ITEM 1.
BUSINESS.
Business Overview
We are a leading paper packaging company in China. Through our wholly-owned subsidiaries, Great Shengda, Shengda Color, Hangzhou Shengming and Suzhou AA, we are principally engaged in the design, manufacture and sale of flexo-printed and color-printed corrugated paper cartons in a variety of sizes and strengths. We also manufacture corrugated paperboards, which are used for the production of our flexo-printed and color-printed cartons.
We provide paper packaging solutions to a wide variety of industries, including food, beverage, cigarette, household appliance, consumer electronics, pharmaceuticals, chemicals, machinery and other consumer or industrial sectors. Our major products are single-layer paper cartons for food, drinks and medicine, double-layer paper cartons for garments, chemicals, furniture, refrigerators and air-conditioners, and triple-layer paper cartons for electrical machinery, motorcycles, and other heavy-duty products. Our sales volume in 2012 reached 317.4 million square meters with an annual production capacity of 545 million square meters in 2012.
Our production facilities are strategically located in the YRD, a manufacturing center in China, thus putting us in close proximity to a large number of paper carton customers. Due to the weight and bulk of paper products and the consequent high shipping costs, paper packaging companies are generally limited to servicing a geographic radius from their production site, usually between 300 and 500 kilometers, within which they can compete economically. The paper carton market, therefore, is highly influenced by regional supply and demand dynamics. Based from our four manufacturing facilities in the provinces of Zhejiang and Jiangsu, we have established a sales network with five customer service centers that can service customers throughout the YRD, which accounted for the majority of our revenues. As the leading paper packaging manufacturer in the YRD, we are well positioned to capitalize on the fast-growing demand for paper cartons driven by the concentration and success of the manufacturing companies in the region.
We serve a broad base of reputable customers, including some of the Fortune 500 companies and Top 500 Chinese enterprises. Our major customers include Nongfu Spring Co., Ltd., Hangzhou Cigarette Company, Samsung’s Chinese subsidiary Suzhou Samsung Electrical Co., Ltd. and Panasonic’s Chinese subsidiary Hangzhou Panasonic Home Electrical Appliance Company. We have developed long-term relationships with and loyalty from our customers, many of which have been with us for over five years. We have also engaged in strategic alliance relationships with ten customers as their preferred supplier. At the same time, we continue to attract new customers to generate higher demand for our products and increase market penetration.
Our senior management has been involved in the paperboards and paper cartons business since 1999, when Zhejiang New Shengda, the company that sold to Great Shengda the assets that form the basis of our operations, was incorporated. We benefit from the industry connections and experience of our senior management, which enable us to develop a strong reputation among our customers and in our industry. Great Shengda was granted the “China Packaging Leading Enterprise Award” by the China Packaging Technology Association (the predecessor of China Packaging Federation), and was named a “Chinese Development and Production Base of Paper Packaging” by the State Economic and Trade Commission and China Packaging Federation. Our Shengda trademark was recognized as a Chinese Well-Known Trademark in 2010 as a result of the market reputation we have built over the years.
Our total revenues for the year ended December 31, 2012 were $125.3 million, an increase of $1.3 million, or 1.1%, from $124.0 million for the year ended December 31, 2011. Our net income attributable to the Company’s common stockholders for the year ended December 31, 2012 was $5.6 million, a decrease of $4.0 million, or 42.2%, from $9.6 million for the year ended December 31, 2011.
Corporate History and Background
We were incorporated in the State of Nevada on March 16, 2007 as a web-based service provider offering an online service where health practitioners (such as chiropractors, dentists, massage therapists, occupational therapists and counselors) could purchase products and services to improve their work and home lives, including books, CDs, clothing, and accessories geared towards the needs of these practitioners. However, we did not engage in any operations and were dormant from our inception until our reverse acquisition of Evercharm on April 8, 2010.
On April 8, 2010, we completed a reverse acquisition transaction through a share exchange with Evercharm and its sole shareholder, Shengda (Group) Holdings Ltd., or Shengda Holdings, whereby we acquired 100% of the issued and outstanding capital stock of Evercharm in exchange for 27,600,000 shares of our common stock, which constituted 92% of our issued and outstanding shares on a fully-diluted basis immediately after the consummation of the reverse acquisition. As a result of the reverse acquisition, Evercharm became our wholly-owned subsidiary and Shengda Holdings became our controlling stockholder. The share exchange transaction with Evercharm was treated as a reverse acquisition, with Evercharm as the accounting acquirer and the Company as the acquired party.
Subsequently on May 10, 2010, Shengda Holdings distributed the shares it received in the reverse acquisition to the family of Nengbin Fang, our Chairman, and certain other individuals. As a result, members of the Fang family own approximately 54.02% of our common stock.
Through our ownership of Evercharm and its principal PRC operating subsidiaries, Great Shengda, Shengda Color, Hangzhou Shengming and Suzhou AA, we design, manufacture and sell paper cartons and offer packaging solutions to principally consumer and industrial goods manufacturing companies in China. Prior to the formation of Great Shengda, Zhejiang New Shengda operated our paper packaging business. Since 1999, the business had been managed under the leadership of Nengbin Fang, Zhejiang New Shengda’s then general manager and our current Chairman. In 2004, when Great Shengda was incorporated, Zhejiang New Shengda transferred all of its paper packaging assets to Great Shengda and became a dormant company, and Mr. Fang became the Chairman of Great Shengda to continue to manage the business.
On September 22, 2011, we incorporated Shuangsheng in Jiangsu Province, PRC. On September 27, 2011, we received Shuangsheng’s business license from the local Administration of Industry and Commerce approving Shuangsheng to be engaged in the business of new paper making technology, related research and the development, application, transfer and consultation of such relevant technology. Pursuant to the business license, Shuangsheng has registered capital of RMB 88 million (approximately $13.7 million) with actually invested capital of RMB 22 million (approximately $3.4 million).
Our Corporate Structure
All of our business operations are conducted through our Chinese subsidiaries. The chart below presents our corporate structure as of the date of this report:
Our Industry
The Paper Packaging Market in China
Our industry has grown steadily since the mid-1980s with one of the highest growth rates in the international packaging market. Corrugated packaging is the largest subsector of the paper packaging industry in China.
Compared to other countries, current per capita paper packaging consumption in China is very low. According to China Packaging Federation, each person in China consumes on average 55 kg of paper packaging annually, which is one-sixth that of the United States, one-fifth of Japan, a quarter of Europe and half of India. With per capita paper packaging consumption far below other large economies in the world, the Chinese paper packaging industry has considerable potential for sustainable growth. According to S&P Consulting, the production volume of corrugated paper cartons will grow to 39.2 million tons in 2013, and the market demand will grow to 62.6 billion square meters in 2013. According to China Packaging Federation, China is expected to overtake the United States as the largest corrugated paper packaging market by 2013.
Demand for Our Products
The main customers of the paper packaging industry are consumer and industrial goods manufacturers that use corrugated paper cartons for packaging and shipping of their products, including food and beverage, home appliances, IT and electronics, daily necessities, pharmaceuticals, chemicals and machinery. The continued robust growth in the retail sales of consumer goods has significant positive impacts on the demand for corrugated packaging products.
Other trends in our industry expected to impact our growth include customer migration toward paper as a more environmentally-responsible packaging material than plastic, glass, metal, or wood; government policies designed to encourage domestic consumption of consumer goods; increasing competition for high-quality, low-cost packaging; and greater consolidation among paper packaging suppliers.
Paper Packaging Market in East China
Our subsidiaries are located in the YRD of East China, which is the most affluent region amongst six major regions in China with the highest per capita gross domestic product, or GDP. The YRD consists of three areas, namely Shanghai, Jiangsu Province and Zhejiang Province, all ranked among top five in China in terms of per capita GDP. The high per capita GDP has led to strong purchasing power for various products, which in turn has generated high demand for corrugated cartons within the region.
Our Products
The corrugated paper cartons that we design, manufacture and sell are flexo-printed or color-printed paper boxes. Our corrugated paper cartons are used for a wide variety of products, such as food, beverage, cigarette, household appliance, consumer electronics, pharmaceuticals, chemicals, furniture, garments, machinery and other consumer and industrial goods. Our paper cartons are available in a wide range of sizes and strengths depending on the type, weight and size of the products and the manner in which these paper cartons are used. For the year ended December 31, 2012, approximately 71.3% and 28.7% of our sales revenue was generated from sales of our flexo-printed and color-printed boxes, respectively, as compared to approximately 72.9% and 27.1%, respectively, for the year ended December 31, 2011.
The following charts illustrate the sales revenue breakdown by paper carton type and end market for 2012:
Revenue Breakdown by Carton Type
Year Ended December 31, 2012
Revenue Breakdown by End Market
Year Ended December 31, 2012
Our paper cartons are made of corrugated paperboards machine-cut to the designed dimensions and then folded into paper cartons. We use single-layer, double-layer and triple-layer corrugated paperboards sandwiched between Kraft paper sheets (Kraft paper is a type of paper, which is strong and relatively coarse, produced from the chemical pulp of softwood under the Kraft process). The thickness of the paperboards and the type of corrugated paper sheets used are key determinants of the strength of the paper cartons manufactured.
Our paperboards and paper cartons are summarized below:
Type of Paperboards Type of Paper Cartons Recommended Applications
Single-layer paperboards comprising a single sheet of corrugated paper sandwiched between two sheets of Kraft paper.
Single-layer paper cartons Packaging for food, drinks and medicine
Double-layer paperboards comprising two sheets of corrugated paper sandwiched between three sheets of Kraft paper.
Double-layer paper cartons Packaging for garments, furniture, refrigerators and air-conditioners
Triple-layer corrugated paperboards comprising three sheets of corrugated paper sandwiched between four sheets of Kraft paper. Triple-layer paper cartons Packaging for electrical machinery, motorcycles, and other heavy-duty products
Our corrugated paper cartons deliver marketing and performance benefits at a competitive cost. We supply corrugated paper cartons designed to protect and contain products while providing:
Convenience through ease of carrying, storage, delivery and removal of the products by the end consumers;
A smooth surface printed with various resolutions of flexo- or multi-color graphic images that help improve brand awareness and visibility of products; and
Durability, stiffness and wet and dry tear strength; leak, abrasion and heat resistance; barrier protection.
Manufacturing and Production
All of our production plants are strategically located within the YRD, the PRC manufacturing belt. We lease most of manufacturing facilities which also contain administrative offices. We own all of equipment and machines.
Utilities
Electricity is the principal source of energy for our manufacturing operations. If a power shortage or stoppage were to occur, we have back-up power supply in the form of our two-way power supply and our own power generators at each of our manufacturing facilities, which we believe are able to provide sufficient back-up power to ensure that our manufacturing operations will not be disrupted. To date, we have not experienced any prolonged power shortages or stoppages.
Maintenance
Our own staff carries out maintenance and servicing of our production equipment on a regular basis. As a result of our regular maintenance, we have not experienced any major shutdown or disruption to our manufacturing operations.
Production Capacity and Utilization
Our production capacity is limited by our production floor area, production equipment and manpower.
The following table illustrates the maximum production capacity and the actual production volume for our production lines for the manufacture of paperboards, flexo-printed paper cartons and color-printed cartons as of December 31, 2012 and 2011:
(1)
Annual production capacity = (The approximate daily maximum production for paperboards, flexo-printed paper cartons or color-printed paper cartons) x 365 days.
Manufacturing Process
The production process for our paperboards and paper cartons is illustrated below:
Product Design
After receiving orders from customers, we meet with our customers to understand their products and target consumer market, and then assist them in designing packaging that is suitable for their purposes and that appeal to their consumers.
While our customers typically provide us with their own packaging design and specifications, our production development team and our design team have also designed paper cartons for many of our customers. Our team works closely with our customers to meet their requirements with regard to the structure, function and graphic design.
Our production team then produces a sample product based on the designs. Tests will be conducted on this sample product at our in-house testing center to ensure that it meets the design specifications. Mass production begins once the sample is approved by the customer.
Corrugated Paperboard Production
Pre-heating and drying. The key raw materials used in the manufacture of our paperboards are Kraft paper and corrugating medium. Corrugating medium is fed into corrugator production machines (such as our BHS2800 corrugated paperboard production line), and pre-heated to reduce the moisture level in the corrugating process.
Corrugating, compression and gluing. The pre-heated paper is transformed into corrugated paper with different flute-depth through a corrugating process. Kraft paper is then glued to this corrugated paper to form a semi-completed paperboard.
Combination of layers of corrugated paperboards. Glue adhesive is applied to combine semi-completed paperboards with Kraft paper or other semi-completed paperboards to form single-layer, double-layer or triple-layer paperboards.
Heating and drying. The corrugated boards then pass through a heating process to dry the glue adhesive to improve the bonding strength between the layers of the corrugated boards before warehouse storage or the manufacture of paper cartons.
Paper Carton Production
Flexo-printing. Flexography (often abbreviated to flexo) is a printing process that utilizes a flexible relief plate and water based ink. It can be used for printing on almost any type of substrate including plastic, metallic films, cellophane, and paper. It is widely used for printing on the non-porous substrates required for various types of food packaging (it is also well suited for printing large areas of solid color). Our customer's approved artwork is transferred to a flexible plate with a plate making machine. Then the flexible plate is installed into a water-based ink printing machine, and the artwork is directly transferred onto the surface of the corrugated boards from the printing machine.
Color-printing. Offset color printing utilizes oil-based ink to print. The visual effect of color-printed artwork is superior to ink-printed artwork. Artwork pre-approved by customers are either captured on film and transferred onto printing plates, or transferred directly onto printing plates from the computer using the computer-to-plate, or CTP, method. CTP involves the transfer of digital images of artwork from computers directly onto printing plates without the use of film. CTP produces images that are closer to the customers’ original artwork and produces cleaner and sharper results and saves time by eliminating the use of film.
Offset printing. Offset printing involves the transfer of ink on paper via a printing plate. The image areas of the printing plates are rendered ink receptive and water repellent, while the non-image areas of the printing plates are rendered water receptive and ink repellent. The printing plates will be mounted onto a cylindrical drum on the printing machine. The printing plates are dampened, first by water rollers then by ink rollers. The image area of the printing plates picks up the ink and water keeps ink out of non-image areas of the printing plates. Each plate transfers its image onto a rubber blanket cylinder, which then transfers the image onto paper.
Lamination and varnishing. Depending on the design specifications and the customer’s requirements, the prints may need a layer of lamination or liquid varnishing. This makes the printed artwork water resistant and gives it a glossy appearance.
Gluing. The printing paper (containing the printed artwork) is then glued onto the semi-completed paperboard.
Die-Cutting, slitting, slotting and scoring. Flexo-printed and offset-printed paperboards undergo die-cutting and slitting to produce a pre-folded paper carton in accordance with the paper carton design, and also undergo slotting and scoring to create the fold-lines for folding.
Folding, and stapling or gluing. The pre-folded paper carton is then stapled or glued by the automated stapling and gluing machines to produce semi-folded paper cartons. These finished products are then prepared for delivery.
Raw Materials and Suppliers
Raw Materials
The key raw materials used in the manufacture of our paperboards are Kraft paper and corrugating medium. Raw materials are purchased only from pre-selected suppliers after evaluation by our purchasing, production and quality assurance departments based on stringent selection criteria such as pricing, the quality of raw materials and services, track record, financial condition and market reputation. Our major suppliers are all well-known PRC companies in the paper manufacturing industry with large capacities to satisfy our requirements.
Suppliers and Supplier Arrangements
Our major suppliers who accounted for 5% or more of our purchases for the years ended December 31, 2012 and 2011 are as follows:
The typical term of a supply contract is less than six months. The purchase prices are generally negotiated every month or every two to three months. In some cases, the prices for raw materials per ton may be fixed in the contract. Our suppliers generally allow us 60 to 120 days’ credit.
Our Customers
We have a diversified customer base in a broad range of end markets. In 2012, we had more than 900 customers. Our five largest customers are Hangzhou Panasonic Home Electrical Appliance Co., Ltd., Suzhou Samsung Electrical Co., Ltd, Nongfu Spring Co., Ltd., China Resources Snow Breweries Co., Ltd., and Hangzhou Cigarette Company, most of whom are Top 500 Chinese Enterprises. We strive to continually increase and diversify our customer base.
For the periods indicated, our major customers who accounted for 5% or more of our total revenue are as follows:
We generally provide customized products to our customers, so we negotiate individual contracts with our customers based on their particular requirements. We usually start with a base product price for the specific product category and quantity, then consider process requirements, technical difficulties, level of competition in the market and specific process required for the particular product to arrive at the final price for a product. We are responsible for delivery, and the transportation cost will be included in the price. We generally allow our customers 60 to 120 days’ credit. For 2012 and 2011, our accounts receivable turnover days were 106 days and 104 days, respectively.
We have also engaged in strategic alliance relationships with ten customers, including our three largest customers, namely, Hangzhou Panasonic Home Electrical Appliance Co., Ltd., Nongfu Spring Co., Ltd. and Hangzhou Cigarette Company. We give our strategic alliance relationship customers priority in fulfilling their orders, and, in exchange, such customers give us priority as a supplier when they place their orders. We also cooperate with these customers in the development of new packaging for their products. We believe that these strategic alliances will strengthen the reliability of our services and help us maintain our key customers.
We are not aware of any information or arrangements that would lead to a cessation or termination of our current relationship with any of our major customers.
Backlog
We do not believe backlog is material to an understanding of our business as our backlog generally does not have a material impact on our revenues. Most customer orders are processed with a lead time of two weeks or less. Orders for existing customers are generally processed in one week and orders for new customer are generally processed within 15 days. Therefore, the amount of our backlog is generally very small. We generally enter into framework sales contracts with most major customers every year. Pursuant to these contracts, the customers contract us as a priority supplier when they place regular orders, and, in exchange, we provide priority fulfillment of their orders.
Sales and Marketing
Our sales and marketing department has 51 sales personnel and marketing executives as of December 31, 2012. Our sales and marketing department is responsible for setting sales and marketing strategies and promoting our products.
Our sales and marketing strategies include (1) direct sales and marketing activities, (2) advertisements and publications and (3) participation in trade fairs and exhibitions.
Our sales team regularly meets with our existing customers to better understand their requirements and promote our new products. The team also reaches out to prospective customers to promote our products.
We advertise through a variety of channels including billboards, industry publications, such as the China Packaging Industry and the Packaging World, our corporate website, www.cnpti.com, and industry websites, such as the China Packaging website, www.pack.cn. Because we principally rely on our long-term relationship and our reputation as an efficient producer of high-quality paper cartons in the YRD, we place less emphasis on advertising and have not spent significant sums on advertising.
We participate regularly in trade fairs and exhibitions in the PRC such as the PRC Corrugated Paper Cartons and Machinery Exhibition and the PRC International Corrugated Exhibition. Those trade fairs and exhibitions provide us with a platform to showcase our new products, establish contact with potential customers and gather information on the latest products.
Customer Service
Our customer service department was comprised of 38 customer service personnel as of December 31, 2012. The customer service department provides pre-sales services such as sample designs; sales services such as production monitoring to ensure timely delivery of products; and after-sales customer service such as feedback and guidance on product usage. Our after-sales customer service is available to our customers 24 hours a day throughout the year.
Our customer service department oversees our five customer service centers in Hangzhou, Suzhou, Taizhou, Ningbo and Shanghai, where many Fortune 500 companies and Top 500 Chinese enterprises are located. These customer services centers have enabled us to provide timely service to our existing customers and have increased our presence and facilitated our sales and marketing activities in these regions.
Research and Development (R&D)
R&D is one of the key factors that has helped us to maintain our competitive strength and leading position in the industry. As of December 31, 2012, our R&D team consisted of 40 experienced professionals, many of whom are certified engineers. Our R&D team includes several key experts who have extensive knowledge about and experience in our industry. In addition to conducting our own research, our R&D department enters into collaborative agreements with reputable academic and research institutions, principally in the YRD, from time to time to carry out specific R&D projects. We have worked with Zhejiang University, China Packaging Federation and Zhejiang Province Paper Packaging Industry Technology Centre. Our current collaborative partners include Zhejiang Sci-Tech University and Zhejiang University of Technology and Science. Under such R&D collaborative partnerships, these institutions provide technical expertise to complement our existing R&D capabilities, while we provide the necessary funding for the R&D projects. We have ownership of the results of the research and the proprietary rights of the products and technology developed through these collaborative projects. We believe that we will continue to improve our research and development capabilities by leveraging our strong R&D platform and expertise of these institutions. With our in-house R&D capabilities and collaborative programs, we have developed 19 items of technical know-how, patents for all of which have been approved by the Intellectual Property Office of China.
We have expended more effort and resources on R&D activities in recent years. R&D costs amounted to $4,277,373 and $4,065,733 for the years ended December 31, 2012 and 2011, respectively. In order to maintain our competitiveness, we will continue to strengthen our R&D capabilities through staff training, equipment upgrade and collaborations with academic and research institutions. We will focus our efforts on the expansion of our product portfolio to meet the changing needs of our customers and the growing demand for packaging products. Moreover, we intend to develop technologies that would help us improve production efficiency and product quality, while lowering production costs. For example, our ongoing research and development projects include waterproof paper cartons with low-temperature endurance and high-strength corrugated paper agglutination technique.
Competition
The packaging market in China is highly fragmented and competitive. There are over 20,000 paperboard manufacturers in China, most of which are relatively small in size. The top ten manufacturers only have an aggregate of less than 10% of the Chinese market.
Due to the geographic radius limitation, we currently only compete with domestic and international corrugated paper packaging companies located within the YRD region. Our major competitors include: Ningbo Asia Paper Tube Paper Carton Co., Ltd., Salfo Package Group Co., Ltd., Zhejiang Dahua Packaging Group Co., Ltd., Zhejiang Zhongbao Pactiv Packaging Co., Ltd., Yuen Foong Yu Paper Enterprise (Kunshan) Co., Ltd. and International Paper (Shanghai) Co., Ltd. We also face competition from upstream paper mills when they expand their business into paper carton manufacturing, and such companies include Zhejiang Jingxing Paper Co., Ltd, Anhui Shanying Paper Industry Co., Ltd, and others.
The primary barriers to enter the market include obtaining a printing license and significant capital investment in large-scale production facilities. We believe our competitive advantages over domestic players are better cost-efficiencies due to economies of scale and significant order volumes, early mover with long standing relationships with customers, advanced technologies and equipment deployed in our manufacturing process, high product quality with competitive cost structure and well-known brand name. Our competitive advantages over international players include significant production capacity, large amount of existing customer base, the flexibility to customize our products, better local knowledge and connections, lower price resulting from lower cost structure and competitive product quality. We believe we have better economies of scale, more experience and better market knowledge than most of the paper mill new market entrants.
Seasonality
Our operating results and operating cash flows historically have not been subject to seasonal variations. This pattern may change, however, as a result of new market opportunities or new product introductions.
Intellectual Property
Great Shengda owns the trademark for , registered in the PRC (trademark number 1275491). The trademark expires on May 20, 2019, but may be extended.
We believe that our trademark has significant value and is important for marketing and building brand recognition. We are not aware of any third party currently using a trademark similar to our Shengda trademark in the PRC for the same types of products.
We have been granted the following patents, each of which will expire 10 years from the application date:
Environmental Matters
Our manufacturing facilities are subject to various pollution control regulations with respect to air, water, solid and noise pollution and the disposal of waste and hazardous materials. We also are subject to periodic inspections by local environmental protection authorities. Our operating subsidiaries have received certifications issued on February 22, 2010 by Hangzhou Xiaoshan Environmental Protection Bureau indicating that, as of the date of these certifications, their business operations are in material compliance with the relevant PRC environmental laws and regulations. We are not currently subject to any pending actions alleging any violations of applicable PRC environmental laws.
