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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
___________
FORM 10-KSB/A
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1997
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____ to _____
___________
COMMISSION FILE NUMBER: 33-18521-NY
CREATIVE MASTER INTERNATIONAL, INC.
(Name of small business issuer in its charter)
DELAWARE 11-2854355
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
CASEY IND. BLDG., 8TH FLOOR N/A
18 BEDFORD RD., TAIKOKTSUI (Zip Code)
KOWLOON, HONG KONG
(Address of principal executive offices)
ISSUER'S TELEPHONE NUMBER: 011-8522-396-0147
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock,
$.0001 par value
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. YES X NO
----- -----
Check if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-B is not contained in this form, and will not be contained, to the best of the
issuer's knowledge, in definitive proxy or information statements incorporated
by reference in Part III of this Form 10-KSB or any amendment to this
Form 10-KSB. _____
Issuer's revenues for its most recent fiscal year: $16,211,000
The aggregate market value of the common stock held by non-affiliates of
the registrant as of September 30, 1998 was approximately $124,932, based upon
the average high and low ask and bid prices quoted on the OTC Electronic
Bulletin Board.
The number of shares outstanding of the registrant's common stock as of
September 30, 1998 was 4,999,746.
Traditional Small Business Disclosure Format (check one): YES NO X
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TABLE OF CONTENTS
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Item Page
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Part I
1. Description of Business.................................................................. 3
2. Description of Property.................................................................. 12
3. Legal Proceedings........................................................................ 13
4. Submission of Matters to a Vote of Security Holders...................................... 13
Part II
5. Market for Common Equity and Related Stockholder Matters................................. 13
6. Management's Discussion and Analysis of Financial Condition and Results of Operations.... 16
7. Financial Statements..................................................................... 22
8. Changes In and Disagreements With Accountants
on Accounting and Financial Disclosure.................................................. 23
Part III
9. Directors, Executive Officers, Promoters and
Control Persons; Compliance with Section 16(a)
of the Exchange Act..................................................................... 23
11. Executive Compensation................................................................... 24
12. Security Ownership of Certain Beneficial Owners and Management........................... 29
13. Certain Relationships and Related Transactions........................................... 30
Part IV
14. Exhibits and Reports on Form 8-K......................................................... 30
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
The statements contained in this 10-KSB/A that are not purely historical are
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934,
as amended. These include statements about the Company's expectations, beliefs,
intentions or strategies for the future, which are indicated by words or phrases
such as "anticipate," "expect," "intend," "plan," "will," "the Company
believes," "management believes" and similar words or phrases. The forward-
looking statements are based on the Company's current expectations and are
subject to certain risks, uncertainties and assumptions, including factors set
forth in the following discussion and under "Item 6. Management's Discussion and
Analysis or Plan of Operation," and other factors described in Exhibit 99.1 to
this Form 10-KSB. The Company's actual results could differ materially from
results anticipated in these forward-looking statements. All forward-looking
statements included in this document are based on information available to the
Company on the date hereof, and the Company assumes no obligation to update any
such forward-looking statements.
OVERVIEW
Creative Master International, Inc. (the "Company" or "Creative Master") is
a leading independent manufacturer of collectible-quality, die-cast replicas of
cars, trucks, buses and other items. Die-cast collectibles are distinguishable
from die-cast toys by their authentic design, exacting engineering and attention
to detail, including abundant use of identifiable brand names, logos and other
licensed marks. The die-cast products the Company manufactures are 1/12/th/ to
1/64/th/ scale and include as many as 450 parts, including numerous moveable
parts. They are marketed and distributed by the Company's customers primarily
to collectors, hobbyists and enthusiasts at retail prices ranging from $20 to
$200 or more. The Company's customers are leading U.S. and European marketers
and distributors of vehicle replicas and other collectibles, including Danbury
Mint, Mattel, Hallmark Cards, Paul's Model Art and Brookfield Collectors Guild.
The Company's mission is to provide the highest level of product quality and
customer service among independent manufacturers of die-cast collectibles. The
Company offers its customers turnkey product development and manufacturing
capabilities that are customized to meet their specific needs. The Company's
vertically integrated process affords complete sourcing of raw materials,
engineering, assembly, quality control and final packaging of die-cast products
in commercial quantities. Depending on the customer's needs, the Company
provides a self-contained production area within one of its factories with
tooling and other production functions dedicated to manufacturing the customer's
products according to its particular design, engineering and quality
requirements. This approach permits customers to closely supervise and control
all aspects of the production process and to protect the confidentiality of
their product design and engineering. The Company's turnkey process enables its
customers to shorten the lead time from conceptual design to product delivery
and to minimize production costs while maintaining high quality and reliability.
All of the Company's manufacturing operations are conducted through CML, the
Company's wholly-owned Hong Kong subsidiary, and CML's subsidiaries. The
Company's manufacturing facilities are located in the Dongguan region of
Guangdong Province, China, approximately 60 miles northwest of Hong Kong. The
Dongguan facilities contain an aggregate of approximately 320,000 square feet of
manufacturing space and related housing for up to approximately 4,100 workers.
On December 30, 1997, CML completed an exchange reorganization with Davin
Enterprises, Inc., a public company that was incorporated in Delaware on April
8, 1987. Through the exchange reorganization, the Company acquired all of the
outstanding capital stock of CML from Messrs. Tong and Kwok and Acma Strategic
Holdings Limited in exchange for the Company's issuance to them of 4,806,000
shares of common stock, representing approximately 96% of the Company's
outstanding stock.
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INDUSTRY
The U.S. collectibles industry comprises numerous market segments and
subsegments served by a variety of toy companies and other distributors. In
addition to die-cast items, including cars, trucks and other vehicles,
collectibles include such items as figurines, dolls, "plush" dolls, ceramic
cottages, prints, plates, glass, ornaments, steins, music boxes and trading
cards. According to the Collectibles Industry Report for 1997 published by
Unity Marketing, an independent market research firm, U.S. consumer sales of
collectibles totalled approximately $10 billion in 1997. According to Unity
Marketing, U.S. consumer sales of die-cast vehicle replicas totalled
approximately $753 million in 1997, which was 47% more than in 1996. The
Company believes that the aging of the so-called baby-boomers, with their
relatively higher discretionary spending on leisure goods such as collectibles,
is the principal reason for the increased demand for collectibles.
The Company believes the total European consumer market for collectibles was
approximately $6 billion in 1997. The BIS Ltd., a European market research
firm, estimates that the European retail consumer market for die-cast
collectibles in Europe was approximately $200 million in 1997. The Company
believes the size and growth of the European collectibles market, the increasing
influence of American culture in collectibles and the growing use of
sophisticated marketing techniques all favor collectible products marketed by
American and European companies.
PRODUCTS
The Company believes there are not more than 20 major marketers and
distributors of die-cast collectibles in the U.S. and Europe. The Company's
customers include many of the leading U.S. and European marketers and
distributors. The following sets forth certain information with respect to the
Company's customers:
<TABLE>
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CUSTOMER NAME PRINCIPAL PRODUCT CATEGORY CUSTOMER SINCE
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. Danbury Mint (1) U.S. classic cars and trucks 1986
. Tyco Hong Kong Limited (2) Matchbox collectibles 1996
. Brookfield Collectors Guild (3) NASCAR racing cars 1996
. Paul's Model Art (4) European Formula One and
Super Touring racing cars 1998
. Mattel (5) Matchbox collectibles 1997
. Corgi Classic Cars Hong Kong buses, United
Kingdom buses and airplanes 1997 (6)
. First Gear Trucks 1998
. Road Champs (7) Police Cars 1998
. Lionel Trains Vintage trains 1998
. Hallmark Cards Pedal cars and ornaments 1997
</TABLE>
____________
(1) Danbury Mint is a division of MBI, Inc.
(2) Tyco Hong Kong Limited was acquired by Mattel in the fourth quarter of 1997.
(3) Brookfield Collectors Guild is a division of Action Performance Companies,
Inc.
(4) Action Performance Companies, Inc. acquired a controlling interest in Paul's
Model Art in August 1998.
(5) Sales to Mattel are made indirectly through its Mattel Vendor Operations
Asia Ltd. subsidiary.
(6) Until mid-1998, sales to Corgi Classic Cars were made indirectly through its
agent, Drumwell Limited.
(7) Road Champs is a subsidiary of JAKKS Pacific.
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Cars, Trucks and Buses. The Company produces a wide range of collectible
die-cast replicas of automobiles, including classic cars, European cars, Formula
1 racing cars, trucks and buses. These replicas are produced at various scales
from 1/12/th/ to 1/64/th/ of the original size. They typically retail from $90
to $200, depending on the number of parts and the level of intricacy in the
design. The Company's replicas have between 200 and 450 parts and quality
finishing that results in an authentic look that appeals to collectors and other
enthusiasts.
While the Company does not manufacture "toy-grade" replicas, it does produce
some replicas that sell at lower retail prices. The price is determined by the
size of the replica, the number of parts and the intricacy of the design. The
Company's medium-feature products typically retail for $40 to $90 and its small-
scale products retail for $20 to $40.
Vintage Trains and Locomotives. In April, 1998, the Company began working
on a limited number of die-cast replicas of vintage locomotives and trains for
Lionel Trains, a U.S. marketer and distributor of electric train sets and model
trains. Depending on the success of the initial product, the Company
anticipates manufacturing additional locomotive and train products in the
future.
Outboard Motors and Marine Products. The Company is in the process of
formalizing an arrangement with Alterscale, a company engaged in the development
of collectible marine replicas, to co-develop die-cast collectible replicas of
outboard motors under license from the owner of the Johnson and Evinrude brands.
The Company has manufactured and sold a limited run of approximately 1,000 of
these replicas, and one of the Company's customers is expected to test market
these replicas. The Company also is engaged in discussions with other owners of
marks for marine related products to discuss licensing opportunities.
PRINCIPAL CUSTOMERS
The Company's customers consist principally of specialty retailers, direct
marketers and other distributors of collectibles in the U.S. and Europe. The
Company's largest customer is Danbury Mint, a division of MBI, Inc. Danbury
Mint is a leading U.S. developer and marketer of 1/24/th/ scale premium die-cast
replicas. Danbury Mint was the Company's first customer in 1987.
The Company's second largest customer is Mattel. In 1996, the Company began
manufacturing the popular Matchbox die-cast collectibles series for Mattel. In
the fourth quarter of 1997, Mattel purchased Tyco Hong Kong Limited, for which
the Company had been producing die-cast vehicle replicas since 1996.
The Company's other customers include Brookfield Collectors Guild
("Brookfield"), a subsidiary of Action Performance Companies, Inc. ("Action
Performance"), Paul's Model Art ("PMA"), First Gear, Hallmark Cards
("Hallmark"), Road Champs and Corgi Classic Cars. Action Performance acquired a
controlling interest in PMA in August 1998.
The following table sets forth sales to its principal customers as a percent
of net sales for the periods shown:
<TABLE>
<CAPTION>
Percent of Net Sales
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Years Ended
Customer December 31, 1997
----------------------------------- -----------------------
<S> <C>
Danbury Mint 64.2%
Mattel(1) 20.4
Brookfield Collectors Guild 4.7
Drumwell Limited 4.2
Hallmark Cards 0.2
</TABLE>
______________
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(1) Includes sales to Tyco Hong Kong Limited, which was acquired by Mattel in
the fourth quarter of 1997.
The Company's sales transactions with its customers are based on purchase
orders received by the Company from time to time which are subject to
cancellation. Although the Company does not have any long-term agreements with
any of its clients, it believes that its relationships with its customers are
excellent.
MARKETING AND SALES
The Company historically has not engaged in any significant marketing
activities, and has relied primarily on its reputation for quality and
efficiency among its customers to obtain new business. The Company's senior
executives work closely with its customers to develop new products to meet
consumer demand for die-cast collectibles. Recently, the Company hired Henry
Hai-Lin Hu to bolster its product development, marketing and sales efforts. Mr.
Hu has extensive experience in the collectible industry. See "Item 9.
Directors, Executive Officers, Promoters and Control Persons; Compliance with
Section 16(a) of the Exchange Act -- Executive Officers and Directors."
Historically, the Company has not sought to license the right to produce
replicas of particular classic cars or other products. The Company is in the
process of formalizing a joint product development agreement with Alterscale, a
company engaged in the development of collectible marine replicas, to develop
and manufacture outboard motors under license from the owner of the Johnson and
Evinrude brands. The Company may selectively license other marks in the future,
where such licensing would not compete with the licensing efforts of the
Company's customers. To the extent the Company obtains any licenses to
manufacture die-cast replicas, it will seek to sublicense one or more of its
existing customers or others to market and distribute such replicas.
BACKLOG AND SEASONALITY
The Company's customers generally contact the Company nine to eighteen
months in advance of product delivery, so that the Company can engineer and
fabricate the necessary molds for producing the die-cast product. Purchase
orders are typically received two to six months in advance of target delivery
dates. Purchase orders are subject to cancellation at any time. The Company
has no significant backlog.
The Company's operating results may fluctuate depending upon general
economic and industry conditions and the Company's sales. Each year, the
Company ceases production for a two-week period due to the Chinese New Year
holiday, which occurs during late January or early February depending on the
calendar. This holiday shutdown has typically resulted in lower revenues during
the first quarter of each year than revenues during the other three quarters.
PRODUCT DEVELOPMENT AND MANUFACTURING
The Company offers turnkey manufacturing capabilities, including complete
raw materials sourcing, computer-aided product engineering, model-making, mold-
making, manufacturing, assembling and packaging of finished products. The
Company can meet all of a customer's design engineering and manufacturing needs,
thus eliminating the need for intermediaries. By coordinating product
development and process design with production and packaging, the Company is
able to shorten the lead time from conceptual design to product delivery and to
lower production costs while maintaining high quality and reliability.
The product production cycle occurs in four stages:
. Product development
. Model making
. Tooling
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. Final production and assembly
The product development phase of the production cycle begins when a customer
provides the Company with photographs, drawings and other specifications for the
new product. The Company then works with the customer to design a product that
meets the customer's specifications and price point. For example, when building
a classic car replica the Company seeks to ensure that the product is properly
proportioned and historically correct. This means that the Company strives to
precisely reproduce the exterior and interior design, color schemes and
accessories of the original car. One example of this precision is the Company's
1/24/th/ scale Mercedes Benz SSKL, for which the Company holds a license. Among
its many authentic details, the Mercedes Benz SSKL includes wire wheels, rubber
tires, genuine leather seats, a working steering wheel and a hood that opens to
reveal the car's engine and a leather strap with a metal buckle to secure the
hood.
The Company believes that model making is critical to producing the highest
quality collectibles. During the model-making stage of the production cycle,
the Company's engineering staff uses computer-aided design systems to develop a
prototype scale model. The Company will include as many functioning moving
parts as possible, given the Customer's desired price point. Examples of such
features are car doors, trunks and hoods that open, steerable wheels and working
suspension. The Company strives to ensure that the models it produces also have
an authentic build and finish. Once the prototype replica is ready, it must be
approved by the customer before the Company begins to fabricate the molds and
tools that will be used to manufacture the product in commercial quantities.
The Company can generally produce a prototype in one to three months.
Once the customer has approved a prototype, the Company begins the tooling
process, which typically requires six to twelve months. The tooling process
occurs in two stages. First, the Company produces tooling and molds that will
be used to fabricate each component part of the product. Next, the Company
tests the components and the assembled product produced with the new tools and
molds. If necessary, the Company refines and modifies the molds and tools
before seeking customer approval to manufacture the product. Upon receiving
customer approval, the Company releases the molds and tools to produce final
products.
