UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB [X] Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 1996 ------------------ [ ] Transition Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from _________ to _________ Commission file number: 0-8128 ------ FREMONT CORPORATION - -------------------------------------------------------------------------------- (Exact name of small business issuer as specified in its charter) Delaware 76-0402886 - ------------------------------- ---------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 9454 Wilshire Boulevard, 6th Floor Beverly Hills, California 90212 - -------------------------------------------------------------------------------- (Address of principal executive offices) Issuer's telephone number, including area code: (310) 358-1006 -------------- Not applicable - -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report.) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- As of October 31, 1996, the issuer had 5,773,639 shares of its common stock outstanding. Transitional Small Business Disclosure Format: Yes No X ----- ----- Total sequentially numbered pages in this document: 27. 1 FREMONT CORPORATION AND SUBSIDIARIES ------------------------------------ INDEX ----- PART 1. FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets (Unaudited) - December 31, 1995 and September 30, 1996 Condensed Consolidated Statements of Operations (Unaudited) - Three Months and Nine Months Ended September 30, 1995 and 1996 Condensed Consolidated Statements of Cash Flows (Unaudited) - Nine Months Ended September 30, 1995 and 1996 Notes to Condensed Consolidated Financial Statements (Unaudited) - Three Months and Nine Months Ended September 30, 1995 and 1996 Item 2. Management's Discussion and Analysis or Plan of Operation PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K SIGNATURES 2 FREMONT CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) (Amounts in thousands, except number of shares and per share data) December 31, 1995 September 30, 1996 ------------------ ------------------ RMB USD RMB USD ------- ------ ------- ------ ASSETS Current assets: Cash and cash equivalents 6,507 781 20,754 2,491 Accounts receivable, net (Note 4) 83,502 10,024 73,097 8,775 Inventories (Note 2) 35,469 4,258 57,982 6,961 Due from related companies (Note 5) 43,501 5,222 27,703 3,326 Other receivables 20,280 2,435 26,422 3,172 Prepayments and other current assets 2,036 244 2,224 267 ------- ------ ------- ------ Total current assets 191,295 22,964 208,182 24,992 ------- ------ ------- ------ Property, plant and equipment (Note 5) 256,107 30,745 148,169 17,787 Less accumulated depreciation (12,715) (1,526) (19,180) (2,302) ------- ------ ------- ------ 243,392 29,219 128,989 15,485 ------- ------ ------- ------ Bank deposits 20,800 2,497 20,800 2,497 Goodwill, net 37,766 4,534 37,033 4,446 Deferred pre-operating costs, net (Note 3) 8,534 1,025 2,133 256 Prepaid rent (Note 5) 26,200 3,145 Intangible assets, net 5,835 700 5,470 657 Other long-term assets 2,136 256 1,955 234 ------- ------ ------- ------ Total assets 509,758 61,195 430,762 51,712 ======= ====== ======= ====== (continued) 3 FREMONT CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)(continued) (Amounts in thousands, except number of shares and per share data) December 31, 1995 September 30, 1996 ----------------- ------------------ RMB USD RMB USD -------- ------- ------- ------ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Short-term bank loans (Note 5) 161,278 19,361 163,300 19,604 Other short-term borrowings 6,656 799 625 75 Accounts payable 31,124 3,736 17,771 2,133 Accrued expenses and other liabilities 17,478 2,098 17,269 2,073 Taxes payable 7,712 926 8,423 1,011 Long-term bank loans, current portion (Note 5) 27,726 3,329 Finance lease obligations, current portion 10,817 1,299 10,817 1,299 ------- ------ ------- ------ Total current liabilities 262,791 31,548 218,205 26,195 Long-term bank loans (Note 5) 43,938 5,275 230 28 Finance lease obligations 18,904 2,269 12,276 1,474 Loan from parent company (Note 6) 33,280 3,995 33,280 3,995 Other long-term payables 9,755 1,171 16,956 2,035 ------- ------ ------- ------ Total liabilities 368,668 44,258 280,947 33,727 ------- ------ ------- ------ Minority interests 11,864 1,424 12,422 1,491 ------- ------ ------- ------ (continued) 4 FREMONT CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)(continued) (Amounts in thousands, except number of shares and per share data) December 31, 1995 September 30, 1996 ----------------- ------------------ RMB USD RMB USD ------- ------ ------- ------ LIABILITIES AND SHAREHOLDERS' EQUITY Shareholders' equity (Note 8): Common stock, par value US$ .001 per share; authorized - 100,000,000 shares; issued and outstanding - 5,602,639 shares at December 31, 1995 and 5,773,639 shares at September 30, 1996 47 6 48 6 Additional paid-in capital 112,145 13,462 116,001 13,926 Dedicated capital 10,213 1,226 10,213 1,226 Retained earnings 6,821 819 11,131 1,336 ------- ------ ------- ------ Total shareholders' equity 129,226 15,513 137,393 16,494 ------- ------ ------- ------ Total liabilities and shareholders' equity 509,758 61,195 430,762 51,712 ======= ====== ======= ====== See accompanying notes to condensed consolidated financial statements. 5 FREMONT CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (Amounts in thousands, except number of shares and per share data) Three Months Ended September 30, ----------------------------------- 1995 1996 --------- ---------------------- RMB RMB USD --------- --------- --------- Sales, including approximately RMB 22,950 in 1995 and RMB 2,104 in 1996 to companies related to SCH 45,156 56,672 6,803 Costs of goods sold 36,055 45,527 5,465 --------- --------- --------- Gross profit 9,101 11,145 1,338 Selling, general and administrative expenses 4,002 4,607 553 Amortization of deferred pre-operating costs (Note 3) 2,134 256 Interest expense, net 1,141 2,043 245 Other (income) expense, net (8) (84) (10) --------- --------- --------- Income before income taxes 3,950 2,445 294 Provision for income taxes (250) (250) (30) --------- --------- --------- Income before minority interests 3,700 2,195 264 Minority interests (1,117) (1,329) (160) --------- --------- --------- Net income 2,583 866 104 ========= ========= ========= Net income per common share .46 .15 .02 ========= ========= ========= Weighted average number of common shares (Note 1) 5,602,639 5,902,514 5,902,514 ========= ========= ========= See accompanying notes to condensed consolidated financial statements. 