Each of Great Shengda, Shengda Color and Hangzhou Shengming holds a pollutant discharge permit issued by the local environmental protection bureau. The pollutants discharged by Great Shengda, Shengda Color and Hangzhou Shengming include solid waste, such as used printing ink containers, paper scraps and garbage, waste water, which contain chemicals such as resin, waste print ink and isopropyl alcohol, and waste chemicals, including waste print ink. Also, we produce noise during manufacturing. Some of the chemicals we use for printing may be classified as potential health hazards. However, our employees generally have minimal contact with these chemicals, and the chemicals are packaged in containers that we believe meet government safety standards and are dispensed directly from the containers in the printing process (much like the ink from ink-jet printing cartridges). Also, with respect to any noise pollution produced, we have made appropriate filings with the local bureaus of health. We believe our pollutant and waste discharge processes meet government standards.
Neither existing environmental and similar laws nor the costs of our compliance with these laws has had a material adverse effect on our financial condition or results of operations, and management does not believe they will in the future. In addition, we have not incurred, and do not expect to incur, any material costs or liabilities due to environmental contamination at our facilities. However, we cannot predict the impact of new or changed laws or regulations on facilities we currently own or may acquire in the future. We have no current plans for substantial capital expenditures with respect to compliance with environmental and similar laws.
Regulation
Because our operating subsidiaries are located in the PRC, we are subject to national and local laws of the PRC.
Paper Packaging Industrial Laws and Regulations
We are subject to governmental regulations related to paper printing and packaging industry. The Regulations on the Administration of Printing Industry requires us to obtain a printing license before production. Great Shengda, Hangzhou Shengming and Suzhou AA each possess a printing license for package decoration printing and Shengda Color has a printing license for package decoration printing and printing of other printed matters. The printing license held by Great Shengda is valid until December 31, 2017, and the printing license held by Suzhou AA is valid until November 17, 2013, each of which is renewable at expiration by application to the relevant authorities. The printing licenses held by Shengda Color and Hangzhou Shengming were valid until December 31, 2012, and the companies are in the process of renewing with local authorities.
Other rules and regulations for the printing industry that impact the packaging industry include:
Administrative Regulations on Fulfilling Printing Orders, which were issued by the General Administration of Press and Publication together with the Ministry of Public Security. Under these regulations, companies engaged in the printing business are required to verify clients' legal documents, such as business licenses and trademark registration certificates, and to file the printing records kept by the companies with competent authorities. We believe we are in material compliance with such requirement;
Interim Provisions on the Establishment of Foreign-invested Printing Enterprises jointly issued by the General Administration of Press and Publication and the former Ministry of Foreign Trade and Economic Cooperation. Under these provisions, approvals by the press and publication administration are required for the establishment of foreign invested enterprises engaging in the printing business. In addition, foreign-invested printing enterprises are not allowed to set up branches; and
Interim Measures on the Qualifications of Printing Operators issued by the General Administration of Press and Publication. These measures specify the qualifications required for enterprises engaged in printing operations. Printing operators must satisfy such qualification requirements in order to obtain approval for their establishment and printing licenses from the press and publication administration. The legal representative or major responsible person must obtain a Training Certificate in Printing Regulations issued by the municipal press and publication administration. The legal representative of Great Shengda, Shengda Color and Shengming, Wuxiao Fang, has obtained the Training Certificate in Printing Regulations (No.0820064) granted by Hangzhou Xiaoshan Culture, Radio, TV, Film, Press and Publication Bureau.
China also has a series of national standards regarding paper packaging production. Such national standards include, but are not limited to, National Standards on Single and Double Corrugated Paper Cartons for Transportation of Packages. These standards relate to the structure, material, size and quality requirement for classification of cartons for transporting different kinds of merchandise. These standards are not compulsory but are followed by many manufacturers.
As a paper packaging production company, we need to reproduce trademarks owned by our customers. As a consequence, the Trademark Printing Administration Measures are applicable to us, which require us to examine the trademark registration certificates and other relevant documents of our customers to verify the trademark ownership. We believe we are in material compliance with such requirement.
Environmental Regulations
Our production processes mainly generate noise, wastewater and solid wastes. The major PRC environmental regulations applicable to us include the Environmental Protection Law of the PRC, the Environmental Impact Appraisal Law of the PRC, the Law of the PRC on the Prevention and Control of Water Pollution, the Law of the PRC on Prevention and Control of Environmental Pollution Caused by Solid Waste, the Law of the PRC on Prevention and Control of Air Pollution and the Law of the PRC on Prevention and Control of Environmental Noise Pollution.
The Environmental Protection Law of the PRC sets out the legal framework for environmental protection in the PRC. The Ministry of Environmental Protection of the PRC, or the MEP, is primarily responsible for the supervision and administration of environmental protection work nationwide and formulating national waste discharge limits and standards. Local environmental protection authorities at the county level and above are responsible for environmental protection in their jurisdictions.
Companies that discharge contaminants must report and register with the MEP or the relevant local environmental protection authorities. Companies discharging contaminants in excess of the discharge limits prescribed by the central or local authorities must pay discharge fees for the excess in accordance with applicable regulations and are also responsible for the treatment of the excessive discharge. Companies that directly or indirectly discharge industrial waste water into the water or are required by law to obtain the pollutant discharge permit before discharging waste water or sewage shall also obtain the pollutant discharge permit.
In addition, the Circular Economy Promotion Law and Law of Promoting Clean Production also apply to our business which requires paper packaging production companies to mitigate environmental pollution by utilizing environmentally friendly raw materials and designs. Where feasible we use recycled paper as raw material. In addition, all of our cartons are recyclable.
Regulation on Labor Protection
The Labor Contract Law of the PRC, effective on January 1, 2008, governs the establishment of employment relationships between employers and employees, and the conclusion, performance, termination of, and the amendment to employment contracts. To establish an employment relationship, a written employment contract must be signed. In the event that no written employment contract was signed at the time of establishment of an employment relationship, a written employment contract must be signed within one month after the date on which the employer starts engaging the employee.
Regulations on Protection of Intellectual Property Rights
China has adopted legislation governing protection of intellectual property rights, including copyrights, trademarks and patents. China is a signatory to the main international conventions governing protection of intellectual property rights and became a member of the Agreement on the Trade Related Aspects of Intellectual Property Rights upon its accession to the World Trade Organization in December 2001.
Patents
The PRC Patent Law, adopted in 1984 and revised in 1992, 2000 and 2008, respectively, and the Implementing Rules of the PRC Patent Law, promulgated by the State Council in 2001 and revised in 2002 and 2010 respectively, govern and protect the proprietary rights to registered patents. The State Intellectual Property Office, or SIPO, handles patent registration and grants a term of twenty years to inventions and a term of ten years to utility models and designs. The protection to patent rights may be terminated before expiry of the term granted as a result of the failure of the registrant to pay the annual registration fee accordingly. Patent license agreements and transfer agreements must be filed with the SIPO for record.
Foreign Currency Regulations
Under the PRC foreign currency exchange regulations applicable to us, RMB is convertible for current account items, including the distribution of dividends, interest payments, trade and service-related foreign exchange transactions. Currently, our PRC operating subsidiaries may purchase foreign currencies for settlement of current account transactions, including payments of dividends to us, employee salaries (even if employees are based outside of China), and payment for equipment purchases outside of China, without the approval of the State Administration of Foreign Exchange of the People’s Republic of China, or SAFE, by complying with certain procedural requirements. Conversion of RMB for capital account items, such as direct investment, loan, security investment and repatriation of investment, however, is still subject to the approval of SAFE. In particular, if our PRC operating subsidiaries borrow foreign currency through loans from us or other foreign lenders, these loans must be registered with SAFE, and if we finance the subsidiaries by means of additional capital contributions, these capital contributions must be approved by certain government authorities, including the Ministry of Commerce, or MOFCOM, or their respective local branches. These limitations could affect our PRC operating subsidiaries’ ability to obtain foreign exchange through debt or equity financing. In the event of a liquidation of our PRC subsidiaries, SAFE approval is required before the remaining proceeds can be expatriated from China.
Taxation
On March 16, 2007, the National People’s Congress of China passed a new Enterprise Income Tax Law, or the EIT Law, and on November 28, 2007, the State Council of China passed its implementing rules, which took effect on January 1, 2008. Before the implementation of the EIT Law, foreign invested enterprises, or FIEs, established in the PRC, unless granted preferential tax treatments by the PRC government, were generally subject to an earned income tax, or EIT, rate of 33.0%, which included a 30.0% state income tax and a 3.0% local income tax. The EIT Law and its implementing rules impose a unified EIT of 25.0% on all domestic-invested enterprises and FIEs, unless they qualify under certain limited exceptions. Despite these changes, the EIT Law gives FIEs established before March 16, 2007, or Old FIEs, a five-year grandfather period during which they can continue to enjoy their existing preferential tax treatments. During this five-year grandfather period, the Old FIEs which enjoyed tax rates lower than 25% under the original EIT law will be subject to gradually increased EIT rates over a 5-year period until their tax rate reaches 25%. In addition, the Old FIEs that are eligible for other preferential tax treatments by the PRC government under the original EIT law are allowed to continue enjoying their preference until these preferential treatment periods expire.
In addition to the changes to the current tax structure, under the EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a resident enterprise and will normally be subject to an EIT of 25% on its global income. The implementing rules define the term “de facto management bodies” as “an establishment that exercises, in substance, overall management and control over the production, business, personnel, accounting, etc., of a Chinese enterprise.” If the PRC tax authorities subsequently determine that we should be classified as a resident enterprise, then our organization’s global income will be subject to PRC income tax of 25%. For detailed discussion of PRC tax issues related to resident enterprise status, see Item 1A
ITEM 1A.
RISK FACTORS.
Investing in our common stock is highly speculative in nature, involves a high degree of risk and should be purchased only by persons who can afford to lose the entire amount invested in our common stock. Before purchasing any of our common stock, you should carefully consider the following factors relating to our business and prospects. You should pay particular attention to the fact that we conduct all of our operations in China and are governed by a legal and regulatory environment that in some respects differs significantly from the environment that may prevail in the U.S. and other countries. If any of the following risks actually occurs, our business, financial condition or operating results will suffer, the trading price of our common stock could decline, and you may lose all or part of your investment.
RISKS RELATED TO OUR BUSINESS
We may not be able to sustain our growth, and the continuation of growth may strain our resources.
Our business has grown and evolved rapidly since our establishment, as demonstrated by our growth in revenue from $79.1 million in 2007 to $125.3 million in 2012. Our net income attributable to our common stockholders has grown from approximately $7.9 million in 2007 to $9.6 million in 2011. However, our net income attributable to our common stockholders decreased to $5.6 million in 2012. We may not be able to achieve growth in future periods. Therefore, our historical operating results may not provide a meaningful basis for evaluating our business, financial performance and prospects in the future. Our ability to achieve satisfactory operating results at higher sales volumes is unproven. In addition, our rapid expansion could significantly strain our resources, management and operational infrastructure, which could impair our ability to meet increased demand for our products and hurt our business results. You should not rely on our past results or our historical rate of growth as an indication of our future performance.
We are vulnerable to shortages in raw paper supply and electricity, and fluctuations in raw paper prices.
The main raw material used in manufacturing our paper cartons is raw paper. The cost of raw paper has historically constituted approximately 65% to 80% of our cost of goods sold. We source our raw paper in China.
In order to ensure timely delivery of quality products to our customers at competitive prices, we need to obtain sufficient quantities of quality raw materials at acceptable prices in a timely manner. We also require a significant amount of electricity in order to maintain our operations. We have not experienced any significant shortage in raw material supply or electricity thus far. There is no assurance that we will be able to obtain sufficient quantities of raw materials of acceptable quality from our suppliers at acceptable prices in a timely manner or that we will not suffer from electricity shortages in the future.
Furthermore, as raw paper is a commodity, we are vulnerable to the risk of rising raw paper prices, which are determined by demand and supply conditions in the global and the PRC markets. Should there be any significant increases in the price of raw paper, and if we are unable to pass on such increases in costs to our customers or find alternative suppliers who are able to supply us raw paper at reasonable prices, our business and profitability would be adversely affected.
We may be adversely affected by a significant or prolonged economic downturn in the level of consumer spending in the industries and markets served by our customers.
Our business is affected by the number of orders that we are able to secure from our customers, which is determined by the level of business activity of our customers. The level of business activity of our customers is in turn determined by the level of consumer spending in the markets our customers serve.
We sell most of our products to consumer goods manufacturers in the YRD. Certain of these customers produce consumer goods for overseas markets, in addition to the PRC market. Any significant or prolonged decline of the PRC economy or economy of such other markets will affect consumers' disposable income and consumer spending in these markets, and lead to a decrease in demand for consumer products. To the extent that such decrease in demand for consumer products translates into a decline in the demand for paper packaging products such as our paper cartons, our performance will be adversely affected.
A large percentage of our sales revenue is derived from sales to a limited number of customers, and our business will suffer if sales to these customers decline.
Sales to our five major customers, Hangzhou Panasonic Home Electrical Appliance Co., Ltd., Suzhou Samsung Electrical Co., Ltd., Nongfu Spring Co., Ltd., China Resources Snow Breweries Co., Ltd., and Hangzhou Cigarette Company accounted in aggregate for approximately 35.0% of our revenue for 2012.
Our ability to retain these major customers is important to our continued success. There is, however, no assurance that these customers will continue to purchase our products at the current levels in the future. There is also no assurance that we will be able to decrease our dependence on these major customers over time. In the event that these major customers cease or reduce significantly their purchase of our products and we are unable to obtain substitute orders of comparable size, there will be a material adverse impact on our financial performance and position.
Our customers are principally located within a 500 kilometer radius from our manufacturing plant. Due to the cost of transportation and the need for timely delivery, serving customers situated outside that radius is less attractive economically for us. If we lose our major customers, we may not be able to replace these accounts with customers within the 500 kilometer radius. If we have to service accounts outside that radius, our cost may increase, thereby affecting our margins adversely.
The continuing consolidation of our customer base may intensify pricing pressures and may negatively affect our financial performance.
Over the last few years, many of our large customers have acquired, or been acquired by, companies with similar or complementary product lines. This consolidation has increased the concentration of our largest customers, and resulted in increased pricing pressures from our customers. The continuing consolidation of our customer base may negatively affect our financial performance.
We may be unable to execute our growth plans or effectively manage our expansion.
We plan to grow externally by acquiring complementary businesses. We also plan to grow organically by increasing purchase commitments from existing clients and further penetrating existing markets. These expansion plans may strain our financial resources. They may also overstretch our management personnel and require us to restructure our management structure. We may be unsuccessful in the timely or cost-efficient expansion of our production capacity to meet anticipated increases in the demand for our products. Expansion projects may not be constructed within the anticipated timetable or within budget. Any material delay in completing such projects, or any substantial increase in costs or quality issues in connection with them, could materially and adversely affect our business, financial condition and results of operations, or result in a loss of business opportunities.
To accommodate our growth pursuant to our strategies, we will need to expand, train, manage and motivate our workforce, and effectively manage our relationships with our customers and suppliers. We will also need to expand capital resources and dedicate personnel to implement and upgrade our accounting, operational and internal management systems and to enhance our record keeping and contract tracking system. All of these endeavors will require substantial management effort and skills and the incurrence of additional expenditures. We cannot assure you that we will be able to efficiently or effectively implement our growth strategies and manage the growth of our operations, and any failure to do so may limit our future growth and hamper our business strategy.
We may require additional funding for our growth plans, and such funding may result in a dilution of your investment, limit our ability to pay dividends or otherwise restrict our business operations.
We attempted to estimate our funding requirements in order to implement our growth plans. Our growth plans include growth through acquisitions. Although the proceeds from our public offering closed in December 2010 should be sufficient for us to implement our near term acquisition strategy, we may require additional capital in order to successfully operate businesses that we acquire.
If the costs of implementing our growth plans, including the cost of operating businesses that we acquire, should exceed these estimates significantly, or if we come across opportunities to grow through expansion plans which cannot be predicted at this time, and funds generated from our operations prove insufficient for such purposes, we may need to raise additional funds.
We may raise additional funds by issuing equity, equity-linked securities or debt securities or by borrowing from banks or other resources. We cannot ensure that we will be able to obtain any additional financing on terms that are acceptable to us, or at all. If we fail to obtain additional financing on acceptable terms, we will not be able to implement such plans fully. Even if we succeed in obtaining financing, such financing may be accompanied by conditions that limit our ability to pay dividends or require us to seek lenders’ consent for payment of dividends, or restrict our freedom to operate.
Additional funding from debt financings may make it more difficult for us to operate our business because we would need to make principal and interest payments on the indebtedness and may be obligated to abide by restrictive covenants contained in the debt financing agreements. Further, if we raise additional funds by issuing new shares, any stockholders unable or unwilling to participate in such fund raising may suffer dilution in their investment.
Covenants in certain loan agreements entered into by us restrict our ability to engage in or enter into a variety of transactions, which may cause disruption to our business operations and have a material adverse effect on our business operations.
We have entered into loan agreements with banks in the PRC which contain various covenants that may limit our discretion in operating the business of our subsidiaries.
Our lenders have rights that include those that:
restrict us from undertaking any shareholding change or restructuring without obtaining prior approval of the lender;
restrict us from undertaking mergers and acquisitions or any other joint venture arrangement without prior approval of the lender;
restrict us from undertaking withdraw of capital, asset transfer, or equity transfer;
restrict us from undertaking major investment, asset transfer, leasing, pledging or mortgaging its assets without obtaining prior approval of the lender; and
restrict the distribution of dividends if after tax profit for a particular fiscal year (1) equals nil or less; (2) is insufficient to offset a deficit of prior years; or (3) is insufficient to pay off principal and interest due during the fiscal year.
There is no assurance that we will be able to obtain the lenders' approval for these transactions. These restrictions on our business may cause disruption in our business operations. Our lenders may restrict us from disposing of or restructuring the ownership of our operating facilities and limit our ability to undertake any acquisition or major investment. Even if we fail to obtain their approval for any such transaction, we must give timely notice of the transaction. In the event of such technical breach, the lender may have the right to rescind the loan, which would materially and adversely affect our operations, future prospects and results of operations.
Our acquisition and investment in other businesses may be unsuccessful.
We intend to selectively pursue strategic acquisition and investment opportunities which complement or enhance our current businesses with new product lines or expand our customer base at the appropriate time. However, we may encounter strong competition during the acquisition or investment process and we may fail to select or value targets appropriately, which may result in our experiencing difficulty in completing such acquisitions or investments at reasonable cost, or at all. Even if an acquisition or investment is successful, we may have to allocate additional capital and human resources to implement the integration of the new line of business. There is no assurance that we can successfully obtain or renew licenses or national or local government approvals for operating new lines of business or successfully integrate newly acquired businesses or do so within a reasonable period of time or that the acquired businesses will generate the expected economic benefits.
One of our growth strategies is to expand our customer base by entering markets in regions outside the YRD. We may face various challenges when entering into markets in other regions. For example, we will have to understand and adjust to local business practices; the transportation infrastructure in other regions may not be as developed as the YRD, which may result in higher costs; and we may encounter difficulty in obtaining or renewing licenses and government approvals.
Furthermore, our experience in serving customers in the YRD may not be applicable in other parts of China. We cannot assure you that we will be able to leverage our experience in the YRD to expand into other parts of China. In our entry into new markets, we may face competition from paper packaging companies with established experience or presence in the geographical areas in which we plan to expand and from other paper packaging companies with similar expansion targets, in addition to the uncertainties discussed in the three preceding risk factors. There is no assurance that we will have similar success in regions outside the YRD. Our failure to manage any of our planned expansion or acquisitions may have a material adverse effect on our business, financial condition and results of operations.
Our certificates, permits, and licenses related to our operations are subject to governmental control and renewal, and failure to obtain or renew such certificates, permits, and licenses will cause all or part of our operations to be terminated.
Our operations require licenses, permits and, in some cases, renewals of these licenses and permits from various governmental authorities in the PRC. Our ability to obtain, maintain, or renew such licenses and permits on acceptable terms is subject to change, as, among other things, the regulations and policies of applicable governmental authorities may change.
Great Shengda holds a printing license for decorative printing on packages, valid until December 31, 2017. Suzhou AA holds a printing license for decorative printing on packages, valid until November 17, 2013. These printing licenses are renewable at the end of their terms by application to the relevant authorities. The printing license held by Shengda Color and Hangzhou Shengming were valid until December 31, 2012, and the companies are in the process of renewing the licences with local authorities. If our printing licenses are revoked or suspended or we are unable to renew a printing license for any reason, we cannot assure you that our business operations will not be stopped and, correspondingly, our financial performance would be adversely affected.
Suzhou AA is in the process of obtaining various approvals, permits and licenses, including, but not limited to, certain environmental approvals and a pollutant discharge permit. We cannot assure you that we will be successful and timely in obtaining such approvals, licenses and permits. Failure to do so may subject us to monetary fines or other penalties, including possible suspension of Suzhou AA’s operations.
We depend heavily on qualified personnel, and loss of these personnel could harm our business.
Our future business and results of operations depend in significant part upon the continued contributions of our senior management and key technical personnel, including our Chairman, Nengbin Fang, and our Chief Executive Officer, Daliang Teng, both of whom have a long history with the Company. Turnover in our senior management could significantly deplete institutional knowledge held by our existing senior management team and impair our operations. If we lose a key employee, or if a key employee fails to perform in his or her current position, our business could suffer. We must attract, recruit and retain a sizeable workforce of technically competent employees. We face competition for qualified personnel from other companies in our industry and from other organizations. Competition for these individuals could cause us to offer higher compensation and other benefits in order to attract and retain these qualified employees, which could materially and adversely affect our results of operations. In addition, the process of hiring qualified personnel is often lengthy. If our recruitment and retention efforts are unsuccessful in the future, it may be more difficult for us to execute our business strategies.
In addition, if any of these qualified personnel joins a competitor or forms a competing company, we may lose some of our customers. We have entered into confidentiality and non-competition agreements with all of our key personnel. However, if any disputes arise between these key personnel and us, it is not clear, in light of uncertainties associated with the PRC legal system, what the court decision will be and the extent to which the court decision could be enforced in China, where all of these key personnel reside and hold most of their assets. See “-Risks Related to Doing Business in China-Uncertainties with respect to the PRC legal system could limit the legal protections available to you and us.”
Any future litigation could have a material adverse impact on our results of operations, financial condition and liquidity. Although we have procured director and officer insurance ("D&O insurance"), our coverage may be insufficient and we may incur substantial sums pursuant to our obligation to indemnify our directors and officers.
From time to time we may be subject to litigation, including potential stockholder derivative actions. Risks associated with legal liability are difficult to assess and quantify, and their existence and magnitude can remain unknown for significant periods of time. We currently have D&O insurance to cover such risk exposure for our directors and officers. Our bylaws require us to indemnify our current and past directors and officers from reasonable expenses related to the defense of any action arising from their service to our Company. If our D&O insurance is insufficient to cover all such expenses for all directors and officers, we would be obligated to cover any shortfall, which may be substantial. Such expenditure could have a material adverse effect on our results of operation, financial condition and liquidity. Further, if D&O insurance becomes prohibitively expensive to maintain in the future, we may consider not to renew such insurance. The lack of D&O insurance may make it difficult for us to retain and attract talented and skilled directors and officers to serve our Company, which could adversely affect our business.
We may be unable to adequately safeguard our intellectual property or we may face claims that may be costly to resolve or that limit our ability to use such intellectual property in the future.
