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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1997
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[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission File Number: 33-26617A
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CBR BREWING COMPANY, INC.
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(Exact name of registrant as specified in its charter)
FLORIDA 65-0145422
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(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
433 NORTH CAMDEN DRIVE, SUITE 1200
BEVERLY HILLS, CALIFORNIA 90210
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(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (310) 274-5172
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. [X]
As of March 31, 1998, the Company had 5,010,013 shares of Class A Common
Stock and 3,000,000 shares of Class B Common Stock issued and outstanding.
The aggregate market value of the issuer's outstanding voting common
stock (Class A) held by non-affiliates on March 31, 1998, computed by
reference to the average closing bid and ask prices on March 31, 1998 of
$6.00 and $7.75, respectively, was $7,218,839.
Documents incorporated by reference: None.
The total number of sequential pages in this report is 168.
The exhibit index is located on pages 62.
2
PART I.
Cautionary Statement Pursuant to Safe Harbor Provisions of the
Private Securities Litigation Reform Act of 1995:
This Annual Report on Form 10-K for the year ended December 31,
1997 contains "forward-looking" statements within the meaning of the Federal
securities laws. These forward-looking statements include, among others,
statements concerning the Company's expectations regarding sales trends,
gross margin trends, operating costs, the availability of funds to finance
capital expenditures and operations, facility expansion plans, and other
statements of expectations, beliefs, future plans and strategies, anticipated
events or trends, and similar expressions concerning matters that are not
historical facts. The forward-looking statements in this Annual Report on
Form 10-K for the fiscal year ended December 31, 1997 are subject to risks
and uncertainties that could cause actual results to differ materially from
those results expressed in or implied by the statements contained herein.
ITEM 1. BUSINESS
CBR Brewing Company, Inc., a Florida corporation (the "Company",
which term shall include, when the context so requires, its subsidiaries and
affiliates), is the parent of High Worth Holdings, Ltd., a British Virgin
Islands corporation ("Holdings"). Since November 1994, Holdings has owned a
60% interest in Zhaoqing Blue Ribbon High Worth Brewery Ltd., a Sino-foreign
joint venture ("High Worth JV"), which, through its subsidiaries and
affiliates, is engaged in the production and sale of Pabst Blue Ribbon beer
in the People's Republic of China ("China" or the "PRC"). The other 40%
interest in High Worth JV is owned by Guangdong Blue Ribbon Group Co. Ltd.
("Guangdong Blue Ribbon"). See "CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS". Substantially all of the beer currently sold by the Company
is marketed under the Pabst Blue Ribbon label, and is brewed under a
sublicense agreement with Guangdong Blue Ribbon, which, through a transfer,
obtained its license from Pabst Brewing Company ("Pabst US").
All of the Company's business operations are located in the PRC.
The Chinese currency is the Renminbi ("RMB"). The exchange rate was
U.S.$1.00 to RMB 8.32 at December 31, 1995, RMB 8.32 at December 31, 1996 and
RMB 8.30 at December 31, 1997.
DESCRIPTION OF BUSINESS
The Company is engaged in the business of brewing, distributing and
marketing Pabst Blue Ribbon beer in China. As of December 31, 1997, the
Company owned effective interests of 60% and 24% in two brewing facilities
currently producing Pabst Blue Ribbon beer in China, both of which are
managed by the Company. The Company is also presently responsible for the
marketing and sale in China of Pabst Blue Ribbon beer produced by the two
brewing facilities.
China is currently ranked as the second largest beer producer in the
world behind the United States. The management of the Company believes
that Pabst Blue Ribbon beer is currently the leading foreign label sold in
China, both in number of units sold and total sales. Pabst Blue Ribbon is
considered a premium brand in China, along with such other labels as
Tsingtao, Carlsberg, Miller, Budweiser, Coors and Heileman.
The Company produces Pabst Blue Ribbon beer in China to avoid
import tariffs that range as high as 120%. Production is concentrated in
Zhaoqing City, which is approximately 100 miles from Hong Kong in the
Guangdong Province of China. Pabst US provides quality control assistance to
the Company on a regular basis. The Company markets Pabst Blue Ribbon beer
in every province in China. The Company currently maintains offices in
Beverly Hills, California, Hong Kong and Zhaoqing City.
High Worth JV holds certain licensing rights for Pabst Blue Ribbon
beer (See "PABST LICENSING ARRANGEMENTS AND TRADEMARKS") and also directly
owns 100% of a Pabst Blue Ribbon brewing complex ("Zhaoqing Brewery"). High
Worth JV also owns 100% of a PRC holding company ("Zhaoqing Brewery HC").
Zhaoqing Brewery HC owns a 40% interest in Zhaoqing Blue Ribbon Brewery Noble
Ltd., a Sino-foreign joint venture ("Noble Brewery"), which in turn owns a
second Pabst Blue Ribbon brewing complex that is also managed by Zhaoqing
Brewery. Goldjinsheng Holdings Ltd., a wholly owned subsidiary of Noble
China, Inc., an unaffiliated company, owns the other 60% interest in Noble
Brewery. See "THE JOINT VENTURE COMPANIES".
In addition, Zhaoqing Brewery HC owns a 70% interest in Zhaoqing
Blue Ribbon Beer Marketing Company Limited, a PRC company (the "Marketing
Company"), which presently conducts the sales, advertising and promotional
efforts for the Company's production of Pabst Blue Ribbon beer in China. The
remaining 30% interest in the Marketing Company is directly owned by
Guangdong Blue Ribbon. Through its ownership in High Worth JV, Guangdong Blue
Ribbon also has a 28% indirect interest in the Marketing Company (See
"MARKETING AND OPERATIONS -Summary of Operations"), resulting in the Company
owning a 42% net interest in the Marketing Company.
In January 1996, Zhaoqing Brewery HC transferred all of its
operating assets and liabilities to High Worth JV pursuant to the original
Joint Venture Agreement, the Asset Transfer Agreement signed in May 1994, and
the relevant government regulations. Subject to the completion of certain
legal procedures and documentation, the investments in Noble Brewery and the
Marketing Company currently held by Zhaoqing Brewery HC will be transferred
to High Worth JV. Zhaoqing Brewery HC is currently acting as the nominee for
High Worth JV with respect to the investments in Noble Brewery and the
Marketing Company. In the following text, "Zhaoqing Brewery" refers to the
brewing complex, which was transferred to High Worth JV in January 1996, and
"Zhaoqing Brewery HC" refers to the PRC entity that previously owned the
brewing complex from November 1994 through December 1995.
In January 1998, the Company, through High Worth JV, established a
brewery in Hubei Province pursuant to a joint venture agreement in which High
Worth JV acquired a 55% interest in Zao Yang Blue Ribbon High Worth Brewery
Ltd. ("Zao Yang High Worth Brewery") equivalent to an effective interest of
33%. See "ADDITION OF NEW BREWERY".
2
Effective December 31, 1997, the Company, through High Worth JV,
entered into a Settlement Agreement that will allow it to acquire a 51%
interest in Sichuan Brewery, equivalent to an effective interest of 31%. See
"SICHUAN BREWERY".
On January 20, 1998, Zhaoqing Brewery and Goldjinsheng entered into
an agreement which calls for the interest of Goldjinsheng in Noble Brewery to
be transferred to Linchpin Holdings Limited, a subsidiary of Noble China Inc.
Upon receipt of approval from and registration by the relevant PRC
authorities, Linchpin Holdings Limited and High Worth JV will own 60% and 40%
equity interests in Noble Brewery, respectively.
The Company conducts a substantial portion of its purchases through
related parties, and has additional significant continuing transactions with
such parties (See "ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS").
PROPERTY AND PRODUCTION FACILITIES
ZHAOQING BREWERY
Zhaoqing Brewery is situated on a site containing approximately
1,421,492 square feet and is three miles from Zhaoqing City, Guangdong
Province. Zhaoqing Brewery occupies the site pursuant to certificates of land
use rights issued by the local government. The certificates do not specify a
period for the use of the land, but normally it does not exceed 70 years.
The original facilities of Zhaoqing Brewery were constructed
between 1978 and 1980 with annual production capacity based on old brewing
technology of approximately 50,000 metric tons or 425,000 barrels of beer.
Prior to 1995, Zhaoqing Brewery had produced exclusively domestic brands
under the names Zhaoqing beer, Dinghu beer and Xile beer. In the middle of
1994, with the assistance of Pabst US, Zhaoqing Brewery commenced the
conversion and refinement of its original facilities and adopted a new
brewing technology in order to produce beer under the Pabst Blue Ribbon
label. In early 1995, the production of all domestic brands ceased, and
Zhaoqing Brewery is now producing substantially all of its beer production
under the Pabst Blue Ribbon label. With the implementation of the new brewing
technology and the purchase of additional equipment, Zhaoqing Brewery reached
an annual production capacity of 100,000 metric tons or 850,000 barrels by
the end of 1995.
Zhaoqing Brewery annually shuts down portions of the facility for a
short period of time during the low season, normally in December, to provide
regular and scheduled maintenance. Zhaoqing Brewery has access to
replacement parts that can be manufactured by several local toolmakers in
Zhaoqing city.
NOBLE BREWERY
Noble Brewery is situated on a site adjacent to Zhaoqing Brewery
containing approximately 1,453,000 square feet. Noble Brewery has land use
rights of 50 years ending in the year 2043.
3
Noble Brewery consists of the original facilities constructed
between 1988 and 1990 by Pabst Blue Ribbon Brewery (Zhaoqing) Co. Ltd.
("Pabst Zhaoqing"), the operator of the facilities prior to the establishment
of Noble Brewery. These facilities had an annual production capacity of
approximately 80,000 metric tons or 680,000 barrels of beer per year. The
second phase of brewing facilities, which was completed in July 1994, has a
production capacity of approximately 120,000 metric tons or 1,020,000 barrels
of beer per year. Pabst US supplied the majority of the equipment in both the
first and second phase of the brewing facilities, in addition to offering
technical assistance in its installation and maintenance. On an annual
basis, Noble Brewery shuts down portions of the facility for a short period
of time during the low season, normally in December, to provide regular and
scheduled maintenance. Noble Brewery has access to replacement parts that
can be manufactured by several local toolmakers in Zhaoqing.
ZAO YANG HIGH WORTH BREWERY
On January 13, 1998, High Worth JV entered into a joint venture
contract with Zao Yang Brewery in Hubei Province to establish a new brewery
with an initial annual production capacity of 40,000 metric tons or 340,000
barrels of beer. The new brewery will be designated Zao Yang Blue Ribbon
High Worth Brewery Ltd. ("Zao Yang High Worth Brewery"), with a total capital
investment of RMB 29,280,000, allocated 55% to High Worth JV and 45% to Zao
Yang Brewery.
Subject to the approval by the Zao Yang City Government and upon
the issuance of a business registration certificate from the local Business
Registration Bureau, Zao Yang High Worth Brewery will initially commence
production of a locally branded beer under the name "Di Huang Quan". This
trademark will be transferred from Zao Yang Brewery to Zao Yang High Worth
Brewery once the joint venture commences operation. High Worth JV is
responsible for transferring the technical know-how and production technique
of brewing Pabst Blue Ribbon beer to Zao Yang High Worth Brewery, which may
take approximately six to nine months.
Zao Yang High Worth Brewery is situated on a site containing
approximately 752,688 square feet and is located within the vicinity of Zao
Yang City, Hubei Province. Zao Yang High Worth Brewery occupies the site
pursuant to a certificate of land use rights issued by the local government.
The land use right is part of the assets acquired by Zao Yang High Worth
Brewery from Zao Yang Brewery.
The original facilities of Zao Yang High Worth Brewery were
constructed between 1980 and 1985 with annual production capacity based on
old brewing technology of approximately 40,000 metric tons or 340,000 barrels
of beer per annum.
High Worth JV, pursuant to the joint venture agreement, will assist
Zao Yang High Worth Brewery in modernizing its brewing technology and
renovating its existing equipment in order to convert the brewery into
another Pabst Blue Ribbon beer brewing complex.
