UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

(Mark One)

FORM 10-K

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
  For the fiscal year ended December 31, 2013

 

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
  For the transition period from _____________to ______________

 

Commission file number   001-34577

 

ORIENT PAPER, INC.

 (Exact name of registrant as specified in its charter)

 

Nevada 20-4158835
State or other jurisdiction of (I.R.S. Employer
Incorporation or organization Identification No.)

 

Science Park, Juli Road,

Xushui County, Baoding City

Hebei Province, The People’s Republic of China 072550

 (Address of principal executive offices) (Zip Code)

 

Registrant’s telephone number, including area code: 011- (86) 312-8698215

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class   Name of each exchange on which registered
Common Stock   NYSE MKT LLC

 

Securities registered pursuant to section 12(g) of the Act:

 

Common Stock

(Title of class)

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

¨ Yes x No

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. ¨ Yes x No

 

Note - Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Exchange Act from their obligations under those Sections.

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

x Yes ¨ No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

x Yes ¨ No

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  ¨   Accelerated filer
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)   Smaller reporting company x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Ac t). ¨ Yes x No

 

The aggregate market value of the voting and non-voting common stock of the issuer held by non-affiliates as of June 30, 2013 was approximately $20,185,416 (13,205,825 shares of common stock held by non-affiliates)  based upon a closing price of the common stock of $1.51 as quoted by the NYSE MKT LLC on June 30, 2013.

 

As of March 15, 2014, there were 18,753,900 shares of common stock, par value $0.001, issued and outstanding.

 

 
 

 

TABLE OF CONTENTS

 

    Page
     
PART I  
     
Item 1. BUSINESS 1
Item 1A. RISK FACTORS 12
Item 1B. UNRESOLVED STAFF COMMENTS 25
Item 2. PROPERTIES 25
Item 3. LEGAL PROCEEDINGS 26
Item 4. MINE SAFETY DISCLOSURES 26
     
PART II  
     
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES 26
Item 6. SELECTED FINANCIAL DATA 28
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 30
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 48
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 48
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 49
Item 9A. CONTROLS AND PROCEDURES 49
Item 9B. OTHER INFORMATION 49
     
PART III  
     
Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE 49
Item 11. EXECUTIVE COMPENSATION 52
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS 54
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE 56
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES 57
     
PART IV  
     
Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES 58
     
SIGNATURES 60

 

 
 

 

 INTRODUCTION

 

In this annual report, “Orient Paper,” “the Company,” “we,” “our” or “us” refer to Orient Paper, Inc., and unless the context requires otherwise, includes its subsidiaries and its controlled entity, Hebei Baoding Orient Paper Milling Company Limited. “Orient Paper Shengde” means our PRC subsidiary Baoding Shengde Paper Co., Ltd. “Orient Paper HB” means Hebei Baoding Orient Paper Milling Company Limited.

 

All references to “RMB” or “Renminbi” refer to the legal currency of China; all references to “US$,” “dollars,” “U.S. dollars” and “$” refer to the legal currency of the United States.

 

This annual report on Form 10-K includes our audited consolidated statements of income and comprehensive income for the years ended December 31, 2011, 2012 and 2013 and audited consolidated balance sheets as of December 31, 2012 and 2013.

 

 FORWARD LOOKING STATEMENTS

 

This Annual Report on Form 10-K contains “forward-looking statements.” These statements are made under the “safe harbor” provisions of the U.S. Private Securities Litigation Reform Act of 1995. You can identify these forward-looking statements by terms such as “may,” “will,” “expects,” “anticipates,” “future,” “intend,” “plan,” “believe,” “estimate,” “is/are likely to” and similar expressions. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from those expressed or implied by the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include, without limitation, our anticipated revenues from the digital photo paper business segment and household/tissue paper business, our ability to introduce new products, our ability to implement the planned capacity expansion of corrugate medium paper, market acceptance of new products, general economic and business conditions, the ability to attract or retain qualified senior management personnel and research and development staff and those specifically addressed under the headings “Risks Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The forward-looking statements made in this annual report relate only to events as of the date on which the statements are made. We undertake no obligation, beyond any than as required by law, to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made, even though our situation will change in the future.

  

We operate in an emerging and evolving environment. New risk factors emerge from time to time and it is impossible for our management to predict all risk factors, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statement.

 

PART I

 

Item 1. Business

 

Corporate History

 

Orient Paper, Inc. was incorporated in the State of Nevada on December 9, 2005, under the name “Carlateral, Inc.” Through the steps described immediately below, we became the holding company for Hebei Baoding Orient Paper Milling Company Limited (“Orient Paper HB”), a producer and distributor of paper products in China, on October 29, 2007, and effective December 21, 2007, we changed our name to “Orient Paper, Inc.” to more accurately describe our business.

 

On November 13, 2006, Dongfang Zhiye Holding Limited (“Dongfang Holding”) was formed as a holding corporation with no operations under the laws of the British Virgin Islands. On July 16, 2007, Dongfang Holding entered an agreement to acquire all of the issued and outstanding stock and ownership of Orient Paper HB and placed such shares in trust with Zhenyong Liu, Xiaodong Liu, and Shuangxi Zhao pursuant to a trust agreement executed as of the same date. Under the terms of the trust agreement, Mr. Liu, Mr. Liu and Mr. Zhao (the original shareholders of Orient Paper HB) would exercise control over the disposition of Dongfang Holding’s shares in Orient Paper HB on Dongfang Holding’s behalf until Dongfang Holding successfully completed the change in registration of Orient Paper HB’s capital with the relevant PRC Administration of Industry and Commerce as the 100% owner of Orient Paper HB’s shares.

 

On October 29, 2007, Orient Paper entered into an agreement and plan of merger (the “Merger Agreement”) with (i) its own wholly owned subsidiary, CARZ Merger Sub, Inc., (ii) Dongfang Holding and (iii) each of Dongfang Holding shareholders (Zhenyong Liu, Xiaodong Liu, Chen Li, Ning Liu, Jie Liu, Shenzhen Huayin Guaranty & Investment Company Limited, Top Good International Limited, Total Giant Group Limited, Total Shine Group Limited, Victory High Investment Limited, Think Big Trading Limited, Huge Step Enterprises Limited, and Sure Believe Enterprise Limited) (the “Dongfang Holding Shareholders”).

 

Pursuant to the Merger Agreement, Dongfang Holding merged with CARZ Merger Sub, Inc. via a share exchange, with Dongfang Holding as the surviving entity (the “Merger Transaction”). In exchange for their shares in Dongfang Holding, the Dongfang Holding Shareholders received an aggregate of 7,450,497 (as adjusted for a four-for-one reverse stock split effected in November 2009) newly-issued shares of our common stock, which shares were distributed pro ratably among the Dongfang Holding Shareholders in accordance with their respective ownership interests in Dongfang Holding.

 

1
 

 

As a result of the merger transaction, Dongfang Holding became a wholly owned subsidiary of Orient Paper, which, in turn, made Orient Paper the indirect owner of Dongfang Holding’s operating company subsidiary, Orient Paper HB. Orient Paper HB, the entity through which we operate our business, currently has no subsidiaries, either wholly or partially-owned.

 

Due to Dongfang Holding’s inability, as the 100% owner of Orient Paper HB, to complete the registration of Orient Paper HB’s capital under its name within the proper time limits set forth under PRC law, it was not recorded as the registered owner of Orient Paper HB in PRC. As such, Dongfang Holding’s ownership of Orient Paper HB was deemed to be held in trust by Zhenyong Liu, Xiaodong Liu, and Shuangxi Zhao. In connection with the consummation of the restructuring transactions described below, Dongfang Holding directed its trustees to return its shares in Orient Paper HB to their original shareholders, and the Orient Paper HB shareholders entered into certain agreements with Baoding Shengde Paper Co., Ltd. (“Orient Paper Shengde”) to transfer the control of Orient Paper HB over to Orient Paper Shengde.

 

On June 24, 2009, the Company consummated a number of restructuring transactions pursuant to which it acquired all of the issued and outstanding shares of Shengde Holdings, Inc., a Nevada corporation. Shengde Holdings Inc. was incorporated in the State of Nevada on February 25, 2009. On June 1, 2009, Shengde Holdings Inc. incorporated Orient Paper Shengde, a limited liability company organized under the laws of the PRC. Because Orient Paper Shengde is a wholly-owned subsidiary of Shengde Holdings, Inc., it is regarded as a wholly foreign-owned entity under PRC law.

 

Effective June 24, 2009 Orient Paper Shengde entered into a number of contractual arrangements with Orient Paper HB and the original shareholders of Orient Paper HB, which were amended on February 10, 2010, pursuant to which Orient Paper Shengde acts as the management company for Orient Paper HB, and Orient Paper HB conducts the principal operations of the business. The contractual agreements, as amended, effectively transferred the preponderance of the economic benefits of Orient Paper HB over to Orient Paper Shengde, and Orient Paper Shengde assumed effective control and management over Orient Paper HB.  The contractual agreements, as amended, include the following:

 

(i) Exclusive Technical Service and Business Consulting Agreement

 

The exclusive technical service and business consulting agreement, entered into by and between Orient Paper Shengde and Orient Paper HB, provides that Orient Paper Shengde shall provide exclusive technical, business and management consulting services to Orient Paper HB, in exchange for service fees including a fee equivalent to 80% of Orient Paper HB’s total annual net profits.  The agreement is terminable upon mutual written agreement.

 

(ii) Call Option Agreement

 

The call option agreement, entered into by and between Orient Paper Shengde, Orient Paper HB and the shareholders of Orient Paper HB, provides that the shareholders of Orient Paper HB irrevocably grant to Orient Paper Shengde an option to purchase all or part of each shareholder’s equity interest in Orient Paper HB. The exercise price for the options shall be RMB1 yuan for each of the shareholders’ equity interests, or if at any time there are PRC laws regulating the minimum price of such options, then to the extent permitted under PRC Law.  The call option agreement contains covenants from Orient Paper HB and its shareholders that they will refrain from taking certain actions without Orient Paper Shengde’s consent that would materially affect Orient Paper HB’s operations and asset value, including (i) supplementing or amending its articles of association or bylaws, (ii) changing Orient Paper HB’s registered capital or shareholding structure, (iii) selling, transferring, mortgaging or disposing of any interests in Orient Paper HB’s assets or income, or encumbering Orient Paper HB’s assets or income in a way that would approve a security interest on such assets, (iv) incurring or guaranteeing any debts not incurred in its normal business operations, (v) entering into any material contract or urging Orient Paper HB management to dispose of any Orient Paper HB assets, unless it is within the company’s normal business operations; (vi) providing any loan or guarantee to any third party; (vii) appointing or removing any management personnel or directors that can be changed upon Orient Paper HB shareholder approval; (viii) declaring or distributing any dividends to the stockholders.  The agreement will remain effective until Orient Paper Shengde or its designees have acquired 100% of the equity interests of Orient Paper HB underlying the options.

 

(iii) Share Pledge Agreement

 

The share pledge agreement entered into by and between Orient Paper Shengde, Orient Paper HB and the shareholders of Orient Paper HB, provides that the Orient Paper HB shareholders will pledge all of their equity interests in Orient Paper HB to Orient Paper Shengde as security for their obligations under the other management agreements described in this section. Specifically, Orient Paper Shengde is entitled to dispose of the pledged equity interests in the event that the Orient Paper HB shareholders or Orient Paper HB fails to pay the service fees to Orient Paper Shengde pursuant to the exclusive technical service and business consulting agreement or fails to perform their other obligations under the other management agreement. The agreement contains promises from Orient Paper HB’s shareholders that they will refrain from taking certain actions without Orient Paper Shengde’s prior written consent, such as transferring or assigning their equity interests, or creating or permitting the creation of any pledges which may have an adverse effect on the rights or benefits of Orient Paper Shengde under the agreement.  The Orient Paper HB shareholders also promise to comply with the laws and regulations relevant to the pledges under the agreement and to facilitate in good faith the protection of the ability of Orient Paper Shengde to exercise its rights under the agreement.  The terms of the share pledge agreement shall remain in effect until all the obligations under the other management agreements have been fulfilled, whether or not the terms of the other management agreements have expired.

 

2
 

 

 (iv) Proxy Agreement

 

The proxy agreement, entered into by and between Orient Paper Shengde, Orient Paper HB and the shareholders of Orient Paper HB, provides that the Orient Paper HB shareholders shall irrevocably entrust a designee of Orient Paper Shengde with such shareholder’s voting rights and the right to represent such shareholder to exercise such shareholder’s rights at any shareholder’s meeting of Orient Paper HB or with respect to any shareholder action to be taken in accordance with the laws and Orient Paper HB’s Articles of Association.  The terms of the agreement are binding on the parties for as long as the Orient Paper HB shareholders continue to hold any equity interest in Orient Paper HB.  An Orient Paper HB shareholder will cease to be a party to the agreement once it transfers its equity interests with the prior approval of Orient Paper Shengde.

 

On June 24, 2009, Zhao Tianqing, the sole shareholder of Shengde Holdings Inc., assigned to Orient Paper, for good and valuable consideration, 100 shares representing 100% of the issued and outstanding shares of Shengde Holdings Inc.  As a result of this assignment and the restructuring transactions described above, Shengde Holdings Inc., Orient Paper Shengde, and Orient Paper HB became directly and indirectly controlled by Orient Paper, and Orient Paper HB continued to function as the Company’s operating entity.

 

In addition to controlling the operations and beneficial ownership of Orient Paper HB, Orient Paper Shengde also acquired a digital photo paper production line (including two photo paper coating lines and ancillary equipments) in an asset acquisition transaction as of November 25, 2009 and began conducting business in the PRC.

 

As part of the restructuring transaction described above, Orient Paper Shengde also entered into a loan agreement with the Orient Paper HB shareholders on June 24, 2009. Because of Company’s decision to fund future business expansions through Orient Paper Shengde instead of Orient Paper HB, such loan agreement was terminated on February 10, 2010. The $10,000,000 loan contemplated under the loan agreement was never made prior to its termination.  The parties believe the termination of the loan agreement does not in itself compromise the effective control of the Company over Orient Paper HB and its businesses in the PRC.

 

An agreement was entered into among Orient Paper Shengde, Orient Paper HB and the Orient Paper HB Equity Owners on December 31, 2010, reiterating that Orient Paper Shengde is fully entitled to the distributable profit of Orient Paper HB, pursuant to the above mentioned Exclusive Technical Service and Business Consulting Agreement. In addition, Orient Paper HB and the Orient Paper HB Equity Owners agree that they shall not declare any of Orient Paper HB’s unappropriated earnings, including any earnings of Orient Paper HB from its establishment to 2010 and thereafter, as dividend.

 

The following diagram sets forth the current corporate structure of Orient Paper:

 

100% ownership
   
Controlled by contractual agreements

 

 

 

3
 

  

Our Business

 

We engages mainly in production and distribution of packaging and printing paper products such as corrugating medium paper, offset printing paper, digital photo paper and other paper and packaging related products.

 

Our principal executive offices are located at Science Park, Juli Road, Xushui County, Baoding City, Hebei Province, People’s Republic of China. Our telephone number is (86) 312-869-8215. Our website is located at http://www.orientpaperinc.com

 

Manufacturing Process

 

Our current products (excluding digital photo paper) generally undergo two stages of manufacturing: (1) creating pulp from recycled paper products, and (2) treating the pulp and molding it into the desired types of paper product.  A brief overview of the pulp and papermaking process is described below.

 

Pulping

 

The recycled waste paper is first sorted by hand and machine, and then broken down and beaten or smashed into small pieces using water and mechanical energy.  It is then put through a course screening drum, followed by a fine screening drum to produce different grades of pulp. In order to purify the pulp further, an approach flow system is used to filter out any impurities or inconsistencies, such as sand, in the pulp. Bleaching agents are added to lighten the color of the pulp.

 

Paper Making

 

The pulp is then sieved to remove the excess water and molded into size. The moisture content is further reduced by applying hydraulic pressure to the pulp.  The pulp then enters the drying section where it is run over heated cylinders. The dried paper is then coated with a mixture of clay, white pigment, and binder to produce a surface on which ink can sit without being fully absorbed, enabling crisper, more consistent print quality.

 

The paper goes through a process called calendaring, which flattens and smoothens the paper into long sheets. The paper is then wound onto a reel that is mounted in a roll-slitting machine for rewinding, during which cutters are used to cut the paper into the desired widths. Upon completion, the rolls are fitted with sleeves, labeled, and then moved to quality control before shipment or storage.

 

4
 

 

 

Digital Photo Paper Making

 

The manufacturing process for making digital photo paper involves multiple steps of coating, drying and calendaring. The major raw material, digital photo base paper, is loaded into the main production line for (1) coating, (2) drying, (3) calendaring, (4) recoating, (5) drying, and (6) reeling for finished products. We make both glossy and semi-matt digital photo papers. Many of the products that we sell through our digital photo paper division at Orient Paper Shengde come in various sizes from A3 to A6 and 3R to 5R sheets, while other sizes and reels of paper roll are also produced and sold.  We have special cutting machine to take reels of digital photo paper rolls and cut the paper into customer-specified sizes before packaging for shipment.

 

Products

 

Corrugating medium paper

 

Corrugating medium paper is used in the manufacturing of cardboards. After the launch of our new 360,000 tonnes/year PM6, corrugating medium paper becomes a major product of the Company and comprises approximately 78% of our total paper production quantities and roughly 64% of our total revenue for the year ended December 31, 2013.  Raw materials used in the production of corrugating medium paper include recycled paper board (or Old Corrugated Cardboard, “OCC”) and certain supplementary agents. In January 2013 we removed PM1, which was previously used to produce corrugating medium paper, from production. We are currently in the process of renovating and converting PM1. We expect PM1 to produce up to 50,000 tonnes/year of insulation liner paper upon the completion of the renovation, which is scheduled for early second quarter of 2014. We currently have only one production line (PM6) that produces corrugating medium paper.

 

Offset printing paper

 

Offset printing paper is used for offset printing.  Our medium-grade offset printing paper comprises approximately 21% of our total paper production quantities and approximately 32% of our total sales revenue for the year ended December 31, 2013. The offset printing paper we manufacture is typically coated and brightened.  Raw materials used in the production of offset printing paper may include recycled white scrap paper, wood pulp, fluorescent whitening agent, sizing agent and pulvis talc. We have not produced any high-grade offset printing paper and have not used wood pulp as a source of raw material since the fourth quarter of year 2009. We currently have two production lines, PM2 and PM3 for the production of offset printing paper.

  

Digital photo paper

 

Starting in March 2010, Orient Paper Shengde began producing digital photo papers that are cast-coating, and water-proof. These digital photo papers are sold to printing companies and paper distributors, who eventually sell to advertising companies and printing companies which use photo-quality paper for multiple-color printing or local photo studios for production of special event printouts or personal home printing use. Our digital photo paper comprises approximately 1% of our total paper production quantities and approximately 4% of our total sales revenue for the year ended December 31, 2013. We have two photo paper coating lines, PM4 and PM5, that produce digital photo paper products.

 

5
 

 

Market for our Products

 

The PRC Paper Making Industry

 

According to the most recent 2012 China Paper Industry Annual Report, issued by the China Paper Association, there were approximately 3,500 paper and paper board manufacturers (down from 3,700 as of year 2010) in the People’s Republic of China, with a total output of 102.5 million tonnes, up 3.22% from 99.30 million tonnes in 2011. Total domestic consumption was 100.48 million tonnes in 2012, up 3.04% from 97.52 million tonnes a year before.

 

Compared with year 2003, output in 2012 had increased by approximately 238.37% and consumption grew by approximately 209.074%.  The output of paper and paper board maintained an average growth rate of approximately 10.13% during the ten-year period of 2003-2012, while consumption increased at an annual rate of 8.54%, both higher than the GDP growth rate of the same period.  The growth rate is expected to continue.  It is believed that the People’s Republic of China is currently the largest country in the world in terms of output and consumption of paper and paper board products ( Wikipedia: Pulp and Paper Industries ).

 

 

Data source: 2012 Annual Report of China Paper Manufacturing, May 2013, China Paper Association

 

Domestic corrugating medium paper production in 2012 totaled 20.20 million tonnes, a 2.02% increase from year 2011. Domestic consumption of corrugating medium paper amounted to 20.27 million tonnes, an increase of 1.81% as compared to year 2011.

 

Domestic coated offset printing paper production in 2012 totaled 7.80 million tonnes, a 7.59% increase from year 2011. Domestic consumption of coated offset printing paper amounted to 6.38 million tonnes, an increase of 6.51% as compared to year 2011.

 

The paper making industry in China is concentrated in eastern, coastal provinces. The largest paper production capacities by province during the years of 2011 and 2012 are summarized as follows. Except for Sichuan, Henan and Hunan provinces, most of the major provinces with large capacities saw at least some moderate increases in paper production capacities.

 

    2011 Capacity     2012 Capacity     Change        
Province   (‘000 tonnes)     (‘000 tonnes)     (‘000 tonnes)     % Change  
Shandong     16,300       17,090       790       4.85 %
Guangdong     14,960       15,790       830       5.55 %
Zhejiang     14,770       15,360       590       3.99 %
Jiangsu     10,510       12,060       1,550       14.75 %
Henan     8,280       7,800       (480 )     -5.80 %
Fujian     4,800       5,390       590       12.29 %
Hebei     4,010       4,240       230       5.74 %
Hunan     3,720       3,550       (170 )     -4.57 %
Guangxi     1,940       2,580       640       32.99 %
Sichuan     3,400       2,320       (1,080 )     -31.76 %

 

Data Sources: 2012 Annual Report of China Paper Manufacturing, May 2013, China Paper Association

 

6
 

 

Industry Consolidation

 

Historically the paper and pulp industry in China was comprised of numerous small-scale production enterprises, many of which used low-tech production processes that were highly polluting.  In 1996, China’s State Council issued “Decisions on Environmental Protection Issues”, setting forth strict rules and regulations intended to reduce pollution, including a directive for the closure of all paper plants with an annual output of less than 50,000 tonnes.  Recognizing that China constitutes one of the largest markets for paper consumption in the world with potential for continued expansion, the PRC government continues its efforts to consolidate, modernize, and promote the environmental sustainability of the industry. As part of its 11th “Five Year Economic Development Plan,” the PRC State Council announced on May 5, 2010 that up to 530,000 tonnes of inefficient/polluting paper production capacity was to be eliminated or shut down in year 2010. On August 5, 2010, the Ministry of Industry and Information Technology published a list of mandatory capacity closures and ordered the shutdown of a total of 4.6 million tonnes by September 2010.

 

Following the first wave of large scale mandatory capacity closure in 2010, the Ministry of Industry and Information Technology (the “MIIT”) announced on July 11, 2011 that 8.2 million tonnes of outdated paper milling capacities located in 599 paper companies across China will be further forced to close down in year 2011 (the “2011 Mandatory Closure”). Of all of the paper mills affected by the 2011 Mandatory Closure, 72 companies with total capacities of 1.07 million tonnes (or 13% of total closure) are located in the province of Hebei, where many of the old paper mills only have capacities under 50,000 tonnes. 

 

According to “ The Twelfth ‘Five-Year Plan’ for the Chinese Paper Industry ,” published jointly by the National Development and Reform Commission, the Ministry of Industry and Information Technology, and the National Forestry Bureau in December 2011, the central government of China has determined that during the five-year period ending year 2015, the government will seek to further eliminate more than 10 million tonnes of current paper production capacity. The goal is, through mandatory capacity elimination and industry consolidation, to transform the paper industry landscape into one where there are more than 20 one-million-tonnes-and-above manufacturers. As of year 2010, only the top-10 paper manufacturers in China have annual production capacity of over one million tonnes. According to the MIIT announcement on September 6, 2012, 9.9 million tonnes of paper production capacity was ordered to shut down in year 2012. The MIIT has again announced on July 25, 2013 the list of outdated paper capacities for the first phase of the mandatory closure of year 2013. A total of 6.21 million tonnes of paper manufacturing capacities across the country are required to be shut down in the July 25, 2013 list (the “2013 Mandatory Closure”), including 930,800 tonnes in the province of Hebei, the area hardest hit two years in a row. Unlike the mandatory closure programs in the previous years when most of the capacities shutdown related to small-scale local mills usually with less 50,000 tonnes of production capability without proper water treatment practice, the 2013 Mandatory Closure includes a number of large capacity paper machines (up to 226,000 tonnes per line) and six large public-traded paper manufacturing companies in China.

 

It is the industry consensus in China that mandatory closures initiated by the government will continue in the next few years and that the paper industry will witness a more severe competition and higher standards for environmental protection measures. See “Risk Factors – Risks Related to Our Business –We might be negatively affected by the industry capacity elimination mandated by the government.”

 

Customers

 

We generally sell our products to companies making corrugated cardboards (in the case of our packaging products like corrugating medium paper) and to printing companies (in the case of our printing paper products). We also sell digital photo paper mainly to distributors and advertising/printing companies. We sold corrugating medium paper and offset printing paper to about 97 customers in year 2013. We had 17 customers buying digital photo paper from us during year 2013. Five of our top 10 customers in year 2013 are printing companies, with the largest customer being a packaging company in Tianjin. 82% of our total corrugating medium and offset printing paper revenue in 2013 was derived from customers in Beijing, Tianjin or Hebei Province.

 

For the year ended December 31, 2013, nine (9) major customers individually accounting for more than 3% of our total sales revenue were as follows:

 

    2013 Sales Amount        
    ($USD, net of     % of Total  
    applicable VAT)     Revenue  
Company A (Tianjin)     6,298,711       5.01 %
Company B (Beijing)     6,187,024       4.92 %
Company C (Baoding)     5,794,109       4.61 %
Company D (Baoding)     5,752,651       4.58 %
Company E (Baoding)     5,481,114       4.36 %
Company F (Shanghai)     5,465,174       4.35 %
Company G (Tianjin)     5,270,771       4.19 %
Company H (Baoding)     4,177,207       3.32 %
Company I (Baoding)     4,042,378       3.22 %
Total Major Customers     48,469,139       38.56 %

 

7
 

 

Out of the top-10 customers of year 2013, seven (representing 77.6% of the 2012 top-10 customer sales) were in the same list for the year ended December 31, 2012. Three of the top-10 customers for the year ended December 31, 2012 fell out of the top customers list in year 2013.

  

Marketing Strategy

 

We target corporate customers in the middle range of the marketplace, where products such as corrugating medium paper and mid-grade offset printing paper with reasonable quality and competitive pricing have potential for high volume growth.  Our primary market has been the region of North China, especially in the province of Hebei.

 

Expand Production Capacity

 

During the year ended December 31, 2013, we had five Paper Machines (PMs) in operation and are in the process of launching three more production lines that are tentatively designated as PM7 through PM9. These production lines include the followings:

 

PM#   Paper Product
Produced
  Designed
Capacity
(tonnes/year)
  Owned by   Operated by   Status as of December 31, 2013
PM1 *   Insulation liner paper   50,000   Orient Paper HB   Orient Paper HB  

Undergoing renovation since January 2013 and being converted from a corrugating medium paper production to one that produces insulation liner paper (which is used to make wall insulation paper for building construction). Slated for test production in Q2 2014.

PM2   Offset printing paper   50,000   Orient Paper HB   Orient Paper HB  

In production

 

PM3   Offset printing paper   40,000   Orient Paper HB   Orient Paper HB  

In production

 

PM4   Digital photo paper   2,500   Orient Paper Shengde   Orient Paper Shengde  

Main photo paper coating line, in production

 

PM5   Digital photo paper   2,500 **   Orient Paper Shengde   Orient Paper Shengde  

Special photo paper coating line, in production

 

PM6   Corrugating medium paper   360,000   Orient Paper Shengde   Orient Paper HB***  

In production

   

PM7*   Specialty paper   10,000   To be determined   To be determined  

Under renovation and preparing for launch by the end of 2014.

 

PM8*   Tissue paper   15,000   To be determined   To be determined   Undergoing construction and preparing for launch in Q4 2014.
PM9*   Tissue paper   15,000   To be determined   To be determined   Paper machine construction agreement expected to be signed in 2014.

 

*: Paper machines under renovation, under construction, or in the planning stage.

   

**: PM4 and PM5 have a total coating capacity of 2,500 tonnes per year.

 

***: The cost of the paper machine is funded and owned by Orient Paper Shengde, while all of the ancillary facilities that support the PM5 corrugating medium paper manufacturing operation are built and owned by Orient Paper HB. For the year ended December 31, 2013, Orient Paper Shengde charges Orient Paper HB an equipment lease that was approximately $1,903,363 for the use of the new corrugating medium paper machine.

 

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On December 31, 2009, we acquired a digital photo paper production line, including two coating lines that are designated as PM4 and PM5 and ancillary equipment, in an asset acquisition transaction for a total purchase price of approximately $13.6 million. The estimated capacity of the entire digital photo paper facility is 2,500 tonnes per year.

 

In order to meet the growing domestic demand for paper, which we believe is currently exceeding domestic supply in the case of corrugating medium paper especially in our region of North China, we installed a brand new corrugating medium paper production line PM6 with an estimated capacity of 360,000 tonnes per year. We completed the installation of the new production line in November 2011 and went into commercial production in December 2011.