Our business is materially dependent on our intellectual property. Our technical know-how is the result of our research and development efforts, which we believe to be proprietary and unique. We have obtained 19 patents for utility models. We cannot, however, assure you that we will be able to prevent third parties from infringing our intellectual property rights and utilize our patented technology. Further, third parties may assert infringement claims against us with respect to our intellectual property or attempt to invalidate our patents; we cannot assure you that such claims will not be successful. Even if we succeed in establishing or protecting our intellectual property rights, we could incur substantial costs and divert significant management resources in enforcing our right or defending any claims. If any party succeeds in asserting a claim against us relating to a disputed intellectual property, we may need to obtain licenses to continue to use the relevant design or technology. We cannot assure you that we will be able to obtain these licenses on commercially reasonable terms, if at all. Failure to obtain the necessary licenses or other rights could cause our business results to suffer. We rely upon a combination of trade secrets, non-disclosure and other contractual agreements with our employees, as well as limitation of access to and distribution of our intellectual property, in our efforts to protect intellectual property. However, our efforts in this regard may be inadequate to deter misappropriation of our proprietary information or we may be unable to detect unauthorized use and take appropriate steps to enforce our rights. Policing unauthorized use of our intellectual property is difficult, and there can be no assurance that the steps taken by us will be successful. If litigation is necessary to safeguard our intellectual property rights, or to determine the validity and scope of the proprietary rights of others, we could incur substantial costs and diversion of our resources, which may have a material adverse effect on our business, financial condition, operating results or future prospects.
Infringement of our Shengda trademark may hurt our business.
Our Shengda trademark is protected through trademark registration in the PRC. Although we do not use the trademark on the cartons we produce, which usually have the trademarks or brand-names of our customers, we have built a significant amount of goodwill around our Shengda trademark among our customers and in the industry. If third parties infringe upon our Shengda trademark by unlawfully passing off their products as our products or imitating or using our Shengda trademark, we may face considerable difficulties and costly litigation in order to fully protect our rights in the trademark. An even more serious consequence may be damage to our reputation as a manufacturer of quality products. Our brand, reputation and sales volume may be materially and adversely affected by an infringement of our trademark.
Our facilities and inventory may be affected by fire or natural calamities. Our operations are also subject to the risk of power outage, equipment failure or labor disturbances and other business interruptions. We have limited insurance coverage and do not carry any business interruption insurance.
A fire, flood or other natural calamity may result in significant damage to our production facilities and inventory. Our operations are subject to risks of various business interruptions, including power outage, equipment failure or disturbances that may result from labor unrest. If we are unable to obtain timely replacements of damaged inventory or equipment, or if we are unable to find an acceptable contract manufacturer in the event our production facilities are damaged by a catastrophic event, then major disruptions to our production could have a significant adverse effect on our operations and financial results. For example, it would take us about four months to replace our German BHS2800 paperboard production line if that line were significantly damaged. During that time, our production would be significantly hampered and our revenues would diminish significantly. Also, our property insurance may not be sufficient to cover damages to our production facilities, and we do not carry any business interruption insurance covering lost profits as a result of the disruption to our production.
We have limited insurance coverage and do not carry any third-party liability insurance or insurance that covers the risk of loss of our products in shipment.
If any of our products are defective, then we may be subject to product liability claims or we may have to engage in a product recall. Our employees or independent third parties may suffer injury from accidents at our facilities. We do not carry any product liability insurance with respect to our products or third-party liability insurance to cover claims pertaining to personal injury or property or environmental damages arising from defects in our products, product recalls or accidents on our property. We only have limited insurance coverage for property and machinery damage. Our existing insurance coverage may not be sufficient to cover all the risks associated with our business. As a result, we may be required to pay for losses, damages and liabilities, including those caused by natural disasters and other events beyond our control, out of our own funds, which could have a material adverse effect on our business, financial condition and results of operations.
Furthermore, under the shipping terms of some of our customer contracts, we bear the risk of loss in the shipment of our products. We do not insure this risk. While we believe that the transportation companies that we use carry adequate insurance or are sufficiently solvent to cover any loss in shipment, there can be no assurance that we will be adequately reimbursed upon the loss of a significant amount of our products.
Aside from impairing our financial performance, any slowdown or interruption in our production processes could negatively affect our brand.
We manufacture or assemble our products at our facilities in Hangzhou, Zhejiang, China. Our manufacturing operations are complicated and integrated; involving the coordination of raw materials sourced from third parties, internal production processes and external distribution processes. While these operations are modified on a regular basis to improve manufacturing and distribution efficiency and flexibility, we may experience difficulties in coordinating the various aspects of our manufacturing processes, thereby causing downtime and delays. We have also been steadily increasing our production capacity. However, we may not be able to obtain enough resources in time to operate our facilities at the same or higher capacity and to increase our production volume. Any interruptions in our production could result in our inability to produce our products, which would reduce our sales revenue and earnings for the affected period. If there is a stoppage in production at any of our facilities, even if only temporary, or delays in delivery times to our customers, our business and reputation could be severely affected. Any significant delays in deliveries to our customers could lead to increased returns or cancellations and cause us to lose future sales. We currently do not have business interruption insurance to offset these potential losses, delays and risks so a material interruption of our business operations could severely damage our business.
Inability to maintain our competitiveness would adversely affect our financial performance.
We operate in a competitive environment and face competition from existing competitors and new market entrants. Companies in our industry compete with each other on quality of products, production capacity, pricing, brand name, timely delivery and customer service. Some of our competitors are large, vertically integrated companies that have greater financial and other resources and greater manufacturing economics of scale, compared to our company.
Competition in the products we manufacture could increase if our competitors begin to price their products more attractively in order to gain market share, or develop or acquire technology to reduce their cost of production.
Furthermore, our industry is currently very fragmented, with a large number of small manufacturers serving local customers. Although this provides opportunities for us to grow externally, other competitors may have the same growth strategy and may be able to execute their growth strategy more speedily than we can, thereby gaining market share at our expense.
There is no assurance that we will be able to compete successfully in the future. Any failure by us to remain competitive would adversely affect our financial performance.
We are exposed to credit risks of our customers.
We typically grant our customers credit periods ranging from 60 to 120 days. For 2012 and 2011, our accounts receivable turnover days were 106 days and 104 days, respectively. If any future event derails the economic growth in China or undermines the confidence in or puts further strains on the world financial system, we may have to extend longer credit periods or our customers may become less creditworthy, which may materially adversely affect our financial condition.
Certain of our existing stockholders have substantial influence over our company, and their interests may not be aligned with the interests of our other stockholders.
Wuxiao Fang, his son, Nengbin Fang, and his daughter, Congyi Fang, together currently own approximately 54.02% of our common stock. As a result, they have significant influence over our business, including decisions regarding mergers, consolidations and the sale of all or substantially all of our assets, election of directors and other significant corporate actions, while their interest may not always align with the interest of other stockholders. The concentration of ownership may also have the effect of discouraging, delaying or preventing a future change of control, which could deprive our stockholders of an opportunity to receive a premium for their shares as part of a sale of our company and might reduce the price of our shares.
Environmental compliance and remediation could result in substantially increased capital requirements and operating costs, which could adversely affect our business.
We are subject to PRC laws and regulations relating to the protection of the environment. These laws continue to evolve and are becoming increasingly stringent. The ultimate impact of complying with such laws and regulations is not always clearly known or determinable because regulations under some of these laws have not yet been promulgated or are undergoing revision. Our business and operating results could be materially and adversely affected if we were required to increase expenditures to comply with any new environmental regulations applicable to our operations.
If we are found liable for violation of environmental regulations, our business, reputation, financial condition and results of operations may be adversely affected and our permits and licenses may be suspended or revoked by Chinese regulatory authorities.
Our operations are subject to various risks associated with our use, handling, storage and disposal of hazardous materials, some of which are corrosive and flammable. If we are found liable for contamination, injury to employees or others, or other harm related to our use, handling, storage and disposal of hazardous materials, our business, reputation, financial condition and results of operations may be adversely affected.
We use, handle, store and dispose of hazardous materials in our operations; therefore, we are required to maintain necessary filings with the local competent authority and Great Shengda, Shengda Color and Hangzhou Shengming have made such filings with the local safety supervision authority as required by law. However, any future failure to maintain or update effective filings with the local safety supervision authority may subject us to monetary fines or suspension or revocation of licenses or permits. In addition, in operating our business we use and store certain materials that may be regarded as occupational hazards. Therefore, we are also required to maintain necessary filings with the local hygiene authority for use and storage of those occupational hazardous materials. Great Shengda, Shengda Color and Hangzhou Shengming have made filings with the local hygiene authority for use of xylene in our production. However, any failure to maintain or update effective filings with the local hygiene authority may subject us to monetary fines or orders to cease operation at our manufacturing facilities.
We cannot completely eliminate the risks of contamination, injury to employees or others, or other harms related to our use, handling, storage and disposal of hazardous materials. Although we have not experienced incidents in the past, there can be no assurance that we will not experience fires, leakages and other accidents. In the event of future incidents, we could be liable for any damages that may result, including potentially significant monetary damages for any civil litigation or government proceedings related to a personal injury claim, as well as fines, penalties and other consequences, including suspension or revocation of our licenses or permits, suspension of production, and cessation of operations at our manufacturing facilities, all of which would have a material adverse effect on our business, reputation, financial condition and results of operations. Furthermore, we currently do not carry any insurance coverage for potential liabilities relating to the release of hazardous materials.
We may be exposed to potential risks relating to our internal controls over financial reporting and our ability to have the operating effectiveness of our internal controls attested to by our independent auditors.
Companies that file reports with the SEC, including us, are subject to the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, or SOX 404. SOX 404 requires management to establish and maintain a system of internal control over financial reporting and annual reports on Form 10-K filed under the Exchange Act to contain a report from management assessing the effectiveness of a company’s internal control over financial reporting. Separately, under SOX 404, as amended by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, public companies that are large accelerated or accelerated filers must include in their annual reports on Form 10-K an attestation report of their regular auditors attesting to and reporting on management’s assessment of internal control over financial reporting. Non-accelerated filers and smaller reporting companies are not required to include an attestation report of their auditors in annual reports.
A report of our management is included under Item 9A “Controls and Procedures” of this report. We are a smaller reporting company and, consequently, are not required to include an attestation report of our auditor in this annual report. Although our management believes that our internal control over financial reporting was effective as of December 31, 2012, we can provide no assurance that we will comply with all of the requirements imposed thereby and we will receive a positive attestation from our independent auditors in the future, when required. In the event we identify significant deficiencies or material weaknesses in our internal controls that we cannot remediate in a timely manner or we are unable to receive a positive attestation from our independent auditors with respect to our internal controls, investors and others may lose confidence in the reliability of our financial statements.
Our holding company structure may limit the payment of dividends.
We have no direct business operations, other than our ownership of our subsidiaries. While we have no current intention of paying dividends, should we decide in the future to do so, as a holding company, our ability to pay dividends and meet other obligations depends upon the receipt of dividends or other payments from our operating subsidiaries and other holdings and investments. In addition, our operating subsidiaries, from time to time, may be subject to restrictions on their ability to make distributions to us, including as a result of restrictive covenants in debt financing agreements, restrictions on the conversion of local currency into U.S. dollars or other hard currency and other regulatory restrictions as discussed below. If future dividends are paid in RMB, fluctuations in the exchange rate for the conversion of RMB into U.S. dollars may reduce the amount received by U.S. stockholders upon conversion of the dividend payment into U.S. dollars.
Chinese regulations currently permit the payment of dividends only out of accumulated profits as determined in accordance with Chinese accounting standards and regulations. Our subsidiaries in China are also required to set aside a portion of their after tax profits according to Chinese accounting standards and regulations to fund certain reserve funds. Currently, our subsidiaries in China are the only sources of revenues or investment holdings for the payment of dividends. If they do not accumulate sufficient profits under Chinese accounting standards and regulations to first fund certain reserve funds as required by Chinese accounting standards, we will be unable to pay any dividends.
RISKS RELATED TO DOING BUSINESS IN CHINA
Adverse changes in political, economic and other policies of the Chinese government could have a material adverse effect on the overall economic growth of China, which could materially and adversely affect the growth of our business and our competitive position.
Our business operations are conducted in China. Accordingly, our business, financial condition, results of operations and prospects are affected significantly by economic, political and legal developments in China. The Chinese economy differs from the economies of most developed countries in many respects, including:
the degree of government involvement;
the level of development;
the growth rate;
the control of foreign exchange;
the allocation of resources;
an evolving regulatory system; and
a lack of sufficient transparency in the regulatory process.
While the Chinese economy has experienced significant growth in the past 30 years, growth has been uneven, both geographically and among various sectors of the economy. The Chinese economy has also experienced certain adverse effects due to the recent global financial crisis. The Chinese government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures benefit the overall Chinese economy, but may also have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by government control over capital investments or changes in tax regulations that are applicable to us.
The Chinese economy has been transitioning from a planned economy to a more market-oriented economy. Although in recent years the Chinese government has implemented measures emphasizing the utilization of market forces for economic reform, the reduction of state ownership of productive assets and the establishment of sound corporate governance in business enterprises, a substantial portion of the productive assets in China is still owned by the Chinese government. The continued control of these assets and other aspects of the national economy by the Chinese government could materially and adversely affect our business. The Chinese government also exercises significant control over Chinese economic growth through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies.
Any adverse change in the economic conditions or government policies in China could have a material adverse effect on overall economic growth, which in turn could lead to a reduction in demand for our products and consequently have a material adverse effect on our businesses.
Uncertainties with respect to the PRC legal system could limit the legal protections available to you and us.
We conduct all of our business through our subsidiaries in the PRC. Our subsidiaries are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to FIEs. The PRC legal system is based on written statutes, and prior court decisions may be cited for reference but have limited precedential value. Since 1979, a series of new PRC laws and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, since the PRC legal system continues to evolve rapidly, the interpretations of many laws, regulations, and rules are not always uniform, and enforcement of these laws, regulations, and rules involve uncertainties, which may limit legal protections available to you and us. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention. In addition, most of our executive officers and directors are residents of China and not of the United States, and substantially all the assets of these persons are located outside the United States. As a result, it could be difficult for investors to affect service of process in the United States or to enforce a judgment obtained in the United States against our Chinese operations and subsidiaries.
You may have difficulty enforcing judgments against us.
Most of our assets are located outside of the United States and most of our current operations are conducted in the PRC. In addition, most of our directors and officers are nationals and residents of countries other than the United States. A substantial portion of the assets of these persons is located outside the United States. As a result, it may be difficult for you to effect service of process within the United States upon these persons. It may also be difficult for you to enforce in U.S. courts judgments on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors, most of whom are not residents in the United States and the substantial majority of whose assets are located outside of the United States. In addition, there is uncertainty as to whether the courts of the PRC would recognize or enforce judgments of U.S. courts. Our counsel as to PRC law has advised us that the recognition and enforcement of foreign judgments are provided for under the PRC Civil Procedures Law. Courts in China may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedures Law based on treaties between China and the country where the judgment is made or on reciprocity between jurisdictions. China does not have any treaties or other arrangements that provide for the reciprocal recognition and enforcement of foreign judgments with the United States. In addition, according to the PRC Civil Procedures Law, courts in the PRC will not enforce a foreign judgment against us or our directors and officers if they decide that the judgment violates basic principles of PRC law or national sovereignty, security, or the public interest. So it is uncertain whether a PRC court would enforce a judgment rendered by a court in the United States.
The PRC government exerts substantial influence over the manner in which we must conduct our business activities.
The PRC government has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate in China may be harmed by changes in its laws and regulations, including those relating to taxation, import and export tariffs, environmental regulations, land use rights, property, and other matters. We believe that our operations in China are in material compliance with all applicable legal and regulatory requirements. However, the central or local governments of the jurisdictions in which we operate may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations or interpretations.
Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof and could require us to divest ourselves of any interest we then hold in Chinese properties or joint ventures.
Our legal right to certain leased properties could be challenged by governmental authorities or third parties due to our lessors' lack of proper land use rights or building ownership over such properties and mortgages on those properties.
We do not own the land or any building on which our production facilities are located. Instead, we lease land and buildings from related parties and a third party. Our lessors are required to comply with various land- and property-related laws and regulations to enable them to lease their properties for industrial use. For example, properties used for productive entities and the underlying land should be approved for industrial use purposes by competent governmental authorities and should have appropriate building ownership certificates. In addition, before any properties located on land owned by collective organizations may be leased to third parties, lessors are required to obtain appropriate approvals from the competent governmental authorities. We lease a parcel of land of approximately 3,328 square meters from Heshang Town Xiangheqiao Village Economic Cooperative, but we were not provided with the land use right certificate in respect of the leased land or any other evidence issued by the proper and competent authority showing that Heshang Town Xiangheqiao Village Economic Cooperative has obtained appropriate approvals to lease the land use rights to us. This failure may subject the lessor or us to monetary fines or other penalties and may lead to the invalidation or termination of our lease by the competent governmental authorities, thereby adversely affecting our ability to operate our manufacturing business. While Heshang Town Xiangheqiao Village Economic Cooperative has agreed to indemnify us against any loss incurred by us related to the title or nature of the use of this land, we cannot assure you that we will be able to successfully enforce the indemnity of the lessor. As a result, we may suffer losses resulting from the lessor's failure to obtain the required approvals to the extent that we could not be fully indemnified by the lessor.
We lease buildings with a total area of approximately 23,568 square meters from SD Group, which does not hold any building ownership certificates related to these buildings. We were informed that SD Group is applying for building ownership certificates for those buildings. We also lease the buildings with total area of approximately 63,536 square meters from Hangzhou Xin Shengda Investment Co. Ltd., or Xin Shengda. Xin Shengda only has building ownership certificates covering approximately 53,180 square meters of the leased buildings. Xin Shengda has advised us that it is applying for building ownership certificates for the remaining areas. However, there can be no assurance that these two lessors will successfully obtain the requisite building ownership certificates. As a result, we cannot assure you that our rights under those leases will not be challenged by competent governmental authorities. Any challenge to our legal rights to the properties under the leases used for our manufacturing operations, if successful, could impair or adversely affect our business and operations on those properties.
The buildings we lease from Xin Shengda are also subject to a mortgage. Xin Shengda did not obtain the required consent to the lease from the mortgagee. As a result, the lease may not be binding on the mortgagee or a transferee who acquires the property upon any foreclosure under the mortgage. While Xin Shengda, as the lessor, has agreed to indemnify us for any loss incurred as a result of the mortgagee's foreclosure on the mortgage, we cannot assure you that we will be able to successfully enforce the lessor's indemnity to the full extent. As a result, we may suffer losses to the extent we are not fully indemnified by the lessor.
Under PRC laws, all lease agreements are required to be registered with the local housing bureau, while as set forth above, not all our lease have been registered. This may expose both our lessors and our subsidiaries to potential monetary fines. Some of our rights under the unregistered leases may also be subordinated to the rights of third parties.
Future inflation in China may inhibit our ability to conduct business in China.
In recent years, the Chinese economy has experienced periods of rapid expansion and highly fluctuating rates of inflation. During the past ten years, the rate of inflation in China has been as high as 6.5% and as low as -0.8% . These factors have led to the adoption by the Chinese government, from time to time, of various corrective measures designed to restrict the availability of credit or regulate growth and contain inflation. High inflation may in the future cause the Chinese government to impose controls on credit and/or prices, or to take other action, which could inhibit economic activity in China, and thereby harm the market for our products and our company.
Restrictions on currency exchange may limit our ability to receive and use our sales effectively.
The majority of our sales will be settled in RMB, and any future restrictions on currency exchanges may limit our ability to use revenue generated in RMB to fund any future business activities outside China or to make dividend or other payments in U.S. dollars. Although the Chinese government introduced regulations in 1996 to allow greater convertibility of the RMB for current account transactions, significant restrictions still remain, including primarily the restriction that FIEs may only buy, sell or remit foreign currencies after providing valid commercial documents, at those banks in China authorized to conduct foreign exchange business. In addition, conversion of RMB for capital account items, including direct investment and loans, is subject to governmental approval in China, and companies are required to open and maintain separate foreign exchange accounts for capital account items. The Chinese regulatory authorities may impose more stringent restrictions on the convertibility of the RMB.
In addition, the Notice of the General Affairs Department of the State Administration of Foreign Exchange on the Relevant Operating Issues concerning the Improvement of the Administration of Payment and Settlement of Foreign Currency Capital of Foreign-Invested Enterprises, issued by SAFE and effective as of August 29, 2008, or Circular 142, regulates the conversion by FIEs of foreign currency into RMB by restricting how the converted RMB may be used. Circular 142 requires that RMB converted from the foreign currency-dominated capital of a FIE may only be used for purposes within the business scope approved by the relevant government authority and may not be used to make equity investments in PRC, unless specifically provided otherwise. SAFE further strengthened its oversight over the flow and use of RMB funds converted from the foreign currency-dominated capital of a FIE. The use of such RMB may not be changed without approval from SAFE, and may not be used to repay RMB loans if the proceeds of such loans have not yet been used. Any violation of Circular 142 may result in severe penalties, including substantial fines.
Fluctuations in exchange rates could adversely affect our business and the value of our securities.
The value of our common stock will be indirectly affected by the foreign exchange rate between the U.S. dollar and RMB and between those currencies and other currencies in which our sales may be denominated. Appreciation or depreciation in the value of the RMB relative to the U.S. dollar would affect our financial results reported in U.S. dollar terms without giving effect to any underlying change in our business or results of operations. Fluctuations in the exchange rate will also affect the relative value of any dividend we issue that will be exchanged into U.S. dollars, as well as earnings from, and the value of, any U.S. dollar-denominated investments we make in the future.
Since July 2005, the RMB has no longer been pegged to the U.S. dollar. Although the People’s Bank of China, or PBOC, regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the RMB may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future PRC authorities may lift restrictions on fluctuations in the RMB exchange rate and lessen intervention in the foreign exchange market.
Very limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions. While we may enter into hedging transactions in the future, the availability and effectiveness of these transactions may be limited, and we may not be able to successfully hedge our exposure at all. In addition, our foreign currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert RMB into foreign currencies.
Restrictions under PRC law on our PRC subsidiaries’ ability to make dividends and other distributions could materially and adversely affect our ability to grow, make investments or acquisitions that could benefit our business, pay dividends to you, and otherwise fund and conduct our business.
All of our sales are earned by our PRC subsidiaries. However, as discussed more fully under Item 1 “Business -Regulation-Dividend Distributions,” PRC regulations restrict the ability of our PRC subsidiaries to make dividends and other payments to their offshore parent company. Any limitations on the ability of our PRC subsidiaries to transfer funds to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends and otherwise fund and conduct our business.
Failure to comply with PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident stockholders to personal liability, limit our ability to acquire PRC companies or to inject capital into PRC subsidiaries, limit our PRC subsidiaries' ability to distribute profits to us or otherwise materially adversely affect us.
In October 2005, SAFE issued the Notice on Relevant Issues in the Foreign Exchange Control over Financing and Return Investment Through Special Purpose Companies by Residents Inside China, generally referred to as Circular 75. Circular 75 requires PRC residents to register with the competent local SAFE branch before establishing or acquiring control over an SPV for the purpose of engaging in an equity financing outside of China. See Item 1 “Business-Regulation-Circular 75” for a detailed discussion of Circular 75 and its implementation.