In the last stage of the production cycle, the Company produces the
component parts, then assembles, finishes, packages and ships the final
products. The die-casting, injection-molding and electrostatic painting areas
of the Company's facilities operate five days per week on a two-shift per day
basis. The finishing, assembly and packing areas also run on a multi-shift
basis. These areas account for most of the total work force and production area
at the Company's facilities.
Typically, customers pay 50% of the Company's tooling and mold-making costs
when the tooling and mold-making process commences and an additional 25% of
these costs when the initial test products are made using the new molds and
tools. The Company receives payment for the final 25% of the tooling costs when
the tools and molds are released for commercial production.
The Company usually insures the tools and molds until they are approved by
the customer for production. At that point, the customer makes takes ownership
and assumes the cost of insuring the molds and tools.
The long lead time required to develop new products and related tools and
molds, combined with each customer's financial commitment at the beginning of
the tooling process, provides the Company with an indication of prospective
orders for six to twelve months in advance.
PRINCIPAL SUPPLIERS AND SOURCES OF SUPPLY
The Company uses zinc alloy and various plastic resins in its die-cast and
injection-molded production operations. The supply and demand for zinc alloy
and for both plastic resins and the petrochemical intermediates from which
plastic resins are produced are subject to cyclical and other market factors and
can
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fluctuate significantly. The Company acquires raw materials for its die-cast
production primarily from Australia and the United Kingdom. The Company's
standard practice is to maintain a supply of raw materials sufficient for
approximately two months of production. The Company anticipates that it will be
able to obtain sufficient supplies of raw materials as it expands its production
capacity and output.
Three of the Company's suppliers accounted for more than 5% of its supplies
in 1997 as shown in the following table:
<TABLE>
<CAPTION>
PERCENT OF TOTAL RAW
MATERIAL SUPPLIED
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COMPONENT YEAR ENDED
SUPPLIER SUPPLIED DECEMBER 31, 1997
- --------------------------------------- -------------------- -----------------------
<S> <C> <C>
. Manfield Coatings Co., Ltd........ Paint 9.0%
. Genesis Off-set Printing Co., Ltd. Packaging Materials 8.5%
. Zinamet Co., Ltd.................. Zinc Alloy 6.9%
. Lee Kee Metal Co., Ltd............ Zinc Alloy 6.1%
</TABLE>
The Company believes there are multiple sources of supply of these and other
raw materials used in the Company's business.
COMPETITION
The Company faces significant competition from toy companies and other
independent manufacturers of die-cast products with production facilities
located in China. Certain of the Company's customers, including Mattel, Action
Performance and Road Champs, have their own die-cast manufacturing facilities in
China.
The Company competes on the basis of quality, technical capabilities and
delivery schedules. To a lesser extent, it competes on the basis of price.
The Company believes it possesses trade secrets relating to sourcing of raw
materials and other aspects of its production process that may represent a
competitive advantage. The Company does not characterize its business as
proprietary, however, and does not own any patents. The Company typically
relies on its customers to obtain licenses from manufacturers of the products on
which its replicas are based. The Company currently holds a license to its
Mercedes Benz SSKL replica, and it intends to selectively seek licenses for
certain new products, such as marine outboard motors and other products that do
not compete with the products of existing customers. Other than trade secrets
and the capital required for factory equipment and training, the Company
believes that there are no significant barriers to entry to the manufacture of
die-cast products. Accordingly, additional participants may enter the market at
any time. Many of the Company's existing or potential competitors have
significantly greater financial, technical, manufacturing and marketing
resources than the Company.
EMPLOYEES
As of September 30, 1998, the Company employed approximately 4,100 persons,
all of which were full-time workers. Of these employees, approximately 3,570
were production workers, 200 were administrative staff, 330 were engineers and
technicians. In addition, the Company employs 30 people in Hong Kong. As is
customary for employers in China, the Company's production facilities includes
housing facilities for its workers. The Company is committed to providing good
working and living conditions for its
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employees in China. The Company has experienced no significant labor stoppages
and believes that the relations with its employees are satisfactory.
The Company anticipates hiring up to 1,600 new employees in connection with
the expansion of its manufacturing facilities currently underway. Historically,
the Company has had no difficulty in hiring additional employees, and it
anticipates that it will be able to hire additional employees in the future as
needed in connection with the growth of its business.
RESEARCH AND DEVELOPMENT
The Company did not incur research and development expenses during 1995,
1996 or 1997. Substantially all development costs associated with manufacturing
products for its customers are expensed as a cost of sales. The Company does
not rely on any proprietary technology. The Company intends to increase its
product development efforts, and may incur future research and development
expenses in connection with these efforts.
DEPENDENCE ON IMPORTANT CUSTOMERS
The Company's business is concentrated among a limited number of customers.
In 1997, sales to Danbury Mint, a subsidiary of MBI, Inc. accounted for
approximately 64.2% of net sales and sales to Mattel Vendor Operations Ltd. and
Tyco Hong Kong Limited, subsidiaries of Mattel totaled approximately 20.4% of
net sales. The Company expects that it will continue to depend on sales to
Danbury Mint and Mattel. If the Company loses any one of its major customers,
particularly Danbury Mint or Mattel, its business, financial condition and
results of operations would be materially adversely affected. See "-- Principal
Customers."
ITEM 2. DESCRIPTION OF PROPERTY
The Company's corporate and administrative offices occupy approximately
10,000 square feet of office space in Hong Kong. The Company subleases these
facilities at a cost of approximately $4,000 per month, pursuant to leases which
run through February 14, 1999 and May 15, 1999. The Company currently expects
to renew its existing leases as they expire. The Company's principal executive
office is located at Casey Ind. Bldg., 8th Floor, 18 Bedford Road, Taikoktsui,
Kowloon, Hong Kong.
The Company's manufacturing facilities contain an aggregate of approximately
320,000 square feet of manufacturing space and dormitory space that can
accommodate up to 4,100 workers. The Company leases the factories from local
Chinese government agencies under separate tenancy agreements expiring from May
1999 to June 2006. The aggregate monthly rent for its factories is
approximately $30,000. The Company also leases dormitory space to house its
factory workers under similar agreements which expire between December 1998 to
February 2000. The Company is currently in the process of negotiating a
renewal of one of its dormitory tenancy agreements which expired in September
1998. The aggregate monthly rent for its dormitory facilities is approximately
$15,000. The Company financed the cost of constructing the Dongguan facilities
and believes that its willingness to do so will facilitate the extension of its
leases on such facilities.
At present, the Company operates three factories in the Dongguan region of
Guangdong Province, China, approximately 60 miles northwest of Hong Kong. Legal
and administrative functions of these factories
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are conducted through the Company's Chinese subsidiary. Each of the Company's
factories houses a self-contained manufacturing operation. Each factory contains
personnel and equipment to provide production planning, engineering, management,
decorative processes and final assembly and packaging. Within each factory, the
Company provides its customers a self-contained production area with tooling and
other production functions dedicated to manufacturing each customer's products
according to its particular design, engineering and quality requirements.
Quality assurance and certain technical functions are centralized in factory no.
1. Certain other functions are centralized in the Company's Hong Kong
headquarters, including materials purchasing, customer service, production
scheduling among the factories, marketing, new product development, shipment of
finished goods and strategic planning.
Factories nos. 1, 2 and 3 are located in space leased exclusively by the
Company. They are surrounded by perimeter walls or fencing and are generally
accessible only to the Company's employees. Factory no. 4 is currently located
in shared rented space. All of these factories are located within a one-mile
radius of each other.
The Company is in the process of expanding factory no. 3 from approximately
70,000 square feet of production area to 100,000 square feet to meet an
anticipated increase in demand from existing customers. The Company is also
building new dormitory space to accommodate additional workers. Construction of
the new manufacturing area and dormitory space is substantially complete, and
the Company expects to commence initial operations in the new space by November
1998.
The Company has substantially completed the construction of its new factory
no. 4 facility, which is intended to be dedicated primarily to model making and
tooling. This facility is expected to occupy 40,000 square feet of leased space
accessible only to the Company's employees and is designed to support the model
making and tooling needs for the Company. Factory no. 4 is also expected to
include approximately 8,000 square feet dedicated to research and development
and to employ approximately 50 technicians for this purpose. The new factory
no. 4 facility also will implement additional security controls to provide
customers enhanced confidentiality of their product design and engineering. The
tool-making production area will be increased to 20,000 square feet in the new
factory no. 4 facility, including workshop, engineering support and office
space, and the Company plans to increase the number of tooling technicians to
approximately 150. The Company expects factory no. 4 to be operational by the
end of 1998.
In July 1998, the Company began construction of its fifth factory, no. 5.
Factory no. 5 will become operational in two phases, the first of which is
expected to be completed in March 1999. The total land area for these two
phases is about 270,000 square feet. The first phase will consist of workshop,
office and paint warehouse facilities in approximately 120,000 square feet. It
is estimated that initially factory no. 5 eventually will employ approximately
1,000 workers and that construction of factory no. 5 will be completed in the
second quarter of 1999. The second phase will be built to provide excess
capacity. Based on the Company's current business expectations, this additional
capacity will begin to be employed in the second half of 1999. The maximum
buildable area is approximately 68,000 square feet for production and 60,000
square feet for dormitories to accommodate up to 1,000 workers.
ITEM 3. LEGAL PROCEEDINGS
The Company is not party to any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's stockholders through
the solicitation of proxies, or otherwise, during the fourth quarter of the
Company's fiscal year ended December 31, 1997.
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is quoted on the OTC Electronic Bulletin Board
under the symbol "CVMI." Trading in the common stock has been limited and
sporadic, however, and there is no established trading market for the common
stock.
As of September 30, 1998, there were 1,199 record holders of the common
stock.
The Company has not paid any cash dividends on the common stock, and it
currently intends to retain any future earnings to fund the development and
growth of its business. Dividends receive favorable tax treatment in Hong Kong
and other non-U.S. jurisdictions where the Company's principal stockholders
reside, and the Company may pay cash dividends in the future. Any future
determination to pay dividends will depend upon the Company's results of
operations, financial condition and capital requirements, applicable
restrictions under any credit facilities or other contractual arrangements and
such other factors deemed relevant by the Company's Board of Directors.
In December 1997, the Company entered into a Share Exchange Agreement with
Carl Ka Wing Tong, Leo Sheck Pui Kwok and Acma Strategic Holdings Limited, all
of whom reside or are domiciled outside the U.S., pursuant to which the Company
issued an aggregate of 4,806,000 shares of common stock in exchange for all of
the capital stock of CML, in Hong Kong corporation. The common stock was issued
in reliance on available exemptions under U.S. federal securities laws,
including Section 4(2) of the Securities Act.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The statements contained in this 10-KSB/A that are not purely historical are
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934,
as amended. These include statements about the Company's expectations, beliefs,
intentions or strategies for the future, which are indicated by words or phrases
such as "anticipate," "expect," "intend," "plan," "will," "the Company
believes," "management believes" and similar words or phrases. The forward-
looking statements are based on the Company's current expectations and are
subject to certain risks, uncertainties and assumptions, including factors set
forth in the following discussion and under "Item 2. Description of Business,"
and other factors described in Exhibit 99.1 to this Form 10-KSB. The Company's
actual results could differ materially from results anticipated in these
forward-looking statements. All forward-looking statements included in this
document are based on information available to the Company on the date hereof,
and the Company assumes no obligation to update any such forward-looking
statements.
OVERVIEW
The Company is a leading independent manufacturer of collectible-quality,
die-cast replicas of cars, trucks, buses and other items. All of the Company's
business and operations are conducted through CML, its wholly-owned Hong Kong
subsidiary, and CML's subsidiaries. CML was co-founded in 1986 by Carl Ka Wing
Tong and Leo Sheck Pui Kwok to produce die-cast replicas of cars and other
vehicles primarily for the collectibles industry. On December 30, 1997, CML
completed an exchange reorganization with Davin Enterprises, Inc., a public
company that was incorporated in Delaware in April 1987. In March 1998, Davin
Enterprises, Inc. changed its name to Creative Master International, Inc.
Through the exchange reorganization, the Company acquired all of the
outstanding capital stock of CML from Messrs. Tong and Kwok and Acma Strategic
Holdings Limited in exchange for the Company's issuance to them of 4,806,000
shares of common stock, representing approximately 96% of the Company's
outstanding stock. Davin Enterprises, Inc. had no significant assets,
liabilities, business or operations prior to the exchange
9
<PAGE>
reorganization. The acquisition of CML by the Company on December 30, 1997 has
been treated as a reverse acquisition since CML is the continuing entity as a
result of the exchange reorganization. On this basis, the historical financial
statements prior to December 30, 1997 represent the consolidated financial
statements of CML. See Note 2 of Notes to Consolidated Financial Statements.
The Company's manufacturing facilities are located in the Dongguan region of
Guangdong Province, China, approximately 60 miles northwest of Hong Kong. In
March 1987, the Company built its first tooling and manufacturing factory in
Guangzhou, China. The Company moved the factory to Dongguan in 1995, and in May
1996, the Company completed its second factory in Dongguan. In September 1996,
the Company built its third factory, which it is in the process of expanding.
The Company believes that this expansion will be completed by November 1998. In
July 1997, the Company established a model-making division that is currently
located in the Company's third factory. The Company is in the process of
building a fourth factory at the Dongguan site to house this model-making
division. This fourth factory will be operational by the end of 1998. This
fourth factory will contain approximately 40,000 square feet of production area
dedicated solely to model making and tool making and will accommodate up to 200
technicians. The Company is also building a fifth factory and related dormitory
facilities with approximately 120,000 square feet of manufacturing space and
accommodating up to 1,000 workers. Construction of this fifth factory began in
July 1998 and the first phase is expected to be completed in March 1999. All
the above-described factories are or will be located within a one-mile radius of
each other. See "Description of Property -- Facilities and Planned Expansion."
The Company's manufacturing operations in China are conducted through a
Chinese limited liability company established in October 1994 between CML and a
local Chinese partner. The Chinese subsidiary has a three-member board of
directors, two of whom are appointed by the Company and one of whom is appointed
by CML's local Chinese partner. Under the terms of the arrangement with the
local Chinese partner, the local Chinese partner is not entitled to any profits
or responsible for any losses from the subsidiary. Because of this profit-
sharing arrangement, the subsidiary is regarded for accounting purposes as if it
were wholly-owned by the Company.
Historically, the Company has paid no taxes in China. The Company is
subject to tax in Hong Kong at the statutory rate of 16% to 16.5%. However,
under current interpretations of Hong Kong tax law, a Hong Kong company which
derives revenues exclusively from manufacturing operations in China recognizes
only 50% of its gross profit as taxable income in Hong Kong.
RESULTS OF OPERATIONS
The following table sets forth selected statement of operations data as a
percentage of net sales for the periods indicated.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------
1995 1996 1997
------- ------- -------
<S> <C> <C> <C>
Net sales...................................... 100.0% 100.0% 100.0%
Cost of goods sold............................. 78.9 69.6 78.4
Gross profit................................... 21.1 30.4 21.6
Selling, general and administrative expenses... 24.0 18.2 11.8
Interest expense, net.......................... 0.9 1.0 0.6
Other expenses, net............................ 1.0 4.0 0.8
Income (Loss) before income taxes (5.1) 6.9 6.2
and minority interests......................
Minority interests............................. -- -- 0.5
Provision for income taxes..................... 0.5 1.1 0.8
Net income (loss).............................. (5.6) 5.8 4.9
</TABLE>
10
<PAGE>
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Net Sales. The Company's net sales for 1997 increased $2,157,000, or 15%,
to $16,211,000 from $14,054,000 for 1996. The increase was primarily due to
increased sales to a new customer, Mattel, and increased sales to Drumwell
Limited, the agent for Corgi Classic Cars. Sales to Mattel and Corgi amounted
to approximately $2,400,000 and $683,000, respectively, in 1997.