 

In the spring of 2010, we initiated the process of acquiring approximately 667,000 square meters of land adjacent to our current facilities and have received governmental approval for our capacity expansion plan. However, since the acquisition process started, we have met significant opposition by certain local residents over the price that we offered for their land. On April 13, 2012, we closed our acquisition of 58,566 square meters of land and secured all associated land use right permits. For the 58,566 square meters of land acquired, we paid a total of $7.5 million in various payments, taxes and recording fees to the sellers and the local government.

 

We have implemented a plan to renovate one of the old production lines that have been idle since the end of year 2007. We previously made papers with anti-counterfeit features from that production line. When the renovation is completed, we intend to produce the base paper (a high quality white graphic paper) that we currently procured from outside supplier for the production of our digital photo paper from the renovated production line. Eventually we plan to produce other high-profit margin specialty papers from the renovated production line. Our currently plan is to complete the renovation project, install a new production and marketing team, and launch the specialty paper production line as PM7 by the end of year 2014.

 

We have commenced our expansion into the household/tissue paper market by announcing in January 2013 that we signed a 15-year lease on some 49.4 acres of land in the Economic Development Zone in Wei County, Hebei Province, China on November 27, 2012 for the purpose of developing a new tissue paper production plant. We plan to build two tissue paper production lines, each with 15,000 tonnes/year capacity, and other packaging facilities and infrastructures on the leased land. In December 2012, we signed a contract with an equipment contractor in Shanghai to build the first of our two tissue paper production lines (PM8) in Wei County. Construction period for PM8 is expected to end in the third quarter of 2014 to be readied for the test operations in the fourth quarter of 2014. Total estimated cost of the PM8 tissue paper project (not including our construction cost of infrastructures in the Wei County Industrial Park) is estimated to be up to $56.8 million. 

 

We have decided to take voluntary action to renovate our 150,000 tonnes/year corrugating medium PM1 in anticipation of increased regulatory concerns on energy efficiencies and to further upgrade the quality of our corrugating medium products. Rather than converting PM1 to a corrugating medium paper machine with expanded 250,000 tonnes/year capacity as original planned, the Company decided in 2013 that the best solution to the renovation, given the market condition and the effect on our waste water treatment capability, appears to be converting PM1 to a produce insulation liner paper with a designed capacity of 50,000 tonnes/year. We intend to produce insulation liner paper and sell it to manufacturers of wall insulation paper, which is used as a construction material for building wall and flooring insulation. The manufacturing process of insulation liner paper is similar to that of the corrugating medium paper and also uses recycled paper boards as a major source of raw material. The renovation has started in January 2013 and is expected to cost approximately $6.8 million. We expect the renovated PM1 to come online for test production in the early second quarter of 2014.

 

Raw Materials and Principal Suppliers

 

The supplies used in our production processes are comprised mainly of recycled paper board (or Old Corrugating Cardboard or “OCC,” as commonly referred to in the United States) and printed and unprinted recycled white scrap paper, all of which are readily available items for which there are multiple domestic and foreign sources. We currently purchase all of our recycled paper supplies from domestic recycling stations and do not rely on any imported recycled paper. We also purchase coal and chemical agents from nearby suppliers.  Ongoing inflationary pressures and higher demand for recycled paper could lead to an increase in our costs of raw materials and production, which we may or may not be able to pass to our customers.

 

We sign annual raw materials supplier contracts with our suppliers.  Although we have supplier contracts with our suppliers, these contracts do not lock-in the purchase price of our raw materials or provide hedge against the fluctuation in the market price of these raw materials.  For the year ended December 31, 2013, we had three large suppliers which accounted for approximately 75%, 10% and 7% of total major purchases, respectively.

 

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For the years ended December 31, 2013 and 2012, our top suppliers were as follows:

 

    2013 Purchase     2012 Purchase  
    Amount ($USD,     Amount ($USD,  
    net of applicable     net of applicable  
    VAT)     VAT)  
Company A     60,060,370       83,761,279  
Company B     7,689,003       8,373,473  
Company C     5,330,481       -  

 

Competition

 

Orient Paper HB's main competitors are: Chenming Paper Group Limited; Huatai Group Limited; Nine Dragons Paper (Holdings) Limited; and Sun Paper Group Limited.  In addition to these competitors, there are numerous smaller family operations in Hebei and neighboring provinces serving the greater-Beijing and Tianjin area printing company customers or competing with us for our corrugating medium paper market in Hebei.  A number of our competitors are larger public entities with larger capacities, broader customer bases and greater financial resources than those available to us.   The business of our primary competitors is briefly described below:

 

Chenming Paper Group, Ltd. (“Chenming”), based in Shandong Province (located in northeast China), produces primarily newsprint paper and art paper (high quality, heavy, two-side coated printing paper).  Chenming is believed to be the first company to have all three types of public listings available in China: renminbi A-shares and foreign currency B-shares in Shenzhen, the smaller of the mainland’s two stock exchanges, and H-shares in Hong Kong.  Chenming has annual production capacity of 6 million tonnes for its coated wood-free paper product and is believed to rank among the top 500 enterprises in China.

 

Huatai Group, Ltd. (“Huatai”), based in Shandong Province (located in the northern part of the eastern coastal region of China), primarily produces newsprint, fine paper, special printing papers, coated board, and tissue paper.  Huatai is the first Shandong papermaker to publicly list its stock and has become a famous brand in China. Its annual paper production volume is estimated to have reached 4 million tonnes.

 

Nine Dragons Paper (Holdings) Limited (“ND Paper”), based in Guangdong Province (located in southern China), is the largest paper manufacturer in China and primarily produces kraft paper and high-strength corrugating medium paper with annual capacity of 13.5 million tonnes.  ND Paper has reported that it has five production lines in the city of Tianjin with a total designed capacity of 2.15 million tonnes, producing products of karft paper, high strength corrugating medium paper, and grey-back duplex board.

 

Sun Paper Group, Ltd., based in Shandong Province, primarily produces card paper, whiteboard paper, and art paper.  It also produces alkaline peroxide mechanical pulp, sourced in part from woodchips harvested by the company’s poplar plantations.  The company has reported that it has an annual production capacity of paper and pulp of approximately 4 million tonnes and has been listed on the Shenzhen Stock Exchange since 2006.

 

With the exceptions of Chenming and ND Paper, which may compete directly with us in the coated printing paper market and the corrugating medium paper market, respectively, of the Beijing/Tianjin/greater Hebei regions, we believe that we face only indirect competition from the above-listed companies, either because we have a different product assortment from these companies, or because, to the extent they do offer products similar to ours, the transportation costs and storage costs make it difficult for these companies to compete effectively with us on price in our markets.

 

Our Competitive Edge

 

Regional advantage (North China).   We believe that Orient Paper HB is one of the leading papermaking enterprises in Hebei Province.  Our proximity to large urban centers in northern China, Beijing and Tianjin, gives us a large market in which to sell our products.

 

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There are other paper manufacturers that are also located in Hebei Province (and close to metropolitan Beijing and Tianjin areas), but most of these other manufacturers are small in scale and are unable to compete with us effectively.  We do compete with other large printing paper manufacturers for Beijing printing company customers.  We believe we do have cost and other advantages over our larger competitors.

 

Cost advantage .  Unlike some of our out-of-province competitors who must set up interim warehouses and ship products from their production base to such interim warehouses close to customer base in Beijing, because we are approximately 60 miles (100 kilometers) from Beijing, the cultural center of China and our largest target market, there is no need for us to set up interim warehouses.  While we don’t separately pay for transportation cost on raw material purchases, the transportation cost included in the raw material purchase price from our recycled paper suppliers is lower than the transportation cost paid by our competitors in the province of Shandong.  We also enjoy lower transportation cost for coal, a major source of energy used in our production process.  Similarly, our customers pay trucking companies to pick up their orders from our finished goods warehouse in Baoding.  The trucking cost our customers pay is lower than what they would pay if they had to pick up goods from offsite locations further away from Beijing.  Tianjin, another large urban center, is also approximately 60 miles from our facilities.  Baoding city itself is also home to numerous printing and packaging companies. We therefore have lower freight costs and other associated costs of sales, enabling us to charge lower prices, if necessary, for our products. Our geographical advantage and easy access to cheaper raw materials allow us to implement a more flexible inventory purchase policy, improve inventory management, lower our purchase price and reduce our production cost.  Additionally, because we buy all recycled paper raw materials from Beijing and Tianjin, rather than from the United States or Japan, our purchase lead time is shorter as compared to manufacturers which reply on import recycled papers.

 

Research and Development

 

Our R&D activities are carried out by a task force led by a group of 5 senior managers (in charge of product development and quality control) and by a group of selected engineers and technicians.  The Company charged the time spent on the R&D projects (manufacturing waste discharge recycling and digital photo paper manufacturing) to R&D expenses and incurred $25,125 and $21,636 in R&D expenses for the years ended December 31, 2013 and 2012, respectively. Our R&D efforts in year 2013 has focused on evaluating and developing new products that are in the pipeline for year 2014, including the production and packaging technology of tissue paper and the manufacturing process of insulation liner paper.

 

In addition to PM1, which is being converted to produce insulation liner paper, we have another idle production line that is under renovation. Since the fourth quarter of year 2010, we have spent approximately $1.57 million in machine parts and new components to renovate one smaller white paper production line, which we expect will be able to produce certain specialty papers, including wood-grain deco and furniture paper, wallpaper, and paper with security features (for anti-counterfeiting purposes). While we are optimistic about the prospect of the renovation project, we cannot guarantee the launch of the specialty paper production (which is tentatively scheduled for the fourth quarter of 2014) and the success of such renovation.

 

Intellectual Property

  

Orient Paper HB has registered one trademark with the Trademark Bureau under the State of Administration for Industry & Commerce, which remains effective through April 6, 2014. We have applied for a renewal as of March 7, 2014.

 

    Certificate            
Trademark   No.   Category   Registrant   Valid Term
Shuangxing   3298963   Fax paper, thermal paper, blueprint paper, sensitized paper, spectrum sensitized paper, blueprint cloth, photographic paper, cyanotype solution, diazo paper   Orient Paper HB   April 4, 2004 through April 6, 2014

  

Domain names

 

Orient Paper owns the rights to the internet domain name, www.orientpaperinc.com .

 

Government Regulation

 

The testing, approval, manufacturing, labeling, advertising and marketing, post-approval safety reporting, and export of our products are extensively regulated by governmental authorities in the PRC. We are also subject to various other regulations and permit systems by the Chinese government. These regulations and their impact on our business are set forth in more detail below.

 

Environmental Regulation

 

Our operations and facilities are subject to environmental laws and regulations stipulated by the national and the local environment protection bureaus in the PRC.

 

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Since the implementation of the State Council’s “Decisions on Environmental Protection Issues” in 1996, the PRC paper industry has been subject to more rigorous environmental standards.  We believe that we are one of the few major paper manufacturers in Hebei Province to obtain a Pollution Discharge Permit, which enables us to operate in compliance with PRC environmental regulations. We were first issued the permit in September 1996 and since we have remained in line with the PRC’s restrictions on carbon dioxide and sulfur oxide byproducts, have successfully renewed the permit each year. Our last renewal of the Pollution Discharge Permit was issued in January 10, 2014, and is effective until January 9, 2015.

 

Waste Water Treatment

 

Orient Paper HB uses a multi-level water recycling process. Waste water from the pulping process is fed into collection pools, where it is divided into two parts, namely water and recovered pulp fiber.  The latter is returned into the pulping process.

 

Chemical agents are added to the waste water, and the waste water is fed into a biogas reactor and filtering pools, producing purified water and depositing sludge.  The purified water is released and the sludge is pumped into a sludge pool, condensed and dehydrated. We then use the sludge as an ingredient in the manufacture of corrugating medium paper.

 

We maintain controls at our production facilities on a 24-hour basis to facilitate compliance with environmental rules and regulations. We are not aware of any investigations, prosecutions, disputes, claims or other proceedings with respect to environmental protection, nor have we been subject to any action by any environmental administration authorities of the PRC. To our knowledge, our operations meet or exceed the existing requirements of the PRC.

 

In April 2012 we had one incident where the biological treatment process of our new water treatment plant failed to function properly. We voluntarily shut down the water treatment and all paper machine operations without any government intervention. As of May 8, 2012, the water treatment plant had resumed normal operation. We have not experienced any other water treatment malfunction since the April 2012 incident.

 

Employees

 

As of December 31, 2013, we have approximately 583 full time employees.  The Company provides private insurance coverage for any workplace accident or injury for all operators of paper milling machinery in the workshops.  These employees are organized into a labor union under the labor laws of the PRC and can bargain collectively with us.  We generally maintain good relations with our employees and the labor union.

 

Available Information

 

We are required to file annual, quarterly and current reports, proxy statements and other information with the U.S. Securities and Exchange Commission (“SEC”). The public may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at http://www.sec.gov.

 

Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are also available free of charge on our Internet site at http://www.orientpaperinc.com as soon as reasonably practicable after such reports are electronically filed with or furnished to the SEC. The information on our website is not, and shall not be deemed to be, a part hereof or incorporated into this or any of our other filings with the SEC.

 

Item 1A.                Risk Factors

 

Risks Relating to our Business

 

Our liquidity position poses risk to our operations, especially our capacity expansion projects.

 

As of December 31, 2013, we had current assets of approximately $26.0 million and current liabilities of approximately $28.4 million (including amounts due to related parties for approximately $2.3 million), resulting in a working capital deficiency of approximately $2.4 million. We are currently seeking to restructure the term of our liabilities by raising funds through long-term loans to pay off liabilities with shorter terms. Our ability to continue as a going concern is dependent upon obtaining the necessary financing or negotiating the terms of the existing short-term liabilities to meet our current and future liquidity needs. In the event that we fail to raise funds or negotiate terms of the current liabilities sufficient to meet our liquidity needs, we may be forced to substantially curtail our operations or otherwise take measures that would materially and adversely affect our business, results of operations and business prospects.

 

12
 

 

Of all of our current liabilities, the largest item is the semi-annual principal installment repayment obligations for $8.3 million under the sale-lease back agreement that we entered into in June 2013. We obtained approximately $24 million from the three-year sale-lease back financing transaction and used the proceeds to pay for part of the construction cost of the tissue paper facilities in the Wei County Industrial Park.

 

On March 3, 2014 we obtained a revolving line of credit facility under which we may draw notes payable for approximately $3.3 million from Shanghai Pudong Development Bank. Hebei Fangsheng Real Estate Development Co. Ltd., which is controlled by our Chairman and CEO Mr. Zhenyong Liu, unconditionally provides certain land use rights that it owns as collateral to secure its guarantee of the notes.

 

On March 25, 2014, our Chairman and CEO Mr. Zhenyong Liu agrees in writing to permit the Company to continue to postpone the repayment of the accrued interest on his loan to Orient Paper HB until the Company is able to pay its other creditors in the normal course of business. The accrued interest owned to Mr. Liu was approximately $566,343 and was recorded as part of the current liabilities as of December 31, 2013.

 

In addition to the working capital deficit, we had entered into contracts (mostly related to the construction of new tissue paper facilities and infrastructures at the Wei County Industrial Park) with capital expenditure commitments for approximately $51,673,158 as of December 31, 2013. We intend to pay for these capital expenditure commitments with cash flows from operating activities and additional debt financing in next 12 months. We generated approximately $30 million of cash from operating activities in the year of 2013 and expect to be able to generate at least the same amount of cash in year 2014. On March 7, 2014, Hebei Tengsheng Paper Co. Ltd., which owns the land use rights of about 330 acres (or 1.33 million square meters) of land in the Wei County Industrial Park and leases about one-fourth of the premises to Orient Paper HB as our production base of tissue paper and other future facilities, agreed in writing to unconditionally provide the 330 acres of land use right as third party collateral for additional bank borrowings in 2014 by Orient Paper HB. Based on the current market value of the land use rights and a 50%-60% loan out ratio, we estimate the maximum amount of debt financing with the entire 330 acres of Wei Country land will be between $36.6 million and $44.0 million.

 

On March 21, 2014 the provincial branch of the Industrial & Commercial Bank of China (“ICBC”) approved a new maximum total banking credit facility for Orient Paper HB for approximately $24.5 million in the year of 2014. We already had various working capital loans for a total of $6.5 million from ICBC as of December 31, 2013, which means that we may be able to draw additional financing under the maximum ICBC facility for up to $18 million. We expect the ICBC may tap into some of the above 330 acres of land use rights as security. If we are unable to obtain sufficient banking facilities or generate sufficient operating cash flow internally, the progress of the construction or renovation may be slowed down. We may also have to curtail the scope of the capital expenditure projects or to shelf some components of the projects (for example, delay the installation of PM9 until additional capital resources are available).

 

Our loan-to-equity ratio was 30.10% as of December 31, 2013. Our debt-asset ratio was 23.13% as of December 31, 2013. According to a search conducted by www.chinadiaoyan.com , the industry average of debt-asset ratio was 53.06% as of September 30, 2013 for the 20 large paper mills that are publicly listed in China. Of the 20 paper mill companies publicly listed in the Chinese stock exchanges, the top 6 (ranked by total revenue) all had debt-asset ratio exceeding 60%. Aside from the short-term liquidity situation, we believe that our overall financial condition, compared to our Chinese peers, is reasonably healthy and should allow us to reasonably expand our financial debt leverage to provide capital for future growth.

 

As management believes it can secure financial resources to satisfy the Company’s current liabilities and the capital expenditure needs in the next 12 months, our consolidated financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern. Should the going concern assumption not be appropriate and we are not able to realize our assets and settle our liabilities, commitments and contingencies in the normal course of operations, adjustments would be required to our consolidated financial statements to the amounts and classifications of assets and liabilities, and these adjustments could be significant.

 

In order to comply with PRC regulatory requirements, we operate our businesses through companies with which we have contractual relationships but in which we do not have controlling ownership. If the PRC government determines that our agreements with these companies are not in compliance with applicable regulations, our business in the PRC could be materially adversely affected.

 

We do not have direct or indirect equity ownership of Orient Paper HB which operates our main business in China. At the same time, however, we have entered into contractual arrangements with Orient Paper HB and its individual owners pursuant to which we received an economic interest in, and exert a controlling influence over Orient Paper HB, in a manner substantially similar to a controlling equity interest.

 

Although we believe the restructuring transaction and our current business operations are in compliance with the current laws in China, we cannot be sure that the PRC government would view our operating arrangements to be in compliance with PRC regulations that may be adopted in the future. If we are determined not to be in compliance, the PRC government could levy fines, revoke our business and operating licenses, require us to discontinue or restrict our operations, restrict our right to collect revenues, require us to restructure our business, corporate structure or operations, impose additional conditions or requirements with which we may not be able to comply, impose restrictions on our business operations or on our customers, or take other regulatory or enforcement actions against us that could be harmful to our business. As a result, our business in the PRC could be materially adversely affected.

 

13
 

 

We rely on contractual arrangements with Orient Paper HB for our operations, which may not be as effective in providing control over these entities as direct ownership.

 

Our operations and financial results are dependent on Orient Paper HB in which we have no equity ownership interest and must rely on contractual arrangements to control and operate the businesses of Orient Paper HB. These contractual arrangements are not as effective in providing control over Orient Paper HB as direct ownership. For example, Orient Paper HB may be unwilling or unable to perform their contractual obligations under our commercial agreements, including payment of consulting fees under the Exclusive Technical Service and Business Consulting Agreement as they become due. Consequently, we will not be able to conduct our operations in the manner currently planned. In addition, Orient Paper HB may seek to renew their agreements on terms that are disadvantageous to us. Although we have entered into a series of agreements that provide us with substantial ability to control Orient Paper HB, we may not succeed in enforcing our rights under them insofar as our contractual rights and legal remedies under Chinese law are inadequate. In addition, if we are unable to renew these agreements on favorable terms when these agreements expire, or to enter into similar agreements with other parties, our business may not be able to operate or expand, and our operating expenses may significantly increase.

 

The shareholders of Orient Paper HB may have potential conflicts of interests with us, which may adversely affect our business.

 

We operate our businesses in China though Orient Paper HB. Our chairman, CEO and 27.94% shareholder, Zhenyong Liu owns 93.26% of the equity interest in Orient Paper HB. Conflicts of interests between his duties to us and to Orient Paper HB may arise. We cannot assure you that when conflicts of interest arise, he will act in the best interests of our company or that any conflict of interest will be resolved in our favor. These conflicts may result in management decisions that could negatively affect our operations and potentially result in the loss of opportunities.

 

Our arrangements with Orient Paper HB and its shareholders may be subject to a transfer pricing adjustment by the PRC tax authorities which could have an adverse effect on our income and expenses.

 

We could face material and adverse tax consequences if the PRC tax authorities determine that our contracts with Orient Paper HB and its shareholders were not entered into based on arm’s length negotiations. Although our contractual arrangements are similar to other companies conducting similar operations in China, if the PRC tax authorities determine that these contracts were not entered into on an arm’s length basis, they may adjust our income and expenses for PRC tax purposes in the form of a transfer pricing adjustment. Such an adjustment may require that we pay additional PRC taxes plus applicable penalties and interest, if any.

 

The exercise of our option to purchase part or all of the equity interests in Orient Paper HB under the Call Option Agreement might be subject to approval by the PRC government. Our failure to obtain this approval may impair our ability to substantially control Orient Paper HB and could result in actions by Orient Paper HB that conflict with our interests.

 

Our Call Option Agreement with Orient Paper HB and its shareholders gives our Chinese subsidiary, Orient Paper Shengde or its designated entity or natural person, the option to purchase all or part of the equity interests in Orient Paper HB. The option may not be exercised by Orient Paper Shengde if the exercise would violate any applicable laws and regulations in China or cause any license or permit held by, and necessary for the operation of Orient Paper HB, to be cancelled or invalidated. Under the laws of China, if a foreign entity, through a foreign investment company that it invests in, acquires a domestic related company, China’s regulations regarding mergers and acquisitions may technically apply to the transaction. If these regulations apply, an examination and approval of the transaction by China’s Ministry of Commerce (“MOFCOM”), or its local counterparts would be required. In addition, an appraisal of the equity interest or the assets to be acquired would also be mandatory. Since the scope of business activities (making of digital photo paper and other cultural paper products) as defined in the business license of Orient Paper Shengde does not involve the MOFCOM approval and monitoring, we do not believe at this time that an approval or an appraisal is required for Orient Paper Shengde to exercise its option to acquire Orient Paper HB. In light of the different views on this issue, however, it is possible that the central MOFCOM office in Beijing will issue a standardized opinion imposing the approval and appraisal requirement. If we are not able to purchase the equity of Orient Paper HB, then we will lose a substantial portion of our ability to control Orient Paper HB and our ability to ensure that Orient Paper HB will act in our interests.

 

We anticipate to incur significant capital expenditures in 2014.

 

We have been implementing significant capital expenditure projects of tissue paper and PM1 renovation since the end of year 2012 and will continue to invest in capital-intensive capacity expansion projects in 2014. We have substantially increased our debt leverage to fund these projects. As of December 31, 2013, we had approximately $51,673,158 in capital expenditure commitments that were mainly related to the construction costs of manufacturing equipment and other facilities in a new industrial park in Wei County of Hebei, China, where we will eventually build two tissue paper production lines PM8 and PM9 and install other paper production machineries in the future. If we cannot fund or effectively manage our capital expenditures or if our capital expenditures do not lead to the results we anticipate, our business, financial position and operating performance may be materially and adversely affected. An increased debt burden may also materially and adversely affect our liquidity, financial condition and our business. If we are unable to obtain sufficient funding through bank borrowings or generate sufficient operating cash flows internally, the progress of the construction or renovation may be slowed down. We may also have to curtail the scope of the capital expenditure projects or to shelf some components of the projects (for example, delay the installation of PM9 until additional capital resources are available).

 

14
 

 

Our operating history may not serve as an adequate basis to judge our future prospects and results of operations.

 

Orient Paper HB commenced its current line of business operations in 1996 and received its initial Pollution Discharge Permit in September 1996, which must be renewed every year for Orient Paper HB to stay in business. Although we have never had problem renewing the Pollution Discharge Permit, we cannot guarantee automatic renewal every year. Our operating history may not provide a meaningful basis on which to evaluate its business. We cannot assure you that Orient Paper HB will maintain its profitability or that we will not incur net losses in the future. We expect that Orient Paper HB’s operating expenses will increase as it expands. Any significant failure to realize anticipated revenue growth could result in significant operating losses. We will continue to encounter risks and difficulties frequently experienced by companies at a similar stage of development, including our potential failure to:

 

raise adequate capital for expansion and operations;
implement our business model and strategy and adapt and modify them as needed;
increase awareness of our brand name, protect our reputation and develop customer loyalty;
manage our expanding operations and service offerings, including the integration of any future acquisitions;
maintain adequate control of our expenses; or
anticipate and adapt to changing conditions in paper markets in which we operate as well as the impact of any changes in government regulations, mergers and acquisitions involving our competitors, technological developments and other significant competitive and market dynamics.

 

If we are not successful in addressing any or all of these risks, our business may be materially and adversely affected.

 

Orient Paper HB’s failure to compete effectively may adversely affect our ability to generate revenue.

 

Through Orient Paper HB, we compete in a highly developed market with companies that have significantly greater experience and history in our industry. If we do not compete effectively, we could lose market share and experience falling prices, adversely affecting our financial results. Our competitors will expand in the key markets and implement new technologies making them more competitive. There is also the possibility that competitors will be able to offer additional products, services, lower prices, or other incentives that we cannot or will not offer or that will make our products less profitable. We cannot assure you that we will be able to compete effectively with current or future competitors or that the competitive pressures we face will not harm our business.

 

We might be negatively affected by the industry capacity elimination mandated by the government.

 

According to “The Twelfth ‘Five-Year Plan’ for the Chinese Paper Industry,” published jointly by the National Development and Reform Commission, the Ministry of Industry and Information Technology, and the National Forestry Bureau in December 2011, the central government of China has determined that during the five-year period ending year 2015, the government will seek to further eliminate more than 10 million tonnes of current paper production capacity. The goal is, through mandatory capacity elimination and industry consolidation, to transform the paper industry landscape into one where there are more than 20 one-million-tonnes-and-above manufacturers. As of year 2010, only the top-10 paper manufacturers in China have annual production capacity of over one million tonnes. According to the MIIT announcement on September 6, 2012, 9.9 million tonnes of paper production capacity was ordered to shut down in year 2012. The MIIT has again announced on July 25, 2013 the list of outdated paper capacities for the first phase of the mandatory closure of year 2013. A total of 6.21 million tonnes of paper manufacturing capacities across the country are required to be shut down in the July 25, 2013 list (the “2013 Mandatory Closure”), including 930,800 tonnes in the province of Hebei, the area hardest hit two years in a row. Unlike the mandatory closure programs in the previous years when most of the capacities shutdown related to small-scale local mills usually with less 50,000 tonnes of production capability without proper water treatment practice, the 2013 Mandatory Closure includes a number of large capacities (up to 226,000 tonnes per line) owned by six large public-traded paper manufacturing companies in China.

 

We have continued to focus on updating our production facilities to improve the operating and energy efficiency and reduce pollution. Based on our discussions with the regulators, we believe that none of our production facilities are currently targeted for mandatory capacity reduction. Based on information currently available to us, we do not expect that we would be ordered to reduce or shut down our production capacities. However, the Chinese government has broad discretion in determining the facilities subject to its production elimination mandate, and we cannot assure you that the government would not require us to shut down some or all of our production capacities. If we were forced to shut down one or more of our production facilities, our business, prospectus, financial condition and results of operations may materially and adversely affected. Depending on the scope of the government capacity elimination order, we could be forced to cease some or all of our operations.

 

Our digital photo paper operations will be relocated in the next few years due to an upcoming land use zoning change

 

Under a Xushui County urban redevelopment plan, the location of our digital photo paper operations will be converted from industrial use to commercial and residential use. As of December 31, 2013, there has been no executive order from the local government setting the deadline for the relocation. However, we have been under increasing pressure from the neighboring residents and the local government to relocate from our current location, which is increasingly surrounded by residential buildings. In addition, we expect the government will require the relocation be implemented within the next 4 years. While we are exploring different possibilities of moving the digital photo paper facilities to other locations that the Company owns or leases, including the new Industrial Park in Wei County, Hebei, China, we cannot assure you that the Company will be able to identify an ideal new location before the local county government orders us to implement the relocation.

 

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Before we are able to relocate the digital photo paper operation to a new industrial area, the current 16-hour per day production schedule may be further limited

 

Because our digital photo paper operation is in a location increasingly surrounded by newly developed residential projects, the nightly operation of our current manufacturing schedule at the digital photo paper plant may be further restricted by the local County government, which has received numerous complaints about noises and disturbance by community residents. Although we have operated under the curtailed but stable daily operational schedule for more than one year, we are unable to predict the degree to which such restriction will affect our production, but we do expect some reductions in production activities in the next few years.