We attempt to comply, and attempt to ensure that our stockholders and beneficial owners of our shares who are subject to Circular 75 comply, with the relevant requirements. Wuxiao Fang, Nengbin Fang and Congyi Fang, who are PRC residents and our stockholders, each has made SAFE 75 filings regarding his or her shareholding in the Company, Evercharm, Shengda Holdings and Wealthcharm Investments Limited with the Zhejiang Provincial Branch of SAFE. However, we completed the acquisition of 25% equity interests in Shengming by Evercharm in 2010. The change of equity investment by Evercharm is yet to be filed to perfect the SAFE 75 filings of Wuxiao Fang, Nengbin Fang and Congyi Fang. We have informed Wuxiao Fang, Nengbin Fang and Congyi Fang to file such change with Zhejiang Provincial Branch of SAFE as soon as practicable.
We have asked our other stockholders, who are PRC residents as defined in Circular 75, to register with the relevant branch of SAFE as currently required in connection with their equity interests in us and our acquisitions of equity interests in our PRC subsidiaries. However, we cannot provide any assurances that they can obtain the above SAFE registrations required by Circular 75. Moreover, because of uncertainty over how Circular 75 will be interpreted and implemented, and how or whether SAFE will apply it to us, we cannot predict how it will affect our business operations or future strategies. For example, our present and prospective PRC subsidiaries’ ability to conduct foreign exchange activities, such as the remittance of dividends and foreign currency-denominated borrowings, may be subject to compliance with Circular 75 by our PRC resident beneficial holders.
In addition, such PRC residents may not always be able to complete the necessary registration procedures required by Circular 75. We also have little control over either our present or prospective direct or indirect stockholders or the outcome of such registration procedures. A failure by our PRC resident beneficial holders or future PRC resident stockholders to comply with Circular 75, if SAFE requires it, could subject these PRC resident beneficial holders to fines or legal sanctions, restrict our overseas or cross-border investment activities, limit our subsidiaries’ ability to make distributions or pay dividends or affect our ownership structure, which could adversely affect our business and prospects.
We may be unable to complete a business combination transaction efficiently or on favorable terms due to complicated merger and acquisition regulations.
On August 8, 2006, six PRC regulatory agencies promulgated the Regulation on Mergers and Acquisitions of Domestic Companies by Foreign Investors, or the M&A Rule, which became effective on September 8, 2006 and was amended on June 22, 2009. The M&A Rule governs the approval process by which a Chinese company may participate in an acquisition of assets or equity interests. Depending on the structure of the transaction, the M&A Rule will require the parties to the transaction to make a series of applications to certain government agencies. In some instances, the application process may require the presentation of economic data concerning a transaction, including appraisals of the target business and evaluations of the acquirer, which are designed to allow the government to assess the transaction. Government approvals will have expiration dates by which a transaction must be completed and reported to the government agencies. Compliance with the M&A Rule is likely to be more time consuming and expensive than in the past, and the government can now exert more control over the combination of two businesses. Accordingly, due to the M&A Rule, our ability to engage in business combination transactions has become significantly more complicated, time consuming and expensive, and we may not be able to negotiate a transaction that is acceptable to our stockholders or sufficiently protect their interests in a transaction. The M&A Rule allows Chinese government agencies to assess the economic terms of a business combination transaction. Parties to a business combination transaction may have to submit to MOFCOM and other relevant government agencies an appraisal report and the acquisition agreement, all of which form part of the application for approval, depending on the structure of the transaction. The M&A Rule also prohibits a transaction at an acquisition price obviously lower than the appraised value of the Chinese business or assets and, in certain transaction structures, requires that consideration must be paid within defined periods, generally not in excess of a year. The M&A Rule also limits our ability to negotiate various terms of the acquisition, including aspects of the initial consideration, contingent consideration, holdback provisions, indemnification provisions and provisions relating to the assumption and allocation of assets and liabilities. Transaction structures involving trusts, nominees and similar entities are prohibited. Therefore, the M&A Rule may impede our implementation of our growth strategy.
Under the Enterprise Income Tax Law, we may be classified as a “resident enterprise” of China. Such classification will likely result in unfavorable tax consequences to us and our non-PRC stockholders.
On March 16, 2007, the National People’s Congress of China passed the EIT Law, and on November 28, 2007, the State Council of China passed its implementing rules, which took effect on January 1, 2008. Under the EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise,” meaning that it can be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes. See Item 1 “Business-Regulation-Taxation” for a detailed discussion of the EIT Law.
It remains unclear whether the PRC tax authorities would require or permit our overseas registered entities to be treated as PRC resident enterprises. We do not currently consider our company to be a PRC resident enterprise. However, if the PRC tax authorities determine that we are a “resident enterprise” for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, we may be subject to the enterprise income tax at a rate of 25% on our worldwide taxable income as well as PRC enterprise income tax reporting obligations. In our case, this would mean that income such as interest on offering proceeds and non-China source income would be subject to PRC enterprise income tax at a rate of 25%. Second, although under the EIT Law and its implementing rules dividends paid to us from our PRC subsidiaries may qualify as “tax-exempt income,” we cannot guarantee that such dividends will not be subject to a 10% withholding tax, as the PRC foreign exchange control authorities, which enforce the withholding tax, have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for PRC enterprise income tax purposes. Finally, it is possible that future guidance issued with respect to the new “resident enterprise” classification could result in a situation in which a 10% withholding tax is imposed on dividends we pay to our non-PRC stockholders and with respect to gains derived by our non-PRC stockholders from transferring our stock.
We face uncertainty from China’s Circular on Strengthening the Administration of Enterprise Income Tax on NonResident Enterprises' Share Transfer that was released in December 2009 with retroactive effect from January 1, 2008.
The Chinese State Administration of Taxation, or SAT, released a circular on December 15, 2009 that addresses the transfer of shares by nonresident companies, generally referred to as Circular 698. Circular 698, which was effective retroactively to January 1, 2008, may have a significant impact on many companies that use offshore holding companies to invest in China. Circular 698, which provides parties with a short period of time to comply with its requirements, indirectly taxes foreign companies on gains derived from the indirect sale of a Chinese company. Where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise by selling the shares in an offshore holding company, and the latter is located in a country or jurisdiction where the effective tax burden is less than 12.5% or where the offshore income of his, her, or its residents is not taxable, the foreign investor is required to provide the tax authority in charge of that Chinese resident enterprise with the relevant information within 30 days of the transfers. Moreover, where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise through an abuse of form of organization and there are no reasonable commercial purposes such that the corporate income tax liability is avoided, the PRC tax authority will have the power to re-assess the nature of the equity transfer in accordance with PRC’s “substance-over-form” principle and deny the existence of the offshore holding company that is used for tax planning purposes. There is uncertainty as to the application of Circular 698. For example, while the term "indirectly transfer" is not defined, it is understood that the relevant PRC tax authorities have jurisdiction regarding requests for information over a wide range of foreign entities having no direct contact with China. Moreover, the relevant authority has not yet promulgated any formal provisions or formally declared or stated how to calculate the effective tax in the country or jurisdiction and to what extent and the process of the disclosure to the tax authority in charge of that Chinese resident enterprise. In addition, there are not any formal declarations with regard to how to decide “abuse of form of organization” and “reasonable commercial purpose,” which can be utilized by us to balance if our Company complies with the Circular 698. As a result, we may become at risk of being taxed under Circular 698 and we may be required to expend valuable resources to comply with Circular 698 or to establish that we should not be taxed under Circular 698, which could have a material adverse effect on our financial condition and results of operations.
The new provisions of the PRC Employment Contract Law may substantially increase our labor-related costs in the future.
The PRC Employment Contract Law, which became effective as of January 1, 2008, contains many more provisions favorable to employees than prior labor regulations in effect in China. This may substantially increase our labor-related costs in our future operations. According to the new law, an employee is entitled to terminate his or her employment relationship with his or her employer for certain causes, such as delay in payment of wages or social insurance contribution or dissatisfactory labor protection, and under such circumstances the employer is liable to pay compensation to the employee. The amount of such compensation payment shall be one month's salary for each year that the employee has served the employer. If the monthly wage of an employee is three times greater than the average monthly wage in the previous year for employees as announced by the people's government at the municipal level directly under the central government or at the city with district level authority where the employer is located, the rate for the financial compensation paid to him shall be three times the average monthly wage of employees and shall be for not more than 12 years of work. In contrast to at-will employment arrangements, most employment arrangements in China are for a fixed term. An employer may also be liable to compensate an employee when the employer decides to terminate an existing employment before its expiration. In addition, if the labor market tightens in China or in the YRD, our labor costs may experience further increase.
Our failure to fully comply with PRC labor laws exposes us to potential liability.
Companies operating in China must comply with a variety of labor laws, including social insurance, housing fund and other employee welfare payment obligations. Uncertainties exist as to the interpretation, implementation and enforcement of these obligations. We believe we have paid all necessary social insurance contributions for all the employees of Great Shengda, Shengda Color and Hangzhou Shengming in accordance with applicable law. Further, we intend to pay all relevant social insurance contributions for all the employees of Suzhou AA, which recently obtained its social insurance registration certificate, in accordance with applicable law. However, if relevant governmental authorities determine that we have not complied fully with these obligations, we may be in violation of applicable PRC labor laws and we cannot assure you that PRC governmental authorities will not impose penalties on us for our failure to comply with these regulations. In addition, if any current or former employee files a complaint with the relevant governmental authorities, we may be subject to fulfilling employee welfare obligations as well as paying administrative fines.
Currently, we do not pay housing fund for our employees as required under the PRC law. The local Xiaoshan housing fund authority issued a certification to us on July 6, 2010, which certifies that the housing fund system is not fully implemented in Xiaoshan district, that the local Xiaoshan housing fund authority will extend the housing fund system to us in the near future and that the local Xiaoshan housing fund authority will not require us to fulfill our past housing fund contribution obligations retroactively. However, there can be no assurance that we will not be challenged by our employees for failure to pay housing fund as required by law and that we will not be punished by the local housing fund authority in the future.
We must comply with the Foreign Corrupt Practices Act and Chinese anti-corruption laws.
We are required to comply with the United States Foreign Corrupt Practices Act, or FCPA, which prohibits U.S. companies from engaging in bribery or making other prohibited payments to foreign officials for the purpose of obtaining or retaining business. Foreign companies, including some of our competitors, are not subject to these prohibitions. The PRC also strictly prohibits bribery of government officials. Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices occur from time to time in China. If our competitors engage in these practices, they may receive preferential treatment from some companies and gain an advantage in securing business, or from government officials who might give them priority in obtaining new licenses, thus putting us at a disadvantage. Our employees, agents, representatives and consultants may not always be subject to our control. If any of them violates the FCPA or other anti-corruption laws, we might be held responsible, and we could be subject to severe penalties as a result. In addition, the U.S. government may seek to hold us liable for successor liability for FCPA violations committed by companies in which we invest or which we acquire.
If we become directly subject to the recent scrutiny, criticism and negative publicity involving U.S.-listed Chinese companies, we may have to expend significant resources to investigate and resolve the matter which could harm our business operations, stock price and reputation and could result in a loss of your investment in our stock, especially if such matter cannot be addressed and resolved favorably.
Recently, U.S. public companies that have substantially all of their operations in China, particularly companies like us which have completed so-called reverse merger transactions, have been the subject of intense scrutiny, criticism and negative publicity by investors, financial commentators and regulatory agencies, such as the SEC. Much of the scrutiny, criticism and negative publicity has centered around financial and accounting irregularities and mistakes, a lack of effective internal controls over financial accounting, inadequate corporate governance policies or a lack of adherence thereto and, in many cases, allegations of fraud. As a result of the scrutiny, criticism and negative publicity, the publicly traded stock of many U.S. listed Chinese companies has sharply decreased in value and, in some cases, has become virtually worthless. Many of these companies are now subject to shareholder lawsuits, SEC enforcement actions and are conducting internal and external investigations into the allegations. It is not clear what effect this sector-wide scrutiny, criticism and negative publicity will have on our Company, our business and our stock price. If we become the subject of any unfavorable allegations, whether such allegations are proven to be true or untrue, we will have to expend significant resources to investigate such allegations and/or defend our company. This situation will be costly and time consuming and distract our management from growing our company. If such allegations are not proven to be groundless, our company and business operations will be severely and your investment in our stock could be rendered worthless.
The disclosures in our reports and other filings with the SEC and our other public pronouncements are not subject to the scrutiny of any regulatory bodies in the PRC. Accordingly, our public disclosure should be reviewed in light of the fact that no governmental agency that is located in China where substantially all of our operations and business are located have conducted any due diligence on our operations or reviewed or cleared any of our disclosure.
We are regulated by the SEC and our reports and other filings with the SEC are subject to SEC review in accordance with the rules and regulations promulgated by the SEC under the Securities Act and the Exchange Act. Unlike public reporting companies whose operations are located primarily in the United States, however, substantially all of our operations are located in China. Since substantially all of our operations and business takes place in China, it may be more difficult for the Staff of the SEC to overcome the geographic and cultural obstacles that are present when reviewing our disclosure. These same obstacles are not present for similar companies whose operations or business take place entirely or primarily in the United States. Furthermore, our SEC reports and other disclosure and public pronouncements are not subject to the review or scrutiny of any PRC regulatory authority. For example, the disclosure in our SEC reports and other filings are not subject to the review of the China Securities Regulatory Commission, a PRC regulator that is tasked with oversight of the capital markets in China. Accordingly, you should review our SEC reports, filings and our other public pronouncements with the understanding that no local regulator has done any due diligence on our company and with the understanding that none of our SEC reports, other filings or any of our other public pronouncements has been reviewed or otherwise been scrutinized by any local regulator.
RISKS RELATED TO THE MARKET FOR OUR STOCK GENERALLY
Our common stock is subject to price volatility related and unrelated to our operations.
The market price of our common stock could fluctuate substantially due to a variety of factors, including market perception of our ability to achieve our planned growth, quarterly operating results of other companies in the same industry, trading volume in our common stock, changes in general conditions in the economy and the financial markets or other developments affecting our competitors or us. In addition, the stock market is subject to extreme price and volume fluctuations. This volatility has had a significant effect on the market price of securities issued by many companies for reasons unrelated to their operating performance and could have the same effect on our common stock.
Our common stock may be delisted from The NASDAQ Global Market, which could negatively impact the price of our common stock and our ability to access the capital markets.
The listing standards of The NASDAQ Global Market provide that a company, in order to qualify for continued listing, must maintain a minimum stock price, satisfy standards relative to minimum stockholders' equity, minimum market value of publicly held shares and various additional requirements. If we fail to comply with all listing standards applicable to issuers listed on The NASDAQ Global Market, our common stock may be delisted. If our common stock is delisted, it could reduce the price of our common stock and the levels of liquidity available to our stockholders. In addition, the delisting of our common stock could materially adversely affect our access to the capital markets and any limitation on liquidity or reduction in the price of our common stock could materially adversely affect our ability to raise capital. Delisting from The NASDAQ Global Market could also result in other negative consequences, including the potential loss of confidence by suppliers, customers and employees, the loss of institutional investor interest and fewer business development opportunities.
We may be subject to penny stock regulations and restrictions.
The SEC has adopted regulations which generally define so-called "penny stocks" to be an equity security that has a market price less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exemptions. If our common stock were delisted and became a "penny stock," we may become subject to Rule 15g-9 under the Exchange Act, or the Penny Stock Rule. This rule imposes additional sales practice requirements on broker-dealers. For transactions covered by Rule 15g-9, a broker-dealer must make a special suitability determination for the purchaser and have received the purchaser's written consent to the transaction prior to sale. As a result, this rule may affect the ability of broker-dealers to sell our securities and may affect the ability of purchasers to sell any of our securities in the secondary market.
For any transaction involving a penny stock, unless exempt, the rules require delivery, prior to any transaction in a penny stock, of a disclosure schedule prepared by the SEC relating to the penny stock market. Disclosure is also required to be made about sales commissions payable to both the broker-dealer and the registered representative and current quotations for the securities. Finally, monthly statements are required to be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks.
There can be no assurance that our common stock will qualify for exemption from the Penny Stock Rule. In any event, even if our common stock were exempt from the Penny Stock Rule, we would remain subject to Section 15(b)(6) of the Exchange Act, which gives the SEC the authority to restrict any person from participating in a distribution of penny stock, if the SEC finds that such a restriction would be in the public interest.
Provisions in our Articles of Incorporation and Bylaws or Nevada law might discourage, delay or prevent a change of control of us or changes in our management and, therefore, depress the trading price of the common stock.
Our Articles of Incorporation authorize our Board of Directors to issue up to 100,000,000 shares of preferred stock. The preferred stock may be issued in one or more series, the terms of which may be determined at the time of issuance by our Board without further action by the stockholders. These terms may include voting rights including the right to vote as a series on particular matters, preferences as to dividends and liquidation, conversion rights, redemption rights and sinking fund provisions. The issuance of any preferred stock could diminish the rights of holders of our common stock, and therefore could reduce the value of such common stock. In addition, specific rights granted to future holders of preferred stock could be used to restrict our ability to merge with, or sell assets to, a third party. The ability of our Board of Directors to issue preferred stock could make it more difficult, delay, discourage, prevent or make it more costly to acquire or effect a change-in-control, which in turn could prevent our stockholders from recognizing a gain in the event that a favorable offer is extended and could materially and negatively affect the market price of our common stock.
In addition, Nevada corporate law and our Articles of Incorporation and Bylaws contain other provisions that could discourage, delay or prevent a change in control of our Company or changes in its management that our stockholders may deem advantageous. These provisions:
deny holders of our common stock cumulative voting rights in the election of directors, meaning that stockholders owning a majority of our outstanding shares of common stock will be able to elect all of our directors;
require any stockholder wishing to properly bring a matter before a meeting of stockholders to comply with specified procedural and advance notice requirements; and
allow any vacancy on the Board, however the vacancy occurs, to be filled by the directors.
We do not intend to pay dividends in the foreseeable future.
We intend to retain any earnings to finance the development and expansion of our business in the foreseeable future, and we do not anticipate paying any cash dividends on our common stock. Accordingly, investors must be prepared to rely on sales of their common stock after price appreciation to earn an investment return, which may never occur. Investors seeking cash dividends should not purchase our common stock. Any determination to pay dividends in the future will be made at the discretion of our Board of Directors and will depend on our results of operations, financial condition, contractual restrictions, restrictions imposed by applicable law and other factors our board deems relevant.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
Not Applicable.
ITEM 2.
ITEM 2. PROPERTIES.
There is no private land ownership in China. Individuals and companies are permitted to acquire land use rights for specific purposes. We currently do not have any land use rights. We are currently in the process of acquiring land use rights from Shuangdeng Paper Industrial Company Limited for land of approximately 166,533 square meters in area located in Yancheng City, Jiangsu Province. The land use rights have a term of 50 years expiring in December 2058. We intend to acquire the land use rights for the construction of plants to expand our business. We lease most of the land and buildings that we need to operate our business from related parties.
Great Shengda leases 110,894 square meters land use right at No. 2 Beitang Road, Xiaoshan Economic and Technological Development Zone from Xin Shengda. Our directors, Nengbin Fang and Congyi Fang, are two of the owners of Xin Shengda. The lease term is from January 1, 2013 to December 31, 2013 and the annual rental rate is RMB 1 million (approximately $0.16 million). Great Shengda leases additional property, also located No. 2 Beitang Road, Xiaoshan Economic and Technological Development Zone, from Xin Shengda consisting of office buildings and warehouses. The annual rental rate is RMB 0.68 million (approximately $0.11 million).
Shengda Color leases 33,500 square meters land use right from Zhejiang Shuang Ke Da Weaving Co., Ltd.(“Shuang Ke Da”). This property is located at Xiang He Qiao Village, Heshan Town, Xiaoshan District, Hangzhou, Zhejiang Province (“Xiang He Qiao Village”). The lease term is from January 1, 2013 to December 31, 2013 and the annual rental rate is RMB 0.5 million (approximately $0.08 million). Shengda Color also leases 30,661 square meters, consisting of buildings and a plant, from from Shuang Ke Da at Xiang He Qiao Village under a lease that began January 1, 2013 and ends December 31, 2013. The annual rental rate is RMB 0.7 million (approximately $0.11 million).
Hangzhou Shengming, as lessee, maintains a 47,942 square meter land use right lease with SD Group, as lessor, at Xiang He Qiao Village. The lease term began January 1, 2013 and expires December 31, 2013. The annual rental rate is RMB 1 million (approximately $0.16 million). Hangzhou Shengming also leases 23,568 square meters, consisting of buildings and a plant, from SD Group at Xiang He Qiao Village under a lease that began January 1, 2013 and ends December 31, 2013. The annual rental rate is RMB 0.8 million (approximately $0.13 million).
As of December 31, 2012, our major equipment includes (i) one BHS2800 paperboard production line from BHS, a German manufacturer; (ii) one Taiwan made XieXu 2500 paperboard production line; (iii) one BHS2500 paperboard production line; (iv) two Taiwan made XieXu 1800 paperboard production line; (v) one 7-color pre-printing production line; (vi) one computer-to-plate (CTP) system. The BHS2800 paperboard production line is among the world's most advanced paperboard production equipment.
We believe that all our properties have been adequately maintained, are generally in good condition, and are suitable and adequate for our business.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
From time to time, we may become involved in various lawsuits and legal proceedings which arise in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business. We are currently not aware of any such legal proceedings or claims that we believe will have a material adverse effect on our business, financial condition or operating results.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES.
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Market Information
Our common stock is listed on the NASDAQ Global Market and trades under the symbol “CPGI.” Our common stock was formerly quoted on the OTC Bulletin Board under the symbol “CPAK.” Prior to our underwritten public offering on December 10, 2010, there had never been an active public market for shares of our common stock.
The following table sets forth, for the fiscal quarters indicated, the high and low sales prices for our common stock as quoted on the NASDAQ Global Market.
Approximate Number of Holders of Our Common Stock
As of March 29, 2013, there were approximately 47 holders of record of our common stock. This number excludes the shares of our common stock owned by stockholders holding stock under nominee security position listings.
Dividends
Great Shengda declared a dividend distribution to Evercharm in 2008 totaling RMB 45.0 million (approximately $6.6 million). Other than this dividend, we have never declared or paid a cash dividend. Any future decisions regarding dividends will be made by our Board of Directors. We currently intend to retain and use any future earnings for the development and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future. Our Board of Directors has complete discretion on whether to pay dividends, subject to compliance with Nevada law governing the payment of dividends and any applicable contractual restrictions on payments of dividends. See Item 1A “Risk Factors-Risks Related to Our Business-Our holding company structure may limit the payment of dividends,” “-Risks Related to Our Business-Covenants in certain loan agreements entered into by Great Shengda and Hangzhou Shengming restrict our ability to engage in or enter into a variety of transactions, which may cause disruption to our business operations and have a material adverse effect on our business operations,” “-Risks Related to Doing Business in China-Restrictions under PRC law on our PRC subsidiaries’ ability to make dividends and other distributions could materially and adversely affect our ability to grow, make investments or acquisitions that could benefit our business, pay dividends to you, and otherwise fund and conduct our business” and Item 1 “Business-Regulation-Dividend Distribution” and for more information regarding restrictions on our payment of dividends. Even if our Board of Directors decides to pay dividends, the form, frequency and amount will depend upon our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors that the Board may deem relevant.
Securities Authorized for Issuance under Equity Compensation Plans
We do not have any compensation plans in effect under which our equity securities are authorized for issuance.
Recent Sales of Unregistered Securities
We have not sold any equity securities during the fiscal year ended December 31, 2012 that were not previously disclosed in a quarterly report on Form 10-Q or a current report on Form 8-K that was filed during the 2012 fiscal year.