4
SICHUAN BREWERY
Sichuan Brewery is situated on a site containing approximately
1,089,000 square feet and is located within the vicinity of Le Shan City,
Sichuan Province, which is approximately 160 kilometers from Chengdu, the
provincial capital of Sichuan Province. The original facilities of Sichuan
Brewery were constructed in 1988 with annual production capacity, based on
old brewing technology of approximately 20,000 metric tons or 170,000 barrels
of beer. Prior to late 1996, the facilities were used exclusively to produce
beer under domestic local brand names. Guangdong Blue Ribbon acquired the
brewery as its branch and started to convert the facility into a Pabst Blue
Ribbon beer brewing complex in late 1996. In April 1997, Sichuan Brewery
commenced to produce beer under the Pabst Blue Ribbon label, which was sold
to the Marketing Company for resale.
MARKETING AND OPERATIONS
SUMMARY OF OPERATIONS
The Company's distribution and marketing operations are conducted
by the Marketing Company. The Marketing Company began purchasing the output
of beer from Noble Brewery in July 1995, Zhaoqing Brewery in April 1995 and
Sichuan Brewery in April 1997 (See "PABST LICENSING ARRANGEMENTS AND
TRADEMARKS") and is responsible for its distribution throughout China. The
Marketing Company is also responsible for the promotion and advertising of
the Company's production of Pabst Blue Ribbon beer in China.
Pursuant to the long term purchase contracts signed between the
Marketing Company, on the one hand, and Zhaoqing Brewery and Noble Brewery in
April 1995 and July 1995, respectively, on the other hand, the Marketing
Company is required to purchase all the Pabst Blue Ribbon beer produced by
Zhaoqing Brewery and Noble Brewery at mutually agreed ex-factory prices. The
Marketing Company also signed a long term purchase contract with Guangdong
Blue Ribbon in April 1995 pursuant to which the Marketing Company is required
to purchase all products labelled Blue Ribbon produced by Guangdong Blue
Ribbon including non-carbonated soft drinks and mineral water. The Marketing
Company is allowed to mark-up the prices of the Pabst Blue Ribbon beer
purchased or adjust the ex-factory prices as necessary in order to adequately
cover the selling, advertising, promotional, distribution and administrative
expenses incurred in selling these beer products to distributors.
PABST BLUE RIBBON BEER
Substantially all of the beer now produced by both Noble Brewery
and Zhaoqing Brewery is Pabst Blue Ribbon Beer. There are two products in
Pabst Blue Ribbon brand breweries' portfolio: 11-degree light processed beer
and draught beer. The 11-degree light processed beer is packaged in 946 ml.,
640 ml. and 355 ml. bottles and 500 ml. and 355 ml. cans and is the primary
product of the breweries. The draught beer is sold only in kegs.
5
The 946 ml. glass bottle and 500 ml. can packages for Pabst Blue
Ribbon beer were introduced by Zhaoqing Brewery in 1996, and by Noble Brewery
in 1997.
Sales of the 11-degree light processed beer in 946 ml., 640 ml. and
355 ml. bottles and 500 ml. and 355 ml. cans accounted for approximately
7.2%, 59.9%, 0.9%, 0.5% and 29.5%, respectively, of the sales volume of the
Company in 1997.
Sales of the 11-degree light processed beer in 946 ml., 640 ml. and
355 ml. bottles and 500 ml. and 355 ml. cans accounted for approximately
7.1%, 60.0%, 1.8%, 0.1% and 28.7% respectively, of the sales volume of the
Company in 1996.
Sichuan Brewery during 1997 produced only 11-degree light processed
Pabst Blue Ribbon beer, which was only packed in 640 ml glass bottles. In
1997, the Marketing Company distributed 8,124 metric tons of Pabst Blue
Ribbon beer produced by Sichuan Brewery, which represented 3.6% of the
Company's total sales volume in 1997.
Pabst Blue Ribbon beer is marketed and sold as a premium beer in
establishments such as restaurants, bars, alcohol and tobacco companies and
retail stores, primarily in urban centers all over China. Management
anticipates that the breweries will continue to expand the distribution of
these products in new China markets, subject to the limitations of the
transportation network, the Company's ability to expand its market share in
these markets and the growth of the Chinese economy.
The specifications and characteristics of the beers produced by the
breweries are set out below:
TYPE OF BEER PACKAGE GENERAL DESCRIPTION
11-degree light processed Can (500 ml. & 355 ml.) 11-degree malt
beer Bottle (946 ml., 640 ml. content,
& 355 ml.) alcohol content 3.4%
(w/w)
Draught beer Keg (30 liters) 11-degree malt
content,
alcohol content 3.4%
(w/w)
Note: w/w refers to weight by weight (i.e., measurement of alcoholic content
of beer by weight of beer).
BRAND PERFORMANCE: The 11-degree light processed beer is the
biggest selling beer in the Company's Pabst Blue Ribbon beer portfolio,
accounting for approximately 98.0% of the Company's production in 1997 and
97.7% of the Company's production in 1996.
6
The 11-degree light processed beer is a beverage that offers
Chinese consumers an attractive alternative to their traditional malt-based
beverage. This product was sold in 32 provinces in China in 1996 and 1997.
SALES: The Company's highest volume sales for Pabst Blue Ribbon
beer have been in the provinces of Guangdong, Fujian and Zhejiang. The
Company utilizes a network of non-exclusive regional distributors whose field
sales force maintains customer contact and satisfaction. Sales of Pabst Blue
Ribbon beer were 226,262 metric tons or approximately 1,923,227 barrels in
1997, a 1.4% decrease over 1996. The Company believes that the decrease was
attributable, in substantial part to widespread flooding in China in 1997
which affected the distribution of the Company's products. Sales of Pabst
Blue Ribbon beer were 229,540 metric tons or approximately 1,951,090 barrels
in 1996, a 22% increase over 1995.
DOMESTIC BRAND NAME BEER
Prior to the end of 1994, Zhaoqing Brewery produced beer
exclusively under domestic brand names, such as Zhaoqing beer, Dinghu beer
and Xile beer, all of which were non-premium beers which targeted customers
in the low to middle economic range. Sales of domestic brand beer were
approximately 33,000 metric tons or 280,500 barrels in 1994, almost the same
as in 1993. Production of these local brand beers was completely
discontinued in March 1995 when Zhaoqing Brewery commenced producing Pabst
Blue Ribbon beer on an exclusive basis. However, beer that does not meet
Pabst Blue Ribbon quality standards is generally packaged and distributed as
local brand beer.
Pabst Blue Ribbon beer is targeted to the premium beer market in
China while the domestic brand beer previously produced by Zhaoqing Brewery
was targeted to the non-premium market.
The following tables present information with respect to the sales
and volume of beer sold by Noble Brewery (which produces Pabst Blue Ribbon
beer exclusively) and by Zhaoqing Brewery in 1996 and 1997. In February
1995, the Marketing Company was established to conduct the distribution,
marketing and promotion of the Company's production of Pabst Blue Ribbon beer
throughout China.
Net Sales
1996 Net Sales Volume Sold per Ton
---- --------- ----------- ---------
(RMB'000) (metric tons) (RMB'000)
Noble Brewery 655,317 154,435 4.2
Zhaoqing Brewery
Local Brands 5,666 2,526 2.2
Pabst Blue Ribbon 367,213 80,913 4.5
Marketing Company
Pabst Blue Ribbon 1,173,060 229,540 5.1
7
Non-alcoholic drinks 75,186 30,687 2.5
Net Sales
1997 Net Sales Volume Sold per Ton
---- --------- ----------- ---------
(RMB'000) (metric tons) (RMB'000)
Noble Brewery 639,679 146,813 4.4
Zhaoqing Brewery
Local Brands 2,282 1,156 2.0
Pabst Blue Ribbon 358,080 73,060 4.9
Marketing Company
Pabst Blue Ribbon 1,181,273 226,262 5.2
Non-alcoholic drinks 1,990 901 2.2
During 1997 the Marketing Company distributed 8,124 metric tons of
Pabst Blue Ribbon beer produced by Sichuan Brewery.
SEASONALITY
The beer industry in China is seasonal. The Company's sales are
usually at their lowest in the months of October and November and highest in
the months of March through September.
LOCATION
Noble Brewery and Zhaoqing Brewery are located adjacent to each
other in the City of Zhaoqing. The municipality of Zhaoqing is one of the
major municipal areas of Guangdong Province. It is strategically located at
the lower and middle reaches of the Zijiang River, 62 miles from Guangzhou,
the provincial capital, by road and 142 sea miles from Hong Kong by water.
The area enjoys a mild, sunny climate with an adequate amount of rainfall.
The climate and soil conditions provide an important base of agriculture and
forestry for Guangdong Province.
Guangdong Province is the fifth most populous province in China
with a population of approximately 65,000,000, of whom over 7,000,000 are
located in the metropolitan Guangdong area. The Municipality of Zhaoqing
covers a total area of 8,500 square miles and has a population of
approximately 5,700,000. The metropolitan City of Zhaoqing has a population
of approximately 400,000 and covers an area of 254 square miles. Zhaoqing
enjoys a well-developed infrastructure, including transportation facilities,
reliable power, communication and service infrastructure. The area contains
extensive agricultural activity and a large population base.
8
Zao Yang High Worth Brewery is located in Hubei Province which is
situated in the center of China. Zao Yang High Worth Brewery has immediate
access to the provincial highway network and is strategically positioned to
serve the surrounding provinces.
Sichuan Brewery is located in the Le Shan City, which is
approximately 160 kilometers from Chengdu, the provincial capital of Sichuan
Province. Sichuan Province is in the western region of the PRC and is the
most populous province, with a population of approximately 110,000,000.
Sichuan Brewery has immediate access to the provincial highway network and is
strategically positioned to serve the surrounding cities in Sichuan Province.
QUALITY CONTROL
Rigorously applied quality control is critical to ensure a
consistently high quality standard for the products produced by the
breweries. In 1990, quality control experts were sent by Pabst US to Zhaoqing
to teach brewery personnel appropriate inspection techniques, quality control
measures and production procedures. In addition, Pabst US experts trained
the brewery's personnel in the specific brewing techniques required in order
to meet the standards set by Pabst US. An engineer from Pabst US is
stationed in Zhaoqing to test random production samples and perform quality
control on a continuing basis. In addition, the breweries send samples of
their beer on a regular basis to Pabst US in the United States for content
examination and testing to ensure that quality standards are adhered to on a
consistent basis. Pabst US participated in the conversion of the brewery
facilities of Zhaoqing Brewery to Pabst Blue Ribbon beer and provided
technical assistance and training.
RAW MATERIALS
The breweries use all-natural ingredients in their brewing process.
The primary raw materials utilized are mainly malt, husked rice, hops and
water. The aggregate cost of the primary raw materials represents
approximately 21% of the direct cost of production, excluding depreciation,
of Pabst Blue Ribbon beer and 22% of the domestic brand beers. Cost of
packaging represents approximately 61% of the total direct cost of
production, excluding depreciation, of Pabst Blue Ribbon beer and 52% of the
domestic brand beers.
MALT: Virtually all of the malt utilized for producing Pabst Blue
Ribbon beer is purchased from regional malt manufacturers, primarily
Guangzhou Malting Company, an unaffiliated company. Guangzhou Malting
Company imports the barley used in producing the malt from suppliers in
Australia, Canada and Europe. Malt for domestic brand beer was sourced from
other domestic suppliers. The cost of malt represented approximately 76% of
the primary raw material cost in the direct cost of production, excluding
depreciation and packaging, of Pabst Blue Ribbon beer and 68% for the
domestic brand beers.
HUSKED RICE: Husked rice is grown on irrigated farmland under
contractual agreements with a variety of local farmers in the Zhaoqing
region. Given the extensive agricultural activity in the region, management
believes
9
that there is an abundant and reliable supply of rice to meet ongoing
production needs. The cost of husked rice represents approximately 17% of
the primary raw material cost in the direct cost of production, excluding
depreciation and packaging, of Pabst Blue Ribbon beer and 19% of the domestic
brand beers.
HOPS: The hops utilized for producing Pabst Blue Ribbon beer are
acquired primarily from one supplier in the United States through a local
importer. The cost of hops represents approximately 5% of the primary raw
material cost in the direct cost of production, excluding depreciation and
packaging, of Pabst Blue Ribbon beer and 6% of the domestic brand beers.
