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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-KSB
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the fiscal year ended December 31, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from _________ to _________
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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
18 BEDFORD RD., TAIKOKTSUI
KOWLOON, HONG KONG N/A
(Address of principal executive offices) (Zip Code)
Issuer's Telephone Number: 011-852-2396-0147
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. [X]
Issuer's revenues for its most recent fiscal year: $40,668,000
The aggregate market value of the common stock held by non-affiliates of the
registrant as of March 27, 2000 was approximately $19,662,456, based upon the
closing sale price of $6.188 as reported by The Nasdaq National Market on such
date.
There were 4,999,322 shares of the Company's common stock outstanding on March
27, 2000.
Transitional Small Business Disclosure Format (check one): YES [ ] NO [X]
DOCUMENTS INCORPORATED BY REFERENCE: Portions of Registrant's Proxy Statement
for its 2000 Annual Meeting of Stockholders, to be filed with the Securities and
Exchange Commission within 120 days after the close of the Registrant's fiscal
year, are incorporated herein by reference in Part III of this Report.
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TABLE OF CONTENTS
Part I
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1. Description of Business............................................................................... 1
2. Description of Property............................................................................... 10
3. Legal Proceedings..................................................................................... 11
4. Submission of Matters to a Vote of Security Holders................................................... 11
Part II
5. Market for Common Equity and Related Stockholder Matters.............................................. 11
6. Management's Discussion and Analysis or Plan of Operation............................................. 11
7. Financial Statements.................................................................................. 18
8. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure.................. 18
Part III
9. Directors, Executive Officers, Promoters and Control Persons; Compliance
with Section 16(a) of the Exchange Act.................................................................... 19
10. Executive Compensation............................................................................... 19
11. Security Ownership of Certain Beneficial Owners and Management....................................... 19
12. Certain Relationships and Related Transactions....................................................... 19
13. Exhibits and Reports on Form 8-K..................................................................... 19
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This annual report contains forward-looking statements within the meaning of the
federal securities laws. These include statements about our expectations,
beliefs, intentions or strategies for the future, which we indicate by words or
phrases such as "anticipate," "expect," "intend," "plan," "will," "we believe,"
"the Company believes," "management believes" and similar language. The
forward-looking statements are based on our current expectations and are subject
to certain risks, uncertainties and assumptions, including those set forth in
the discussion under "Description of Business," including the "Risk Factors"
described in that section, and "Management's Discussion and Analysis or Plan of
Operation." Our actual results may differ materially from results anticipated in
these forward-looking statements. We base our forward-looking statements on
information currently available to us, and we assume no obligation to update
them.
PART I
ITEM 1. DESCRIPTION OF BUSINESS.
OVERVIEW
Creative Master International, Inc. (the "Company") is a leading independent
manufacturer of collectible-quality, die-cast replicas of cars, trucks, buses
and other items. In addition, during 1999, the Company developed a proprietary
line of die-cast marine products, including boats and engines. 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 1/6th to 1/160th 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
primarily U.S. and European marketers and distributors of vehicle replicas and
other collectibles, including Danbury Mint (MBI), Paul's Model Art, Mattel,
Action Performance, First Gear, Corgi Classics, Road Champs and Hallmark Cards.
With the acquisition of the Sinar Industrial Limited group of companies
("Sinar") in July 1999, the Company expanded its range of products to
computer and interactive video game peripherals ("CGPs"). Sinar designs and
markets a variety of game controllers for various game platforms such as
Nintendo, Sony PlayStation & PC. The range of products includes a wide
variety of ergonomic designed joysticks, joypads, steering wheels, light
guns, cable products and multimedia peripherals. Sinar's products are
distributed and sold primarily in the United States, Europe, and Asia. The
new products compliment our die-cast collectibles by broadening the product
lines of some of our existing customers. These products also appeal to an end
customer with similar demographics to our collectors. In the past, Sinar has
designed and marketed its products, but outsourced all manufacturing to
third-party vendors. The Company will provide its experience in manufacturing
and production control to ensure product quality and enhance margins.
The Company's mission is to provide the highest level of product quality and
customer service among independent manufacturers of die-cast collectibles and
computer and video game peripherals. 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 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 Creative
Master Limited ("CML"), the Company's 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. 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 over
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550,000 square feet of manufacturing space plus housing and related facilities
for approximately 6,000 workers. Some of the CGPs will be manufactured by CML at
its Dongguan factories starting in 2000.
PROPOSED CHANGE IN CONTROL OF THE COMPANY
As described under "Management's Discussion and Analysis or Plan of Operation,"
subsequent to December 31, 1999, the Company entered into an agreement in
principle to acquire PacificNet.com LLC ("PNC") in a transaction in which the
owners of PNC would acquire control of the Company. The consummation of the
acquisition is subject to certain closing conditions, and there can be no
assurance that it will be completed. If it is completed, it is anticipated that
the Company's primary business focus in the future will be PNC's start-up
trans-Pacific business-to-business electronic commerce instead of the Company's
current business. PNC also has indicated its interest in disposing of the
Company's current business if the acquisition is completed. The Company's
acquisition, if it is completed, would materially impact the business activities
and future results of operations. The discussions in this annual report are
based on the Company's current business and operations and do not address
changes that will occur in the future assuming the PNC acquisition is completed.
PRINCIPAL CUSTOMERS
The Company's customers for its die-cast replicas consist principally of
specialty retailers, direct marketers and other distributors of collectibles,
primarily in the U.S. and Europe. These include Danbury Mint (a division of MBI,
Inc.) and Mattel Inc. In 1997, the Company began manufacturing the popular
Matchbox die-cast collectibles series for Mattel. In 1997, Mattel purchased Tyco
Hong Kong Limited, for which the Company had been producing die-cast vehicle
replicas since 1996. Other customers include Paul's Model Art, Action
Performance, First Gear, Corgi Classics, Road Champs and Hallmark Cards. The
Company has reduced its dependence on its key customers by continuing to
diversify its customer base, products and markets through new manufacturing
arrangements.
The Company's customers for its CGPs consist principally of major game marketing
companies, primarily in United States, Europe and Asia. Customers include Take2
Interactive, Nuby Interactive, Arista Enterprises and Jack-Of-All-Games.
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.
The following sets forth certain information with respect to the Company's
principal customers during 1999:
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PRINCIPAL PRODUCT CATEGORY CUSTOMER PERCENTAGE OF
SINCE NET SALES
YEAR ENDED
DECEMBER 31,
1999
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MBI, Inc. (1) U.S. classic cars and trucks 1986 22.7%
Paul's Model Art GmbH (2) European street and Formula One cars 1990 15.8%
Corgi Classics Limited Hong Kong buses, United Kingdom 1996 9.7%
buses and airplanes
Mattel Vendor Operations Asia Ltd. (4) Matchbox collectibles 1997 9.3%
Action Performance Co. (2) NASCAR, IRL and CART racing cars and
Super Touring racing cars 1996 8.5%
First Gear Premium trucks and vans 1997 7.2%
Road Champs Ltd. (3) Police cars and other U.S. cars 1997 6.0%
Hallmark Cards Keep sake collectibles 1998 5.8%
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(1) Danbury Mint is a division of MBI, Inc.
(2) Action Performance Companies, Inc. owns 100% of Brookfield Collectors
Guild and a controlling interest in Paul's Model Art.
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(3) Road Champs is a subsidiary of JAKKS Pacific, Inc.
(4) Sales to Mattel are made indirectly through its Mattel Vendor Operations
Asia Ltd. subsidiary and include sales to Tyco Hong Kong Limited, which
was acquired by Mattel in 1997.
PRODUCTS
DIE-CAST
The Company produces a wide range of collectible die-cast replicas of vehicles,
including classic cars, European cars, Formula One racing cars, trucks, trains,
planes, boats, buses and other items. These replicas are produced at various
scales from 1/6th to 1/160th of the original size. They typically retail for up
to $200, depending on the number of parts and the level of intricacy in the
design. The Company's replicas have up to 450 parts and quality finishing that
results in an authentic look that appeals to collectors and other enthusiasts.
Most replicas are produced for marketing customers who obtain licenses for the
vehicles and the various decorative logos and designs used.
COMPUTER AND VIDEO GAME PERIPHERALS
The Company designs and markets a wide range of CPG products which include a
variety of ergonomically designed joysticks, joypads, steering wheels, light
guns, cable products and multimedia peripherals.
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 additional die-cast collectibles.
The Company generally has obtained certain rights to produce replicas of a
number of products. 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 licenses to manufacture
die-cast replicas, it intends to pursue strategic alliances, joint ventures or
other arrangements with one or more of its existing customers or others to
market and distribute such replicas.
The CGPs are marketed through representatives in the U.S. and Europe with
assistance from senior management in Hong Kong, where the activities are
coordinated.
BACKLOG
For new products, the Company's customers generally contact the Company six to
eighteen months in advance of product delivery, so that the Company can engineer
and fabricate the necessary molds and tools 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 if the Company fails
to meet its production schedules.
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
lower production costs while maintaining high quality and reliability.
The product production cycle occurs in the following stages:
- Product development
- Model making
- Tooling
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- Decorative artwork rendering
- 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. 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.
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 working prototype in two to 10 weeks.
Once the customer has approved a prototype, the Company begins the tooling
process, which typically requires three 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.
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 takes ownership and assumes the cost of insuring the
molds and tools.
Once tooling is completed, we develop artwork for the product decorations in
accordance with the customer's requirements. There are increasing demands on the
Company to add authentic decorative schemes to the products. Typical examples
are the corporate logos and other custom imprints used for racing car replicas
and on the newly-developed fishing boat replicas. We are able to prepare
complete decorated samples in two weeks by using Internet and computer-aided
film output equipment.
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 and a half 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.
During the year ended December 31, 1999, the Company invested approximately $1.2
million in tools for proprietary products in new lines, primarily boats and
related engines. In November 1999, the Company announced that it was awarded
multiple trademark licenses by Operation Bass Inc. and Genmar Holdings, Inc. to
manufacture 1/24th scale die-cast replica Ranger boats used in the 1999 Wal-Mart
FLW Tour. Operation Bass Inc. operates professional fishing tournaments and
Genmar Holdings, Inc. owns Ranger, the second largest manufacturer of motorized
recreational boats in the United States. The cost of our proprietary tools will
be amortized over future sales or written off if sufficient sales are not
generated.
Sinar's product development process is in many ways similar to CML's. Sinar's
senior executives work closely with its marketing partners and customers to stay
abreast of the changing computer game market. Sinar offers a full range of
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peripherals that customers can sell under their own private labels. In many
instances, Sinar will develop its own tools and molds to shorten development
time. In the past, production of all products was subcontracted to third
parties. Beginning in 2000, certain of this manufacturing will be subcontracted
to the Company.
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
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 each accounted for more than 10% of total
consolidated purchases for the year ended December 31, 1999, as follows:
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PERCENTAGE OF TOTAL RAW MATERIAL
COMPONENT SUPPLIED PURCHASES
YEAR ENDED DECEMBER 31, 1999
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Manfield Coatings Co., Ltd. Paint 11.5%
Genesis Off-set Printing Co., Ltd. Packaging materials 11.1%
Trident Alloys Limited Zinc alloy 10.0%
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Management believes there are multiple sources of supply for these and other raw
materials used in the Company's business.
FACILITIES
The Company's growth is closely related to its manufacturing capacity. At
present, the Company operates five factories in the Dongguan region of Guangdong
Province, China. Legal and administrative requirements of these factories are
facilitated through the Company's Chinese subsidiary.
The Company's factories occupy approximately 550,000 square feet of
manufacturing space plus an additional 350,000 square feet for related housing
of workers. This represents an increase of approximately 25% when compared to
1998 and more than double the space that was available in 1997.
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.
In addition, as is the custom and practice in China, each factory has adjacent
dormitories to house the factory workers. The workers are provided housing,
meals, work clothes and medical care for which they pay only a nominal monthly
amount. The Company also pays for the cost of electricity, water supply and
housekeeping services for the dormitories. The Company's costs of providing
these services are included in cost of goods sold.