Cost of Goods Sold. The Company's cost of goods sold for 1997 was
approximately $12,703,000, an increase of approximately $2,921,000, or 30%, from
approximately $9,782,000 for 1996. Such increase reflected higher sales volume,
as well as increases of approximately $949,000 in salaries and direct labor
costs, approximately $795,000 in sub-contracting charges for the production of
molds and approximately $233,000 in depreciation charges. Cost of goods sold
constituted 78% of net sales in 1997, compared to 70% in 1996. The increase was
primarily a result of staff increases and production inefficiencies associated
with the start-up of production of new customer orders and operations at the
Company's new manufacturing facilities.
Selling, General and Administrative Expenses. The Company's selling,
general and administrative expenses totaled approximately $1,921,000 in 1997, a
decrease of $631,000, or 25%, from approximately $2,552,000 in 1996. The
decrease was primarily the result of a higher acceptance rate of products by
customers, which resulted in lower repair costs for the Company, and reduced air
freight charges resulting from better compliance with customers delivery
schedules. Air freight charges are typically incurred only when the Company
fails to meet customer delivery schedules. The higher acceptance rate resulted
from better quality control and an improvement in meeting product delivery
schedules. Selling, general and administrative expenses constituted 12% of net
sales in 1997 and 18% in 1996.
Interest Expense, Net. The Company's net interest expense was $104,000 in
1997 compared to a net interest expense of $140,000 in 1996. The decrease in
net interest expenses resulted from an increase in interest income arising from
higher average bank balances and higher prevailing interest rates in 1997.
Minority Interests. Minority interests were approximately $82,000 in 1997.
There were no minority interests in 1996.
Provision for Income Taxes. The Company's effective income tax rate was 13%
in 1997 and 16% in 1996. The decrease in 1997 was primarily due to an increase
in the recognized tax losses contributed by the Company's Hong Kong
subsidiaries.
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Net Sales. The Company's net sales in 1996 totaled approximately
$14,054,000, an increase of approximately $4,072,000, or 41%, from approximately
$9,982,000 for 1995. This growth resulted from increased sales to Danbury Mint
and the addition of two new customers, Tyco and Brookfield, and was supported by
an increase in the Company's production capacity. Sales to Danbury Mint
increased to approximately $11,418,000 in 1996 from approximately $8,055,000 in
1995. New orders from Tyco and Brookfield amounted to approximately $714,000
and $1,081,000, respectively.
Cost of Goods Sold. The Company's cost of goods sold for 1996 was
approximately $9,782,000, an increase of approximately $1,904,000 or 24% from
approximately $7,878,000 for 1995. This reflected an increase of approximately
$986,000 in materials cost and an increase of approximately $395,000 in direct
labor costs. Costs of goods sold constituted 70% of net sales in 1996, compared
to 79% in 1995. The reduction was primarily a result of increased operating
efficiencies at the Company's Dongguan facilities and the shut down of its
Guangzhou facility.
11
<PAGE>
Selling, General and Administrative Expenses. The Company's selling,
general and administrative expenses totaled $2,552,000 in 1996 compared to
$2,394,000 in 1995, an increase of $158,000 or 7%. The increase resulted
primarily from increased administrative costs related to the Company's increased
manufacturing capacity. Selling, general and administrative expenses decreased
to 18% of net sales in 1996 from 24% of net sales in 1995, a decrease of 6%.
The decrease as a percentage of sales resulted from costs the Company incurred
in relocating its manufacturing operations from Guangzhou to the Dongguan
facilities in 1995, which was not expensed in 1996.
Interest Expense, Net. The Company's net interest expense was $140,000 in
1996 compared to a net interest expense of $88,000 in 1995. The increase in
interest expense was primarily due to increased borrowings to purchase
additional machinery and equipment.
Minority Interests. There were no minority interests in 1996 or 1995.
Provision for Income Taxes. The Company's effective income tax rate was 16%
in 1996. In 1995, the Company paid approximately $52,000 in income taxes
despite having a consolidated net loss before income taxes and minority
interests of approximately $507,000 due to taxes on net income of certain of its
Hong Kong subsidiaries. The effective rate increased because the amount of net
loss of certain of the Company's subsidiaries substantially decreased in 1996.
The net loss incurred by those subsidiaries decreased to $472,000 in 1996 from
$743,000 in 1995.
LIQUIDITY AND CAPITAL RESOURCES
Historically the Company has financed its operations through a combination
of cash from operations, bank financing and capital lease arrangements. The
Company's operations provided cash of approximately $696,000 in 1997 and
approximately $1,048,000 in 1996. Investing activities generated approximately
$16,000 in 1997 and used approximately $854,000 in 1996. The Company used
approximately $672,000 of cash in financing activities during 1997. The Company
generated approximately $115,000 of cash in financing activities during 1996.
Cash and bank deposits, as of December 31, 1997 and 1996, were $471,000 and
$435,000, respectively.
At December 31, 1997, net accounts and bills receivable totaled
approximately $2,827,000 as compared to approximately $1,733,000 at December 31,
1996. These increases were due primarily to increased sales. Consistent with
practice in the die-cast collectibles industry, the Company offers 30 to 60 days
accounts receivable terms to its customers. This practice has created working
capital requirements that the Company generally has financed with a combination
of internally generated cash flow and credit facilities provided by affiliates
and third parties. Creative Master actively monitors the creditworthiness of
its customers, and to date has not experienced any significant problems with
collection of its accounts receivable. See Note 22 of Notes to Consolidated
Financial Statements.
The Company's accounts payable and accrued liabilities increased by
approximately $996,000, to approximately $3,487,000 at December 31, 1997 as
compared to approximately $2,491,000 at December 31, 1996.
The Company's inventories increased by approximately $1,384,000 or 90%, to
approximately $2,928,000 at December 31, 1997 as compared to approximately
$1,544,000 at December 31, 1996. Inventory increases resulted from increases in
the Company's purchase of materials to support increased sales.
In 1997, additions to property, plant and equipment were $1,226,000 as
compared to $1,198,000 in 1996. In each of these periods, the Company expanded
its facilities and entered into capital leases for plant and equipment. The
Company anticipates that it will make approximately $3,241,000 of additional
12
<PAGE>
expenditures to expand and improve its manufacturing operations during 1998. As
of December 31, 1997, the aggregate outstanding amount under all capital leases
was approximately $1,030,000 as compared to approximately $503,000 at December
31, 1996.
The Company repaid short-term bank loans of approximately $825,000 in 1997
and obtained equipment lease financing in the aggregate amount of approximately
$835,000. The Company also obtained additional short-term bank loans in the
total amount of approximately $1,097,000 secured by the individual guarantees of
Messrs. Tong and Kwok and by the corporate guarantee of Acma Strategic Holdings
Limited, its principal stockholder, and a standby letter of credit from Acma
Ltd., the parent corporation of Acma Strategic Holding Limited.
The Company has revolving lines of credit with Hang Seng Bank, Banque
Nationale de Paris, Bank of China and Commonwealth Finance Corporation Limited.
As of December 31, 1997, the Company had approximately $1,290,000 outstanding
under these revolving lines of credit.
The Company expects that its cash needs for the foreseeable future will
arise primarily from working capital requirements, capital expenditures and debt
service requirements. The Company has no capital commitments to purchase
machinery or tools but expects to spend approximately $3,241,000 to purchase
such items during 1998. The Company anticipates that its capital expenditures
will increase substantially in 1999 due to the planned expansion and improvement
of its manufacturing facilities.
The Company expects that its principal sources of cash will be net cash from
operating activities, borrowings under existing lines of credit and potential
new bank lines. The Company believes that these sources will be adequate to
meet the Company's anticipated cash requirements for at least the next twelve
months. However, there can be no assurance that these resources will be
adequate to meet the Company's needs, particularly in the event that the Company
elects to further expand its manufacturing facilities beyond the currently
planned expansion. See "Item 2. Description of Property -- Facilities and
Planned Expansion." In the event that the Company requires additional capital,
it may issue additional equity securities, which could result in dilution to
existing stockholders, or borrow funds, which could adversely affect operating
results.
Inflation. The Company believes that inflation has not had a material
impact on its business in recent years.
Year 2000 Compliance
The Company is not aware of any material operational issues or costs
associated with preparing its internal systems for the year 2000. However,
there can be no assurance that there will not be a delay in, or increased costs
associated with, the Company's implementation of the necessary systems and
changes to address the year 2000 issues. If the Company is unable to implement
such systems and changes in a timely manner, it could have a material adverse
effect on the Company's business, financial condition and results of operations.
The Company also relies, directly and indirectly, on external systems of
business enterprises such as financial institutions, government agencies,
customers and suppliers for accurate exchange of data. Even if the internal
systems of the Company are not materially affected by the year 2000 issue, the
Company could be affected by disruptions in the operation of the enterprises
with which the Company interacts.
Currency Exchange Fluctuations
All of the Company's sales are denominated either in U.S. dollars or Hong
Kong dollars, while its expenses are denominated primarily in Hong Kong dollars
and renminbi, the Chinese currency, the basic unit of which is the yuan. Given
the current Asian financial crisis, there can be no assurance that the yuan-to-
U.S.
13
<PAGE>
dollar rate will remain stable. Although a devaluation of the Hong Kong dollar
or renminbi relative to the U.S. dollar would be likely to reduce the Company's
expenses, any material increase in the value of the Hong Kong dollar or renminbi
relative to the U.S. dollar would increase the Company's expenses, and could
have a material adverse effect on the Company's business, financial condition
and results of operations. The Company has never engaged in currency hedging
operations and has no present intention to do so.
Seasonality
Each year, the Company ceases production for a two-week period due to the
Chinese New Year holiday, which occurs during late January or early February.
This holiday shutdown has typically resulted in lower revenues during the first
quarter of each year than during the other three quarters.
The Company experiences fluctuations in quarterly sales due to the timing of
receipt of orders from customers and product shipments. The Company also incurs
substantial tooling and other costs of manufacturing new products from three to
nine months in advance of obtaining the first customer orders for the new
product. This long lead time may contribute to fluctuations in the Company's
quarterly results of operations.
International Sales
The Company sells substantially all of its products to customers in the U.S.
and Europe. In 1997, approximately 6.2% of the Company's net sales were
attributable to sales to European customers. The U.S. and European governments
may, from time to time, impose new quotas, duties, tariffs, or other charges or
restrictions, or adjust presently prevailing quota, duty or tariff levels, which
could adversely affect the Company's ability to continue to export products to
the U.S. and Europe at current or increased levels.
ITEM 7. FINANCIAL STATEMENTS
The Consolidated Financial Statements which are attached hereto as pages F-1
through F-26 are incorporated herein by reference.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
14
<PAGE>
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT
The executive officers, directors, director nominees and key employee of
Creative Master and their ages and positions with Creative Master as of
September 1, 1998 are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION/(1)/
---- --- -------------
<S> <C> <C>
EXECUTIVE OFFICERS AND DIRECTORS
Carl Ka-Wing Tong............. 48 President, Chief Executive Officer, Chief Financial Officer
and Chairman of the Board
Leo Sheck-Pui Kwok............ 42 Chief Operating Officer and Director
Henry Hai-Lin Hu.............. 53 Executive Vice President-Marketing
Shing Kam Ming................ 37 Senior Vice-President and Controller
Paul Mo....................... 46 Senior Vice-President - Marketing Services and Secretary
Denny Cheng................... 37 Vice-President - Customer Service and Engineering
Chou Kong Seng................ 43 Director
KEY EMPLOYEE
Albert Chui................... 48 Assistant Vice President - Quality Assurance
</TABLE>
_______________
(1) Each of the executive officers and key employees of the Company also serves
in various corresponding capacities with CML or its subsidiaries.
EXECUTIVE OFFICERS AND DIRECTORS
Carl Ka-Wing Tong is the Chairman, Chief Executive Officer, President and
Chief Financial Officer of the Company. He has served as Chairman, Chief
Executive Officer and President since December 1997 and Chief Financial Officer
since September 1998. He also serves as a Director of Acma Strategic Holdings
Limited. Mr. Tong co-founded CML in 1986. From 1993 to 1995, he also served as
Chief Financial Officer of ZIC Holdings Limited, the holding company of Zindart
Industrial Co. Ltd., a manufacturer of toys and collectibles. Prior to founding
CML, from 1985 to 1987 Mr. Tong was Vice President of Citibank N.A.'s
Institutional Banking, Specialized Finance Group. He is a certified public
accountant in Hong Kong and a chartered accountant in the United Kingdom. See
"Item 11. Security Ownership of Certain Beneficial Owners and Management."
Leo Sheck-Pui Kwok has been the Chief Operating Officer and a Director of
the Company since December 1997. Mr. Kwok co-founded CML in 1986. Before
founding CML, Mr. Kwok worked for the Hallmark Group in Asia from 1980 to 1987,
where his last position was as the Chief Merchandise Manager.
Henry Hai-Lin Hu has been Executive Vice-President-Marketing of the Company
since September 1998. Prior to joining the Company, from 1996 through 1998 Mr.
Hu served in executive management positions with various Hong Kong toy
manufacturers. Mr. Hu also served as the Chairman and Chief Executive Officer
of Zindart Industrial Co., Ltd. from 1993 until 1996.
15
<PAGE>
Shing Kam Ming has been the Senior Vice-President of the Company since
January 1998. He also served as Chief Financial Officer until September 1998,
when he was appointed Controller. Mr. Shing joined Creative Master Limited in
March 1993 as Manager - Finance and Administration.
Paul Mo has served as the Company's Senior Vice President - Marketing
Services since August 1996 and as Secretary of the Company since September 1998.
Mr. Mo joined the Company as Director of Engineering in November 1994 and helped
establish the Company's first Dongguan factory. Prior to joining the Company,
from 1992 to 1994 he was a General Manager of Sinomex (Hong Kong).
Denny Cheng has served as Vice President-Customer Service and Engineering
since November 1996. Before joining the Company, Mr. Cheng served as an
Engineering Manager with Sinomex (Hong Kong) from 1993 to 1996.
Chou Kong Seng has been a director of the Company since December 1997. Mr.
Chou has been the Finance Director of Acma Limited, a Company listed on the
Singapore stock exchange since 1994. He also serves as a Director of Acma
Strategic Holdings Limited, a principal stockholder of the Company. Before
joining Acma Limited, he was a senior manager with KPMG Peat Marwick LLP in
Singapore.
KEY EMPLOYEE
The Company also considers the following person to be important to its
operations:
Albert Chui has served as Assistant Vice President - Quality Assurance and
Training since 1996. Before joining the Company, Mr. Chui served as a plant
manager with Sunshine Toys Manufacturing Limited from 1995 to 1996. In
addition, Mr. Chui worked as a quality manager with Artin Industries Company
Limited from 1993 to 1994.
COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934
Under the federal securities laws, the Company's directors, executive
officers, and any person holding more than 10% of the Company's Common Stock,
are required to report their ownership of the Company's securities and any
changes in that ownership to the Securities and Exchange Commission. Specific
due dates for these reports have been established, and the Company is required
to report in this form 10-KSB/A any failures to file by these dates during the
last fiscal year. Based upon the Forms 3, 4 and 5 filed with the Securities and
Exchange Commission during 1997, the following persons failed to file timely
reports. Each of Carl Ka Wing Tong, Leo Sheck Pui Kwok, Paul Mo, Denny Cheng,
Chou Kong Seng, Acma Strategic Holdings Limited and Acma Investments Pte., Ltd.
failed to file a Form 3 for the share exchange and management and director
changes which were effected on December 31, 1997. Each such person also failed
to file a Form 5 with respect to the failure to file timely a Form 3.