WATER: The breweries utilize naturally filtered water from deep
underground wells adjacent to the brewery facilities that tap the Beriling
Shan water source. The pristine water quality and composition were primary
factors in choosing this particular water source. Specifically, the Beriling
Shan water source contains a relatively low mineral content making it very
suitable for brewing the particular types of beers produced by the breweries.
The breweries intensively monitor the quality of the water used in the
brewing process for compliance with the Company's own stringent quality
standards. The breweries have recently expanded their water system to ensure
an adequate supply so as to meet all of their present requirements. However,
the breweries continue to add water reservoir capacity to provide for
long-term strategic growth plans and to sustain brewing operations in the
event of a prolonged drought.
CONTAINERS
Zhaoqing Brewery used six types of containers for its beer in 1997:
946 ml. bottles, 640 ml. bottles, 355 ml. bottles, 500 ml. and 355 ml.
aluminum cans and, for its draught beer, beer kegs. In 1997, approximately
36.2% of Zhaoqing Brewery's products were packaged in aluminum cans and 61.7%
were packaged in glass bottles. The remainder of the malt beverages sold in
1997, representing 2.1% of production, were packaged in stainless steel kegs.
In 1997, Zhaoqing Brewery's domestic brand beers were primarily packaged in
640 ml. bottles. The cost of aluminum and glass containers represents the
single largest cost element in the production and packaging of Zhaoqing
Brewery's beer.
Noble Brewery used five types of containers for its beer in 1997:
946 ml. bottles, 640 ml. bottles, 355 ml. bottles and 355 ml. aluminum cans
and, for its draught beer, beer kegs. In 1997, approximately 28.9% of Noble
Brewery's products were packaged in aluminum cans and 69.0% were packaged in
glass bottles. The remainder of the malt beverages sold in 1997,
representing 2.1% of production, were packaged in stainless steel kegs. The
cost of aluminum and glass containers represents the single largest cost
element in the production and packaging of Noble Brewery's beer.
To date, all of the beer bottles required by the Company have been
supplied by four unaffiliated regional glass manufacturers. Currently, there is
a recycling bottle program in place and the Company uses both new and recycled
bottles and new cans in packaging its beer. The primary supplier of
10
glass bottles to the Company is Guangdong Glass Factory in Guangzhou, with
the balance of the bottle requirements being sourced from Zhaoqing Glass
Factory, Shenzhen Hua Jing Glass Ltd. and Zhanjiang Glass Factory, which are
located in an adjacent province. In addition, a variety of other bottle
manufacturers are located in the Guangdong Province and neighboring
provinces, and represent an easily available alternative source of supply of
bottles. As a result of both Zhaoqing Brewery and Noble Brewery maintaining
a bottle recycling program in 1996 and 1997, the containers represented a
much smaller proportion of the overall cost.
American National Can (Zhaoqing) Company Limited ("American
National Can") supplies approximately 90% of the aluminum cans used by the
breweries. American National Can utilizes an automatic easy-open production
line from Italy and current annual output is 360 million cans. American
National Can produces cans of high quality that meet the ISO standard. The
manufacturing facility for American National Can is located within the same
industrial complex as the breweries. American National Can supplies cans
pursuant to supply contracts with each of the breweries that have no fixed
expiration date. American National Can has agreed to meet the can supply
requirements of the breweries at a pre-negotiated price.
TRANSPORTATION/DISTRIBUTION
In view of the single location of Zhaoqing and Noble breweries and
the wide geographic market in China, the Company is constantly reviewing the
methods of distributing its malt beverages.
TRANSPORTATION: During 1997, 42% of the Company's products sold
were shipped by rail tank cars from Zhaoqing to distributors throughout the
Guangdong Province. The railcars assigned to the breweries by the shipping
railroads are specially built and insulated to maintain temperature control
en route.
The remaining 58% of the Company's volume is shipped by truck (51%)
and boat (7%) directly to distributors. Transportation vehicles are
insulated to keep malt beverage products at proper temperatures until they
are delivered to distributor locations.
Domestic brand beers made by Zhaoqing Brewery were primarily
transported by trucks and shipped within the regional markets.
The production of beer by Sichuan Brewery was primarily distributed
within the Sichuan regional market by trucks.
DISTRIBUTION: Delivery of Pabst Blue Ribbon beer to retail markets
in Guangdong Province and the rest of China is accomplished through a network
of non-exclusive regional distributors which sell to tobacco and alcohol
companies, bars, restaurants and retail stores. The Marketing Company has
over 400 distributors throughout China. During 1995 and 1996, the Marketing
Company generally required a 50% cash deposit from its customers as security,
based on the volume of their order flow. However, for those customers
located in Guangdong Province, the deposit policy had been replaced
11
by cash-on-delivery or pre-approved credit terms. Commencing January 1,
1997, as a result of more intensive competition from the breweries in China,
the Marketing Company abolished the customer deposit requirement except for
certain new customers which are required to make a cash deposit as security.
Customers with material transaction volume are required to issue bills of
exchange from their respective banks to secure payment on the due date. As a
matter of policy, each regional distributor works on a non-exclusive basis.
The breweries typically appoint only one distributor in each region (except
for a large region in which more than one may be appointed) to ensure that
such distributor devotes adequate effort and resources to the development of
a broad based retail distribution network for Pabst Blue Ribbon beer in that
distributor's region. These distribution arrangements include the
flexibility for the breweries to replace distributors, or reach different
arrangements with existing distributors, if it is in their best interest. No
single distributor accounted for more than approximately 5% of 1997 barrel
sales.
In order to ensure the highest product quality, distributors must
maintain proper rotation of the products at retail accounts and are required
to replace the Company's malt beverage products at their own expense if sales
to consumers have not occurred within the prescribed time period.
In 1997, approximately RMB 63,000,000 was allocated to promotional
advertising for Pabst Blue Ribbon beer and approximately RMB 63,700,000 was
allocated to other specific promotional activities and incentives to
distributors. Advertising media include television, radio, billboards,
magazines and newspapers. In addition, the breweries provide their
distributors with promotional gift items, sales incentive bonuses and volume
discounts, and special lucky draw and specific promotional campaigns are held
during the year. Pabst Blue Ribbon beer has also been featured in beer
festivals organized by the National Beer Industry Cooperative District
Organizations in major, highly populated urban centers such as Beijing,
Shanghai and Guangzhou.
MARKETS AND COMPETITION
With the recent influx of foreign branded beer into the China
markets, the Company anticipates that competition among all premium beers
will grow and more marketing and advertising efforts will have to be utilized
in order to maintain its market leadership.
There is a considerable difference in the prices at which local or
regional beer is sold in China as compared to the price of foreign or premium
brands such as Pabst Blue Ribbon beer or the San Miguel, Foster's or
Carlsberg brands. Generally, a 640 ml. bottle of local beer typically sells
for 1-2 RMB ($0.12 U.S. to $0.24 U.S.), compared to premium beers which sells
for 4-6 RMB ($0.48 U.S. to $0.72 U.S.).
MARKETS: The beer market in China is experiencing tremendous
growth in rates of production and demand. However, the industry is largely
fragmented and highly regionalized. A key reason for the fragmented market
is the lack of an effective transportation system. China's system of
highways is in an early stage of development, and combined with heavy
traffic, makes it
12
inefficient to distribute beer over long distances. Another reason for the
fragmented market is that local breweries are generally small in capacity and
lack the financial resources and capability to launch a national distribution
network and promotion program.
Approximately 850 breweries exist in China, over 90% of which are
small local breweries that produce non-premium beer for local or regional
consumption. However, certain Chinese taxes based on volume rather than
sales price favor the higher priced premium beer breweries.
To the extent the Chinese economy is constrained by the actions of
the central government of China to reduce inflation and slow growth rates,
the demand for the Company's premium beer products may be constrained.
Recent development of the beer market tends towards the lower priced beer
product, especially when restructured state owned enterprises have released
their surplus work force, which then has less disposable income for premium
beer consumption. The Company is taking steps to maintain its premium beer
market share and to develop a new range of lower-priced products to suit the
market's changing needs.
COMPETITION: Of the brands comprising the premium sector, Tsing
Tao and Pabst Blue Ribbon are the market leaders. Tsing Tao is the largest
brewer of beer in China, producing approximately 400,000 metric tons or
3,400,000 barrels of beer in 1997. Tsing Tao is one of the best selling
beers in China and the largest Chinese exported brand. It is sold in 32
countries and is China's largest exported beer to the United States.
However, the Company has been able to attract distributors from Tsing Tao due
to the faster growth rate of Pabst Blue Ribbon beer as well as by offering
higher margins. Other companies seeking market share in the Chinese market
include Carlsberg, Singha, San Miguel, Beck's, Lowenbrau, Anheuser-Busch,
Stroh's, Miller, Foster's, Coor's and Heileman. Sales for most of these
brands in China are substantially lower than sales of beer produced under the
Pabst Blue Ribbon and Tsing Tao labels.
CAPITAL EXPANSION
In 1994, the Company launched an expansion program to increase
brewing capacity to fulfill projected volume requirements for the foreseeable
future. Noble Brewery spent approximately RMB 216,300,000 in 1994 to
construct the second phase brewing facilities and RMB 5,000,000 to perform
routine maintenance in all plants and to make incremental capital upgrades to
all production facilities. Zhaoqing Brewery spent approximately RMB
30,800,000 in 1994 to convert the facilities to produce Pabst Blue Ribbon
beer and RMB 1,700,000 to perform routine maintenance. In order to expand
the annual production capacity from 50,000 metric tons to 100,000 metric
tons, Zhaoqing Brewery commenced its expansion program in early 1995 and had
completed all major equipment installation by the end of 1995. Zhaoqing
Brewery spent approximately RMB 139,800,000 in 1995 and early 1996 for this
expansion program.
In 1997, Noble Brewery spent approximately RMB 66,000,000 to
acquire new packaging equipment and machinery, and Zhaoqing Brewery spent
13
approximately RMB 5,000,000 for acquiring new equipment and renovating the
existing machinery.
INVESTMENT IN NEW BREWERY
Pursuant to the joint venture agreement relating to Zao Yang High
Worth Brewery, High Worth JV will contribute a total of RMB 16,104,000 as its
capital contribution to Zao Yang High Worth Brewery, which will be payable in
four installments through October 1998 to obtain 55% of the assets previously
owned by Zao Yang Brewery. All the revalued assets and liabilities of Zao
Yang Brewery will be injected into Zao Yang High Worth Brewery upon
completion of approval procedures.
The Joint Venture Agreement also provides that loans of RMB
29,280,000 and RMB 16,000,000 from financial institutions will be arranged by
Zao Yang High Worth Brewery in order to meet the funding requirements for
equipment renovation and working capital, respectively. If Zao Yang High
Worth Brewery is unable to borrow the necessary amounts, High Worth JV and
Zao Yang Brewery are obligated to contribute additional funds to Zao Yang
High Worth Brewery in proportion to their respective interests.
On February 12, 1998, the Board of Directors of High Worth JV
agreed that, with the approval of Zao Yang Brewery, Zao Yang High Worth
Brewery may be changed into a joint stock company in which High Worth JV will
reduce its equity interest to 51%, Zao Yang Brewery to 24%, with the
remaining 25% to be allocated to the management and employees of Zao Yang
High Worth Brewery. This proposed change is subject to approval from the
local management.
RESEARCH AND DEVELOPMENT
The Company is continually engaging in research and development
programs and has developed various improvements in raw materials, processes
and packaging systems and in the development of innovative, quality products.
The Company's research and development expenditures are primarily
devoted to new product development, its brewing process and ingredients,
brewing equipment, improved manufacturing techniques for packaging supplies
and environmental improvements in the Company's operational processes. The
focus of these programs is to improve the quality and value of its malt
beverage products while reducing costs through more efficient processing
techniques, equipment design and improved varieties of raw materials.
ENERGY
The breweries use both heavy oil and electricity as primary sources
of energy. Heavy oil is used as the primary fuel in their steam generation
system and is supplied from regional sources.
14
Electricity is supplied by the Zhaoqing City Electricity Bureau.
Since the breweries are one of the larger employers in the region, the
breweries are given priority in obtaining electricity. The breweries have
not experienced any energy supply problems to date. As an alternative source
of energy, the Company also has fuel oil and propane available. Management
of the Company does not anticipate any supply problems in the future with
respect to these natural resources.