6 FREMONT CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (Amounts in thousands, except number of shares and per share data) Nine Months Ended September 30, ----------------------------------- 1995 1996 --------- ---------------------- RMB RMB USD --------- --------- --------- Sales, including approximately RMB 30,340 in 1995 and RMB 27,104 in 1996 to companies related to SCH 127,310 139,650 16,765 Costs of goods sold 102,340 111,984 13,444 --------- --------- --------- Gross profit 24,970 27,666 3,321 Selling, general and administrative expenses 10,144 10,139 1,217 Amortization of deferred pre-operating costs (Note 3) 6,401 768 Interest expense, net 3,702 4,957 595 Other (income) expense, net 1 51 6 Non-recurring recapitalization cost (Note 8) 6,407 --------- --------- --------- Income before income taxes 4,718 6,118 735 Provision for income taxes (750) (1,250) (150) --------- --------- --------- Income before minority interests 3,968 4,868 585 Minority interests (1,072) (558) (67) --------- --------- --------- Net income 2,896 4,310 518 ========= ========= ========= Net income per common share .55 .74 .09 ========= ========= ========= Weighted average number of common shares (Note 1) 5,260,417 5,829,150 5,829,150 ========= ========= ========= See accompanying notes to condensed consolidated financial statements. 7 FREMONT CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (Amounts in thousands) Nine Months Ended September 30, ------------------------------- 1995 1996 ------- ----------------- RMB RMB USD ------- ------- ------ Cash flows from operating activities: Net income 2,896 4,310 518 Adjustments to reconcile net income to net cash used in operating activities: Depreciation 7,493 6,464 776 Amortization 733 9,299 1,116 Non-recurring recapitalization cost 6,407 Minority interests 1,072 558 67 Foreign exchange loss 15 Changes in operating assets and liabilities: (Increase) decrease in - Accounts receivable, net (7,802) (2,715) (326) Inventories (17,754) (22,513) (2,703) Due from related companies (12,202) (1,465) Other receivables (6,142) (737) Prepayments and other current assets (3,244) (190) (23) Other long-term assets 93 183 22 Increase (decrease) in - Accounts payable 918 (13,410) (1,610) Accrued expenses and other liabilities 5,272 (153) (18) Taxes payable 3,820 711 85 Other long-term payables 7,201 865 ------- ------- ------ Net cash used in operating activities (81) (28,599) (3,433) ------- ------- ------ Cash flows from investing activities: Additions to property, plant and equipment (41,041) (23,528) (2,825) ------- ------- ------ Net cash used in investing activities (41,041) (23,528) (2,825) ------- ------- ------ (continued) 8 FREMONT CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (continued) (Amounts in thousands) Nine Months Ended September 30, ------------------------------- 1995 1996 ------ ------------------- RMB RMB USD ------ ------- ------ Cash flows from financing activities: Net proceeds from short-term bank loans 17,868 102,901 12,353 Net proceeds from other short-term borrowings 625 75 Repayment of other short-term borrowings (6,656) (799) Net proceeds from (repayments of) long-term bank loans 27,380 (27,726) (3,328) Payments of finance lease obligations (8,438) (6,628) (796) Sale of common stock and warrants, net of costs 3,733 448 Exercise of warrants 125 15 ------ ------- ------ Net cash provided by financing activities 36,810 66,374 7,968 ------ ------- ------ Cash and cash equivalents: Net increase (decrease) (4,312) 14,247 1,710 At beginning of period 8,275 6,507 781 ------ ------- ------ At end of period 3,963 20,754 2,491 ====== ======= ====== See accompanying notes to condensed consolidated financial statements. 9 FREMONT CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 1. ORGANIZATION AND BASIS OF PRESENTATION Organization - Fremont Corporation, a Delaware corporation (the "Company"), was - ------------ incorporated in the State of Utah on April 22, 1955, as Fremont Uranium Corporation. As of July 1, 1993, a change of domicile merger was effected, the result of which was that the Company changed its name to Fremont Corporation and became incorporated in the State of Delaware. Reverse Acquisition - From 1989 through April 28, 1995, the Company was engaged - ------------------- in acquiring interests in oil and natural gas properties and in seeking potential acquisition or merger opportunities. The Company entered into a Share Exchange Agreement dated as of March 23, 1995, and as amended on March 30, 1995, with Million Treasure Enterprises Limited ("MTE") and Winfill Holdings International Limited ("Winfill"), both of which are British Virgin Islands corporations. Pursuant to the Share Exchange Agreement, on April 28, 1995, the Company acquired from MTE 41,000 shares of common stock of Winfill, representing all of the issued and outstanding capital stock of Winfill, in exchange for the issuance of 4,760,000 shares of the Company's common stock, together with a warrant which allows MTE and/or its designee to receive up to 2,000,000 shares of Class B common stock in exchange for an equivalent number of shares of common stock. The terms of the Class B common stock are identical to that of the common stock (which will be designated Class A common stock) except that the holder thereof will be entitled to three votes per share. The warrant can be exercised after the Company's Certificate of Incorporation is amended to authorize the Class B common stock. Immediately prior to this transaction, the Company had a total of 842,639 shares of common stock issued and outstanding, after a 1-for-100 reverse stock split effective April 28, 1995. The 4,760,000 shares of common stock represented approximately 85% of the outstanding shares of common stock of the