The Company works closely with its customers in order to understand and plan for
each customer's anticipated production needs. Plans for the expansion of the
Company's manufacturing facilities are based largely on the anticipated needs of
its primary customers. Adequate, available undeveloped land adjacent to the
Company's facilities in China should permit expansion as necessary. Typically,
the Company can complete new facilities within six months. This six-month time
frame is within the normal product development cycle, and the Company
historically has not experienced any significant delays in bringing additional
capacity on-line to meet increased customer demand.
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The Board of Directors of the Company has approved approximately $600,000 in
capital expenditures in 2000 to establish a CGP manufacturing facility within
the Company's existing facilities in Dongguan. Approximately 50,000 square feet
will be dedicated for this purpose and a maximum of 600 workers will be utilized
in the CGP production.
COMPETITION
The Company faces competition from certain toy companies and other independent
manufacturers of die-cast products with production facilities located in China.
Certain of the Company's customers, including Mattel, Corgi and Road Champs,
have their own die-cast manufacturing facilities in China.
The Company competes primarily on the basis of quality, technical capabilities
and ability to meet customer delivery schedules. To a lesser extent, it competes
on the basis of price. Although some of the Company's competitors are larger and
have substantially more resources than the Company, based on the preceding
criteria, the Company believes that it competes effectively with these larger
manufacturers. In addition, the Company believes that its exclusive focus on
manufacturing collectible-quality, die-cast replicas distinguishes it from other
competitors who manufacture both toy-grade products and collectible-quality
products.
The Company believes it possesses trade secrets relating to application and
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.
Sinar, the Company's 55% owned subsidiary, can deliver a full range of CGP
products on a turnkey basis. The Company faces competition from China-based
manufacturers who supply similar products at a low price, but do not offer the
design and development services that Sinar does. Sinar also holds proprietary
protocols, developed by its engineers, for certain of its CGPs.
GOVERNMENT REGULATION
The Company is not engaged in a regulated industry. The Company is subject to
import regulations in China, where it imports supplies to manufacture tools,
molds and finished die-cast collectibles. The Company also is subject to export
regulations in China, because it exports all of its product to customers outside
of China. The Company believes that its import and export practices comply with
applicable regulations and that its business and results of operations are not
significantly impacted by these regulatory requirements.
The Company uses a variety of paints and oils in the manufacture and detailing
of its die-cast collectibles, and has established procedures for the proper
storage, use and disposal of such materials. The Company believes that it has
complied with all environmental regulations applicable to its business.
EMPLOYEES
As of December 31, 1999, the Company had approximately 5,200 employees in China,
all of which are full-time. Of these employees, approximately 4,450 were
production workers, 450 were general & administrative staff, and 300 were
quality & engineering support staff. In addition, the Company employs
approximately 90 people in Hong Kong. We have recruited professional staff from
Hong Kong, China, Malaysia and Singapore to manage the production of the high
quality products that our customers have come to expect.
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As is customary for manufacturers in China, the Company's production facilities
include housing facilities for its workers. The Company is committed to
providing good working and living conditions for its employees in China. The
Company has experienced no significant labor stoppages and believes that the
relations with its employees are satisfactory.
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 significant research and development expenses during
1997, 1998 or 1999. Substantially all development costs associated with
manufacturing products for its customers are expensed as a cost of goods sold.
The Company does not rely on any significant proprietary technology. The Company
has recently increased its development efforts with respect to certain
proprietary products, and is likely to incur future research and development
expenses in connection with these efforts.
RISK FACTORS
In addition to the other information in this annual report, the following
factors should be considered carefully in evaluating the Company's business and
prospects:
CONDUCTING BUSINESS IN CHINA. Our manufacturing facilities are located in the
Dongguan region of Guangdong Province, China, approximately 60 miles northwest
of Hong Kong. Therefore, we are subject to certain inherent risks of doing
business in China.
INTERNAL POLITICAL RISKS. Our 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 our 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. We conduct our manufacturing operations in China
through a contract processing arrangement with a Chinese subcontractor and a
contractual joint venture with a local Chinese partner. We plan to phase out the
contractual joint venture operations in favor of operating through a contractual
arrangement with a Chinese subcontractor. The legal existence of this Chinese
contractual joint venture expires in 2006, and we have no assurance that it can
be extended if the Company desired to extent it. If we cannot extend the
contract processing arrangement or the legal existence of the contractual joint
venture, we may be forced to move our manufacturing operations outside of China,
and there can be no assurance that we would be able to continue our
manufacturing operations. In the event of such a disruption, our profitability,
competitiveness and market position could be materially adversely affected.
NON-RENEWAL AND ENFORCEMENT OF LEASES OF CHINESE FACILITIES. We operate our
Chinese factories under tenancy agreements with local Chinese government
agencies that expire between January 2002 and June 2006. We also lease dormitory
facilities under similar tenancy agreements that expire between March 2000 and
November 2003. The factories and dormitories that we are building will be leased
under similar agreements. The continuance and renewal of our tenancy agreements
and operations at our Chinese facilities depend on our relationship with the
local government. Our operations and prospects will be materially adversely
affected if the local government fails to honor the tenancy agreements. We also
may have difficulty enforcing our rights under the tenancy agreements in China.
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NON-RENEWAL OF BUSINESS LICENSES. Our activities in China, including our
contractual joint venture, 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 our activities or grant or renew our licenses. Our inability to
obtain needed approvals or licenses would have a material adverse effect on our
business, financial condition and results of operations.
UNRECOVERABLE PROPERTY DAMAGE LOSSES. By U.S. standards, fire fighting, disaster
relief and assistance and other infrastructure is relatively undeveloped in the
Dongguan region of China, where our manufacturing facilities are located. While
we currently maintain property damage insurance covering our manufacturing
facilities, we have no business interruption insurance. Material damage to, or
the loss of, our manufacturing facilities due to fire, severe weather,
earthquake or other causes, even if insured against, could have a material
adverse effect on our business, financial condition and results of operations.
Furthermore, we may not be able to find suitable alternative facilities if any
of our factories were destroyed or become inoperable for any reason.
LACK OF REMEDIES AND IMPARTIALITY UNDER CHINESE 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 our 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.
FOREIGN CORRUPT PRACTICES ACT. We are 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
us, are not subject to these prohibitions. Corruption, extortion, bribery,
pay-offs, theft and other fraudulent practices occur from time-to-time in China.
We have attempted to implement safeguards to prevent losses from such practices
and to discourage such practices by our employees and agents. There is no
assurance, however, that we will not suffer such losses or that our employees or
other agents will not engage in such conduct for which we might be held
responsible.
DEPENDENCE ON IMPORTANT CUSTOMERS. Our business is concentrated among a limited
number of customers. In 1999, sales to Danbury Mint, a subsidiary of MBI, Inc.,
accounted for 22.7% of our total net sales and sales to Action Performance and
its subsidiaries, including Paul's Model Art, totaled 24.3% of total net sales.
Since 1997, we have sought to diversify our customer base and our efforts
resulted in several new customers in 1998 and 1999. Despite our diversification
efforts, we expect that we will continue to depend on sales to Danbury Mint and
Action Performance. If we lose any one of our major customers, particularly
Danbury Mint or Action Performance, our business, financial condition and
results of operations would be materially adversely affected.
CONCENTRATION OF CREDIT RISK. Our working capital position, financial condition
and results of operations depend heavily on the creditworthiness of our five
largest customers, which accounted for approximately 66% of our accounts
receivable at December 31, 1999. If one or more of these customers does not pay
us, our business, financial condition and results of operations could be
materially adversely affected.
INCREASED DIFFICULTIES IN COMPETING. There can be no assurance that we will be
able to continue to compete successfully. We face significant competition from
toy companies and other independent manufacturers of die-cast products with
manufacturing facilities located primarily in China. There also are no
significant barriers to entering the die-cast manufacturing business, and if the
market for die-cast collectibles continues to grow, we expect increased
competition from other industry participants. Many of our existing and potential
competitors have significantly greater financial, technical, manufacturing and
marketing resources than we do.
INSTABILITY OF CUSTOMER BASE RESULTING FROM INDUSTRY CONSOLIDATION. Our loss of
one or more important customers because of industry consolidation could have a
material adverse effect on our business, financial condition and results of
operations. The die-cast collectibles industry is fragmented and there appears
to be a trend toward consolidation among
8
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marketers and distributors of collectibles. In 1999, Corgi Classics, which
comprised almost 10% of total net sales of the Company, was acquired by Zindart
Industrial Ltd, a company which owns die-cast manufacturing facilities in China.
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 our customers. In
1997, Mattel acquired Tyco Hong Kong Limited, which accounted for approximately
5.6% of our net sales in 1997. We believe that both Mattel and Action
Performance currently intend to continue the business relationships we have
developed with these customers, although Corgi, in all likelihood, will not.
These changes and potential future changes in ownership of our
customers may adversely affect our ongoing relationship with them.
LOSS OF CUSTOMERS RESULTING FROM CUSTOMER MANUFACTURING CAPABILITIES. Certain
customers, including Mattel and Road Champ, manufacture and distribute their own
die-cast products in addition to marketing die-cast products that we manufacture
for them. Action Performance has a close business relationship with a large,
independent die-cast manufacturer that competes with us. Corgi Classics, a
significant customer in 1999, was recently acquired by a die-cast manufacturer
that competes with us. There can be no assurance that we will be able to
continue our relationships with these customers, or that other customers will
not develop their own manufacturing capabilities, thereby reducing or
eliminating their need for our services. Such events could have a material
adverse effect on our business, financial condition and results of operations.
DEPENDENCE ON INTRODUCTION OF NEW PRODUCTS BY CUSTOMERS; LACK OF MARKET
ACCEPTANCE. Our operating results and growth in net sales depend substantially
upon our customers' ability to develop and market new products and upon
continuing market acceptance of our customers' products by collectors. Our
customers' failure or delay in introducing new products could impair our results
of operations and limit our future growth. Changes in consumer tastes affect the
market for die-cast collectibles. Die-cast collectible products typically have
limited life cycles and our customers may discontinue them at any time.
Accordingly, there can be no assurance that our customers' products will achieve
or maintain market acceptance.
OUR GROWTH MAY BE LIMITED BY CAPACITY AT PRODUCTION FACILITIES. Our ability to
grow is a function of our manufacturing capacity. If we were unable to increase
our manufacturing capacity on a timely basis and on commercially reasonable
terms, our growth would be materially adversely effected. We expect to continue
to require additional manufacturing capacity in the near future.
PROPRIETARY TOOLING EXPENDITURES. Prior to 1999, virtually all the Company's
tooling and mold production costs for the development of new products were
underwritten by customers. During 1999, the Company invested approximately $1.2
million in tooling costs for proprietary products, primarily boats and boat
engines. These costs are capitalized in machinery and equipment in the balance
sheet as of December 31, 1999, and will be amortized against future sales of
these products. If there are no future sales or if future sales are insufficient
to absorb these capitalized costs, then the write-off of these costs may result
in losses reported by the Company.
FAILURE TO COMPLY WITH ENVIRONMENTAL REGULATIONS. We use a variety of paints and
oils in the manufacture and detailing of our die-cast collectibles. We have
established procedures for the proper storage, use and disposal of such
materials. To our knowledge, we have complied with all environmental regulations
applicable to our business. The failure to comply with such regulations or to
pass annual inspections at our facilities, however, could materially adversely
affect our business, results of operations and financial condition.
INCOME TAX PROVISIONS AND POTENTIAL LIABILITY FOR ADDITIONAL TAXES. The
Company and its subsidiaries are subject to income taxes on an entity basis
on income arising in or derived from each of the tax jurisdictions in which
they operate, including China, Hong Kong and the United States. When products
are manufactured in one jurisdiction and exported for sale into a separate
jurisdiction, the tax laws can be complicated and subject to interpretation.
The Company annually provides what management considers to be adequate
provisions for income taxes as required under generally accepted accounting
principles in the United States, and this provision amounted to 13% of income
before income taxes in 1997, 9% in 1998 and 10% in 1999. There can be no
assurance, however, that examinations of the Company's various income tax
returns will not result in disagreements over the Company's reported taxable
income that could result in additional liabilities for the Company, which may
be material.