Purchases of Equity Securities
No repurchases of our common stock were made during the fourth quarter of 2012.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
Not applicable.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following management’s discussion and analysis should be read in conjunction with our financial statements and the notes thereto and the other financial information appearing elsewhere in this report. In addition to historical information, the following discussion contains certain forward-looking information. See “Special Note Regarding Forward Looking Statements” above for certain information concerning those forward looking statements.
Overview
We are a leading paper packaging company in China. Through our wholly-owned subsidiaries, Great Shengda, Shengda Color, Hangzhou Shengming and Suzhou AA, we are principally engaged in the design, manufacture and sale of flexo-printed and color-printed corrugated paper cartons in a variety of sizes and strengths. We also manufacture corrugated paperboards, which are used for the production of our flexo-printed and color-printed cartons.
We provide paper packaging solutions to a wide variety of industries, including food, beverage, cigarette, household appliance, consumer electronics, pharmaceuticals, chemicals, machinery and other consumer or industrial sectors. Our major products are single-layer paper cartons for food, drinks and medicine, double-layer paper cartons for garments, chemicals, furniture, refrigerators and air-conditioners, and triple-layer paper cartons for electrical machinery, motorcycles, and other heavy-duty products. Our sales volume in 2012 reached 317.4 million square meters with an annual production capacity of 545 million square meters in 2012.
Our production facilities are strategically located in the YRD, a manufacturing center in China, thus putting us in close proximity to a large number of paper carton customers. Due to the weight and bulk of paper products and the consequent high shipping costs, paper packaging companies are generally limited to servicing a geographic radius from their production site, usually between 300 and 500 kilometers, within which they can compete economically. The paper carton market, therefore, is highly influenced by regional supply and demand dynamics. Based from our four manufacturing facilities in the provinces of Zhejiang and Jiangsu, we have established a sales network with five customer service centers that can service customers throughout the YRD, which accounted for the majority of our revenues. As the leading paper packaging manufacturer in the YRD, we are well positioned to capitalize on the fast-growing demand for paper cartons driven by the concentration and success of the manufacturing companies in the region.
We serve a broad base of reputable customers, including some of the Fortune 500 companies and Top 500 Chinese enterprises. Our major customers include Nongfu Spring Co., Ltd., Hangzhou Cigarette Company, Samsung’s Chinese subsidiary Suzhou Samsung Electrical Co., Ltd. and Panasonic’s Chinese subsidiary Hangzhou Panasonic Home Electrical Appliance Company. We have developed long-term relationships with and loyalty from our customers, many of which have been with us for over five years. We have also engaged in strategic alliance relationships with ten customers as their preferred supplier. At the same time, we continue to attract new customers to generate higher demand for our products and increase market penetration.
Our total revenues for the year ended December 31, 2012 were $125.3 million, an increase of $1.3 million, or 1.1%, from $124.0 million for the year ended December 31, 2011. Our net income attributable to the Company’s common stockholders for the year ended December 31, 2012 was $5.6 million, a decrease of $4.0 million, or 42.2%, from $9.6 million for the year ended December 31, 2011.
Significant Events in 2012
On July 13, 2012, we held an annual meeting of shareholders in Hangzhou, Zhejiang Province in China. At the meeting, shareholders re-elected each of the following nominees to the Board of Directors of the Company for a term that will continue until the next annual meeting of shareholders: Nengbin Fang, Congyi Fang, Yaoquan Zhang, Zhihai Mao and Michael Zhang. Shareholders also ratified the appointment of Marcum Bernstein & Pinchuk LLP as the independent registered public accounting firm of the Company for the fiscal year ending December 31, 2012.
On May 7, 2012, the Company received a letter from The Nasdaq Stock Market, or NASDAQ, notifying it of its failure to maintain a minimum closing bid price of $1.00 over the then preceding 30 consecutive trading days for its common stock as required by NASDAQ Listing Rule 5450(a)(1). The letter stated that the Company had until November 5, 2012 to demonstrate compliance by maintaining a minimum closing bid price of at least $1.00 for a minimum of 10 consecutive trading days. The letter was issued in accordance with standard NASDAQ procedures. This notification had no immediate effect on the listing of our common stock.
On October 30, 2012, the Company received a notice from NASDAQ notifying it that its common stock had regained compliance with NASDAQ Listing Rule 5450(a)(1), relating to the requirement to maintain a closing bid price of $1.00. The notice indicated that NASDAQ determined that the closing bid price of the Company’s common stock had been at $1.00 per share or greater for ten consecutive business days, from October 15, 2012 to October 26, 2012.
On October 15, 2012, our Board of Directors received a preliminary, non-binding proposal from our Chairman, Mr. Nengbin Fang, in which Mr. Fang offered to acquire all of the outstanding shares of our common stock that he and his family do not own in a going-private transaction at a proposed price of $1.40 per share to be paid in cash. According to the proposal, Mr. Fang intended to fund the acquisition with a combination of debt and equity financing. At the time of the proposal, Mr. Fang and his family collectively beneficially owned approximately 54.03% of our common stock. Upon receipt of the proposal, our Board established a special committee to consider this proposal and any additional proposals that may be made by Mr. Fang and his affiliates, if any. The special committee was comprised of the following independent directors of the Company: Mr. Zhihai Mao, Mr. Michael Zhang, and Mr. Yaoquan Zhang.
On November 13, 2012 the special committee received a letter from Mr. Fang, withdrawing the preliminary non-binding proposal that he submitted to the Board on October 15, 2012, although he intends to continue to pursue a possible going-private transaction with respect to the Company. Mr. Fang stated in an amendment to his Schedule 13D filing with the SEC that he is in preliminary discussions with a limited number of shareholders of the Company and potential debt financing sources, including VStone Investment Management Limited, in each case regarding their potential participation in a going private transaction, and that he may approach one or more other shareholders of the Company for such purpose. There can be no assurance, however, that Mr. Fang will make another proposal to take the Company private in the future or that if he does make another proposal to take the Company private that it will be consummated. On December 6, 2012 our Board voted unanimously to dissolve the special committee.
Executive Overview of Financial Results
Financial Performance Highlights
The following are some financial highlights for the year:
Revenues: Revenues increased by $1.3 million, or 1.1%, to $125.3 million for 2012 from $124.0 million for 2011.
Gross profit: Our gross profit decreased by $3.1 million, or 12.0%, to $22.6 million for 2012 from $25.7 million for 2011. Gross profit as a percentage of revenues was 18.0% for 2012, as compared to 20.7% for 2011.
Net income applicable to common stockholders: Net income applicable to our common stockholders decreased by $4.0 million, or 42.2%, to $5.6 million for 2012 from $9.6 million for 2011.
Fully diluted net income per share: Fully diluted net income per share was $0.14 for 2012 as compared to $0.25 for 2011.
Principal Factors Affecting Our Financial Performance
We believe that the following factors will continue to affect our financial performance:
Rising Consumer Purchasing Power and Growth of the Chinese Economy. Rising consumer purchasing power in China and growth of the Chinese economy in the last few years has translated into an increasing demand for, and sales of, consumer products, such as food products, household electrical appliances and furniture. We believe this increase in demand for consumer products has led, and will continue to lead, to increasing demand for paper packaging products. While the export sector may not achieve growth rates as strong as those experienced in the past decade, we believe consumer spending in China will help keep the Chinese economy buoyant in view of the Chinese government's stated goal of stimulating domestic consumer spending.
Ability to Maintain Margin. We have flexibility in pricing our products. We negotiate prices with over 900 customers for their orders based on order size and product requirements. We believe most of our customers are willing to pay us higher prices for our high quality products, timely delivery and strong production capacity that meets their requirements, which we expect will allow us to maintain high profit margins for our products. We also strive to diversify our products and have started to develop high gross margin products such as color-printed carton and pre-printing paper. The trends favoring high-quality and environmentally friendly packaging solutions, as discussed below, also should allow us to maintain our profit margins.
Fluctuation in Raw Material Costs. Historically, approximately 70% to 85% of our cost of goods sold has been comprised of raw materials, mainly raw paper. Thus our cost of goods sold is sensitive to the price of raw paper. We have experienced fluctuation in raw material costs in the last couple of years as a result of world economic conditions. We anticipate that raw paper prices will stabilize throughout 2013.
Dependence on the YRD Region. The YRD, which includes Xiaoshan, the location of our subsidiaries, is an important manufacturing base in China with a highly developed transportation infrastructure. Given the relatively high cost of transporting paper, our sales have been limited to areas within 300-500 kilometers of our manufacturing facilities. Therefore, most of our customers are in the YRD region and we are dependent on the region's continued economic growth. The YRD accounts for signification portion of China’s GDP and China’s imports and exports. In August 2007, Xinhua News Agency reported that the region’s GDP was forecasted to grow at an annual rate of approximately 11% and reach RMB 16.0 trillion (approximately $2.4 trillion) by 2020. We do not believe any of our key customers will relocate out of the region in the foreseeable future.
Industry Trends. We believe we benefit from a number of favorable trends. According to S&P Consulting, market demand for corrugated paper cartons will grow from 2009 at a compound annual growth rate of 14.2% to 62.6 billion square meters in 2013, with China, according to the China Packaging Federation, overtaking the United States as the largest corrugated paper carton market in the world. With environmental concern becoming an increasingly important topic around the world, packaging materials are expected to be energy saving, toxic-free, reusable, degradable and multi-functional. Government mandate as well as consumer preference make paper a more environmentally-friendly substitute for metal, plastic, glass or wood as packaging material. All of the foregoing translates into significant growth potential for the corrugated paper packaging industry in the PRC. Furthermore, as the standard of living rises, consumers are becoming more discerning about product image and presentation. The increased consumer sophistication translates into growing demand for high-quality and aesthetically pleasing packaging. We are well positioned to take advantage of these market trends as we expand our capacity for color-printed cartons.
Expansion Plans. We intend to grow our business through further penetration of existing markets, entry into new markets and acquisition of complementary businesses or competitors. We are building a paper manufacturing plant in Jiangsu Province, PRC. If we successfully implement the plan, we should be able to produce some of the raw paper we use and gain new customers in new markets.
Taxation
China Shengda Packaging Group Inc. is subject to United States tax at a tax rate of 34%. No provision for income tax in the United States has been made as China Shengda Packaging Group Inc. had no U.S. taxable income for 2012 and 2011, and accumulated earnings from its PRC subsidiaries will be permanently reinvested in the PRC.
Evercharm was incorporated in the BVI and under the current laws of the BVI, is not subject to income tax.
In October 2010, Great Shengda qualified as a National High-Tech Enterprise, a status recognized by China’s Ministry of Science and Technology, Ministry of Finance, and State Administration of Taxation. In December 2010, the status was approved by the local tax bureau. As a result, Great Shengda is entitled to a preferential tax rate of 15%, retroactively effective as of January 1, 2010. Such status is subject to review by government authorities every three years. We cannot assure that we will continue to have such status after 2013 or that the PRC government will continue the preferential tax treatment of designated high-tech enterprises.
Hangzhou Shengming was entitled to two years’ exemption followed by three years’ half deduction on its income tax rate from 2007; thus it was exempt from EIT for 2007 and 2008 and was granted a 12.5% EIT rate for 2009, 2010 and 2011. Hangzhou Shengming is subject to the uniform income tax rate of 25% for calendar year 2012.
Shengda Color, Suzhou AA and Shuangsheng are not entitled to any tax holidays or preferential tax treatment. Therefore, they are each subject to the uniform income tax rate of 25% for calendar years 2011 and 2012.
The EIT Law and its implementing rules generally provide that a 10% withholding tax applies to China-sourced income derived by non-resident enterprises for PRC enterprise income tax purposes unless the jurisdiction of incorporation of such enterprises’ stockholder has a tax treaty with China that provides for a different withholding arrangement.
Results of Operations
The following table sets forth key components of our results of operations during the fiscal years ended December 31, 2012 and 2011, both in dollars and as a percentage of our revenues.
Revenues. We generate revenues from the sale of our paper cartons and other paper products. Our revenues increased by $1.3 million, or 1.1%, to $125.3 million for the year ended December 31, 2012, from $124.0 million for the year ended December 31, 2011. The increase was primarily attributable to the increase in average sales price. The average price per square meter increased by $0.01, or 2.5%, to $0.395 for the year ended December 31, 2012, from $0.385 for the year ended December 31, 2011 in response to the increased cost of raw materials. Sales volume decreased by 4.4 million square meters, or 1.4%, to 317.4 million square meters for the year ended December 31 30, 2012, from 321.7 million square meters for the year ended December 31, 2011. The decreased sales volume was mainly the result of the challenging domestic and foreign economic environment.
For the year ended December 31, 2012, color cartons accounted for 28.7% of our revenues and flexo cartons accounted for 71.3% of our revenues, compared to 27.1% and 72.9%, respectively, in the year ended December 31, 2011. Average per square meter prices for our color cartons and flexo cartons during the year ended December 31, 2012 were approximately $0.42 and $0.39, respectively, as compared to approximately $0.44 and $0.37, respectively, for the year ended December 31, 2011.
Consumer and industrial goods manufacturing sectors are the principal markets we serve. Our major customers remained home appliances and electronics manufacturers and food, beverage and cigarette manufacturers in the YRD, which accounted for 23.2% and 30.1%, respectively, of our revenues for the year ended December 31, 2012, as compared to 26.1% and 27.4%, respectively, of our revenues for the year ended December 31, 2011.
Cost of goods sold. Our cost of goods sold is comprised of raw materials, labor cost for production-related workers, depreciation and amortization of production-related equipment, utilities consumption costs and overhead allocation. Our cost of goods sold increased by $4.4 million, or 4.5%, to $102.7 million for the year ended December 31, 2012, from $98.3 million for the year ended December 31, 2011. Average cost of goods sold per square meter during the year ended December 31, 2012 was approximately $0.32, an increase of approximately $0.02, as compared to approximately $0.30 for the year ended December 31, 2011. This increase was primarily due to the increased cost of raw materials . Management will keep monitoring raw material prices for cost control.
Gross profit. Our gross profit decreased by $3.1 million, or 12.0%, to $22.6 million for the year ended December 31, 2012, from $25.7 million for the year ended December 31, 2011. Gross profit from flexo cartons decreased by $2.3 million, or 13.0%, to $15.5 million for the year ended December 31, 2012, from $17.8 million for the year ended December 31, 2011. Gross profit from color cartons decreased by $0.8 million, or 9.9%, to $7.1 million for the year ended December 31, 2012, from $7.9 million in the year ended December 31, 2011. Gross profit as a percentage of revenues was 18.0% for the year ended December 31, 2012, as compared to 20.7% for the year ended December 31, 2011. The decrease in our gross profit was mainly due to increased cost of goods sold as noted above.
Selling expenses. Our selling expenses include freight, salary and benefits for sales and marketing personnel, travelling and advertising expenses. Our selling expenses increased by $0.4 million, or 8.7%, to $5.1 million for the year ended December 31, 2012, from $4.7 million for the year ended December 31, 2011. Such increase resulted mainly from a $0.1 million increase in sales staff costs, which include salary, benefits, social insurance and other relevant staff expenses; and a $0.3 million increase in freight which was mainly caused by the increasing cost of our service providers. As a percentage of revenues, selling expenses for the year ended December 31, 2012 increased to 4.1% from 3.8% for the year ended December 31, 2011.
General and administrative expenses. Our general and administrative expenses are comprised of research and development, or R&D expense, salary and benefits for administrative personnel, rental fees, depreciation and amortization for equipment used other than for production and miscellaneous expenses unrelated to production. Our general and administrative expenses increased by $0.8 million, or 7.5%, to $11.0 million for the year ended December 31, 2012, from $10.2 million for the year ended December 31, 2011. This was mainly attributable to a $0.5 million increase in staff costs, which includes salary, benefits, social insurance and other relevant staff expenses. As a percentage of revenues, general and administrative expenses for the year ended December 31, 2012 increased to 8.8%, as compared to 8.3% for the year ended December 31, 2011.
Subsidy income. We received local government funds in support of our R&D activities and hi-tech development in the amounts of $0.4 million and $1.1 million for the years ended December 31, 2012 and 2011, respectively. Such subsidies are recognized as income in the period in which funds were received from the government.
Income tax expense. Our income tax expense decreased to $0.9 million for the year ended December 31, 2012, as compared to $1.7 million for the year ended December 31, 2011. The decrease in income tax expense was mainly attributable to the decrease in income before income tax expense and noncontrolling interest, as discussed above.
Net income attributable to common stockholders. Our net income attributable to our common stockholders decreased by $4.0 million, or 42.2%, to $5.6 million for the year ended December 31, 2012, from $9.6 million for the year ended December 31, 2011, as a result of the cumulative effect of the above factors.
Liquidity and Capital Resources
Cash generated from our operations and borrowing capacity under our lines of credit are used as our primary source of liquidity. As of December 31, 2012, we had cash and cash equivalents of $11.9 million and restricted cash of $22.6 million.
We anticipate that cash on hand, and cash generated from our operations will be sufficient to satisfy our obligations for at least the next 12 months.
The following table sets forth a summary of our cash flows for the periods indicated:
Operating Activities
Net cash provided by operating activities was $27.2 million for the year ended December 31, 2012, as compared to $4.8 million net cash used in operating activities for the year ended December 31, 2011. This was attributable to our net income of $5.6 million, adjusted by depreciation and amortization expenses of $4.5 million, and a net increase in cash from accounts and notes payable of 20.2 million, and a net decrease in cash from other working capital items of $3.1 million.
Investing Activities
Net cash used in investing activities was $27.7 million for the year ended December 31, 2012, as compared to $9.6 million for the year ended December 31, 2011. The $27.7 million net cash used in investing activities during the year ended December 31, 2012 was attributable to the purchases of property, plant and equipment, primarily related to the capital expenditure of our paper mill including machinery purchases of $15.6 million and plant construction of $11.2 million.
Financing Activities
Net cash used in financing activities was $7.0 million for the year ended December 31, 2012, as compared to $3.0 million net cash used in financing activities for the year ended December 31, 2011. During the year ended December 31, 2012, we received loan proceeds amounting to $11.1 million, repaid $13.3 million loans and deposited restricted cash of $5.0 million for the notes payable and loans as collateral.
As of December 31, 2012, we were party to a Loan Agreement, dated December 28, 2011, between Great Shengda, as borrower, and Tokyo Branch of Bank of China, pursuant to which the bank provided a loan in the principal amount of $4.5 million. The agreement’s maturity date is December 28, 2013. The interest rate is London Interbank Offer Rates (USD) plus 2.5%, which will be re-priced on June 21 and December 21 each year before the maturity date. The agreement contains restrictive covenants restricting us during the term of the loan from undertaking any disposal of assets in a manner that is detrimental to our ability to repay the loan. The agreement also contains covenants that restrict us from making dividend distributions if we are unable to pay principal and interest or if our after tax profit for a particular fiscal year (1) equals nil or less; or (2) is insufficient to offset deficits of prior years.
As of December 31, 2012, we were party to a Loan Agreement, dated April 24, 2012, between Great Shengda, as borrower, and Tokyo Branch of Bank of China, pursuant to which the bank provided a loan in the principal amount of $3.5 million. The agreement’s maturity date is April 24, 2013. The interest rate is London Interbank Offer Rates plus 2.5%, which will be re-priced on June 21 and December 21 each year before the maturity date. The agreement contains restrictive covenants restricting us during the term of the loan from undertaking any disposal of assets in a manner that is detrimental to our ability to repay the loan. The agreement also contains covenants that restrict us from making dividend distributions if we are unable to pay principal and interest or if our after tax profit for a particular fiscal year (1) equals nil or less; or (2) is insufficient to offset deficits of prior years.
As of December 31, 2012, we were party to a Loan Agreement, dated February 20, 2012, between Great Shengda, as borrower, and Tokyo Branch of Bank of China, pursuant to which the bank provided a loan in the principal amount of $4.5 million. The agreement’s maturity date is February 28, 2014. The interest rate is London Interbank Offer Rates (USD) plus 2.5%, which will be re-priced on June 21 and December 21 each year before the maturity date. The agreement contains restrictive covenants restricting us during the term of the loan from undertaking any disposal of assets in a manner that is detrimental to our ability to repay the loan. The agreement also contains covenants that restrict us from making dividend distributions if we are unable to pay principal and interest or if our after tax profit for a particular fiscal year (1) equals nil or less; or (2) is insufficient to offset deficits of prior years.
Seasonality
Our operating results and operating cash flows historically have not been subject to seasonal variations. This pattern may change, however, as a result of new market opportunities or new product introductions.
Inflation
Inflation and changing prices have not had a material effect on our business, and we do not expect that inflation or changing prices will materially affect our business in the foreseeable future. However, our management will closely monitor price changes in the Chinese economy and our industry, and continually maintain effective cost controls in operations.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to our investors.
Critical Accounting Policies
The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America, or U.S. GAAP, requires our management to make assumptions, estimates and judgments that affect the amounts reported, including the notes thereto, and related disclosures of commitments and contingencies, if any. We have identified certain accounting policies that are significant to the preparation of our financial statements. These accounting policies are important for an understanding of our financial condition and results of operation. Critical accounting policies are those that are most important to the portrayal of our financial condition and results of operations and require management's difficult, subjective, or complex judgment, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods. Certain accounting estimates are particularly sensitive because of their significance to financial statements and because of the possibility that future events affecting the estimate may differ significantly from management's current judgments. We believe the following critical accounting policies involve the most significant estimates and judgments used in the preparation of our consolidated financial statements.
Revenue Recognition
We recognize revenue in accordance with Accounting Standards Codification (“ASC”) Topic 605 “Revenue Recognition”. All of the following criteria must exist in order for us to recognize revenue: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) price to the buyer is fixed or determinable; and (4) collectability is reasonably assured.
Delivery does not occur until the products have been shipped to the customers, risk of loss has transferred to the customers and customers’ acceptance has been obtained, or we have objective evidence that the criteria specified in customers’ acceptance provisions have been satisfied. The sales price is not considered to be fixed or determinable until all contingencies related to the sale have been resolved.
In the PRC, value added tax, or VAT, of 17% on invoice amount is collected in respect of the sales of goods on behalf of tax authorities. Revenue is recognized on a net basis, and VAT collected is not recognized as revenue of the Company.
Accounts and Notes Receivable
Accounts receivable are recognized and carried at the original sales amount less an allowance for uncollectible accounts, as needed.
Accounts receivable are reviewed periodically as to whether they are past due based on contractual terms and their carrying value has become impaired. An allowance for doubtful accounts is recorded in the period in which loss is determined to be probable based on an assessment of specific evidence indicating doubtful collection, historical experience, account balance aging and prevailing economic conditions. Accounts receivable balances are written off after all collection efforts have been exhausted. No significant account receivable balance was written off for the years ended December 31, 2012 and 2011. Based on our collection experience, management does not believe that bad debt reserve is warranted at this time.
Notes receivable represents bankers' acceptances that have been arranged with third-party financial institutions by certain customers to settle their purchases from us. These bankers' acceptances are non-interest bearing and are collectible within six months. Such sales and purchasing arrangements are consistent with industry practices in the PRC.
Income Taxes
We follow ASC Topic 740 “Income Taxes”, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates, applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.
Fair Value Measurements
Financial instruments include cash and cash equivalents, accounts and notes receivable, prepayments and other receivables, short-term loans, accounts and notes payable, other payables and amounts due to related parties. The carrying amounts of these financial instruments approximate their fair value due to the short term maturities of these instruments.
We adopted ASC Topic 820 “Fair Value Measurements” on January 1, 2008 for all financial assets and liabilities and nonfinancial assets and liabilities that are recognized or disclosed at fair value in the consolidated financial statements on a recurring basis (at least annually). ASC Topic 820 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. We have not adopted ASC Topic 820 for non financial assets and non financial liabilities, as these items are not recognized at fair value on a recurring basis.