Company, after all shares were issued and the 1-for-100 reverse stock split was effected as set forth in the Share Exchange Agreement. All common share and per share data in the accompanying condensed consolidated financial statements have been restated to reflect this reverse stock split. South China Bicycles Winfill Limited ("SCBW") is a Sino-foreign joint venture formed to engage in the design, manufacture and marketing of bicycles, bicycle parts and components, steel tubes, and exercise equipment. Winfill owns a 98% equity interest in SCBW and South China Bicycles Company (Holdings) 10 Limited ("SCH"), a state-owned enterprise incorporated in the People's Republic of China, owns the remaining 2% equity interest in SCBW. Winfill and SCH formed SCBW effective July 1, 1994, to acquire and operate the bicycle, bicycle parts and components and steel tube manufacturing operations of SCH at a consideration of RMB 152,076,000. Except for a 69% interest in South China Bicycles Co., Ltd. ("SCB"), SCBW owns 100% interests in its principal operating subsidiaries, all of which are organized in the People's Republic of China. The factory operations of SCBW's subsidiaries are located at several sites in Zhaoqing City, Guangdong Province, People's Republic of China. For accounting purposes, the transaction has been treated as a recapitalization of Winfill with Winfill as the acquiror (reverse acquisition). The historical financial statements prior to April 28, 1995 are those of Winfill. The consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America. Pursuant to the terms of the Share Exchange Agreement, the Company transferred to Joseph W. Petrov, the Company's former president and controlling shareholder, all of its operating assets existing immediately subsequent to the closing of the previously described transaction (excluding the shares of Winfill) in exchange for the assumption by Mr. Petrov of all of the liabilities of the Company as of the closing and the delivery of a release of all obligations owed by the Company to an affiliate of Mr. Petrov. In addition, at the closing, each member of the Company's Board of Directors resigned, and was replaced by representatives of MTE and Winfill. Foreign Currency Translation - In preparing the consolidated financial - ---------------------------- statements, the financial statements of the Company are measured using Renminbi ("RMB") as the functional currency. All foreign currency transactions are translated into RMB using the applicable floating rates of exchange as quoted by the People's Bank of China prevailing at the date of the transactions. Monetary assets and liabilities denominated in foreign currencies are translated into RMB using the applicable exchange rates prevailing at the balance sheet dates. The resulting exchange gains or losses are recorded in the consolidated statements of operations for the periods in which they occur. The Company's share capital is denominated in United States dollars ("USD" or "US$") and the reporting currency is the RMB. For financial reporting purposes, the USD share capital amounts have been translated into RMB at the applicable rates prevailing on the transaction dates. Translation of amounts from RMB into USD for the convenience of the reader has been made at the noon buying rate in New York City for cable transfers in foreign currencies as certified for customs purposes by the Federal Reserve Bank of New York on 11 September 30, 1996 of US$1.00 = RMB 8.33. No representation is made that the RMB amounts could have been, or could be, converted into USD at that rate or at any other certain rate. Basis of Presentation - The accompanying consolidated financial statements are - --------------------- unaudited but, in the opinion of management of the Company, contain all adjustments necessary to present fairly the financial position at September 30, 1996, the results of operations for the three months and nine months ended September 30, 1995 and 1996, and the changes in cash flows for the nine months ended September 30, 1995 and 1996. These adjustments are of a normal recurring nature. The consolidated balance sheet as of December 31, 1995 is derived from the Company's audited financial statements. The accompanying consolidated financial statements include the operations of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain information and footnote disclosures normally included in financial statements that have been prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission, although management of the Company believes that the disclosures contained in these financial statements are adequate to make the information presented therein not misleading. For further information, refer to the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10- KSB for the fiscal year ended December 31, 1995, as filed with the Securities and Exchange Commission. The results of operations for the three months and nine months ended September 30, 1996 are not necessarily indicative of the results of operations to be expected for the full fiscal year ending December 31, 1996. Net Income (Loss) Per Common Share - During April 1995, the Company issued new - ---------------------------------- shares of common stock in consideration for the acquisition of all of the capital stock of Winfill, in a transaction which has been accounted for as a reverse acquisition. As a result, for nine months ended September 30, 1995, net income per common share is presented on a pro forma basis, and has been calculated using the shares of common stock as if the existing and new common shares had been outstanding throughout the period, except for the common shares issued to consultants related to the non-recurring recapitalization cost, which were appropriately weighted in the calculation. Net income per common share for the three months ended September 30, 1995, and the three months and nine months ended September 30, 1996, is based on the weighted average number of shares of common stock outstanding, including common stock equivalents. Common stock equivalents consist of outstanding common stock purchase 12 warrants. 