16
<PAGE>
ITEM 10. EXECUTIVE COMPENSATION
Summary Compensation Table. The following table sets forth certain
information regarding compensation earned by the Company's Chief Executive
Officer and its one other executive officer (the "Named Executive Officers")
whose compensation exceeded $100,000 for the periods indicated:
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION
---------------------------------------
FISCAL OTHER ANNUAL
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION(1)
- ------------------------------- ------ ----------- --------- --------------
<S> <C> <C> <C> <C>
Carl Ka-Wing Tong, President,
Chief Executive Officer and
Chief Financial Officer....... 1997 $115,000(2) $ -- --
1996 88,000(2) -- --
1995 12,000(4) -- --
Leo Sheck-Pui Kwok
Chief Operating Officer....... 1997 $ 46,000 $4,000 $63,000(3)
1996 43,200 -- 59,000(3)
1995 102,000(5) -- --
</TABLE>
_____________________
(1) Does not include dividends paid to the Named Executive Officers with respect
to shares of stock of CML. See "Item 12. Certain Relationships and Related
Transactions -- Dividends."
(2) Represents compensation paid to Acma Strategic Holdings Limited for
consulting services. See "Item 12. Certain Relationships and Related
Transactions -- Tong Consulting Arrangement."
(3) Pursuant to an agreement dated January 2, 1996, the Company leases from
Wellholding Limited, a company beneficially owned by Mr. Kwok, a Hong Kong
apartment in which Mr. Kwok resides. The lease calls for a monthly rental
of approximately $5,000. The term of such lease expires in August 2000.
(4) Represents compensation paid to Carl Tong & Associates Management
Consultancy Limited, a Company beneficially owned by Mr. Tong, for Mr.
Tong's services. See "Item 12. Certain Relationships and Related
Transactions -- Tong Consulting Agreement."
(5) Represents compensation paid to Excel Master Limited, a company beneficially
owned by Mr. Kwok at such time.
COMPENSATION PURSUANT TO PLANS
Pension Plan. In January 1997, CML adopted a defined contribution pension
plan (the "Pension Plan") which is available to all of the Company's Hong Kong
employees with at least three months of continuous service. Participating
employees may make monthly contributions to the Pension Plan of up to 5% of each
employee's base salary, with matching contributions by the Company. The Hong
Kong employees (or their beneficiaries) are entitled to receive their entire
contribution and the Company's matching contributions, with accrued interest
thereon, upon retirement or death of the employee. Upon resignation or
termination (other than for serious misconduct), employees are entitled to
receive their entire contributions to the Pension Plan, with accrued interest
thereon, plus the vested portion of the Company's matching contributions. A
participating employee becomes fully vested with respect to 30% of the Company's
matching contributions to the Pension Plan after completing three years of
service with the Company and becomes vested with respect to an additional 10% of
the Company's matching contributions for each year of continuous service
thereafter through year ten. CML's subsidiaries, Excel Master Limited and
Carison Engineering Limited, have each adopted pension plans for their employees
which are identical to the Pension Plan.
DIRECTOR AND OFFICER INDEMNIFICATION AND LIABILITY
As is customary among Delaware corporations, the Company's amended
Certificate of Incorporation eliminates the liability of directors of the
Company for monetary damages for breach of their fiduciary duty as directors,
except (i) for breach of the director's duty of loyalty to the Company or its
stockholders; (ii) for acts or omissions by the director not in good faith or
which involve intentional misconduct or a knowing violation of law; (iii) for
willful or negligent declaration of an
17
<PAGE>
unlawful dividend, stock purchase or redemption; and (iv) for transactions from
which the director derived an improper personal benefit. Such limitation of
liability does not affect the availability of equitable remedies such as
injunctive relief or rescission. The Certificate of Incorporation also provides
for indemnification of officers and directors of the Company to the fullest
extent permitted under Delaware law.
The Company believes that it is the position of the Commission that, insofar
as the forgoing provisions may be invoked to disclaim liability for damages
arising under the Securities Act of 1933, as amended (the "Securities Act"), the
provisions are against public policy as expressed in the Securities Act and are,
therefore, unenforceable.
DIRECTOR COMPENSATION
The Company reimburses each director for reasonable expenses incurred in
attending meetings of the Company's board of directors. Directors currently
receive no other compensation for their services as Directors.
The Board of Directors currently has no standing committees.
EMPLOYMENT AGREEMENTS
The Company is party to a consulting agreement with Acma Strategic Holdings
Limited, which in turn has entered into a consulting agreement with Carl Tong &
Associates Management Consultancy Limited, a company beneficially owned by Carl
Ka-Wing Tong ("Associates Management"), pursuant to which Mr. Tong acts as
Managing Director of Acma Strategic Holdings Limited and performs certain other
duties, including acting as the President, Chief Executive Officer and Chief
Financial Officer of the Company. The terms of these agreements are described
under "Item 12. Certain Relationships and Related Transactions -- Tong
Consulting Arrangement." Consulting arrangements such as the Company's
arrangements with Mr. Tong are commonplace in Hong Kong.
In January 1996, the Company entered into a service agreement with Leo Sheck
Pui Kwok pursuant to which he was appointed as an executive officer of the
Company, effective as of February 1, 1996, for a term of three years. The
appointment automatically renews for a one-year term on each anniversary
beginning on February 1, 1999, unless either party provides six months written
notice to terminate the agreement. Mr. Kwok receives a salary of $46,000 per
year and a bonus of up to 2.5% of the Company's net after-tax profits on a
consolidated basis, provided the Company achieves certain net income targets.
In addition, the Company provides Mr. Kwok with a residence allowance of
approximately $5,000 per month.
Other than Mr. Kwok, the Company's executive officers and key employees are
not subject to any noncompetition agreements or other contractual obligations
regarding the confidentiality of this Company's trade secrets or other
information.
18
<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the beneficial ownership of common stock as
of September 30, 1998 by (i) each person known by the Company to beneficially
own 5% or more of the outstanding shares of common stock, (ii) each director of
the Company, (iii) each Named Executive Officer of the Company, and (iv) all
directors and executive officers of the Company as a group. The information set
forth in the table and accompanying footnotes has been furnished by the named
beneficial owners.
<TABLE>
<CAPTION>
COMMON STOCK OWNED
PRIOR TO THE OFFERING
----------------------
NAME AND ADDRESS OF NUMBER OF PERCENT OF
BENEFICIAL OWNER(1) SHARES CLASS
------------------- ---------- ----------
<S> <C> <C>
Carl Ka-Wing Tong(2)..................... 344,195 6.9%
Casey Ind. Bldg., 8th Floor
18 Bedford Rd., Taikoktsui
Kowloon, Hong Kong
Leo Sheck-Pui Kwok(3).................... 753,250 15.1
Casey Ind. Bldg., 8th Floor
18 Bedford Rd., Taikoktsui
Kowloon, Hong Kong
Acma Ltd. (4)............................ 3,402,573 68.0
17 Jurong Port Road
Singapore 619092
All directors and officers as a group
(9 persons)............................ 1,097,445 22.0
</TABLE>
____________________
(1) Beneficial ownership is determined in accordance with the rules of the
Commission and generally includes voting or investment power with respect to
the shares shown. Except as indicated by footnote and subject to community
property laws where applicable, the persons named in the table have sole
voting and investment power with respect to all shares of common stock shown
as beneficially owned by them.
(2) Mr. Tong is a Managing Director and 10% shareholder of Acma Strategic
Holdings Limited. As such, Mr. Tong shares investment and voting power with
respect to the shares beneficially owned by Acma Strategic Holdings
Limited (see footnote 4), as to which he disclaims beneficial ownership.
Acma Strategic Holdings Limited guarantees a banking facility of the
Company.
(3) The shares shown are held of record by Superego, Inc., a British Virgin
Islands company beneficially owned by Mr. Kwok.
(4) The shares shown as being owned by Acma Ltd. consist of 2,450,876 shares
held of record by Acma Strategic Holdings Limited and an additional 951,697
shares held of record by Acma Investments Pte., Ltd., a wholly-owned
subsidiary of Acma Ltd. Acma Investments Pte., Ltd. is a 90% shareholder of
Acma Strategic Holdings Limited. Acma Strategic Holdings Limited has
guaranteed the Company's indebtedness under its bank credit facilities and
Acma Ltd. has provided a standby letter of credit in favor of one of the
Company's lenders.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Tong Consulting Arrangement. In January 1996, the Company entered into a
consulting agreement with Acma Strategic Holdings Limited ("Acma Strategic"),
the principal stockholder of the Company. See "--Acma Consulting Arrangement"
below. Mr. Tong is a director and 10% shareholder of Acma Strategic. In turn,
Acma Strategic entered into a consulting agreement with Associates Management, a
company beneficially
19
<PAGE>
owned by Mr. Tong, pursuant to which Mr. Tong acts a director of Acma Strategic
and performs such other duties as requested by Acma Strategic, including acting
as Chief Executive Officer, President and Chief Financial Officer of the
Company. Acma Strategic is an investment company whose only investment is its
ownership of common stock of the Company. Also, pursuant to the agreement
between Associates Management and Acma Strategic, Associates Management is
entitled to receive the entire amount of any bonus paid to Acma Strategic by the
Company under the consulting agreement between the Company and Acma Strategic.
The Company pays a bonus of up to 2.5% of its net after-tax profits on a
consolidated basis. During 1996 and 1997, the Company paid consulting fees to
Acma Strategic in the amounts of $88,000 and $115,000, respectively, including
bonuses. In 1996 and 1997, Acma Strategic paid consulting fees to Associates
Management in the amounts of $239,000 and $261,000, respectively, including
bonuses.
Acma Consulting Arrangement. In January 1996, the Company entered into a
consulting agreement with Acma Strategic under which Acma Strategic will receive
an annual consulting fee of approximately $106,000. In addition, under the
terms of the agreement the Company may, at its discretion pay Acma Strategic a
performance bonus of up to 2.5% of the Company's consolidated net after-tax
profits (but not exceeding the highest bonus paid to any executive of CML).
During 1996 and 1997, the Company paid consulting fees in the amounts of $88,000
and $115,000, respectively, to Acma Strategic for consulting services provided.
These services consisted primarily of management of manufacturing facilities,
production design and personnel matters. In addition, pursuant to a consulting
agreement between Acma Strategic and Associates Management, Acma Strategic pays
Associates Management the amount of any bonus it receives from its consulting
agreement with the Company.
Loans to Company. Messrs. Kwok and Tong had outstanding certain non-interest
bearing loans to CML in the amounts of $614,000 and $316,000, respectively as of
December 31, 1996 and $612,000 and $316,000, respectively, as of December 31,
1997. The loans were repayable on demand.
In addition, in 1997 Acma Strategic advanced $9,000 on CML's behalf.
Loans from Company. During 1996 and 1997, Mr. Tong borrowed certain amounts
from CML. The maximum balance of such loans at any one time was $124,000. As
of December 31, 1997, the amount outstanding was $67,000. As of that date,
however, CML owed Mr. Tong $316,000. See "-- Loans to Company."
Dividends. During the year ended December 31, 1997, Carison Engineering
Limited, a subsidiary 70% owned by the Company, paid a dividend in the amount of
approximately $215,000. K.T. Yiu, Vice-President - Mold Engineering and
Production of the Company and 30% shareholder of Carison Engineering Limited,
received approximately $64,500 of such dividend. For the year ended December
31, 1997, CML declared dividends in the amounts of approximately $183,000 to
Acma Strategic, approximately $108,000 to Leo Sheck Pui Kwok and approximately
$32,000 to Carl Ka Wing Tong. These dividends were declared and will be paid
strictly in accordance with their respective share holdings in CML.
Guarantees of Company Debt. As of December 31, 1996 and 1997, the Company
had $782,000 and $1,290,000 outstanding under credit facilities which Messrs.
Tong and Kwok personally guarantee. The facilities are also secured by a
mortgage on certain real property owned by Mr. Tong. Additionally, Acma
Strategic guarantees certain of the Company's debt and Acma Ltd. has provided a
standby letter of credit in favor of one of the Company's lenders to further
secure the Company's obligations.
20
<PAGE>
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) The Company did not file any reports on Form 8-K during the fourth quarter
of 1997.
(b) Exhibits
The following exhibits are filed as part of this report:
<TABLE>
<CAPTION>
Exhibit
Number Description
------ -----------
<C> <S>
3.1 Certificate of Incorporation of the Company (incorporated by
reference to exhibit 3.1 of the Company's Form SB-2 filed on
October 21, 1998).
3.2 Bylaws of the Company (incorporated by reference to the exhibits
of the Company's registration statement (file no. 33-14521-NY).
4.1 Specimen Stock Certificate of the Company.*
10.1 Share Exchange Agreement by and among Davin Enterprises, Inc.,
Carl Tong, Leo Kwok and Acma Strategic Holdings Limited dated
December 15, 1997 (incorporated by reference to exhibit 10.2 of
the Company's Form SB-2 filed on October 21, 1998).
10.2 Joint Enterprise Agreement between Creative Master Limited and
Dongguan Heng Li Trading Company dated September 10, 1994
(incorporated by reference to exhibit 10.3 of the Company's Form
SB-2 filed on October 21, 1998).
10.3 Supplement to Joint Enterprise Agreement between Creative Master
Limited and Dongguan Heng Li Trading Company dated April 1, 1996
(incorporated by reference to exhibit 10.4 of the Company's Form
SB-2 filed on October 21, 1998).
10.4 Processing Agreement between Creative Master Limited and
Dongguang Process Assembly Servicing Company dated June 11,
1995.*
10.5 Entrepreneur Agreement by and among Creative Master Limited,
Chen Hao Qiang, Gan Zi Kuen and Wu Qing Su (undated)
(incorporated by reference to exhibit 10.8 of the Company's Form
SB-2 filed on October 21, 1998).
10.6 Letter to extend credit facilities between Banque Nationale de
Paris Hong Kong Branch and Creative Master Limited dated April
21, 1997 (incorporated by reference to exhibit 10.11 of the
Company's Form SB-2 filed on October 21, 1998).
10.7 Letter agreement to extend credit facilities between Bank of
China, Hong Kong Branch and Creative Master Limited dated May
25, 1992 (incorporated by reference to exhibit 10.12 of the
Company's Form SB-2 filed on October 21, 1998).
10.8 Letter agreement to extend credit facilities between
Commonwealth Finance Corporation Limited and Creative Master
Limited dated December 20, 1997 (incorporated by reference to
exhibit 10.13 of the Company's Form SB-2 filed on October 21,
1998).
10.9 Consultancy Agreement between Creative Master Limited and Acma
Strategic Holdings Limited dated January 19, 1996 (incorporated
by reference to exhibit 10.2 of the Company's Form 10-KSB filed
on September 2, 1998).
10.10 Consultancy Agreement between Carl Tong & Associates Management
Consulting Limited and Acma Strategic Holdings Limited dated
January 19, 1996 (incorporated by reference to exhibit 10.1 of
the Company's Form 10-KSB filed on September 2, 1998).
10.11 Joint and Several Guarantee By Individuals or Partner in a Firm
by and among Commonwealth Finance Corporation Limited, Carl Tong
and Leo Kwok dated March 30, 1993 (incorporated by reference to
exhibit 10.16 of the Company's Form SB-2 filed on October 21,
1998).
10.12 Guarantee to be Given by an Individual by and between
Commonwealth Finance Corporation Limited and Carl Tong dated
March 30, 1993 (incorporated by reference to exhibit 10.17 of
the Company's Form SB-2 filed on October 21, 1998).