EMPLOYEES
There are approximately 1,610 employees employed by Zhaoqing
Brewery, Noble Brewery and the Marketing Company, as of December 31, 1997,
categorized as follows:
ZHAOQING NOBLE MARKETING
FUNCTION TOTAL BREWERY BREWERY COMPANY
-------- ----- -------- ------- ---------
(1) Production 859 351 508 --
(2) Engineering, Technology
and Quality Control 135 62 73 --
(3) Management and
Administration 199 43 70 86
(4) Warehouse 154 22 42 90
(5) Others 263 115 103 45
----- --- --- ---
1,610 593 796 221
----- --- --- ---
----- --- --- ---
In 1997, labor costs (including the cost of benefits) accounted for
approximately 3.2% and 4.5% of the total costs of production for Noble
Brewery and Zhaoqing Brewery, respectively. The Company expects average wage
rates of the employees will increase by approximately 10% in 1998.
Each full time employee is a member of a local trade union. Labor
relations have remained positive and the breweries have not had any employee
strikes or major labor disputes. Unlike trade unions in the western
countries, trade unions in most parts of China are organizations mobilized by
the government and the management of the enterprises.
PABST LICENSING ARRANGEMENTS AND TRADEMARKS
PABST TRADEMARKS IN CHINA
The arrangements regarding the use of Pabst trademarks in China
were formalized in an agreement dated August 30, 1993 (the "License
Agreement") between Pabst US and Pabst Zhaoqing. Pabst Zhaoqing was
wholly-owned at that time by Zhaoqing Brewery, which in turn was owned by
Guangdong Blue Ribbon. The License Agreement was for a period of fifteen
years from November 7, 1988. Under the terms of the License Agreement, Pabst
Zhaoqing obtained the exclusive right to produce and market products under
Pabst trademarks in China, the non-exclusive right to market such Pabst
products in other Asian countries except Hong Kong, Macau, Japan and South
Korea, and the
15
right to sublicense the use of the Pabst trademarks to any other enterprise
in China, subject to approval of Pabst US. Royalties are payable quarterly
to Pabst US based on the volume (units) of beer produced.
By an Assets Transferring Agreement dated May 20, 1994 between
Pabst Zhaoqing, Pabst US and Guangdong Blue Ribbon, all rights and duties of
the License Agreement were assigned and transferred from Pabst Zhaoqing to
Guangdong Blue Ribbon. Guangdong Blue Ribbon agreed to fulfill the
obligation as sublicensor under the License Agreement between Pabst Zhaoqing
as sublicensor, and Noble Brewery and High Worth JV as sublicensee,
respectively, which are described below.
NOBLE BREWERY
By a Sublicense Agreement dated October 12, 1993 (the "Noble
Sublicense Agreement") between Pabst Zhaoqing and Noble Brewery and approved
by Pabst US, Pabst Zhaoqing granted to Noble Brewery a sublicense to use
beer-related Pabst trademarks, the non-exclusive right to produce beer in
accordance with its production capacity under the sublicensed Pabst
trademarks, and the non-exclusive right to market such Pabst products in
China and other Asian countries except Hong Kong, Macau, Japan and South
Korea. Royalties calculated on the same basis as those payable to Pabst US
are payable by Noble Brewery to Pabst Zhaoqing. Under the terms of the Noble
Sublicense Agreement, Pabst Zhaoqing agreed that, except with respect to the
enterprises of Guangdong Blue Ribbon, it would not grant further sublicenses
to any other enterprises in Guangdong Province to use the Pabst trademarks
thereby granted. At the time of the Noble Sublicense Agreement, Zhaoqing
Brewery was a member enterprise of Guangdong Blue Ribbon.
HIGH WORTH JV/ZHAOQING BREWERY
By a Sublicense Agreement dated May 6, 1994 (the "High Worth
Sublicense Agreement") between Pabst Zhaoqing and High Worth JV and approved
by Pabst US on September 18, 1994, Pabst Zhaoqing granted to High Worth JV a
sublicense to allow Zhaoqing Brewery to use Pabst trademarks to produce beer
in accordance with its production capacity under the sublicensed Pabst
trademarks and to market such Pabst products in China and other Asian
countries except Hong Kong, Macau, Japan and South Korea. With respect to
the production of Pabst Blue Ribbon beer in Guangdong Province, since
Zhaoqing Brewery was a member enterprise of Guangdong Blue Ribbon at the time
of the Noble Sublicense Agreement, Zhaoqing Brewery was entitled to produce
Pabst Blue Ribbon beer in Guangdong Province.
Under the terms of the High Worth Sublicense Agreement, High Worth
JV and/or its affiliates have the sole right to be granted further
sublicenses by Pabst Zhaoqing for the use of the Pabst trademarks to produce
beer in China provided that they are located outside Guangdong Province.
Further, Pabst Zhaoqing covenanted that it would not grant further
sublicenses with respect to the Pabst trademarks to produce beer to any other
enterprises except High Worth JV or its affiliates. Accordingly, High Worth
JV controls all future sublicensing for the production of Pabst Blue Ribbon
beer in China, which can be sold throughout China and other Asian countries,
excluding Hong Kong, Macau, Japan and South Korea.
16
The term of the High Worth Sublicense Agreement is the same as the
License Agreement. Royalties are payable quarterly by High Worth JV to Pabst
Zhaoqing based on the volume (units) of beer produced.
SICHUAN BREWERY
In late 1996, Guangdong Blue Ribbon established a wholly-owned
subsidiary in Le Shang City, Sichuan Province, PRC, and started converting an
existing brewery with an annual production capacity of 20,000 metric tons
into a Pabst Blue Ribbon brewing complex ("Sichuan Brewery"). Production and
sale of Pabst Blue Ribbon beer commenced in April 1997.
In order to facilitate the efficient distribution and sale of Pabst
Blue Ribbon beer in China, the Company and Guangdong Blue Ribbon agreed at
that time to coordinate the sales of Pabst Blue Ribbon beer in an orderly
manner. In April 1997, the Marketing Company and Sichuan Brewery entered
into a Memorandum of Understanding which required Sichuan Brewery to sell all
of its production of Pabst Blue Ribbon beer to the Marketing Company at
mutually agreed ex-factory prices, and granted the Marketing Company the
right to regulate production of Pabst Blue Ribbon beer to reflect market
demand.
Since the Marketing Company is only allowed to mark-up the cost of
Pabst Blue Ribbon beer purchased in order to adequately cover the selling,
advertising, promotional, distribution and administrative expenses incurred
in selling to distributors, the sale of the Sichuan Brewery's production by
the Marketing Company did not have a material effect on the Company's
consolidated results of operations. In 1997, Sichuan Brewery's production
amounted to 13,430 metric tons, of which the Marketing Company distributed
8,124 metric tons, representing 3.6% of the Company's total 1997 sales volume.
In early October 1997, Sichuan Brewery advised the Marketing
Company that it intended to commence selling its production of Pabst Blue
Ribbon beer directly and that it would therefore cease selling its production
of Pabst Blue Ribbon beer to the Marketing Company, effective immediately.
In late October 1997, High Worth JV and the Marketing Company
instituted formal legal proceedings against Guangdong Blue Ribbon and Sichuan
Brewery. A Statement of Claims was filed with the High Court of Guangdong
Province in which Guangdong Blue Ribbon and Sichuan Brewery were named as the
first and second defendant, respectively. The Statement of Claims asserted
that the defendants violated the terms of the Sublicensing Agreement signed
between High Worth JV and Guangdong Blue Ribbon and breached the Long Term
Sales Contracts signed between Marketing Company and Guangdong Blue Ribbon.
With the liaison efforts of the Guangdong Provincial Government and
Zhaoqing City Government, High Worth JV, Marketing Company, Guangdong Blue
Ribbon and Sichuan Brewery reached an out-of-court settlement on December 30,
1997("Settlement Agreement"). The Settlement Agreement, signed by all
parties involved and witnessed by the High Court of Guangdong Province,
included the following terms and provisions:
(a) High Worth JV will serve as the core organization for managing the
production and operation of the Pabst Blue Ribbon beer business in the
17
PRC. A Management Committee will be set up under the Board of Directors
of High Worth JV to liaise, coordinate and manage the procurement,
production, sale and future development of all Pabst Blue Ribbon beer
producing enterprises.
(b) The Marketing Company will act as the entity to unify and coordinate all
sales of Pabst Blue Ribbon beer in the PRC. All of the Pabst Blue
Ribbon beer products produced by High Worth JV, Noble Brewery and any
other new joint ventures set up by High Worth JV will be distributed by
the Marketing Company under the coordination of the Management Committee.
(c) The sales and marketing of Blue Ribbon mineral waters and non-carbonated
soft drinks will be handled by Guangdong Blue Ribbon upon confirmation
by the Board of Directors of the Marketing Company.
(d) Sichuan Brewery will be restructured and renamed Sichuan Blue Ribbon
High Worth Brewery E Mei Limited ("Sichuan High Worth Brewery"). High
Worth JV, Guangdong Blue Ribbon and E Mei Brewery will own equity
interests in Sichuan High Worth Brewery of 51%, 20% and 29%,
respectively. E Mei Brewery is the local brewery in Sichuan, which
leased its brewing facilities to Guangdong Blue Ribbon to form the
Sichuan Brewery. The existing assets in Sichuan Brewery will be
revalued to derive their fair market value prior to the completion of
the formal restructuring, which is expected to be completed by the
middle of 1998.
On February 12, 1998, the Board of Directors of High Worth JV resolved
that the new equity structure for Sichuan High Worth Brewery should be
revised to reflect 60% owned by High Worth JV and 40% owned by E Mei
Brewery. The Board of Directors further resolved that if agreed by the
respective parties, Sichuan High Worth Brewery may be converted into a
joint stock company in which the equity interests of High Worth JV and E
Mei Brewery will be reduced to 51% and 24%, respectively, with the
remaining 25% allocated to the management and employees of Sichuan High
Worth Brewery. All the above proposed changes will be subject to
approval by the local government.
(e) Guangdong Blue Ribbon committed to sublicense the right to use the Pabst
Blue Ribbon trademark to all new breweries to be established by High
Worth JV in the future. Any new brewery will pay a royalty fee at the
same rate as Pabst US charges Guangdong Blue Ribbon plus a surcharge of
RMB 25 per metric ton. All other terms and conditions will be the same
as the License Agreement.
(f) All legal costs incurred with regard to this proceeding will be equally
shared by the plaintiffs and defendants.
ZAO YANG HIGH WORTH BREWERY
Pursuant to the terms of the Settlement Agreement and the High Worth
Sublicense Agreement, Guangdong Blue Ribbon is committed to grant a sublicense
agreement to Zao Yang High Worth Brewery for the right to produce
18
and sell beer products under the Pabst Blue Ribbon label. Zao Yang High
Worth Brewery is required to pay royalty fees at the same rate as Pabst US
charges Guangdong Blue Ribbon plus a surcharge of RMB 25 per metric ton. The
granting of this sublicense is subject to confirmation by Pabst US, and Zao
Yang High Worth Brewery meeting the required production standards for the
production of Pabst Blue Ribbon beer.
THE JOINT VENTURE COMPANIES
FORMATION OF THE JOINT VENTURE COMPANIES
In 1980, Zhaoqing Brewery was initially established as a
state-owned enterprise to manufacture beer and non-alcoholic beverages. In
1992, Zhaoqing Brewery became a member enterprise (affiliate) of Guangdong
Blue Ribbon. In June 1993, Zhaoqing Brewery entered into a Joint Venture
Agreement with Goldjinsheng Holdings Ltd. ("Goldjinsheng") to form Noble
Brewery (the "Noble Joint Venture Agreement"), pursuant to which Goldjinsheng
acquired a 60% interest and Zhaoqing Brewery acquired a 40% interest.
Goldjinsheng was a wholly-owned subsidiary of Noble China Inc., a company
listed on the Toronto Stock Exchange. Upon formation of the joint venture,
Noble Brewery consisted of the beer production facilities and assets of Pabst
Zhaoqing, the then subsidiary of Zhaoqing Brewery, which were utilized to
produce and distribute beer under the Pabst Blue Ribbon brand name. Zhaoqing
Brewery continued to produce beer under local brands in its separate facility.