2. INVENTORIES Inventories consisted of the following at December 31, 1995 and September 30, 1996: December 31, 1995 September 30, 1996 --------------------- --------------------- RMB USD RMB USD ---------- --------- ---------- --------- Raw materials 18,743,000 2,250,000 21,213,000 2,547,000 Work-in-progress 3,075,000 369,000 10,868,000 1,305,000 Finished goods 13,651,000 1,639,000 25,901,000 3,109,000 ---------- --------- ---------- --------- 35,469,000 4,258,000 57,982,000 6,961,000 ========== ========= ========== ========= 3. DEFERRED PRE-OPERATING COSTS Deferred pre-operating costs represent organization and certain start-up costs (excluding capital expenditures) related to the new production facility. Through December 31, 1995, such deferred pre-operating costs aggregated RMB 8,534,000, and are being amortized on the straight line basis over one year commencing January 1, 1996, the date of commencement of commercial production from the new production facility. Amortization expense was RMB 2,134,000 and RMB 6,401,000 for the three months and nine months ended September 30, 1996, respectively. 4. TRANSFER OF ACCOUNTS RECEIVABLE In conjunction with the formation of SCBW and the transfer of the operating assets of SCH to SCBW effective July 1, 1994, SCBW was granted an option to transfer to SCH certain accounts receivable outstanding as of July 1, 1994 at cost, should such accounts receivable remain uncollected as of June 30, 1996. As of December 31, 1995, the amount of such outstanding accounts receivable was RMB 13,120,000. The parties elected to modify the option's transfer date, and accordingly, as of January 1, 1996, SCBW transferred to SCH RMB 13,120,000 of accounts receivable, and SCH assumed an equivalent amount of SCBW's short-term bank debt. 5. SALE/LEASEBACK Effective as of January 1, 1996, SCBW entered into a 13 sale/leaseback transaction with SCH. Pursuant to this transaction, SCBW sold the new production facility's buildings and land with net book values of RMB 83,507,000 and RMB 47,960,000, respectively (aggregate net book value of RMB 131,467,000), to SCH in exchange for RMB 131,467,000. SCH paid such consideration by assuming RMB 87,759,000 of SCBW's short-term bank debt and RMB 43,708,000 of SCBW's long-term bank debt. This transaction did not result in any gain or loss. In the opinion of management, this transaction was at fair value. SCBW leased back the buildings from SCH for a period of 20 years under an operating lease agreement that provides for escalating minimum rental payments during the first five years of the lease, and also an escalating minimum usage rate, of RMB 28,000,000. The escalating minimum usage rate increases from 30% in 1996 to 70% in 2000, and to the extent that the usage rate is between the respective annual rate and 70%, such portion of rent expense payable will be deferred. SCBW prepaid the first five years of rent to SCH, assuming a usage rate of 70%, of RMB 28,000,000 by reducing its accounts receivable due from SCH by an equal amount. To the extent that the utilization rate is less than 70% in any year during the five year period ending December 31, 2000, the unused prepaid rent can be carried forward during the first four years of such five year period. The Company estimates that rent expense for 1996 will be RMB 2,400,000. In the opinion of management, the prepaid rent will be fully utilized during the five years ending December 31, 2000. 6. LOAN FROM PARENT COMPANY The unsecured loan of RMB 33,280,000 from MTE, the parent company, is denominated in USD, bears no interest, and has no fixed repayment terms. 7. SALE OF SECURITIES During March 1996, the Company sold 166,000 units, each unit consisting of one share of common stock and one common stock purchase warrant, generating net proceeds of RMB 3,733,000 (USD 448,000). Each common stock purchase warrant entitles the holder to purchase one share of common stock for US$3.00 per share on or before February 28, 1998. During August 1996, 5,000 common stock purchase warrants were exercised, generating net proceeds of RMB 14 125,000 (USD 15,000), and resulting in the issuance of 5,000 shares of common stock. For each common stock purchase warrant exercised in August 1996, the Company issued an identical common stock purchase warrant. 8. NON-RECURRING RECAPITALIZATION COST On April 5, 1995, the Company issued 770,000 shares of common stock to certain consultants in conjunction with the reverse acquisition. The Company accounted for the value of the 770,000 shares as a non-recurring recapitalization cost during the nine months ended September 30, 1995, and recorded a charge to operations of RMB 6,407,000 as management's estimate of the fair value of the consideration paid. 9. ANTI-DUMPING INVESTIGATION The Company manufactures bicycles in the People's Republic of China (the "PRC" or "China") through its subsidiary, SCBW, and exports to the United States through various distributors and trade intermediaries. Although there are other markets for SCBW's products, the United States market is considered an important market for SCBW. Pursuant to a petition filed by three United States bicycle manufacturers in early 1995, the U.S. International Trade Commission (the "ITC") launched an anti-dumping investigation against companies which manufacture bicycles in the PRC for import into the United States. In May 1995, the ITC found a reasonable indication that "a U.S. industry is materially injured or threatened with material injury by reason of imports of bicycles (from the PRC) allegedly sold at less than fair value." After the ITC's initial determination, the U.S. Department of Commerce ("Commerce") began its investigation of the PRC bicycle manufacturing industry, requesting financial and other information from several Chinese bicycle manufacturers (not including SCBW), in order to calculate dumping margins and impose anti-dumping duties. During November 1995, Commerce issued a preliminary determination which calculated a 61.67% dumping margin on bicycles manufactured by SCBW and all but nine Chinese bicycle manufacturers. As a result, each Chinese bicycle manufacturer which continued to export product to the United States was required to post a "single-entry bond" equal to the estimated potential duty on bicycles exported to the United States from the date of the preliminary notice until the date of the final determination. 