9
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FLUCTUATING RESULTS. Our production and net sales during the first quarter of
each year have historically been lower than in other quarters, because in
keeping with Chinese customs, each year we close our facilities for two weeks
during the month of January or February to celebrate the Chinese New Year
holidays. We expect this trend to continue in future years. The shutdown of our
operations for two weeks delays our responsiveness to customer orders and
shipments in the initial weeks of the year. The inability to meet certain time
schedules, even for short periods, could negatively impact our competitiveness
for customer business. The loss of customers for a single project increases the
likelihood of losing additional projects from such customers, which, if it
occurred, could have a material adverse affect on our business. We also
experience quarterly fluctuation in our sales due to the timing of customer
orders and product shipments. In addition, we incur substantial tooling and
other costs relating to the manufacturing of new products from three to nine
months in advance of when we receive the first customer orders for new products.
This long lead-time can contribute to fluctuations in our quarterly operating
results.
LOSSES FROM CHANGES IN CURRENCY EXCHANGE RATES. Any material increase in the
value of the Hong Kong dollar or yuan relative to the U.S. dollar would increase
our expenses, and could have a material adverse effect on our business,
financial condition and results of operations. All of our sales are denominated
either in U.S. dollars or Hong Kong dollars. Our expenses are denominated
primarily in Hong Kong dollars and Renminbi, the Chinese currency, the basic
unit of 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. A devaluation of
the Hong Kong dollar or yuan relative to the U.S. dollar would be likely to
reduce our expenses when stated in U.S. dollars. However, any benefits we
receive from a devaluation could be offset if the devaluation results in
inflation or political unrest.
LACK OF TRADE SECRET PROTECTION. We may not have adequate protection in the
event an officer or employee leaves our employ and goes into competition with
us. Although we plan to implement such agreements in the near future, our
executive officers and key employees are not subject to non-competition
agreements or similar contractual obligations protecting the confidentiality of
our trade secrets or other information.
DEPENDENCE ON CONTINUED SERVICES OF MESSRS. TONG AND KWOK. Our success depends
to a significant extent upon the continued services of Carl Ka Wing Tong and Leo
Sheck Pui Kwok. If we lose the services of either of these executives, our
business could be materially adversely affected. Messrs. Tong and Kwok
co-founded Creative Master Limited, our wholly-owned Hong Kong subsidiary, in
1986 and have continuously served as the Chief Executive Officer and Chief
Operating Officer, respectively, since that time. Accordingly, Messrs. Tong and
Kwok have unique experience, knowledge and expertise in our management and
direction. They also have served as the principal contacts with our customers
and have developed long-standing relationships with them, and we believe that
their continued involvement with our customers is important to the maintenance
of these relationships. We maintain "key person" life insurance of approximately
$2,000,000 on Mr. Tong and approximately $1,500,000 on Mr. Kwok. However, there
is no assurance that the proceeds of this insurance would be sufficient to
compensate us for their loss.
ITEM 2. DESCRIPTION OF PROPERTY.
The Company's corporate and administrative offices occupy approximately 12,000
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, 2001 and May 15, 2001.
The Company's current manufacturing facilities in China contain approximately
550,000 square feet of manufacturing space and approximately 350,000 square
feet of dormitory space that can accommodate up to 6,000 workers. See
"Description of Business--Facilities." The Company leases the factories from
local Chinese government agencies under separate tenancy agreements expiring
from January 2002 to June 2006. The aggregate monthly rent for its factories
is approximately $56,000. The Company also leases dormitory space to house
its factory workers under similar agreements which expire between March 2000
and November 2003. The aggregate monthly rent
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for dormitory facilities is approximately $36,000. The Company financed the cost
of constructing the Dongguan facilities and believes that its willingness to
continue operations and finance future expansion will facilitate the extension
of its leases on such facilities.
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.
None.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Beginning December 23, 1998, the Company's common stock was listed on the Nasdaq
National Market under the symbol "CMST." Previously, the Company's common stock
had been quoted on the OTC Electronic Bulletin Board under the symbol "CVMI,"
and trading in the common stock has been limited and sporadic. The following
table shows the range of high and low bid quotations reported by the OTC
Electronic Bulletin Board in each fiscal quarter from January 1, 1998 to
September 30, 1998, and the high and low sales prices reported by Nasdaq for the
fiscal quarter ended December 31, 1998 and each fiscal quarter in 1999. The OTC
Electronic Bulletin Board quotations reflect inter-dealer prices, without retail
mark-up, mark-down or commission, and may not represent actual transactions.
<TABLE>
<CAPTION>
HIGH LOW
<S> <C> <C>
FISCAL 1998
Quarter Ended March 31, 1998 $0.27 $0.27
Quarter Ended June 30, 1998 $0.03 $0.03
Quarter Ended September 30, 1998 $0.69 $0.69
Quarter Ended December 31, 1998 $6.00 $5.00
FISCAL 1999
Quarter Ended March 31, 1999 $8.00 $5.00
Quarter Ended June 30, 1999 $6.81 $4.44
Quarter Ended September 30, 1999 $6.00 $4.00
Quarter Ended December 31, 1999 $4.50 $2.13
</TABLE>
As of March 23, 2000, there were approximately 1,160 record holders of the
common stock.
The Company has not paid any cash dividends on its common stock, and it
currently intends to retain any future earnings to fund the development and
growth of its business.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
This annual report contains forward-looking statements within the meaning of the
federal securities laws. These include statements about our expectations,
beliefs, intentions or strategies for the future, which we indicate by words or
phrases such as "anticipate," "expect," "intend," "plan," "will," "we believe,"
"the Company believes," "management believes" and similar language. The
forward-looking statements are based on our current expectations and are subject
to certain risks, uncertainties and assumptions, including those set forth in
the discussion under "Description of Business," including the "Risk Factors"
described in that section, and "Management's Discussion and Analysis or Plan of
Operation." Our actual results may differ materially from results anticipated in
these forward-looking statements. We
11
<PAGE>
base our forward-looking statements on information currently available to us,
and we assume no obligation to update them.
AGREEMENT TO ACQUIRE PACIFICNET.COM LLC
As previously reported by the Company, pursuant to the terms of a Share Exchange
Agreement, signed on February 17, 2000, among the Company, PacificNet.com LLC
("PNC"), and the owners of PNC, the Company has agreed in principle to acquire
all the outstanding capital stock of PNC. In consideration for the acquisition,
the Company expects to issue 21 million shares of its common stock to the owners
of PNC, or approximately 80% of the common stock of the Company expected to be
outstanding immediately following the acquisition.
PNC is a privately-held Internet start-up company headquartered in Minneapolis,
Minnesota and Hong Kong that focuses on trans-Pacific business-to-business
electronic commerce. The owners of PNC include China Strategic Holdings Limited
("CSH"), an investment holding company listed on the Hong Kong Stock Exchange,
and Mr. Oei Hong Leong, the Chairman of CSH. CSH is the parent company of China
Tire Holdings Ltd., which is listed on the New York Stock Exchange. Fortune
Tele.com Limited, a Hong Kong-listed mobile telecommunications company with
operations in China, is also a strategic investor in PNC.
The parties are currently preparing a supplement to the Share Exchange Agreement
to document their understanding of certain details of the proposed acquisition.
The consummation of the proposed acquisition is subject to the execution of the
supplement, receipt of a fairness opinion from the Company's financial advisor,
approval of the Company's shareholders, and the satisfaction of other customary
conditions, and there can be no assurance that the acquisition will be
completed. In connection with obtaining the approval of its shareholders, the
Company will prepare a definitive proxy statement which will include a complete
description of the proposed acquisition and the business of PNC. It is
anticipated that the proxy statement will be mailed to the Company's
shareholders in May.
If the acquisition of PNC is consummated, it is anticipated that the Company's
primary business focus in the future will be PNC's business-to-business
electronic commerce, instead of the Company's current business of manufacturing
collectible-quality, die-cast replicas of cars, trucks, buses, and other items.
PNC has indicated its interest in disposing of the Company's current business if
the acquisition is completed. In light of this, as previously reported, a
management group led by the Company's Chairman and Chief Executive Officer, Mr.
Carl Tong, has indicated an interest in negotiating a purchase of the Company's
current business. However, the Company has not entered into any formal
understanding or arrangement with respect to any disposition of its current
business, and it is not expected that any such disposition will be a condition
to the acquisition of PNC.
There is no assurance that the PNC acquisition will be completed or, assuming it
is, whether or on what terms the Company might dispose of its current business.
In the meantime, the Company will carry on its current business and activities
substantially as it has in the past. The Company's acquisition of PNC, if it is
completed, would materially impact the business activities and future results of
operations of the business. The Company expects to incur substantial legal,
accounting and other due diligence expenses relating to the proposed acquisition
of PNC. If such acquisition is not consummated, these expenses will reduce the
Company's earnings for the periods in which they are reported.
The following discussion is based on the Company's current business and
operations and does not address changes that might occur in the future assuming
the PNC acquisition is completed.
OVERVIEW
The Company is an independent manufacturer of collectible-quality, die-cast
replicas of cars, trucks, buses and other items and designs and markets computer
and interactive video game peripherals. All of the Company's business and
operations are conducted through Creative Master Limited, its wholly-owned Hong
Kong subsidiary ("CML"), and CML's subsidiaries, including Sinar Industrial
Limited ("Sinar"), acquired in July 1999.
On December 30, 1997, CML completed an exchange reorganization with Davin
Enterprises, Inc., a public company incorporated in Delaware in 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. Davin
Enterprises, Inc. had no
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<PAGE>
significant assets, liabilities, business or operations prior to the exchange
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. 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. In March 1998, Davin Enterprises, Inc.
changed its name to Creative Master International, Inc.
The Company's manufacturing operations in China are conducted by CML through
contract processing arrangements with a Chinese subcontractor and through a
contractual joint venture established in October 1994 between CML and a local
Chinese partner. The Company expects to phase out the operations of the
contractual joint venture, and instead conduct these operations through contract
processing arrangements. Most of the Company's operations will be conducted
through contract processing arrangements in 2000.
Historically, the Company has paid no taxes in China. Under Chinese law, the
contractual joint venture is exempted from China state and local income tax for
a two-year period starting from the first year that the contractual joint
venture is profitable. Following the initial two-year tax exemption, the
contractual joint venture would become subject to taxation in China beginning in
1999, but would receive a 50% reduction in its Chinese income taxes for the next
three years. The contract processing arrangement with the Chinese subcontractor,
however, is not currently subject to taxation 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 that derives
revenues from manufacturing operations through contract processing arrangements
in China recognizes only 50% of this 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,
1997 1998 1999
--------------- --------------- ---------------
<S> <C> <C> <C>
Net sales................................................. 100.0% 100.0% 100.0%
Cost of goods sold........................................ 78.4 72.8 75.6
Gross profit.............................................. 21.6 27.2 24.4
Selling, general and administration expenses.............. 11.8 15.2 14.7
Interest expense, net..................................... 0.6 0.7 0.1
Other income (expenses), net.............................. (3.0) 0.9 0.3
Income before income taxes and minority interests......... 6.2 12.2 10.2
Minority interests........................................ 0.5 2.0 2.0
Provision for income taxes................................ 0.8 1.1 1.1
Income before cumulative effect of accounting change...... 4.9 9.1 7.1
Cumulative effect of accounting change.................... 0.0 0.0 0.5
Net income................................................ 4.9 9.1 6.6
</TABLE>
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
NET SALES. The Company's net sales for the year ended December 31, 1999 were
$40,668,000, an increase of $7,035,000, or 21%, from $33,633,000 in 1998. The
increase reflected higher sales to existing customers and, to a lesser extent,
higher sales to new customers, and the acquisition of the Sinar group. Sinar's
sales from acquisition in July1999 to December 31, 1999 were $3,385,000.