In May 1994, Guangdong Blue Ribbon and Holdings entered into a
Joint Venture Agreement providing for the establishment of High Worth JV.
The term of the joint venture is 50 years, and is subject to extension by
agreement of the parties and approval from the government. Holdings
contributed 60% of the capital, which was used by High Worth JV to purchase
Zhaoqing Brewery from Guangdong Blue Ribbon, including its 40% interest in
Noble Brewery. Holdings and Guangdong Blue Ribbon then owned 60% and 40%
interests, respectively, in High Worth JV. All of the governmental approvals
for the ownership transfer of Zhaoqing Brewery to High Worth JV were
completed in November 1994. Zhaoqing Brewery produced and distributed beer
under local brands at the time of this transaction. Subsequently, in
December 1994, the Company acquired all of the shares of Holdings (See
"BUSINESS DEVELOPMENT").
OPERATION OF THE JOINT VENTURE COMPANIES
The establishment and activities of High Worth JV and Noble Brewery
are governed by the joint venture law and regulations of China and the
applicable joint venture agreements. Holdings' interest in the profits of
High Worth JV is in the same proportion (i.e., 60%) as its investment in High
Worth JV; Zhaoqing Brewery's interest in the profits of Noble Brewery is in
the same proportion (i.e., 40%) as its investment in Noble Brewery.
With regard to Noble Brewery, pursuant to the Noble Joint Venture
Agreement, the term of the joint venture is for 20 years, which may be
extended upon the agreement of the two joint venture partners and approval
from the applicable Chinese governmental agencies. Under the Noble Joint
Venture Agreement, Noble Brewery is governed by a board of directors
19
consisting of five individuals, three of whom, including the Chairman, are
nominated by Goldjinsheng, with the remaining two, including the Vice
Chairman, by Zhaoqing Brewery. The operation and management of Noble Brewery
is the responsibility of Zhaoqing Brewery. Accordingly, Zhaoqing Brewery has
the decision making authority on substantially all aspects of the daily
operations of Noble Brewery such as purchasing, production, sales and
marketing, finance and human resources. Goldjinsheng may appoint staff to
participate in the accounting functions of Noble Brewery. All matters to be
approved by the Board of Directors require either unanimous vote or the vote
of four out of the five directors. Accordingly, no board decision can be
made without the approval of Zhaoqing Brewery's designee.
With regard to High Worth JV, pursuant to the High Worth JV Joint
Venture Agreement, High Worth JV is governed by a board of directors
consisting of seven individuals, four of whom are appointed by Holdings and
three of whom are appointed by Guangdong Blue Ribbon. The Board of Directors
controls the management and operation of High Worth JV. Generally, votes on
the board of directors are taken by majority vote, except for the following
matters relating to the existence and legal structure of the joint venture,
all of which require a unanimous vote: amendments to the articles of
association; termination or dissolution of the joint venture; increase in, or
transfer of, the registered capital of the joint venture; establishment of
subsidiaries or combination with other entities; and change in the share
structure. The general manager is appointed by the Board of Directors and is
responsible for carrying out the decisions of the Board as well as for the
day-to-day management of High Worth JV.
Zao Yang High Worth Brewery was formed as a Chinese limited company
with two joint venture owners. Pursuant to the Zao Yang High Worth Brewery
Joint Venture Agreement, Zao Yang High Worth Brewery is governed by a board
of directors consisting of five individuals, three of whom, including the
chairman, are nominated by High Worth JV, with the remaining two, including
the vice-chairman, by Zao Yang Brewery. Generally, votes on the board of
directors are taken by majority vote, except for the following matters
relating to the existence and legal structure of the joint venture, all of
which require a unanimous vote: amendment to the articles of association;
termination or dissolution of the joint venture; increase in, or transfer of,
the registered capital of the joint venture; establishment of subsidiaries or
combination with other entities; and change in the share structure. The
general manager is appointed by the Board of Directors and is responsible for
carrying out the decisions of the Board as well as for the day-to-day
management of Zao Yang High Worth Brewery.
Subsequent to the conclusion of the Sichuan Brewery Settlement
Agreement, a Management Committee has been set up under High Worth JV's Board
of Directors to serve as the central liaison and coordination body for the
Pabst Blue Ribbon beer business in China. Any future expansion and
development of the Pabst Blue Ribbon beer production will be monitored by
High Worth JV. The Company is seeking expansion and cooperation
opportunities to extend its brewing operation into other provinces with local
breweries outside of Guangdong Province.
20
GOLDJINSHENG AGREEMENT
A provisional agreement, subject to the approval of the applicable
Chinese governmental agencies and the execution of separate definitive
agreements with respect to the various matters referred to below, was made
among Goldjinsheng the owner of the remaining 60% interest in Noble Brewery,
Zhaoqing Brewery, Noble Brewery, High Worth JV and Guangdong Blue Ribbon on
May 10, 1995 (the "Goldjinsheng Agreement") confirming that:
(a) High Worth JV was entitled to brew and sell beer under the Pabst Blue
Ribbon label produced in its brewing facilities up to a maximum
production capacity of 100,000 tons per annum.
(b) High Worth JV and/or companies in which High Worth JV has an interest
are entitled to be granted a sublicense from Guangdong Blue Ribbon with
the right to produce and sell beer under the Pabst Blue Ribbon label in
the Guangdong Province of the PRC ("Additional Facility") to a maximum
production capacity of 300,000 tons per annum.
In the event that High Worth JV desires to obtain a sublicense for any
Additional Facility, Goldjinsheng has the right to purchase up to a 40%
interest in such Additional Facility. The purchase price for such
interest will be the actual cost of such Additional Facility multiplied
by the percentage interest that Goldjinsheng elects to purchase.
(c) A marketing company, owned 8% by Guangdong Blue Ribbon, 52% by High
Worth JV and 40% by Goldjingsheng, will handle and organize the sales of
Pabst Blue Ribbon beer produced by High Worth JV and Noble Brewery.
High Worth JV and Noble Brewery will each create a separate distribution
company or division of their own. The distribution company of High
Worth JV will have the sole right to acquire 100% of the production of
High Worth JV and 40% of the production of Noble Brewery, while the
distribution company of Noble Brewery will have the sole right to
acquire 60% of the production of Noble Brewery. The respective
distribution companies will appoint the Marketing Company as their sole
and exclusive agent to market Pabst Blue Ribbon beer in the PRC. If the
provisions as to ownership are implemented, the respective interests of
Guangdong Blue Ribbon and the Company in the Marketing Company will be
adjusted (See "MARKETING AND OPERATIONS--Summary of Operations").
Subsequent to the signing of the Goldjinsheng Agreement, the
Company, Guangdong Blue Ribbon and Goldjinsheng have attempted to complete
the respective separate definitive agreements. In December 1996, Guangdong
Blue Ribbon and Goldjinsheng advised the Company that they intended to modify
some of the terms of the Goldjinsheng Agreement and to propose incorporating
those modifications in the respective separate definitive agreements.
Although the negotiation process was interrupted by the Sichuan Brewery
issue, the Company anticipates that these discussions will be resumed in 1998.
21
OPERATING IN CHINA
Because the operations of the Company are based exclusively in
China, the Company is subject to rules and restrictions governing China's
legal and economic system as well as general economic and political
conditions in that country.
INFLATION/ECONOMIC POLICIES. General economic conditions in China
could have a significant impact on the Company. The economy of China differs
in certain material respects from that of the United States, including its
structure, levels of development and capital reinvestment, growth rate,
government involvement, resource allocation, rate of inflation and balance of
payments position. Although the majority of China's productive assets is
still owned by the state, the adoption of an economic reform policy since
1978 has resulted in the gradual reduction in the role of state economic
plans and the allocation of resources, pricing and management of such assets,
with increased emphasis on the utilization of market forces, and rapid growth
in the Chinese economy. The success of the Company depends in substantial
part on the continued economic growth in the Chinese economy.
In recent years, the Chinese economy has experienced periods of
rapid economic growth as well as high rates of inflation, which in turn, has
resulted in the adoption by the Chinese government from time to time of
various corrective measures designed to regulate growth and contain
inflation. Since 1993, the Chinese government has implemented an economic
program to control inflation which has resulted in the tightening of working
capital available to Chinese state-owned enterprises, and in the slowing of
the pace of economic growth and general market consumption.
CURRENCY MATTERS. The State Administration for Exchange Control
("SAEC"), under the authority of the People's Bank of China ("PBOC"),
controls the conversion of RMB into foreign currency. Prior to January 1,
1994, RMB could be converted into foreign currency through the Bank of China
or other authorized institutions at official rates fixed daily by the SAEC.
RMB could also be converted at swap centers ("Swap Centers") open to Chinese
enterprises and foreign-funded Chinese enterprises, subject to SAEC approval
of each foreign currency trade, at exchange rates negotiated by the parties
for each transaction. In the year ended December 31, 1993, as much as 80% by
value of all foreign exchange transactions in China took place through the
Swap Centers. The exchange rate quoted by the Bank of China differed
substantially from that available in the Swap Centers. Effective January 1,
1994, a unitary exchange rate system was introduced in China, replacing the
dual-rate system previously in effect. In connection with the creation of a
unitary exchange rate, the establishment of the China Foreign Exchange
Trading System inter-bank foreign exchange market and the phasing out of the
Swap Centers were announced. However, the Swap Centers were retained, and
foreign-funded enterprises have been permitted to satisfy foreign exchange
requirements through the Swap Centers.
Effective July 1, 1996, the government of China began to take steps
to make its currency fully convertible on a "current account" basis. This
will allow foreign-funded enterprises, whether wholly-owned or joint ventures
with Chinese parties, to buy and sell foreign exchange in banks for
22
purposes of trade, services, debt repayment and profit repatriation. The
"current account" measures the flow of money into and out of a nation,
including the net balance on trade in goods and services, plus remittances.
LEGAL SYSTEM. Since 1979, many laws and regulations dealing with
economic matters in general and foreign investment in particular have been
promulgated in China. The Chinese constitution adopted in 1989 authorizes
foreign investment, and guaranties the "lawful rights and interests" of
foreign investors in China. The trend of legislation over the past twelve
years has significantly enhanced the protection afforded foreign investment
and allowed for more active control by foreign parties of foreign investment
enterprises in China. There can be no assurance, however, that the current
trend and economic legislation toward promoting market reforms and
experimentation will not be slowed, curtailed or reversed, especially in the
event of a change in leadership, social or political disruption, or
unforeseen circumstances affecting China's political, economic or social life.
Despite some progress in developing a legal system, China does not
have a comprehensive system of laws. The interpretation of Chinese laws may
be subject to policy changes reflecting domestic political factors.
Enforcement of existing laws may be uncertain and sporadic, and
implementation and interpretation may be inconsistent. The Chinese judiciary
is relatively inexperienced in enforcing the laws or terms of contracts,
leading to a higher than usual degree of uncertainty as to the outcome of
litigation. Even where adequate laws exist in China, it may be impossible to
obtain swift and equitable law enforcement, or to obtain enforcement of a
judgment by a court of another jurisdiction. As the Chinese legal system
develops, the promulgation of new laws, changes to existing laws, and the
preemption of local regulations by national laws may adversely affect foreign
investors, such as the Company.
The Company's activities in China may by law be subject, in some
cases, to administrative review and approval by various national, provincial
and local agencies of the Chinese government. While China has promulgated an
administrative procedural law permitting redress to the courts with respect
to certain administrative actions, this law appears to be largely untested.
TAX MATTERS. The Company's operations in China are subject to four
types of taxes: Income Tax, Value Added Tax ("VAT"), Consumption Tax and
other Sales Tax.
Noble Brewery and High Worth JV are governed by the Income Tax Law
of China concerning Foreign Investment Enterprises and Foreign Enterprises
(the "FIE Law"). Under the current FIE Law, Noble Brewery and High Worth JV
are exempt from payment of Income Tax for the first two taxation years in
which Noble Brewery and High Worth JV become profitable. The Income Tax rate
for the following three years is reduced by 50% and is thereafter calculated
at the full rate. The 100% tax exemption for High Worth JV and the 50% tax
exemption for Noble Brewery commenced on January 1, 1996. The current
official Income Tax rate on profits for Noble Brewery is 27% (33% less a 6%
temporary reduction provided as an economic incentive by the Chinese
government) and for High Worth JV is 33%, unless specifically exempted or
reduced by the local authorities.