15 In April 1996, Commerce finalized this dumping margin and the ITC began its investigation of Chinese bicycle manufacturers. An affirmative ITC injury or threat of material injury determination would have resulted in the imposition of the Department's dumping margin. Throughout the investigations by Commerce and the ITC, SCBW has maintained that it has not engaged in "dumping" bicycles in the United States market and has opposed the imposition of the anti-dumping duty. In this regard, SCBW and other PRC bicycle manufacturers retained legal counsel to protect their legal rights and to investigate and pursue several alternative solutions. On June 4, 1996, the ITC made a negative final determination in its anti- dumping investigation on imports of bicycles from China. The negative ITC determination means that the ITC found that there is not a reasonable indication that a United States industry is materially injured or threatened with material injury by reason of imports of bicycles from China. The negative ITC determination allows SCBW to resume its normal operations and export to the United States without the imposition of an anti-dumping duty. The United States bicycle manufacturers appealed the determinations of both Commerce and the ITC in the United States Court of International Trade on June 30, 1996 and July 19, 1996, respectively. Legal counsel for SCBW is responding to such appeals, and, in addition, has filed its own action to challenge Commerce's calculation methodologies with respect to the 61.67% dumping margin. The resolution of the appeals will take approximately one year to complete. The Company is unable to predict the ultimate resolution of this matter. 16 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION Overview: Effective April 28, 1995, the Company acquired Winfill. Winfill owns a 98% interest in SCBW, a Sino-foreign joint venture engaged in the design, manufacture and marketing of bicycles, bicycle parts and components, steel tubes, and exercise equipment. Winfill commenced operations effective July 1, 1994. Except for a 69% interest in SCB, SCBW owns 100% interests in its principal operating subsidiaries, all of which are organized in the People's Republic of China. The factory operations of SCBW's subsidiaries are located at several sites in Zhaoqing City, Guangdong Province, People's Republic of China. For accounting purposes, the transaction has been treated as a recapitalization of Winfill with Winfill as the acquiror (reverse acquisition). The historical financial statements prior to April 28, 1995 are those of Winfill. All amounts in the following discussion are in RMB. Anti-Dumping Investigation: The Company manufactures bicycles in the People's Republic of China (the "PRC" or "China") through its subsidiary, SCBW, and exports to the United States through various distributors and trade intermediaries. Although there are other markets for SCBW's products, the United States market is considered an important market for SCBW. Pursuant to a petition filed by three United States bicycle manufacturers in early 1995, the U.S. International Trade Commission (the "ITC") launched an anti-dumping investigation against companies which manufacture bicycles in the PRC for import into the United States. In May 1995, the ITC found a reasonable indication that "a U.S. industry is materially injured or threatened with material injury by reason of imports of bicycles (from the PRC) allegedly sold at less than fair value." After the ITC's initial determination, the U.S. Department of Commerce ("Commerce") began its investigation of the PRC bicycle manufacturing industry, requesting financial and other information from several Chinese bicycle manufacturers (not including SCBW), in order to calculate dumping margins and impose anti-dumping duties. During November 1995, Commerce issued a preliminary determination which calculated a 61.67% dumping margin on bicycles manufactured by SCBW and all but nine Chinese bicycle manufacturers. As a result, each Chinese bicycle manufacturer which continued to export product to the United States was 17 required to post a "single-entry bond" equal to the estimated potential duty on bicycles exported to the United States from the date of the preliminary notice until the date of the final determination. In April 1996, Commerce finalized this dumping margin and the ITC began its investigation of Chinese bicycle manufacturers. An affirmative ITC injury or threat of material injury determination would have resulted in the imposition of the Department's dumping margin. Throughout the investigations by Commerce and the ITC, SCBW has maintained that it has not engaged in "dumping" bicycles in the United States market and has opposed the imposition of the anti-dumping duty. In this regard, SCBW and other PRC bicycle manufacturers retained legal counsel to protect their legal rights and to investigate and pursue several alternative solutions. On June 4, 1996, the ITC made a negative final determination in its anti- dumping investigation on imports of bicycles from China. The negative ITC determination means that the ITC found that there is not a reasonable indication that a United States industry is materially injured or threatened with material injury by reason of imports of bicycles from China. The negative ITC determination allows SCBW to resume its normal operations and export to the United States without the imposition of an anti-dumping duty. The United States bicycle manufacturers appealed the determinations of both Commerce and the ITC in the United States Court of International Trade on June 30, 1996 and July 19, 1996, respectively. Legal counsel for SCBW is responding to such appeals, and, in addition, has filed its own action to challenge Commerce's calculation methodologies with respect to the 61.67% dumping margin. The resolution of the appeals will take approximately one year to complete. The Company is unable to predict the ultimate resolution of this matter. Consolidated