10.13 Guarantee to be Given by an Individual by and between
Commonwealth Finance Corporation Limited and Leo Kwok dated
March 30, 1993 (incorporated by reference to exhibit 10.18 of
the Company's Form SB-2 filed on October 21, 1998).
</TABLE>
- --------------
* To be filed by amendment
21
<PAGE>
<TABLE>
<C> <S>
10.14 Creative Master Limited Defined Contribution Scheme Rules
effective January 1, 1997 (incorporated by reference to exhibit
10.19 of the Company's Form SB-2 filed on October 21, 1998).
10.15 Hang Seng Pooled Provident Plan Defined Contribution Policy by
and between Excel Master Limited and Hang Seng Life Limited
effective January 1, 1997; and Excel Master Limited Defined
Contribution Scheme Rules (incorporated by reference to exhibit
10.20 of the Company's Form SB-2 filed on October 21, 1998).
10.16 Hang Seng Pooled Provident Plan Defined Contribution Policy by
and between Carison Limited and Hang Seng Life Limited effective
January 1, 1997; and Carison Limited Defined Contribution Scheme
Rules (incorporated by reference to exhibit 10.21 of the
Company's Form SB-2 filed on October 21, 1998).
10.17 Service Agreement by and between Creative Master Limited and Leo
Kwok dated January __, 1996 (incorporated by reference to
exhibit 10.22 of the Company's Form SB-2 filed on October 21,
1998).
10.18 Factory and dormitory leases for CML No. 1.*
10.19 Factory and dormitory leases for CML No. 2.*
10.20 Factory and dormitory leases for CML No. 3.*
10.21 Factory and dormitory leases for CML No. 4.*
10.22 Factory and dormitory leases for CML No. 5.*
10.23 Joint Enterprise Agreement between Creative Master Limited and
Dongguan Changying Toys Factory Co. (not dated).*
10.24 Import Material & Processing Agreement between Dongguang Process
Assembly Servicing Company and the Company dated November 10,
1995.*
10.25 Lease of Unit B, Casey Industrial Building, Kowloon, Hong Kong
between Creative Master Limited and Fortune Wind Investments
Limited dated April 3, 1997.*
10.26 Lease of Unit A1, Casey Industrial Building, Kowloon, Hong Kong
between Excel Master limited and Fortune Wind Investments
Limited.*
10.27 Lease of Unit A2, Casey Industrial Building, Kowloon, Hong Kong
between Creative Master Limited and Fortune Wind Investments
Limited.*
10.28 Loan Agreement dated January 31, 1996 between Carl Tong and
Sheck Pui Kwok as lenders and Creative Master Limited as
borrower in the aggregate amount of H.K. $1,000,000
(incorporated by reference to exhibit 10.34 of the Company's
From SB-2 filed on October 21, 1998).
10.29 Loan Agreement dated April 18, 1995 between Carl Tong and Sheck
Pui Kwok as lenders and Creative Master Limited as borrower in
the aggregate amount of H.K. $2,000,000 (incorporated by
reference to exhibit 10.35 of the Company's From SB-2 filed on
October 21, 1998).
10.30 Lease of apartment from Wellholding Limited by Creative Master
Limited dated January 2, 1996 (incorporated by reference to
exhibit 10.38 of the Company's Form SB-2 filed on October 21,
1998).
21.1 List of Subsidiaries (incorporated by reference to exhibit 21.1
of the Company's Form SB-2 filed on October 21, 1998).
23.1 Consent of Arthur Andersen & Co. (incorporated by reference to
Page II-7).
99.1 Other Considerations.
</TABLE>
- --------------
* To be filed by amendment
22
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
--------
<S> <C>
Report of Independent Public Accountants F-2
Consolidated Balance Sheets - as of December 31, 1996 and 1997 F-3
Consolidated Statements of Operations -for each of the three years ended F-4
December 31, 1995, 1996 and 1997
Consolidated Statements of Cash Flows - for each of the three years ended F-5
December 31, 1995, 1996 and 1997
Consolidated Statements of Changes in Stockholders' Equity - for each of F-7
the three years ended December 31, 1995, 1996 and 1997
Notes to Consolidated Financial Statements F-8
</TABLE>
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders and the Board of Directors of Creative Master International,
Inc.:
We have audited the accompanying consolidated balance sheets of Creative Master
International, Inc. (a company incorporated in the State of Delaware, United
States of America; formerly known as Davin Enterprises, Inc.; "the Company") and
Subsidiaries ("the Group") as of December 31, 1996 and 1997, and the related
consolidated statements of operations, cash flows and changes in stockholders'
equity for the years ended December 31, 1995, 1996 and 1997. These financial
statements give retroactive effect, for all years presented, to the acquisition
of Creative Master Limited as a reverse acquisition as described in Note 2 to
the accompanying financial statements. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards
in the United States of America. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Creative Master
International, Inc. and Subsidiaries as of December 31, 1996 and 1997, and the
results of their operations and cash flows for the years ended December 31,
1995, 1996 and 1997 after giving retroactive effect to the acquisition of
Creative Master Limited as a reverse acquisition as described in Note 2 to the
accompanying financial statements, in conformity with generally accepted
accounting principles in the United States of America.
ARTHUR ANDERSEN & CO.
Certified Public Accountants
Hong Kong
Hong Kong,
September 30, 1998.
F-2
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1996 AND 1997
(AMOUNTS EXPRESSED IN UNITED STATES DOLLARS)
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------------------
NOTE 1 9 9 6 1 9 9 7
--------- ----------------------- -----------------------
$'000 $'000
<S> <C> <C> <C>
ASSETS
- ------
Current assets:
Cash and bank deposits.................................... 19 435 471
Accounts receivable, net.................................. 5 1,733 2,827
Deposits and prepayments.................................. 6 204 307
Inventories, net.......................................... 7 1,544 2,928
Due from a related company................................ 20 41 -
----------------------- -----------------------
Total current assets.................................... 3,957 6,533
Machinery, equipment and capital leases..................... 8 2,398 3,155
Long-term investment........................................ 9 1 1
Goodwill.................................................... 10 395 810
Deferred taxation........................................... 14 1 -
----------------------- -----------------------
Total assets............................................ 6,752 10,499
======================= =======================
LIABILITIES, MINORITY INTERESTS AND
STOCKHOLDERS' EQUITY
- -----------------------------------
Current liabilities:
Short-term bank borrowings................................ 11 782 1,290
Capital lease obligations, current portion................ 12 258 764
Accounts payable.......................................... 1,512 1,908
Deposits from customers................................... - 560
Accrued liabilities....................................... 13 979 1,579
Due to directors.......................................... 20 879 861
Due to parent company..................................... 20 - 9
Taxation payable.......................................... 14 18 68
Dividend payable.......................................... - 323
----------------------- -----------------------
Total current liabilities............................... 4,428 7,362
Capital lease obligations, non-current portion.............. 12 245 266
Deferred taxation........................................... 14 - 57
----------------------- -----------------------
Total liabilities....................................... 4,673 7,685
----------------------- -----------------------
Minority interests.......................................... - 75
----------------------- -----------------------
Stockholders' equity:
Common stock, par value $0.0001; authorized
60,000,000 shares; outstanding and fully paid
4,999,746 shares......................................... 16 1 1
Additional paid-in capital................................ 1,202 1,401
Retained earnings......................................... 872 1,337
Cumulative translation adjustments........................ 4 -
----------------------- -----------------------
Total stockholders' equity.............................. 2,079 2,739
----------------------- -----------------------
Total liabilities, minority interests and
stockholders' equity................................... 6,752 10,499
======================= =======================
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(AMOUNTS EXPRESSED IN UNITED STATES DOLLARS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------
NOTE 1 9 9 5 1 9 9 6 1 9 9 7
-------- -------------- -------------- --------------
$'000 $'000 $'000
<S> <C> <C> <C> <C>
Net sales.......................... 21 9,982 14,054 16,211
Cost of goods sold................. (7,878) (9,782) (12,703)
-------------- -------------- --------------
Gross profit................... 2,104 4,272 3,508
Selling, general and
administrative expenses........... (2,394) (2,552) (1,921)
Interest income.................... - - 112
Interest expense................... (88) (140) (216)
Other expenses, net................ (96) (567) (137)
Gain on dilution of equity
interest in a subsidiary.......... - - -
Reorganization expense............. 15 - - (284)
Amortization of goodwill........... (33) (44) (62)
-------------- -------------- --------------
Income (Loss) before income
taxes and minority interests.. (507) 969 1,000
Provision for income taxes......... 14 (52) (154) (130)
-------------- -------------- --------------
Income (Loss) before minority
interests..................... (559) 815 870
Minority interests................. - - (82)
-------------- -------------- --------------
Net income (loss).............. (559) 815 788
============== ============== ==============
Net income (loss) per common
share............................. 4.k $ (0.11) $ 0.16 $ 0.16
============== ============== ==============
Weighted average number of
common shares outstanding......... 4,999,746 4,999,746 4,999,746
============== ============== ==============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(AMOUNTS EXPRESSED IN UNITED STATES DOLLARS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------
1 9 9 5 1 9 9 6 1 9 9 7
------------- ------------- -------------
$'000 $'000 $'000
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)............................... (559) 815 788
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating
activities-
Depreciation of machinery and equipment....... 320 448 469
Net (gain) loss on disposals of machinery and
equipment.................................... 20 12 (6)
Net (gain) loss on disposal of short-term
investment................................... (14) 2 -
Write-back of receivable from minority
interests.................................... - (112) -
Write down of long-term investment............ 235 449 -
Reorganization expense........................ - - 199
Amortization of goodwill...................... 33 44 62
Minority interests............................ - - 82
Deferred income taxes......................... - 37 58
(Increase) Decrease in operating assets-
Accounts receivable, net...................... (471) (766) (1,094)
Deposits and prepayments...................... (15) (130) 7
Inventories, net.............................. 200 (980) (1,161)
Increase (Decrease) in operating liabilities-
Accounts payable.............................. 143 598 234
Deposits from customers....................... - - 560
Accrued liabilities........................... 64 600 439
Due to parent company......................... - - 9
Taxation payable.............................. (164) 31 50
------------- ------------- -------------
Net cash provided by (used in) operating
activities................................ (208) 1,048 696
------------- ------------- -------------
Cash flows from investing activities:
Acquisition of machinery and equipment........ (474) (804) (24)
Proceeds from disposals of machinery and
equipment.................................... - 8 -
Proceeds from disposal of short-term
investment................................... 136 12 -
Net cash outflow from acquisition of a
subsidiary................................... - (29) (1)
Decrease (Increase) in due from a related
company...................................... - (41) 41
Decrease (Increase) in due from directors..... 303 - -
------------- -------------- ------------
Net cash provided by (used in) investing
activities................................ (35) (854) 16
------------- ------------- -------------
</TABLE>
(To be continued)
F-5
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(AMOUNTS EXPRESSED IN UNITED STATES DOLLARS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
1 9 9 5 1 9 9 6 1 9 9 7
----------------- ----------------- ----------------
$'000 $'000 $'000
<S> <C> <C> <C>
Cash flows from financing activities:
Increase (Decrease) in bank overdrafts....... - 25 (28)
New short-term bank loans.................... 651 564 1,097
Repayment of short-term bank loans........... (295) (468) (825)
Increase in import trust receipts bank
loans....................................... 2 166 77
Repayment of capital element of capital
lease obligations........................... (203) (206) (605)
(Decrease) Increase in due to directors...... 238 34 (18)
Decrease in due to a related company......... - - (363)
Finance from minority interests of a
subsidiary.................................. - - -
Dividends paid to minority interests
of a subsidiary............................. (370) - (7)
------------------- ----------------- ----------------
Net cash (used in) provided by
financing activities..................... 23 115 (672)
------------------- ----------------- ----------------
Effect of cumulative translation
adjustments................................... (1) - (4)
------------------- ----------------- ----------------
Net increase (decrease) in cash and bank
deposits...................................... (221) 309 36
Cash and bank deposits, as of beginning
of year....................................... 347 126 435
------------------- ---------------- ----------------
Cash and bank deposits, as of end of
year.......................................... 126 435 471
=================== ================ ================
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(AMOUNTS EXPRESSED IN UNITED STATES DOLLARS)
<TABLE>
<CAPTION>
Common stock
------------------------------- Additional Cumulative
Number of paid-in Retained translation
shares Amount capital Earnings adjustments
------------- -------------- --------------- --------------- -----------------
'000 $'000 $'000 $'000 $'000
<S> <C> <C> <C> <C> <C>
Balance as of December 31,
1994.......................... 5,000 1 1,202 986 6
Net loss....................... - - - (559) -
Dividends...................... - - - (370) -
Translation adjustments........ - - - - 1
------------- -------------- --------------- --------------- ---------------
Balance as of December 31,
1995.......................... 5,000 1 1,202 57 7
Net income..................... - - - 815 -
Translation adjustments........ - - - - (3)
------------- -------------- --------------- --------------- ---------------
Balance as of December 31,
1996.......................... 5,000 1 1,202 872 4
Net income..................... - - - 788 -
Dividends...................... - - - (323) -
Reorganization expense
contributed by stockholders
(Note 15)..................... - - 199 - -
Translation adjustments........ - - - - (4)
------------- -------------- --------------- --------------- ---------------
Balance as of December 31,
1997.......................... 5,000 1 1,401 1,337 -
============= ============== =============== =============== ===============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-7
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(AMOUNTS EXPRESSED IN UNITED STATES DOLLARS UNLESS OTHERWISE STATED)
1. ORGANIZATION AND PRINCIPAL ACTIVITIES
Creative Master International, Inc. ("the Company") is incorporated in the State
of Delaware, United States of America. With effect from March 2, 1998, the
Company changed its name from Davin Enterprises, Inc. to Creative Master
International, Inc., the present one.
During the period from January 1, 1995 (the earliest date covered by this
report) to December 30, 1997, the Company's sole asset was investment in a 9.6%
interest in Target Vision Inc., a company incorporated in the State of Delaware,
United States of America, which is principally engaged in the trading of
communication systems.
ACQUISITION OF CML
On December 30, 1997, the Company acquired 100% interest in Creative Master
Limited ("CML"; a company incorporated in Hong Kong) by issuing 4,806,000 shares
of common stock of par value $0.0001 each (after the reverse stock splits and
the redenominations of par value as described in Note 16) to Acma Strategic
Holdings Limited ("ASHL"; a company incorporated in Hong Kong), Mr. Leo Sheck-
Pui Kwok and Mr. Carl Ka-Wing Tong. ASHL is 90% owned by Acma Ltd., a company
incorporated in Singapore and listed on the Singapore Stock Exchange Limited,
and 10% owned by Mr. Carl Ka-Wing Tong. CML and its subsidiaries (the "CML
Group") are principally engaged in the manufacturing of collectible replica
racing and classic cars for sale to customers in the United States of America
and Europe. The CML Group maintains its head office in Hong Kong, where it
coordinates sales and marketing, purchasing and administrative functions. Its
production facilities are located in Guangdong Province, the People's Republic
of China ("the PRC").
2. BASIS OF PRESENTATION
The acquisition of CML by the Company on December 30, 1997 has been treated as a
reverse acquisition since CML is the continuing entity as a result of the
exchange reorganization. On this basis, the historical financial statements
prior to December 30, 1997 represent the consolidated financial statements of
the CML Group. The historical stockholders' equity accounts of the Company as
of December 31, 1995 and 1996 have been retroactively restated to reflect the
issuance of 4,806,000 shares of common stock of par value $0.0001 each (after
the effect of the reverse stock splits and the redenominations of par value as
described in Note 16) in connection with the acquisition.