COST OF GOODS SOLD. Cost of goods sold includes the cost of raw materials,
subcontracting charges for production of molds, direct labor costs, utilities
and other energy costs and depreciation and amortization of the Company's
equipment and other depreciable manufacturing assets. The Company's cost of
goods sold for the year ended December 31, 1999
13
<PAGE>
was $30,740,000, an increase of $6,250,000, or 26%, from $24,490,000 in the
prior year. This was largely attributable to the higher sales volume, which
resulted in an increase of $3,106,000 in materials cost and an increase of
$1,711,000 in salaries and other direct labor costs. Cost of goods sold
constituted 76% of net sales for the year ended December 31, 1999, compared to
73% for 1998. The reduction in gross profit margin was primarily a result of
smaller production runs at CML and inherently lower margins in the CGP business.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. The Company's selling, general and
administrative expenses totaled $5,961,000 for the year ended December 31, 1999,
an increase of $848,000, or 17%, from $5,113,000 for the year ended December 31,
1998. Selling, general and administrative expenses increased due to an increase
in administrative and personnel costs to support the increase in sales and
manufacturing capacity and Sinar's SG&A expenses of $456,000. Selling, general
and administrative expenses decreased as a percentage of net sales to 14.7% of
net sales for the year ended December 31, 1999, as compared to 15.2% of net
sales for the year ended December 31, 1998. The decrease as a percentage of
sales was due to some economies of scale achieved.
Selling expenses consist primarily of shipping expenses and inspection charges.
General and administrative expenses consist of salaries and other employee
expenses for the Company's administrative and product development staff, the
majority of which are located in Hong Kong, and rent and other overhead expenses
of the Hong Kong office. Shipping expenses increased by $95,000 to $598,000 for
the year ended December 31, 1999, compared to $503,000 for the year ended
December 31, 1998. This increase was primarily due to higher sales volume and
Sinar shipping expenses of $60,000 for the period since acquisition. Salaries
increased by $1,047,000 to $3,150,000 for the year ended December 31, 1999,
compared to $2,103,000 for the year ended December 31, 1998. This increase was
primarily due to the addition of new employees to the Company's administrative
and development staff in Hong Kong, increases in salaries of some existing
employees and salaries to Sinar's employees since acquisition of $127,000.
INTEREST EXPENSE, NET. The Company's interest expense, net was $49,000 during
the year ended December 31, 1999, as compared to a net interest expense of
$244,000 during the year ended December 31, 1998. The reduction was primarily
attributable to interest income earned on the remaining proceeds from the common
shares issued by the Company in December 1998 and reduced interest charges after
using the proceeds to pay off capital leases and short-term bank debt.
MINORITY INTERESTS. The Company includes in net income before minority interests
all net income of its wholly-owned and majority-owned subsidiaries. The portion
of such net income attributable to minority interests held by others is then
deducted. Minority interests for the year ended December 31, 1999 was $827,000,
as compared to $677,000 in 1998. Minority interests increased as a result of the
acquisition of Sinar and its subsidiary, Titan Industrial Limited, and increases
in the relative profitability of other minority-held subsidiaries.
PROVISION FOR INCOME TAXES. The Company's provision for income taxes was
$437,000 for the year ended December 31, 1999, reflecting an effective income
tax rate of 10.5%. The Company's provision for income taxes was $354,000 for the
year ended December 31, 1998, reflecting an effective income tax rate of 8.7%.
The increase in the effective tax rate was due primarily to changes in
contributions from subsidiaries which qualify for the manufacturing tax credit.
Income earned by a Hong Kong company from manufacturing activities through
contract processing arrangements in China is taxed at 50% of Hong Kong's
statutory tax rate.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE. Deferred expenditures reported as of
December 31, 1998 represented pre-operating costs incurred for new production
facilities, which were previously deferred and amortized on a straight-line
basis over three years. No amortization was recorded for the years ended
December 31, 1997 and 1998. Effective from January 1, 1999, the Company has
adopted Statement of Position 98-5 issued by the Accounting Standards Executive
Committee of the American Institute of Certified Public Accountants, which
requires all pre-operating costs to be charged to expense when incurred.
Accordingly, deferred expenditures of $201,000, net of tax, were written off as
a cumulative effect of accounting change in the consolidated statement of
operations for the year ended December 31, 1999.
14
<PAGE>
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
NET SALES. The Company's net sales for the year ended December 31, 1998 were
$33,633,000, an increase of $17,422,000, or 107%, from $16,211,000 in 1997. The
increase reflected higher sales to existing customers.
COST OF GOODS SOLD. Cost of goods sold includes the cost of raw materials,
subcontracting charges for production of molds, direct labor costs, utilities
and other energy costs and depreciation and amortization of the Company's owned
equipment and other depreciable manufacturing assets. The Company's cost of
goods sold for the year ended December 31, 1998 was $24,490,000, an increase of
$11,787,000, or 93%, from $12,703,000 last year. This increase reflected an
increase of $5,420,000 in materials cost and an increase of $1,689,000 in
salaries and other direct labor costs. Cost of goods sold constituted 73% of net
sales for the year ended December 31, 1998, compared to 78% for the same period
in 1997. The increase in gross profit margin was primarily a result of increased
sales volume and efficiencies from better utilization of manufacturing capacity.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. The Company's selling, general and
administrative expenses totaled $5,113,000 for the year ended December 31, 1998,
an increase of $3,192,000, or 166%, from $1,921,000 for the year ended December
31, 1997. The Company added dedicated staff during 1998 to handle customer
service for the customers added in the past two years and to cope with the
anticipated increase in business volume next year. Selling, general and
administrative expenses increased as a percentage of net sales to 15% of net
sales for the year ended December 31, 1998, as compared to 12% of net sales for
the year ended December 31, 1997. This increase as a percentage of sales was due
primarily to the fact that certain components of selling, general and
administrative expenses, including the number of general and administrative
employees and their salaries, did not increase proportionally with the increase
in sales.
Selling expenses consist primarily of shipping expenses and inspection charges.
General and administrative expenses consist of salaries and other employee
expenses for the Company's administrative and product development staff, the
majority of which are located in Hong Kong, and rent and other overhead expenses
of the Hong Kong office. Shipping expenses increased by $376,000 to $503,000 for
the year ended December 31, 1998, compared to $127,000 for the year ended
December 31, 1997. This increase was primarily due to higher sales volume.
Salaries increased by $880,000 to $2,103,000 for the year ended December 31,
1998, compared to $1,223,000 for the year ended December 31, 1997. This increase
was primarily due to the addition of new employees to the Company's
administrative and development staff in Hong Kong and increases in salaries of
some existing employees.
INTEREST EXPENSE, NET. The Company's interest expense, net was $244,000 during
the year ended December 31, 1998, as compared to a net interest expense of
$104,000 during the year ended December 31, 1997. The increase was due to
increased borrowings under the Company's credit facilities to fund the expansion
of the Company's facilities and to fund the increase in business volume.
MINORITY INTERESTS. Minority interests at December 31, 1998 totaled
approximately $677,000. The Company includes in net income before minority
interests all net income of its wholly-owned and majority-owned subsidiaries.
The portion of such net income attributable to minority interests in the
subsidiaries held by others is then eliminated.
PROVISION FOR INCOME TAXES. The Company's provision for income taxes was
$354,000 for the year ended December 31, 1998, reflecting an effective income
tax rate of 9%. The Company's provision for income taxes for the year ended
December 31, 1997 was $130,000, reflecting an effective income tax rate of 13%
for the year ended December 31, 1997. The decrease in the effective tax rate to
9% for the year ended December 31, 1998 was due primarily to the net effect of
an increase in taxable income of the Company's Hong Kong subsidiaries earned
from manufacturing activities in China. Income earned by a Hong Kong company
from manufacturing activities through contract processing arrangements in China
is taxed at 50% of Hong Kong's statutory tax rate.
15
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
Prior to 1998, the Company had financed its operations through a combination of
cash from operations, bank financing and capital lease arrangements. In December
1998, the Company completed a public offering of its common stock which resulted
in net proceeds to the Company of approximately $4,497,000. The Company's
operating activities provided cash of $1,654,000 in 1999 and $4,907,000 in 1998.
Investing activities used $4,634,000 in 1999 and $2,691,000 in 1998. The Company
used $575,000 of cash in financing activities in 1999 and generated $2,368,000
of cash in 1998.
Working capital at December 31, 1999 was $4,685,000 as compared to $5,261,000 at
December 31, 1998. The investment in machinery and equipment in 1999 was the
primary use of cash from operations and other activities. At December 31, 1999,
net accounts receivable totaled $4,718,000, as compared to $4,343,000 at
December 31, 1998. The increase was due primarily to increased sales to
customers with longer credit terms, including the customers of Sinar. Consistent
with practice in the die-cast collectibles and CGP industries, 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.
At December 31, 1999, the Company's five largest customers accounted for
approximately 66% of its accounts receivable. The Company actively monitors the
creditworthiness of its customers, and to date has not experienced any
significant problems with collection of its accounts receivable. See Note 5 of
Notes to Consolidated Financial Statements for further information.
The Company's accounts payable and accrued liabilities decreased by $1,309,000,
or 19%, to $5,570,000 at December 31, 1999, as compared to $6,879,000 at
December 31, 1998. This decrease was primarily related to settlement of debts
relating to completing construction work on factories 4 and 5 which were
outstanding at the end of 1998.
The Company's inventories increased by $904,000, or 24%, to $4,691,000 at
December 31, 1999, as compared to $3,787,000 at December 31, 1998. The Company
generally purchases raw materials six to eight weeks in advance of production,
and the inventory increase at December 31, 1999 resulted in part from lower than
expected sales in the fourth quarter.
For the year ended December 31, 1999, additions to property and equipment were
$5,235,000 as compared to $3,226,000 in 1998. Included in the additions are the
capitalized costs of the proprietary tools produced during the period of
approximately $1.2 million. For 2000, the Company expects to spend approximately
$600,000 in capital expenditures and as much as $200,000 in startup costs to
convert a portion of its manufacturing facilities to be able to produce CGPs.
During 1999, the Company repaid short-term bank loans in the total amount of
$29,000. These loans were secured by the individual guarantees of Messrs. Tong
and Kwok and by the corporate guarantee of Acma Strategic Holdings Limited, the
Company's principal stockholder. The Company also repaid capital lease
obligations in an aggregate amount of approximately $185,000. As of December 31,
1999, the aggregate outstanding obligations under all capital leases was
approximately $306,000 as compared to approximately $461,000 at December 31,
1998.
The Company has revolving lines of credit with Hang Seng Bank, Banque Nationale
de Paris, and Commonwealth Finance Corporation Limited. As of December 31, 1999,
these lines of credit allowed for aggregate borrowings of up to
$2,737,000. As of December 31, 1999, the Company had approximately
$1,150,000 outstanding under these revolving lines of credit.
In July 1999, the Company acquired a 55% interest in Sinar Industrial Limited.
Details of assets acquired and liabilities assumed were as follows (in
thousands):
<TABLE>
<S> <C>
Cash and bank deposits 396
Accounts receivable, net 1,032
16
<PAGE>
Deposits and prepayments 190
Machinery, equipment and capital leases, net 143
Accounts payable (1,530)
Accrued liabilities (130)
Taxation payable (37)
-----------
Net assets of Sinar 64
The Company's share 55%
-----------
Net assets acquired as of the date of acquisition 35
Goodwill 230
-----------
Consideration satisfied in cash 265
Less: Cash and bank deposits acquired (396)
-----------
Net cash inflow:
Cash received 131
===========
</TABLE>
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 expects that its principal sources of cash
will be operating cash flow, cash on hand, bank lines of credit and other
external credit sources, and, to a lesser extent, credit facilities provided by
affiliates or related parties.
The Company believes that these sources will be adequate to meet the Company's
anticipated cash requirements for 2000. 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. 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.
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 (RMB). There can be no assurance that the
RMB-to-U.S. dollar rate will remain stable. Although a devaluation of the Hong
Kong dollar or RMB 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 RMB 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. Foreign currency
transactions produced a net loss of $16,000 in 1998 and a net gain of $10,000 in
1999.
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. Certain fixed costs,
however, continue despite the Company's closing. This reduction in revenues,
without a corresponding reduction in costs, diminishes liquidity during the
first quarter.
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.