Results of Operations: Three Months Ended September 30, 1995 and 1996 - Sales for the three months ended September 30, 1996 were RMB 56,672,000, as compared to RMB 45,156,000 for the three months ended September 30, 1995, an increase of RMB 11,516,000 or 25.5%. Sales to companies related to SCH, a related entity, for the three months ended September 30, 1996 were approximately RMB 2,104,000 or 3.7% of sales, as compared to RMB 22,950,000 or 50.8% of sales for the three months ended September 30, 1995. The increase in sales in 1996 as compared to 1995 was a result of the following factors: (1) the development of new distribution channels in the domestic bicycle market in China; (2) the recent resolution of the anti- 18 dumping investigation, which allowed the Company to resume export sales to the United States during the three months ended September 30, 1996; and (3) the recent introduction of an exercise equipment product line, which was developed for export to the United States and Canada. Export sales to the United States aggregated approximately RMB 22,000,000 during the three months ended September 30, 1996. The Company has focused its recent sales efforts on not only increasing domestic sales in China under its "Seven Stars" brand, but also on concurrently developing distribution channels to markets outside North America, including Southeast Asia and Australia, and on establishing an exercise equipment product line. Gross profit for the three months ended September 30, 1996 was RMB 11,145,000 or 19.7% of sales, as compared to RMB 9,101,000 or 20.2% of sales for the three months ended September 30, 1995. Selling, general and administrative expenses for the three months ended September 30, 1996 were RMB 4,607,000 or 8.1% of sales, as compared to RMB 4,002,000 or 8.9% of sales for the three months ended September 30, 1995, an increase of RMB 605,000 or 15.1%. Selling, general and administrative expenses increased on an absolute basis in 1996 as compared to 1995 primarily as a result of additional shipping costs incurred with respect to increased export sales in 1996, and additional costs in 1996 related to the operation of a public company. Amortization of deferred pre-operating costs for the three months ended September 30, 1996 was RMB 2,134,000. Deferred pre-operating costs represent organization and certain start-up costs (excluding capital expenditures) related to the new production facility. Through December 31, 1995, such deferred pre- operating costs aggregated RMB 8,534,000, and are being amortized on the straight line basis over one year commencing January 1, 1996, the date of commencement of commercial production from the new production facility. Interest expense, net of amounts capitalized in 1995, for the three months ended September 30, 1996 was RMB 2,043,000 or 3.6% of sales, as compared to RMB 1,141,000 or 2.5% of sales for the three months ended September 30, 1995. The increase in interest expense was primarily a result of an increase in bank loans utilized to finance working capital requirements in 1996 as compared to 1995. As a result of the aforementioned factors, for the three months ended September 30, 1996, net income was RMB 866,000 (per share - RMB .15; USD .02) or 1.5% of sales; excluding the amortization of deferred pre-operating costs of RMB 2,134,000, pro forma net income would have been RMB 3,000,000 (per share - RMB .51; USD .06) or 5.3% of sales. For the three months ended September 30, 1995, net income was RMB 2,583,000 (RMB .46 per share) or 5.7% of sales. 19 Nine Months Ended September 30, 1995 and 1996 - Sales for the nine months ended September 30, 1996 were RMB 139,650,000, as compared to RMB 127,310,000 for the nine months ended September 30, 1995, an increase of RMB 12,340,000 or 9.7%. Sales to companies related to SCH, a related entity, for the nine months ended September 30, 1996 were approximately RMB 27,104,000 or 19.4% of sales, as compared to RMB 30,340,000 or 23.8% of sales for the nine months ended September 30, 1995. The increase in sales in 1996 as compared to 1995 occurred primarily during the three months ended September 30, 1996, and was a result of the following factors: (1) the development of new distribution channels in the domestic bicycle market in China; (2) the recent resolution of the anti-dumping investigation, which allowed the Company to resume export sales to the United States during the three months ended September 30, 1996; and (3) the recent introduction of an exercise equipment product line, which was developed for export to the United States and Canada. The Company has focused its recent sales efforts on not only increasing domestic sales in China under its "Seven Stars" brand, but also on concurrently developing distribution channels to markets outside North America, including Southeast Asia and Australia, and on establishing an exercise equipment product line. Gross profit for the nine months ended September 30, 1996 was RMB 27,666,000 or 19.8% of sales, as compared to RMB 24,970,000 or 19.6% of sales for the nine months ended September 30, 1995. Selling, general and administrative expenses for the nine months ended September 30, 1996 were RMB 10,139,000 or 7.3% of sales, as compared to RMB 10,144,000 or 8.0% of sales for the nine months ended September 30, 1995. Amortization of deferred pre-operating costs for the nine months ended September 30, 1996 was RMB 6,401,000. Deferred pre-operating costs represent organization and certain start-up costs (excluding capital expenditures) related to the new production facility. Through December 31, 1995, such deferred pre- operating costs aggregated RMB 8,534,000, and are being amortized on the straight line basis over one year commencing January 1, 1996, the date of commencement of commercial production from the new production facility. 