F-8
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
3. SUBSIDIARIES
Details of the Company's subsidiaries (which together with the Company are
collectively referred to as "the Group") as of December 31, 1997 were as
follows:
<TABLE>
<CAPTION>
PERCENTAGE OF
PLACE OF EQUITY INTEREST
NAME INCORPORATION HELD PRINCIPAL ACTIVITIES
- ---------------------------------- ------------------ ------------------ ------------------------
<S> <C> <C> <C>
Creative Master Limited Hong Kong 100% Manufacturing and
trading of collectible
replica products
Excel Master Limited Hong Kong 100% Trading of collectible
replica products
Mastercraft Engineering Limited Hong Kong 100% Manufacturing of molds
(formerly known as Queenex Note b
Enterprises Limited)
Carison Engineering Limited Hong Kong 70% Manufacturing of molds
(formerly known as Carison Note c
Limited)
Techtime Industries Limited Hong Kong 55% Manufacturing of
collectible replica
products
Dongguan Chuangying Toys Factory The PRC Note a Manufacturing of
Co., Ltd. collectible replica
products
</TABLE>
Notes -
a Dongguan Chuangying Toys Factory Co., Ltd. is a contractual joint venture
established in the PRC to be operated for 12 years until October 2006.
Under the joint venture agreement dated September 10, 1994 and the
supplemental agreement dated April 1, 1996, the Group's joint venture
partner is not entitled to any profit of the joint venture and is not
responsible for any loss of the joint venture. In view of the profit
sharing arrangement, the joint venture is regarded as 100% owned by the
Company.
F-9
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
b Effective from April 15, 1998, Queenex Enterprises Limited changed its name
to Mastercraft Engineering Limited ("MEL"), the present one. Prior to
April 14, 1998, MEL was 100% owned by the Group. On April 14, 1998, MEL
issued 9,000 shares of common stock of par value $0.129 each (equivalent of
HK$1 each) to three parties which are not involved in management of the
Company at par and 11,000 shares of common stock to the Group at par. As a
result, the Group's equity interest in MEL was diluted from 100% to 70%,
and recognized a gain on dilution of approximately $77,000.
c Effective from May 20, 1998, Carison Limited changed its name to Carison
Engineering Limited, the present one.
4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a BASIS OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company,
its subsidiaries and its contractual joint venture which is considered as a
de facto subsidiary. All material intra-group balances and transactions
have been eliminated on consolidation.
b GOODWILL
Goodwill, being the excess of cost over the fair value of the Group's share
of net assets of subsidiaries acquired, is amortized on a straight-line
basis over ten years. The amortization recorded during the years ended
December 31, 1995, 1996 and 1997 was approximately $33,000, $44,000 and
$62,000, respectively. Accumulated amortization as of December 31, 1996
and 1997 was approximately $77,000 and $139,000, respectively. Management
assesses the carrying amount and the remaining life of the goodwill
annually, taking into consideration current operating results and future
prospects of the subsidiaries.
c CONTRACTUAL JOINT VENTURE
A contractual joint venture is an entity established between the Group and
one or more other parties, with the rights and obligations of the joint
venture partners governed by a contract. If the Group owns more than 50%
of the joint venture and is able to govern and control its financial and
operating policies and its board of directors, such joint venture is
considered as a de facto subsidiary and is accounted for as a subsidiary.
F-10
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
d INVENTORIES
Inventories are stated at the lower of cost, on a first-in first-out basis,
and market value. Costs of work-in-process and finished goods are composed
of direct materials, direct labor and an attributable portion of production
overhead.
e MACHINERY, EQUIPMENT AND CAPITAL LEASES
Machinery, equipment and capital leases are recorded at cost. Gains or
losses on disposals are reflected in current operations. Depreciation for
financial reporting purposes is provided using the straight-line method
over the estimated useful lives of the assets as follows: machinery and
tools 3 to 10 years, leasehold improvements 3 to 10 years, furniture and
office equipment 3 to 5 years, and motor vehicles 3 to 4 years. All
ordinary repair and maintenance costs are expensed as incurred.
The Group recognizes an impairment loss on machinery and equipment when
evidence, such as the sum of expected future cash flows (undiscounted and
without interest charges), indicates that future operations will not
produce sufficient revenue to cover the related future costs, including
depreciation, and when the carrying amount of the asset cannot be realized
through sale. Measurement of the impairment loss is based on the fair
value of the assets.
f LONG-TERM INVESTMENTS
Investments held for the long-term are stated at market value. Income from
investments is accounted for to the extent of dividends received and
receivable.
g NET SALES
Net sales represent the invoiced value of merchandise/molds supplied to
customers, net of sales returns and allowances. Sales are recognized upon
delivery of goods and passage of title to customers.
Deposits or advanced payments from customers prior to delivery of goods and
passage of title are recorded as deposits from customers.
h INCOME TAXES
The Group accounts for income tax under the provisions of Statement of
Financial Accounting Standards No. 109, which requires recognition of
deferred tax assets and liabilities for the expected future tax
consequences of events that have been included in the financial statements
or tax returns. Deferred income taxes are provided using the liability
method. Under the liability method, deferred income taxes are recognized
for all significant temporary differences between the tax and financial
statement bases of assets and liabilities.
F-11
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
i OPERATING LEASES
Operating leases represent those leases under which substantially all the
risks and rewards of ownership of the leased assets remain with the
lessors. Rental payments under operating leases are charged to expense on
the straight-line basis over the period of the relevant leases.
j FOREIGN CURRENCY TRANSLATION
The translation of the financial statements of subsidiaries into United
States dollars is performed for balance sheet accounts using the closing
exchange rate in effect at the balance sheet dates and for revenue and
expense accounts using an average exchange rate during each reporting
period. The gains or losses resulting from translation are included in
stockholders' equity separately as cumulative translation adjustments.
Aggregate losses (gains) from foreign currency transactions included in the
results of operations for the years ended December 31, 1995, 1996 and 1997
were approximately $20,000, $104,000 and $47,000, respectively.
k NET INCOME (LOSS) PER COMMON SHARE
Net income (loss) per common share is computed in accordance with Statement
of Financial Accounting Standards No. 128 by dividing net income (loss) for
each year/period by the weighted average number of shares of common stock
outstanding during the year/period, as if the common stock issued for the
acquisition of CML (see Note 1) and the reverse stock splits and the
redenominations of par value (see Note 16) had been consummated prior to
the years/periods presented. The weighted average number of shares used to
compute net income (loss) per common share was 4,999,746 for all
years/periods presented.
l USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles in the United States of America requires
management to make estimates and assumptions that affect certain reported
amounts and disclosures. Accordingly, actual results could differ from
those estimates.
m FAIR VALUE OF FINANCIAL INSTRUMENTS
The Group's financial instruments are carried at cost, which approximate
their fair values.
F-12
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
5. ACCOUNTS RECEIVABLE
Accounts receivable comprised:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
1 9 9 6 1 9 9 7
--------------- ---------------
$'000 $'000
<S> <C> <C>
Trade receivables 1,857 2,966
Less: Allowance for doubtful accounts (124) (139)
--------------- ---------------
Accounts receivable, net 1,733 2,827
=============== ===============
</TABLE>
6. DEPOSITS AND PREPAYMENTS
Deposits and prepayments comprised:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
1 9 9 6 1 9 9 7
--------------- ---------------
$'000 $'000
<S> <C> <C>
Deposits for acquisition of molds 105 149
Rental and utility deposits 38 69
Prepayments 32 83
Others 29 6
--------------- ---------------
204 307
=============== ===============
</TABLE>
7. INVENTORIES
Inventories comprised:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
1 9 9 6 1 9 9 7
--------------- ---------------
$'000 $'000
<S> <C> <C>
Raw materials 911 1,358
Work-in-process 229 722
Finished goods 431 959
--------------- ---------------
1,571 3,039
Less: Allowance for slow-moving and obsolete
inventories (27) (111)
--------------- ---------------
Inventories, net 1,544 2,928
=============== ===============
</TABLE>
F-13
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
8. MACHINERY, EQUIPMENT AND CAPITAL LEASES
Machinery, equipment and capital leases comprised:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
1 9 9 6 1 9 9 7
--------------- ---------------
$'000 $'000
<S> <C> <C>
Machinery and equipment:
Machinery and tools 1,170 769
Leasehold improvements 899 1,033
Furniture and office equipment 330 455
Motor vehicles 19 21
Capital leases:
Machinery and tools 1,060 2,412
Furniture and office equipment - 14
--------------- ---------------
Cost 3,478 4,704
Less: Accumulated depreciation
Machinery and equipment (863) (1,066)
Capital leases (217) (483)
--------------- ---------------
Machinery, equipment and capital leases, net 2,398 3,155
=============== ===============
</TABLE>
9. LONG-TERM INVESTMENT
Long-term investment represented a 9.6% interest in Target Vision Inc. (a
company incorporated in the State of Delaware, United States of America), which
was principally engaged in the trading of communication systems. The carrying
cost of the long-term investment represented:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
1 9 9 6 1 9 9 7
--------------- ---------------
$'000 $'000
<S> <C> <C>
Long-term investment 685 685
Less: Write down of investment cost (684) (684)
--------------- ---------------
Long-term investment, net 1 1
=============== ===============
</TABLE>
The carrying cost of the long-term investment approximated its market value.
F-14
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
10. GOODWILL
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
1 9 9 6 1 9 9 7
--------------- ---------------
$'000 $'000
<S> <C> <C>
Goodwill 472 949
Less: Accumulated amortization (77) (139)
--------------- ---------------
Goodwill, net 395 810
=============== ===============
</TABLE>
11. SHORT-TERM BANK BORROWINGS
Short-term bank borrowings comprised:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
1 9 9 6 1 9 9 7
--------------- ---------------
$'000 $'000
<S> <C> <C>
Overdrafts 25 -
Short-term loans 452 908
Import trust receipts loans 305 382
--------------- ---------------
782 1,290
=============== ===============
</TABLE>
Short-term bank borrowings are denominated in Hong Kong dollars and bear
interest at the Hong Kong prime lending rate plus 1.5% to 4.3%, which ranged
from 11.0% to 13.8% per annum as of December 31, 1997. They are collaterized by
the Group's bank deposits of approximately $72,000 as of December 31, 1997,
personal guarantees provided by Mr. Leo Sheck-Pui Kwok and Mr. Carl Ka-Wing
Tong, mortgage over real estate property owned by Mr. Carl Ka-Wing Tong,
corporate guarantee provided by Acma Strategic Holdings Limited, and a standby
letter of credit issued by Acma Ltd. (see Note 19). They were drawn for working
capital purposes and are renewable with the consent of the relevant banks.
F-15
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Supplemental information with respect to short-term bank borrowings for the year
ended December 31, 1997 are as follows:
<TABLE>
<CAPTION>
MAXIMUM AMOUNT AVERAGE AMOUNT WEIGHTED AVERAGE WEIGHTED AVERAGE
OUTSTANDING OUTSTANDING INTEREST RATE AT INTEREST RATE
DURING THE DURING THE THE END OF DURING THE
YEAR/PERIOD YEAR/PERIOD YEAR/PERIOD YEAR/PERIOD
-------------------- -------------------- -------------------- --------------------
$'000 $'000
YEAR ENDED
DECEMBER 31, 1997
- --------------------------
<S> <C> <C> <C> <C>
Overdrafts 111 17 12.5% 12.1%
==================== ==================== ==================== ====================
Short-term loans 908 686 10.7% 10.1%
==================== ==================== ==================== ====================
Import trust receipts
loans 448 291 12.5% 11.9%
==================== ==================== ==================== ====================
</TABLE>
12. CAPITAL LEASE OBLIGATIONS
Future minimum lease payments under capital leases, together with the present
value of the minimum lease payments, are:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
1 9 9 6 1 9 9 7
--------------- ---------------
$'000 $'000
<S> <C> <C>
Payable during the following period
- - Within one year 299 830
- - Over one year but not exceeding two years 211 195
- - Over two years but not exceeding three years 50 91
--------------- ---------------
Total minimum lease payments 560 1,116
Less: Amount representing interest (57) (86)
--------------- ---------------
Present value of minimum lease payments 503 1,030
Less: Current portion (258) (764)
--------------- ---------------
Non-current portion 245 266
=============== ===============
</TABLE>
F-16
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
13. ACCRUED LIABILITIES
Accrued liabilities comprised:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
1 9 9 6 1 9 9 7
--------------- ---------------
$'000 $'000
<S> <C> <C>
Accruals for operating expenses
- - Salaries, wages and bonus 360 575
- - Subcontracting charges 230 463
- - Rentals 39 41
- - Others 214 120
Accruals for purchases of loose tools and
consumables 64 269
Others 72 111
--------------- ----------------
979 1,579
=============== ================
</TABLE>
14. INCOME TAXES
The Company and its subsidiaries are subject to income taxes on an entity basis
on income arising in or derived from the tax jurisdiction in which they operate.
The Company is subject to the United States federal tax at a rate of 35%. The
Hong Kong subsidiaries are subject to Hong Kong profits tax at a rate of 16.5%
for the years ended December 31, 1995, 1996 and 1997.
The contractual joint venture established in the PRC (Dongguan Chuangying Toys
Factory Co., Ltd.) is subject to PRC income taxes at a rate of 33% (30% state
income tax and 3% local income tax). However, the joint venture is exempted
from state income tax and local income tax for two years starting from the first
year of profitable operations and is subject to a 50% reduction in state income
tax for the next three years. The first profitable year of operations for
Dongguan Chuangying Toys Factory Co., Ltd. was the year ended December 31, 1997.
If the tax holiday had not existed, the Group's income tax expenses would have
been increased by approximately nil, nil and $8,000 for the years ended December
31, 1995, 1996 and 1997, respectively.
F-17
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Provision for income taxes comprised:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------
1 9 9 5 1 9 9 6 1 9 9 7
------------------ ------------------ ------------------
<S> <C> <C> <C>
Current taxes
- - Hong Kong Profits Tax 52 117 72
Deferred taxes - 37 58
------------------ ------------------ ------------------
52 154 130
================== ================== ==================
</TABLE>
The reconciliation of the United States federal income tax rate to the effective
income tax rate based on income (loss) before income taxes stated in the
consolidated statements of operations is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
1 9 9 5 1 9 9 6 1 9 9 7
------------------ ------------------ ------------------
<S> <C> <C> <C>
United States federal income
tax rate 35.0% 35.0% 35.0%
Non-taxable income arising
from activities which
qualified as offshore 21.9% (6.5%) (6.0%)
Non-taxable/non-deductible
activities (7.2%) (4.8%) (3.6%)
Tax losses not recognized (93.3%) 15.8% 7.7%
Effect of different tax rates
in foreign jurisdictions 33.3% (23.6%) (20.1%)
------------------ ------------------ ------------------
Effective income tax rate (10.3%) 15.9% 13.0%
================== ================== ==================
</TABLE>
Components of deferred tax assets (liabilities) as of December 31, 1996 and 1997
are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------------------
1 9 9 6 1 9 9 7
----------------------- -----------------------
$'000 $'000
<S> <C> <C>
Cumulative tax losses 77 42
Accumulated differences between taxation allowance
and depreciation expenses of machinery and equipment
(76) (99)
----------------------- -----------------------
Deferred taxation 1 (57)
======================= =======================
</TABLE>
F-18
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
15. REORGANIZATION EXPENSE
The reorganization expense comprised (i) the valuation of $199,000 of the
305,984 shares of common stock of the Company (after the effect of reverse stock
splits and the redenominations of par value as described in Note 16) transferred
from Mr. Leo Sheck-Pui Kwok, Mr. Carl Ka-Wing Tong and Acma Strategic Holdings
Limited, three of the Company's stockholders, to a consultant in return for his
services in connection with Company's acquisition of CML as described in Note 1,
and (ii) other professional fees for the acquisition of CML.