  

If Orient Paper HB fails to comply with covenants in its loan agreements, its lenders may allege a breach of a covenant and seek to accelerate the loan or exercise other remedies, which could strain our cash flow and harm our business, liquidity and financial condition.

 

Orient Paper HB received loans from commercial banks to fund its operations. Typically, these loans are made pursuant to customary loan agreements which contain representations and warranties about its business, financial covenants to which Orient Paper HB must adhere and other negative covenants in respect of its operations. Under some of these agreements, Orient Paper HB may be required to obtain the consent of its lenders prior to entering into its contractual arrangement with us but Orient Paper HB did not receive such prior consent. To date, our lenders have not given us any notice of default or otherwise objected to our contractual arrangements with Orient Paper HB. If any lender raises any concern in this regard, we intend to secure a waiver from our lenders, but cannot assure you that we will successfully do so. If we cannot obtain such a wavier and Orient Paper HB’s lenders declare it to be in default under the loan agreements, they may accelerate Orient Paper HB’s indebtedness to them which would negatively affect our cash flows and business operations.

 

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We may not be able to effectively control and manage the growth of Orient Paper HB.

 

If Orient Paper HB’s business and markets grow and develop, it will be necessary for us to finance and manage expansion in an orderly fashion. An expansion would increase demands on existing management, workforce and facilities. Failure to satisfy such increased demands could interrupt or adversely affect our operations and cause delay in production and delivery of our paper products, as well as administrative inefficiencies.

 

We, through our subsidiaries, may engage in future acquisitions that could dilute the ownership interests of our stockholders and cause us to incur debt and assume contingent liabilities.

 

We, through our subsidiaries, may review acquisition and strategic investment prospects that we believe would complement the current product offerings of Orient Paper HB, augment its market coverage or enhance its technical capabilities, or otherwise offer growth opportunities. From time to time we review investments in new businesses and we, through our subsidiaries, expect to make investments in, and to acquire, businesses, products, or technologies in the future. We expect that when we raise funds from investors for any of these purposes we will be either the issuer or the primary obligor while the proceeds will be forwarded to Orient Paper HB. In the event of any future acquisitions, we could:

 

issue equity securities which would dilute current stockholders’ percentage ownership;
incur substantial debt;
assume contingent liabilities; or
expend significant cash.

  

These actions could have a material adverse effect on our operating results or the price of our common stock. Moreover, even if through our subsidiaries, we do obtain benefits in the form of increased sales and earnings, there may be a lag between the time when the expenses associated with an acquisition are incurred and the time when we recognize such benefits. Acquisitions and investment activities also entail numerous risks, including:

 

difficulties in the assimilation of acquired operations, technologies and/or products;
unanticipated costs associated with the acquisition or investment transaction;
the diversion of management’s attention from other business concerns;
adverse effects on existing business relationships with suppliers and customers;
risks associated with entering markets in which Orient Paper HB has no or limited prior experience;
the potential loss of key employees of acquired organizations; and
substantial charges for the amortization of certain purchased intangible assets, deferred stock compensation or similar items.

 

We cannot ensure that we will be able to successfully integrate any businesses, products, technology, or personnel that we might acquire in the future and our failure to do so could have a material adverse effect on our and/or Orient Paper HB’s business, operating results and financial condition.

 

We are responsible for the indemnification of our officers and directors.

 

Our Articles of Incorporation provides for the indemnification and/or exculpation of our directors, officers, employees, agents and other entities which deal with us to the maximum extent provided, and under the terms provided, by the laws and decisions of the courts of the state of Nevada. Although we do maintain professional error and omission insurance for the officers and directors, due to limitations of the insurance coverage these indemnification provisions could still result in substantial expenditures which we may be unable to recoup through the insurance and could adversely affect our business and financial conditions. Zhenyong Liu, our Chairman of the Board and Chief Executive Officer, Winston C. Yen, our Chief Financial Officer, Dahong Zhou, our Secretary, and Drew Bernstein, Wenbing Christopher Wang, Zhaofang Wang, and Fuzeng Liu, our directors, are key personnel with rights to indemnification under our Articles of Incorporation.

 

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We are dependent on certain key personnel and loss of these key personnel could have a material adverse effect on our business, financial condition and results of operations.

 

Our success is, to a certain extent, attributable to the management, sales and marketing, and paper factory operational expertise of key personnel. Zhenyong Liu, our Chief Executive Officer and Chairman of the Board, Winston C. Yen, our Chief Financial Officer, Dahong Zhou, our Secretary, and Shuting Liang, Orient Paper HB’s General Engineer, Gengqi Yang, Orient Paper HB’s Vice President of Sales and Marketing, Fulai Huang, Orient Paper HB’s Vice President of Environmental Protection and Xiaodong Liu, Orient Paper Shengde’s General Manager, perform key functions in the operation of our business. Although all of our Directors and the key management personnel have not had any turnover since year 2009, there can be no assurance that Orient Paper or Orient Paper HB or Orient Paper Shengde will be able to retain these officers after the term of their employment contracts expire. The loss of these officers could have a material adverse effect upon our business, financial condition, and results of operations. We do not carry key man life insurance for any of our key personnel or personnel nor do we foresee purchasing such insurance to protect against a loss of key personnel and the key personnel.

 

We are dependent upon the services of Mr. Zhenyong Liu for the continued growth and operation of our Company because of his experience in the industry and his personal and business contacts in the PRC. Although Mr. Liu has entered into an employment agreement with Orient Paper Shengde Paper Co., Ltd., our wholly owned subsidiary and a PRC company, and that we have no reason to believe that Mr. Liu will discontinue his services with us or Orient Paper HB, the interruption or loss of his services would adversely affect our ability to effectively run our business and pursue our business strategy as well as our results of operations.

 

We may not be able to hire and retain qualified personnel to support our growth and if we are unable to retain or hire these personnel in the future, our ability to improve our products and implement our business objectives could be adversely affected.

 

We must attract, recruit and retain a sizeable workforce of technically competent employees. Competition for senior management and senior personnel in the PRC is intense, the pool of qualified candidates in the PRC is very limited, and we may not be able to retain the services of our senior executives or senior personnel, or attract and retain high-quality senior executives or senior personnel in the future. This failure could materially and adversely affect our future growth and financial condition.

 

Our operating results may fluctuate as a result of factors beyond our control.

 

Our operating results may fluctuate significantly in the future as a result of a variety of factors, many of which are beyond our control. These factors include:

 

the costs of paper products and development;
the relative speed and success with which we can obtain and maintain customers, merchants and vendors for our products;
capital expenditure for equipment;
marketing and promotional activities and other costs;
changes in our pricing policies, suppliers and competitors;
the ability of our suppliers to provide products in a timely manner to their customers;
changes in operating expenses;
increased competition in the paper markets; and
other general economic and seasonal factors.

   

We face risks related to product liability claims.

 

We presently do not maintain product liability insurance. We face the risk of loss because of adverse publicity associated with product liability lawsuits, whether or not such claims are valid. We may not be able to avoid such claims. Although product liability lawsuits in the PRC are rare, and we have not, to date, experienced significant failure of our products, there is no guarantee that we will not face such liability in the future. This liability could be substantial and the occurrence of such loss or liability may have a material adverse effect on our business, financial condition and prospects.

 

Our operating results also depend on the availability and pricing of energy and raw materials.

 

In addition to our dependence upon wood pulp, recycled white scrap paper and paperboard costs, our operating results depend on the availability and pricing of energy and other raw materials, including chemical agents and coal. An interruption in the supply of supplemental chemical agents could cause a material disruption at our mill in Baoding. In addition, an interruption in the supply of coal could cause a material disruption at our facilities in Baoding. At present, our raw materials including coal are purchased from a number of suppliers, of which the three largest suppliers account for over 80% of all purchases. If any of these contracts were to be terminated for any reason, or not renewed upon expiration, or if market conditions were to substantially change creating a significant increase in the price of coal and recycled paper, we may not be able to find alternative, comparable suppliers or suppliers capable of providing coal to us on terms or in amounts satisfactory to us. As a result of any of these events, our business, financial condition and operating results could suffer.

 

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A material disruption at one of our manufacturing facilities could prevent us from meeting customer demand, reduce our sales, and/or negatively affect our net income.

 

Any of our manufacturing facilities, or any of our machines within an otherwise operational facility, could cease operations unexpectedly due to a number of events, including:

 

maintenance outages;
prolonged power failures;
an equipment failure, including any malfunction of our waste water treatment facilities;
disruption in the supply of raw materials, such as wood fiber, energy, or chemicals;
a chemical spill or release;
closure because of environmental-related concerns;
explosion of a boiler;
the effect of a drought or reduced rainfall on our water supply;
disruptions in the transportation infrastructure, including roads, bridges, railroad tracks, and tunnels;
fires, floods, earthquakes, hurricanes, or other catastrophes;
terrorism or threats of terrorism;
labor difficulties; or
other operational problems.

  

We have purchased property base insurance from Property Insurance and Casualty Company Limited, valid from July 2013 through July 2014. However, if any of the abovementioned events were to occur, we may be unable to meet customer demand, which may adversely affect our sales and net income.

 

Our certificates, permits, and licenses related to our papermaking operations are subject to governmental control and renewal and failure to obtain renewal will cause all or part of our operations to be terminated.

 

Due to the nature of our business, we are subject to environmental, health, and safety laws and regulations, including those related to the disposal of hazardous waste from our manufacturing processes. Compliance with existing and future environmental, health and safety laws could subject us to future costs or liabilities; impact our production capabilities; constrict our ability to sell, expand or acquire facilities; and generally impact our financial performance. Under the original factory land lease dated January 2, 2002, Orient Paper HB was obligated to return the land to the government to its original condition prior to the expiration of the lease. As such, Orient Paper would have to accrue the cost estimated to return the land to its prior condition over the 30-year life of the lease. However, on March 15, 2010, an amendment to the original January 2, 2002 lease was signed and removed the obligation of Orient Paper HB to return the land to its condition prior to the expiration of the lease. The management of the Company thus believes that no liabilities under the lease should be accrued as of December 31, 2013. Nevertheless, because of the uncertainties associated with environmental assessment and remediation activities, future expense to remediate any sites, which could be identified in the future for cleanup, could be higher than expected.

 

In 1988, the National Environmental Protection Bureau issued Interim Measures on the Administration of Water Pollutants Discharge Permits, requiring all companies discharging pollution into the water as a direct or indirect byproduct of production to adhere to certain caps on pollution discharge. Additionally, such companies were required to obtain and annually renew a Pollution Discharge Permit in order to conduct their operations. The PRC government has the authority to shut down a company’s operations for failure to maintain a valid permit. We renewed our Pollution Discharge Permit in January 2014. Our latest permit is effective from January 10 2014 through January 09, 2015. An application to renew will be filed with the local environment protection agency before the expiration.

 

The failure by us to obtain any certificate, permit, and license necessary for our operations or failure by us to obtain the renewal of any such certificate, permit or license may materially and adversely affect our business, prospects, financial condition and results of operation.

 

Compliance with environmental regulations is expensive, and noncompliance may result in adverse publicity and potentially significant monetary damages and fines or suspension of our business operations.

 

We are required to comply with all Chinese national and local regulations regarding the protection of the environment. Compliance with environmental regulation is expensive. The Chinese government is adopting more stringent environmental protection and operational safety regulations and the costs of complying with these regulations are expected to increase. Although we have obtained all of the necessary approvals and permits for our production facilities currently existing, we cannot assure you that we will be able to comply with all applicable environmental protection and operational safety requirements, and obtain all of the required governmental approvals and permits that may be or may become applicable to us on a timely basis, or at all, or will be able to complete all our registrations and filings with the government, in time for our future projects. The relevant governmental authorities may impose on us fines for any non-compliance, set deadlines for rectification, and order us to cease construction or production if we fail to comply with their requirements. 

 

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If we are unable to make necessary capital investments or respond to pricing pressures, our business may be harmed.

 

In order to remain competitive, we need to invest in research and development, manufacturing, customer service and support, and marketing. From time to time we also have to adjust the prices of our products to remain competitive. We may not have available sufficient financial or other resources to continue to make investments necessary to maintain our competitive position.

 

In the last few years, the central government of China has adopted policies to force the elimination of small, inefficient competitors in certain industries (e.g., coal, steal, paper and cement) where production produces pollutants to the environment. In the paper industry, the government has implemented two rounds of “mandatory closures” in years 2010 and 2011 and forced hundreds of small paper mills across China to shut down. The purpose of the mandatory closure is to make sure that the market is left with only an optimal number of medium to large competitors, which size and financial resources are such that production efficiency can be enhanced and environment protection measures will not be compromised. The paper mills or production lines affected by the mandatory closures are typically with capacities of less than 50,000 tonnes. The central government of China has announced that, during the “Twelfth Five-Year Plan” period of 2011 through 2015, it intends to eliminate more than 10 million tonnes of paper production capacity nationwide. It is commonly believed that further mandatory of small and inefficient capacities will continue to be shut down in year 2014 and the following years. Although we do not believe any of our production line is in danger of being targeted by the government, if we are unable to maintain our competitiveness by replacing old production equipments with larger, newer equipments and by maintaining our water-treatment capability, over time we may be required by the government to increase capital investments to keep up with the competition if industry consolidation intensifies.

 

If we fail to introduce enhancements to our existing products or to develop new products, our business and results of operations could be adversely affected.

 

We believe our future success depends in part on our ability to enhance our existing products and develop new products in order to continue to meet customer demands. Our failure to introduce new or enhanced products on a timely and cost-competitive basis, or the development of processes that make our existing products obsolete, could harm our business and results of operations.

 

Our auditor, like other independent registered public accounting firms operating in China, is not permitted to be subject to inspection by the Public Company Accounting Oversight Board, and as such, investors may be deprived of the benefits of such inspection.

 

The independent registered public accounting firm that issues the audit reports included in our annual reports filed with the SEC, as an auditor of companies that are traded publicly in the United States and a firm registered with the Public Company Accounting Oversight Board (United States), or PCAOB, is required by the laws of the United States to undergo regular inspections by PCAOB to assess its compliance with the laws of the United States and professional standards. Because our auditor is located in China, a jurisdiction where PCAOB is currently unable to conduct inspections without the approval of the PRC authorities, our auditor, like other independent registered public accounting firms operating in China, is currently not inspected by PCAOB. Inspections of other firms that PCAOB has conducted outside of China have identified deficiencies in those firms’ audit procedures and quality control procedures, which may be addressed as part of the inspection process to improve future audit quality. The inability of PCAOB to conduct inspections of independent registered public accounting firms operating in China makes it more difficult to evaluate the effectiveness of our auditor’s audit procedures or quality control procedures. As a result, investors may be deprived of the benefits of PCAOB inspections.

 

The SEC’s recent administrative proceedings against five China-based accounting firms, including a former mainland China affiliate of our independent registered public accounting firm, may significantly and adversely affect our ability to comply with the requirements for financial statements as a reporting company.

 

The SEC has brought administrative proceedings against five accounting firms in China recently, alleging that they refused to hand over documents to the SEC for ongoing investigations into certain China-based companies. We were not and are not subject to any such SEC investigations, nor are we involved in the proceedings brought by the SEC against the accounting firms. However, a former mainland China affiliate of our independent registered public accounting firm is one of the five accounting firms named in the SEC’s proceedings and we may be adversely affected by the outcome of the proceedings, along with other U.S.-listed companies audited by these accounting firms. If the SEC prevails in the proceedings, the former mainland China affiliate of our independent auditors and other four accounting firms in China in the proceedings may be barred from practicing before the SEC and hence unable to continue to be the auditors for China-based companies. If none of the China-based auditors are able to continue to be auditors for China-based companies listed in the U.S., we will not be able to meet the reporting requirements under the Securities Exchange Act of 1934, as amended, or the Securities Exchange Act, which may ultimately result in our deregistration from the SEC and delisting from the NYSE MKT.

 

We have limited insurance coverage and may incur losses resulting from product liability claims or business interruptions.

 

As the insurance industry in China is still in an early stage of development, insurance companies in China currently offer limited business insurance products. We do not have any product liability insurance or business interruption insurance. Based on the insurance products available in China, even if we decide to take out business interruption coverage, such insurance as currently available offers limited coverage compared to that offered in many other jurisdictions. Any business disruption, natural disaster, or product liability claim could result in our incurring substantial costs and diversion of resources, which would have an adverse effect on our business and results of operations. 

 

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Risks Related To Doing Business in the PRC

 

Changes in the policies of the PRC government could have a significant impact upon the business we may be able to conduct in the PRC and the profitability of such business.

 

Our business operations may be adversely affected by the current and future political environment in the PRC. The PRC has operated as a socialist state since the middle of the 20th century and is controlled by the Communist Party of China. The Chinese government exerts substantial influence and control over the manner in which we must conduct our business activities. The PRC has only permitted provincial and local economic autonomy and private economic activities since 1978. The government of the PRC has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy, including the paper industry, through regulation and state ownership. Our ability to operate in the PRC may be adversely affected by changes in Chinese laws and regulations, including those relating to taxation, import and export tariffs, raw materials, environmental regulations, land use rights, property and other matters. Under its current leadership, the government of the PRC has been pursuing economic reform policies that encourage private economic activity and greater economic decentralization. There is no assurance, however, that the government of the PRC will continue to pursue these policies, or that it will not significantly alter these policies from time to time without notice.

 

The PRC’s economy is in a transition from a planned economy to a market oriented economy subject to five-year and annual plans adopted by the government that set national economic development goals. Policies of the PRC government can have significant effects on the economic conditions of the PRC. The PRC government has confirmed that economic development will follow the model of a market economy. Under this direction, we believe that the PRC will continue to strengthen its economic and trading relationships with foreign countries and business development in the PRC will follow market forces. While we believe that this trend will continue, there can be no assurance that this will be the case.

 

A change in policies by the PRC government could adversely affect our interests by, among other factors: changes in laws, regulations or the interpretation thereof, confiscatory taxation, restrictions on currency conversion, imports or sources of supplies, or the expropriation or nationalization of private enterprises. Although the PRC government has been pursuing economic reform policies for more than two decades, there is no assurance that the 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 other circumstances affecting the PRC’s political, economic and social life.

 

The PRC laws and regulations governing our current business operations are sometimes vague and uncertain. Any changes in such PRC laws and regulations may harm our business.

 

The PRC laws and regulations governing our current business operations are sometimes vague and uncertain. The PRC’s legal system is a civil law system based on written statutes, in which system decided legal cases have little value as precedents unlike the common law system prevalent in the United States. There are substantial uncertainties regarding the interpretation and application of PRC laws and regulations, including but not limited to the laws and regulations governing our business, the enforcement and performance of our contractual arrangements with our affiliated Chinese entity, Orient Paper HB, and its shareholders, or the enforcement and performance of our arrangements with customers in the event of the imposition of statutory liens, death, bankruptcy and criminal proceedings. The Chinese government has been developing a comprehensive system of commercial laws, and considerable progress has been made in introducing laws and regulations dealing with economic matters such as foreign investment, corporate organization and governance, commerce, taxation and trade. However, because these laws and regulations are relatively new, and because of the limited volume of published cases and judicial interpretation and their lack of force as precedents, interpretation and enforcement of these laws and regulations involve significant uncertainties. New laws and regulations that affect existing and proposed future businesses may also be applied retroactively. Our major operating entity, Orient Paper HB, conducts its operations in China, and as a result, we are required to comply with PRC laws and regulations. We cannot assure you that our current ownership and operating structure would not be found in violation of any current or future PRC laws or regulations. Any of these or similar actions could significantly disrupt our business operations or restrict us from conducting a substantial portion of our business operations, which could materially and adversely affect our business, financial condition and results of operations. We cannot predict what effect the interpretation of existing or new PRC laws or regulations may have on our business. If the relevant authorities find that we are in violation of PRC laws or regulations, they would have broad discretion in dealing with such a violation, including, without limitation:

 

levying fines;
revoking Orient Paper HB’s business and other licenses;
requiring that we restructure our ownership or operations; and
requiring that we discontinue any portion or all of our business.

   

Among the material laws that we are subject to are the Price Law of The People’s Republic of China, Measurement Law of The People’s Republic of China, Tax Law, Environmental Protection Law, Contract Law, Patent Law, Accounting Laws and Labor Law.

 

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Our contractual arrangements with Orient Paper HB and its shareholders may not be as effective in providing control over Orient Paper HB as direct ownership.

 

Since the law of the PRC limits foreign equity ownership in companies in China, we operate our business through Orient Paper HB. We have no equity ownership interest in Orient Paper HB and rely on contractual arrangements to control and operate its business. These contractual arrangements may not be effective in providing control over Orient Paper HB as direct ownership. For example, Orient Paper HB could fail to take actions required for our business despite its contractual obligation to do so. If Orient Paper HB fails to perform under their agreements with us, we may have to incur substantial costs and resources to enforce such arrangements and may have to rely on legal remedies under the law of the PRC, which may not be effective. In addition, we cannot assure you that the Orient Paper HB’s shareholders would always act in our best interests.

 

Because we may rely on the consulting services agreement with Orient Paper HB for essentially all of our revenue and cash flows, any difficulty for Orient Paper HB to pay consulting fees to Orient Paper Shengde under the consulting agreement may have a material adverse effect on our operations.

 

We are a holding company and currently do not conduct any business operations other than the contractual arrangements between Orient Paper Shengde and Orient Paper HB. As a result, we may rely entirely for our revenues on dividend payments from Orient Paper Shengde for any payment from Orient Paper HB pursuant to the consulting services agreement which forms a part of the contractual arrangements between Orient Paper Shengde and Orient Paper HB. Since Orient Paper Shengde is not a legal shareholder of Orient Paper HB under PRC statutes, the arrangement for Orient Paper HB to pay a substantial portion of its net income to Orient Paper Shengde may be challenged by the PRC government, which could prevent us from issuing dividends to our shareholders or making required payments to some of our service providers.

 

A slowdown, inflation or other adverse developments in the PRC economy may harm our customers and the demand for our services and products.

 

All of our operations are conducted in the PRC and all of our revenue is generated from sales in the PRC. Although the PRC economy has grown significantly in recent years, we cannot assure you that this growth will continue. A slowdown in overall economic growth, an economic downturn, a recession or other adverse economic developments in the PRC could significantly reduce the demand for our products and harm our business.

 

While the PRC economy has experienced rapid growth, such growth has been uneven among various sectors of the economy and in different geographical areas of the country. Rapid economic growth could lead to growth in the money supply and rising inflation. If prices for our products rise at a rate that is insufficient to compensate for the rise in the costs of supplies, it may harm our profitability. In order to control inflation in the past, the PRC government has imposed controls on bank credit, limits on loans for fixed assets and restrictions on state bank lending. Such an austere policy can lead to a slowing of economic growth.

 

Governmental control of currency conversion may affect the value of your investment.

 

The PRC government imposes controls on the convertibility of Renminbi into foreign currencies and, in certain cases, the remittance of currency out of the PRC. We receive substantially all of our revenue in Renminbi, which is currently not a freely convertible currency. Shortages in the availability of foreign currency may restrict our ability to remit sufficient foreign currency to pay dividends, or otherwise satisfy foreign currency denominated obligations. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and expenditures from the transaction, can be made in foreign currencies without prior approval from the PRC State Administration of Foreign Exchange by complying with certain procedural requirements. However, approval from appropriate governmental authorities is required where Renminbi is to be converted into foreign currency and remitted out of the PRC to pay capital expenses such as the repayment of bank loans denominated in foreign currencies.

 

The PRC government may also in the future restrict access to foreign currencies for current account transactions. If the foreign exchange control system prevents us from obtaining sufficient foreign currency to satisfy our currency demands, we may not be able to pay certain of our expenses as they come due.

 

The fluctuation of the Renminbi may harm your investment.

 

The value of the Renminbi against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in the PRC’s political and economic conditions. According to the Financial Management website of http://fms.treas.gov/intn.html, as of December 31, 2013, $1 = 6.0540 Yuan (RMB). As we rely entirely on revenues earned in the PRC, any significant revaluation of the Renminbi may materially and adversely affect our cash flows, revenues and financial condition. For example, to the extent that we need to convert U.S. dollars we receive from an offering of our securities into Renminbi for Orient Paper HB’s operations, appreciation of the Renminbi against the U.S. dollar would diminish the value of the proceeds of the offering and this could harm our business, financial condition and results of operations because it would reduce the proceeds available to us for capital investment in proportion to the appreciation of the Renminbi. Thus if we raise 1,000,000 dollars and the Renminbi appreciates against the U.S. dollar by 15%, then the proceeds will be worth only RMB5,145,900 as opposed to RMB 6,054,000 prior to the appreciation. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of making payments for dividends on our common shares or for other business purposes and the U.S. dollar appreciates against the Renminbi, the U.S. dollar equivalent of the Renminbi we convert would be reduced in proportion to the amount the U.S. dollar appreciates. In addition, the depreciation of significant RMB denominated assets could result in a charge to our income statement and a reduction in the dollar value of these assets. Thus if Orient Paper HB has RMB1,000,000 in assets and Renminbi is depreciated against the U.S. dollar by 15%, then the assets will be valued at $143,635 as opposed to $165,180 prior to the depreciation.

 

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On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the Renminbi to the U.S. dollar. Under the new policy, the Renminbi is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy has resulted in an approximately 35.29% appreciation of the Renminbi against the U.S. dollar as of December 31, 2013. While the international reaction to the Renminbi revaluation has generally been positive, there remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in a further and more significant appreciation of the Renminbi against the U.S. dollar.

 

Failure to comply with PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may materially adversely affect us.

 

In October 2005, the PRC State Administration of Foreign Exchange, or SAFE, issued the Notice on Relevant Issues in the Foreign Exchange Control over Financing and Round-Trip Investment Through Special Purpose Companies by Residents Inside China, generally referred to as Circular 75. The policy announced in this notice required PRC residents to register with the relevant SAFE branch before establishing or acquiring control over an offshore special purpose company, or SPV, for the purpose of engaging in an equity financing outside of China on the strength of domestic PRC assets originally held by those residents. Internal implementing guidelines issued by SAFE, which became public in May 2007 (known as Notice 106), expanded the reach of Circular 75. In the case of an SPV which was established, and which acquired a related domestic company or assets, before the implementation date of Circular 75, a retroactive SAFE registration was required to have been completed before March 31, 2006; this date was subsequently extended indefinitely by Notice 106, which also required that the registrant establish that all foreign exchange transactions undertaken by the SPV and its affiliates were in compliance with applicable laws and regulations. Failure to comply with the requirements of Circular 75, as applied by SAFE in accordance with Notice 106, may result in fines and other penalties under PRC laws for evasion of applicable foreign exchange restrictions. Any such failure could also result in the SPV’s affiliates being impeded or prevented from distributing their profits and the proceeds from any reduction in capital, share transfer or liquidation to the SPV, or from engaging in other transfers of funds into or out of China.

 

Because of uncertainty over the interpretation of Circular 75, we cannot assure you that, if challenged by government agencies, the structure of our organization has fully complied with all applicable registrations or approvals 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. A failure by such PRC resident beneficial holders or future PRC resident stockholders to comply with Circular 75 and Notice 106, 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.

 

The PRC’s legal and judicial system may not adequately protect our business and operations and the rights of foreign investors.

 

The PRC legal and judicial system may negatively impact foreign investors. In 1982, the National People’s Congress amended the Constitution of China to authorize foreign investment and guarantee the “lawful rights and interests” of foreign investors in the PRC. However, the PRC’s system of laws is not yet comprehensive. The legal and judicial systems in the PRC are still rudimentary, and enforcement of existing laws is inconsistent. Many judges in the PRC lack the depth of legal training and experience that would be expected of a judge in a more developed country. Because the PRC judiciary is relatively inexperienced in enforcing the laws that do exist, anticipation of judicial decision-making is more uncertain than would be expected in a more developed country. It may be impossible to obtain swift and equitable enforcement of laws that do exist, or to obtain enforcement of the judgment of one court by a court of another jurisdiction. The PRC’s legal system is based on the civil law regime, that is, it is based on written statutes; a decision by one judge does not set a legal precedent that is required to be followed by judges in other cases. In addition, the interpretation of Chinese laws may be varied to reflect domestic political changes.

 

The trend of legislation over the last 20 years has significantly enhanced the protection of foreign investment and allowed for more control by foreign parties of their investments in Chinese enterprises. However, the promulgation of new laws, changes to existing laws and the pre-emption of local regulations by national laws may adversely affect foreign investors. A change in leadership, social or political disruption, or unforeseen circumstances affecting the PRC’s political, economic or social life, may affect the PRC government’s ability to continue to support and pursue these reforms. Such a shift could have a material adverse effect on our business and prospects.