20 On April 5, 1995, the Company issued 770,000 shares of common stock to certain consultants in conjunction with the reverse acquisition. The Company accounted for the value of the 770,000 shares as a non-recurring recapitalization cost during the nine months ended September 30, 1995, and recorded a charge to operations of RMB 6,407,000 as management's estimate of the fair value of the consideration paid. Interest expense, net of amounts capitalized in 1995, for the nine months ended September 30, 1996 was RMB 4,957,000 or 3.5% of sales, as compared to RMB 3,702,000 or 2.9% of sales for the nine months ended September 30, 1995. The increase in interest expense was primarily a result of an increase in bank loans utilized to finance working capital requirements in 1996 as compared to 1995. As a result of the aforementioned factors, for the nine months ended September 30, 1996, net income was RMB 4,310,000 (per share - RMB .74; USD .09) or 3.1% of sales; excluding the amortization of deferred pre-operating costs of RMB 6,401,000, pro forma net income would have been RMB 10,711,000 (per share - RMB 1.84; USD .22) or 7.7% of sales. For the nine months ended September 30, 1995, net income was RMB 2,896,000 (RMB .55 per share) or 2.3% of sales; excluding the non-recurring recapitalization cost of RMB 6,407,000, pro forma net income would have been RMB 9,303,000 (RMB 1.77 per share) or 7.3% of sales. Consolidated Financial Condition - September 30, 1996: Liquidity and Capital Resources - For the nine months ended September 30, 1996, the Company's operations utilized cash resources of RMB 28,599,000. The most significant components of the cash utilized by operations in 1996 were the increase in inventories of RMB 22,513,000, the increase in due from related companies (as a result of sales to companies related to SCH) of RMB 12,202,000, the increase in other receivables of RMB 6,142,000, and the decrease in accounts payable of RMB 13,410,000, which was partially offset by an increase of RMB 7,201,000 in other long-term payables. Through December 31, 1995, the Company relied primarily on short-term bank loans to finance the construction of its new production facility, resulting in a net working capital deficit of RMB 71,496,000 at December 31, 1995. However, primarily as a result of the sale/leaseback transaction described below, the Company had reduced its net working capital deficit to RMB 10,023,000 at September 30, 1996. As a result, the Company's 21 current ratio at September 30, 1996 was .95:1, as compared to .73:1 at December 31, 1995. Except with regard to the initial transaction pursuant to which SCBW was organized and capitalized and the sale of the Company's equity securities during March and August 1996, the Company's primary method of financing its capital requirements has been bank loans. Short-term bank loans are unsecured, repayable within one year, have interest rates ranging from 9.9% to 13.0%, and have been utilized for working capital purposes and to finance the expansion of the production facility and the purchase of equipment. Long-term bank loans are secured by property, plant and equipment and long-term bank deposits, have interest rates ranging from 5.4% to 13.2%, are guaranteed by related enterprises of SCH, and have been utilized to finance the expansion of the production facility and the purchase of equipment. Exclusive of the reduction in short-term and long-term bank loans as a result of the sale/leaseback with SCH and the transfer of accounts receivable to SCH as discussed below, during the nine months ended September 30, 1996, short- term bank loans increased by RMB 102,901,000, which were utilized to repay other short-term borrowings of RMB 6,656,000, payments of finance lease obligations of RMB 6,628,000 and long-term bank loans (including the current portion) of RMB 27,726,000. During March 1996, the Company raised net proceeds of RMB 3,733,000 (USD 448,000) through the sale of 166,000 units, each unit consisting of one share of common stock and one common stock purchase warrant. Each common stock purchase warrant entitles the holder to purchase one share of common stock for US$3.00 per share on or before February 28, 1998. During August 1996, 5,000 common stock purchase warrants were exercised, generating net proceeds of RMB 125,000 (USD 15,000), and resulting in the issuance of 5,000 shares of common stock. For each common stock purchase warrant exercised in August 1996, the Company issued an identical common stock purchase warrant. During the nine months ended September 30, 1996, the net cash provided by financing activities of RMB 66,374,000 was utilized to fund additions to property, plant and equipment of RMB 23,528,000 and operating cash flow requirements. SCBW is considered by the government of China as an important component of the bicycle production and exporting base of China, and has been designated for continuing financial support by the Zhaoqing Branch of the Bank of China. SCBW has utilized borrowings from the Bank of China to support increases in production and sales, and to finance the expansion of the production facility and to purchase equipment. Pursuant to guidelines issued by the government of China, SCBW increased its 22 short-term borrowings during 1995 and 1996 from the Bank of China with loans having maturities ranging from one to three months. The working capital loans that the Bank of China makes to SCBW are renewed so long as SCBW's production and business operations continue to meet certain operating and financial criteria. Management believes that the Bank of China will continue to renew SCBW's existing borrowings and increase its borrowing base as necessary to support operations at current levels. In connection with the formation of SCBW as a Sino-foreign joint venture between SCH and Winfill in June 1994, Winfill issued a note payable to MTE for RMB 34,800,000. The unsecured note is denominated in United States dollars, bears no interest, has no fixed repayment terms, and had a balance of RMB 33,280,000 at September 30, 1996. There have been no payments on this note, with the principal balance changing only as a result of changes in the currency conversion rates between the Chinese Renminbi and the United States dollar. The Company believes that the existing terms of this note will continue until substantial full-scale production at the new facility is reached. Although the new production facility has been completed and is expected to become fully operational in 1996, substantial full-scale