16. SHARE CAPITAL
During the period from January 1, 1995 (the earliest date covered by this
report) to May 28, 1996, the Company had authorized share capital of 250,000,000
shares of common stock, par value $0.0001 each, and outstanding share capital of
193,745,200 shares of common stock, par value $0.0001 each. On May 29, 1996,
the Company effected a one-for-one hundred reverse stock split and a
redenomination of par value in share capital, resulting in 1,937,452 shares of
common stock, par value $0.0001 each, outstanding. Also, on May 29, 1996, the
authorized share capital of the Company was decreased from 250,000,000 shares of
common stock, par value $0.0001 each, to 50,000,000 shares of common stock, par
value $0.0001 each. On December 30, 1997, the Company issued 48,060,000 shares
of common stock (after the one-for-one hundred reverse stock split as described
above but before the one-for-ten reverse stock split as described below), par
value $0.0001 each, to the stockholders of CML in connection with its
acquisition of CML as described in Note 1. On March 2, 1998, the authorized
capital of the Company was increased to 60,000,000 shares of common stock, par
value $0.0001 each. On March 12, 1998, the Company effected a one-for-ten
reverse stock split and a redenomination of par value in share capital,
resulting in 60,000,000 shares of common stock, par value $0.0001 each,
authorized, and 4,999,746 shares of common stock, par value $0.0001 each,
outstanding.
The effects of the one-for-one hundred reverse stock split, the one-for-ten
reverse stock split, and the redenominations of par value in share capital have
been reflected retroactively in the financial statements and all net income
(loss) per common share computations.
F-19
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
17. OPERATING LEASE COMMITMENTS
The Group has various operating lease agreements for office, factory and staff
quarters premises, which extend through 2006. Rental expenses for the years
ended December 31, 1995, 1996 and 1997 were approximately $447,000, $509,000 and
$602,000, respectively. Future minimum rental payments as of December 31, 1997
under agreements classified as operating leases with non-cancellable terms, are
as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-----------------
<S> <C>
Payable during the following period
- - Within one year 563
- - Over one year but not exceeding two years 487
- - Over two years but not exceeding three years 427
- - Over three years but not exceeding four years
448
- - Over four years but not exceeding five years 390
- - Thereafter 977
-----------------
3,292
</TABLE> =================
18. RETIREMENT PLAN
The Group's employees in the PRC are all hired on a contractual basis and
consequently the Group has no obligation for pension liabilities to these
employees.
From January 1, 1997, the employees in Hong Kong, after completing a probation
period, may join the Group's defined contribution pension fund managed by an
independent trustee. Both the Group and its Hong Kong employees make monthly
contributions to the plan of 5% of the employees' basic salaries. The Hong Kong
employees are entitled to receive their entire contribution together with
accrued interest thereon at any time upon leaving the Group, and 100% of the
Group's employer contribution and the accrued interest thereon upon retirement
or leaving the Group after completing ten years of service or at a reduced scale
of between 30% to 90% after completing three to nine years of service. Any
forfeited contributions made by the Group and the accrued interest thereon are
used to reduce future employer's contributions. The aggregate amount of the
Group's employer contributions (net of forfeited contributions) for the year
ended December 31, 1997 was $50,000.
The Group has no other post-retirement or post-employment benefit plans.
F-20
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
19. BANKING FACILITIES
As of December 31, 1997, the Group had banking facilities of approximately
$1,421,000 for overdrafts, loans and trade financing. Unused facilities as of
December 31, 1997 amounted to approximately $99,000. These facilities were
secured by :
a Pledges over the Group's bank deposits of approximately $72,000 as of
December 31, 1997;
b Personal guarantees provided by Mr. Leo Sheck-Pui Kwok and Mr. Carl Ka-Wing
Tong;
c Mortgage over real estate property owned by Mr. Carl Ka-Wing Tong;
d Corporate guarantee provided by Acma Strategic Holdings Limited; and
e A standby letter of credit issued by Acma Ltd.
20. RELATED PARTY TRANSACTIONS
a The Group entered into the following transactions with related companies:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------
1 9 9 5 1 9 9 6 1 9 9 7
----------- ----------- -----------
$'000 $'000 $'000
<S> <C> <C> <C>
Consultancy/Management fees paid to Carl Tong
& Associate Management Consultancy Limited* 12 - -
Management fee paid to Acma Strategic
Holdings Limited - 88 115
Rental expenses paid to Wellholding Limited** - 59 -
=========== =========== ===========
</TABLE>
* Carl Tong & Associate Management Consultancy Limited is beneficially
owned by Mr. Carl Ka-Wing Tong.
** Wellholding Limited is beneficially owned by Mr. Leo Sheck-Pui Kwok.
F-21
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
20. RELATED PARTY TRANSACTIONS (CONT'D)
b Details of amounts due to directors of the Company are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1 9 9 6 1 9 9 7
----------- -----------
$'000 $'000
<S> <C> <C>
Mr. Leo Sheck-Pui Kwok 614 612
Mr. Carl Ka-Wing Tong 265 249
----------- -----------
879 861
=========== ===========
</TABLE>
The amounts due to directors are unsecured, non-interest bearing and
without pre-determined repayment terms.
c Details of amount due from a related company are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1 9 9 6 1 9 9 7
----------- -----------
$'000 $'000
<S> <C> <C>
Mastercraft Engineering Limited 41 -
=========== ===========
</TABLE>
Mastercraft Engineering Limited is a company in which Mr. Leo Sheck-Pui
Kwok and Mr. Carl Ka-Wing Tong are directors. During the year ended
December 31, 1997, the Company acquired 100% equity interest in Mastercraft
Engineering Limited for approximately $1,000. The amount due from the
related company was unsecured, non-interest bearing and without pre-
determined repayment terms.
d Details of amount due to parent company are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1 9 9 6 1 9 9 7
----------- -----------
$'000 $'000
<S> <C> <C>
Acma Strategic Holdings Limited - 9
=========== ===========
</TABLE>
The amount due to the parent company was unsecured, non-interest bearing
and without pre-determined repayment terms.
F-22
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
e As of December 31, 1997, the Group's banking facilities were secured by
personal guarantees provided by Mr. Leo Sheck-Pui Kwok and Mr. Carl Ka-Wing
Tong; mortgage over real estate property owned by Mr. Carl Ka-Wing Tong;
corporate guarantee provided by Acma Strategic Holdings Limited; and a
standby letter of credit issued by Acma Ltd.
21. SEGMENTAL ANALYSIS
a NET SALES
Net sales comprised:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1 9 9 5 1 9 9 6 1 9 9 7
----------- ----------- -----------
$'000 $'000 $'000
<S> <C> <C> <C>
Sales of merchandise 9,648 12,358 13,438
Sales of molds 333 1,667 2,678
Others 1 29 95
----------- ----------- -----------
9,982 14,054 16,211
=========== =========== ===========
</TABLE>
A substantial portion of Group's sales are made to customers in the United
States of America.
b ASSETS
Substantially all of the Group's assets are located in Hong Kong and the
PRC.
c MAJOR CUSTOMERS
Details of individual customers accounting for more than 5% of the Group's
sales are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1 9 9 5 1 9 9 6 1 9 9 7
----------- ----------- -----------
<S> <C> <C> <C>
MBI, Inc. 80.7% 81.2% 64.2%
Mattel Vendor Operations Asia Ltd. - - 14.8%
Drumwell Limited - 1.8% 4.2%
Brookfield Collectors Guild - 7.7% 4.7%
Hallmark Cards (Hong Kong) Ltd. - - 0.2%
Tyco Hong Kong Limited - 5.1% 5.6%
=========== =========== ===========
</TABLE>
F-23
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
d MAJOR SUPPLIERS
Details of individual suppliers accounting for more than 5% of the Group's
purchases are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------
<S> <C> <C> <C>
1 9 9 5 1 9 9 6 1 9 9 7
-------------- ------------- -------------
Manfield Coatings Co., Ltd. 12.6% 8.1% 9.0%
Genesis Off-set Printing Co., Ltd. - 5.4% 8.5%
Lee Kee Metal Co. , Ltd. - 0.7% 6.1%
Zinamet Co., Ltd. 8.7% 2.7% 6.9%
============== ============= =============
</TABLE>
22. OPERATING RISKS
a COUNTRY RISK
The Group's operations are conducted in Hong Kong and the PRC.
Accordingly, the Group's business, financial condition and results of
operations may be influenced by the political, economic and legal
environments in Hong Kong and the PRC, and by the general state of the Hong
Kong and the PRC economies.
On July 1, 1997, sovereignty over Hong Kong was transferred from the United
Kingdom to the PRC, and Hong Kong became a Special Administrative Region of
the PRC ("the Hong Kong SAR"). As provided in the Basic Law of the Hong
Kong SAR of the PRC, the Hong Kong SAR will have full economic autonomy and
its own legislative, legal and judicial systems for fifty years. The
Group's management does not believe that the transfer of sovereignty over
Hong Kong will have an adverse impact on the Group's financial and
operating environment. There can be no assurance, however, that changes in
political or other conditions will not result in such an adverse impact.
The Group's operations in the PRC are subject to special considerations and
significant risks not typically associated with companies in North America
and Western Europe. These include risks associated with, among others, the
political, economic and legal environments and foreign currency exchange.
The Group's results may be adversely affected by changes in the political
and social conditions in the PRC, and by changes in governmental policies
with respect to laws and regulations, anti-inflationary measures, currency
conversion and remittance abroad, and rates and methods of taxation, among
other things.
b DEPENDENCE ON STRATEGIC RELATIONSHIP
The Group conducts its manufacturing operations through its contractual
joint venture established between the Company and a PRC party, and several
subcontracting agreements entered into with certain PRC parties. The
F-24
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
deterioration of any or all of these strategic relationships may have an
adverse effect on the operations of the Group.
c CONCENTRATION OF CREDIT RISK
Concentration of accounts receivable is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------
<S> <C> <C>
1 9 9 6 1 9 9 7
--------------------- --------------------
$'000 $'000
Five largest accounts receivable 94.2% 92.1%
===================== ====================
</TABLE>
The Group performs ongoing credit evaluation of each customer's financial
condition. It maintains reserves for potential credit losses and such
losses in aggregate have not exceeded management's projections.
23. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
a In March 1996, CML acquired an additional 19% equity interest in Carison
Engineering Limited for cash consideration of approximately $29,000. This
increase in the Group's equity interest in Carison Engineering Limited from
51% to 70% resulted in goodwill of approximately $139,000.
b In October 1997, CML acquired a 100% interest in Mastercraft Engineering
Limited for a cash consideration of $1,000. Details of assets acquired and
liabilities assumed were as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1997
--------------------
<S> <C>
$'000
Deposits and prepayments 110
Inventories 223
Machinery, equipment and capital leases 361
Bank overdrafts (3)
Short-term bank loans (184)
Accounts payable (162)
Accrued liabilities (161)
Due to a related company (363)
Capital lease obligations (297)
--------------------
Net liabilities assumed as of the date of acquisition (476)
Goodwill 477
--------------------
Consideration satisfied in cash 1
====================
Net cash outflow:
Cash paid 1
====================
</TABLE>
F-25
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
c Cash paid for interest and income taxes comprised:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1 9 9 5 1 9 9 6 1 9 9 7
----------- ----------- -----------
$'000 $'000 $'000
<S> <C> <C> <C>
Interest 88 140 216
=========== =========== ===========
Income taxes 217 94 75
=========== =========== ===========
</TABLE>
d Supplemental disclosure of investing activities:
During the years ended December 31, 1995, 1996 and 1997, the Group entered
into capital lease arrangements to purchase machinery and equipment with a
capital value of approximately $318,000, $394,000 and $835,000,
respectively.
24. OTHER SUPPLEMENTAL INFORMATION
The following items were included in the consolidated statements of operations:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1 9 9 5 1 9 9 6 1 9 9 7
----------- ----------- -----------
$'000 $'000 $'000
<S> <C> <C> <C>
Depreciation of machinery and equipment
- - owned assets 242 275 122
- - assets held under capital leases 78 173 347
Provision for/write-off of doubtful
accounts - 98 15
Provision for slow-moving and obsolete
inventories - 11 84
Write down of long-term investment 235 449 -
Interest expenses for
- - bank overdrafts and loans 56 85 107
- - capital lease obligations 32 55 109
Operating lease rentals for rented 447 509 602
premises
Repairs and maintenance expenses 157 251 266
Net foreign exchange (gain) loss 20 104 47
=========== =========== ===========
</TABLE>
F-26
<PAGE>
SIGNATURES
In accordance with the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CREATIVE MASTER INTERNATIONAL, INC.
By: /s/ CARL KA-WING TONG
--------------------------------------------------
Carl Ka Wing Tong
President and Chief Executive Officer
23
<PAGE>
EXHIBIT 99.1
OTHER CONSIDERATIONS
THE STATEMENTS CONTAINED IN THIS EXHIBIT 99.1 THAT ARE NOT PURELY HISTORICAL
ARE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE
SECURITIES ACT OF 1933, AS AMENDED AND SECTION 21E OF THE SECURITIES EXCHANGE
ACT OF 1934, AS AMENDED. THESE INCLUDE STATEMENTS ABOUT THE COMPANY'S
EXPECTATIONS, BELIEFS, INTENTIONS OR STRATEGIES FOR THE FUTURE, WHICH ARE
INDICATED BY WORDS OR PHRASES SUCH AS "ANTICIPATE," "EXPECT," "INTEND," "PLAN,"
"WILL," "THE COMPANY BELIEVES," "MANAGEMENT BELIEVES" AND SIMILAR WORDS OR
PHRASES. THE FORWARD-LOOKING STATEMENTS ARE BASED ON THE COMPANY'S CURRENT
EXPECTATIONS AND ARE SUBJECT TO CERTAIN RISKS, UNCERTAINTIES AND ASSUMPTIONS,
INCLUDING FACTORS SET FORTH IN THE FOLLOWING DISCUSSION AND UNDER "ITEM 1.
DESCRIPTION OF BUSINESS" AND "ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR
PLAN OF OPERATION" IN THE FORM 10-KSB FOR WHICH THIS IS AN EXHIBIT. THE
COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM RESULTS ANTICIPATED IN
THESE FORWARD-LOOKING STATEMENTS. ALL FORWARD-LOOKING STATEMENTS INCLUDED IN
THIS DOCUMENT ARE BASED ON INFORMATION AVAILABLE TO THE COMPANY ON THE DATE
HEREOF, AND THE COMPANY ASSUMES NO OBLIGATION TO UPDATE ANY SUCH FORWARD-LOOKING
STATEMENTS.
Dependence on Important Customers
The Company's business is concentrated among a limited number of customers.
In 1997, sales to Danbury Mint, a subsidiary of MBI, Inc. accounted for
approximately 64.2% of net sales and sales to Mattel Vendor Operations Ltd. and
Tyco Hong Kong Limited, subsidiaries of Mattel totaled approximately 20.4% of
net sales. The Company expects that it will continue to depend on sales to
Danbury Mint and Mattel. If the Company loses any one of its major customers,
particularly Danbury Mint or Mattel, its business, financial condition and
results of operations would be materially adversely affected.
Conducting Business in China
The Company's manufacturing facilities are located in the Dongguan region of
Guangdong Province, China, approximately 60 miles northwest of Hong Kong.
Therefore, the Company is subject to certain inherent risks of doing business in
China.
Internal Political Risks. The Company's manufacturing operations and assets
in China are subject to significant political and economic uncertainties.