17
<PAGE>
INTERNATIONAL SALES
The Company sells substantially all of its products to customers in the U.S. and
Europe. During the year ended December 31, 1999, approximately 32.1% of the
Company's net sales arose from sales to European customers, and in 1998
approximately 13.5% 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.
ACCOUNTING FOR STOCK OPTIONS
The Board of Directors of the Company has adopted a 1998 Stock Option Plan under
which the Company has reserved shares of common stock for issuance upon the
exercise of options granted under the plan. On December 23, 1998, the Company
granted stock options under the plan to certain directors, officers, employees
and consultants to purchase 340,500 shares of common stock at an exercise price
equal to the market price of the common stock on that date. On July 16, 1999,
the Company's shareholders ratified an amendment to the plan to increase the
number of shares available for grant from 420,000 to 650,000.
In October 1995, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"), which established the "fair value" method of
accounting for stock-based compensation arrangements, under which compensation
cost is determined using the fair value of the stock option at the grant date
and the number of options vested, and is recognized over the period in which the
related services are rendered. For securities issuances to employees, SFAS 123
also permits the use of the "intrinsic value based" method as set forth in the
Statement of Financial Accounting Standards No. 116. At present, the Company
intends to report using the intrinsic value based method for issuances to
employees, as allowed by SFAS 123. As further provided in SFAS 123, the Company
has disclosed the pro forma effect of adopting the fair value based method in
Note 17 of Notes to Consolidated Financial Statements.
ITEM 7. FINANCIAL STATEMENTS.
The consolidated financial statements and the reports and notes, which are
attached hereto beginning at page F-1, are incorporated herein by reference.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Effective April 30, 1998, Greenberg & Company, LLC, which had been the Company's
auditor prior to the exchange reorganization, resigned as the independent
accountants of the Company. The Company's Board of Directors approved the
appointment of Arthur Andersen & Co. as its new independent accountants on April
30, 1998, and this appointment was subsequently ratified by the Company's
shareholders on July 16, 1999.
Greenberg & Company, LLC's report on the Company's financial statements for the
past two years did not contain an adverse opinion or disclaimer, and was not
modified as to uncertainty, audit scope or accounting principles during that
period. The Company did not have any disagreements with Greenberg & Company, LLC
on any matter of accounting principles, financial statements, auditing scope or
procedure during that period.
18
<PAGE>
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT.
The information required by this Item will be contained in the Company's
definitive Proxy Statement for its 2000 Annual Meeting of Stockholders, and is
incorporated herein by reference.
ITEM 10. EXECUTIVE COMPENSATION.
The information required by this Item will be contained in the Company's
definitive Proxy Statement for its 2000 Annual Meeting of Stockholders, and is
incorporated herein by reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item will be contained in the Company's
definitive Proxy Statement for its 2000 Annual Meeting of Stockholders, and is
incorporated herein by reference.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item will be contained in the Company's
definitive Proxy Statement for its 2000 Annual Meeting of Stockholders, and is
incorporated herein by reference.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
The following exhibits are filed as part of this report:
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------ -----------
<S> <C>
3.1 Restated Certificate of Incorporation of the Company(2).
3.2 By Laws of the Company (incorporated by reference to the exhibits of the
Company's registration statement (file no. 33-14521-NY)).
3.3 Amendment to By Laws of the Company.
4 Specimen Stock Certificate of the Company(1).
10.1 Form of Indemnification Agreement with officers and directors(1).
10.2 Share Exchange Agreement by and among Davin Enterprises, Inc., Carl Tong,
Leo Kwok and Acma Strategic Holdings Limited dated December 15, 1997(1).
10.3 Joint Enterprise Agreement between Creative Master Limited and Dongguan
Heng Li Trading Company dated September 10, 1994(1).
10.4 Supplement to Joint Enterprise Agreement between Creative Master Limited
and Dongguan Heng Li Trading Company dated April 1, 1996(1).
10.5 Processing Agreement by and between Creative Master Limited and Dongguan
Heng Li Zhen Trading Company dated June 18, 1998(2).
10.6 Entrepreneur Agreement by and among Creative Master Limited, Chen Hao
Qiang, Gan Zi Kuen and Wu Qing Su (undated)(1).
10.7 Letter to extend credit facilities from Hang Seng Bank Limited to
Creative Master Limited dated July 16, 1998(1).
10.8 Letter agreement to extend credit facilities between Hang Seng Bank
Limited and Creative Master Limited dated June 10, 1996(1).
19
<PAGE>
10.9 Letter to extend credit facilities between Banque Nationale de Paris Hong
Kong Branch and Creative Master Limited dated April 21, 1997(1).
10.10 Letter agreement to extend credit facilities between Bank of China Hong
Kong Branch and Creative Master Limited dated May 25, 1992(1).
10.11 Letter agreement to extend credit facilities between Commonwealth Finance
Corporation Limited and Creative Master Limited dated December 20,
1997(1).
10.12 Consultancy Agreement between Creative Master Limited and Acma Strategic
Holdings Limited dated January 19, 1996 (incorporated by reference to the
Company's Form 10-KSB for fiscal 1998, filed on September 2, 1998).
10.13 Consultancy Agreement between Carl Tong & Associates Management
Consulting Limited and Acma Strategic Holdings Limited dated January 19,
1996 (incorporated by reference to the Company's Form 10-KSB for fiscal
1998, filed on September 2, 1998).
10.14 Joint and Several Guarantee By Individuals or Partners in a Firm by and
among Commonwealth Finance Corporation Limited, Carl Tong and Leo Kwok
dated March 30, 1993(1).
10.15 Guarantee to be Given by an Individual by and between Commonwealth
Finance Corporation Limited and Carl Tong dated March 30, 1993(1).
10.16 Guarantee to be Given by an Individual by and between Commonwealth
Finance Corporation Limited and Leo Kwok dated March 30, 1993(1).
10.17 Creative Master Limited Defined Contribution Scheme Rules effective
January 1, 1997(1).
10.18 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(1).
10.19 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(1).
10.20 Service Agreement by and between Creative Master Limited and Leo Sheck
Pui Kwok dated January , 1996(1).
10.21 Factory and dormitory leases for CML No. 1(2).
10.22 Factory and dormitory leases for CML No. 2(2).
10.23 Factory and dormitory leases for CML No. 3(2).
10.24 Factory and dormitory leases for CML No. 4(2).
10.25 Factory and dormitory leases for CML No. 5(2).
10.26 Consulting Agreement between Henry Hai-Lin Hu, Business Plus Consultants
Limited and the Company dated August 18, 1998(2).
10.27 Import Material & Processing Agreement between Dongguan Process Assembly
Servicing Company and the Company dated November 10, 1995(2).
10.28 Lease of Unit B, Casey Industrial Building, Kowloon, Hong Kong between
Creative Master Limited and Fortune Wind Investments Limited dated April
3, 1997(2).
10.29 Lease of Unit A1, Casey Industrial Building, Kowloon, Hong Kong between
Excel Master limited and Fortune Wind Investments Limited(2).
10.30 Lease of Unit A2, Casey Industrial Building, Kowloon, Hong Kong between
Creative Master Limited and Fortune Wind Investments Limited(2).
10.31 Loan Agreement dated January 31, 1996 between Carl Tong and Leo Sheck Pui
Kwok as lenders and Creative Master Limited as borrower in the aggregate
amount of H.K. $1,000,000(1).
10.32 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(1).
10.33 Promissory Note, dated as of October 1, 1998, in the principal amount of
$227,118 from Creative Master Limited in favor of Carl Ka Wing Tong(2).
10.34 Promissory Note, dated as of October 1, 1998, in the principal amount of
$493,889 from Creative Master Limited to Leo Sheck Pui Kwok(2).
10.35 Lease of apartment from Wellholding Limited by Creative Master Limited
dated January 2, 1996(1).
10.36 1998 Stock Option Plan, as amended(3).
10.37 Form of Notice of Stock Option Grant and Stock Option Agreement under the
1998 Stock Option Plan(3).
10.38 Standby Letter of Credit of Acma Ltd(2).
20
<PAGE>
10.39 Guarantee of Carl Tong to Banque Nationale de Paris in favor of Creative
Master Limited dated June 13, 1990(2).
10.40 Guarantee of Leo Kwok to Banque Nationale de Paris in favor of Creative
Master Limited dated June 13, 1990(2).
10.41 Deed of Guarantee of Carl Tong and Leo Kwok to Bank of China in favor of
Creative Master Limited(2).
10.42 Guarantee to be Given by a Limited Company by and between Commonwealth
Finance Corporation Limited and Acma Strategic Holdings Limited dated
July 14, 1997(2).
10.43 Warrant Agreement between the Company and Cruttenden Roth Incorporated,
including the Representative's Warrant(3).
10.44 Underwriting Agreement, dated December 22, 1998, among the Company and
the underwriters named therein(3).
10.45 Share Exchange Agreement, signed on February 17, 2000, among the Company,
PacificNet.com LLC, and the Owners of PacificNet.com LLC(4).
16 Letter re: Change in Certifying Accountant (incorporated by reference to
the Company's Form 8-K dated April 30, 1998).
21 List of Subsidiaries(2).
23 Consent of Arthur Andersen & Co.
27 Financial Data Schedule.
</TABLE>
- -------------------------------------------------
(1) Incorporated by reference to the Company's Form SB-2 filed on October 21,
1998.
(2) Incorporated by reference to the Company's Form SB-2/A filed on November
25, 1998.
(3) Incorporated by reference to the Company's Form 10-KSB filed on March 30,
1999.
(4) Incorporated by reference to the Company's Form 8-K filed on March 8,
2000.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the last quarter of fiscal 1999.
21
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Public Accountants................................... F-1
Consolidated Balance Sheets - As of December 31, 1998 and 1999............. F-2
Consolidated Statement of Operations - For the Years Ended
December 31, 1997, 1998 and 1999.......................................... F-3
Consolidated Statement of Cash Flows - For the Years Ended
December 31, 1997, 1998, and 1999......................................... F-4
Consolidated Statements of Change in Stockholders' Equity -
For the Years Ended December 31, 1997, 1998 and 1999...................... F-6
Notes to Consolidated Financial Statements................................. F-7
</TABLE>
22
<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, 1998 and 1999, and the related
consolidated statements of operations, cash flows and changes in stockholders'
equity for the years ended December 31, 1997, 1998 and 1999. The financial
statements for the year ended December 31, 1997 give retroactive effect 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, 1998 and 1999, and the
results of their operations and their cash flows for the years ended December
31, 1997, 1998 and 1999, 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,
February 14, 2000 (except with respect to the matter discussed in Note 26 as to
which the date is February 18, 2000).
-F-1-
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1998 AND 1999
(Amounts expressed in United States dollars)
<TABLE>
<CAPTION>
Note 1 9 9 8 1 9 9 9
--------- ------------------- -------------------
$'000 $'000
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and bank deposits 20 5,055 1,500
Accounts receivable, net 5 4,343 4,718
Deposits and prepayments 6 681 1,384
Inventories, net 7 3,787 4,691
------------------- -------------------
Total current assets 13,866 12,293
Machinery, equipment and capital leases, net 8 5,663 9,316
Long-term investment 9 1 -
Deferred expenditures 221 -
Goodwill, net 10 716 841
------------------- -------------------
Total assets 20,467 22,450
=================== ===================
LIABILITIES, MINORITY INTERESTS AND
STOCKHOLDERS' EQUITY
Current liabilities:
Short-term bank borrowings 11 1,062 1,150
Capital lease obligations, current portion 12 173 202
Accounts payable 3,965 3,368
Deposits from customers 136 235
Accrued liabilities 13 2,914 2,202
Loans from directors, current portion 21 222 267
Taxation payable 14 133 184
------------------- -------------------
Total current liabilities 8,605 7,608
Capital lease obligations, non-current portion 12 288 104
Loans from directors, non-current portion 21 444 240
Deferred taxation 14 220 399
------------------- -------------------
Total liabilities 9,557 8,351
------------------- -------------------
Minority interests 618 1,240
------------------- -------------------
Stockholders' equity:
Common stock, par value $0.0001:
- - Authorized - 25,000,000 shares as of
December 31, 1998 and 1999
- - Outstanding and fully paid - 4,999,322
shares as of December 31, 1998 and 1999 17 1 1
Preferred stock, par value $0.0001:
- - authorized - 5,000,000 as of December 31,
1998 and 1999
- - outstanding - nil as of December 31, 1998
and 1999 17 - -
Additional paid-in capital 5,898 5,784
Retained earnings 4,393 7,074
------------------- -------------------
Total stockholders' equity 10,292 12,859
------------------- -------------------
Total liabilities, minority interests and
stockholders' equity 20,467 22,450
=================== ===================
The accompanying notes are an integral part of these financial statements.