23
Zao Yang High Worth Brewery is established as a China joint venture
limited company and is subject to the Income Tax Law of China concerning a
Chinese limited company. The current official Income Tax rate on profits for
Zao Yang High Worth Brewery is 33%. However, local tax authorities may
specifically exempt or reduce the tax rate as an economic incentive.
In addition to the FIE Law, which is computed on profits, Noble
Brewery, Zhaoqing Brewery and Zao Yang High Worth Brewery are also subject to
two kinds of turnover taxes for their respective sales, the VAT and
Consumption Tax. The applicable VAT rate is 17% for brewery products sold in
China. The amount of VAT liability is determined by applying the applicable
tax rate to the invoiced amount less VAT paid on purchases made with the
relevant invoices in support. The Consumption Tax rate together with a
government surcharge for brewery products is RMB 220 per metric ton. The
Consumption Tax is determined on the volume of sales within China.
Currently, there are no withholding taxes imposed on dividends paid
by High Worth JV to Holdings.
DISTRIBUTION OF PROFITS. Applicable Chinese laws and regulations
require that, before a Sino-foreign joint venture enterprise (such as High
Worth JV and Noble Brewery) distributes profits to investors, it must (1)
satisfy all tax liabilities; (2) provide for losses in previous years; and
(3) make allocations in proportions determined at the sole discretion of the
Board of Directors to a general reserve fund, an enterprise development fund
and a staff welfare and employee bonus fund. Distribution of profits by the
joint ventures to the Company and their other equity investors are required
to be in proportion to each party's respective investment in the joint
venture.
REGULATIONS
Central, provincial and local laws and regulations govern the
operations of the breweries. The central government and all provinces in
which the Company's malt beverage products are distributed regulate trade
practices, advertising and marketing practices, relationships with
distributors and related matters. Governmental entities also levy various
taxes, license fees and other similar charges and may require bonds to ensure
compliance with applicable laws and regulations.
BUSINESS DEVELOPMENT
The Company was organized in the state of Florida as Video
Promotions, Inc. on April 20, 1988. The Company subsequently changed its
name to National Sweepstakes, Inc. and then to Natural Fuels, Inc. For a
period of time prior to December 16, 1994, the business of the Company was
devoted to seeking potential acquisition or merger opportunities.
On December 16, 1994, the Company acquired all of the outstanding
shares of Holdings from Oriental Win Holdings Ltd. ("Oriental Win") and
Goldchamp Ltd. ("Goldchamp") in exchange for 3,960,000 shares and 240,000
shares of the Company's Class A Common Stock issued to Oriental Win and
24
Goldchamp, respectively, and 3,000,000 shares of the Company's Class B Common
Stock issued to Oriental Win. The Class B Common Stock carries two votes per
share but is otherwise equivalent to the Class A Common Stock. In addition,
the Company issued an aggregate of 600,000 shares of the Company's Class A
Common Stock to various parties for consulting services in connection with
the acquisition of Holdings. At the time of the acquisition, Holdings owned
a 60% interest in High Worth JV. This transaction was accounted for as a
recapitalization of Holdings with Holdings as the acquirer (reverse
acquisition).
On November 22, 1994, the Company effected a 1-for-22 reverse stock
split in anticipation of the transaction.
On March 15, 1995, the Company changed its name to CBR Brewing
Company, Inc.
ITEM 2. PROPERTIES
The Company's major facilities are set forth below:
FACILITY LOCATION PRODUCT
- -------- -------- -------
Noble Brewery City of Zhaoqing on a site Malt Beverages
containing approximately
135,000 square meters
Zhaoqing Brewery City of Zhaoqing on a site Malt Beverages
containing approximately
131,000 square meters
Zao Yang High Worth City of Zao Yang on a site Malt Beverages
Brewery (formed in containing approximately
1998) 70,000 square meters
Sichuan Brewery (to City of Le Shanon on a site Malt Beverages
be changed to Sichuan containing approximately
High Worth Brewery 100,000 square meters
in mid-1998)
The facilities of Noble Brewery and Zhaoqing Brewery are well
maintained and suitable for their respective operations. The facilities of
Zao Yang High Worth Brewery will be modernized and new equipment will be
added to convert it into another Pabst Blue Ribbon beer producing complex.
In 1997, the Company estimates that Zhaoqing Brewery and Noble
Brewery operated at approximately 74% and 73%, respectively, of their
theoretical brewing capacities. Annual production capacity can vary due to
product mix, packaging mix and seasonality.
25
ITEM 3. LEGAL PROCEEDINGS
In late October 1997, High Worth JV and the Marketing Company
instituted formal legal proceedings against Guangdong Blue Ribbon and Sichuan
Brewery. A Statement of Claims was filed with the High Court of Guangdong
Province in which Guangdong Blue Ribbon and Sichuan Brewery were named as the
first and second defendant, respectively. The Statement of Claims asserted
that the defendants violated the terms of the Sublicensing Agreement signed
between High Worth JV and Guangdong Blue Ribbon and breached the Long Term
Sales Contract signed between Marketing Company and Guangdong Blue Ribbon. A
Settlement Agreement was entered into on December 30, 1997. See ITEM 1
"PABST LICENSING ARRANGEMENTS AND TRADEMARKS - Sichuan Brewery".
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security
holders during the fourth quarter of the fiscal year ended December 31, 1997.
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Class A Common Stock of CBR Brewing Company, Inc. is listed for
trading on the OTC Bulletin Board under the symbol CBRB. During 1995, 1996
and 1997, there was extremely limited trading activity.
The approximate number of security holders of record of the Class A
Common Stock at March 31, 1998 was 10.
The Company has never paid cash dividends on its Common Stock and
has no present intention of paying cash dividends in the foreseeable future.
It is the present policy of the Board of Directors to retain all earnings to
provide for the future growth of the Company.
The Company's ability to pay dividends to its shareholders is
dependent on the Company receiving distributions through Holdings from its
PRC subsidiaries and affiliates which generate all of the Company's earnings.
Pursuant to the relevant laws and regulations of Sino-foreign joint
venture enterprises, the profits of High Worth JV, calculated pursuant to
generally accepted accounting principles in the PRC ("PRC GAAP"), are
available for distribution in the form of cash dividends to each equity
investor, in proportion to each investor's interest in the joint venture,
after satisfaction of all tax liabilities, provision for any losses in
previous years, and appropriations to reserve funds, as determined at the
discretion of the board of directors in accordance with PRC accounting
standards and regulations. The principal adjustments necessary to conform
PRC GAAP financial statements to financial statements prepared in accordance
with generally accepted accounting principles in the United States ("US
GAAP") are the reclassification of certain expense items from income
appropriations to
26
charges against income, adjustments for sales, other income and purchases
recognized on a cash basis, depreciation charges, deferred taxation and
revaluation of fixed assets.
In accordance with the relevant laws and regulations in the PRC,
the profits available for distribution are based on PRC GAAP financial
statements. If High Worth JV has foreign currency available after meeting the
operational needs of its PRC subsidiaries, it may make a profit distribution
to Holdings. Otherwise, it will be necessary to obtain approval and convert
such distributions at the exchange centers. At December 31, 1997, the
Company's distributable profits were approximately RMB 65,972,000.
On November 25, 1997, the Board of Directors of High Worth JV
declared the first dividend distribution in which Holdings was entitled, of
approximately RMB 83,000,000 which was based on PRC GAAP financial
statements. The dividend will be distributed in installments in order to
avoid any disruption to High Worth JV's normal operating cash flow position.
During the year ended December 31, 1997, Holdings received a total of RMB
10,000,000 as a partial dividend distribution.
ITEM 6. SELECTED FINANCIAL DATA
The following financial data has been derived from the audited
consolidated financial statements and should be read in conjunction with the
consolidated financial statements and notes thereto appearing elsewhere in
this document. All amounts are in RMB. The exchange rate was US$1.00 to RMB
8.32 at December 31, 1995, RMB 8.32 at December 31, 1996 and RMB 8.30 at
December 31, 1997.
CBR Brewing Company, Inc.
(in RMB) and Subsidiaries
------------------------
Years Ended December 31,
----------------------------------------------
1997 1996 1995
------------- ------------- -----------
Consolidated Statement
of Income Data:
Sales, net of sales taxes 1,169,286,489 1,233,277.624 566,786,939
Gross profit 208,326,796 194,138,432 71,133,533
Operating income 11,214,860 25,325,483 6,458,405
Net income 30,762,902 20,211,809 19,625,968
Net income per common share 3.84 2.53 2.45
Cash dividends declared per
common share -0- -0- -0-
27
As of December 31,
----------------------------------------------
1997 1996 1995
------------- ------------- -----------
Consolidated Balance
Sheet Data:
Net working capital
(deficiency) (102,725,259) (83,554,409) (97,555,553)
Total assets 835,094,540 826,502,148 746,898,874
Long term liabilities 16,512,851 15,862,549 24,897,291
Advances from shareholders 73,617,552 73,794,948 73,794,948
Shareholders' equity 178,351,384 147,588,482 127,376,673
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Effective December 16, 1994, the Company acquired Holdings, which,
through its subsidiaries and affiliates, is engaged in the production and
sale of Pabst Blue Ribbon beer in China. Holdings is a holding company which
was formed solely to effect the acquisition of a 60% interest in High Worth
JV. On October 31, 1994, High Worth JV acquired a 100% interest in Zhaoqing
Brewery, including Zhaoqing Brewery's 40% interest in Noble Brewery.
The acquisition of Zhaoqing Brewery, including Zhaoqing Brewery's
40% interest in Noble Brewery, has been accounted for under the purchase
method of accounting. The consolidated financial statements include the
results of operations of Zhaoqing Brewery on a consolidated basis and Noble
Brewery under the equity method of accounting for investments commencing
October 31, 1994. Accordingly, the Company's post-acquisition consolidated
statements of income are presented for the years ended December 31, 1995,
1996 and 1997.
For accounting purposes, the acquisition of Holdings by the Company
has been treated as a recapitalization of Holdings with Holdings as the
acquirer (reverse acquisition).
During February 1995, the Marketing Company was established to
conduct the distribution, marketing and promotion throughout China of the
Pabst Blue Ribbon beer produced by Zhaoqing Brewery and Noble Brewery and the
mineral water and non-carbonated soft drinks produced by Guangdong Blue
Ribbon under the Blue Ribbon brand name. Zhaoqing Brewery HC owns a 70%
interest and Guangdong Blue Ribbon owns a direct 30% interest and an indirect
28% interest in the Marketing Company. As a result, the Company owns a 42%
net interest in the Marketing Company. Zhaoqing Brewery and Noble Brewery
commenced selling their production of Pabst Blue Ribbon beer through the
Marketing Company in April 1995 and July 1995, respectively. Sichuan Brewery
commenced selling its production of Pabst Blue Ribbon beer through the
Marketing Company in April 1997 (See ITEM 1. BUSINESS - SICHUAN BREWERY).
The consolidated financial statements include the results of operations of
the Marketing Company on a consolidated basis commencing from April 1, 1995.
The Company has a
28
controlling interest in the Marketing Company even though it has an effective
interest of only 42% because of the Company's 60% interest in High Worth JV
and 70% interest in the Marketing Company (through Zhaoqing Brewery HC), and
because the Company controls the majority of the votes on the board of
directors of the Marketing Company and Zhaoqing Brewery HC.
Prior to March 1995, Zhaoqing Brewery had produced exclusively
domestic brands of beer, and had an annual production capacity of 50,000
metric tons or 425,000 barrels of beer. In late 1994, Zhaoqing Brewery
commenced the conversion and refinement of its original facilities and
adopted a new brewing technology in order to produce beer under the Pabst
Blue Ribbon label. During March 1995, Zhaoqing Brewery discontinued the
production of all domestic brand beer and commenced exclusive production of
Pabst Blue Ribbon beer. However, less than 5% of beer production normally
does not meet Pabst Blue Ribbon quality standards and is packed and
distributed as lower priced, local brand beer. With the implementation of
the new brewing technology and the purchase of additional equipment during
1995, Zhaoqing Brewery reached its current full-scale annual production
capacity of 100,000 metric tons or 850,000 barrels of beer at the end of 1995.