 

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The practical effect of the PRC legal system on our business operations in the PRC can be viewed from two separate but intertwined considerations. First, as a matter of substantive law, the foreign invested enterprise laws provide significant protection from government interference. In addition, these laws guarantee the full enjoyment of the benefits of corporate articles and contracts to foreign invested enterprise participants. These laws, however, do impose standards concerning corporate formation and governance, which are qualitatively different from the general corporation laws of the United States. Similarly, the PRC accounting laws mandate accounting practices, which are not consistent with U.S. generally accepted accounting principles. PRC’s accounting laws require that an annual “statutory audit” be performed in accordance with PRC accounting standards and that the books of account of foreign invested enterprises are maintained in accordance with Chinese accounting laws. Article 14 of the People’s Republic of China Wholly Foreign-Owned Enterprise Law requires a wholly foreign-owned enterprise to submit certain periodic fiscal reports and statements to designated financial and tax authorities, at the risk of business license revocation. While the enforcement of substantive rights may appear less clear than United States procedures, foreign invested enterprises and wholly foreign-owned enterprises are Chinese registered companies, which enjoy the same status as other Chinese registered companies in business-to-business dispute resolution. Any award rendered by an arbitration tribunal is enforceable in accordance with the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (1958). Therefore, as a practical matter, although no assurances can be given, the Chinese legal infrastructure, while different in operation from its United States counterpart, should not present any significant impediment to the operation of foreign invested enterprises.

 

Any recurrence of an epidemic of Severe Acute Respiratory Syndrome (SARS) or Avian Influenza A (H7N9) or another widespread public health problem, could harm our operations.

 

A renewed outbreak of SARS or another widespread public health problem (such as Avian Flu H7N9) in the PRC, where all of our revenues are derived, could significantly harm our operations. Our operations may be impacted by a number of health-related factors, including quarantines or closures of any of our two locations in the city of Baoding that would adversely disrupt our operations. Any of the foregoing events or other unforeseen consequences of public health problems could significantly harm our operations.

 

Because our principal assets are located outside of the United States and most of our directors and officers reside outside of the United States, it may be difficult for you to enforce your rights based on U.S. federal securities laws against us and our officers or to enforce U.S. court judgment against us or them in the PRC.

 

Most of our directors and officers reside outside of the United States. In addition, our operating company is located in the PRC and substantially all of our assets are located outside of the United States. It may therefore be difficult for investors in the United States to enforce their legal rights based on the civil liability provisions of the U.S. Federal securities laws against us in the courts of either the U.S. or the PRC and, even if civil judgments are obtained in U.S. courts, to enforce such judgments in PRC courts. Further, it is unclear if extradition treaties now in effect between the United States and the PRC would permit effective enforcement against us or our officers and directors of criminal penalties, under the U.S. Federal securities laws or otherwise.

 

We may be required to broaden the coverage of the mandatory social security insurance programs under the New Labor Law of the PRC

 

The PRC New Labor Law, effective January 1, 2008, requires that employers enroll in the following social security insurance programs and offer certain employer-sponsored premium benefits to eligible employees: (1) retirement endowment, (2) healthcare insurance, (3) unemployment insurance, (4) workers’ compensation insurance, and (5) pregnancy insurance. Of these insurance programs, the retirement endowment fund requires employee withholdings of 4% to 8% of the gross compensation, while the employer’s matching contribution varies from 16% to 20% of such compensation. While the Company is enrolled in the retirement endowment fund and is withholding employees’ portion and the employer’s portion of the endowment contribution, many of the Company’s employees have elected to waive their coverage under these mandatory social security insurance programs in favor of certain other low-cost, local government-sponsored social security insurance programs for residents in non-urban districts. Although we have verified with the local government agencies for the validity of the employee waivers and reasonably believe that we are not required to cover the employees who waived the benefits, the local government may change its policy and ask us to broaden our insurance coverage to those who have specifically waived their rights.

 

Risks Related to Our Common Stock

 

Our officers and directors control us through their positions and stock ownership and their interests may differ from other stockholders.

 

As of December 31, 2013, there were 18,753,900 shares of our common stock issued and outstanding. Our officers and directors beneficially own approximately 28.72% of our common stock. Mr. Zhenyong Liu, our Chief Executive Officer, beneficially owns approximately 27.94% of our common stock. As a result, he is able to influence the outcome of stockholder votes on various matters, including the election of directors and extraordinary corporate transactions including business combinations. Yet Mr. Liu’s interests may differ from those of other stockholders. Furthermore, ownership of 28.72% of our common stock by our officers and directors reduces the public float and liquidity, and may affect the market price, of our common stock as traded on the NYSE MKT.

 

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We may not continue to pay cash dividends and any return on investment may be limited to the value of our common stock.

 

While we intend to retain the majority of any future earnings for use in the operation and expansion of our business, we did declare four quarterly cash dividends in April of 2012, as well as in November 2013. Although it is likely that our Board of Directors will continue the quarterly cash dividend as a regular dividend policy in the coming years, there is no guarantee that the cash dividend will not be discontinued or reduced. Should we decide to continue the cash dividend, 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. In addition, our operating subsidiaries, from time to time, may be subject to restrictions on their ability to make distributions to us, including restrictions on the conversion of local currency into U.S. dollars or other hard currency and other regulatory restrictions.

 

If we fail to comply with Section 404 of the Sarbanes-Oxley Act of 2002 in a timely manner, our business could be harmed and our stock price could decline.

 

Rules adopted by the SEC pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 require annual assessment of U.S. public companies’ internal control over financial reporting. The standards that must be met for management to assess the internal control over financial reporting as effective are new and complex, and require significant documentation, testing and possible remediation to meet the detailed standards. While there has not been any detected significant deficiency or material weakness in our internal control and with respect to the assessment of the internal control for the year ended December 31, 2013, we cannot guarantee the implementation of controls and procedures in future years to be without any significant deficiency or material weakness.

 

Our common stock may be affected by limited trading volume and may fluctuate significantly.

 

Our common stock is traded on the NYSE MKT. Although an active trading market has developed for our common stock, there can be no assurance that an active trading market for our common stock will be sustained. Failure to maintain an active trading market for our common stock may adversely affect our shareholders’ ability to sell our common stock in short time periods, or at all. Our common stock has experienced, and may experience in the future, significant price and volume fluctuations, which could adversely affect the market price of our common stock.

 

Future financings may dilute stockholders or impair our financial condition.

 

In the future, we may need to raise additional funds through public or private financing, which might include the sale of equity securities. The issuance of equity securities could result in financial and voting dilution to our existing stockholders. The issuance of debt could result in effective subordination of stockholders’ interests to the debt, create the possibility of default, and limit our financial and business alternatives.

 

Item 1B. Unresolved Staff Comments

 

Not applicable.

 

Item 2. Properties

 

Our headquarter is located at Hebei Baoding Orient Paper Milling Company Limited, Juli Road, Xushui County, Baoding City, Hebei Province, People’s Republic of China. The headquarter and our main production base, separated by approximately 4 kilometers apart in Xushui County of the city of Baoding, have a total area of 345.91 mu, or approximately 56.97 acres.

 

All land in the PRC is owned by the government and cannot be sold to any individual or entity. Instead, the government grants landholders a "land use right" after a purchase price for such "land use right" is paid to the government. The "land use right" allows the holder the right to use the land for a specified long-term period of time and enjoys all the incidents of ownership of the land. The following are the details regarding Orient Paper HB’s land use rights with regard to the land that it uses in its business.

 

The land of our major operating entity and our main production base (the “Xushui Paper Mill”), comprising 200 mu, or approximately 33 acres, of land, is leased from the local government pursuant to a 30 year lease that expires December 31, 2031.  The lease requires an annual payment of approximately $19,633 (RMB 120,000) due by June 30 every year.

 

The remaining 58.06 mu, approximately 9.5 acres, of land (the “Headquarter Compound”) on which our principal executive offices and other production facilities are situated (including the two digital photo paper production lines), was obtained by Orient Paper HB pursuant to a land use right granted by the local government on March 10, 2003.  Orient Paper HB obtained the right to use the 58.06 mu of land for 50 years through March 10, 2053.  The purchase price of the land use right was approximately $2,375,202 (RMB14,984,200), which was fully paid on March 8, 2005.

 

25
 

 

On August 7, 2013 the Company’s Audit Committee and the Board of Directors approved the sale of the land use right of the Headquarters Compound (the “LUR”), the office building and essentially all industrial-use buildings in the Headquarters Compound (the “Industrial Buildings”), and three employee dormitory buildings located within the Headquarters Compound (the “Dormitories”) to Hebei Fangsheng for cash prices of approximately $2.77 million, $1.15 million, and $4.28 million, respectively. In connection with the sale of the Industrial Buildings, Hebei Fangsheng agrees to lease the Industrial Buildings back to the Company for its original use for a term of up to three years, with an annual rental payment of approximately $161,439. As a condition for the sale of the Dormitories, Hebei Fangsheng agrees that it will act as an agent for the Company, which does not have the qualification to sell residential housing units in China, and that it is obligated to sell all of the 132 apartment units in the Dormitories to qualified employees of the Company at its acquisition price. Hebei Fangsheng further represents that it will not seek to profit from the resale of the Dormitories units and will allow the Company to inspect the books and records of the sale upon completion of the resale of the Dormitories units to ensure the objectives are achieved.

 

The sale was conducted on an arms-length basis, and was reviewed by the Company’s Audit Committee and approved by the Board of Directors. As of December 31, 2013, the sale of the LUR and Industrial Buildings has been completed. The Company generated a total sales price of $3,920,927 and a net gain on disposal of approximately $84,972. Land appreciation tax and other transactional taxes and fees in the amount of approximately $235,556 are paid out of the proceeds of the sale to various local government tax authorities. We expect the sale of Dormitories will be closed in the second half of 2014. Net proceeds from the sale will be in the approximate total amount of $7.96 million and are expected to be used to fund our tissue paper production line construction.

 

We have not identified new locations for the office and the digital photo paper workshop but are exploring the possibility of moving the headquarters office to near our Xushui Paper Mill. We may also consider moving the digital photo paper operations to the new industrial park in Wei County.

 

In the spring of 2010, we initiated the process of acquiring approximately 667,000 square meters of land adjacent to our Xushui Paper Mill and have received governmental approval for our capacity expansion plan. However, since the start of the acquisition process, we have met significant opposition by certain local residents over the price that we offered for their land. On April 13, 2012, we closed our acquisition of 58,566 square meters of land and secured all associated land use right permits. For the 58,566 square meters of land acquired, we paid a total of $7.5 million for various payments of compensation, taxes, and recording fees to the sellers and the local government.

 

As of December 31, 2013 we had a prepayment in the amount of $1,492,098 in respect of a land use right purchase from the local residents’ council made on October 26, 2012 for the entitlement of land use right for some 54,267 square meters of land located inside of our Xushui Paper Mill. The entitlement process of the purchase is expected to be completed in year 2014.

 

As of December 31, 2013, our facilities include a total of 7 production lines (PM2 through PM6, plus PM1 and PM7, both idle and undergoing a renovations), 4 warehouses, 1 office building, 2 cafeterias, and 6 dormitories (of which three are pending for entitlement procedures as a result of sale to Hebei Fangsheng in August 2013). 

   

Item 3. Legal Proceedings

 

None.

 

Item 4. Mine Safety Disclosures.

 

Not Applicable.

 

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Market Information

 

Orient Paper’s common stock is quoted on NYSE MKT Equities under the symbol “ONP”.

 

The range of high and low bid quotations by quarter from January 1, 2012 through December 31, 2013 is listed below. The quotations are taken from the NYSE MKT. They reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not necessarily represent actual transaction prices.

 

Calendar Quarter   High Bid     Low Bid  
2012 First Quarter     4.84       3.15  
2012 Second Quarter     3.81       1.87  
2012 Third Quarter     2.66       1.95  
2012 Fourth Quarter     2.10       1.66  
2013 First Quarter     3.19       1.71  
2013 Second Quarter     1.86       1.43  
2013 Third Quarter     2.37       1.48  
2013 Fourth Quarter     2.95       1.62  

 

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As of March 1, 2014, we had approximately 3,100 shareholders of record of our common stock.

 

Dividends

 

On June 1, 2012, the Company’s Board of Directors approved a quarterly cash dividend of $0.0125 per share for each of the next four quarters. The first quarterly dividend was declared on June 1, 2012 to shareholders of record as of June 15, 2012. The dividends were paid on July 2, 2012.

 

On September 4, 2012, the Company declared another quarterly dividend of $0.0125 per share to shareholders of record as of September 14, 2012. The dividends were paid on October 1, 2012.

 

On December 6, 2012, the Company declared a third quarterly cash dividend of $0.0125 per share to shareholders of record as of December 17, 2012. The dividend was paid on December 31, 2012. Total dividends declared and paid for the year ended December 31, 2012 were $692,242.

 

On April 4, 2013, the Company declared another quarterly dividend of $0.0125 per share to shareholders of record as of April 16, 2013. The dividend was paid on April 30, 2013.

 

On November 21, 2013, the Company declared another quarterly dividend of $0.005 per share to shareholders of record as of November 29, 2013. The dividend was paid on December 10, 2013. Total dividends declared and paid for the year ended December 31, 2013 were $323,032. 

  

Future declaration of dividends will depend on, among other things, the Company's results of operations, capital requirements, financial condition and on such other factors as the Company's Board of Directors may in its discretion consider relevant and in the best long term interest of the shareholders.

 

Equity Compensation Plan Information

  

On August 28, 2011, the Company’s Annual General Meeting approved the 2011 Incentive Stock Plan (the “2011 ISP”) as previously adopted by the Board of Directors on July 5, 2011. Under the 2011 ISP, the Company may grant an aggregate of 375,000 shares of the Company’s common stock to the Company’s directors, officers, employees or consultants. Specifically, the Board and/or the Compensation Committee have authority to (a) grant, in its discretion, Incentive Stock Options or Non-statutory Options, Stock Awards or Restricted Stock Purchase Offers; (b) determine in good faith the fair market value of the stock covered by any grant; (c) determine which eligible persons shall receive grants and the number of shares, restrictions, terms and conditions to be included in such grants; and (d) make all other determinations necessary or advisable for the 2011 ISP's administration. No stock or option was issued under the 2011 ISP until January 11, 2012, when the Compensation Committee granted 109,584 shares of restricted common stock to certain officers and directors of the Company. On December 31, 2013, the Compensation Committee granted remaining 265,416 shares of restricted common stock to 39 recipients who are employees, officers and directors of the Company.

 

On September 10, 2012, the Company’s Annual General Meeting approved the 2012 Incentive Stock Plan (the “2012 ISP”). Under the 2012 ISP, the Company may grant an aggregate of 200,000 shares of the Company’s common stock to the Company’s directors, officers, employees or consultants. Specifically, the Board and/or the Compensation Committee have authority to (a) grant, in its discretion, Incentive Stock Options or Non-statutory Options, Stock Awards or Restricted Stock Purchase Offers; (b) determine in good faith the fair market value of the stock covered by any grant; (c) determine which eligible persons shall receive grants and the number of shares, restrictions, terms and conditions to be included in such grants; and (d) make all other determinations necessary or advisable for the 2012 ISP's administration. On December 31, 2013, the Compensation Committee granted 31,584 shares of restricted common stock under the 2012 ISP to 39 recipients who are employees, officers and directors of the Company.

 

The total number shares of common stock under the 2011 and 2012 ISPs, including shares originally authorized by equity holders and shares remaining for future issuance as of December 31, 2013, is as follows:

 

Plan category   Number of securities to be
issued upon exercise of
outstanding options, warrants
and rights
 (a)
    Weighted-average exercise
price of outstanding options,
warrants and rights
 (b)
    Number of securities
remaining available for future
issuance under equity
compensation plans (excluding
securities reflected in column
(a))
 (c)
 
Equity compensation plans approved by security holders     n/a       n/a       168,416 *
Equity compensation plans not approved by security holders     -       n/a       -  
Total     n/a       n/a       168,416  

 * All shares remaining available for future issuance are under the 2012 ISP.

 

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Recent Sales of Unregistered Securities

 

On January 12, 2012, the Company’s Compensation Committee granted 109,584 shares of restricted common stock to certain officers and directors of the Company. The shares, which are issued out of the 2011 ISP that was approved by the 2011 Annual General Meeting, have not been registered with the Securities and Exchanges Commission. See “Equity Compensation Plan Information” above for details of the 2011 ISP.

 

On December 31, 2013, the Company’s Compensation Committee granted 297,000 shares of restricted common stock to 39 recipients who are employees, officers and directors of the Company. The shares, which are issued out of the 2011 ISP and 2012 ISP that are pre-approved by the 2011 and 2012 Annual General Meetings, have not been registered with the Securities and Exchanges Commission. See “Equity Compensation Plan Information” above for details of the 2012 ISP.

 

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

 

None.

 

Company Stock Performance

 

 

 

The above graph compares the cumulative total stockholder return from January 29, 2008, the date of our common stock first began quoted on the Over-the-Counter Bulletin Board with a reverse-split adjusted price of $2.04/share, through March 5, 2014, for our existing common stock, the S&P 500 Index and the NASDAQ Composite Index. We have assumed that dividends have been reinvested, and the returns of each company in the S&P 500 Index and the peer groups have been weighted to reflect relative stock market capitalization. The graph above assumes that $100 was invested on January 29, 2008, in each of our existing common stock, the stocks comprising the S&P 500 Index and the stocks comprising the NASDAQ Composite Index.

 

Item 6. Selected Financial Data

 

The selected financial data set forth below is derived from the consolidated financial information of the Company. The financial information has been prepared in accordance with U.S. GAAP. All financial information referred to herein is expressed in U.S. dollars unless otherwise noted.

 

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    Year Ended December 31,  
    2013     2012     2011     2010     2009  
  (in thousands, except per share data)  
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME      
Revenues   $ 125,718     $ 151,117     $ 150,747     $ 123,990     $ 102,143  
Gross profit   $ 23,326     $ 27,056     $ 32,950     $ 26,176     $ 20,035  
Selling, general and administrative expenses   $ 4,567     $ 3,361     $ 2,518     $ 3,074     $ 2,029  
Loss on impairment of assets (1)   $ -     $ (2,762 )   $ -     $ -     $ -  
Gain (Loss) from disposal of property, plant and equipment (2)   $ 85     $ 45     $ (321 )   $ (1,115 )   $ -  
Income from operations   $ 18,843     $ 20,979     $ 30,111     $ 21,986     $ 18,006  
Depreciation   $ 7,795     $ 8,383     $ 4,425     $ 4,148     $ 3,510  
Interest expense   $ 996     $ 872     $ 700     $ 633     $ 728  
Net income   $ 13,015     $ 14,673     $ 21,649     $ 15,552     $ 12,720  
Basic earnings per share   $ 0.71     $ 0.79     $ 1.18     $ 0.89     $ 1.04  
                                         
CONSOLIDATED BALANCE SHEETS                                        
Cash and cash equivalents   $ 3,131     $ 13,140     $ 4,165     $ 11,348     $ 6,950  
Accounts receivable, net   $ 3,327     $ 2,836     $ 3,821     $ 1,839     $ 2,057  
Inventories   $ 11,428     $ 15,104     $ 10,008     $ 7,423     $ 6,926  
Property, plant and equipment, net   $ 178,535     $ 122,391     $ 114,651     $ 87,446     $ 55,304  
Total assets   $ 209,526     $ 162,846     $ 144,958     $ 115,506     $ 71,700  
Total liabilities   $ 48,473     $ 20,078     $ 17,432     $ 13,964     $ 15,425  
Total shareholders' equity   $ 161,053     $ 142,769     $ 127,526     $ 101,542     $ 56,275  

 

(1) The impairment loss in 2012 is related to the planned demolition of certain equipments and parts under the renovation project of the corrugating medium PM1.
(2) The loss from disposal of property, plant and equipment in 2010 was mainly attributable to the demolition of an old corrugating medium paper production line, which location was part of the current workshop that houses our new corrugating medium PM6.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the selected financial data, the financial statements, and the notes to those statements that are included elsewhere in this annual report.

 

Results of Operations

 

Revenue for the year ended December 31, 2013 was $125,717,630, a decrease of $25,399,176 or 16.81% from $151,116,806 for the previous year.

 

Revenue of Offset Printing Paper and Corrugating Medium Paper

 

Revenue from sales of offset printing paper and corrugating medium paper (“CMP”) for the year ended December 31, 2013 was $120,747,633, a decrease of $24,181,159 or 16.68% from $144,928,792 for the previous year in 2012.  The decrease was primarily because of the suspension of production at one of our CMP production lines for renovation since January 2013. Revenue from the suspended paper machine PM1 during the year of 2012 was $28,572,825 (or 118.16% of the decrease in sales of total offset printing paper and corrugating medium paper in 2013) and was $nil in 2013. Other factor contributing the net decrease include (1) declines in Average Selling Prices (“ASPs”) for both CMP and offset printing paper products in 2013, as discussed in details below, and (2) production interruption in the first quarter of 2013 by the extended government environmental inspections of our facilities. Nevertheless, we compensated the loss in revenue from the above factors with a higher ramp up at our CMP production PM6, especially in the second half of year 2013. PM6 produced 25,672 tonnes of CMP in the month of December 2013, which represents a monthly utilization of 85.57%, versus an annual utilization rate of 48.82% for the year of 2012.

   

Total offset printing and corrugating medium paper sold during the year ended December 31, 2013 amounted to 275,745 tonnes, a decrease of 46,319 tonnes or 14.38%, compared to 322,064 tonnes sold in the comparable period in the previous year. As previously announced, we suspended in January 2013 the operation of PM1, which produced and sold 78,742 tonnes of corrugating medium paper during year 2012, for a production line renovation project. All of the CMP produced and sold in 2013 was by PM6 and totaled 217,136 tonnes, as compared to only 175,758 tonnes in 2012. The increase of 41,378 tonnes of CMP produced and sold by PM6 represents an increase of 23.54% as a result of the ramp up. The changes in revenue dollar amount and in tonnage from the year ended December 31, 2013 are summarized as follows:

 

    Year Ended     Year Ended           Percentage  
Sales   December 31, 2013     December 31, 2012     Change in     Change  
Revenue   Qty.(Tonne)     Amount     Qty.(Tonne)     Amount     Qty.(Tonne)     Amount     Qty.     Amount  
                                                 
CMP-by PM6     217,136     $ 80,896,026       175,758     $ 67,255,876       41,378     $ 13,640,150       23.54 %     20.28 %
CMP-by PM1     -     $ -       78,742     $ 28,572,825       (78,742 )   $ (28,572,825 )     n/a %     n/a %
Total Corrugating Medium Paper     217,136     $ 80,896,026       254,500     $ 95,828,701       (37,364 )   $ (14,932,675 )     -14.68 %     -15.58 %
Offset Printing Paper     58,609     $ 39,851,607       67,564     $ 49,100,091       (8,955 )   $ (9,248,484 )     -13.25 %     -18.84 %
Total Corrugating Medium and Offset Printing Paper Revenue     275,745     $ 120,747,633       322,064     $ 144,928,792       (46,319 )   $ (24,181,159 )     -14.38 %     -16.68 %

 

Monthly sales revenue (excluding revenue of digital photo paper) for the 24 months ended December 31, 2013, are summarized below:

 

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The ASPs for our main products in the year ended December 31, 2012 and 2013 are summarized as follows:

 

    Offset Printing
Paper ASP
    Corrugating
Medium Paper
ASP
 
             
Year ended December 31, 2012   $ 727     $ 377  
Year ended December 31, 2013   $ 680     $ 373  
Increase(decrease) from comparable period in the previous year   $ (47 )   $ (4 )
Increase(decrease) as a percentage     -6.46 %     -1.06 %

 

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The following is a chart showing the month-by-month ASPs (excluding the ASPs of the digital photo paper) for the 24 month period ended December 31, 2013:

 

 

 

Corrugating Medium Paper

 

Revenue from corrugating medium paper amounted to $80,896,026 (or 67.00% of total offset printing paper and corrugating medium paper revenue) for the year ended December 31, 2013, representing a $14,932,675 (or 15.58%) decrease from the corrugating medium paper revenue of $95,828,701 for the comparable period in 2012.  We sold 217,136 tonnes of corrugating medium paper in the year ended December 31, 2013 as compared to 254,500 tonnes for the same period in 2012, representing a 14.68% decrease in quantities sold. As explained above, the decrease is mainly due to the suspension of operation at PM1, which produced $28,572,825 of CMP revenue in 2012 and none in 2013. ASP for corrugating medium paper also dropped slightly from $377/tonne in 2012 to $373/tonne in the year ended December 31, 2013, representing a 1.06% decrease over the comparable period.  Despite the temporary loss of PM1 capacity and lower ASP, the ramp up of our new 360,000 tonnes/year CMP production lime PM6 produced more paper in 2013 than in 2012. Compared to 2012, PM6 produced and sold some additional 41,378 tonnes of CMP for $13,640,150 in 2013.

 

Our quarter-over-quarter ASP for CMP products has been recovering slightly since the second quarter of 2013. For the quarter ended December 31, 2013, ASP for CMP rose to $373/tonne from $369/tonne (or 1.08%) in the comparative period in 2012. We interpret the 1.08% recovery and similar trend since the second quarter of 2013 in CMP ASP as a sign of stabilization for the downward pressure in the Chinese packaging paper industry, which is largely affected by the slowdown of the domestic economic growth since the end of 2011 and an over-supply within the Chinese paper industry.

 

To cope with the contraction in paper product demand, nationwide capacity surplus and environmental pollution caused by smaller producers, the Ministry of Industry and Information Technology of China announced on July 25, 2013 the list of outdated paper capacities for the first phase of the mandatory closure of year 2013. A total of 6.21 million tonnes of paper manufacturing capacities across the country are required to be shut down in the July 25, 2013 list, including 930,800 tonnes in the province of Hebei, the area hardest hit two years in a row. We believe the central government’s 2013 mandatory capacity closure has had some substantial effects on the supply of paper in the Chinese market. Unlike the mandatory closure programs in the previous years when most of the capacities shut down related to small-scale local mills usually with less 50,000 tonnes of production capability without proper water treatment practice, the closed production lines in the 2013 mandatory closure list include a number of large capacity paper machines (up to 226,000 tonnes per line) and six large public-traded paper manufacturing companies in China. However, despite the mild economic recovery and the government's continued elimination of outdated capacity, the consensus among industry analysts, appears to be that paper ASPs in China may continue to stay the same level as in 2013 for the coming months. We believe that while the ASP for the corrugating medium paper may not substantially decline, the price may not noticeably improve in year 2014.

 

We launched the new 360,000 tonnes/year PM6 in December 2011. In December 2013 and for the first time since the launch of this production line, we produced more than 25,000 tonnes (or approximately 83% of the monthly utilization) of CMP at PM6. Quantities sold for units produced by PM6 from January 2012 to December 2013 are as follows.

 

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We are cautiously confident that, barring unforeseen events of production disruption, we should be able to maintain higher PM6 utilization rates in 2014 and afterwards.

   

Offset Printing Paper

 

Revenue from offset printing paper amounted to $39,851,607 (or 33.00% of total offset printing paper and corrugating medium paper revenue) for the year ended December 31, 2013, which represents a $9,248,484 (or 18.84%) decrease from the offset printing paper revenue of $49,100,091 for the comparable period in 2012.  We sold 58,609 tonnes of offset printing paper in the year ended December 31, 2013 compared to 67,564 tonnes of offset printing paper in the comparable period in year 2012, a decrease of 8,955 tonnes or 13.25%.  In addition to the decline in quantities produced and sold in 2013 (mainly due to the production interruption in the first quarter of 2013 during a prolonged government environmental inspection period), a declining offset printing paper ASP in year 2013 compared to year 2012 also contributed to the decrease of total offset printing paper revenue in 2013. We sold offset printing paper at an ASP of $680/tonne in the year of 2013, which is 6.46% lower than the ASP of $727/tonne in year 2012.

 

Revenue of Digital Photo Paper

 

Revenue generated from selling digital photo paper was $4,969,997 (or 3.95% of total revenue) for the year ended December 31, 2013, a decrease of $1,218,017 or 19.68% from $6,188,014 (or 4.09% of total revenue) for the year ended December 31, 2012. When comparing to the year ended December 31, 2012, the ASP of our digital photo paper in 2013 decreased slightly from $3,858/tonne to $3,871/tonne, representing a year-over-year change of 0.34%. There are more residential buildings and residents living in the surrounding areas of our digital photo paper plant than just a few years ago. We have been under increasing pressure since October 2012 by local residents and from government urban planning officials to minimize our operations during night time, which resulted in a curtailment of our production schedule. We sold 1,284 tonnes of digital photo paper in the year ended December 31, 2013, as compared to 1,604 tonnes in the same period a year ago. We continue to believe the market demand and the ASP for commercial applications of the digital photo paper may not fully recover until fundamental improvements in the PRC domestic economy take place. 

