. See Note
19.
On September 30, 1998, 1,600,000 shares of stock were issued to two
directors of the Company to settle amounts due to them. The stock was
issued at US$.42 per share, which approximates trading value at that date.
The total reduction to due to directors in relation to this transaction was
HK$5,263,105.
Harry Ho, assumed On December 31, 1998, pursuant to a signed written
agreement with the Company, the Company's Chairman, Mr. HK$17,534,193 of
the Company's accrued liabilities. Mr. Ho then contributed his assumption
of those liabilities to additional paid-in capital.
F-27
CHINA CONTINENTAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
21. ADDITIONAL NON-CASH TRANSACTIONS (continued)
During 1998, High Glad Industries Limited filed for dissolution (strike
off) in Hong Kong. In order to file for strike off, all assets and
liabilities must be removed from the books. The following non-cash items
were transferred to a Company director, Mr. Chan Kwai Chiu.
HK$
Other assets - deposit (2,000,000)
Amounts due to Mr. Chan Kwai Chiu 1,326,777
Accounts payable and accrued expenses 673,223
------------
Total -
22. YEAR 2000 ISSUES (UNAUDITED)
Many computer systems were not designed to handle any dates beyond the year
1999 and, therefore, computer hardware and software will need to be
modified prior to the year 2000 in order to remain functional; this is the
so called "Year 2000" problem. The Company does not believe it has material
exposure with respect to Year 2000 issues. The Company currently utilizes
commercially produced hardware and software packages that were purchased to
be Year 2000-compliant. The Company does not rely on any one supplier or
vendor for its goods and services, so the failure of any supplier or vendor
with Year 2000 problems to convert its systems on a timely basis should not
have a material effect on the Company's business, financial condition and
results of operations. Software and hardware, such as telecommunications
and office automation systems that facilitate operations of the Company's
locations and corporate headquarters comprise the Company's primary non-IT
systems and were likewise purchased or upgraded to be Year 2000-compliant.
Additionally, the Company is currently communicating with its significant
customers to determine the extent to which the Company may be vulnerable to
their failure to remedy their own Year 2000 issues. The Company anticipates
that it will complete this investigation by October 1999, at which time it
will assess the need to formulate any necessary contingency plans to deal
with Year 2000 issues relating to customers, if any. Although the Company's
IT and non-IT systems were represented as being Year 2000-compliant when
purchased or upgraded, there can be no guarantee that the Company, its
customers or other third party business associates will not experience Year
2000 compliance difficulties which could have a material adverse effect on
the Company's business, results of operations and financial condition.
F-28