ASC Topic 820 defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for an asset or liability required or permitted to be recorded at fair value, we consider the principal or most advantageous market in which it would be transacted and consider assumptions that market participants would use when pricing the asset or liability.
ASC Topic 820 establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument's categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. ASC Topic 820 establishes three levels of inputs that may be used to measure fair value:
Level 1 applies to assets or liabilities for which there are quoted prices in active markets for identical assets or liabilities.
Level 2 applies to assets or liabilities for which there are inputs other than quoted prices included within Level 1 that are observable for the asset or liability such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical assets or liabilities in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which significant inputs are observable or can be derived principally from, or corroborated by, observable market data.
Level 3 applies to assets or liabilities for which there are unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of the assets or liabilities.
Current Vulnerability Due To Certain Other Concentrations
Our operations may be adversely affected by significant political, economic and social uncertainties in the PRC. Although the PRC government has been pursuing economic reform policies for more than 30 years, no assurance can be given that the PRC government will continue to pursue such policies or that such policies may not be significantly altered, especially in the event of a change in leadership, social or political disruption or unforeseen circumstances affecting the PRC’s political, economic and social conditions. There is also no guarantee that the PRC government’s pursuit of economic reforms will be consistent or effective.
We transact the majority of our business in RMB, which is not freely convertible into foreign currencies. On January 1, 1994, the PRC government abolished the dual rate system and introduced a single rate of exchange as quoted daily by the PBOC. However, the unification of the exchange rates does not imply that RMB may be readily convertible into dollars or other foreign currencies. All foreign exchange transactions continue to take place either through the PBOC or other banks authorized to buy and sell foreign currencies at the exchange rates quoted by the PBOC. Approval of foreign currency payments by the PBOC or other institutions requires submitting a payment application form together with suppliers’ invoices, shipping documents and signed contracts.
Additionally, the value of RMB is subject to changes in central government policies and international economic and political developments affecting supply and demand in the PRC foreign exchange trading system market.
Recent Accounting Pronouncements
See Note 2(x) (recently issued accounting standards) to our consolidated financial statements included elsewhere in this report.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The full text of our audited consolidated financial statements as of December 31, 2012 and 2011 begins on page of this annual report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES.
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Disclosure controls and procedures refer to controls and other procedures designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
As required by Rule 13a-15(e), our management has carried out an evaluation, with the participation and under the supervision of our Chief Executive Officer, Mr. Daliang Teng and our Chief Financial Officer, Mr. Ken He, of the effectiveness of the design and operation of our disclosure controls and procedures, as of December 31, 2012. Based upon, and as of the date of this evaluation, Messrs. Teng and He determined that our disclosure controls and procedures were effective.
Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting refers to the process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer, and effected by our Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP, and includes those policies and procedures that:
(1) 	
pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets;
(2) 	
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that our receipts and expenditures are being made only in accordance with the authorization of our management and directors; and
(3) 	
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Our management evaluated the effectiveness of our internal control over financial reporting as of December 31, 2012. In making this evaluation, management used the framework set forth in the report entitled Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO. The COSO framework summarizes each of the components of a company’s internal control system, including (i) the control environment, (ii) risk assessment, (iii) control activities, (iv) information and communication, and (v) monitoring. Based on our evaluation we determined that, as of December 31, 2012, our internal control over financial reporting is effective at the reasonable assurance level based on those criteria.
Because the Company is a smaller reporting company, this annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm.
Changes in Internal Control Over Financial Reporting
There have been no changes in our internal control over financial reporting during the fourth quarter of fiscal year 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION.
On January 1, 2013, Great Shengda entered into a land use right lease with Xin Shengda for 110,894 square meters land use right at No. 2 Beitang Road, Xiaoshan Economic and Technological Development Zone. Our directors, Nengbin Fang and Congyi Fang, are two of the owners of Xin Shengda. The lease term is from January 1, 2013 to December 31, 2013 and the annual rental rate is RMB 1 million (approximately $0.16 million). Great Shengda leases additional property, also located No. 2 Beitang Road, Xiaoshan Economic and Technological Development Zone, from Xin Shengda consisting of office buildings and warehouses. The annual rental rate is RMB 0.68 million (approximately $0.11 million).
On January 1, 2013, Shengda Color entered into a lease with Shuang Ke Da for the land use right of 33,500 square meters located at Xiang He Qiao Village, Heshan Town, Xiaoshan District, Hangzhou, Zhejiang Province (“Xiang He Qiao Village”). The lease term is from January 1, 2013 to December 31, 2013 and the annual rental rate is RMB 0.5 million (approximately $0.08 million). Shengda Color also leases 30,661 square meters, consisting of buildings and a plant, from from Shuang Ke Da at Xiang He Qiao Village under a lease that began January 1, 2013 and ends December 31, 2013. The annual rental rate is RMB 0.7 million (approximately $0.11 million).
On January 1, 2013, Hangzhou Shengming entered into a lease agreement with SD Group for the land use right of 47,942 square meter at Xiang He Qiao Village. The lease term began January 1, 2013 and expires December 31, 2013. The annual rental rate is RMB 1 million (approximately $0.16 million). Hangzhou Shengming also leases 23,568 square meters, consisting of buildings and a plant, from SD Group at Xiang He Qiao Village under a lease that began January 1, 2013 and ends December 31, 2013. The annual rental rate is RMB 0.8 million (approximately $0.13 million).
The English translation of the lease agreements are attached hereto as Exhibits 10.22 through 10.27.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
Directors and Executive Officers
The following table sets forth the name and position of each of our current directors and executive officers.
Mr. Nengbin Fang. Mr. Fang became our Chairman on April 8, 2010, the day we consummated our reverse acquisition of Evercharm, and has served as the Chief Executive Officer of our subsidiary Great Shengda since 2005, formulating the business strategies and overseeing the management and operation of Great Shengda. He resigned from his position as the Chief Executive Officer of the Company on April 8, 2010. Concurrently, Mr. Fang also serves as president of Great Shengda and as a director of Evercharm, Wealthcharm, Shengda Holdings, the SD Group, Great Shengda, and our subsidiaries Shengda Color and Hangzhou Shengming. Mr. Fang has more than 20 years of experience in the paper packaging industry. From 1989 to 1999, Mr. Fang was a marketing manager at Xiaoshan Packaging Factory. Mr. Fang joined Zhejiang New Shengda as general manager where he was responsible for the management of that company’s day-today operations from 1999 until 2004, when New Shengda sold all of its assets to Great Shengda. Mr. Fang has received several prestigious awards such as the “China Prominent Packaging Entrepreneur,” on April 20, 2006 from China Packaging Federation, the “Asia Brand Innovation Personality” on September 9, 2008 at the Organizing Committee of Asia Brand Ceremony, and the “Hangzhou Working Model” in April 2010 from the Hangzhou government. Mr. Fang holds a college diploma in business administration from Zhejiang Radio & TV University and a Master’s degree in packaging engineering from Zhejiang University. Mr. Fang has also completed post-graduate business administration courses at Tsinghua University.
Mr. Daliang Teng. Mr. Teng became our Chief Executive Officer on April 8, 2010, the day we consummated our reverse acquisition of Evercharm. He is also the General Manager of our subsidiary Great Shengda. He is responsible for overseeing and managing our day-to-day operations as well as implementing our business strategies and policies. He joined Great Shengda in October 2004 as Vice President and General Manager and was responsible for product management, as well as technology and product development. From 1990 to 1995, Mr. Teng was employed by Shaoxing Xinhua Printing Co., Ltd. in various capacities, including as head of technology. In December 1995, Mr. Teng was promoted to vice general manager where he was responsible for production management until December 1998. From 1998 to 2004, Mr. Teng was employed by Zhejiang New Shengda. Mr. Teng holds a Bachelor’s degree in engineering, majoring in electronics engineering, from Beijing University of Aeronautics and Astronautics.
Mr. Ken He. Mr. He became our Chief Financial Officer on August 19, 2011. Before joining us, Mr. He was an Investment Director of Wealthcharm Investments Limited, a private investment company, from September 2009. Prior to that, Mr. He spent five years at PricewaterhouseCoopers Australia and China. Having several years of experience in the accounting field, Mr. He is experienced and familiar with Chinese accounting standards, Hong Kong accounting standards, international accounting standards and U.S. GAAP, as well as the differences among them. Mr. He holds a Master’s degree in applied finance from Macquarie University. Mr. He also holds a Certified Public Accountant designation from the Chinese Institute of CPA, a Certified Practicing Accountant designation from the CPA Australia and a Chartered Financial Analyst designation from the CFA Institute.
Ms. Congyi Fang. Ms. Fang became a member of our Board of Directors on April 8, 2010, the day we consummated our reverse acquisition of Evercharm. She is also a director of Wealthcharm and Evercharm. She has been Great Shengda’s Vice President and General Manager of Marketing since 2004 and is responsible for sales and marketing. Ms. Fang has 13 years of experience in the packaging industry. From 1999 to 2004, Ms. Fang was employed by Zhejiang New Shengda as vice manager in charge of daily operations.
Mr. Zhihai Mao. Mr. Mao became a member of our Board of Directors on November 16, 2010. Mr. Mao is a
U.S. Certified Public Accountant with extensive experience in corporate financial reporting and disclosure. He has been the Managing Director of Dynamic China Investments Limited since December 2010. From January 2008 to October 2010, Mr. Mao was the Chief Financial Officer of China TransInfo Technology Corp., a company listed on NASDAQ. Since August 2006, Mr. Mao has been a senior auditor at Deloitte & Touche Tohmatsu CPA, Ltd.’s Beijing office. Prior to that, Mr. Mao was a senior auditor at Deloitte & Touche USA LLP from October 2004 through July 2006. From July 2003 to October 2004, Mr. Mao was a senior tax consultant at Deloitte Tax LLP. Mr. Mao also was previously employed as a budget analyst at the University of North Carolina at Chapel Hill, Program for International Training in Health, from December 2002 through May 2003. Mr. Mao holds a Master’s degree in accounting from the University of North Carolina at Chapel Hill, and holds a Bachelor’s degree in Japanese from the University of International Relations at Beijing, China.
Mr. Michael Zhang. Mr. Zhang became a member of our Board of Directors on November 1, 2010. Mr. Zhang has over 16 years of experience in internal and external auditing procedures and risk management. Since February 2012, he has been the Vice President for Beijing KangDe Xin Composite Material Co., Ltd. He was the Vice President and SOX Project Director of A-Power Energy Generation Systems Ltd. from January 2010 to January 2012. He has also served as Executive Director of Beijing Kingstar Consulting Firm Limited since September 2009 and as an independent director of Well-Tech (Changzhou) Electronic Technology Co., Ltd. since May 2009. From August 2007 to May 2009, Mr. Zhang was Executive Director of Business Risk Services with Ernst & Young (China) Advisory Limited. From April 2005 to April 2007, he was the Director of Enterprise Risk Services with Deloitte Touche Tohmatsu CPA Ltd. Mr. Zhang graduated from Northwest University with a Bachelor’s Degree in computational mathematics. He received an MBA in finance from Hong Kong Chinese University. Mr. Zhang is designated as a Certified Internal Auditor by the Institute of Internal Auditors.
Mr. Yaoquan Zhang. Mr. Zhang became a member of our Board of Directors on November 1, 2010. Mr. Zhang has more than 20 years of experience in the paper packaging industry. He is currently the Vice President of China Packaging Federation and President of Zhejiang Province Paper Packaging Industry Technology Center. He has held these positions since 2005. Mr. Zhang graduated from Huadong Institute of Technology with a Bachelor’s degree.
Except as set forth in our discussion below in Item 13 “Certain Relationships and Related Transactions, and Director Independence-Transactions with Related Persons,” none of our directors, director nominees or executive officers has been involved in any transactions with us or any of our directors, executive officers, affiliates or associates which are required to be disclosed pursuant to the rules and regulations of the SEC.
Pursuant to the Securities Purchase Agreement dated April 29, 2010, as amended, we agreed that so long as Envision Capital Partners, the lead investor, holds at least 1/3 of the shares issued to it in the private placement, it shall be entitled to nominate one independent member of our Board of Directors.
Directors are elected annually and serve until their successors are duly elected and qualified.
Director Qualifications
Directors are responsible for overseeing our business consistent with their fiduciary duty to stockholders. This significant responsibility requires highly-skilled individuals with various qualities, attributes and professional experience. The Board believes that there are general requirements for service on our Board of Directors that are applicable to all directors and that there are other skills and experience that should be represented on the board as a whole but not necessarily by each director. The Board considers the qualifications of directors and director candidates individually and in the broader context of the Board’s overall composition and our current and future needs.
Qualifications for All Directors
In its assessment of each potential candidate, including those recommended by stockholders, the Board considers the nominee’s judgment, integrity, experience, independence, understanding of our business or other related industries and such other factors the Board determines are pertinent in light of the current needs of the Board. The Board also takes into account the ability of a director to devote the time and effort necessary to fulfill his or her responsibilities to the Company.
The Board requires that each director be a recognized person of high integrity with a proven record of success in his or her field. Each director must demonstrate innovative thinking, familiarity with and respect for corporate governance requirements and practices, an appreciation of multiple cultures and a commitment to sustainability and to dealing responsibly with social issues. In addition to the qualifications required of all directors, the Board assesses intangible qualities including the individual’s ability to ask difficult questions and, simultaneously, to work collegially.
The Board does not have a specific diversity policy, but considers diversity of race, ethnicity, gender, age, cultural background and professional experiences in evaluating candidates for Board membership. Diversity is important because a variety of points of view contribute to a more effective decision-making process.
Qualifications, Attributes, Skills and Experience to be Represented on the Board as a Whole
The Board has identified particular qualifications, attributes, skills and experience that are important to be represented on the Board as a whole, in light of our current needs and business priorities. We are a leading paper packaging company in China listed on the NASDAQ Global Market. Therefore, the Board believes that a diversity of professional experiences in China’s paper packaging industry, specific knowledge of key geographic growth areas, and knowledge of U.S. capital markets and of U.S. accounting and financial reporting standards should be represented on the Board.
Summary of Qualifications of Directors
Set forth below is a narrative disclosure that summarizes some of the specific qualifications, attributes, skills and experiences of our directors. For more detailed information, please refer to the biographical information for each director set forth above.
Mr. Nengbin Fang. Mr. Fang’s 20-plus years of experience in the paper packaging industry and his extensive institutional knowledge of the Company and its business are invaluable to our Company. He has also received several prestigious awards from industry associations and local governments and he is well-respected by employees, business partners and government officials within his community. Integrity and modesty are among the several personal attributes that have facilitated Mr. Fang’s leadership success and we believe will continue to do so.
Ms. Congyi Fang. Ms. Fang’s 14 years of experience in the packaging industry and her extensive institutional knowledge of the Company and its business are invaluable to our Company. Her professional knowledge of the industry and her hands-on experience enable her to facilitate effective management and communication, which we believe is very important.
Mr. Zhihai Mao. Mr. Mao is a U.S. Certified Public Accountant with extensive experience in corporate financial reporting and disclosure. Mr. Mao’s experience as an executive officer of a listed company and familiarity with management compensation considerations makes him a suitable compensation committee chairman.
Mr. Michael Zhang. Mr. Zhang’s 16 years of experience in auditing procedures and risk management, his designation as a Certified Internal Auditor by the Institute of Internal Auditors and his work experience with auditing firms affiliated with two of the “big four” auditing firms in the United States, Ernst & Young LLP and Deloitte & Touche, will help us comply with the requirements of the Sarbanes-Oxley Act of 2002 and with our other financial reporting requirements. Mr. Zhang possesses extensive knowledge of accounting and financial reporting procedures and he is qualified, as determined by the Board, as an audit committee financial expert as defined in Item 407 of Regulation S-K.
Mr. Yaoquan Zhang. Mr. Zhang’s more than 20 years of experience in the paper packaging industry will be invaluable to our Company in its business, operations and future plans for growth. His knowledge and experience will provide direction and advice that few others in the Chinese paper packaging industry could provide.
Family Relationships
Nengbin Fang is the brother of Congyi Fang. There are no other family relationships between any of our directors or executive officers.
Involvement in Certain Legal Proceedings
To the best of our knowledge, none of our directors or executive officers has, during the past ten years:
been convicted in a criminal proceeding or been subject to a pending criminal proceeding (excluding traffic violations and other minor offences);
had any bankruptcy petition filed by or against the business or property of the person, or of any partnership, corporation or business association of which he was a general partner or executive officer, either at the time of the bankruptcy filing or within two years prior to that time;
been subject to any order, judgment, or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction or federal or state authority, permanently or temporarily enjoining, barring, suspending or otherwise limiting, his involvement in any type of business, securities, futures, commodities, investment, banking, savings and loan, or insurance activities, or to be associated with persons engaged in any such activity;
been found by a court of competent jurisdiction in a civil action or by the SEC or the Commodity Futures Trading Commission to have violated a federal or state securities or commodities law, and the judgment has not been reversed, suspended, or vacated;
been the subject of, or a party to, any federal or state judicial or administrative order, judgment, decree, or finding, not subsequently reversed, suspended or vacated (not including any settlement of a civil proceeding among private litigants), relating to an alleged violation of any federal or state securities or commodities law or regulation, any law or regulation respecting financial institutions or insurance companies including, but not limited to, a temporary or permanent injunction, order of disgorgement or restitution, civil money penalty or temporary or permanent cease-and-desist order, or removal or prohibition order, or any law or regulation prohibiting mail or wire fraud or fraud in connection with any business entity; or
been the subject of, or a party to, any sanction or order, not subsequently reversed, suspended or vacated, of any self-regulatory organization (as defined in Section 3(a)(26) of the Exchange Act (15 U.S.C. 78c(a)(26))), any registered entity (as defined in Section 1(a)(29) of the Commodity Exchange Act (7 U.S.C. 1(a)(29))), or any equivalent exchange, association, entity or organization that has disciplinary authority over its members or persons associated with a member.
Section 16(A) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires our executive officers, directors and beneficial owner of more than 10% of a registered class of our equity securities to file with the SEC statements of ownership and changes in ownership. The same persons are required to furnish us with copies of all Section 16(a) forms they file. We believe that all of our executive officers, directors and beneficial owner of more than 10% of a registered class of our equity securities complied with the applicable filing requirements during fiscal year 2012.
In making these statements, we have relied upon examination of the copies of all Section 16(a) forms provided to us and the written representations of our executive officers, directors and beneficial owner of more than 10% of a registered class of our equity securities.
Code of Ethics
Our Board of Directors has adopted a code of ethics that applies to all employees, including our principal executive officer, principal accounting officer or controller or persons performing similar functions. A copy of the code of ethics has been filed as Exhibit 14.1 to our Current Report on Form 8-K filed on November 2, 2010. The code of ethics is available on our website at www.cnpti.com. Amendments to, or waivers from, a provision of the code of ethics that applies to our directors, executive officers or employees will be posted to our website within four business days following the date of such amendment or waiver.
Board Composition and Committees
The Company is governed by a Board of Directors that currently consists of five members: Mr. Nengbin Fang, Ms. Congyi Fang, Mr. Zhihai Mao, Mr. Michael Zhang and Mr. Yaoquan Zhang. Messrs. Zhihai Mao, Michael Zhang and Yaoquan Zhang are “independent” directors, within the meaning of the NASDAQ Marketplace Rules. All actions of the Board of Directors require the approval of a majority of the directors in attendance at a meeting at which a quorum is present.
The Board has established three standing committees: the Audit Committee, the Compensation Committee and the Governance and Nominating Committee. Each of the Audit Committee, Compensation Committee and Governance and Nominating Committee are comprised entirely of independent directors. From time to time, the Board may establish other committees. The Board has adopted a written charter for each of the Committees which are available on the corporate governance page of our website at www.cnpti.com.
Audit Committee and Audit Committee Financial Expert
Our Audit Committee is currently composed of three members: Messrs. Zhihai Mao, Michael Zhang and Yaoquan Zhang. Our Board of Directors determined that each member of the Audit Committee meets the independence criteria prescribed by applicable regulation and the rules of the SEC for Audit Committee membership and is an “independent” director within the meaning of the NASDAQ Marketplace Rules. Each Audit Committee member also meets NASDAQ’s financial literacy requirements. Mr. Michael Zhang serves as Chair of the Audit Committee.
The Audit Committee, established in accordance with section 3(a)(58)(A) of the Exchange Act, oversees our financial reporting process on behalf of the Board of Directors. The Audit Committee’s responsibilities include the following functions:
approving and retaining the independent auditors to conduct the annual audit of our books and records;
reviewing the proposed scope and results of the audit;
reviewing and pre-approving the independent auditors’ audit and non-audited services rendered;
approving the audit fees to be paid;
reviewing accounting and financial controls with the independent auditors and our internal auditors and financial and accounting staff;
reviewing and approving transactions between us and our directors, officers and affiliates;
recognizing and preventing prohibited non-audit services; and
meeting separately and periodically with management and our internal auditor and independent auditors.
Our Board of Directors has determined that Mr. Michael Zhang is the “audit committee financial expert” as such term is defined in Item 407(d) of Regulation S-K promulgated by the SEC and also meets NASDAQ’s financial sophistication requirements.
Compensation Committee
Our Compensation Committee is currently composed of three members: Messrs. Zhihai Mao, Michael Zhang and Yaoquan Zhang, each of whom is “independent” within the meaning of the NASDAQ Marketplace Rules. Mr. Mao serves as Chair of the Compensation Committee.
The Compensation Committee is responsible for making recommendations to the Board concerning salaries and incentive compensation for our officers and employees and administers our stock option plans. The Compensation Committee’s responsibilities include the following functions:
reviewing and recommending policy relating to the compensation and benefits of our officers and employees, including reviewing and approving corporate goals and objectives relevant to the compensation of our Chief Executive Officer and other senior officers;
evaluating the performance of these officers in light of those goals and objectives and setting compensation of these officers based on such evaluations;
administering our benefit plans and the issuance of stock options and other awards under our stock plans;
reviewing and establishing appropriate insurance coverage for our directors and executive officers;
recommending the type and amount of compensation to be paid or awarded to members of our Board of Directors, including consulting, retainer, meeting, committee and committee chair fees and stock option grants or awards; and
reviewing and approving the terms of any employment agreements, severance arrangements, change-of-control protections and any other compensatory arrangements for our executive officers.
Management will play a role in the compensation-setting process. The most significant aspects of management’s role include evaluating employee performance, establishing business performance targets and objectives and recommending salary levels and any equity awards. The Chief Executive Officer will work with the Compensation Committee to provide background information regarding the Company’s strategic objectives, his evaluation of the performance of the senior executive officers and compensation recommendations as to senior executive officers (other than himself). Although our Chief Executive Officer may recommend to the Compensation Committee the compensation package and awards to our executive officers, the Compensation Committee will approve the compensation packages.
The Compensation Committee may retain a compensation consultant from time to time to assist the Compensation Committee in researching and evaluating executive officer and director compensation and compensation programs. The Company did not engage any independent compensation consultants in 2012.
Governance and Nominating Committee
Our Governance and Nominating Committee is currently composed of three members: Messrs. Zhihai Mao, Michael Zhang and Yaoquan Zhang, each of whom is “independent” within the meaning of the NASDAQ Marketplace Rules. Mr. Yaoquan Zhang serves as Chair of the Governance and Nominating Committee.