 

Changes in sales revenue and quantities sold of our digital photo paper for the years of 2013 and 2012 are summarized as follows:

 

    Year Ended     Year Ended           Percentage  
Sales   December 31, 2013     December 31, 2012     Change in     Change  
Revenue   Qty.(Tonne)     Amount     Qty. (Tonne)     Amount     Qty.(Tonne)     Amount     Qty.(Tonne)     Amount  
Digital Photo Paper     1,284     $ 4,969,997       1, 604     $ 6,188,014       (320 )   $ (1,218,017 )     -19.95 %     -19.68 %

 

 We currently produce glossy and semi-matte photo paper in various weights (from 120g/m 2 to 260g/m 2 ).   Digital photo paper products’ monthly ASPs, monthly sales quantity (in tonnes) and monthly sales revenue for the 24 months from January 2012 to December 31, 2013 are summarized as follows:

 

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Cost of Sales

 

Total cost of sales for corrugating medium paper and offset printing paper for the year ended December 31, 2013 was $98,428,893, a decrease of $20,883,229 or 17.50% from $119,312,122 for the comparable period in 2012.  Cost of sales for total corrugating medium paper amounted to $65,995,811 for the year ended December 31, 2013, as compared to $78,139,499 for the year of 2012. Because of declining raw material price since the second quarter of 2013 (see details below), average cost of sales per tonne of corrugating medium paper went down from $307 in the year of 2012 to $304 in year 2013, while average cost of sales per tonne of offset printing paper also went down from $609 in the year of 2012 to $553 in year 2013. Changes in cost of sales and cost per tonne by product for the years ended December 31, 2013 and 2012 are summarized below:

 

    For the Year ended     For the Year ended                    
    December 31, 2013     December 31, 2012     Change in     Change in percentage  
    Cost of Sales    

Cost per

tonne

    Cost of Sales    

Cost per

tonne

    Cost of Sales    

Cost per

tonne

   

Cost of

Sales

   

Cost per

tone

   
Corrugating medium paper   $ 65,995,811     $ 304     $ 78,139,499     $ 307     $ (12,143,688 )   $ (3 )     -15.54 %     -0.98 %  
Offset printing paper   $ 32,433,082     $ 553     $ 41,172,623     $ 609     $ (8,739,541 )   $ (56 )     -21.23 %     -9.20 %  
Total corrugating medium and offset printing paper   $ 98,428,893      $   n/a     $ 119,312,122     $   n/a     $ (20,883,229 )   $ n/a       -17.50 %     n/a %    

 

Global and domestic unit prices for recycled paper boards (or Old Corrugating Cardboards, “OCCs”) have been noticeably higher since October of 2012, while the costs of all other types of our major raw materials have remained relatively stable or even lower since November of 2011. However, it is observed that the quantity and price of imported OCC began to fall in April 2013, when the Chinese government’s Green Fence policy started to affect most recycled paper shipments and an increasing number of containers were rejected and turned away. The “Operation Green Fence” is a policy that was implemented by the Chinese Customs for 10 months from February to the end of the year in 2013. The goal of Operation Green Fence is to limit the importation of solid waste-contaminated shipments into China through stricter inspection and a higher rejection rate of substandard recycled materials. As a result of the Green Fence, shippers became more hesitant to ship recycled materials to China and imported recycled paper prices across the board has fallen, as suppliers have been more likely to accept lower prices in order to reduce inventory that would normally be on its way to China. Some industry commentators believe the drop should be temporary, as the Chinese mills that use imported OCC and other recycled paper will eventually exhaust their inventory and be buying imported recycled paper at a higher cost. Although the Chinese Customs has rolled out new measures after the conclusion of Operation Green Fence in October 2013 to strengthen the imported waste inspection, our observation is that the effect of the Green Fence policy has started to wane in the third quarter of 2013, hence the domestic recycled paper price may be adjusted upward accordingly.

 

Our average unit purchase costs (net of applicable value added tax) of recycled paper board and recycled white scrap paper in the year of 2013 were RMB 1,063/tonne and RMB 2,151/tonne (or approximately $171/tonne and $345/tonne), respectively, compared to RMB 1,145/tonne and RMB 2,366/tonne (or approximately $181/tonne and $375/tonne) for the year of 2012. These changes (in US dollars) represent year-over-year decreases of 5.52% and 8.00% for the OCC and recycled white scrap paper, respectively. Our production uses entirely domestic recycled paper (sourced mainly from the Beijing-Tianjin metropolitan area) and does not have to rely on imported recycled paper, which tends to have a more volatile pricing behavior than the domestic recycled paper. However, our experience suggests that the pricing of domestic recycled paper still bears some correlations to the price of imported recycled paper. Depending on the regional economic outlook for the rest of the year of 2013 and the future impact of Operation Green Fence, we believe that the short-term waste paper raw material costs, including the cost of OCC, may become volatile in the next few months and may affect our gross profit margin.

 

The pricing trends of our major raw materials for the 24-month period from January 2012 to December 2013 are shown below:

 

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Electricity and coal are the two main energy sources of our paper manufacturing activities.  Coal prices have been subject to seasonal fluctuations in China, with peaks often occurring in the winter months.  Historically, electricity and coal account for approximately 10% and 12% of our total cost of sales, or approximately 8% and 9% of total sales, respectively.  The monthly energy costs (electricity and coal) as a percentage of total monthly sales of our main paper products for the 24 months ended December 31, 2013 are summarized as follows:

 

 

Gross Profit

 

Corrugating Medium Paper and Offset Printing Paper

 

Gross profit for corrugating medium paper and offset printing paper for the year ended December 31, 2013 was $22,318,740, a net decrease of $3,297,930 or 12.87% from $25,616,670 for the year in 2012.  The decrease in gross profit of corrugating medium paper and offset printing paper was primarily attributable to the 16.68% annual decrease in CMP and offset printing paper sales revenue as explained above. The decrease in 2013 was partially offset by a favorable decline in raw material costs starting in the second quarter of 2013, as explained above.

 

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Notwithstanding the decrease in sales volume caused by the temporary suspension of PM1 for renovation and the lower ASP, because of (i) a better capacity utilization at our CMP PM6 during 2013 and (ii) a lower raw material unit costs for OCC and recycled white scrap paper as explained above, the overall gross profit margin for corrugating medium paper and offset printing paper for the year ended December 31, 2013 increased slightly by 80 basis points, from 17.68% in 2012 to 18.48% for the year ended December 31, 2013.

 

Gross profit margin for the corrugating medium paper for the year ended December 31, 2013 was 18.42%, compared to 18.46% for the comparable period a year ago. Gross profit margin for the offset printing paper was 18.62% for the year ended December 31, 2013, compared to 16.15% for the comparable period a year ago. 

 

Monthly gross profit margins on the sales of our corrugating medium paper and offset printing paper for the 24-month period ended December 31, 2013 are as follows:

 

 

Digital Photo Paper

 

Gross profit from the sales of digital photo paper for the year ended December 31, 2013 amounted to $1,006,860 or 20.26% as a percentage of total digital photo paper sales, compared with $1,439,577, or 23.26% as a percentage to total digital photo paper sales in the same period last year. In addition to the softening demand for digital photo paper products throughout year 2013, the decrease in gross profit margin is also a direct result of a lower ASP of $3,871 in the year of 2013 as compared to $3,857 in the previous year in 2012. As explained above, the daily hours of operations of our digital photo paper have been severely restricted by the local county government since October 2012 because of concerns raised by residents surrounding our digital photo paper plant over the nightly operations of the production lines. We are in the process of searching for a new industrial-use location where we can run production schedules without restrictions.

 

Selling, General and Administrative Expenses

  

Selling, general and administrative expenses for the year ended December 31, 2013 were $4,567,079, an increase of $1,206,559 or 35.90% from $3,360,520 for the prior year in 2012.  The increase was mainly attributable to, among other things, the following changes in the composition of the expenses:

 

(1) an additional $411,955 expense in stock-based compensation as the difference between the value of restricted stock issued to some 39 employees and directors during year 2013 for $790,020 and the restricted stock issued to officers and directors for $378,065 during year 2012;

 

(2) lease expense paid for the land on which our facilities in the Wei County Industrial Park are being built. We signed the lease in November 2012 and recorded a related lease expense of $95,063 for fiscal year 2012. The lease expense in 2013 was $581,179, representing an increase of $486,116 from 2012;

 

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(3) an increase in depreciation, including the amortization of land use rights for the parcel of land across the street from our Xushui Paper Mill, of $56,429 in 2013;

 

(4) an increase in the investor relations expense of $59,653 in 2013;

 

(5) an increase in legal fees in 2013 of $56,662; and

 

(6) an increase in non-stock-based compensation in 2013 of $57,130.

 

Income from Operations

 

Operating income for the year ended December 31, 2013 was $18,843,492, a decrease of $2,135,174 or 10.18% from $20,978,666 for year in 2012.  In addition to the changes in gross profit and selling, general and administrative expenses as explained above, the difference also reflects a $2,762,349 loss on impairment of assets in 2012 and an increase in gain from disposition of assets in 2013. The Company realized a net gain of $84,972 from the sale of the land use right and certain industrial and office buildings to an entity controlled by our Chairman and CEO in August 2013. Gain from disposition of assets in the year ended December 31, 2012 was $45,288.

 

Other Income and Expenses

 

Interest expense in the year ended December 31, 2013 increased by $123,860 as compared to the previous year in 2012, from $871,834 in 2012 to $995,694 in 2013. The Company had total short-term and long-term interest-bearing loans and leasing obligations in the amount of $40,317,972 as of December 31, 2013, as opposed to the total of $15,178,632 of such loans as of December 31, 2012. The Company also received government subsidies for improving environmental protection in the total amount of $171,125 during the year ended December 31, 2013.

 

Net Income

 

Net income was $13,014,648 for the year ended December 31, 2013, a decrease of $1,658,015 or 11.30% from $14,672,663 for the year of 2012. The decrease was primarily attributable to the removal of PM1 from production in 2013 for renovation and other factors as explained in the changes in items of revenue, cost of sales, and various expenses between the years of 2012 and 2013.

 

Accounts Receivable

 

Net accounts receivable and trade notes receivable increased by $491,159 (or 17.32%) to $3,327,494 as of December 31, 2013, compared with $2,836,335 as of December 31, 2012. We usually collect accounts receivable within 30 days of delivery and completion of sales.

 

Inventories

 

Inventories consist of raw materials (accounting for 92.73% of total value of ending inventory as of December 31, 2013) and finished goods. As of December 31, 2013, the recorded value of inventory decreased by 24.34% to $11,428,405 from $15,104,101 as of December 31, 2012. The largest change came from the inventory item of recycled paperboard, which is the main raw material for the production of corrugating medium paper and was stated at $8,004,988 as of December 31, 2013. The balance of recycled paperboard on December 31, 2013 was lower than the balance at December 31, 2012 by $3,269,395. Because of limited space for our raw material stocking ground, we have to place more frequent purchase orders of raw materials with our suppliers as the production of the new corrugating medium paper line ramps up. Consequently, inventory balance of recycled paperboard at any given date may fluctuate, depending on the status of the reordering point.

  

We did not purchase any recycled printed paper since May 2013 because the decision to use only recycled white scrap paper as the single feedstock for our offset printing paper at the time when relatively low raw material prices justifies the reduced workload of our water treatment plant for deinking the recycled printed paper.

 

A summary of changes in major inventory items is as follows:

 

    December 31,
2013
    December 31,
2012
    $ Change     % Change  
Raw Materials                                
Recycled paper board   $ 8,004,988     $ 11,274,383     $ (3,269,395 )     -29.00 %
Pulp     14,257       13,813       444       3.21 %
Recycled printed paper     -       884,236       (884,236 )     -100 %
Recycled white scrap paper     1,791,873       766,144       1,025,729       133.88 %
Coal     573,799       621,107       (47,308 )     -7.62 %
Digital photo base paper and other raw materials     212,984       225,912       (12,928 )     -5.72 %
Total Raw Materials     10,597,901       13,785,595       (3,187,694 )     -23.12 %
                                 
Finished Goods     830,504       1,318,506       (488,002 )     -37.01 %
Totals   $ 11,428,405     $ 15,104,101     $ (3,675,696 )     -24.34 %

 

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Asset Held For Sale

 

As of December 31, 2013, assets held for sale in the amount of $4,130,590 represented the three employee dormitory buildings to be sold for a gross sales price of approximately $4,277,853 to a related party company controlled by our Chairman and CEO Mr. Zhenyong Liu. As the sale was not yet completed by December 31, 2013, the dormitories were classified as held for sale in accordance with ASC 360-10-35. It was expected that the sales will be consummated in the second half of year 2014.

 

Accounts Payable

 

Accounts payable was $926,571 as of December 31, 2013, a decrease of $86,335 or 8.52% from $1,012,906 as of December 31, 2012.  All accounts payable as of December 31, 2013 and December 31, 2012 were within the normal payment terms of our suppliers.

 

Other payables and accrued liabilities

 

Other payables and accrued liabilities was $2,651,472 as of December 31, 2013, an increase of $1,389,188 over the balance of the account at $1,262,284 as of December 31, 2012. The increase is mainly attributable to (1) a value added tax (“VAT”) payable and other surcharges of $940,400 as of December 31, 2013, as opposed to $nil as of December 31, 2012, (2) and increase in $289,742 in accrued interest expense for the loan payable to our Chairman and CEO and a long-term bank loan, and (3) an accrued worker’s compensation settlement for a work-related accident for approximately $155,427 as of December 31, 2013.

  

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Liquidity and Capital Resources

 

Overview

 

As of December 31, 2013 we had a net working capital deficit of $2,419,395, a decrease of $24,286,039 from the net working capital of $21,866,644 at December 31, 2012. While total current assets at December 31, 2013 amounted to $25,953,328, which was lower than the balance as of December 31, 2012 by $12,114,239, we have substantially more current liabilities at December 31, 2013 than as of December 31, 2012. Because of a three-year sale-leaseback financing that we secured on June 16, 2013 (see details below), current liabilities at December 31, 2013 included a current portion of the capital lease payable in the amount of $8,264,795. There are also various dues to related parties in the total amount of approximately $2,266,961 as of December 31, 2013, including security deposit, rent payable and accrued interest payable to our Chairman and CEO Mr. Zhenyong Liu. Most of our current short-term and long-term bank loans are either revolving or term loans, but we do expect to renew the loans with the banks and the credit union with similar terms at or before maturity. Except for the sale-leaseback financing and the new 5-year, $4.30 million loan from a local credit union borrowed on July 15, 2013, all of our short-term and long-term bank loans feature interest-only monthly or quarterly payments with balloon payment for the entire principal at the maturity of the loan. In addition to the quarterly interest payment, the 5-year credit union loan requires semi-annual principal repayment of approximately $16,361, with one large balloon payment of approximately $4 million at maturity. The CNFTFL lease financing requires quarterly payment of both interest and principal repayment, ranging from approximately $4.5 million to approximately $63,585 during the entire three-year term.

 

We finance our daily operations mainly by cash flows generated from our business operations and loans from banking institutions (including leasing companies) and our major shareholders. Major capital expenditures in the year of 2013 were primarily financed by cash flows generated from business operations and the CNFTFL sale-leaseback described below. As of December 31, 2013, we had approximately $51,673,158 in capital expenditure commitments that were mainly related to the construction costs of manufacturing equipments and other facilities in a new industrial park in Wei County of Hebei, China, where we will eventually build two tissue paper production lines PM8 and PM9, and install other paper production machineries in the future.

 

We expect to finance such capital expenditure commitments mainly by cash flows internally generated from our business operations and possibly more debt financings to support the future capital expenditure and capacity expansions. We expect to satisfy all of the commitments as of December 31, 2013 within the next 12-18 months. We generated approximately $30 million of cash from our operating activities during the year of 2013. On March 27, 2014, Hebei Tengsheng Paper Co. Ltd., which owns the land use rights of about 330 acres (or 1.33 million square meters) of land in the Wei County Industrial Park and leases about one-fourth of the premises to Orient Paper HB as our production base of tissue paper and other future facilities, agreed in writing to unconditionally provide land use rights to the 330 acres of land as third party collateral for additional bank borrowings in 2014 by Orient Paper HB. Based on the current market value of the land use rights and a 50%-60% loan out ratio, we estimate the maximum amount of debt financing with the entire 330 acres of Wei Country land will be between $36.6 million and $44.0 million.

 

On March 21, 2014 the provincial branch of the Industrial & Commercial Bank of China (“ICBC”) approved a new maximum total banking credit facility for Orient Paper HB for approximately $24.5 million in the year of 2014. We already had various working capital loans for a total of $6.5 million from ICBC as of December 31, 2013, which means that we may be able to draw additional financing under the maximum ICBC facility for up to $18 million. We expect the ICBC may tap into some of the above 330 acres of land use rights as security

 

Our loan-to-equity ratio was 30.10% as of December 31, 2013. Our debt-asset ratio was 23.13% as of December 31, 2013. According to a search conducted by www.chinadiaoyan.com , the industry average of debt-asset ratio was 53.06% as of September 30, 2013 for the 20 large paper mills that are publicly listed in China. Of the 20 paper mill companies publicly listed in the Chinese stock exchanges, the top 6 (ranked by total revenue) all had debt-asset ratio exceeding 60%. Aside from the short-term liquidity situation, we believe that our overall financial condition, compared to our Chinese peers, is reasonably healthy and should allow us to reasonably expand our financial debt leverage to provide capital for future growth.

 

We are seeking more working capital loans to support the operations of our legacy CMP and printing paper business so that we may use more cash generated from operating activities to pay for our capital expenditures. On March 3, 2014 we obtained a revolving line of credit facility under which we may draw notes payable for approximately $3.3 million from Shanghai Pudong Development Bank. Hebei Fangsheng Real Estate Development Co. Ltd., which is controlled by our Chairman and CEO Mr. Zhenyong Liu, unconditionally provided certain land use rights that it owns as collateral to secure its guarantee of the notes. The facility has a term for the period of March 3, 2014 through January 12, 2015.

 

On March 25, 2014, our Chairman and CEO Mr. Zhenyong Liu agreed in writing to permit the Company to continue to postpone the repayment of the accrued interest on his loan to Orient Paper HB until the Company is able to pay its other creditors in the normal course of business. The accrued interest owned to Mr. Liu was approximately $566,343 and was recorded as part of the currently liabilities as of December 31, 2013.

 

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We are currently seeking to raise funds through long-term loans to pay off liabilities with shorter terms. We cannot guarantee that our effort would be successful. Nor can we guarantee that we would always be able to obtain additional funding to meet our liquidity needs. If we are unable to obtain sufficient banking facilities or generate sufficient operating cash flow internally, the progress of the construction or renovation may be slowed down. We may also have to curtail the scope of the capital expenditure projects or to shelf some components of the projects (for example, delay the installation of PM9 until additional capital resources are available). See “Risk Factors – Risks Relating to Our Business—Our liquidity position poses risk to our operations, especially our capacity expansion projects.”

 

Financing with Sale-Leaseback

 

The Company entered into a sale-leaseback arrangement (the “Lease Financing Agreement”) with China National Foreign Trade Financial & Leasing Co., Ltd ("CNFTFL") on June 16, 2013, for a total financing proceeds in the amount of RMB150 million (approximately US$24 million). Under the sale-leaseback arrangement, Orient Paper HB sold certain of its paper manufacturing equipment (the “Leased Equipment”) to CNFTFL for an amount of RMB 150 million (approximately US$24 million). Concurrent with the sale of equipment, Orient Paper HB leases back all of the equipment sold to CNFTFL for a lease term of three years. At the end of the lease term, Orient Paper HB may pay a nominal purchase price of RMB 15,000 (approximately $2,400) to CNFTFL and buy back all of the Leased Equipment. The sale-leaseback is treated by the Company as a mere financing and capital lease transaction, rather than a sale of assets (under which gain or loss is immediately recognized) under ASC 840-40-25-4. All of the Leased Equipment are included as part of the property, plant and equipment of the Company’s as of December 31, 2013; while the net present value of the minimum lease payment (including a lease service charge equal to 5.55% of the amount financed) was recorded as obligations under capital lease and was calculated with CNFTFL’s implicit interest rate of 6.15% per annum and stated at $25,750,170 at the inception of the lease on June 16, 2013. As of December 31, 2013 the balance of the long-term obligations under capital lease was $12,296,639, which is net of its current portion in the amount of $8,264,795.

 

Total interest expenses for the sale-leaseback arrangement for the year ended December 31, 2013 and 2012 were $471,473 and $nil, respectively.

 

As a result of the sale, a deferred gain on sale of Leased Equipment in the amount of $1,379,282 was created at the closing of the transaction and presented as a non-current liability. The deferred gain would be amortized by the Company over the lease term and would be used to offset the depreciation of the Leased Equipment, which was recorded at the new cost of $25,993,677 as of December 31, 2013.

 

As part of the sale-leaseback transaction, Orient Paper HB entered into a Collateral Agreement with CNFTFL and pledged the land use right in the amount of approximately $7,502,794 on some 58,566 square meters of land as collateral for the lease. In addition to Orient Paper HB’s collateral, Orient Paper Shengde also entered into a Guarantee Contract with CNFTFL on June 16, 2013. Under the Guarantee Contract, Orient Paper Shengde agrees to guarantee Orient Paper HB’s performance under the lease and agrees to pledge essentially all of its production equipment as additional collateral. Net book value of Orient Paper Shengde’s asset guarantee was $36,134,038 as of December 31, 2013.

 

Capital Expenditures

 

We have plans for several capital expenditure projects for the year of 2014 and early 2015. These projects include: (1) three workshops, four warehouses, an office building, employee cafeteria, and two employee dormitory buildings, as well as infrastructure and landscaping projects in the Wei County Industrial Park for an estimated cost of $20 million (which is in addition to the contracts that we have already entered into as of December 31, 2013), (2) a second 15,000 tonnes/year tissue paper production line (to be designated as PM9) for an estimated cost of $8.3 million, and (3) completing the major renovation of the old corrugating medium paper production line PM1 and related facilities to enhance energy efficiency and produce the new product of insulation liner paper with an remaining unpaid cost of approximately $4.3 million. We estimate that total capital expenditure for 2014 to be approximately $32.6 million, which is expected to be funded by additional debt financing, cash on hand and cash flows generated from our own operations. Our cash and cash equivalents was $3,131,163 as of December 31, 2013, and cash flows generated from our own operations amounted to approximately $29.92 million in the year ended December 31, 2013. We believe that, unless we encounter major operational problem or production interruption, such as the comprehensive environmental inspection in February and March of 2013, the Company should be able to generate sufficient cash flows from its operations to help support the capital expenditures of 2014 and the first half of 2015. However, if we are unable to obtain sufficient banking facilities or generate sufficient operating cash flows internally, the progress of the construction or renovation may be slowed down. We may also have to curtail the scope of the capital expenditure projects or to shelf some components of the projects (for example, delay the installation of PM9 until additional capital resources are available).

 

41
 

 

Acquisition of Land

 

In the spring of 2010, we initiated the process of acquiring approximately 667,000 square meters of land adjacent to our Xushui Paper Mill facilities and have received governmental approval for our capacity expansion plan. However, since the start of the acquisition process, we have met significant opposition by certain local residents over the price that we offered for their land. On April 13, 2012, we closed our acquisition of 58,566 square meters of land and secured all associated land use right permits. For the 58,566 square meters of land acquired, we paid a total of $7.5 million for various payments of compensation, taxes, and recording fees to the sellers and the local government.

 

Relocation of Facilities and Sale of Headquarters Compound Real Properties

 

A recent Xushui County urban redevelopment plan mandates that the current site of our Headquarters Compound and its neighboring area be reserved for residential use only and that, like other manufacturers in the covered area, we will be required to eventually cease all operations currently conducted on our Headquarters Compound site. In order to comply with this government mandate, we intend to initiate the process of relocating our offices and facilities to a new site. To that end, we have entered into negotiations concerning the potential sale of this property and all of the buildings and facilities located thereon (the “Potential Sale”) with Hebei Fangsheng Real Estate Development Co., Ltd. (“Hebei Fangsheng”), a real estate development company recently formed and owned by Mr. Zhenyong Liu, our Chairman and Chief Executive Officer and his family. In November 2012, Hebei Fangsheng provided us with a payment of $1,075,606 earnest money deposit payment to proceed with discussion, as no binding agreement between Hebei Fangsheng and the Company was reached in connection with the Potential Sale at that time. The earnest money deposit would be refunded to Hebei Fangsheng in the event that the parties fail to reach an agreement on the terms of the Potential Sale. We have previously announced that we intended to pursue negotiations with respect to the Potential Sale on an arm’s length basis with Hebei Fangsheng, and would only consummate such Potential Sale on terms that would be not less advantageous to us than as if Hebei Fangsheng were an independent, unaffiliated party. We would only enter into legally binding agreements with Hebei Fangsheng in connection with the Potential Sale upon appraisals by independent appraisal firms, and a finding by our Audit Committee that these conditions have been met.

 

On August 7, 2013 the Company’s Audit Committee and the Board of Directors approved the sale of the land use right of the Headquarters Compound (the “LUR”), the office building and essentially all industrial-use buildings in the Headquarters Compound (the “Industrial Buildings”), and three employee dormitory buildings located within the Headquarters Compound (the “Dormitories”) to Hebei Fangsheng for cash prices of approximately $2.77 million, $1.15 million, and $4.28 million, respectively. In connection with the sale of the Industrial Buildings, Hebei Fangsheng agrees to lease the Industrial Buildings back to the Company for its original use for a term of up to three years, with an annual rental payment of approximately $161,439. As a condition for the sale of the Dormitories, Hebei Fangsheng agrees that it will act as an agent for the Company, which does not have the qualification to sell residential housing units in China, and that it is obligated to sell all of the 132 apartment units in the Dormitories to qualified employees of the Company at its acquisition price. Hebei Fangsheng further represents that it will not seek to profit from the resale of the Dormitories units and will allow the Company to inspect the books and records of the sale upon completion of the resale of the Dormitories units to ensure the objectives are achieved.

 

The sale was conducted on an arms-length basis, and was reviewed by the Company’s Audit Committee and approved by the Board of Directors. The $2.77 million sale price of the industrial land use right was determined by the valuation from a government designated appraisal, which was 3.35% higher than a second independent appraisal commissioned by the Company. The $1.15 million sale price of the Industrial Buildings was determined by negotiation between the Company and Hebei Fangsheng and is equal to the appraised value based on the assumption that the use of the buildings would be continued until they are retired. Based on the assumption that such buildings would have to be torn down to comply with the re-zoning, a second independent appraisal obtained by the Company put the value at $0.4 million. Although the Company and Hebei Fangsheng agree to set the sale price of the Dormitories at the Company’s original construction cost of the three dormitory buildings for $4.28 million, an independent appraisal shows that the value for the three buildings as employee dormitories was $4.61 million. The Company internally estimated that had the Company been a licensed real estate developer and allowed to resell the dormitory units, the fair market value of the Dormitories (which is located within the wall of our Headquarters Compound and next to the digital photo paper factory) could be approximately $5.10 million.

 

As of December 31, 2013, the sale of the LUR and Industrial Buildings has been completed. The Company generated a total sales price of $3,920,927 and a net gain on disposal of approximately $84,972. Land appreciation tax and other transactional taxes and fees in the amount of approximately $235,556 are paid out of the proceeds of the sale to various local government tax authorities. We expect the sale of Dormitories will be closed in the second half of 2014. Net proceeds from the sale will be in the approximate total amount of $7.96 million and are expected to be used to fund our tissue paper production line construction.

 

We have not identified new locations for the office and the digital photo paper workshop but are exploring the possibility of moving the headquarters office to near our Xushui Paper Mill. We may also consider moving the digital photo paper operations to the new industrial park in Wei County.

  

  Wei County Tissue Paper PM8 and PM9

 

In November 2012 we entered into a 15-year land lease with a land investment company in Wei County for the purpose of developing the 49.4 acres of land into the base of our next capacity expansion. In December 2012 we signed a contract with an equipment contractor in Shanghai to build the first of our two tissue paper production lines in Wei County. The two production lines, each having 15,000 tonnes/year capacity, will be designated as PM8 and PM9 upon completion. Total estimated cost of the tissue paper project (excluding the general infrastructures and administrative facilities such as warehouses, offices, dorms, landscaping, etc) may be up to $65.1 million.

 

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Renovation of PM1

 

We have decided to take voluntary action to renovate our 150,000 tonnes/year corrugating medium PM1 in anticipation of increased regulatory concerns on energy efficiencies. A renovation plan is being developed to rebuild a new paper machine in line with the Company’s upgrade and modernization program. The renovation period is scheduled for the period of December 31, 2012 through the end of year 2014. There will be no production output from PM1 throughout the renovation period, as most of the equipment and parts of the paper machine portion of the production line will be demolished and replaced. As of December 31, 2013, the Company is in the process of rebuilding PM1 into a 2.64-meter width production machine for the production of thermal liner paper, which is a building construction material. Thermal liner paper uses recycled paper board, or OCC, as its primary raw material and will be sold to construction material suppliers. Under the current plan, the Company expects the PM1 renovation project will cost approximately $6.8 million (of which approximately $2.5 million was already paid in year 2013) in total and will come online in early second quarter of year 2014, ahead of its original goal line in the second half of 2014.

  

While we have always been in discussion with financial institutions for debt financing opportunities, we currently do not have plan for any equity financing transaction in the next 12 months.