production is expected to take at least two years to attain. Through the end of 1997, SCBW currently plans to expend approximately RMB 40,000,000 with respect to the second phase of development of the new production facility, including the tube production line and the spare parts welding line, which is expected to be funded through long-term debt, to the extent available, and/or the sale of the Company's equity securities. In conjunction with the formation of SCBW and the transfer of the operating assets of SCH to SCBW effective July 1, 1994, SCBW was granted an option to transfer to SCH certain accounts receivable outstanding as of July 1, 1994 at cost, should such accounts receivable remain uncollected as of June 30, 1996. As of December 31, 1995, the amount of such outstanding accounts receivable was RMB 13,120,000. The parties elected to modify the option's transfer date, and accordingly, effective as of January 1, 1996, SCBW transferred to SCH RMB 13,120,000 of accounts receivable, and SCH assumed an equivalent amount of SCBW's short-term bank debt. Effective as of January 1, 1996, SCBW entered into a sale/leaseback transaction with SCH. Pursuant to this transaction, SCBW sold the new production facility's buildings and land, with net book values of RMB 83,507,000 and RMB 47,960,000, respectively (aggregate net book value of RMB 131,467,000), to SCH in exchange for RMB 131,467,000. SCH paid such consideration by assuming RMB 87,759,000 of SCBW's short-term bank debt and RMB 43,708,000 of SCBW's long- term bank debt. This transaction did not result in any gain or loss. In the 23 opinion of management, this transaction was at fair value. SCBW leased back the buildings from SCH for a period of 20 years under an operating lease agreement that provides for escalating minimum rental payments during the first five years of the lease, and also an escalating minimum usage rate, of RMB 28,000,000. The escalating minimum usage rate increases from 30% in 1996 to 70% in 2000, and to the extent that the usage rate is between the respective annual rate and 70%, such portion of rent expense payable will be deferred. SCBW prepaid the first five years of rent to SCH, assuming a usage rate of 70%, of RMB 28,000,000 by reducing its accounts receivable due from SCH by an equal amount. To the extent that the utilization rate is less than 70% in any year during the five year period ending December 31, 2000, the unused prepaid rent can be carried forward during the first four years of such five year period. The Company estimates that rent expense for 1996 will be RMB 2,400,000. In the opinion of management, the prepaid rent will be fully utilized during the five years ending December 31, 2000. As a result of this sale/leaseback transaction, the Company has been able to substantially reduce future depreciation expense related to the new production facility and interest expense related to the debt that had been incurred to build the new production facility. The Company believes that its cash flow provided by operations, combined with short-term borrowings, will be sufficient to support operations at current levels. However, in order to increase sales and fully utilize the expanded production capacity of the new production facility, the Company will require operating capital substantially in excess of that available from domestic sources in China. The availability of working capital represents a substantial limitation on the ability of the Company to finance increased production levels. As a result of the Company's existing capital structure and reliance on borrowings, such additional operating capital would most likely be in the form of some type of an equity investment. 24 Inflation and Currency Matters - In recent years, the Chinese economy has experienced periods of rapid economic growth as well as high rates of inflation, which in turn has resulted in the periodic adoption by the Chinese government of various corrective measures designed to regulate growth and contain inflation. During the nine months ended September 30, 1996, the general inflation rate in China was in excess of 10% on an annualized basis. Since 1993, the Chinese government has implemented an economic program designed to control inflation, which has resulted in the tightening of working capital available to Chinese business enterprises. The success of the Company depends in substantial part on the continued growth and development of the Chinese economy. Foreign operations are subject to certain risks inherent in conducting business abroad, including price and currency exchange controls, and fluctuations in the relative value of currencies. Changes in the relative value of currencies occur periodically and may, in certain instances, materially affect the Company's results of operations. A substantial portion of the Company's revenues are denominated in RMB. As a result, devaluation of the RMB against the USD would adversely affect the Company's financial performance when measured in USD, and could have material adverse effects upon the results of operations and financial position. In addition, a significant portion of revenues will need to be converted into USD on a continuing basis to meet foreign currency obligations. Although prior to 1994 the RMB experienced significant devaluation against the USD, the RMB has remained fairly stable since late 1994. The unified exchange rate was US$1.00 to RMB 8.70 at December 31, 1993, RMB 8.45 at December 31, 1994, RMB 8.32 at December 31, 1995, and RMB 8.33 at September 30, 1996. 25 PART II. OTHER INFORMATION --------------------------- ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits - 27 Financial Data Schedule (electronic filing only) (b) Reports on Form 8-K - Three Months Ended September 30, 1996: None. 26 SIGNATURES ---------- In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FREMONT CORPORATION ------------------- (Registrant) Date: November 13, 1996 By: /s/ WINSTON WU ________________________ Winston Wu President (Duly Authorized Officer) Date: November 13, 1996 /s/ ROBERT N. WEINGARTEN By: ________________________ Robert N. Weingarten Chief Financial Officer (Principal Financial Officer) 27