</TABLE>
-F-2-
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
(Amounts expressed in United States dollars)
<TABLE>
<CAPTION>
Note 1 9 9 7 1 9 9 8 1 9 9 9
--------- ------------------ ------------------ -----------------
$'000 $'000 $'000
<S> <C> <C> <C> <C>
Net sales 22 16,211 33,633 40,668
Cost of goods sold (12,703) (24,490) (30,740)
------------------ ------------------ -----------------
Gross profit 3,508 9,143 9,928
------------------ ------------------ -----------------
Selling, general and administrative
expenses (1,921) (5,113) (5,961)
Interest income 112 39 90
Interest expense (216) (283) (139)
Other income (expenses), net (137) 318 190
Gain on disposal of long-term investment 9 - - 143
Gain on dilution of interest in a
subsidiary - 77 -
Reorganization expense 15 (284) - -
Amortization of goodwill (62) (94) (105)
------------------ ------------------ -----------------
Income before income taxes and
minority interests 1,000 4,087 4,146
Provision for income taxes 14 (130) (354) (437)
------------------ ------------------ -----------------
Income before minority interests 870 3,733 3,709
Minority interests (82) (677) (827)
------------------ ------------------ -----------------
Income before cumulative effect of
accounting change 788 3,056 2,882
Cumulative effect of accounting change 4.f - - (201)
------------------ ------------------ -----------------
Net income 16 788 3,056 2,681
================== ================== =================
BASIC AND DILUTED EARNINGS PER COMMON SHARE
Income before cumulative effect of
accounting change $ 0.22 $ 0.81 $ 0.58
Cumulative effect of accounting change - - (0.04)
------------------ ------------------ -----------------
Net income 4.l $ 0.22 $ 0.81 $ 0.54
================== ================== =================
</TABLE>
The accompanying notes are an integral part of these financial statements.
-F-3-
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
(Amounts expressed in United States dollars)
<TABLE>
<CAPTION>
1 9 9 7 1 9 9 8 1 9 9 9
----------------- ----------------- -----------------
$'000 $'000 $'000
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income 788 3,056 2,681
Adjustments to reconcile net income to net cash
provided by operating activities-
Depreciation of machinery and equipment 469 705 1,651
Net (gain) loss on disposals of machinery
and equipment (6) 14 (1)
Net gain on disposal of long-term investment - - (143)
Reorganization expense 199 - -
Gain on dilution of interest in a subsidiary - (77) -
Amortization of goodwill 62 94 105
Minority interests 82 677 798
Deferred taxation 58 163 179
(Increase) Decrease in operating assets-
Accounts receivable, net (1,094) (1,516) 657
Deposits and prepayments 7 (374) (513)
Inventories, net (1,161) (859) (904)
Increase (Decrease) in operating liabilities-
Accounts payable 234 2,057 (2,127)
Deposits from customers 560 (424) 99
Accrued liabilities 439 1,335 (842)
Due to parent company 9 (9) -
Taxation payable 50 65 14
----------------- ----------------- -----------------
Net cash provided by operating
activities 696 4,907 1,654
----------------- ----------------- -----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of machinery and equipment (24) (2,470) (5,157)
Proceeds from disposals of machinery and
equipment - - 27
Proceeds from disposal of long-term
investment - - 144
Net cash (outflow) inflow from acquisition
of a subsidiary (1) - 131
(Increase) Decrease in deferred expenditures - (221) 221
Decrease in due from a related company 41 - -
----------------- ----------------- -----------------
Net cash provided by (used in)
investing activities 16 (2,691) (4,634)
----------------- ----------------- -----------------
</TABLE>
(Continued on next page)
-F-4-
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
(Continued)
(Amounts expressed in United States dollars)
<TABLE>
<CAPTION>
1 9 9 7 1 9 9 8 1 9 9 9
----------------- ----------------- -----------------
$'000 $'000 $'000
<S> <S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Decrease in bank overdrafts (28) - -
New short-term bank loans 1,097 2,895 129
Repayment of short-term bank loans (825) (3,347) (29)
Increase (Decrease) in import trust
receipts bank loans 77 224 (12)
Repayment of capital element of capital
lease obligations (605) (1,326) (185)
Decrease in loans from directors (18) (195) (159)
Decrease in due to a related company (363) - -
Dividends paid to minority interests of a
subsidiary (7) (58) (205)
Finance from minority interests of a
subsidiary - 1 -
Dividends paid - (323) -
Proceeds from issuance of common stock - 6,250 -
Common stock issuance expenditures - (1,753) (114)
----------------- ----------------- -----------------
Net cash (used in) provided by
financing activities (672) 2,368 (575)
----------------- ----------------- -----------------
Effect of cumulative translation adjustments (4) - -
----------------- ----------------- -----------------
Net increase (decrease) in cash and bank
deposits 36 4,584 (3,555)
Cash and bank deposits, as of beginning of year 435 471 5,055
----------------- ----------------- -----------------
Cash and bank deposits, as of end of year 471 5,055 1,500
================= ================= =================
</TABLE>
The accompanying notes are an integral part of these financial statements.
-F-5-
<PAGE>
CREATIVE MASTER INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
(Amounts expressed in United States dollars)
<TABLE>
<CAPTION>
Accumulated
other
Common stock comprehensive
------------------------------ income -
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 January 1, 1997 3,605 1 1,202 872 4
Effect of the exchange
reorganization 145 - - - -
Reorganization expense
contributed by
stockholders (Note 15) - - 199 - -
Net income - - - 788 -
Dividends - - - (323) -
Translation adjustments - - - - (4)
-------------- -------------- -------------- -------------- --------------
Balance as of December 31,
1997 3,750 1 1,401 1,337 -
Issuance of common stock 1,250 - 6,250 - -
Common stock issuance
expenditures - - (1,753) - -
Net income - - - 3,056 -
-------------- -------------- -------------- -------------- --------------
Balance as of December 31,
1998 5,000 1 5,898 4,393 -
Common stock issuance
expenditures - - (114) - -
Net income - - - 2,681 -
-------------- -------------- -------------- -------------- --------------
Balance as of December 31,
1999 5,000 1 5,784 7,074 -
============== ============== ============== ============== ==============
</TABLE>
The accompanying notes are an integral part of these financial statements.
-F-6-
<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, 1997 (the earliest date covered by these
financial statements) 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 was principally engaged
in the trading of communication systems.
On December 30, 1997, the Company acquired 100% interest in Creative Master
Limited ("CML"; a company incorporated in Hong Kong) by issuing a total of
3,604,500 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 17) 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-quality, die-cast replicas of cars, trucks, buses,
boats and engines and other products for sale to customers primarily located in
the United States of America and Europe. Through Sinar Industrial Limited,
acquired by CML in July 1999 (see Notes 2 and 24), the CML Group is also engaged
in the design and marketing of peripheral products for personal computers and
interactive video games. 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").
On December 24, 1998, the Company issued 1,250,000 shares of common stock, for a
cash consideration of $5 per share through a public offering and raised net
proceeds of approximately $4,383,000.
-F-7-
<PAGE>
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 represented the consolidated financial statements of
the CML Group. The historical stockholders' equity accounts of the Company as of
December 31, 1997 represented the 3,604,500 shares of common stock (after the
effect of the reverse stock splits and the redenominations of par value as
described in Note 17) issued in connection with the acquisition. The original
145,310 shares of common stock (after the effect of the reverse stock splits and
the redenominations of par value as described in Note 17) outstanding prior to
the exchange reorganization have been reflected as an addition in the
stockholders' equity account of the Company on December 30, 1997.
The acquisition of Sinar Industrial Limited ("Sinar") by the CML Group in July
1999 has been accounted for using the purchase method of accounting (see Note
24). Accordingly, the assets acquired and the liabilities assumed have been
recorded at their estimated fair values, and the operations for Sinar are
included in the consolidated financial statements of the Company from the date
of acquisition. The following is an unaudited pro forma summary of the combined
results of operations of the Group and Sinar for the year ended December 31,
1999 as if the acquisition had occurred as of January 1, 1999. The unaudited pro
forma summary is not necessarily indicative either of the results of operations
that would have occurred had the acquisition been made as of January 1, 1999, or
of future results of operations of the combined companies.
<TABLE>
<CAPTION>
$'000
(unaudited)
<S> <C>
Pro forma combined net sales $ 43,040
Pro forma combined net income 2,749
Pro forma combined basic and diluted earnings per common share - net income 0.55
</TABLE>
-F-8-
<PAGE>
3. SUBSIDIARIES
Details of the Company's subsidiaries (which together with the Company are
collectively referred to as "the Group") as of December 31, 1999 were as
follows:
<TABLE>
<CAPTION>
Percentage of
effective
Place of equity
Name incorporation interest held Principal activities
- ---------------------------------------- ----------------- ---------------- --------------------------------------
<S> <C> <C> <C>
Creative Master Limited Hong Kong 100% Manufacturing and sales of
collectible replica products
Excel Master Limited Hong Kong 100% Sales of collectible replica
products
Creative Master Overseas Holdings Hong Kong 100% Investment holding
Limited
Creative Master Special Holdings Hong Kong 70% Sales of collectible replica
Limited products
Mastercraft Engineering Limited (Note Hong Kong 70% Manufacturing of molds
b)
Carison Engineering Limited Hong Kong 70% Manufacturing of molds
(Note c)
Techtime Industries Limited Hong Kong 55% Manufacturing of collectible
replica products
Sinar Industrial Limited Hong Kong 55% Design and marketing of
computer and video game
peripherals
Sports Master Limited Hong Kong 50% Dormant
High Road Solution Limited (Note d) Hong Kong 38.5% Dormant
Titan Industrial Limited (Note d) Hong Kong 33% Sales of computer game
peripherals
Dongguan Chuangying Toys Factory Co., The PRC Note a Manufacturing of collectible
Ltd. replica products
Creative Master Special Holdings Inc. The British 100% Dormant
Virgin Islands
</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 contract dated September 10, 1994
and the supplemental contract dated April 1, 1996, the Company'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 effective from
September 10, 1994. In view of their profit sharing arrangement, the
joint venture is regarded as 100% owned by the Company.
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 the Group recognized
a gain on dilution of approximately $77,000.
-F-9-
<PAGE>
3. SUBSIDIARIES (Cont'd)
Notes - (Cont'd)
c. Effective from May 20, 1998, Carison Limited changed its name to
Carison Engineering Limited, the present one.
d. High Road Solution Limited and Titan Industrial Limited are considered
as subsidiaries of the Company as Sinar Industrial Limited owned 70%
and 60% of their equity interest, respectively.
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, 1997, 1998 and 1999 was approximately
$62,000, $94,000 and $105,000, respectively. Accumulated amortization
as of December 31, 1998 and 1999 was approximately $233,000 and
$338,000, respectively.
Management reviews and evaluates the recoverability of goodwill
periodically as part of its assessment of the recoverability of the
Group's share of net assets of subsidiaries to which it relates. The
determinants used for this evaluation include management's estimate of
the business ability to generate positive income from operations and
positive cash flows in future periods. In the opinion of the
management, no material impairment exists as of December 31, 1999.
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.
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 overheads.
-F-10-
<PAGE>
4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont'd)
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. Major
expenditures for betterments and renewals are capitalized. All ordinary
repair and maintenance cots are expensed as incurred.
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.
The carrying value of machinery and equipment is assessed annually and
when factors indicating a potential impairment are present. The Group
determines whether any such impairment should be recorded by estimating
the undiscounted future cash flows and comparing such amount to the net
asset carrying value. If an impairment is present, the assets are
reported at the lower of carrying value or fair value.
f. DEFERRED EXPENDITURES
Deferred expenditures reported as of December 31, 1998 represented
pre-operating costs incurred for new production facilities, which were
previously deferred and amortized on a straight-line basis over three
years. No amortization was recorded for the years ended December 31,
1997 and 1998.