 

Cash and Cash Equivalents

 

Our cash and cash equivalents as of December 31, 2013 was $3,131,163, a decrease of $10,009,125 from $13,140,288 as of December 31, 2012.  The decrease of cash and cash equivalents during the year ended December 31, 2013 was primarily attributable to the use of cash to fund our capital expenditure in the Wei County Industrial Park, as explained above, and a number of other factors including the following:

 

i. Net cash provided by operating activities

 

Net cash provided by operating activities was $29,921,941 for the year ended December 31, 2013 and is the largest amount of net cash flow generated from operating activities in our corporate history. The 2013 balance represents an increase of $7,689,975 or 34.59% from $22,231,966 for the year of 2012.  The net income of the year ended December 31, 2013 in the amount of $13,014,648, representing a decrease of $1,658,015 or 11.30% from $14,672,663 for the year of 2012.  Nevertheless, changes in various asset and liability account balances throughout the year of 2013 cause the net cash generated from operating activities in 2013 to exceed the amount of cash similarly generated in 2012. Chief among such changes is the decrease in inventory (and as an increase to net income for the 2013 cash flow purposes) as of December 31, 2013 for $4,105,876, compared to a year-over-year increase in inventory (and as a reduction from net income for 2012 cash flow purposes) as of December 31, 2012 for $5,024,459. In addition to the increase in cash from the reduction in the 2013 inventory balance, the Company had non-cash expenses in (1) depreciation and amortization in the amount of $7,794,743 in year 2013 and (2) stock-based compensation in the amount of $773,862 that are added back to the net income for cash flow purposes. The Company also had a net decrease in prepayment and other current assets for $1,211,679, a net increase in notes payable for $1,614,387, and a net decrease in other payables and accrued liabilities for $1,599,375 that are added back to the net income as positive cash flow from operating activities during the year of 2013. These additions are further reduced by a net increase in deferred tax asset for $409,665 and a net decrease in income tax payable for $200,900.

 

  ii. Net cash used in investing activities

 

We incurred $60,362,479 in net cash expenditures for investing activities during the year ended December 31, 2013, compared to $11,915,693 for the previous year in 2012. Essentially all expenditures in the year ended December 31, 2013 were for the progress payments for (1) the construction of our first tissue paper production line PM8 and related facilities, including a new office, two employee dormitories, a cafeteria, pulping station, three paper mill workshops and maintenance workshops, and four warehouses at the Wei County industrial park in Wei County, Hebei province, and (2) renovation cost for production line PM1. The cash expenditures for investing activities for the year of 2012 were mainly for constructing employee dormitories (for a total cost of approximately $4.6 million) in our Headquarters Compound and ancillary facilities of the new corrugating medium paper production line in the Xushui Paper Mill, including the facilities to house a new 75-tonne boiler, and additional power substation equipment. We expect to finance any future capital expenditure commitment with cash flows from operating activities in the next twelve months, and additional bank loans or capital leases, if necessary.

 

During the year ended December 31, 2013, we received the security deposit and net proceeds from the sale of the Dormitories and the Headquarters Compound LUR to Hebei Fangsheng in the amount of approximately $1,614,387 and $2,589,919, respectively.

 

iii. Net cash provided by financing activities

 

Net cash provided by financing activities was $20,100,686 for the year ended December 31, 2013, as compared to net cash used in financing activities in the amount of $1,367,557 for the year in 2012. During the year ended December 31, 2013, we entered into a sale-leaseback agreement with CNFTFL and obtained proceeds from the sale of certain of our production equipment in the amount of approximately $24.2 million (see “Financing with Sale-Leaseback” above for details). As of December 31, 2013 we have made the first three interest and principal payments under the lease to CNFTFL in the total amount of approximately $6,219,426 (included the 5.55% lease service charge in the amount of approximately $1,362,030). The sale-leaseback is intended as a financing arrangement, rather than separate transactions of sale of assets and a lease. Under the sale-leaseback agreement with CNFTFL, we may purchase all of the assets sold to CNFTFL with a nominal purchase price of approximately $2,400 when all principal and interest payments (approximately $27 million in three years) are paid off in June 2016.

 

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In addition to the CNFTFL financing, we also had three short-term bank loans and one long-term local credit union loan matured and paid-off during the year of 2013. We used $8,281,807 in cash to honor the principal repayment obligations of these short-term and long-term bank loans before renewing these loans in year 2013. We also renewed the two short-term bank loans and a long-term credit union loan during year 2013 and received the proceeds from the renewal of these loans in the total amount of $6,667,420. We also entered into a new short-term bank loan agreement with ICBC for a loan balance of $4,035,969 on September 2, 2013.

 

Short-term bank loans

 

   

December 31,

2013

   

December 31,

2012

 
Industrial & Commercial Bank of China (a)  $ -      $ 792,568  
Industrial & Commercial Bank of China (b)   -       1,585,138  
Bank of Hebei (c)   -       1,585,138  
Industrial & Commercial Bank of China (d)   4,090,180       -  
Industrial & Commercial Bank of China (e)    818,036       -  
Industrial & Commercial Bank of China (f)   1,636,072       -  
Total short-term bank loans   $ 6,544,288     $ 3,962,844  

 

(a)

On September 4, 2012, the Company refinanced with the Industrial & Commercial Bank of China (“ICBC”) an accounts receivable factoring facility with a maximum credit limit of $792,568 as of December 31, 2012. Under the factoring agreement, the bank has recourse against the Company if the receivables, which remain in the Company’s books at all times, are not fully collected. The factoring facility carried an interest rate of 6.6% per annum. The Company paid off the principal balance and accrued interest under the factoring facility on August 28, 2013. 

 

 (b) On November 9, 2012, the Company obtained from the ICBC another accounts receivable factoring facility with a maximum credit limit of $1,585,138 as of December 31, 2012. Under the factoring agreement, the bank has recourse against the Company if the receivables, which remain in the Company’s books at all times, are not fully collected. The term of the factoring facility expired on November 8, 2013 and carried an interest rate of 6.6% per annum, or 1.0% plus the prime rate for the loan set forth by the People’s Bank of China at the time of funding. The Company paid off the principal balance and accrued interest under the factoring facility on November 8, 2013.
   
(c) On September 19, 2012, the Company obtained from the Bank of Hebei a new banking facility with maximum credit limit on bank loans of $1,585,138 and on notes payable of $1,585,138 as of December 31, 2012. The facility was guaranteed by an independent third party. On the same day, the Company drew down from this banking facility a new working capital loan of $1,585,138 as of December 31, 2012. The loan bore interest at the rate of 6.6% per annum. Both the term of the banking facility and loan were for one year and expired on September 19, 2013. The Company paid off the loan balance on September 18, 2013.
   
(d)

On September 2, 2013, the Company entered into a working capital loan agreement with the ICBC for $4,090,180, with which $818,036 is payable on June 5, 2014 and $3,272,144 is payable on August 15, 2014. The loan bears an interest rate of 115% over the primary lending rate of the People’s Bank of China and was at 6.9% per annum at the time of funding.

 

 Concurrent with the signing of the working capital loan agreement, the Company also entered into a trust agreement with the ICBC, which provides trust account management services to the Company during the terms of the underlying loan. The working capital loan is guaranteed by Hebei Fangsheng Real Estate Development Co. Ltd. (“Hebei Fangsheng”) with the land use right on our Headquarters Compound pledged by Hebei Fangsheng as collateral for the benefit of the bank. The land use right on our Headquarters Compound was acquired by Hebei Fangsheng from the Company on August 9, 2013 (see “Relocation of Facilities and Sale of Headquarters Compound Real Properties” above for the related party transaction). Hebei Fangsheng is controlled by the Company’s Chairman and CEO Mr. Zhenyong Liu. 

 

(e)

On September 6, 2013, the Company obtained a new accounts receivable factoring facility from the ICBC for $818,036. Under the factoring agreement, the bank has recourse against the Company if the receivables, which remain in the Company’s books at all times, are not fully collected. The factoring facility will expire on August 4, 2014 and bears an interest rate of 110% of the primary lending rate of the People’s Bank of China and was at 6.6% per annum at the time of funding.

 

 Concurrent with the signing of the new factoring agreement, the Company also entered into a financial service agreement with ICBC, which provides accounts receivable management services to the Company during the terms of the underlying factoring facility. The factoring facility is personally guaranteed by the Company’s Chairman and CEO Mr. Zhenyong Liu.

 

(f) On December 3, 2013, the Company obtained from the ICBC an accounts receivable factoring facility with a maximum credit limit of $1,636,072 as of December 31, 2013. Under the factoring agreement, the bank has recourse against the Company if the receivables, which remain in the Company’s books at all times, are not fully collected. The term of the factoring facility expires on October 21, 2014 and carries an interest rate of 6.6% per annum, or 1.0% plus the prime rate for the loan set forth by the People’s Bank of China at the time of funding. The unpaid balance of the loan was in the amount of $1,636,072 as of December 31, 2013.

 

44
 

 

As of December 31, 2013 and 2012, there were secured short-term borrowings of $6,544,288 and $2,377,706, respectively, and unsecured bank loans of $nil and $1,585,138, respectively. The factoring facility was secured by the Company’s accounts receivable in the amount of $3,272,528 and $2,836,335 as of December 31, 2013 and 2012, respectively.

 

As of December 31, 2013 and 2012, the Company had no unutilized credit facility for bank loans with the banks. The average short-term borrowing rates for the years ended December 31, 2013, 2012 and 2011 were approximately 6.68%, 7.82% and 6.38%, respectively.

 

Long-term loans from credit union

 

As of December 31, 2013 and 2012, loan payable to Rural Credit Union of Xushui County, amounted to $5,914,401 and $5,730,273, respectively.

 

On March 31, 2011, the Company entered into a three-year term loan agreement with Rural Credit Union of Xushui County for an amount that is $1,611,531 as of December 31, 2013 and $1,561,361 as of December 31, 2012. The loan is guaranteed by an independent third party. Interest payment is due quarterly and bears the rate of 0.72% per month. As of December 31, 2013, the entire balance of the loan in the amount of $1,611,531 was presented as current portion of long-term loan from credit union in the consolidated balance sheet.

 

On June 10, 2011, the Company entered into a term loan agreement with the Rural Credit Union of Xushui County for an amount that was $4,168,912 as of December 31, 2012. Interest payment is due quarterly and bears the rate of 0.72% per month. The loan is secured by its manufacturing equipment of $9,316,645 as of December 31, 2012, and became matured on June 9, 2013. On July 26, 2013, the Company paid off the unpaid principal balance and accrued interest.

 

On July 15, 2013, the Company entered into a new agreement with the Rural Credit Union of Xushui County for a term of 5 years, which is due and payable on various scheduled repayment dates between December 21, 2013 and July 26, 2018. The loan is secured by certain of the Company’s manufacturing equipments in the amount of $21,901,456 as of December 31, 2013. Interest payment is due quarterly and bears a fixed rate of 0.72% per months. As of December 31, 2013, total outstanding loan balance was $4,302,870, with $49,082 becoming due within one year and presented as current portion of long term loan from credit union in the consolidated balance sheet.

 

Total interest expenses for the short-term bank loans and long-term loans for the years ended December 31, 2013, 2012 and 2011 were $828,157, $736,457 and $495,978, respectively. 

 

Shareholder Loans

 

Mr. Zhenyong Liu is the director, principal stockholder and chief executive officer of the Company. He loaned money to Orient Paper HB for working capital purposes over a period of time. On August 31, 2009, Orient Paper, Orient Paper HB, and Mr. Liu entered into a tri-party Debt Assignment and Assumption Agreement, under which Orient Paper agreed to assume the loan of $4,000,000 due from Orient Paper HB to Mr. Liu. Concurrently, Orient Paper issued 1,204,341 shares of restricted common stock to Mr. Liu at the market price of $3.32132 per share.

 

The unsecured loan of Mr. Liu is interest bearing and the interest rate is equal to the rate established by the People’s Bank of China, which was 5.85% per annum as of December 31, 2012. The term is for 3 years and starts from January 1, 2010 and is due December 31, 2012. On January 1, 2013, Orient Paper HB and Mr. Liu entered into another three-year term and extended the maturity date further to December 31, 2015. The unsecured loan carries an annual interest rate based on the People’s Bank of China at the time of the renewal and was set at 6.15% per annum. As of December 31, 2013, net amount due to Mr. Liu was $2,389,633.

 

The interest expenses incurred for above related party loans are $145,015, $135,377 and $203,914 for the years ended December 31, 2013, 2012 and 2011, respectively.

 

During the years ended December 31, 2013 and 2012, the Company borrowed $1,390,802 and $1,030,097, respectively, from shareholders to pay for various expenses incurred in the U.S. The amount is repayable on demand with interest free. The Company repaid the entire balance by the end of fiscal year 2013 and 2012, respectively.

   

Critical Accounting Policies and Estimates

 

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Management makes these estimates using the best information available at the time the estimates are made. However, actual results could differ materially from those estimates. The most critical accounting policies are listed below:

 

45
 

 

Revenue Recognition Policy

 

The Company recognizes revenue when goods are delivered and a formal arrangement exists, the price is fixed or determinable, the delivery is completed, no other significant obligations of the Company exist, and collectability is reasonably assured.  Goods are considered delivered when the customer’s truck picks up goods at our finished goods inventory warehouse.

 

Long-Lived Assets

 

The Company evaluates the recoverability of long-lived assets and the related estimated remaining useful lives when events or circumstances lead management to believe that the carrying value of an asset may not be recoverable and the undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amount. In such circumstances, those assets are written down to estimated fair value. Our judgments regarding the existence of impairment indicators are based on market conditions, assumptions for operational performance of our businesses, and possible government policy toward operating efficiency of the Chinese paper manufacturing industry. For the years ended December 31, 2013, no events or circumstances occurred for which an evaluation of the recoverability of long-lived assets was required. We are currently not aware of any events or circumstances that may indicate any need to record such impairment in the future.

 

Foreign Currency Translation

 

The functional currency of Orient Paper HB and Orient Paper Shengde is the Chinese Yuan Renminbi (“RMB”).  Under ASC Topic 830-30, all assets and liabilities are translated into United States dollars using the current exchange rate at the end of each fiscal period. The current exchange rates used by the Company as of December 31, 2013 and 2012 to translate the Chinese RMB to the U.S. Dollars are 6.1122:1 and 6.3086:1, respectively. Revenues and expenses are translated using the prevailing average exchange rates at 6.1943:1, and 6.3116:1 for the years ended December 31, 2013 and 2012, respectively. Translation adjustments are included in other comprehensive income (loss).

 

Contractual Obligations and Off-Balance Sheet Arrangements

 

Contractual Obligations

 

We have certain fixed contractual obligations and commitments that include future estimated payments as of December 31, 2013. Changes in our business needs, cancellation provisions, changing interest rates, and other factors may result in actual payments differing from the estimates. We cannot provide certainty regarding the timing and amounts of payments. We have presented below a summary of the most significant assumptions used in our determination of amounts presented in the tables, in order to assist in the review of this information within the context of our financial position, results of operations, and cash flows.  

 

    Payments Due by Period  
Contractual Obligations   Total     Less than
1 year
    1 - 3 years     4 - 5 years     More than
5 years
 
Debt Obligations (including sale-leaseback payment obligations)   $ 40,091,113     $ 18,964,117     $ 16,368,513     $ 4,758,483     $ -  
Equipment and Construction Costs Commitment     51,673,158       51,673,158       -       -       -  
Operating Lease Obligations     8,436,484       707,680       1,544,452       1,217,238       4,967,115  
Total   $ 100,200,755     $ 71,344,955     $ 17,912,965     $ 5,975,721     $ 4,967,115  

 

Incentive Stock Plan

 

On August 28, 2011, the Company’s Annual General Meeting approved the 2011 ISP as previously adopted by the Board of Directors on July 5, 2011. Under the 2011 ISP, the Company may grant an aggregate of 375,000 shares of the Company’s common stock to the Company’s directors, officers, employees or consultants. No stock or option was issued under the 2011 ISP until January 11, 2012, when the Compensation Committee granted 109,584 shares of restricted common stock to certain officers and directors of the Company. On December 31, 2013, the Compensation Committee granted remaining 265,416 shares of restricted common stock under the 2011 ISP to certain officers and directors of the Company.

 

46
 

 

On September 10, 2012, the Company’s Annual General Meeting approved the 2012 ISP. Under the 2012 ISP, the Company may grant an aggregate of 200,000 shares of the Company’s common stock to the Company’s directors, officers, employees or consultants. Specifically, the Board and/or the Compensation Committee have authority to (a) grant, in its discretion, Incentive Stock Options or Non-statutory Options, Stock Awards or Restricted Stock Purchase Offers; (b) determine in good faith the fair market value of the stock covered by any grant; (c) determine which eligible persons shall receive grants and the number of shares, restrictions, terms and conditions to be included in such grants; and (d) make all other determinations necessary or advisable for the 2012 ISP's administration. On December 31, 2013, the Compensation Committee granted 31,584 shares of restricted common stock under the 2012 ISP to certain officers and directors of the Company.

 

Cross-Guarantee with a Third Party

 

As of December 31, 2012, the Company used land use right in the amount of $7,419,614 as a pledge for a bank loan of an independent third party, which cross-guarantees the Company’s credit facility of $1,585,138 from the Bank of Hebei. That long-term loan of the third party had been paid off on June 3, 2013, while the credit facility guaranteed by the independent third party expired on September 19, 2013.

 

Off Balance Sheet Arrangements

 

None.

 

Recent Accounting Pronouncements

 

In July 2013, the FASB issued ASU 2013-11, Income Tax (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. The ASU provides guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The amendments in this Update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Its adoption of ASU2013-11 is not expected to have any material impact on the Company's consolidated financial statements.

 

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Item 7A. Quantitative and Qualitative Disclosures about Market Risk

 

Foreign Exchange Risk

 

While our reporting currency is the US dollar, almost all of our consolidated revenues and consolidated costs and expenses are denominated in RMB. All of our assets are denominated in RMB except for some cash and cash equivalents and accounts receivables. As a result, we are exposed to foreign exchange risk as our revenues and results of operations may be affected by fluctuations in the exchange rate between US dollar and RMB. If the RMB depreciates against the US dollar, the value of our RMB revenues, earnings and assets as expressed in our US dollar financial statements will decline. We have not entered into any hedging transactions in an effort to reduce our exposure to foreign exchange risk.

 

Inflation

 

Although we are generally able to pass along minor incremental cost inflation to our customers, inflationary factors such as increases in the costs of our products and overhead costs may adversely affect our operating results. We do not believe that inflation in China has had a material impact on our financial position or results of operations to date, a high rate of inflation in the future may have an adverse effect on our ability to maintain current levels of gross margin and selling and distribution, general and administrative expenses as a percentage of net revenues if the selling prices of our products do not increase to cope with these increased costs.

    

Item 8. Financial Statements and Supplementary Data

 

Our audited financial statements for the fiscal years ended December 31, 2013, 2012 and 2011, together with the report of the independent certified public accounting firms thereon and the notes thereto, are presented beginning at page F-1.

 

48
 

 

R EPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders of

Orient Paper, Inc.

 

We have audited the accompanying consolidated balance sheets of Orient Paper, Inc. (the “Company”) as of December 31, 2013 and 2012 and the related consolidated statements of income and comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2013. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with 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 financial statements are free of material misstatement. The Company 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 Company’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 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 consolidated financial position of the Company at December 31, 2013 and 2012, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2013 , in conformity with accounting principles generally accepted in the United States of America.

 

/s/ BDO China Shu Lun Pan Certified Public Accountants LLP

Shenzhen, The People’s Republic of China

March 25, 2014

 

F- 1
 

 

ORIENT PAPER, INC.

CONSOLIDATED BALANCE SHEETS

AS OF DECEMBER 31, 2013 AND 2012

 

    December 31,     December 31,  
    2013     2012  
             
ASSETS                
                 
Current Assets                
Cash and cash equivalents   $ 3,131,163     $ 13,140,288  
Restricted cash     2,454,108       1,585,138  
Accounts receivable (net of allowance for doubtful accounts of $67,592 and $57,643 as of December 31, 2013 and 2012, respectively)     3,327,494       2,836,335  
Inventories     11,428,405       15,104,101  
Prepayments and other current assets     1,068,031       5,401,705  
Asset held for sale     4,130,590       -  
Deferred tax assets - current     413,537       -  
                 
Total current assets     25,953,328       38,067,567  
                 
Prepayment on property, plant and equipment     1,492,098       1,445,645  
Property, plant, and equipment, net     178,535,259       122,391,456  
Recoverable VAT     3,277,188       -  
Deferred tax asset – non-current     268,329       941,656  
                 
Total Assets   $ 209,526,202     $ 162,846,324  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY                
                 
Current Liabilities                
Short-term bank loans   $ 6,544,288     $ 3,962,844  
Current portion of long-term loan from credit union     1,660,613       4,168,912  
Current obligations under capital lease     8,264,795       -  
Accounts payable     926,571       1,012,906  
Notes payable     4,908,216       3,170,276  
Security deposit from a related party     1,636,072       1,075,606  
Due to a related party     64,546       -  
Accrued payroll and employee benefits     498,010       292,638  
Other payables and accrued liabilities     2,651,472       1,262,284  
Income taxes payable     1,218,140       1,255,457  
                 
Total current liabilities     28,372,723       16,200,923  
                 
Loan from credit union     4,253,788       1,561,361  
Loan from a related party     2,389,633       2,315,239  
Deferred gain on sale-leaseback     1,160,271       -  
Long-Term obligations under capital lease     12,296,639       -  
                 
Total liabilities     48,473,054       20,077,523  
                 
Commitments and Contingencies                
                 
Stockholders' Equity                
Common stock, 500,000,000 shares authorized, $0.001 par value per share, 18,753,900 and 18,459,775 shares issued and outstanding as of December 31, 2013 and 2012, respectively     18,754       18,460  
Additional paid-in capital     46,909,543       46,135,975  
Statutory earnings reserve     6,038,406       5,963,960  
Accumulated other comprehensive income     17,146,308       12,327,439  
Retained earnings     90,940,137       78,322,967  
                 
Total stockholders' equity     161,053,148       142,768,801  
                 
Total Liabilities and Stockholders' Equity   $ 209,526,202     $ 162,846,324  

 

See accompanying notes to consolidated financial statements.

 

F- 2
 

 

ORIENT PAPER, INC.

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

 

          Year Ended        
    December 31,  
    2013     2012     2011  
                   
Revenues   $ 125,717,630     $ 151,116,806     $ 150,747,316  
                         
Cost of Sales     (102,392,031 )     (124,060,559 )     (117,797,241 )
                         
Gross Profit     23,325,599       27,056,247       32,950,075  
                         
Selling, general and administrative expenses     (4,567,079 )     (3,360,520 )     (2,517,530 )
Loss on impairment of assets     -       (2,762,349 )     -  
Gain (Loss) from disposal of property, plant and equipment, net     84,972       45,288       (321,200 )
                         
Income from Operations     18,843,492       20,978,666       30,111,345  
                         
Other Income (Expense):                        
Interest income     90,260       30,674       36,437  
Subsidy income     171,125       -       -  
Interest expense     (995,694 )     (871,834 )     (699,892 )
                         
Income before Income Taxes     18,109,183       20,137,506       29,447,890  
                         
Provision for Income Taxes     (5,094,535 )     (5,464,843 )     (7,799,226 )
                         
Net Income     13,014,648       14,672,663       21,648,664  
                         
Other Comprehensive Income:                        
Foreign currency translation adjustment     4,818,869       884,872       4,304,334  
                         
Total Comprehensive Income   $ 17,833,517     $ 15,557,535     $ 25,952,998  
                         
Earnings Per Share:                        
Basic and Fully Diluted Earnings per Share   $ 0.71     $ 0.79     $ 1.18  
                         
Weighted Average Number of Shares Outstanding – Basic and Fully Diluted     18,458,446       18,456,781       18,349,332  

 

See accompanying notes to consolidated financial statements.

 

F- 3
 

 

ORIENT PAPER, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

 

                      Accumulated              
          Additional     Statutory     Other              
    Common Stock     Paid-in     Earnings     Comprehensive     Retained        
    Shares     Amount     Capital     Reserve     Income     Earnings     Total  
                                           
Balance at December 31, 2010     18,344,811     $ 18,345     $ 45,727,656     $ 5,661,587     $ 7,138,233     $ 42,996,255     $ 101,542,076  
                                                         
Issuance of shares to officer and directors     5,380       5       30,364       -       -       -       30,369  
                                                         
Foreign currency translation adjustment     -       -       -       -       4,304,334       -       4,304,334  
                                                         
Transfer to statutory earnings reserve     -       -       -       201,855       -       (201,855 )     -  
                                                         
Net income for the year of 2011     -       -       -       -       -       21,648,664       21,648,664  
                                                         
Balance at December 31, 2011     18,350,191       18,350       45,758,020       5,863,442       11,442,567       64,443,064       127,525,443  
                                                         
Issuance of shares to officer and directors     109,584       110       377,955       -       -       -       378,065  
                                                         
Foreign currency translation adjustment     -       -       -       -       884,872       -       884,872  
                                                         
Transfer to statutory earnings reserve     -       -       -       100,518       -       (100,518 )     -  
                                                         
Cash dividend paid     -       -       -       -       -       (692,242 )     (692,242 )
                                                         
Net income for the year of 2012     -       -       -       -       -       14,672,663       14,672,663  
                                                         
Balance at December 31, 2012     18,459,775     $ 18,460     $ 46,135,975     $ 5,963,960     $ 12,327,439     $ 78,322,967     $ 142,768,801  
                                                         
Issuance of shares to officer and directors     297,000       297       789,723       -       -       -       790,020  
                                                         
Foreign currency translation adjustment     -       -       -       -       4,818,869       -       4,818,869  
                                                         
Transfer to statutory earnings reserve     -       -       -       74,446       -       (74,446 )     -  
                                                         
Cancellation of certain director compensation shares     (2,875 )     (3 )     (16,155 )     -       -       -       (16,158 )
                                                         
Cash dividend paid     -       -       -       -       -       (323,032 )     (323,032 )
                                                         
Net income for the year of 2013     -       -       -       -       -       13,014,648       13,014,648  
                                                         
Balance at December 31, 2013     18,753,900     $ 18,754     $ 46,909,543     $ 6,038,406     $ 17,146,308     $ 90,940,137     $ 161,053,148  

 

See accompanying notes to consolidated financial statements.

 

F- 4
 

 

ORIENT PAPER, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

 

    Year Ended  
    December 31,  
    2013     2012     2011  
                   
Cash Flows from Operating Activities:                        
Net income   $ 13,014,648     $ 14,672,663     $ 21,648,664  
Adjustments to reconcile net income to net cash provided by operating activities:                        
Depreciation and amortization     7,794,743       8,382,859       4,424,531  
(Gain) Loss from impairment and disposal of property, plant and equipment     (84,972 )     2,717,061       321,200  
Allowance for (Recovery from) bad debts     7,990       (19,631 )     37,087  
Stock-based expense for service received     773,862       378,065       30,369  
Deferred tax     409,665       (941,207 )     -  
Changes in operating assets and liabilities:                        
Accounts and notes receivable     (402,709 )     1,029,978       (1,597,193 )
Prepayments and other current assets     1,211,679       (295,763 )     (4,803,656 )
Inventories     4,105,876       (5,024,459 )     (2,246,090 )
Accounts payable     (117,308 )     (1,771,968 )     2,299,240  
Notes payable     1,614,387       3,168,769       -  
Accrued payroll and employee benefits     194,795       (17,306 )     (39,473 )
Other payables and accrued liabilities     1,599,375       453,546       (1,402,290 )
Income taxes payable     (200,090 )     (500,641 )     (42,340 )
Net Cash Provided by Operating Activities     29,921,941       22,231,966       18,630,049  
                         
Cash Flows from Investing Activities:                        
Purchases of property, plant and equipment     (384,794 )     (13,518,955 )     (25,424,280 )
Payment for construction in progress     (64,181,991 )     (2,759,997 )     (2,298,633 )
Refund of prepayment for purchase of property, plant and equipment     -       3,112,571       -  
Security deposit from a related party     1,614,387       1,075,095       -  
Proceeds from disposal of property, plant and equipment     2,589,919       175,593       271,508  
Net Cash Used in Investing Activities     (60,362,479 )     (11,915,693 )     (27,451,405 )
                         
Cash Flows from Financing Activities:                        
Proceeds from related party loans     1,390,802       1,030,097       200,000  
Repayment of related party loans     (1,390,802 )     (1,230,097 )     (2,091,596 )
Proceeds from bank loans     10,703,389       5,941,441       8,389,626  
Proceeds from sale-leaseback financing     24,215,811       -       -  
Payment of capital lease obligation     (5,406,481 )     -       -  
Repayments of bank loans     (8,281,807 )     (4,832,372 )     (5,001,239 )
Restricted cash     (807,194 )     (1,584,384 )     -  
Dividend Paid     (323,032 )     (692,242 )     -  
Net Cash Provided by (Used in) Financing Activities     20,100,686       (1,367,557 )     1,496,791  
                         
Effect of Exchange Rate Changes on Cash and Cash Equivalents     330,727       26,126       141,903  
                         
Net (Decrease) Increase in Cash and Cash Equivalents     (10,009,125 )     8,974,842       (7,182,662 )
                         
Cash and Cash Equivalents - Beginning of Period     13,140,288       4,165,446       11,348,108  
                         
Cash and Cash Equivalents - End of Period   $ 3,131,163     $ 13,140,288     $ 4,165,446  
                         
Supplemental Disclosure of Cash Flow Information:                        
Cash paid for interest, net of capitalized interest cost   $ 708,089     $ 486,278     $ 689,869  
Cash paid for income taxes   $ 4,884,961     $ 6,909,690     $ 7,841,566  

 

See accompanying notes to consolidated financial statements.