Noble Brewery has produced Pabst Blue Ribbon beer exclusively since
it commenced operations. Prior to 1994, Noble Brewery had an annual
production capacity of 80,000 metric tons or 680,000 barrels of beer. With
the completion of a second brewing facility in July 1994, Noble Brewery
reached its full-scale annual production capacity of 200,000 metric tons or
1,700,000 barrels of beer in late 1994.
In January 1996, Zhaoqing Brewery HC transferred all of its
operating assets and liabilities to High Worth JV pursuant to the original
Joint Venture Agreement, the Asset Transfer Agreement signed in May 1994, and
the relevant government regulations. Subject to the completion of certain
legal procedures and documentation, the investments in Noble Brewery and the
Marketing Company will be transferred to High Worth JV. Zhaoqing Brewery HC
is currently acting as the nominee for High Worth JV with respect to the
investments in Noble Brewery and the Marketing Company.
Upon the completion of the required procedures and documentation,
all of the assets and liabilities formerly controlled by Zhaoqing Brewery
will have been transferred to High Worth JV. During 1996 and 1997, the
operating activities of Zhaoqing Brewery were part of High Worth JV. The
consensus and approval from the local tax authority was obtained during
January 1996. In the following text, "Zhaoqing Brewery" refers to the
brewing complex, which was transferred to High Worth JV in January 1996, and
"Zhaoqing Brewery HC" refers to the PRC entity that previously owned the
brewing complex from November 1994 through December 1995.
In late 1996, Guangdong Blue Ribbon established a wholly-owned
subsidiary in Le Shang City, Sichuan Province, PRC, and started converting an
existing brewery with an annual production capacity of 20,000 metric tons
into a Pabst Blue Ribbon brewing complex ("Sichuan Brewery"). Production and
sale of Pabst Blue Ribbon beer commenced in April 1997.
29
In 1997, Sichuan Brewery's production amounted to 13,430 metric
tons and the Marketing Company has distributed 8,124 metric tons for Sichuan
Brewery in 1997, which represented 3.6% of the Company's total 1997 sales
volume.
In 1998, Zao Yang High Worth Brewery will commence production of
Pabst Blue Ribbon beer after the completion of converting the existing
facilities into a Pabst Blue Ribbon beer brewing facility. Pursuant to the
joint venture agreement, Zao Yang High Worth Brewery is committed to sell all
its beer products to the Marketing Company for resale.
CONSOLIDATED RESULTS OF OPERATIONS:
Zhaoqing Brewery and Noble Brewery commenced distribution of their
production of Pabst Blue Ribbon beer through the Marketing Company during
April 1995 and July 1995, respectively. The commencement of the Marketing
Company's operations, which are presented on a consolidated basis, resulted
in a significant change in the Company's operating structure and income
statement presentation during 1995. Accordingly, a comparison of results of
operations for the years ended December 31, 1996 and 1997 to results of
operations for the year ended December 31, 1995 is not necessarily meaningful.
The Company conducts a substantial portion of its purchases through
related parties, and has additional significant continuing transactions with
such parties (See "ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS")
YEARS ENDED DECEMBER 31, 1997 AND 1996:
SALES:
For the year ended December 31, 1997, net sales, all of which were
conducted through the Marketing Company, were RMB 1,169,286,489, of which RMB
1,167,296,661 (99.8%) was from the sale of 227,418 metric tons of beer and
RMB 1,989,828 (0.2%) was from the sale of mineral water and non-carbonated
soft drinks. During the year ended December 31, 1997, the Marketing Company
purchased for resale RMB 675,247,962 and RMB 33,052,735 of beer products from
Noble Brewery and Sichuan Brewery, respectively, and nil of mineral water and
non-carbonated soft drinks from Guangdong Blue Ribbon. Approximately 99% of
total sales in 1997 were from products with the Pabst Blue Ribbon brand name.
For the year ended December 31, 1996, net sales, all of which were
conducted through the Marketing Company, were RMB 1,233,277,624 of which RMB
1,158,091,595 (93.9%) was from the sale of 232,066 metric tons of beer and
RMB 75,186,029 (6.1%) was from the sale of mineral water and non-carbonated
soft drinks. During the year ended December 31, 1996, the Marketing Company
purchased for resale RMB 695,150,225 of beer products from Noble Brewery and
RMB 69,166,604 of mineral water and non-carbonated soft drinks from Guangdong
Blue Ribbon. Approximately 99% of total sales in 1996 were from products
with the Pabst Blue Ribbon brand name.
Net sales decreased by RMB 63,991,135 or 5.2% in 1997 as compared to
1996, as a result of the Company's elimination of the sales of mineral
30
water, non-carbonated soft drinks and red wine in 1997. During 1996, the
Company sold mineral water, non-carbonated soft drinks and red wine, which
were purchased from Guangdong Blue Ribbon. The Company discontinued the sale
of mineral water, non-carbonated soft drinks and red wine in late 1996.
During the year ended December 31, 1997, net sales of beer products increased
by RMB 9,205,066 or 0.8% to RMB 1,167,296,661, as compared to RMB
1,158,091,595 for the year ended December 31, 1996. The Company sold 227,418
metric tons of beer to distributors in 1997 as compared to 232,066 metric
tons of beer in 1996. The slight increase in net sales of beer products in
1997 as compared to 1996 was primarily attributable to a shift in the sales
mix to higher value products in 1997.
During the year ended December 31, 1997, Zhaoqing Brewery sold
74,216 metric tons of beer to the Marketing Company, of which 1,156 metric
tons (1.6%) were local brand beer and 73,060 metric tons (98.4%) were Pabst
Blue Ribbon beer. The 1,156 metric tons of local brand beer were produced
throughout 1997. During the year ended December 31, 1996, Zhaoqing Brewery
sold 83,439 metric tons of beer to the Marketing Company, of which 2,526
metric tons (3.0%) were local brand beer and 80,913 metric tons (97.0%) were
Pabst Blue Ribbon beer. Total beer sold by Zhaoqing Brewery to the Marketing
Company decreased by 9,223 metric tons or 11.1% from 1996 to 1997.
The Marketing Company regulates the production of Pabst Blue Ribbon
beer by Zhaoqing Brewery and Noble Brewery in accordance with their
respective production capacities in order to balance warehouse inventory
levels and accommodate projected market demand. As a result of heavy rains
in China during the three months ended September 30, 1997, which caused
widespread flooding and washed out many roads, the Company's ability to ship
its beer products to distributors was significantly impaired during this
period. In addition, the Company believes that the widespread flooding also
caused a temporary decrease in consumer's discretionary income available to
purchase the Company's products. In 1997, the production by Sichuan Brewery
also represented sales volume of 8,124 metric tons. As a result of these
factors, total beer sold by Zhaoqing Brewery and Noble Brewery to the
Marketing Company decreased during the year ended December 31, 1997 as
compared to the year ended December 31, 1996, as the Company reduced
production to correspond to lower demand in an effort to avoid excessive
finished goods inventory.
GROSS PROFIT:
For the year ended December 31, 1997, total gross profit was RMB
208,326,796 or 17.8% of total net sales, and consisted of gross profit from
beer sales of RMB 208,269,171 or 17.8% of net sales of beer and gross profit
from sales of mineral water and non-carbonated soft drinks of RMB 57,625 or
2.9% of net sales of mineral water and non-carbonated soft drinks. For the
year ended December 31, 1996, total gross profit was RMB 194,138,432 or 15.7%
of total net sales, and consisted of gross profit from beer sales of RMB
188,204,326 or 16.3% of net sales of beer and gross profit from sales of
mineral water, non-carbonated soft drinks and red wine of RMB 5,934,106 or
7.9% of net sales of mineral water, non-carbonated soft drinks and red wine.
31
Gross margin from beer sales increased to 17.8% in 1997 as compared
to 16.3% in 1996 as a result of a shift in the sales mix to slightly higher
margin products in 1997 in response to changing market conditions, as well as
the effect of cost control measures.
The Company expects that it will experience pressure on its gross
profit margin in 1998 as a result of the following factors: a continuing
softening of consumer demand in China caused in substantial part by the
central government of China's regulatory controls and economic policies, and
increasing competition from foreign premium brand beers.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:
For the year ended December 31, 1997, selling, general and
administrative expenses were RMB 197,111,936 or 16.9% of net sales,
consisting of selling expenses of RMB 129,202,587 and general and
administrative expenses of RMB 67,909,349. Net of the allowance for doubtful
accounts of RMB 5,314,858 recorded during 1997, general and administrative
expenses were RMB 62,594,491.
For the year ended December 31, 1996, selling, general and
administrative expenses were RMB 168,812,949 or 13.7% of net sales,
consisting of selling expenses of RMB 103,460,671 and general and
administrative expenses of RMB 65,352,278. Net of the allowance for doubtful
accounts of RMB 9,914,114 recorded during 1996, general and administrative
expenses were RMB 55,438,164.
Selling expenses include costs relating to the advertising,
promotion, marketing and distribution of Pabst Blue Ribbon beer in China.
Selling expenses increased by RMB 25,741,916 or 24.9% in 1997 as compared to
1996, and as a percent of net sales, to 11.0% in 1997 from 8.4% in 1996.
Selling expenses increased in 1997 as compared to 1996, both on an absolute
basis and as a percentage of sales, as a result of the increase in selling
expenses in 1997 related to beer products exceeding the reduction in selling
expenses related to mineral water, non-carbonated soft drinks and red wine,
which products the Company sold in 1996 but is not selling in 1997. During
1997, the Company implemented a substantially expanded advertising and
promotional program to stimulate consumer demand, provide distributor
incentives and to maintain the market position of Pabst Blue Ribbon beer in
China as a result of softening consumer demand and increasing competition
from foreign premium brand beer.
General and administrative expenses include the costs associated
with the operation of the Company's management and executive offices and the
legal and accounting costs associated with the operation of a public company.
Excluding the allowance for doubtful accounts, general and administrative
expenses increased by RMB 7,156,327 or 12.9% in 1997 as compared to 1996, and
as a percentage of net sales, to 5.4% in 1997 from 4.5% in 1996. General and
administrative expenses increased in 1997 as compared in 1996 primarily as a
result of increased personnel and personnel related costs.
The allowance for doubtful accounts, which is calculated based
primarily on the age of outstanding accounts receivable, decreased to 0.5% of
32
net sales in 1997 as compared to 0.8% of net sales in 1996 as a result of a
reduction in the age of accounts receivable outstanding in 1997. However,
accounts receivable are typically outstanding for a longer period of time in
China than in the United States.
OPERATING INCOME:
For the year ended December 31, 1997, operating income was RMB
11,214,860 or 1.0% of net sales. For the year ended December 31, 1996,
operating income was RMB 25,325,483 or 2.1% of net sales. The decrease in
operating income is primarily attributable to the elimination of the sales of
mineral water, non-carbonated soft drinks and red wine, reduction in sales
tonnage and increased selling, general and administrative expenses. The
adjustment and regulation of production between Zhaoqing Brewery and Noble
Brewery by the Marketing Company also contributed to the decrease in
operating income in 1997 as compared to 1996. The Marketing Company
purchases Pabst Blue Ribbon beer at mutually agreed ex-factory prices, and is
only allowed to mark-up the cost of Pabst Blue Ribbon beer purchased in order
to adequately cover its selling, advertising, promotional, distribution and
administrative expenses incurred in selling to distributors. The Marketing
Company incurred certain excessive selling and advertising expenses in 1997
that were not fully compensated for in the Marketing Company's intra-company
pricing structure. Accordingly, the Marketing Company has reduced the price
that it pays for Pabst Blue Ribbon beer by 3% in 1998, which is expected to
benefit the Company's consolidated results of operations in 1998 and
subsequent periods.
INTEREST INCOME AND INTEREST EXPENSE:
For the year ended December 31, 1997, interest income was RMB
6,255,590 as compared to interest income of RMB 6,119,470 for the year ended
December 31, 1996. The increase in interest income in 1997 of RMB 136,120 or
2.2% as compared to 1996 was primarily the result of an increase of RMB
1,554,699 in interest earned on amounts due from Guangdong Blue Ribbon during
1997.