The Governance and Nominating Committee is responsible for identifying potential candidates to serve on our Board of Directors and its committees. The Governance and Nominating Committee’s responsibilities include the following functions:
making recommendations to the Board regarding the size and composition of the Board;
identifying and recommending to the Board nominees for election or re-election to the Board, or for appointment to fill any vacancy;
establishing procedures for the nomination process;
advising the Board periodically with respect to corporate governance matters and practices, including periodically reviewing corporate governance guidelines to be adopted by the Board; and
establishing and administering a periodic assessment procedure relating to the performance of the Board as a whole and its individual members.
The Governance and Nominating Committee will also consider director nominees recommended by stockholders and will evaluate such director candidates in the same manner as it evaluates director candidates recommended by our directors, management or employees. There have been no material changes to the procedures by which stockholders may recommend nominees to our Board of Directors during the fiscal year ended December 31, 2012.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
Summary Compensation Table
The following table sets forth information concerning all cash and non-cash compensation awarded to, earned by or paid to the named persons for services rendered in all capacities during the noted periods. Except as noted below, no other executive officer received total annual salary and bonus compensation in excess of $100,000.
Agreements with Executive Officers
All of our employees, including Mr. Daliang Teng, our Chief Executive Officer, Mr. Nengbin Fang, President of Great Shengda, Ms. Congyi Fang, Vice President and General Manager of Marketing of Great Shengda, and Mr. Ken He, our Chief Financial Officer, have executed our standard employment agreement. The employment agreements with Messrs. Teng, Fang and Ms. Fang do not provide for an annual salary; however, for 2012, our Board of Directors established an annual salary of $100,000 for Mr. Teng, annual salary of RMB 60,000 (approximately $8,876) and cash bonus of RMB 250,000 (approximately $36,985) for Mr. Fang, and annual salary of $80,000 for Ms. Fang. On August 19, 2011, the Company and Mr. He entered into an employment agreement which is effective as of August 19, 2011. Mr. He’s employment agreement provides him a salary of $8,000 per month. Our employment agreements do not provide for the term of employment, thus the parties can terminate such agreements in accordance with PRC labor laws. We expect our compensation committee will review all of our executive officers’ compensation and make any adjustments it deems necessary and appropriate and may recommend new employment agreements with the executive officers.
Each of our executive officers has entered into our form of non-disclosure and non-compete agreement. Such agreement provides that while employed by us and thereafter, the employee may not disclose our confidential information to any third party and within two years after termination of the employment, the employee may not compete in the same business in China (including Hong Kong, Macao and Taiwan) as us. In addition, the employee shall not solicit our employees. For an employee’s performance of the non-compete obligation, we will pay monthly compensation to such employee for the post-employment period of the non-compete term. If the employee breaches the agreement, such employee shall be required to repay the amount of the compensation received and pay liquidated damages of up to two times of such total compensation.
Other than the salary and necessary social benefits required by the government, which are defined in the employment agreement, we currently do not provide other benefits to our officers at this time. Our executive officers are not entitled to severance payments upon the termination of their employment agreements or following a change in control.
Outstanding Equity Awards at Fiscal Year End
None of our executive officers received any equity awards, including, options, restricted stock or other equity incentives during the fiscal year ended December 31, 2012.
Compensation of Directors
The following table sets forth the total compensation earned by our directors during fiscal year ended December 31, 2012:
Our independent directors, Messrs. Zhihai Mao, Michael Zhang and Yaoquan Zhang, each entered into independent director agreements dated as of November 16, 2010, November 1, 2010 and November 1, 2010, respectively. Pursuant to such agreements, Messrs. Mao, M. Zhang and Y. Zhang will be entitled to RMB 180,000 (approximately $28,556), $20,000 (or the RMB equivalent) and RMB 100,000 (approximately $15,865), respectively, as an annual director fee, which will be payable monthly.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
Security Ownership of Certain Beneficial Owners and Management
The following table sets forth information regarding beneficial ownership of our common stock as of March 29, 2013 (1) by each person who is known by us to beneficially own more than 5% of our common stock; (2) by each of our officers and directors; and (3) by all of our officers and directors as a group. Unless otherwise specified, the address of each of the persons set forth below is in care of the Company, No. 2 Beitang Road, Xiaoshan Economic and Technological Development Zone, Hangzhou, Zhejiang Province, People’s Republic of China.
(4)
Beneficial Ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities. Each of the beneficial owners listed above has direct ownership of and sole voting power and investment power with respect to the shares of our common stock.
(2) A total of 38,790,811 shares of our common stock are considered to be outstanding pursuant to SEC Rule 13d-3(d)(1) as of March 29, 2013.
(5)
Wuxiao Fang is the father of Nengbin Fang, our Chairman, and also serves as a consultant, for no compensation, to our company. Mr. Fang has approximately 28 years of experience in the paper packaging industry and has been appointed as the vice chairman of the China Packaging Federation. He provides consulting services on our overall business strategies and policies.
Changes in Control
We do not currently have any arrangements which if consummated may result in a change of control of our Company.
Securities Authorized for Issuance Under Equity Compensation Plans
We presently do not have any equity based or other long-term incentive programs.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
Transactions with Related Persons
The following includes a summary of transactions since the beginning of the 2012 fiscal year, or any currently proposed transaction, in which we were or are to be a participant and the amount involved exceeded or exceeds the lesser of $120,000 or one percent of the average of our total assets at year end for the last two completed fiscal years, and in which any related person had or will have a direct or indirect material interest (other than compensation described under Item 11 “Executive Compensation”). We believe the terms obtained or consideration that we paid or received, as applicable, in connection with the transactions described below were comparable to terms available or the amounts that would be paid or received, as applicable, in arm’s-length transactions.
A number of transactions described below are between one or another of our subsidiaries and SD Group. SD Group is owned 30.69% by Wuxiao Fang, our consultant, principal stockholder and the father of Nengbin Fang, our Chairman and our executive officer, 29.49% by Xinya Qu, the spouse of Wuxiao Fang, and 39.82% by Xin Shengda. Xin Shengda, in turn, is owned 55% by Xinya Qu, 25% by Nengbin Fang and 20% by Congyi Fang, one of our directors and our executive officer.
On January 1, 2010, Great Shengda entered into a land use right lease agreement under which it leased 112,437 square meters from Xin Shengda at No. 2 Beitang Road, Xiaoshan Economic and Technological Development Zone. The lease term was from January 1, 2010 to December 31, 2012 and the annual rental rate was RMB 1 million (approximately $0.16 million).
On January 1, 2013, Great Shengda entered into a land use right lease agreement under which it leased 110,894 square meters from Xin Shengda at No. 2 Beitang Road, Xiaoshan Economic and Technological Development Zone. The lease term was from January 1, 2013 to December 31, 2013 and the annual rental rate was RMB 1 million (approximately $0.16 million).
On January 1, 2012, Hangzhou Shengming entered into a land use right lease agreement under which it leased 47,942 square meters from SD Group at Xiang He Qiao Village. The lease term was from January 1, 2012 to December 31, 2012. The annual rental rate was RMB 1 million (approximately $0.16 million ).
On January 1, 2012, Hangzhou Shengming entered into a building and plant lease agreement under which it leased 23,568 square meters from SD Group at Xiang He Qiao Village. The lease term was from January 1, 2012 to December 31, 2012 and the annual rental rate was RMB 0.8 million (approximately $0.13 million).
On January 1, 2013, Hangzhou Shengming entered into a land use right lease agreement under which it leased 47,942 square meters from SD Group at Xiang He Qiao Village. The lease term was from January 1, 2013 to December 31, 2013. The annual rental rate was RMB 1 million (approximately $0.16 million).
On January 1, 2013, Hangzhou Shengming entered into a building and plant lease agreement under which it leased 23,568 square meters from SD Group at Xiang He Qiao Village. The lease term was from January 1, 2013 to December 31, 2013 and the annual rental rate was RMB 0.8 million (approximately $0.13 million).
On February 22, 2012, SD Group entered into a maximum debt guarantee contract with Xiaoshan Branch Bank of China, under which SD Group agreed to act as guarantor for loans borrowed by Hangzhou Shengming from Xiaoshan Branch Bank of China. The maximum guaranteed amount is RMB 50.0 million (approximately $7.9 million) for any loans borrowed by Shengming from the bank from February 22, 2012 to February 22, 2013.
On February 22, 2012, SD Group entered into a maximum debt guarantee contract with Xiaoshan Branch Bank of China under which SD Group agreed to act as guarantor for loans borrowed by Great Shengda from Xiaoshan Branch Bank of China. The maximum guaranteed amount is RMB 80.0 million (approximately $12.7 million) for any loans borrowed by Great Shengda from the bank from February 22, 2012 to February 22, 2013.
On November 15, 2012, SD Group entered into a maximum debt guarantee contract with Xiaoshan Branch Industrial Commercial Bank of China under which SD Group agreed to act as guarantor for loans borrowed by Great Shengda from Xiaoshan Branch Industrial Commercial Bank of China. The maximum guaranteed amount is RMB 70.0 million (approximately $11.1 million) for any loans borrowed by Great Shengda from the bank from November 15, 2012 to November 15, 2014.
On April 24, 2012, Great Shengda entered into a loan agreement with Tokyo Branch Bank of China, pursuant to which provided a loan of $3.5 million in principal amount. According to Xiaoshan Bank of China, SD Group guaranteed the loan.
As ending balance of December 31, 2012, Great Shengda entered into several commercial bill acceptance agreements with Xiaoshan Branch Bank of China. With total amount RMB 76 million (approximately $12.1 million), those agreements came with 50% time deposits as mortgage. The other 50% notes payable were guaranteed by SD Group.
As ending balance of December 31, 2012, Great Shengda entered into a commercial bill acceptance agreement with Xiaoshan Branch Industrial Commercial Bank of China. With total amount RMB 28 million (approximately $4.4 million), this agreement came with 50% time deposits as mortgage. The other 50% notes payable were guaranteed by SD Group.
During 2012, we purchased water and electricity from Zhejiang Shuang Ke Da Weaving Co., Ltd. amounting 1.3 million.
During 2012, we made sales to Shuangdeng Paper Industrial Company Limited amounting 0.3 million, and sales to Shengda Xiang Wei Chemical Company Limited amounting 0.2 million.
Other than as set forth above, none of our directors, director nominees or executive officers has been involved in any transactions with us or any of our directors, executive officers, affiliates or associates that are required to be disclosed pursuant to the rules and regulations of the SEC.
Director Independence
Each of Messrs. Zhihai Mao, Michael Zhang and Yaoquan Zhang serves on our board as an “independent” director as defined by the applicable rules of the SEC and the NASDAQ Marketplace Rules.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
Independent Auditors’ Fees
The following is a summary of the fees billed to the Company by its principal accountants for professional services rendered for the fiscal years ended December 31, 2012 and 2011:
“Audit Fees” consisted of the aggregate fees billed for professional services rendered for the audit of our annual financial statements and the reviews of the financial statements included in our Forms 10-Q and for any other services that were normally provided in connection with our statutory and regulatory filings or engagements.
“Audit Related Fees” consisted of the aggregate fees billed for professional services rendered for assurance and related services that were reasonably related to the performance of the audit or review of our financial statements and were not otherwise included in Audit Fees.
“Tax Fees” consisted of the aggregate fees billed for professional services rendered for tax compliance, tax advice and tax planning. Included in such Tax Fees were fees for preparation of our tax returns and consultancy and advice on other tax planning matters.
“All Other Fees” consisted of the aggregate fees billed for products and services provided and not otherwise included in Audit Fees, Audit Related Fees or Tax Fees.
Pre-Approval Policies and Procedures
Under the Sarbanes-Oxley Act of 2002, all audit and non-audit services performed by our auditors must be approved in advance by our Board of Directors to assure that such services do not impair the auditors’ independence from us. In accordance with its policies and procedures, our Board of Directors pre-approved the audit service performed by Marcum Bernstein & Pinchuk LLP for our financial statements as of and for the year ended December 31, 2012.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
Financial Statements and Schedules
The financial statements are set forth under Item 8 of this annual report on Form 10-K. Financial statement schedules have been omitted since they are either not required, not applicable, or the information is otherwise included.
Exhibit List
The list of exhibits in the Exhibit Index to this report is incorporated herein by reference.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: March 29, 2013
CHINA SHENGDA PACKAGING GROUP INC.
By: /s/ Daliang Teng
Daliang Teng
Chief Executive Officer
By: /s/ Ken He
Ken He
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ Daliang Teng
Chief Executive Officer March 29, 2013
Daliang Teng
(Principal Executive Officer)
/s/ Ken He
Chief Financial Officer March 29, 2013
Ken He
(Principal Financial and Accounting Officer)
/s/ Nengbin Fang
Chairman March 29, 2013
Nengbin Fang
/s/ Congyi Fang
Director March 29, 2013
Congyi Fang
/s/ Zhihai Mao
Director March 29, 2013
Zhihai Mao
/s/ Michael Zhang
Director March 29, 2013
Michael Zhang
/s/ Yaoquan Zhang
Director March 29, 2013
Yaoquan Zhang
CHINA SHENGDA PACKAGING GROUP INC.
____________________________________________
Consolidated Financial Statements
____________________________________________
December 31, 2012 and 2011
CHINA SHENGDA PACKAGING GROUP INC. AND SUBSIDIARIES
CONTENTS
Report of independent registered public accounting firm
To the Board of Directors and Shareholders of
China Shengda Packaging Group Inc.
We have audited the accompanying consolidated balance sheets of China Shengda Packaging Group Inc. and Subsidiaries (the “Group”) as of December 31, 2012 and 2011, and the related consolidated statements of income and comprehensive income, changes in equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Group’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Group is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Group’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial positions of China Shengda Packaging Group Inc. and Subsidiaries as of December 31, 2012 and 2011, and the consolidated results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
/s/Marcum Bernstein & Pinchuk LLP
New York, New York
March 29, 2013
CHINA SHENGDA PACKAGING GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in US$)
See notes to the consolidated financial statements
CHINA SHENGDA PACKAGING GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(Amounts in US$)
See notes to the consolidated financial statements
CHINA SHENGDA PACKAGING GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(Amounts in US$, except shares)
See notes to the consolidated financial statements
CHINA SHENGDA PACKAGING GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in US$)
See notes to the consolidated financial statements
CHINA SHENGDA PACKAGING GROUP INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in US$)
1.
PRINCIPAL ACTIVITIES AND ORGANIZATION
The consolidated financial statements include the financial statements of China Shengda Packaging Group Inc. (the “Company” or “China Shengda Packaging”) and its subsidiaries, Evercharm Holdings Limited (“Evercharm”), Zhejiang Great Shengda Packaging Co., Ltd (“Great Shengda”), Zhejiang Shengda Color Pre-printing Co. Ltd (“Shengda Color”), Hangzhou Shengming Paper Co., Ltd (“Hangzhou Shengming”), Suzhou Asian and American Paper Products Co., Ltd (“Suzhou AA”) and Jiangsu Shuangsheng Paper Technology Development CO., Ltd. (“Shuangsheng”). The Company and its subsidiaries are collectively referred to as the “Group”.
The Company, formly named as Healthplace Corporation, was incorporated in the State of Nevada on March 16, 2007 as a web-based service provider offering an online service where health practitioners could purchase products and services to improve their work and home lives, including books, CDs, clothing, and accessories geared towards the needs of these practitioners. However, it did not engage in any operations and was dormant from its inception until its reverse acquisition of Evercharm on April 8, 2010.
On April 8, 2010, the Company completed a reverse acquisition transaction through a share exchange with Evercharm and its sole shareholder, Shengda (Hangzhou) Holdings Limited (“Shengda Holdings”), whereby China Shengda Packaging acquired 100% of the issued and outstanding capital stock of Evercharm, in exchange for 27,600,000 shares of China Shengda Packaging’s common stock, which constituted 92% of its issued and outstanding shares on a fully-diluted basis of China Shengda Packaging immediately after the consummation of the reverse acquisition. As a result of the reverse acquisition, Evercharm became China Shengda Packaging’s wholly-owned subsidiary and Shengda Holdings, the former shareholder of Evercharm, became China Shengda Packaging’s controlling stockholder. The share exchange transaction with Evercharm was treated as a reverse acquisition, with Evercharm as the accounting acquirer and China Shengda Packaging as the acquired party.
On April 29, 2010, the Company completed a private placement of shares of its common stock with a group of accredited investors. Pursuant to a securities purchase agreement with the investors, the Company issued to the investors an aggregate of 1,456,311 shares at a price per share of US$3.43 for US$5 million. Net proceeds after deducting offering costs were approximately US$4.0 million.
On December 10, 2010, the Company completed a public offering and issued an aggregate of 8,000,000 shares at a price per share of US$4.0 for US$32 million. Net proceeds after deducting offering costs were approximately US$29.7 million.
On July 18, 2011, the Company’s board of directors authorized a share repurchase program for up to $5 million of its common stock over the next twelve months, subject to market and other conditions. Under this plan, the Company can repurchase shares from time to time for cash in open market purchases, block transactions, and privately negotiated transactions in accordance with applicable US federal securities laws. This share repurchase program may be modified, suspended, terminated or extended by the Company at any time without prior notice. The repurchases will be funded with available cash on hand. (See Note 17)
Evercharm was incorporated in British Virgin Islands (“BVI”) on September 15, 2004, and is a holding company without any operation.
Great Shengda, Evercharm’s wholly-owned subsidiary, was incorporated in Hangzhou city, Zhejiang province, People’s Republic of China (“PRC”) on November 22, 2004. Its registered capital was US$39 million as of December 31, 2012. Great Shengda is engaged in manufacturing and processing corrugated fibreboard boxes and paper board and package decoration printing and selling.
Shengda Color, Great Shengda’s 100% wholly-owned subsidiary, was incorporated in Hangzhou city, Zhejiang province, PRC on August 8, 2005 with registered capital of RMB10 million. Shengda Color is engaged in the manufacturing and sale of paper boxes and paper board, as well as the research and development of paper packing technology.
CHINA SHENGDA PACKAGING GROUP INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in US$)
Hangzhou Shengming, 75% held by Shengda Color and 25% held by Evercham, was incorporated in Hangzhou city, Zhejiang province, PRC on December 28, 2006 with registered capital of US$12 million. It is engaged in the manufacturing and sale of paper boxes and paper board, as well as the research and development of paper packing technology.
Suzhou AA was incorporated in Suzhou city, Jiangsu province, PRC on June 22, 2010, with registered capital amounting to RMB1.58 million. It is engaged in manufacturing and sales of paper products. On August 12, 2010, Great Shengda acquired 100% equity interest of Suzhou AA from its original shareholders, for cash consideration amounting to RMB3 million (US$0.44 million).
Shuangsheng was incorporated in Yancheng city, Jiangsu province, PRC on September 22, 2011. Shuangsheng has register capital RMB88 million with actually invested capital of RMB22 million, 97% held by Great Shengda and 3% held by Shuangdeng Paper Industrial Company Limited (“Shuangdeng Paper”), a company incorporated in PRC, and is controlled by the same ultimate stockholders of the Company. Shuangsheng is engaged in the business of new paper making technology, related research and the development, application, transfer and consultation of such relevant technology. It was at the developing stage as of December 31, 2012.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Change of reporting entity and basis of presentation
The consolidated financial statements include the financial statements of the Company and its subsidiaries. All significant inter-company transactions and balances have been eliminated in consolidation.
Noncontrolling interest represents the ownership interests in a subsidiary that was held by owners other than the parent and is part of the equity of the consolidated group. The noncontrolling interest is reported in the consolidated statement of financial position within equity, separately from the parent’s equity. Net income or loss and comprehensive income or loss is attributed to the parent and the noncontrolling interest. If losses attributable to the parent and the noncontrolling interest in a subsidiary exceed their interests in the subsidiary’s equity, the excess, and any further losses attributable to the parent and the noncontrolling interest, is attributed to those interests.
(b)
Use of estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires the Group to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
(c)
Cash and cash equivalents
Cash includes not only currency on hand but demand deposits with banks or other financial institutions. Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and have original maturities of three months or less.
(d)
Restricted cash
Restricted cash represents the deposits held as compensating balances against banks’ acceptances issued and loan borrowed, amounting to US$22,615,099 and US$7,851,387 as of December 31, 2012 and 2011, respectively.
(e)
Accounts and notes receivable
CHINA SHENGDA PACKAGING GROUP INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in US$)
Accounts receivable are recognized and carried at original sales amounts less an allowance for uncollectible accounts, as needed.
Accounts receivable are reviewed periodically as to whether they are past due based on contractual terms and their carrying value has become impaired. An allowance for doubtful accounts is recorded in the period in which loss is determined to be probable based on an assessment of specific evidence indicating doubtful collection, historical experience, account balance aging and prevailing economic conditions. Accounts receivable balances are written off after all collection efforts have been exhausted. No significant account receivable balance was written off for years ended December 31, 2012 and 2011, respectively.
Notes receivable represent banks’ acceptances that have been arranged with third-party financial institutions by certain customers to settle their purchases from us. These banks’ acceptances are non-interest bearing and are collectible within six months. Such sales and purchasing arrangements are consistent with industry practices in the PRC.
There are no outstanding amounts from customers that individually represent greater than 10% of the total balance of accounts receivable as of December 31, 2012 and 2011.
(f)
Inventories
Inventories are stated at lower of cost or market. Cost is determined using weighted average method. Inventory includes raw materials and finished goods. The variable production overheads are allocated to each unit of production on the basis of the actual use of the production facilities. The allocation of fixed production overheads to the costs of conversion is based on the normal capacity of the production facilities.
Where there is evidence that the utility of inventories, in their disposal in the ordinary course of business, will be less than cost, whether due to physical deterioration, obsolescence, changes in price levels, or other causes, the inventories is written down to their fair value for the difference with charges to cost of sales.
No value was written down for the inventories as of December 31, 2012 and 2011.
(g)
Property, plant and equipment and construction in process
Other than those acquired in a business combination, property, plant and equipment is stated at historical cost less accumulated depreciation and impairment. The historical cost of acquiring an item of property, plant and equipment includes the costs necessarily incurred to bring it to the condition and location necessary for its intended use. If an item of property, plant and equipment requires a period of time in which to carry out the activities necessary to bring it to that condition and location, the interest cost incurred during that period as a result of expenditures for the item is a part of the historical cost. This item is categorized as construction in progress and is not depreciated until substantially all the activities necessary to bring it to the condition and location necessary for its intended use are completed.
Depreciation of property, plant and equipment is calculated using the straight-line method (after taking into account their respective estimated residual value) over the estimated useful lives of the assets as follows.
CHINA SHENGDA PACKAGING GROUP INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in US$)
Depreciation of property, plant and equipment attributable to manufacturing activities is capitalized as part of inventories, and expensed to cost of goods sold when inventories are sold. Expenditures for maintenance and repairs are expensed as incurred.
The gain or loss on the disposal of property, plant and equipment is the difference between the net sales proceeds and the carrying amount of the relevant assets and is recognized in the consolidated statements of operations.
Construction in progress represented capital expenditure in respect of direct costs of construction or acquisition and design fees incurred. Capitalization of these costs ceases and the construction in progress is transferred to the appropriate category of property, plant and equipment when substantially all the activities necessary to prepare the assets for their intended use are completed. Construction in progress is not depreciated.
(h) Land use right
Land use right represents the cost paid to the PRC government authorities. Land use right is amortized on a straight line basis over its estimated useful live, which is the periods over which the asset is expected to contribute directly or indirectly to the future cash flows of the Group. The land use right, with 166,533 square meters in area, has a term of 50 years and will expire in December 2058, the estimated useful live is as follows:
(i)
Goodwill
Goodwill represents the excess of acquisition costs over the fair value of tangible net assets and identifiable intangible assets of businesses acquired. Goodwill and certain other intangible assets deemed to have indefinite lives are not amortized. Intangible assets determined to have definite lives are amortized over their useful lives. Goodwill and indefinite lived intangible assets are subject to impairment testing annually as of the fiscal year- end or whenever events or changes in circumstances indicate that the carrying amount may not be fully recoverable, using the guidance and criteria described in Accounting Standards Codification (“ASC”) Topic 350, “Goodwill and Other Intangible Assets”. This testing compares carrying values to fair values and, when appropriate, the carrying value of these assets is reduced to fair value.