 

F- 5
 

 

ORIENT PAPER, INC.

 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

(1) Organization and Business Background

 

Orient Paper, Inc. (“Orient Paper” or “the Company”) was incorporated under the laws of the State of Nevada on December 9, 2005, under the name of Carlateral, Inc. Carlateral, Inc. started its business by providing financing services specializing in subprime title loans, secured primarily using automobiles (and also boats, recreational vehicles, machinery, and other equipment) as collateral.

 

Hebei Baoding Orient Paper Milling Company Limited (“Orient Paper HB”) was incorporated on March 10, 1996, under the laws of the People’s Republic of China (“PRC”). Orient Paper HB is mainly engaged in the production and distribution of paper products such as corrugating medium paper and offset printing paper. Orient Paper HB also has capability to produce other paper and packaging-related products, such as plastic paper and craft paper. Orient Paper HB uses recycled paper as its primary raw material.

 

Dongfang Zhiye Holding Limited (“Dongfang Holding”) was formed on November 13, 2006, under the laws of the British Virgin Islands, and is an investment holding company. As such, Dongfang Holding does not generate any financial or operating transactions. On July 16, 2007, Dongfang Holding entered into an agreement to acquire the equity ownership of Orient Paper HB and placed all the equity interest in trust with Mr. Zhenyong Liu, Mr. Xiaodong Liu, and Mr. Shuangxi Zhao (the original equity owners of Orient Paper HB, each, an “Orient Paper HB Equity Owner” and collectively, “Orient Paper HB Equity Owners”), pursuant to a trust agreement executed on the same date. Under the terms of the trust agreement, the Orient Paper HB Equity Owners would exercise control over the disposition of Dongfang Holding’s shares in Orient Paper HB on Dongfang Holding’s behalf until Dongfang Holding successfully completed the change in registration of Orient Paper HB’s capital with the relevant PRC Administration of Industry and Commerce as the 100% owner of Orient Paper HB’s equity interest. In connection with the consummation of the restructuring transactions on June 24, 2009 as described below, Dongfang Holding directed its trustee to return its equity ownership in Orient Paper HB to the Orient Paper HB Equity Owners.

 

On October 29, 2007, Orient Paper entered into an Agreement and Plan of Merger (“Merger Agreement”) with (i) Orient Paper wholly owned subsidiary, CARZ Merger Sub, Inc., (ii) Dongfang Holding, and (iii) all shareholders of Dongfang Holding (Zhenyong Liu, Xiaodong Liu, Chen Li, Ning Liu, Jie Liu, Shenzhen Huayin Guaranty & Investment Company Limited, Top Good International Limited, Total Giant Group Limited, Total Shine Group Limited, Victory High Investment Limited, Think Big Trading Limited, Huge Step Enterprises Limited, and Sure Believe Enterprise Limited).

 

Pursuant to the Merger Agreement, Dongfang Holding merged with CARZ Merger Sub, Inc. via a share exchange, with Dongfang Holding as the surviving entity. In exchange for their shares in Dongfang Holding, the Dongfang Holding shareholders received an aggregate of 7,450,497 newly-issued shares of Orient Paper’s common stock, $0.001 par value, which were distributed pro ratably among the Dongfang Holding shareholders in accordance with their respective ownership interests in Dongfang Holding.

 

As a result of the merger transaction, Dongfang Holding became a wholly-owned subsidiary of Orient Paper, which, in turn, has the controlling right on Dongfang Holding’s operating company, Orient Paper HB, pursuant to the terms of the trust agreement. Orient Paper HB, the entity through which the Company operates its business currently has no subsidiaries, either wholly- or partially-owned.

 

Prior to the completion of the reverse merger, Orient Paper only had limited operations (since its incorporation on December 9, 2005). On December 21, 2007, the name of the Company was changed from Carlateral, Inc. to Orient Paper, Inc. in order to better reflect the current business plan subsequent to the reverse merger. Accordingly, the reverse merge has been recorded as a recapitalization of Orient Paper.

 

F- 6
 

 

ORIENT PAPER, INC.

 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

To ensure proper compliance of the Company’s control over the ownership and operations of Orient Paper HB with certain PRC regulations, on June 24, 2009, the Company entered into a series of contractual agreements (the “Contractual Agreements”) with Orient Paper HB and Orient Paper HB Equity Owners via the Company’s wholly owned subsidiary Shengde Holdings, Inc. (“Shengde Holdings”) a Nevada corporation and Baoding Shengde Paper Co., Ltd. (“Orient Paper Shengde”), a wholly foreign-owned enterprise in the PRC with an original registered capital of $10,000,000 (subsequently increased to $60,000,000 in June 2010). Orient Paper Shengde is mainly engaged in production and distribution of digital photo paper and is 100% owned by Shengde Holdings. Prior to February 10, 2010, the Contractual Agreements included (i) Exclusive Technical Service and Business Consulting Agreement, which generally provides that Orient Paper Shengde shall provide exclusive technical, business and management consulting services to Orient Paper HB, in exchange for service fees including a fee equivalent to 80% of Orient Paper HB’s total annual net profits; (ii) Loan Agreement, which provides that Orient Paper Shengde will make a loan in the aggregate principal amount of $10,000,000 to Orient Paper HB Equity Owners in exchange for each such shareholder agreeing to contribute all of its proceeds from the loan to the registered capital of Orient Paper HB; (iii) Call Option Agreement, which generally provides, among other things, that Orient Paper HB Equity Owners irrevocably grant to Orient Paper Shengde an option to purchase all or part of each owner’s equity interest in Orient Paper HB. The exercise price for the options shall be RMB1 which Orient Paper Shengde should pay to each of Orient Paper HB Equity Owner for all their equity interests in Orient Paper HB; (iv) Share Pledge Agreement, which provides that Orient Paper HB Equity Owners will pledge all of their equity interests in Orient Paper HB to Orient Paper Shengde as security for their obligations under the other agreements described in this section. Specifically, Orient Paper Shengde is entitled to dispose of the pledged equity interests in the event that Orient Paper HB Equity Owners breach their obligations under the Loan Agreement or Orient Paper HB fails to pay the service fees to Orient Paper Shengde pursuant to the Exclusive Technical Service and Business Consulting Agreement; and (v) Proxy Agreement, which provides that Orient Paper HB Equity Owners shall irrevocably entrust a designee of Orient Paper Shengde with such shareholder’s voting rights and the right to represent such shareholder to exercise such owner’s rights at any equity owners’ meeting of Orient Paper HB or with respect to any equity owner action to be taken in accordance with the laws and Orient Paper HB’s Articles of Association. The terms of the agreement are binding on the parties for as long as Orient Paper HB Equity Owners continue to hold any equity interest in Orient Paper HB. An Orient Paper HB Equity Owner will cease to be a party to the agreement once it transfers its equity interests with the prior approval of Orient Paper Shengde. As the Company had controlled Orient Paper HB since July 16, 2007 through Dongfang Holding and the trust until June 24, 2009, and continues to control Orient Paper HB through Orient Paper Shengde and the Contractual Agreements, the execution of the Contractual Agreements is considered as a business combination under common control.

 

On February 10, 2010, Orient Paper Shengde and the Orient Paper HB Equity Owners entered into a Termination of Loan Agreement to terminate the above $10,000,000 Loan Agreement. Because of the Company’s decision to fund future business expansions through Orient Paper Shengde instead of Orient Paper HB, the $10,000,000 loan contemplated was never made prior to the point of termination. The parties believe the termination of the Loan Agreement does not in itself compromise the effective control of the Company over Orient Paper HB and its businesses in the PRC.

 

An agreement was also entered into among Orient Paper Shengde, Orient Paper HB and the Orient Paper HB Equity Owners on December 31, 2010, reiterating that Orient Paper Shengde is entitled to 100% of the distributable profit of Orient Paper HB, pursuant to the above mentioned Contractual Agreements. In addition, Orient Paper HB and the Orient Paper HB Equity Owners shall not declare any of Orient Paper HB’s unappropriated earnings as dividend, including the unappropriated earnings of Orient Paper HB from its establishment to 2010 and thereafter.

 

Orient Paper has no direct equity interest in Orient Paper HB. However, through the Contractual Agreements described above Orient Paper is found to be the primary beneficiary of Orient Paper HB and is deemed to have the effective control over Orient Paper HB’s activities that most significantly affect its economic performance, resulting in Orient Paper HB being treated as a controlled variable interest entity of Orient Paper in accordance with Topic 810 - Consolidation of the Accounting Standards Codification (the “ASC”) issued by the Financial Accounting Standard Board (the “FASB”). The revenue of the Company generated from Orient Paper HB for the years ended December 31, 2013, 2012 and 2011 were 96.05%, 95.91% and 94.5%, respectively. Orient Paper HB also accounted for 80.25% and 73.51% of the total assets of the Company as at December 31, 2013 and 2012 respectively.

 

F- 7
 

  

ORIENT PAPER, INC.

 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

As of December 31, 2013 and 2012, details of the Company’s subsidiaries and variable interest entities are as follows:

 

        Place of        
    Date of Incorporation   Incorporation or   Percentage of    
Name   or Establishment   Establishment   Ownership   Principal Activity
Subsidiary:                
Dongfang Holding   November 13, 2006   BVI   100%   Inactive investment holding
Shengde Holdings   February 25, 2009   State of Nevada   100%   Investment holding

Orient Paper Shengde

  June 1, 2009   PRC   100%   Paper Production and distribution
Variable interest entity:                
Orient Paper HB   March 10, 1996   PRC   Control*   Paper Production and distribution

 

* Orient Paper HB is treated as a 100% controlled variable interest entity of the Company

 

(2) Significant Accounting Policies

 

Basis of Consolidation

 

The consolidated financial statements of the Company are prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”), and include the assets, liabilities, revenues, expenses and cash flows of all subsidiaries and variable interest entity. All significant inter-company balances, transactions and cash flows are eliminated on consolidation.

 

Foreign Currency Translation

 

The Company accounts for foreign currency translation pursuant to ASC Topic 830, Foreign Currency Matters . The functional currency of Orient Paper HB and Orient Paper Shengde is the Chinese Yuan Renminbi (“RMB”). Monetary assets and liabilities denominated in currencies other than RMB are translated into RMB at the rates of exchange ruling at the balance sheet date. Transactions in currencies other than RMB are converted into RMB at the applicable rates of exchange prevailing the transactions occurred. Transaction gains and losses are recognized in the consolidated statements of income. The functional currency of Orient Paper, Dongfang Holding and Shengde Holdings is United States dollars. Monetary assets and liabilities denominated in currencies other than United States dollars are translated into United States dollars at the rates of exchange ruling at the balance sheet date. Translation in currencies other than United States dollars are converted into United States dollars at the applicable rates of exchange prevailing when the transactions occurred. Transaction gains or losses are recognized in the consolidated statement of income.

 

Under ASC Topic 830-30, all assets and liabilities are translated into United States dollars using the current exchange rate at the end of each fiscal period. The current exchange rates used by the Company as of December 31, 2013 and 2012 to translate the Chinese RMB to the U.S. Dollars are 6.11220:1, and 6.30860:1, respectively. Revenues and expenses are translated using the average exchange rates prevailing throughout the respective years at 6.19430:1, 6.31160:1 and 6.45440:1 for the years ended December 31, 2013, 2012 and 2011, respectively. Translation adjustments are included in other comprehensive income (loss).

 

Use of Estimates

 

The preparation of consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of December 31, 2013 and 2012, and revenues and expenses for the years ended December 31, 2013, 2012 and 2011. The most significant estimates relate to allowance for uncollectible accounts receivable, inventory valuation, useful lives and impairment for property, plant and equipment, valuation allowance for deferred tax assets and contingencies. Actual results could differ from those estimates made by management.

 

F- 8
 

 

ORIENT PAPER, INC.

 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Cash and Cash Equivalents

 

For purposes of reporting within the statements of cash flows, Orient Paper considers all cash on hand, cash accounts not subject to withdrawal restrictions or penalties, and all highly liquid debt instruments purchased with a maturity of three months or less to be cash and cash equivalents.

 

Accounts Receivable

 

Trade accounts receivable are recorded on shipment of products to customers. The trade receivables are all without customer collateral and interest is not accrued on past due accounts. Periodically, management reviews the adequacy of its provision for doubtful accounts based on historical bad debt expense results and current economic conditions using factors based on the aging of its accounts receivable. Additionally, the Company may identify additional allowance requirements based on indications that a specific customer may be experiencing financial difficulties. Actual bad debt results could differ materially from these estimates. As of December 31, 2013 and 2012, the balance of allowance for doubtful accounts was $67,592 and $57,643, respectively; and the movement of the provision of the doubtful accounts is as below. While management uses the best information available upon which to base estimates, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used for the purposes of analysis.

 

    December 31,     December 31,     December 31,  
Allowance of doubtful accounts   2013     2012     2011  
Opening balance   $ 57,643     $ 76,752     $ 37,535  
Provision (Reversal of provision) for the year     7,990       (19,631 )     37,087  
Exchange difference     1,959       522       2,130  
Closing balance   $ 67,592     $ 57,643     $ 76,752  

 

Inventories

 

Inventories consist principally of raw materials and finished goods, and are stated at the lower of cost (average cost method) or market. Cost includes labor, raw materials, and allocated overhead. No provision in inventories has been provided for the fiscal years 2013, 2012 and 2011.

 

Property, Plant, and Equipment

 

Property, plant, and equipment are stated at cost less accumulated depreciation and any impairment losses. Major renewals, betterments, and improvements are capitalized to the asset accounts while replacements, maintenance, and repairs, which do not improve or extend the lives of the respective assets, are expensed to operations. At the time property, plant, and equipment are retired or otherwise disposed of, the asset and related accumulated depreciation or amortization accounts are relieved of the applicable amounts. Gains or losses from retirements or sales are credited or charged to operations.

 

Construction-in-progress is stated at cost and capitalized as expenses are incurred or as payments are made pursuant to relevant construction contracts. Contract retention is recorded as accrued liability. Construction in progress is not depreciated until project completion and the constructed property being placed in service, at which time the capitalized balance will be transferred to appropriate account of property, plant and equipment.

 

The Company depreciates property, plant, and equipment using the straight-line method as follows:

 

Land use right Over the lease term
Building and improvements 30 years
Machinery and equipment 5-15 years
Vehicles 15 years

 

F- 9
 

  

ORIENT PAPER, INC.

 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Valuation of long-lived asset

 

The Company reviews the carrying value of long-lived assets to be held and used when events and circumstances warrants such a review. The carrying value of a long-lived asset is considered impaired when the anticipated undiscounted cash flow from such asset is separately identifiable and is less than its carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair market value of the long-lived asset and intangible assets. Fair market value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved. Losses on long-lived assets and intangible assets to be disposed are determined in a similar manner, except that fair market values are reduced for the cost to dispose.

 

Assets held for sale

 

When assets are identified by management as held for sale, the Company discontinues depreciating the assets and estimates the sales price, net of selling costs, of such assets. If, in management's opinion, the estimated net sales price of the assets which have been identified as held for sale is less than the net book value of the assets, a valuation allowance is established. Properties identified as held for sale and/or disposed of are presented as Assets held for sale for all periods presented.

 

If circumstances arise that previously were considered unlikely and, as a result, the Company decides not to sell a property previously classified as held for sale, the property is reclassified as held and used. A property that is reclassified is measured and recorded individually at the lower of (a) its carrying amount before the property was classified as held for sale, adjusted for any depreciation (amortization) expense that would have been recognized had the property been continuously classified as held and used, or (b) the fair value at the date of the subsequent decision not to sell.

 

Fair Value of Financial Instruments

 

The Company estimates the fair value of financial instruments using the available market information and valuation methods. Considerable judgment is required in estimating fair value. Accordingly, the estimates of fair value may not be indicative of the amounts that the Company could realize in a current market exchange. As of December 31, 2013 and 2012, the carrying value of the Company’s short term financial instruments, such as cash and cash equivalents, accounts receivable, accounts and notes payable, and balance due to a related party, approximate at their fair values because of the short maturity of these instruments; while bank loans, loan from a related party and obligation under capital lease approximate at their fair value as the interest rates thereon are close to the market rates of interest published by the People’s Bank of China.

 

Statutory Reserves

 

According to the laws and regulations in the PRC, the Company is required to provide for certain statutory funds, namely, reserve fund by an appropriation from net profit after taxation but before dividend distribution based on the local statutory financial statements of the PRC subsidiary and variable interest entity prepared in accordance with the PRC accounting principles and relevant financial regulations.

 

The Company’s wholly owned subsidiary and variable interest entity in the PRC are required to allocate at least 10% of its net profit to the reserve fund until the balance of such fund has reached 50% of its registered capital. Appropriations of additional reserve fund are determined at the discretion of its directors. The reserve fund can only be used, upon approval by the relevant authority, to offset accumulated losses or increase capital.

 

For the years ended December 31, 2013, 2012 and 2011, Orient Paper made transfers to this reserve fund in the amounts of $74,446, $100,518, and $201,855, respectively. For the years ended December 31, 2013, 2012 and 2011, all transfers to statutory reserves were made by Orient Paper Shengde. The Company’s variable interest entity Orient Paper HB, which statutory reserve account has been fully funded for 50% of its registered capital in the amount of RMB 75,030,000 (or approximately $11,811,470) as of December 31, 2010, did not make any transfer to statutory reserves during the years ended December 31, 2013, 2012 and 2011.

 

Employee Benefit Plan

 

Full time employees of the PRC entities participate in a government mandated multi-employer defined contribution plan pursuant to which certain pension benefits, medical care, unemployment insurance and other welfare benefits are provided to employees. The total provision for such employee benefits was $nil, $nil and $nil for the years ended December 31, 2013, 2012 and 2011.

  

F- 10
 

 

ORIENT PAPER, INC.

 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Revenue Recognition Policy

 

The Company recognizes revenue when goods are delivered, when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, no other significant obligations of the Company exist, and collectability is reasonably assured. Goods are considered delivered when customer’s truck picks up goods at our finished goods inventory warehouse.

 

Shipping Cost

 

Substantially all customers use their own trucks or hire commercial trucking companies to pick up goods from the Company. The Company usually incurs no shipping cost for delivery of goods to customers. For those rare situations where products are not shipped utilizing customer specified shipping services, the Company charges customers a shipping fee which is included in net revenues and was not material. Freight-in and handling costs incurred by the Company with respect to purchased goods are recorded as a component of inventory cost and charged to cost of sales when the inventory items are sold.

 

Advertising

 

The Company expenses all advertising and promotion costs as incurred. The Company incurred $5,085, $10,478 and $6,818 of advertising and promotion costs for the years ended December 31, 2013, 2012 and 2011, respectively.

 

Research and development costs

 

Research and development costs are expensed as incurred and included in selling, general and administrative expenses. Research and development expenses incurred $25,125, $21,636 and $19,756 for the years ended December 31, 2013, 2012 and 2011, respectively.

 

Borrowing costs

 

Borrowing costs attributable directly to the acquisition, construction or production of qualifying assets which require a substantial period of time to be ready for their intended use or sale, are capitalized as part of the cost of those assets. Income earned on temporary investments of specific borrowings pending their expenditure on those assets is deducted from borrowing costs capitalized. All other borrowing costs are recognized in interest expenses in the period in which they are incurred.

 

Government subsidies

 

A government subsidy is not recognized until there is reasonable assurance that: (a) the enterprise will comply with the conditions attached to the grant; and (b) the grant will be received. When the Company received the government subsidies but the conditions attached to the grants have not been fulfilled, such government subsidies are deferred and recorded under other payables and accrued expenses, and other long-term liability. The reclassification of short-term or long-term liabilities is depended on the management's expectation of when the conditions attached to the grant can be fulfilled. For the years ended December 31, 2013, 2012 and 2011, the Company received government subsidies of $171,125, $nil and $nil, which are recognized as subsidy income in the statements of income in that fiscal year.

 

Lease Obligations

 

All non-cancellable leases with an initial term greater than one year are categorized as either capital or operating leases. For the lessee, a lease is a capital lease if any of the following conditions exist: a) ownership is transferred to the lessee by the end of the lease term, b) there is a bargain purchase option, c) the lease term is at least 75% of the property’s estimated remaining economic life or d) the present value of the minimum lease payments at the beginning of the lease term is 90% or more of the fair value of the leased property to the lessor at the inception date. A capital lease is accounted for as if there was an acquisition of an asset and an incurrence of an obligation at the inception of the lease. All other leases are accounted for as operating leases. Assets recorded under capital leases are amortized according to the same depreciation methods employed for property, plant and equipment or over the term of the related lease, if shorter.

 

The Company defers any profit or loss from a sale-leaseback transaction unless any of the following conditions exist: a) the seller-lessee relinquishes the right to substantially all of the remaining use of the property sold retaining only a minor portion of such use; b) the seller-lessee retains more than a minor part but less than substantially all of the use of the property through the leaseback and realizes a profit on the sale in excess of the recorded amount of the leased assets; or c) the fair value of the property at the time of the transaction is less than its undepreciated cost, in which circumstance a loss shall be recognized immediately.

 

F- 11
 

 

ORIENT PAPER, INC.

 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Income Taxes

 

The Company accounts for income taxes pursuant to ASC Topic 740, Income Taxes. Income taxes are provided on an asset and liability approach for financial accounting and reporting of income taxes. Any tax paid by subsidiaries during the year is recorded. Current tax is based on the profit or loss from ordinary activities adjusted for items that are non-assessable or disallowable for income tax purpose and is calculated using tax rates that have been enacted or substantively enacted at the balance sheet date. ASC Topic 740 also requires the recognition of deferred tax assets and liabilities for both the expected impact of differences between the financial statements and the tax basis of assets and liabilities, and for the expected future tax benefit to be derived from tax losses and tax credit carry-forwards. ASC Topic 740 additionally requires the establishment of a valuation allowance to reflect the likelihood of realization of deferred tax assets. Realization of deferred tax assets, including those related to the U.S. net operating loss carry-forwards, are dependent upon future earnings, if any, of which the timing and amount are uncertain.

 

The Company adopted ASC Topic 740-10-05, Income Tax , which provides guidance for recognizing and measuring uncertain tax positions, it prescribes a threshold condition that a tax position must meet for any of the benefits of the uncertain tax position to be recognized in the financial statements. It also provides accounting guidance on derecognizing, classification and disclosure of these uncertain tax positions.

 

The Company’s policy on classification of all interest and penalties related to unrecognized income tax positions, if any, is to present them as a component of income tax expense.

 

Value Added Tax

 

Both the PRC subsidiary and variable interest entity of the Company are subject to value added tax (“VAT”) imposed by the PRC government on its purchase and sales of goods. The output VAT is charged to customers who purchase goods from the Company and the input VAT is paid when it purchases goods from its vendors. VAT rate is 17% in general, depending on the types of products purchased and sold. The input VAT can be offset against the output VAT. Debit balance of VAT payable represents a credit against future collection of output VAT instead of a receivable.

 

Comprehensive Income (Loss)

 

The Company presents comprehensive income (loss) in accordance with ASC Topic 220, Comprehensive Income . ASC Topic 220 states that all items that are required to be recognized under accounting standards as components of comprehensive income (loss) be reported in the consolidated financial statements. The components of comprehensive income were the net income for the years and the foreign currency translation adjustments. 

 

F- 12
 

 

ORIENT PAPER, INC.

 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Earnings Per Share

 

Basic earnings per share is computed by dividing the net income attributable to the common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed similar to basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive.

 

Share-Based Compensation

 

The Company uses the fair value recognition provision of ASC Topic 718, Compensation-Stock Compensation, which requires the Company to expense the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of such instruments over the vesting period.

 

The Company also applies the provisions of ASC Topic 505-50, Equity Based Payments to Non-Employees to account for stock-based compensation awards issued to non-employees for services. Such awards for services are recorded at either the fair value of the consideration received or the fair value of the instruments issued in exchange for such services, whichever is more reliably measurable.

 

Fair Value Measurements

 

The Company has adopted ASC Topic 820, Fair Value Measurements and Disclosures , which defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. It does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information.

 

Its establishes a three-level valuation hierarchy of valuation techniques based on observable and unobservable inputs, which may be used to measure fair value and include the following:

 

Level 1 - Quoted prices in active markets for identical assets or liabilities.

 

Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

 

Classification within the hierarchy is determined based on the lowest level of input that is significant to the fair value measurement.

 

Non-Recurring Fair Value Measurements

 

Long-lived assets are measured at fair value on a non-recurring basis using mostly Level 3 inputs as defined in the fair value hierarchy. These assets are not measured at fair value on an ongoing basis, but are subject to fair value adjustments only in certain circumstances. Assets that are written down to fair value when impaired and retained investments are not subsequently adjusted to fair value unless further impairment occurs.

 

Fair value of long-lived assets, including real estate, are determined by estimating the amount and timing of net future cash flows (which are unobservable inputs) and discounting them using a risk-adjusted rate of interest. The Company estimates future cash flows based on its experience and knowledge of the market. Significant increases or decreases in actual cash flows may result in valuation changes. For real estate, fair values are based on discounted cash flow estimates which reflect current and projected lease profiles and available industry information about capitalization rates and expected trends in rents and occupancy and are corroborated by external appraisals.

 

F- 13
 

 

Working Capital Deficit and Management’s Plan.

 

As of December 31, 2013, the Company had current assets of $25,953,328 and current liabilities of $28,372,723 (including amounts due to related parties for $2,266,961), resulting in a working capital deficit of approximately $2,419,395. We are currently seeking to restructure the term of our liabilities by raising funds through long-term loans to pay off liabilities with shorter terms. Our ability to continue as a going concern is dependent upon obtaining the necessary financing or negotiating the terms of the existing short-term liabilities to meet our current and future liquidity needs. As management believes it can secure financial resources to satisfy the Company’s current liabilities and the capital expenditure needs in the next 12 months, our consolidated financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern.

 

On March 3, 2014 Orient Paper entered into a Revolving Line of Credit Agreement with Shanghai Pudong Development Bank for a total credit facility in the amount of approximately $3.3 million. Pursuant to the credit facility, the Company may draw six-month bank acceptance notes for up to approximately $3.3 million for making supplier payments. The facility has a term for the period of March 3, 2014 through January 12, 2015 and is collateralized by a land use right provided by Hebei Fangsheng Real Estate Development Co. Ltd., a related party controlled by our Chairman and CEO Mr. Zhenyong Liu.

 

On March 25, 2014, our Chairman and CEO Mr. Zhenyong Liu in writing agrees to permit the Company to continue to postpone the repayment of the accrued interest on his loan to Orient Paper HB until the Company is able to pay its other creditors in its normal course of business. The accrued interest owned to Mr. Liu was approximately $566,343 and was recorded as part of the current liabilities as of December 31, 2013.

 

On March 7, 2014, Hebei Tengsheng Paper Co. Ltd., which owns the land use rights of about 330 acres (or 1.33 million square meters) of land in the Wei County Industrial Park and leases about one-fourth of the premises to Orient Paper HB as our production base of tissue paper and other future facilities, agreed in writing to unconditionally provide the 330 acres of land use right as third party collateral to Orient Paper HB for additional bank loans in 2014.

 

F- 14
 

 

ORIENT PAPER, INC.

 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

(3) Restricted Cash

 

Restricted cash of $2,454,108 as of December 31, 2013 was presented for the cash deposited at the Bank of Hebei for purpose of securing the bank acceptance notes from the bank (see Note (12)). The restriction will be lifted upon the maturity of the notes payable from May 15 through June 19 during the year of 2014.

 

Restricted cash of $1,585,138 as of December 31, 2012 was presented for the cash deposited at the Bank of Hebei for purpose of securing the bank acceptance notes from the bank (see Note (12)). The restriction was lifted upon the maturity of the notes payable on June 18, 2013.