For the year ended December 31, 1997, interest expense, net of
amounts capitalized, was RMB 15,503,189, as compared to RMB 20,767,252 for
the year ended December 31, 1996. The decrease in interest expense in 1997
of RMB 5,264,063 or 25.3% as compared to 1996 was primarily the result of a
decrease in customer deposits, a decrease in capital lease obligations, a
decrease in interest rates on bank borrowings by Zhaoqing Brewery, and a
decrease of RMB 4,655,308 in interest paid on amounts due to Guangdong Blue
Ribbon and other related companies.
INCOME TAXES:
For the year ended December 31, 1997, no income tax expense was
provided, as Zhaoqing Brewery's operations in China were subject to a 100%
tax exemption in 1996 and 1997. With respect to the Company's estimated
United States Federal income tax liability for the distributed earnings of
High Worth JV, no income tax expense was provided due to the Company's
election in 1997 to treat High Worth JV as a partnership for United States
Federal income tax purposes.
33
NET INCOME:
For the year ended December 31, 1997, net income increased to RMB
30,762,902 (RMB 3.84 per share) or 2.6% of net sales, as compared to net
income of RMB 20,211,809 (RMB 2.53 per share) or 1.6% of net sales for the
year ended December 31, 1996.
YEARS ENDED DECEMBER 31, 1996 AND 1995:
SALES:
For the year ended December 31, 1996, net sales, almost all of
which were conducted through the Marketing Company, were RMB 1,233,277,624,
of which RMB 1,158,091,595 (93.9%) was from the sale of 232,066 metric tons
of beer and RMB 75,186,029 (6.1%) was from the sale of mineral water and
non-carbonated soft drinks. During the year ended December 31, 1996, the
Marketing Company purchased for resale RMB 695,150,225 of beer products from
Noble Brewery and RMB 69,166,604 of mineral water and non-carbonated soft
drinks from Guangdong Blue Ribbon. Approximately 99% of total sales in 1996
were from products with the Pabst Blue Ribbon brand name.
For the year ended December 31, 1995, net sales, consisting of
sales both by Zhaoqing Brewery directly and through the Marketing Company,
were RMB 566,786,939, of which RMB 504,500,315 (89.0%) was from the sale of
107,015 metric tons of beer and RMB 62,286,624 (11.0%) was from the sale of
mineral water and non-carbonated soft drinks. During the year ended December
31, 1995, the Marketing Company purchased for resale RMB 327,805,406 of beer
product from Noble Brewery and RMB 61,708,086 of mineral water and
non-carbonated soft drinks from Guangdong Blue Ribbon. Approximately 95% of
total sales in 1995 were from products with the Pabst Blue Ribbon brand name.
For the year ended December 31, 1996, Zhaoqing Brewery sold 83,439
metric tons of beer, of which 2,526 metric tons (3.0%) were local brand beer
and 80,913 metric tons (97.0%) were Pabst Blue Ribbon beer. The 2,526 metric
tons of local brand beer were produced throughout 1996. During the year
ended December 31, 1995 Zhaoqing Brewery sold 45,708 metric tons of beer, of
which 11,388 metric tons (24.9%) were local brand beer and 34,320 metric tons
(75.1%) were Pabst Blue Ribbon beer. Total beer sold increased by 37,731
metric tons or 82.5% from 1995 to 1996 as a result of increase in production
capacity.
GROSS PROFIT:
For the year ended December 31, 1996, gross profit was RMB
194,138,432 or 15.7% of net sales, as compared to RMB 71,133,533 or 12.6% of
net sales for the year ended December 31, 1995. The increase in the gross
profit margin of 3.1% on an absolute basis or 24.6% in 1996 as compared to
1995 was a result of a change in the product mix, an increase in sales unit
volume, an increase in sales prices, the introduction of a bottle recycling
program during 1996, and production of Pabst Blue Ribbon beer throughout 1996.
34
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:
For the year ended December 31, 1996, selling, general and
administrative expenses were RMB 168,812,949 (13.7% of net sales), consisting
of selling expenses of RMB 103,460,671 and general and administrative
expenses of RMB 65,352,278. For the year ended December 31, 1995, selling,
general and administrative expenses were RMB 64,675,128 (11.4% of net sales),
consisting of selling expenses of RMB 32,821,498 and general and
administrative expenses of RMB 31,853,630.
Selling expenses include costs relating to the advertising,
promotion, marketing and distribution of Pabst Blue Ribbon beer in China.
During 1995, the Marketing Company was established to market throughout China
the Pabst Blue Ribbon beer produced by Zhaoqing Brewery and Noble Brewery.
The Marketing Company assumed the responsibility for marketing the Pabst Blue
Ribbon beer produced by Zhaoqing Brewery and Noble Brewery during April 1995
and July 1995, respectively, and incurred most of the 1995 and almost all of
the 1996 selling expenses. General and administrative expenses include the
costs associated with the operation of the Company's executive offices, and
the legal and accounting costs associated with the operation of a public
company.
Selling expenses increased by RMB 70,639,173 or 215.2% in 1996 as
compared to 1995, and represented 8.4% of net sales in 1996 as compared to
5.8% of net sales in 1995, as a result of increased marketing and promotion
costs incurred during 1996 to support increased marketing efforts
necessitated by the increased production capacity of Zhaoqing Brewery and
Noble Brewery. General and administrative expenses increased by RMB
33,498,648 or 105.2% in 1996 as compared to 1995, and represented 5.3% of net
sales in 1996 as compared to 5.6% of net sales in 1995. During the year
ended December 31, 1996, the Company recorded an allowance for doubtful
accounts of RMB 9,914,114, as compared to an allowance for doubtful accounts
of RMB 5,600,000 for the year ended December 31, 1995.
OPERATING INCOME:
For the year ended December 31, 1995, operating income was RMB
25,325,483 or 2.1% of net sales, as compared to operating income of RMB
6,458,405 or 1.1% of net sales for the year ended December 31, 1995.
INTEREST INCOME AND INTEREST EXPENSE:
For the year ended December 31, 1996, interest income was RMB
6,119,470. There was no interest income for the year ended December 31,
1995. The increase in interest income in 1996 as compared to 1995 is
primarily the result of interest earned on amounts due from Guangdong Blue
Ribbon during 1996.
For the year ended December 31, 1996, interest expense, net of
amounts capitalized, was RMB 20,767,252, as compared to RMB 3,236,058 for the
year ended December 31, 1995. The increase in interest expense in 1996 as
compared to 1995 is primarily the result of amounts borrowed from Guangdong
Blue Ribbon, increased borrowings by Zhaoqing Brewery and the amounts
borrowed
35
from related companies that are controlled by beneficial shareholders of the
Company.
INCOME TAXES:
For the year ended December 31, 1996, income tax expense was RMB
4,721,444. Although the Company's operations in China were subject to a 100%
tax exemption in 1995 and 1996, deferred income taxes of RMB 308,444 were
recorded with respect to the Company's operations in China, and RMB 4,413,000
were recorded with respect to the Company's estimated United States Federal
income tax liability resulting from earnings distributed as dividends by
Noble Brewery in 1997. For the year ended December 31, 1995, income tax
expense was RMB 1,000,000, which represented deferred income taxes as a
result of temporary timing differences with respect to accelerated
depreciation of property, plant and equipment.
NET INCOME:
For the year ended December 31, 1996, net income was RMB 20,211,809
(RMB 2.53 per share) or 1.6% of net sales, as compared to net income of RMB
19,625,968 (RMB 2.45 per share) or 3.5% of net sales for the year ended
December 31, 1995.
NOBLE BREWERY
Years Ended December 31, 1997 and 1996:
SALES:
For the year ended December 31, 1997, net sales were RMB
639,678,595, consisting of 146,148 metric tons of beer sold to the Marketing
Company for resale and 665 metric tons of beer sold to Guangdong Blue Ribbon.
For the year ended December 31, 1996, net sales were RMB 655,316,991,
consisting of 154,435 metric tons of beer sold to the Marketing Company for
resale.
During the year ended December 31, 1997, Noble Brewery sold 146,813
tmetric tons of beer, as compared to 154,435 metric tons of beer sold during
the year ended December 31, 1996. Total beer sold decreased by 7,622 metric
tons or 4.9% from 1996 to 1997 as a result of the regulation of sales by the
Marketing Company, which purchases beer from the two breweries in accordance
with their respective production capacities, reduction in sales tonnage, and
the production by Sichuan Brewery in 1997.
GROSS PROFIT:
For the year ended December 31, 1997, gross profit was RMB
179,062,125 or 28.0% of net sales, as compared to gross profit of RMB
145,150,002 or 22.1% of net sales for the year ended December 31, 1996. The
increase in the gross profit margin of 5.9% on an absolute basis or 26.7% in
1997 as compared to 1996 was a result of a change in the product mix, the
decrease in cost of raw materials, cost control measures, and the Marketing
36
Company handling the distribution of all of the Company's production of Pabst
Blue Ribbon beer throughout 1997.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:
For the year ended December 31, 1997, selling, general and
administrative expenses were RMB 36,193,085 (5.7% of net sales), consisting
of selling expenses of RMB 3,692,522 and general and administrative expenses
of RMB 32,500,563. For the year ended December 31, 1996, selling, general
and administrative expenses were RMB 38,937,354 (5.9% of net sales),
consisting of selling expenses of RMB 6,057,013 and general and
administrative expenses of RMB 32,880,341. Selling expenses consist of
warehousing, storage and freight costs.
During 1995, the Marketing Company was established to market
throughout China the Pabst Blue Ribbon beer produced by Zhaoqing Brewery and
Noble Brewery. The Marketing Company assumed the responsibility for
marketing the Pabst Blue Ribbon beer produced by Noble Brewery during July
1995, and incurred most of the 1995 and almost all of the 1996 and 1997
selling expenses.
Selling expenses decreased by RMB 2,364,491 or 39.0% in 1997 as
compared to 1996, and represented 0.6% of net sales in 1997 as compared to
0.9% of net sales in 1996, as a result of effective cost controls and the
establishment of the Marketing Company to be responsible for all the
advertising and promotional activities. General and administrative expenses
decreased by RMB 379,778 or 1.2% in 1997 as compared to 1996, and represented
5.1% of net sales in 1997 as compared to 5.0% of net sales in 1996. During
the year ended December 31, 1997, Noble Brewery credited allowance for
doubtful accounts of RMB 1,207,252, as compared to providing an allowance for
doubtful accounts of RMB 1,459,963 for the year ended December 31, 1996.
OPERATING INCOME:
For the year ended December 31, 1997, operating income was RMB
142,869,040 or 22.3% of net sales, as compared to operating income of RMB
106,212,648 or 16.2% of net sales for the year ended December 31, 1996.
INTEREST INCOME AND INTEREST EXPENSE:
For the year ended December 31, 1997, interest income was RMB
2,078,006, as compared to interest income of RMB 3,901,929 for the year ended
December 31, 1996, due mainly to the fact that the amount of the average
monthly bank balance was lower in 1997. Also, starting from the last quarter
of 1997, the Marketing Company commenced to assign and endorse short term
bills receivable to Noble Brewery and High Worth JV in order to facilitate
the two breweries to arrange their own financing, resulting in lower interest
income from bank deposits in 1997 for Noble Brewery.
For the year ended December 31, 1997, interest expense was RMB
1,458,454, as compared to interest expense of RMB 3,450,585 for the year
ended December 31, 1996, as a result of lower borrowings.
37
INCOME TAXES:
For the year ended December 31, 1997, income tax expense was RMB
21,331,616, which consisted of RMB 18,131,616 for PRC income taxes and RMB
3,200,000 for deferred income taxes as a result of temporary timing
differences with respect to accelerated depreciation of property, plant and
equipment. For the year ended December 31, 1996, income tax expense was RMB
16,535,421, which consisted of RMB 13,053,421 for PRC income taxes and RMB
3,500,000 for deferred income taxes as a result of temporary timing
differences with respect to accelerated depreciation of property, plant and
equipment. The two-year income tax holiday for Noble Brewery expired on
December 31, 1995. Commencing in 1996, Noble Brewery is required to pay
local income tax at half the normal rate of 33% on its profit as determined
in accordance with PRC accounting standing standards applicable to Noble
Brewery.
NET INCOME:
For the year ended December 31, 1997, net income was RMB
122,156,976 or 19.