(j)
Customer relationships
Customer relationship are amortized on a straight line basis over their respective estimated useful lives, which are the periods over which the assets are expected to contribute directly or indirectly to the future cash flows of the Group. The customer relationship is subject to impairment testing annually as of the fiscal year-end or whenever events or changes in circumstances indicate that the carrying amount may not be fully recoverable.
(k)
Impairment of long-lived assets
A long-lived asset (disposal group) classified as held for sale is measured at the lower of its carrying amount or fair value less cost to sell. A long-lived asset is not depreciated (amortized) while it is classified as held for sale. A gain or loss not previously recognized that result from the sale of a long-lived asset (disposal group) is recognized at the date of sale.
A long-lived asset (asset group) is tested for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. An impairment loss is recognized only if the carrying amount of a long-lived asset (asset group) is not recoverable and exceeds its fair value. The carrying amount of a long-lived asset (asset group) is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset (asset group). The assessment is based on the carrying amount of the asset (asset group) at the date it is tested for recoverability, whether in use or under development. An impairment loss is measured as the amount by which the carrying amount of a long-lived asset (asset group) exceeds its fair value. There were no events or changes in circumstances that necessitated a review of impairment of long-lived assets as of December 31, 2012 and 2011, respectively.
CHINA SHENGDA PACKAGING GROUP INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in US$)
(l)
Foreign currency translation and transactions
The Company’s and Evercharm’s functional currency is the United States dollar (“US$”). The functional currency of the Company’s subsidiaries in the PRC is Renminbi (“RMB”).
At the date a foreign currency transaction is recognized, each asset, liability, revenue, expense, gain, or loss arising from the transaction is measured initially in the functional currency of the recording entity by use of the exchange rate in effect at that date. The increase or decrease in expected functional currency cash flows upon settlement of a transaction resulting from a change in exchange rates between the functional currency and the currency in which the transaction is denominated is recognized as foreign currency transaction gain or loss that is included in determining net income for the period in which the exchange rate changes. At each balance sheet date, recorded balances that are denominated in a foreign currency are adjusted to reflect the current exchange rate.
The Company’s reporting currency is US$. Assets and liabilities of the PRC subsidiaries are translated at the current exchange rate at the balance sheet dates, and revenues and expenses are translated at the average exchange rates during the reporting periods. Translation adjustments are reported in other comprehensive income.
(m)
Commitments and contingencies
In the normal course of business, the Group is subject to loss contingencies, such as legal proceedings and claims arising out of its business, that cover a wide range of matters, including, among others, government investigations, product and environmental liability, and tax matters. In accordance with ASC Topic 450 the Group records accruals for such loss contingencies when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. Historically, the Group has not experienced any material service liability claims.
(n)
Appropriated retained earnings
The income of the Company’s PRC subsidiaries is distributable to its stockholders after transfer to reserves as required by relevant PRC laws and regulations and the subsidiaries’ articles of association. Appropriations to the reserves are approved by the respective boards of directors.
Reserves include statutory reserves and other reserves. Statutory reserves can be used to make good previous years’ losses, if any, and may be converted into capital in proportion to the existing equity interests of stockholders, provided that the balance after such conversion is not less than 25% of the registered capital. The appropriation of statutory reserve may cease to apply if the balance of the fund is equal to 50% of the entity’s registered capital. Pursuant to relevant PRC laws and articles of association of Great Shengda, Shengda Color, Hangzhou Shengming, Suzhou AA and Shuangsheng Paper, the appropriation to the statutory reserves and other reserves is 15% of net profit after taxation of respective entity, as determined in accordance with PRC accounting standards and regulations. The results of operations reflected in the financial statements prepared in accordance with U.S. GAAP might differ from those reflected in the statutory financial statements of the Company’s subsidiaries.
As of December 31, 2012 and 2011, the statutory reserve recorded by the Company’s subsidiaries incorporated in the PRC amounted to US$6,997,530 and US$6,843, 616, respectively.
As of December 31, 2012, the statutory reserve balances of Great Shengda, Hangzhou Shengming, Shengda Color, Suzhou AA and Shuangsheng Paper accounted for approximately 13.7%, 12.1%, 48.2%, 16.4% and nil of their registered capital, respectively. The future income of these subsidiaries will be subject to statutory reserve.
CHINA SHENGDA PACKAGING GROUP INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in US$)
(o)
Revenue recognition
The Group recognizes revenue in accordance with ASC Topic 605. All of the following criteria must exist in order for the Group to recognize revenue: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) price to the buyer is fixed or determinable; and (4) collectability is reasonably assured.
Delivery does not occur until products have been shipped to the customers, risk of loss has transferred to the customers and customers’ acceptance has been obtained, or the Group has objective evidence that the criteria specified in customers’ acceptance provisions have been satisfied. The sales price is not considered to be fixed or determinable until all contingencies related to the sale have been resolved.
In the PRC, value added tax (the “VAT”) of 17% on invoice amount is collected in respect of the sales of goods on behalf of tax authorities. Revenue is recognized on a net basis, and the VAT collected is not recognized as revenue of the Company.
(p)
Research and development costs
Research and development costs are expensed as incurred. These expenses consist of the costs of the Company’s internal research and development activities and the costs of developing new products and enhancing existing products. Research and development costs amounted to US$4,277,373 and US$4,065,733 were recorded in general and administrative expenses for the years ended December 31, 2012 and 2011, respectively.
(q)
Advertising
Advertising which generally represents the cost of promotions to create or stimulate a positive image of the Group or a desire to buy the Group’s products and services, are expensed as incurred. Advertising costs amounted to nil and US$18,721 was recorded in the selling expenses for the years ended December 31, 2012 and 2011, respectively.
(r)
Retirement and other postretirement benefits
Full-time employees of the Group in the PRC participate in a government mandated defined contribution plan, pursuant to which certain pension benefits, medical care, maternity insurance, work-related injury insurance and other welfare benefits are provided to employees. Chinese labor regulations require that the PRC subsidiaries of the Group make contributions to the government for these benefits based on certain percentages of the employees’ salaries. The Group has no legal obligation for the benefits beyond the contributions made. The total amounts for such employee benefits, which were expensed as incurred, were approximately US$1,162,770 and US$1,107,748 for the years ended December 31, 2012 and 2011, respectively.
(s)
Income taxes
The Group follows ASC Topic 740 “Income Taxes”, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates, applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.
CHINA SHENGDA PACKAGING GROUP INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in US$)
(t)
Uncertain tax positions
The Group follows ASC Topic 740, according to which prescribes a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. ASC Topic 740 also provides guidance on recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, accounting for income taxes in interim periods, and income tax disclosures. The Group did not have any interest and penalties associated with tax positions and did not have any significant unrecognized uncertain tax positions as of December 31, 2012 and 2011.
(u)
Earnings per share
Earnings per share are calculated in accordance with ASC Topic 260 “Earnings Per Share”. Basic earnings per share are computed by dividing income attributable to holders of common shares by the weighted average number of common shares outstanding during the period. Diluted earnings per common share reflects the potential dilution that could occur if securities or other contracts to issue common shares were exercised or converted into common shares.
(v)
Comprehensive income
The Group follows ASC Topic 220 “Comprehensive Income”, which establishes standards for reporting and display of comprehensive income, its components and accumulated balances. Comprehensive income is defined to include all changes in equity except those resulting from investments by owners and distributions to owners. Among other disclosures, ASC Topic 220 requires that all items that are required to be recognized under current accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. During the periods presented, the Group’s comprehensive income represents its net income and foreign currency translation adjustments.
(w)
Fair value measurements
Financial instruments include cash and cash equivalents, accounts and notes receivable, prepayments and other receivables, short-term loans, accounts and notes payable, other payables and amounts due to related party. The carrying amounts of these financial instruments approximate their fair value due to the short term maturities of these instruments.
The Group adopted ASC Topic 820-10 for all financial assets and liabilities and nonfinancial assets and liabilities that are recognized or disclosed at fair value in the consolidated financial statements on a recurring basis (at least annually). ASC Topic 820-10 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The Group has not adopted ASC Topic 820-10 for non-financial assets and non-financial liabilities, as these items are not recognized at fair value on a recurring basis.
ASC Topic 820-10 defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value, the Group considers the principal or most advantageous market in which it would transact and it considers assumptions that market participants would use when pricing the asset or liability.
ASC Topic 820-10 establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. ASC Topic 820-10 establishes three levels of inputs that may be used to measure fair value:
CHINA SHENGDA PACKAGING GROUP INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in US$)
Level 1 applies to assets or liabilities for which there are quoted prices in active markets for identical assets or liabilities.
Level 2 applies to assets or liabilities for which there are inputs other than quoted prices included within Level 1 that are observable for the asset or liability such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical assets or liabilities in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which significant inputs are observable or can be derived principally from, or corroborated by, observable market data.
Level 3 applies to assets or liabilities for which there are unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of the assets or liabilities.
(x) Recently issued accounting standards
In July 2012, the FASB issued ASU 2012-02, “Intangibles-Goodwill and Other (Topic 350): Testing Indefinite- Lived Intangible Assets for Impairment." This ASU simplifies how entities test indefinite-lived intangible assets for impairment which improve consistency in impairment testing requirements among long-lived asset categories. These amended standards permit an assessment of qualitative factors to determine whether it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying value. For assets in which this assessment concludes it is more likely than not that the fair value is more than its carrying value, these amended standards eliminate the requirement to perform quantitative impairment testing as outlined in the previously issued standards. The guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, early adoption is permitted. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial position and results of operations.
In February 2013, the FASB issued ASU 2013-02, “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” This ASU does not change the current requirements for reporting net income or other comprehensive income in financial statements. However, this guidance requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail about those amounts. For public entities, the guidance is effective prospectively for reporting periods beginning after December 15, 2012. For nonpublic entities, the guidance is effective prospectively for reporting periods beginning after December 15, 2013. Early adoption is permitted. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial position and results of operations.
Except for the ASUs above, in the period ended March 31, 2013, The FASB has issued ASU No. 2012-01 through ASU 2013-05, which is not expected to have a material impact on the consolidated financial statements upon adoption.
(y) Concentration of Risks
Concentration of Credit Risk
Assets that potentially subject the Group to significant concentration of credit risk primarily consist of cash and cash equivalents, accounts and notes receivable. As of December 31, 2012 and 2011, substantially all of the Group’s cash and cash equivalents were deposited in financial institutions located in the PRC, which management believes are of high credit quality. Accounts receivable are typically unsecured and are derived from revenue earned from customers in the PRC. The risk with respect to accounts receivable is mitigated by credit evaluations the Group performs on its customers and its ongoing monitoring process of outstanding balances.
CHINA SHENGDA PACKAGING GROUP INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in US$)
Concentration of Customers
There are no revenues from customers which individually represent greater than 10% of the total revenues during the years ended December 31, 2012 and 2011.
Concentration of Suppliers
The Company purchased its products from two major suppliers during the year ended December 31, 2012, accounting for 12% and 11% of the purchases, respectively. There are no purchases from supplier which individually represent greater than 10% of the total purchase during the year ended December 31, 2011.
Current vulnerability due to certain other concentrations
The Group’s operations may be adversely affected by significant political, economic and social uncertainties in the PRC. Although the PRC government has been pursuing economic reform policies for more than 30 years, no assurance can be given that the PRC government will continue to pursue such policies or that such policies may not be significantly altered, especially in the event of a change in leadership, social or political disruption or unforeseen circumstances affecting the PRC’s political, economic and social conditions. There is also no guarantee that the PRC government’s pursuit of economic reforms will be consistent or effective.
The Group transacts all of its business in RMB, which is not freely convertible into foreign currencies. On January 1, 1994, the PRC government abolished the dual rate system and introduced a single rate of exchange as quoted daily by the People’s Bank of China (the “PBOC”). However, the unification of the exchange rates does not imply that RMB may be readily convertible into US$ or other foreign currencies. All foreign exchange transactions continue to take place either through the PBOC or other banks authorized to buy and sell foreign currencies at the exchange rates quoted by the PBOC. Approval of foreign currency payments by the PBOC or other institutions requires submitting a payment application form together with suppliers’ invoices, shipping documents and signed contracts.
Additionally, the value of RMB is subject to changes in central government policies and international economic and political developments affecting supply and demand in the PRC foreign exchange trading system market.
(z) Reclassification
The Company has reclassified certain comparative amounts in the consolidated financial statements for 2011 to conform to the current year’s presentation.
The principal reclassifications related to the separate presentation of restrict cash as operating activity and financing activity item in the statement of cash flow, which was previously included in operating activity. The reclassification did not have an impact on reported total assets, liabilities and stockholders’ equity. The following table summarized the corrections made to the previously reported 2011 consolidated statement of cash flows.
CHINA SHENGDA PACKAGING GROUP INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in US$)
3. ACCOUNTS AND NOTES RECEIVABLE, NET
Accounts and notes receivable consist of the following:
No allowance for doubtful amounts was provided as of December 31, 2012and 2011.
4. INVENTORIES
Inventories consist of the following:
5. PREPAYMENTS AND OTHER RECEIVABLES
Prepayments and other receivables consist of the following:
6. PROPERTY, PLANT AND EQUIPMENT, NET
Property, plant and equipment consist of the following:
The Group recorded depreciation expenses of US$4,011,742 and US$3,563,123 for the years ended December 31, 2012 and 2011, respectively. The Group purchased a land use right in October 2010, which is located in Yancheng city, Jiangsu province for construction of paper manufacturing plants to expand the Group’s business (Note 7).
CHINA SHENGDA PACKAGING GROUP INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in US$)
No property, plant and equipment were pledged as collateral for bank loans as of December 31, 2012 and 2011.
7.
LAND USE RIGHT
In October 2010, Great Shengda paid US$11,902,684 (RMB75,000,000) to Shengda Group Jiangsu Shuangdeng Paper Industrial Co., Ltd. (“Shuangdeng Paper”), a related party of the Group, for the acquisition of the land use right, which is located in Yancheng city, Jiangsu province. The land use right, with 166,533 square meters in area, has a term of 50 years and will expire in December 2058. It was purchased for construction of paper manufacturing plants to expand the Group's business, and its transaction price was determined with reference to market prices. As of December 31, 2012, the Shuangsheng’s construction was substantially completed, the Company transferred the prepayment to land use right, and started amortization in December 2012. The Group recorded amortization expense of US$21,524 and nil for the years ended December 31, 2012 and 2011, respectively. However, the license of land use right is still awaiting the local government’s authorization. The annual amortization is as follows:
8.
CUSTOMER RELATIONSHIP, NET
Customer relationship recognized in the acquisition of Hangzhou Shengming on November 22, 2007 and in the acquisition of Suzhou AA on August 12, 2010 is amortized using straight-line method over their estimated useful life of five years and three years, respectively.
The customer relationship is summarized as follows:
Total amortization expenses were and US$479,928 and US$458,920 for the years ended December 31, 2012 and 2011, respectively. As of December 31, 2012 customer relationship recognized in the acquisition of Hangzhou Shengming has been fully amortized. Customer relationship recognized in the acquisition of Suzhou AA has a remaining useful life of eight months, and will be amortized at US$74,766 and in 2013.
CHINA SHENGDA PACKAGING GROUP INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in US$)
9.
BORROWINGS
Short-term loan
Short-term loan consist of the following:
Note* the effective interest rate was 4.1% as of December 31, 2012.
The short-term loan was denominated in USD for working capital purpose. It was guaranteed by Shengda Group, with weighted average balances of US$6,388,317 and US$11,220,349 and weighted average interest rates of 4.535% and 5.269% for the years ended December 31, 2012 and 2011, respectively.
Current portion of long-term borrowing
Current portion of long-term borrowing consist of the following:
The current portion of long-term borrowing was denominated in USD for working capital purpose. It was with weighted average balances of US$4,500,000 and weighted average interest rates of 4.050% for the years ended December 31, 2012.
Long-term loan
Long-term loan consist of the following:
Note* the effective interest rate was 4.1% and 3.3% as of December 31, 2012 and 2011, respectively.
The long term loan was with weighted average balances of US$3,882,145 and US$36,296; with weighted average interest rates of 4.050% and 3.300% for December 31, 2012 and 2011.
CHINA SHENGDA PACKAGING GROUP INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in US$)
Restricted bank deposits of approximately US$ 4,999,127 and US $4,999,127 were provided by Great Shengda as collateral for the current portion of long-term borrowing of US$ 4,500,000 and long-term loan of US$ 4,500,000, respectively. The remaining US$12.59 million restricted cash was the deposit for notes payable of Great Shengda. The bank loans were denominated in USD for working capital purposes.
The following table summarizes the unused lines of credit:
The above lines of credit were guaranteed by Shengda Group for working capital and general corporate purposes. The unused credit facilities can be withdrawn upon demand. The lines of credit from the Bank of China are in progress of renewal.
10.
ACCOUNTS AND NOTES PAYABLE
Accounts and notes payable consist of the following:
The notes payable were issued by the Great Shengda to their suppliers for raw materials purchase, the amounts were US$25,233,689 and US$3,148,000 for December 31, 2012 and 2011.All the notes payable were bank accepted notes payable without interest and due within six months.
11.
ACCRUED EXPENSES AND OTHER PAYABLES
Accrued expenses and other payables as of the end of the periods presented consist of the following:
CHINA SHENGDA PACKAGING GROUP INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in US$)
12.
RELATED PARTY TRANSACTION
The amount due from Shuangsheng Logistic and Shuangdeng Paper represents the receivable from them for selling the paper boxes. They were recorded as “amount due from related parties” in the consolidated balance sheets, non-interest bearing and receivable within one year.
The amount due to New Shengda represents the payable for land lease from New Shengda by the Group, the amount due to Shuangsheng Logistic represents the payable for transportation fee. It was recorded as “amount due to related party” in the consolidated balance sheets, non-interest bearing and repayable within one year.
CHINA SHENGDA PACKAGING GROUP INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in US$)
The transactions prices were determined with reference to market prices.
Guarantee by Shengda Group Co., Ltd (“SD Group”)
SD Group entered into maximum debt guarantee contracts with Xiaoshan Bank of China and Xiaoshan Industrial Commercial Bank of China, under which SD Group agreed to act as guarantor for loans borrowed by Great Shengda and Hangzhou Shengming from Xiaoshan Bank of Chian and Xiaoshan Industrial Commercial Bank of China. The maximum guaranteed amount is RMB80 million (approximately US$12.7 million), RMB50 million (approximately US$7.9 million) and is RMB70 million (approximately US$11.1 million), for any loans borrowed by Great Shengda, Hangzhou Shengming and Great Shengda, respectively (Note 9).
13.
RESTRICTED NET ASSETS
The Company’s ability to pay dividends is primarily dependent on the Company receiving distributions of dividends from its PRC subsidiaries. As described in note 2(m), the net income of the Company’s PRC subsidiaries is distributable only after sufficient appropriation of reserves.
Amounts restricted include paid-in capital and reserve funds of the Company’s PRC subsidiaries as determined pursuant to the PRC accounting standards and regulations, totaling approximately US$50,072,785 and US$49,918,871 as of December 31, 2012 and 2011, respectively.
CHINA SHENGDA PACKAGING GROUP INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in US$)
14.
TAXATION
Taxes payable are composed of the following:
The Company and its consolidated entities each files tax returns separately.
1)
VAT
Pursuant to the Provisional Regulation of the PRC on VAT and their implementing rules, all entities and individuals (“taxpayers”) that are engaged in the sale of products in the PRC are generally required to pay VAT at a rate of 17% of the gross sales proceeds received, less any deductible VAT already paid or borne by the taxpayers. Further, when exporting goods, the exporter is entitled to a portion of or all the refund of VAT that it has already paid or incurred.
The Group’s PRC subsidiaries are subject to VAT at 17% for their revenues.
2)
Income tax
United States
China Shengda Packaging is subject to United States tax at a tax rate of 34%. In the years ended December 31, 2012 and 2011, the Company does not provide for U.S. income taxes on foreign subsidiaries’ undistributed earnings as they will be permanently reinvested in foreign operations.
BVI
Incorporated in BVI, Evercharm is governed by the income tax law of BVI. According to current BVI income tax law, the applicable income tax rate for Evercharm is 0%.
PRC
Great Shengda has obtained the approval and is qualified as New and High-Tech Enterprise (“NHTE”) by relevant government authorities in December 2010. According to the PRC Enterprise Income Tax Law, Great Shengda is eligible to enjoy a preferential tax rate of 15% for the calendar year of 2010, 2011 and 2012.
Shengda Color, Suzhou AA and Shuangsheng are manufacturing domestic enterprises and are not entitled to any tax holiday. They were subject to income tax at a rate of 25% for calendar years 2011 and 2012.
Hangzhou Shengming is qualified as a manufacturing foreign-invested enterprise and thus was entitled to a tax holiday of two years full-exemption beginning with the first profitable year net of all loss carryforwards from the previous five years, followed by three years of taxation at half of the normal tax rate. Hangzhou Shengming’s first tax profitable year was 2007; therefore it was subject to income tax at a rate of 12.5% for calendar years 2009, 2010 and 2011, and 25% for 2012.
CHINA SHENGDA PACKAGING GROUP INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in US$)
Under the Enterprise Income Tax Law, dividends, interests, rent, royalties and gains on transfers of property payable by a foreign-invested enterprise in the PRC to their foreign investors who are a non-resident enterprises will be subject to a 20% withholding tax, unless such non-resident enterprise’s jurisdiction of incorporation has a tax treaty with the PRC that provides for a reduced rate of withholding tax.
The following table reconciles the Group’s effective tax for the years presented:
The significant components of income tax expense are as follows:
Deferred tax assets and deferred tax liabilities reflect the tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purpose and the tax bases used for income tax purpose. The following represents the tax effect of each major type of temporary difference:
15.
COMMITMENTS AND CONTINGENCIES
The Group has entered into construction for the factory. The estimated annual capital commitment is as follows:
The Group has entered into operating lease agreements for land, offices and plants. The estimated annual rental expense for lease commitment is as follows:
Year
Amount
CHINA SHENGDA PACKAGING GROUP INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in US$)
The Group is not currently a party to any legal proceeding, investigation or claim which, in the opinion of the management, is likely to have a material adverse effect on the business, financial condition or results of operations.
The Group did not identify any contingency as of December 31, 2012 and 2011.
16. SEGMENT REPORTING
The management has determined that the Group, as defined by Topic 280-10, “Segment Reporting”, has only one operating segment.
17. TREASURY STOCK
The Company repurchased 665,500 common shares at a cost of $729,444 both as of December 31, 2012 and 2011, respectively.
18. EARNINGS PER SHARE
The Group reports earnings per share in accordance with ASC Topic 260, which requires presentation of basic and diluted earnings per share in conjunction with the disclosure of the methodology used in computing such earnings per share. Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted average common shares outstanding during the period. Diluted earnings per share takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock. There was no incremental share through calculation to cause a dilutive effect. The following is a reconciliation of the basic and diluted earnings per share computations for the years ended December 31, 2012 and 2011:
19. SUBSEQUENT EVENT
The Group has evaluated subsequent events through the issuance of the consolidated financial statements and no subsequent event is identified.
EXHIBIT INDEX
*Filed herewith