Changes in laws and regulations, or their interpretation, or the imposition of
confiscatory taxation, restrictions on currency conversion, imports and sources
of supply, devaluations of currency or the nationalization or other
expropriation of private enterprises could have a material adverse effect on the
Company's business, results of operations and financial condition. Under its
current leadership, the Chinese government has been pursuing economic reform
policies that encourage private economic activity and greater economic
decentralization. There is no assurance, however, that the Chinese government
will continue to pursue these policies, or that it will not significantly alter
these policies from time to time without notice.
Loss of Chinese Facilities. The Company conducts all of its manufacturing
operations in China through a Chinese limited liability company with a local
Chinese partner. The legal existence of this Chinese subsidiary expires in
2006, and the Company has no assurance that it will be extended. If the Company
cannot extend the legal existence, or it was otherwise required to move its
manufacturing operations outside of China, the Company's profitability,
competitiveness and market position could be materially adversely affected.
Furthermore, there is no assurance that the Company could continue its
manufacturing operations.
Foreign Corrupt Practices Act. The Company is subject to the U.S. Foreign
Corrupt Practices Act, which generally prohibits U.S. companies from engaging in
bribery or other prohibited payments to foreign officials for the purpose of
obtaining or retaining business. Foreign companies, including some that may
compete with the Company, are not subject to these prohibitions. Corruption,
extortion, bribery, pay-offs, theft and other fraudulent practices are common in
China. The Company has attempted to implement safeguards to prevent losses from
such
1
<PAGE>
practices and to discourage such practices by its employees and agents. There
is no assurance, however, that the Company will not suffer such losses or that
its employees or other agents will not engage in such conduct for which the
Company might be held responsible.
Legal System. Unlike the U.S., China has a civil law system based on written
statutes in which judicial decisions have little precedential value. The
Chinese government has enacted some laws and regulations dealing with matters
such as corporate organization and governance, foreign investment, commerce,
taxation and trade. However, their experience in implementing, interpreting and
enforcing these laws and regulations is limited, and the Company's ability to
enforce commercial claims or to resolve commercial disputes is unpredictable.
These matters may be subject to the exercise of considerable discretion by
agencies of the Chinese government, and forces unrelated to the legal merits of
a particular matter or dispute may influence their determination.
The Company's activities in China require business licenses. This requires a
review and approval of our activities by various national and local agencies of
Chinese government. There can be no assurance that the Chinese government will
continue to approve of the Company's activities or grant or renew its licenses.
The Company's inability to obtain needed approvals or licenses would have a
material adverse effect on its business, financial condition and results of
operations.
Effect of Trade Disputes. China currently enjoys Most-Favored-Nation ("MFN")
status from the U.S., under which the U.S imposes the lowest applicable tariffs
on Chinese exports to the U.S. The U.S. annually reconsiders whether it should
renew MFN trading status for China. In the past, the U.S. has had disputes with
China relating to trade and human rights issues and has considered imposing
trade sanctions against China, including the non-renewal of MFN status. There
can be no assurance that the U.S. will renew the MFN status with China in future
years or will not impose trade sanctions against China that involve collectibles
such as those we manufacture. Either event would cause an increase in the cost
of the Company's products to its customers. This, in turn, could result in
lower demand for the Company's manufacturing services by its U.S. customers and
materially adversely affect our business, financial condition and results of
operations.
Lease of Chinese Facilities. The Company operates its Chinese factories
under tenancy agreements with local Chinese government agencies that expire
between May 1999 and June 2006. The Company also leases dormitory facilities
under similar tenancy agreements that expire between December 1998 and February
2000. The factories and dormitories that the Company is building will be leased
under similar agreements. The continuance and renewal of the Company's tenancy
agreements and operations at the Chinese facilities depend on its relationship
with the local government. The Company's operations and prospects will be
materially adversely affected if the local government fails to honor the tenancy
agreements. The Company also may have difficulty enforcing its rights under the
tenancy agreements in China.
Property Damage. By U.S. standards, fire fighting, disaster relief and
assistance and other infrastructure is relatively undeveloped in the Dongguan
region of China, where the Company's manufacturing facilities are located. The
Company currently maintains approximately $7,800,000 of property damage
insurance covering its manufacturing facilities. The Company has no business
interruption insurance. Material damage to, or the loss of, its manufacturing
facilities due to fire, severe weather, earthquake or other causes, even if
insured against, could have a material adverse effect on its business, financial
condition and results of operations. Furthermore, the Company may not be able
to find suitable alternative facilities if any of its factories were destroyed
or become inoperable for any reason.
Maintaining Headquarters in Hong Kong
The Company maintains headquarters in Hong Kong and conduct substantially all
of its administrative and sales operations there. The United Kingdom
transferred sovereignty over Hong Kong to China on July 1, 1997, and Hong Kong
became a Special Administrative Region of China. According to the Basic Law of
Hong Kong, Hong Kong will have a high degree of autonomy for 50 years, except as
to foreign affairs and defense. Based on the current political conditions and
the Company's understanding of this new law, we believe that the transfer of
sovereignty over Hong Kong will not have a material adverse effect on its
business, financial condition or results of operations.
2
<PAGE>
There can be no assurance, however, that the political, economic or commercial
conditions in Hong Kong will remain stable.
Customer Consolidation
The die-cast collectibles industry is fragmented and there appears to be a
trend toward consolidation among marketers and distributors of collectibles. In
the fourth quarter of 1997, Mattel acquired Tyco Hong Kong Limited, which
accounted for 5.6% of the Company's net sales in 1997. In 1998, Action
Performance Companies, Inc., a marketer and distributor of NASCAR die-cast
replicas and related products, acquired Brookfield Collectors Guild and a
controlling interest in Paul's Model Art, two of the Company's customers. The
Company believes that both Mattel and Action Performance currently intend to
continue the business relationships the Company has developed with these
customers. However, the change in ownership of these customers may adversely
affect the Company's ongoing relationship with them. Mattel owns and operates
manufacturing facilities that are capable of producing die-cast replicas, and
Action Performance has a close business relationship with a large, independent
die-cast manufacturer that competes with us. The loss of one or more of these
customers or other important customers because of industry consolidation would
have a material adverse effect on the Company's business, financial condition
and results of operations.
Concentration of Credit Risk
The Company's five largest customers -- Danbury Mint, Mattel (including
Tyco), Brookfield Collectors Guild, Corgi Classic Cars and Hallmark -- accounted
for approximately 92% of Company accounts receivable at December 31, 1997.
Therefore, the Company's working capital position, financial condition and
results of operations depend heavily on the creditworthiness of these customers.
If one or more of these customers do not pay the Company, the Company's
business, financial condition and results of operations could be materially
adversely affected.
Introduction of New Products by Customers; Market Acceptance
The Company's operating results and growth in net sales depend substantially
upon its customers' ability to develop and market new products and upon
continuing market acceptance of its customers' products. The customers' failure
or delay in introducing new products could impair the Company's results of
operations and limit its future growth. Changes in consumer tastes affect the
market for die-cast collectibles. Die-cast collectible products typically have
limited life cycles and the Company's customers may discontinue them at any
time. Accordingly, there can be no assurance that products of the Company's
customers' will achieve or maintain market acceptance.
Competition
The Company faces significant competition from toy companies and other
independent manufacturers of die-cast products with manufacturing facilities
located primarily in China. There are no significant barriers to entering the
die-cast manufacturing business, and if the market for die-cast collectibles
continues to grow, the Company expects increased competition from other industry
participants. Many of the Company's existing and potential competitors have
significantly greater financial, technical, manufacturing and marketing
resources than does the Company. There can be no assurance that the Company
will be able to compete successfully.
The Company's executive officers and key employees are not subject to
noncompetition agreements or similar contractual obligations protecting the
confidentiality of Company trade secrets or other information. Accordingly, the
Company may not have adequate protection in the event an officer or employee was
to leave the Company's employ and go into competition with the Company.
Certain of the Company's customers, including Mattel and Road Champs,
manufacture and distribute their own die-cast products in addition to marketing
die-cast products that the Company manufactures for them. There can be no
assurance that the Company will be able to continue its relationships with these
customers, or that other
3
<PAGE>
customers will not develop their own manufacturing capabilities, thereby
reducing or eliminating their need for the Company's services. Such events
could have a material adverse effect on the Company's business, financial
condition and results of operations.
Company Growth May Be Limited by Capacity at Production Facilities
The Company's ability to grow is a function of its manufacturing capacity.
The Company's manufacturing facilities are currently operating at or near
capacity. The Company is in the process of building two new factories, the
first of which it expects to become operational by the end of 1998. The Company
intends to use a portion of the net proceeds of this offering to pay for the
cost of constructing and equipping these new factories. The Company expects to
continue to require additional manufacturing capacity in the near future. If
the Company was unable to increase capacity on a timely basis and on
commercially reasonable terms, its growth would be materially adversely
effected.
Potential Increases in Raw Materials Costs
The Company uses zinc alloy and various plastic resins in its manufacturing
operations. The supply and demand for these and other raw materials are subject
to cyclical and other market factors and may fluctuate significantly.
Therefore, the Company's raw materials costs are subject to increases over which
it has no control. To the extent that future increases in the cost of raw
materials cannot be passed on to customers, the Company's business, financial
condition and results of operations could be materially adversely affected.
International Sales
The Company sells substantially all of its products to customers in the U.S.
and Europe. In 1997, approximately 6.2% of Company net sales were attributable
to sales to European customers. The balance of the Company's sales during these
periods was to customers in the U.S. The U.S. and European governments may,
from time to time, impose new quotas, duties, tariffs, or other charges or
restrictions, or adjust presently prevailing quota, duty or tariff levels. Any
changes of this nature could adversely affect the Company's ability to continue
to export products to the U.S. and Europe at current or increased levels.
Failure to Comply with Environmental Regulations
The Company is subject to Chinese laws that regulate environmental quality,
the utilization of natural resources and the reduction of pollution. As a
manufacturer, the Company is subject to annual inspections. If the Company
fails to comply with these laws or to pass inspections, its business, results of
operations and financial condition could be materially adversely affected.
Seasonality; Fluctuating Results
In keeping with Chinese customs, each year the Company closes its facilities
for two weeks during the month of January or February to celebrate the Chinese
New Year holidays. As a result, production and net sales during the first
quarter of each year have historically been lower than in other quarters. The
Company expects this trend to continue in future years.
The Company experiences quarterly fluctuation in its sales due to the timing
of customer orders and product shipments. In addition, the Company incurs
substantial tooling and other costs relating to the manufacturing of new
products from three to nine months in advance of when the Company receives the
first customer orders for new products. This long lead-time can contribute to
fluctuations in quarterly operating results.
Foreign Currency Exchange Rates
All of the Company's sales are denominated either in U.S. dollars or Hong
Kong dollars. The Company's expenses are denominated primarily in Hong Kong
dollars and renminbi, the Chinese currency, the basic unit of
4
<PAGE>
which is the yuan. Since 1983, the Hong Kong government has maintained a policy
of linking the U.S. dollar and the Hong Kong dollar at an exchange rate of
approximately HK$7.80 to U.S.$1.00. There can be no assurance that this link
will be continued. In January 1994, the Chinese government established its
current floating exchange rate system, which resulted in an approximately 35%
devaluation of the renminbi against most major currencies and the yuan-to-U.S.
dollar exchange rate has largely stabilized since that time. However, in 1997
China's finance minister stated that if China failed to achieve its target 8%
growth in 1998, this failure could affect the stability of the yuan against
other currencies. Estimates of China's growth for 1998 are now between 4% and
7%, and there can be no assurance that the yuan will not be devalued against the
to U.S. dollar.
Any material increase in the value of the Hong Kong dollar or yuan relative
to the U.S. dollar would increase Company expenses, and could have a material
adverse effect on the Company's business, financial condition and results of
operations. A devaluation of the Hong Kong dollar or yuan relative to the U.S.
dollar would be likely to reduce Company expenses. However, any benefits
received from a devaluation could be offset if the devaluation results in
inflation or political unrest. Furthermore, if our sales in Europe increase,
the Company may experience increased currency risk. The Company does not
currently hedge any foreign exchange positions.
Market Decline in East Asia
Several countries in East Asia, including Japan, South Korea, Thailand and
Indonesia, have experienced significant devaluations of their currencies and
declines in the value of their capital markets during the past twelve months.
In addition, these countries have experienced a number of bank failures and
consolidations. Hong Kong, where the Company conducts its sales and
administrative activities, is in a recession. Because virtually all of the
Company's products are sold into the U.S. and Europe, which are not generally
experiencing these declines, the Company believes that the economic situation in
East Asia will not materially affect the demand for its products. Furthermore,
because most of the Company's products are, or at our request may be, paid for
in U.S. dollars, the Company believes that it is less susceptible to the effects
of a possible devaluation in the Hong Kong dollar or the yuan. However, the
decline in the currencies of East Asian countries may render the Company's
products less competitive if competitors in East Asia are able to manufacture
competing products at a lower effective cost. There can be no assurance that
the Company's products will continue to be competitive with the products of
competitors from these countries. Currency fluctuations or other effects of the
economic downturn in East Asia also may have a material adverse effect on the
Company's business, financial condition and results of operations.
Possible Delays in Obtaining Raw Materials
The Company purchases its raw materials from a limited number of suppliers,
primarily in Australia and the United Kingdom, and has no written agreements
with any of such suppliers. The Company has not had trouble obtaining needed
materials, but there is no assurance that it will be able to obtain sufficient
quantities of such raw materials to meet its future needs. To the extent the
Company is unable to obtain needed raw materials in sufficient quantities or at
affordable prices, its business, financial condition and results of operations
could be materially adversely affected.
Failure to Comply with Year 2000 Computer Standards
The Company is not aware of any material operational issues or costs
associated with preparing its internal systems for the year 2000. However, the
Company may have operational problems or increased costs because of its
implementation of systems and changes necessary to address year 2000 issues.
The Company's inability to implement such systems and changes in a timely manner
could have a material adverse effect on its business, financial condition and
results of operations.
The Company also relies, directly and indirectly, on external systems of
business enterprises such as financial institutions, government agencies,
customers and suppliers for accurate exchange of data. Even if the year 2000
issue does not materially affect its internal systems, disruptions in the
operation of the enterprises with which the Company interacts could adversely
affect it.
5
<PAGE>
Dependence on Key Personnel
The Company's success depends to a significant extent upon the continued
services of certain of its executive officers and key employees, including
Messrs. Tong and Kwok. If the Company loses the services of either of these
executives, its business could be materially adversely affected. The Company
maintains "key person" life insurance on Messrs. Tong and Kwok totaling
approximately $333,000. The Company is applying to increase its insurance to
approximately $2,000,000 on Mr. Tong and to approximately $1,500,000 on Mr.
Kwok. However, there is no assurance that the proceeds of this insurance would
be sufficient to compensate the Company for their loss.
Control by Directors, Executive Officers and Principal Stockholders
The Company's directors, executive officers and principal stockholders
beneficially own approximately 90% of the outstanding shares of Company common
stock. These stockholders will have the ability to control the election of
directors and most of the Company's corporate actions. See "Item 11. Security
Ownership of Certain Beneficial Owners and Management."
Anti-Takeover Provisions
Section 203 of the Delaware General Corporation Law prohibits the Company
from engaging in a "business combination" with an "interested stockholder" for
three years, unless the business combination is approved in the manner required
by Delaware law. Section 203 could delay or prevent a change of control.
Furthermore, certain provisions of the Company's amended certificate of
incorporation and bylaws may delay or prevent a change in Company control or
management, which could adversely affect the market price of Company common
stock.
6