Effective from January 1, 1999, the Group has adopted Statement of
Position 98-5 issued by the Accounting Standards Executive Committee of
the American Institute of Certified Public Accountants, which requires
all pre-operating costs to be charged to expense when incurred.
Accordingly, deferred expenditures of $201,000, net of tax, were
written off as a cumulative effect of accounting change in the
consolidated statements of operations for the year ended December 31,
1999.
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 of merchandise/molds are recorded as deposits from
customers.
h. INCOME TAXES
The Group accounts for income tax under the provisions of Statement of
Financial Accounting Standards ("SFAS") 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>
4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont'd)
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. COMPREHENSIVE INCOME
The Company has adopted SFAS No. 130, which establishes guidance for
the reporting and disclosure of comprehensive income and its
components. The purpose of reporting comprehensive income is to report
a measure of all changes in equity that resulted from recognized
transactions and other economic events of the period other than
transactions with shareholders. Adoption of the standard had no
economic impact on the Company's consolidated financial position,
results of operations or cash flows, although the presentation of
certain items has changed. The components of accumulated other
comprehensive income included in the consolidated balance sheets
consist of cumulative translation adjustments as of the end of each
year. Prior year financial statements have been restated to conform to
the requirements of SFAS No. 130.
k. 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 statements of operations for the years
ended December 31, 1997, 1998 and 1999 were approximately $(47,000),
$(16,000) and $10,000, respectively.
l. EARNINGS PER COMMON SHARE
Basic earnings per common share is computed in accordance with SFAS No.
128 by dividing net income for each year by the weighted average number
of shares of common stock outstanding during the years, 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 17)
had been consummated prior to the years presented.
The computation of diluted earnings per common share is similar to
basic earnings per common share, except that the denominator is
increased to include the number of additional common shares that would
have been outstanding if all dilutive securities outstanding during the
years were exercised.
The basic and diluted earnings per common share were the same for the
years presented because no dilutive securities were outstanding or
exercisable as of December 31, 1997 and 1998, and the options and
warrants outstanding during 1999 (see Note 17) had no dilutive effect.
The numerator in calculating both basic and diluted earnings per share
for each year is the reported net income. The denominator is based on
the following weighted-average number of common shares:
-F-12-
<PAGE>
4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont'd)
l. EARNINGS PER COMMON SHARE (Cont'd)
<TABLE>
<CAPTION>
1 9 9 7 1 9 9 8 1 9 9 9
------------------ ------------------ ------------------
<S> <C> <C> <C>
Basic 3,605,294 3,776,719 4,999,322
Diluted 3,605,294 3,776,719 4,999,322
</TABLE>
m. 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 about potential future
events that affect certain reported amounts and disclosures.
Accordingly, actual results could differ from those estimates and
assumptions.
n. FAIR VALUE OF FINANCIAL INSTRUMENTS
All financial instruments of the Group are carried at cost, which
approximate their fair value.
5. ACCOUNTS RECEIVABLE
Accounts receivable consisted of:
<TABLE>
<CAPTION>
1 9 9 8 1 9 9 9
------------------- ------------------
$'000 $'000
<S> <C> <C>
Trade receivables 5,125 5,820
Less: Allowance for doubtful accounts (782) (1,102)
------------------- ------------------
Accounts receivable, net 4,343 4,718
=================== ==================
</TABLE>
6. DEPOSITS AND PREPAYMENTS
Deposits and prepayments consisted of:
<TABLE>
<CAPTION>
1 9 9 8 1 9 9 9
------------------- ------------------
$'000 $'000
<S> <C> <C>
Deposits for acquisition of molds 219 298
Rental and utility deposits 229 266
Prepayments 224 298
Others 9 522
------------------- ------------------
681 1,384
=================== ==================
</TABLE>
-F-13-
<PAGE>
7. INVENTORIES
Inventories consisted of:
<TABLE>
<CAPTION>
1 9 9 8 1 9 9 9
------------------- ------------------
$'000 $'000
<S> <C> <C>
Raw materials 1,753 2,428
Work-in-process 1,226 1,413
Finished goods 1,124 988
------------------- ------------------
4,103 4,829
Less: Allowance for slow-moving and obsolete inventories (316) (138)
------------------- ------------------
Inventories, net 3,787 4,691
=================== ==================
</TABLE>
8. MACHINERY, EQUIPMENT AND CAPITAL LEASES
Machinery, equipment and capital leases consisted of:
<TABLE>
<CAPTION>
1 9 9 8 1 9 9 9
------------------- ------------------
$'000 $'000
<S> <C> <C>
Machinery and equipment:
Machinery and tools 4,930 8,768
Leasehold improvements 1,415 2,112
Furniture and office equipment 827 1,589
Motor vehicles 85 154
Capital leases:
Machinery and tools 623 497
Furniture and office equipment 32 44
Motor vehicles - 32
------------------- ------------------
Cost 7,912 13,196
Less: Accumulated depreciation
Machinery and equipment (2,220) (3,779)
Capital leases (29) (101)
------------------- ------------------
Machinery, equipment and capital leases, net 5,663 9,316
=================== ==================
</TABLE>
-F-14-
<PAGE>
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 sale of communication systems. The carrying cost
of the long-term investment represented:
<TABLE>
<CAPTION>
1 9 9 8 1 9 9 9
------------------- ------------------
$'000 $'000
<S> <C> <C>
Long-term investment 685 -
Less: Write-down of investment cost (684) -
------------------- ------------------
Long-term investment, net 1 -
=================== ==================
</TABLE>
In April 1999, the Company disposed of its entire interest in Target Vision Inc.
for approximately $144,000 in cash, and recognized a gain of approximately
$143,000.
10. GOODWILL
Goodwill consisted of:
<TABLE>
<CAPTION>
1 9 9 8 1 9 9 9
------------------- ------------------
$'000 $'000
<S> <C> <C>
Goodwill 949 1,179
Less: Accumulated amortization (233) (338)
------------------- ------------------
Goodwill, net 716 841
=================== ==================
</TABLE>
11. SHORT-TERM BANK BORROWINGS
Short-term bank borrowings consisted of:
<TABLE>
<CAPTION>
1 9 9 8 1 9 9 9
------------------- ------------------
$'000 $'000
<S> <C> <C>
Short-term loans 456 556
Import trust receipts loans 606 594
------------------- ------------------
1,062 1,150
=================== ==================
</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% or the United
States prime lending rate plus 2.3%, which ranged from 10.0% to 10.8% per annum
as of December 31, 1999. They were collaterized by the Group's bank deposits of
approximately $632,000 as of December 31, 1999, personal guarantees provided by
Mr. Leo Sheck Pui Kwok and Mr. Carl Ka Wing Tong, mortgage over a real estate
property owned by Mr. Carl Ka Wing Tong, and corporate guarantee provided by
Acma Strategic Holdings Limited (see Note 20). They were drawn for working
capital purposes and are renewable with the consent of the relevant banks.
-F-15-
<PAGE>
11. SHORT-TERM BANK BORROWINGS (Cont'd)
Supplemental information with respect to short-term bank borrowings for the
years ended December 31, 1998 and 1999 are as follows:
<TABLE>
<CAPTION>
Weighted
average Weighted
Maximum amount Average amount interest rate average
outstanding outstanding at the end of interest rate
during the year during the year year during the year
----------------- ----------------- ----------------- ----------------
$'000 $'000
<S> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1999
Short-term loans 556 436 10.5% 10.0%
================= ================= ================= ================
Import trust receipts loans 714 538 9.3% 9.0%
================= ================= ================= ================
YEAR ENDED DECEMBER 31, 1998
Overdrafts 49 6 - 14.2%
================= ================= ================= ================
Short-term loans 609 433 10.5% 11.6%
================= ================= ================= ================
Import trust receipts loans 1,426 990 10.0% 10.6%
================= ================= ================= ================
</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>
1 9 9 8 1 9 9 9
------------------- ------------------
$'000 $'000
<S> <C> <C>
Payable during the following period
- Within one year 221 233
- Over one year but not exceeding two years 215 108
- Over two years but not exceeding three years 105 -
------------------- ------------------
Total minimum lease payments 541 341
Less: Amount representing interest (80) (35)
------------------- ------------------
Present value of minimum lease payments 461 306
Less: Current portion (173) (202)
------------------- ------------------
Non-current portion 288 104
=================== ==================
</TABLE>
-F-16-
<PAGE>
13. ACCRUED LIABILITIES
Accrued liabilities consisted of:
<TABLE>
<CAPTION>
1 9 9 8 1 9 9 9
------------------- ------------------
$'000 $'000
<S> <C> <C>
Accruals for operating expenses
- Salaries, wages and bonus 1,251 1,244
- Subcontracting charges 471 161
- Rental expense 21 18
- Others 169 262
Accrual for common stock issuance expenditures 100 -
Accruals for purchases of
- loose tools and consumables 588 365
- machinery and tools 181 -
Others 133 152
------------------- ------------------
2,914 2,202
=================== ==================
</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 United States federal income tax at a rate of 34%. The
Hong Kong subsidiaries are subject to Hong Kong profits tax at a rate of 16%.
The contractual joint venture established in the PRC (Dongguan Chuangying Toys
Factory Co., Ltd.) is subject to PRC income taxes at a rate of 27% (24% state
income tax and 3% local income tax). However, the joint venture is exempted from
state and local income taxes for two years starting from the first year of
profitable operations. and it is entitled to a 50% reduction in national 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 expense would have
been increased by approximately $8,000, $55,000 and $2,800 for the years ended
December 31, 1997, 1998 and 1999, respectively.
Provision for income taxes consisted of:
<TABLE>
<CAPTION>
1 9 9 7 1 9 9 8 1 9 9 9
------------------- ------------------- -------------------
<C> <C> <C> <C>
Current tax
- Hong Kong profits tax 72 191 325
- Special rebate by Government of
Hong Kong Special Administrative
Region - - (70)
- PRC income tax - - 3
Deferred tax
- Hong Kong profits tax 58 163 179
------------------- ------------------- -------------------
130 354 437
=================== =================== ===================
</TABLE>
-F-17-
<PAGE>
14. INCOME TAXES (Cont'd)
The reconciliation of the United States federal income tax rate to the effective
income tax rate based on income before income taxes stated in the consolidated
statements of operations is as follows:
<TABLE>
<CAPTION>
1 9 9 7 1 9 9 8 1 9 9 9
----------------- ----------------- -----------------
<S> <C> <C> <C>
United States federal income tax rate 34.0% 34.0% 34.0%
Non-taxable income arising from activities
which qualified as offshore (6.0%) (12.1%) (10.4%)
Non-taxable/non-deductible activities (3.6%) (1.2%) 2.0%
Tax losses not recognized 7.7% 6.0% 2.9%
Effect of different tax rates in foreign
jurisdictions (19.1%) (18.0%) (18.0%)
----------------- ----------------- -----------------
Effective income tax rate 13.0% 8.7% 10.5%
================= ================= =================
</TABLE>
Components of deferred tax liabilities as of December 31, 1998 and 1999 are as
follows:
<TABLE>
<CAPTION>
1 9 9 8 1 9 9 9
------------------- ------------------
$'000 $'000
<S> <C> <C>
Cumulative tax losses (35) (166)
Accumulated differences between taxation allowance and
depreciation expenses of machinery and equipment 263 575
Other timing differences (8) (10)
------------------- ------------------
220 399
=================== ==================
</TABLE>
15. REORGANIZATION EXPENSE
The reorganization expense in 1997 consisted of (i) the valuation of $199,000
placed on the 229,488 shares of common stock of the Company (after the effect of
reverse stock splits and the redenominations of par value as described in Note
17) transferred from Mr. Leo Sheck Pui Kwok, Mr. Carl Ka Wing Tong and ASHL, to
a consultant in return for his services in connection with Company's acquisition
of CML as described in Note 1 (these 229,488 shares are included in the
3,604,500 shares of common stock issued in connection with the Company's
acquisition of CML as described in Note 1), and (ii) other professional fees for
the acquisition of CML.