 

(4) Inventories

 

Raw materials inventory includes mainly recycled paper and coal. Finished goods include mainly products of corrugating medium paper and offset printing paper. Inventories consisted of the following as of December 31, 2013 and 2012:

 

    December 31,     December 31,  
    2013     2012  
Raw Materials                
Recycled paper board   $ 8,004,988     $ 11,274,383  
Pulp     14,257       13,813  
Recycled printed paper     -       884,236  
Recycled white scrap paper     1,791,873       766,144  
Coal     573,799       621,107  
Base paper and other raw materials     212,984       225,912  
      10,597,901       13,785,595  
Finished Goods     830,504       1,318,506  
Totals   $ 11,428,405     $ 15,104,101  

 

(5) Prepayments and other current assets

 

Prepayments and other current assets consisted of the following as of December 31, 2013 and 2012:

 

    December 31,     December 31,  
    2013     2012  
Prepaid NYSE MKT annual fee   $ 7,500     $ 6,875  
Recoverable VAT     500,000       4,784,074  
Prepaid insurance     61,529       55,922  
Prepayment for purchase of materials     8,180       77,445  
Prepaid land lease     490,822       475,541  
Others     -       1,848  
    $ 1,068,031     $ 5,401,705  

 

As of December 31, 2013, the Company recorded a total recoverable VAT of $3,777,188, out of which $3,277,188 presented as non-current asset in the consolidated balance sheet. As of December 31, 2012, the Company recorded the entire balance of recoverable VAT of $4,784,074 as current asset under prepayments and other current assets in the consolidated balance sheet.

 

(6) Prepayment on property, plant and equipment

 

As of December 31, 2013 and 2012, prepayment on property, plant and equipment consisted of $1,492,098 and $1,445,645, respectively in respect of prepaid land use right prepayment made on October 26, 2012 for the entitlement of land use right for some 54,267 square meters of land located in our Xushui County, Baoding plant. The purchase is expected to be completed in year 2014.

 

F- 15
 

 

ORIENT PAPER, INC.

 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

(7) Assets held for sale

 

As of December 31, 2013, assets held for sale in the amount of $4,130,590 represented the three employee dormitory buildings to be sold to a related party company controlled by our Chairman and CEO Mr. Zhenyong Liu. Please refer to Note (11) for the details of the related party transaction. As the sale was not yet completed by the end of December 31, 2013, the dormitories were classified as held for sale in accordance with ASC 360-10-35. It was expected that the sales will be consummated by the second half of year 2014.

  

(8) Property, plant and equipment

 

As of December 31, 2013 and 2012, property, plant and equipment consisted of the following:

 

    December 31,     December 31,  
    2013     2012  
Property, Plant, and Equipment:                
Land use rights   $ 7,761,511     $ 9,895,081  
Building and improvements     22,406,836       31,625,816  
Machinery and equipment     121,088,942       111,857,002  
Vehicles     683,051       439,007  
Construction in progress     65,160,213       1,315,664  
      217,100,553       155,132,570  
Less: accumulated depreciation and amortization     (38,565,294 )     (32,741,114 )
Property, Plant and Equipment, net   $ 178,535,259     $ 122,391,456  

 

As of December 31, 2012, land use rights represented two parcels of state-owned land located in Xushui County of Hebei Province in China, with lease terms of 50 years expiring in 2053 and 2061, respectively. On August 9, 2013, one of these land use rights was sold to a related party company controlled by our Chairman and CEO Mr. Zhenyong Liu. See Note (11) for the details of the related party transaction. The remaining land use right as of December 31, 2013 will expire in year 2061.

 

The Company entered into a sale-leaseback arrangement with a leasing company in China on June 16, 2013 for a total financing proceeds in the amount of RMB150 million (approximately US$24 million). Under the sale-leaseback arrangement, Orient Paper HB sold certain of its paper manufacturing equipment to the leasing company for an amount of RMB 150 million (approximately US$24 million). Concurrent with the sale of equipment, Orient Paper HB leases back all of the equipment (“Leased Equipment”) sold to the leasing company for a lease term of three years. At the end of the lease term, Orient Paper HB may pay a nominal purchase price of RMB 15,000 (approximately $2,400) to the leasing company and buy back all of the Leased Equipment. The sale-leaseback is treated by the Company as a mere financing and capital lease transaction, rather than a sale of assets (under which gain or loss is immediately recognized) under ASC 840-40-25-4. All of the Leased Equipment are included as part of the property, plant and equipment of the Company as of December 31, 2013. As a result of the sale, a deferred gain on sale of Leased Equipment in the amount of $1,379,282 was created at the closing of the transaction and presented as a non-current liability. The deferred gain would be amortized by the Company during the lease term and would be used to offset the depreciation of the Leased Equipment, which are recorded at the new cost of $25,993,677 as of December 31, 2013. See “ Financing with Sale-Leaseback” under Note (10), Loans Payable, for details of the transaction and asset collaterals. The depreciation of Leased Equipment has started in July 2013 and was included with the depreciation expense of the Company’s own assets in the consolidated statement of income. During the year ended December 31, 2013, depreciation of Leased Equipment was $818,796. The accumulated depreciation of the leased asset was $829,794 as of December 31, 2013. During the year ended December 31, 2013, the gain realized on sale-leaseback transaction was $228,979. The gain realized was recorded in cost of sales as a reduction of depreciation expenses. The unamortized deferred gain on sale-lease back was $1,160,271 as of December 31, 2013.

 

Construction in progress mainly represents payments for the new 15,000 tonnes per year tissue paper manufacturing equipment PM8, the tissue paper workshops, four warehouses, office buildings and the new staff dormitory in the Wei County industrial park, as well as the equipment for the renovation of PM1. Tissue paper manufacturing equipment PM8 and ancillary facilities were expected to start installation in the first quarter of year 2014; while the renovation of PM1 is expected to be completed by the third quarter of year 2014. Upon completion, it will bring about an addition of $116,067,537 to the Company’s machinery and equipment. For the years ended December 31, 2013, 2012 and 2011, the amount of interest capitalized is $448,950, $nil and $nil, respectively.

 

As of December 31, 2013, the three employee dormitory buildings in the amount of $4,130,590, which will be sold to a related party company controlled by our Chairman and CEO Mr. Zhenyong Liu by the second half of year 2014, were reclassified as assets held for sale. Please refer to Note (7) for details.

 

F- 16
 

 

ORIENT PAPER, INC.

 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

As of December 31, 2013 and December 31, 2012, certain property, plant and equipment of Orient Paper HB with net values of $21,901,456 and $9,316,645 have been pledged for the long-term loan from credit union of Orient Paper HB, respectively. As of December 31, 2013, certain of the Company’s property, plant and equipment in the amount of $34,177 have been pledged for the facility obtained from Bank of Hebei. See “ Notes Payable” under Note (12) for details. In addition, land use right with net values of $7,502,794 as of December 31, 2013 was pledged for the sale-leaseback financing. See “ Financing with Sale-Leaseback” under Note (10), Loans Payable, for details of the transaction and asset collaterals.

 

As of December 31, 2013, essentially all production equipment of Orient Paper Shengde with net value of $36,134,038 has been pledged for the guarantee of Orient Paper HB’s performance under the capital lease.

 

In addition, as of December 31, 2012, land use right of $7,419,614 was pledged for a bank loan of an independent third party which cross-guarantees the Company’s credit facility from the Bank of Hebei. The amount of that long-term loan of the third party was $1,505,881 as of December 31, 2012 and has been paid off on June 3, 2013. The credit facility guaranteed by the independent third party was expired on September 19, 2013.

 

Depreciation and amortization of property, plant and equipment was $7,794,743, $8,382,859 and $4,424,531 for the years ended December 31, 2013, 2012 and 2011, respectively.

 

(9) Fair Value Measurement

 

The following table presents fair values for those assets measured at fair value on a non-recurring basis at December 31, 2013 and 2012:

 

    December 31,     December 31,  
    2013     2012  
Long-lived assets                
Using Level 1   $ -     $ -  
Using Level 2     -       -  
Using Level 3     -       1,561,361  
Property, Plant and Equipment, net   $ -     $ 1,561,361  

 

During 2012, the Company recognized $2,762,349 in impairment charges related to its corrugating medium production line PM1. The carrying value of the asset was $4,325,023 and was written down to $1,561,361. The Company used unobservable inputs based on its experience and knowledge of the market, as such, the Company classified the fair value of this asset within Level 3. No impairment charges on property, plant and equipment was made for the year ended December 31, 2013.

 

F- 17
 

     

ORIENT PAPER, INC.

 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

(10) Loans Payable

 

Short-term bank loans

 

        December 31,
2013
    December 31,
2012
 
Industrial & Commercial Bank of China   (a)   $ -     $ 792,568  
Industrial & Commercial Bank of China   (b)     -       1,585,138  
Bank of Hebei   (c)     -       1,585,138  
Industrial & Commercial Bank of China   (d)     4,090,180       -  
Industrial & Commercial Bank of China   (e)     818,036       -  
Industrial & Commercial Bank of China   (f)     1,636,072       -  
Total short-term bank loans       $ 6,544,288     $ 3,962,844  

 

(a)

On September 4, 2012, the Company refinanced with the Industrial & Commercial Bank of China (“ICBC”) an accounts receivable factoring facility with a maximum credit limit of $792,568 as of December 31, 2012. Under the factoring agreement, the bank has recourse against the Company if the receivables, which remain in the Company’s books at all times, are not fully collected. The factoring facility carried an interest rate of 6.6% per annum. The Company paid off the principal balance and accrued interest under the factoring facility on August 28, 2013. 

 

 (b) On November 9, 2012, the Company obtained from the ICBC another accounts receivable factoring facility with a maximum credit limit of $1,585,138 as of December 31, 2012. Under the factoring agreement, the bank has recourse against the Company if the receivables, which remain in the Company’s books at all times, are not fully collected. The term of the factoring facility expired on November 8, 2013 and carried an interest rate of 6.6% per annum, or 1.0% plus the prime rate for the loan set forth by the People’s Bank of China at the time of funding. The Company paid off the principal balance and accrued interest under the factoring facility on November 8, 2013.
   
(c) On September 19, 2012, the Company obtained from the Bank of Hebei a banking facility with maximum credit limit on bank loans of $1,585,138 and on notes payable of $1,585,138 as of December 31, 2012. The facility was guaranteed by an independent third party. On the same day, the Company drew down from this banking facility a new working capital loan of $1,585,138 as of December 31, 2012. The loan bore interest at the rate of 6.6% per annum. Both the term of the banking facility and loan were for one year and expired on September 19, 2013. The Company paid off the loan balance on September 18, 2013.
   
(d)

On September 2, 2013, the Company entered into a working capital loan agreement with the ICBC for $4,090,180, with which $818,036 is payable on June 5, 2014 and $3,272,144 is payable on August 15, 2014. The loan bears an interest rate of 115% over the primary lending rate of the People’s Bank of China and was at 6.9% per annum at the time of funding.

 

Concurrent with the signing of the working capital loan agreement, the Company also entered into a trust agreement with the ICBC, which provides trust account management services to the Company during the terms of the underlying loan. The working capital loan is guaranteed by Hebei Fangsheng Real Estate Development Co. Ltd. (“Hebei Fangsheng”) with the land use right on our Headquarters Compound pledged by Hebei Fangsheng as collateral for the benefit of the bank. The land use right on our Headquarters Compound was acquired by Hebei Fangsheng from the Company on August 9, 2013 (see Note (11) for the related party transaction). Hebei Fangsheng is controlled by the Company’s Chairman and CEO Mr. Zhenyong Liu. 

  

(e)

On September 6, 2013, the Company obtained a new accounts receivable factoring facility from the ICBC for $818,036. Under the factoring agreement, the bank has recourse against the Company if the receivables, which remain in the Company’s books at all times, are not fully collected. The factoring facility will expire on August 4, 2014 and bears an interest rate of 110% of the primary lending rate of the People’s Bank of China and was at 6.6% per annum at the time of funding.

 

Concurrent with the signing of the new factoring agreement, the Company also entered into a financial service agreement with ICBC, which provides accounts receivable management services to the Company during the terms of the underlying factoring facility. The factoring facility is personally guaranteed by the Company’s Chairman and CEO Mr. Zhenyong Liu.

   

 

F- 18
 

     

ORIENT PAPER, INC.

 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

(f) On December 3, 2013, the Company obtained from the ICBC an accounts receivable factoring facility with a maximum credit limit of $1,636,072 as of December 31, 2013. Under the factoring agreement, the bank has recourse against the Company if the receivables, which remain in the Company’s books at all times, are not fully collected. The term of the factoring facility expires on October 21, 2014 and carries an interest rate of 6.6% per annum, or 1.0% plus the prime rate for the loan set forth by the People’s Bank of China at the time of funding. The unpaid balance of the loan was in the amount of $1,636,072 as of December 31, 2013.

 

As of December 31, 2013 and 2012, there were secured short-term borrowings of $6,544,288 and $2,377,706, respectively, and unsecured bank loans of $nil and $1,585,138, respectively. The factoring facility was secured by the Company’s accounts receivable in the amount of $3,272,528 and $2,836,335 as of December 31, 2013 and 2012, respectively.

 

As of December 31, 2013 and 2012, the Company had no unutilized credit facility for bank loans with the banks. The average short-term borrowing rates for the years ended December 31, 2013, 2012 and 2011 were approximately 6.68%, 7.82% and 6.38%, respectively.

 

Long-term loans from credit union

 

As of December 31, 2013 and 2012, loan payable to Rural Credit Union of Xushui County, amounted to $5,914,401 and $5,730,273, respectively.

 

On March 31, 2011, the Company entered into a three-year term loan agreement with Rural Credit Union of Xushui County for an amount that is $1,611,531 as of December 31, 2013 and $1,561,361 as of December 31, 2012. The loan is guaranteed by an independent third party. Interest payment is due quarterly and bears the rate of 0.72% per month. As of December 31, 2013, the entire balance of the loan in the amount of $1,611,531 was presented as current portion of long-term loan from credit union in the consolidated balance sheet.

 

On June 10, 2011, the Company entered into a term loan agreement with the Rural Credit Union of Xushui County for an amount that was $4,168,912 as of December 31, 2012. Interest payment is due quarterly and bears the rate of 0.72% per month. The loan is secured by its manufacturing equipment of $9,316,645 as of December 31, 2012, and became matured on June 9, 2013. On July 26, 2013, the Company paid off the unpaid principal balance and accrued interest.

 

On July 15, 2013, the Company entered into a new agreement with the Rural Credit Union of Xushui County of $4,302,870 for a term of 5 years, which is due and payable on various scheduled repayment dates between December 21, 2013 and July 26, 2018. The loan is secured by certain of the Company’s manufacturing equipments in the amount of $21,901,456 as of December 31, 2013. Interest payment is due quarterly and bears a fixed rate of 0.72% per month. As of December 31, 2013, total outstanding loan balance was $4,302,870, with $49,082 becoming due within one year and presented as current portion of long term loan from credit union in the consolidated balance sheet.

 

Total interest expenses for the short-term bank loans and long-term loans for the years ended December 31, 2013, 2012 and 2011 were $828,157, $736,457 and $495,978, respectively.

   

F- 19
 

     

ORIENT PAPER, INC.

 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Financing with Sale-Leaseback

 

The Company entered into a sale-leaseback arrangement (the “Lease Financing Agreement”) with China National Foreign Trade Financial & Leasing Co., Ltd ("CNFTFL") on June 16, 2013, for a total financing proceeds in the amount of RMB150 million (approximately US$24 million). Under the sale-leaseback arrangement, Orient Paper HB sold certain of its paper manufacturing equipment (the “Leased Equipment”) to CNFTFL for an amount of RMB 150 million (approximately US$24 million). Concurrent with the sale of equipment, Orient Paper HB leases back all of the equipment sold to CNFTFL for a lease term of three years. At the end of the lease term, Orient Paper HB may pay a nominal purchase price of RMB 15,000 (approximately $2,400) to CNFTFL and buy back all of the Leased Equipment. The sale-leaseback is treated by the Company as a mere financing and capital lease transaction, rather than a sale of assets (under which gain or loss is immediately recognized) under ASC 840-40-25-4. All of the Leased Equipment are included as part of the property, plant and equipment of the Company’s as of December 31, 2013; while the net present value of the minimum lease payment (including a lease service charge equal to 5.55% of the amount financed, i.e. approximately US$1.36 million) was recorded as obligations under capital lease and was calculated with CNFTFL’s implicit interest rate of 6.15% per annum and stated at $25,750,170 at the inception of the lease on June 16, 2013. The balance of the long-term obligations under capital lease was $12,296,639 as of December 31, 2013, which is net of its current portion in the amount of $8,264,795.

 

Total interest expenses for the sale-leaseback arrangement for the years ended December 31, 2013, 2012 and 2011 were $471,472, $nil and $nil, respectively.  

 

As a result of the sale, a deferred gain on sale of leased equipment in the amount of $1,379,282 was created at the closing of the transaction and is presented as a non-current liability. The deferred gain would be amortized by the Company during the lease term and would be used to offset the depreciation of the Leased Equipment, which was recorded at the new cost of $25,993,677 as of December 31, 2013.

 

As part of the sale-leaseback transaction, Orient Paper HB entered into a Collateral Agreement with CNFTFL and pledged the land use right in the amount of approximately $7,502,794 on some 58,566 square meters of land as collateral for the lease. In addition to Orient Paper HB’s collateral, Orient Paper Shengde also entered into a Guarantee Contract with CNFTFL on June 16, 2013. Under the Guarantee Contract, Orient Paper Shengde agrees to guarantee Orient Paper HB’s performance under the lease and to pledge all of its production equipment as additional collateral. Net book value of Orient Paper Shengde’s asset guarantee was $36,134,038 as of December 31, 2013.

 

The future minimum lease payments of the capital lease as of December 31, 2013 were as follows: 

Year Ending December 31,   Amount  
2014   $ 9,327,690  
2015     8,817,611  
2016     4,218,050  
    $ 22,363,351  

 

F- 20
 

 

ORIENT PAPER, INC.

 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

  

(11) Related Party Transactions

 

Mr. Zhenyong Liu is the director, principal stockholder and chief executive officer of the Company. He loaned money to Orient Paper HB for working capital purposes over a period of time. On August 31, 2009, Orient Paper, Orient Paper HB, and Mr. Liu entered into a tri-party Debt Assignment and Assumption Agreement, under which Orient Paper agreed to assume the loan of $4,000,000 due from Orient Paper HB to Mr. Liu. Concurrently, Orient Paper issued 1,204,341 shares of restricted common stock to Mr. Liu at the market price of $3.32132 per share. As of December 31, 2012, net amount due to Mr. Liu was $2,315,239.

 

The unsecured loan of Mr. Liu is interest bearing and the interest rate is equal to the rate established by the People’s Bank of China, which was 5.85% per annum as of December 31, 2012. The term is for 3 years and starts from January 1, 2010 and is due December 31, 2012. On January 1, 2013, Orient Paper HB and Mr. Liu entered into another three-year term and extended the maturity date further to December 31, 2015. The unsecured loan carries an annual interest rate based on the People’s Bank of China at the time of the renewal and was set at 6.15% per annum. As of December 31, 2013, net amount due to Mr. Liu was $2,389,633.

 

The interest expenses incurred for above related party loans are $145,015, $135,377 and $203,914 for the years ended December 31, 2013, 2012 and 2011, respectively. On March 25, 2014, our Chairman and CEO Mr. Zhenyong Liu agreed in writing to permit the Company to continue to postpone the repayment of the accrued interest on his loan to Orient Paper HB until the earliest date on which the Company's quarterly or annual financial statements filed with the SEC show a satisfactory working capital level. The accrued interest owned to Mr. Liu was approximately $566,343 and was recorded as part of the current liabilities as of December 31, 2013.

 

During the years ended December 31, 2013, 2012 and 2011, the Company borrowed $1,390,802, $1,030,097 and $200,000, respectively, from shareholders to pay for various expenses incurred in the U.S. The amount is repayable on demand with interest free. The Company repaid the entire balance by the end of fiscal year 2013, 2012 and 2011, respectively.

 

Sale of Headquarters Compound Real Properties to a Related Party

 

The Company was informed in 2012 that a recent Xushui County urban redevelopment plan mandates that the current site on which our principal executive offices and other production facilities are situated (the “Headquarters Compound”) and neighboring area be reserved for residential use only. It is expected that the Company, like other manufacturers in the affected area, will be required eventually to cease all operations currently conducted on the Headquarters Compound site. In order to comply with this government mandate, the Company intends to initiate the process of relocating its offices and facilities to a new site. To that end, the Company has entered into negotiations concerning the potential sale of this property and all of the buildings and facilities located thereon (the “Potential Sale”) with Hebei Fangsheng Real Estate Development Co. Ltd. (“Hebei Fangsheng”), a real estate development company owned by Mr. Zhenyong Liu, our Chairman and Chief Executive Officer and his family. In November 2012, Hebei Fangsheng provided the Company with a payment of approximately $1,075,606 earnest money deposit payment in connection with the Potential Sale, which would be refunded to Hebei Fangsheng in the event that the parties fail to reach an agreement on the terms of the Potential Sale. The Company recorded the receipt of the earnest money deposit as a security deposit as of December 31, 2012 accordingly.

 

On August 7, 2013 the Company’s Audit Committee and the Board of Directors approved the sale of the land use right of the Headquarters Compound (the “LUR”), the office building and essentially all industrial-use buildings in the Headquarters Compound (the “Industrial Buildings”), and three employee dormitory buildings located within the Headquarters Compound (the “Dormitories”) to Hebei Fangsheng for cash prices of approximately $2.77 million, $1.15 million, and $4.28 million, respectively. In connection with the sale of the Industrial Buildings, Hebei Fangsheng agrees to lease the Industrial Buildings back to the Company for its original use for a term of up to three years, with an annual rental payment of approximately $161,439. As of December 31, 2013, the Company accrued the rent due to Hebei Fangsheng in the amount of $64,546.

 

As a condition for the sale of the Dormitories, Hebei Fangsheng agrees that it will act as an agent for the Company, which does not have the qualification to sell residential housing units in China, and that it is obligated to sell all of the 132 apartment units in the Dormitories to qualified employees of the Company at its acquisition price. Hebei Fangsheng further represents that it will not seek to profit from the resale of the Dormitories units and will allow the Company to inspect the books and records of the sale upon completion of the resale of the Dormitories units to ensure the objectives are achieved.

 

F- 21
 

     

ORIENT PAPER, INC.

 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

  

The sale was conducted on an arms-length basis, and was reviewed by the Company’s Audit Committee and approved by the Board of Directors. The $2.77 million sale price of the industrial land use right was determined by the valuation from a government designated appraisal, which was 3.35% higher than a second independent appraisal commissioned by the Company. The $1.15 million sale price of the Industrial Buildings was determined by negotiation between the Company and Hebei Fangsheng and is equal to the appraised value based on the assumption that the use of the buildings would be continued until they are retired. Based on the assumption that such buildings would have to be torn down to comply with the re-zoning, a second independent appraisal obtained by the Company put the value at $0.4 million. Although the Company and Hebei Fangsheng agree to set the sale price of the Dormitories at the Company’s original construction cost of the three dormitory buildings for $4.28 million, an independent appraisal shows that the value for the three buildings as employee dormitories was $4.61 million.

 

For the sale of the Headquarters Compound LUR and the Industrial Buildings, it generated a net gain on disposal of approximately $84,972, net of land appreciation tax and other transactional taxes and fees paid out of the proceeds of the sale to various local government tax authorities.

 

The dormitories were reclassified as assets held for sale on August 9, 2013 in accordance with ASC 360-10-45-9. As the sale was not yet completed by the end of December 31, 2013, the dormitories remained as assets held for sale under current asset in the amount of $4,130,590 as of December 31, 2013. The closing of the sale is expected to be consummated by the second half of year 2014. In December 2013, Hebei Fangsheng provided the Company with a payment of approximately $1,636,072 earnest money deposit payment in connection with the sale of the dormitories. The Company recorded the receipt of the earnest money deposit as a security deposit as of December 31, 2013 accordingly.

 

(12) Notes payable

 

As of December 31, 2013, the Company had three bank acceptance notes from Bank of Hebei to one of its major suppliers for a total amount of $4,908,216. An amount equal to $2,454,108 is under the banking facility obtained from Bank of Hebei in November 13, 2013, while the remaining portion, amount of $2,454,108 are secured with a restricted bank deposit as mentioned in Note (3). The banking facility obtained from Bank of Hebei was secured by certain of the Company’s property, plant and equipment in the amount of $34,177, and guaranteed by the Company’s Chairman and CEO Mr. Liu Zhenyong and two independent third parties. The bank acceptance notes bear interest rate at nil% per annum and 0.05% of notes amount as handling change. They will become due and payable on various dates starting from May 15 through June 19 during the year of 2014.

 

As of December 31, 2012, the Company had six bank acceptance notes from Bank of Hebei to one of its major suppliers for a total amount of $3,170,276. An amount equal to $1,585,138 is under the banking facility obtained from Bank of Hebei in September 13, 2012 as mention in Note (10), while the remaining portion, amount of $1,585,138, are secured with a restricted bank deposit as mention in Note (3). The bank acceptance notes bear interest rate at nil% per annum and 0.05% of notes amount as handling charge. They will become due and payable on various dates starting from March 24 through June 18 during the year of 2013.

 

(13) Other payables and accrued liabilities

 

Other payables and accrued liabilities consist of the following:

 

    December 31,     December 31,  
    2013     2012  
Accrued electricity   $ 372,726     $ 232,763  
Accrued professional fees     58,000       143,597  
Value-added tax payable     940,400       -  
Accrued interest to a related party     566,343       406,324  
Accrued bank loan interest     380,022       250,299  
Payable for purchase of equipment     -       152,173  
Advance from customer     11,453       -  
Insurance premium payable     62,348       56,773  
Others     260,180       20,355  
Totals   $ 2,651,472     $ 1,262,284  

 

F- 22
 

 

ORIENT PAPER, INC.

 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

(14) Common Stock

 

Issuance of common stock pursuant to the 2011 Incentive Stock Plan and 2012 Incentive Stock Plan

 

On January 12, 2012, the Company issued shares of 109,584 out of the 2011 Incentive Stock Plan of Orient Paper, Inc. (the “2011 ISP”) to certain of its directors and officers when the stock was at $3.45 per share, as compensation for their services in the past years. Total fair value of the stock was calculated at $378,065 as of the date of issuance. The 2011 ISP was approved by the shareholders of the Company in August 2011 and sets aside 375,000 shares of the Company’s common stock for the purpose of compensating services provided by the employees, directors and other service providers.

 

On December 31, 2013, the Company issued restricted common shares of 297,000 out of the 2011 ISP and 2012 Incentive Stock Plan (the “2012 ISP”) of Orient Paper, Inc. to certain of its directors and officers when the stock was at $2.66 per share, as compensation for their services in the past years. Total fair value of the stock was calculated at $790,020 as of the date of grant. See Note (17), Stock Incentive Plan, for more details of the 2011 ISP and the 2012 ISP.

 

Cancellation of certain director compensation shares

 

On April 4, 2013, the Company cancelled 2,875 shares of common stock previously issued on March 31, 2011 to two of its directors. The cancellation of shares was at the request of the New York Stock Exchange following a review of the Company’s shares listing application, where the stock exchange believes the shares were issued without shareholder approval and after the Company was subject to the shareholder approval requirement for any stock compensation. The Company reversed the related capital accounts and 2011 compensation expense of $3 and $16,155, respectively, during the year ended December 31, 2013.

 

Dividend declared

 

On June 1, 2012, the Company’s Board of Directors approved a quarterly cash dividend of $0.0125 per share for each of the coming four quarters. The first quarterly dividend was declared on June 1, 2012 to shareholders of record as of June 15, 2012. The dividends were paid on July 2, 2012.

 

On September 4, 2012, the Company declared another quarterly dividend of $0.0125 per share to shareholders of record as of September 14, 2012. The dividends were paid on October 1, 2012. On December 6, 2012, the Company declared a third quarterly cash dividend of $0.0125 per share to shareholders of record as of December 17, 2012. The dividends were paid on December 31, 2012. Total dividends declared and paid for the year ended December 31, 2012 were $692,242.

 

On April 4, 2013, the Company declared another quarterly dividend of $0.0125 per share to shareholders of record as of April 16, 2013. The dividend was paid on April 30, 2013.

 

On November 21, 2013, the Company declared another quarterly dividend of $0.005 per share to shareholders of record as of November 29, 2013. The dividend was paid on December 10, 2013. Total dividends declared and paid for the year ended December 31, 2013 were $323,032.

 

Future declaration of dividends will depend on, among other things, the Company's results of operations, capital requirements, financial condition and on such other factors as the Company's Board of Directors may in its discretion consider relevant and in the best long term interest of the shareholders.

 

F- 23
 

 

ORIENT PAPER, INC.

 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

(15) Earnings Per Share

 

For the years ended December 31, 2013, 2012 and 2011, basic and diluted net income per share are calculated as follows:

 

          Year Ended        
    December 31,  
    2013     2012     2011  
Basic income per share                        
Net income for the year - numerator   $ 13,014,648     $ 14,672,663     $ 21,648,664  
Weighted average common stock outstanding - denominator     18,458,446       18,456,781       18,349,332  
Net income per share   $ 0.71     $ 0.79     $ 1.18  
                         
Diluted income per share                        
Net income for the year - numerator   $ 13,014,648     $ 14,672,663     $ 21,648,664  
Weighted average common stock outstanding - denominator     18,458,446       18,456,781       18,349,332  
Effect of dilution     -       -       -  
Weighted average common stock outstanding - denominator     18,458,446       18,456,781       18,349,332  
Diluted income per share   $ 0.71