-F-18-
<PAGE>
16. COMPREHENSIVE INCOME
Comprehensive income and its components, net of tax, consisted of:
<TABLE>
<CAPTION>
1 9 9 7 1 9 9 8 1 9 9 9
------------------- ------------------- -------------------
$'000 $'000 $'000
<S> <C> <C> <C>
Net income 788 3,056 2,681
Other comprehensive income -
Translation adjustments (4) - -
------------------- ------------------- -------------------
Comprehensive income 784 3,056 2,681
=================== =================== ===================
</TABLE>
17. SHARE CAPITAL AND STOCK OPTIONS
a. COMMON STOCK
During the period from January 1, 1997 (the earliest date covered by
these financial statements) to December 29, 1997, the Company had
authorized share capital of 50,000,000 shares of common stock, par
value $0.0001 each, and 1,937,452 shares of common stock outstanding.
On December 30, 1997, the Company issued 48,060,000 shares of common
stock, 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 share of common
stock, par value $0.0001 each, authorized and 4,999,746 shares of
common stock outstanding. On December 14, 1998, the Company effected a
three-for-four reverse stock split and a redenomination of par value in
share capital, resulting in 3,749,322 shares of common stock, par value
$0.0001 each, outstanding. Also, on December 14, 1998, the authorized
share capital of the Company was decreased from 60,000,000 to
25,000,000 shares of common stock, par value $0.0001 each, and
5,000,000 shares of preferred stock, par value $0.0001 each.
On December 24, 1998, the Company issued 1,250,000 shares of common
stock, for a cash consideration of $5 per share through a public
offering and raised net proceeds of approximately $4,383,000.
The effects of the one-for-ten reverse stock split, the three-for-four
reverse stock split, and the redenominations of par value in share
capital have been reflected retroactively in the financial statements
and all earnings per common share computations.
-F-19-
<PAGE>
17. SHARE CAPITAL AND STOCK OPTIONS (Cont'd)
b. OPTIONS
The Company has reserved an aggregate of 420,000 shares of common
stock, for issuance under the Company's 1998 stock option plan, which
will expire in September 2008.
In December 1998, the Company granted stock options under the 1998
stock option plan to purchase 340,500 shares of common stock, par value
$0.0001 each, at an exercise price of $5, which was equal to the public
offering price of its common stock on December 24, 1998. The stock
options are exercisable according to a pre-determined vesting schedule
beginning in 1999. The options expire on December 23, 2006.
Changes in outstanding options under the plan during the years ended
December 31, 1998 and 1999 are as follows:
<TABLE>
<CAPTION>
1 9 9 8 1 9 9 9
---------------------------------- ---------------------------------
Options Exercise price Options Exercise price
---------------- ---------------- --------------- ----------------
$ $
<S> <C> <C> <C> <C>
Outstanding, beginning of year - - 340,500 5.00
Granted at market price 340,500 5.00 - -
---------------- ---------------- --------------- ----------------
Outstanding, end of year 340,500 5.00 340,500 5.00
================ ================ =============== ================
Exercisable, end of year - 5.00 131,250 5.00
================ ================ =============== ================
</TABLE>
The Company accounts for stock-based compensation using the intrinsic
value method prescribed by Accounting Principles Board ("APB") Opinion
No. 25, under which no compensation expense for stock options is
recognized for stock option awards granted with exercise price at or
above fair market value. On December 24, 1998, the exercise price of
the granted options was equal to the public offering price at the same
date. Therefore, no compensation expense was recognized.
Had compensation expense for the Company's stock option grants been
determined based upon fair values at the grant dates in accordance with
SFAS No. 123, the Company's pro forma net income during the years ended
December 31, 1998 and 1999 would be approximately $3,056,000 and
$2,480,000, respectively. The Company's pro forma basic and diluted
earnings per common share - net income would both be approximately
$0.81 for the year ended December 31, 1998 and approximately $0.50 for
the year ended December 31, 1999. The pro forma effects of applying
SFAS No. 123 may not be representative of actual results had the
Company accounted for stock option awards using the fair-value-based
method.
The weighted average fair value of options granted during the years
ended December 31, 1998 is estimated on the date of grant using the
Black-Scholes option-pricing model to be $4.73. The fair value of the
options granted is estimated on the date of grant using the following
assumptions:
<TABLE>
<S> <C>
Risk-free interest rate 6%
Expected dividend yield 0%
Expected option life 8 years
Expected stock price volatility 73.08%
</TABLE>
-F-20-
<PAGE>
17. SHARE CAPITAL AND STOCK OPTIONS (Cont'd)
b. OPTIONS (Cont'd)
A summary of stock options outstanding and exercisable as of December
31, 1999 is as follows:
<TABLE>
<CAPTION>
Options outstanding Options exercisable
------------------------------------------------ -------------------------------
Weighted
average Weighted Weighted
Number remaining average Number average
Exercise price outstanding life in years exercise price exercisable exercise price
---------------- -------------- --------------- --------------- -------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
$ 5.00 340,500 5.98 $ 5.00 131,250 $ 5.00
</TABLE>
c. WARRANTS
In connection with the initial public offering, the Company issued
warrants on February 10, 1999 to the representative underwriter of the
Company's public offering for a consideration of $125 to purchase up to
125,000 shares of common stock, at an exercise price of $8.25 per
share, which is equal to 1.65 times the public offering price. The
warrants are exercisable for a period of four years beginning December
24, 1999.
18. OPERATING LEASE COMMITMENTS
a. CAPITAL COMMITMENTS
As of December 31, 1999, the Group had capital commitments amounting to
approximately $468,000, for the acquisition of fixed assets.
b. OPERATING LEASE COMMITMENTS
The Group has various operating lease agreements for office, factory
and staff quarters premises, which extend through 2008. Rental expenses
for the years ended December 31, 1997, 1998 and 1999 were approximately
$602,000, $703,000 and $1,066,000, respectively. Future minimum rental
payments as of December 31, 1999, under agreements classified as
operating leases with non-cancellable terms, are as follows:
<TABLE>
<S> <C>
$'000
Payable during the following period
- Within one year 1,238
- Over one year but not exceeding two years 1,167
- Over two years but not exceeding three years 1,048
- Over three years but not exceeding four years 920
- Over four years but not exceeding five years 769
- Thereafter 992
------------------
6,134
==================
</TABLE>
-F-21-
<PAGE>
19. 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 contributions (net of forfeited contributions) for the years ended
December 31, 1997, 1998 and December 31, 1999 was approximately $50,000, 68,000
and $103,000, respectively.
The Group has no other post-retirement or post-employment benefit plans.
20. BANKING FACILITIES
As of December 31, 1999, the Group had banking facilities of approximately
$2,737,000, for overdrafts, loans and trade financing. Unused facilities as of
December 31, 1999 amounted to approximately $1,276,000. These facilities were
secured by:
a. Pledges of the Group's bank deposits of approximately $632,000 as of
December 31, 1999;
b. Personal guarantees provided by Mr. Leo Sheck Pui Kwok and Mr. Carl Ka
Wing Tong;
c. Mortgage over a real estate property owned by Mr. Carl Ka Wing Tong;
and
d. Corporate guarantee provided by ASHL.
-F-22-
<PAGE>
21. RELATED PARTY TRANSACTIONS
a. The Group entered into the following transactions with related
companies:
<TABLE>
<CAPTION>
1 9 9 7 1 9 9 8 1 9 9 9
----------------- ------------------ ------------------
$'000 $'000 $'000
<S> <C> <C> <C>
Management fee paid to ASHL 115 116 -
Consultancy/Management fees paid to Carl
Tong & Associate Management
Consultancy Limited* - 61 227
Purchase of machinery and tools from
Faithera Engineering Limited** - 362 -
================= ================== ==================
</TABLE>
* Carl Tong & Associate Management Consultancy Limited is
beneficially owned by Mr. Carl Ka Wing Tong.
** Faithera Engineering Limited is beneficially owned by certain
minority stockholders of Mastercraft Engineering Limited.
b. Loans from directors as of December 31, 1998 and 1999 consisted of:
<TABLE>
<CAPTION>
1 9 9 8 1 9 9 9
------------------ ------------------
$'000 $'000
<S> <C> <C>
Mr. Leo Sheck Pui Kwok 435 321
Mr. Carl Ka Wing Tong 231 186
------------------ ------------------
Total loans from directors 666 507
Less: current portion (222) (267)
------------------ ------------------
Non-current portion 444 240
================== ==================
</TABLE>
The loans from directors are unsecured and non-interest bearing. Prior
to October 1, 1998, the loans from directors had no pre-determined
repayment terms. On October 1, 1998, the directors agreed to convert
the outstanding loan balances to term loans to be repayable by six
equal semi-annual installments commencing March 31, 1999.
c. As of December 31, 1999, 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 a real estate property owned by Mr. Carl Ka
Wing Tong; and corporate guarantee provided by ASHL (see Notes 11 and
20).
-F-23-
<PAGE>
22. BUSINESS SEGMENT AND GEOGRAPHIC ANALYSIS
The Group is principally engaged in two business segments : (i) manufacturing
and sales of collectible-quality, die-cast replica products; and (ii) design and
marketing of computer and video game peripherals.
a. NET SALES
Net sales consisted of:
<TABLE>
<CAPTION>
1 9 9 7 1 9 9 8 1 9 9 9
----------------- ----------------- ------------------
$'000 $'000 $'000
<S> <C> <C> <C>
Collectible replica products 16,211 33,633 37,283
Computer and video game peripherals - - 3,385
----------------- ----------------- ------------------
16,211 33,633 40,668
================= ================= ==================
<CAPTION>
Geographical analysis of net sales is as follows:
1 9 9 7 1 9 9 8 1 9 9 9
----------------- ----------------- ------------------
$'000 $'000 $'000
<S> <C> <C> <C>
United States of America 16,089 29,085 25,796
Europe 122 4,548 13,042
Others - - 1,830
----------------- ----------------- ------------------
16,211 33,633 40,668
================= ================= ==================
<CAPTION>
b. OPERATING PROFIT*
1 9 9 7 1 9 9 8 1 9 9 9
----------------- ----------------- ------------------
$'000 $'000 $'000
<S> <C> <C> <C>
Collectible replica products 1,525 3,936 3,752
Computer and video game peripherals - - 110
----------------- ----------------- ------------------
1,525 3,936 3,862
================= ================= ==================
</TABLE>
* Operating profit represent gross profit less selling, general
and administrative expenses and amortization of goodwill.
-F-24-
<PAGE>
22. BUSINESS SEGMENT AND GEOGRAPHIC ANALYSIS (Cont'd)
c. IDENTIFIABLE ASSETS**
<TABLE>
<CAPTION>
1 9 9 8 1 9 9 9
----------------- -----------------
$'000 $'000
<S> <C> <C>
Collectible replica products 19,751 20,080
Computer and video game peripherals - 1,529
----------------- -----------------
19,751 21,609
================= =================
</TABLE>
** Identifiable assets represent total assets less goodwill.
Substantially all of the Group's identifiable assets are located in
Hong Kong and the PRC.
d. CAPITAL EXPENDITURES
<TABLE>
<CAPTION>
1 9 9 7 1 9 9 8 1 9 9 9
----------------- ----------------- ------------------
$'000 $'000 $'000
<S> <C> <C> <C>
Collectible replica products 24 2,470 5,039
Computer and video game peripherals - - 196
----------------- ----------------- ------------------
24 2,470 5,235
================= ================= ==================
<CAPTION>
e. DEPRECIATION AND AMORTIZATION
1 9 9 7 1 9 9 8 1 9 9 9
----------------- ----------------- ------------------
$'000 $'000 $'000
<S> <C> <C> <C>
Collectible replica products 531 799 1,687
Computer and video game peripherals - - 69
----------------- ----------------- ------------------
531 799 1,756
================= ================= ==================
</TABLE>
f. MAJOR CUSTOMERS
Details of individual customers accounting for more than 10% of the
Group's net sales are as follows:
<TABLE>
<CAPTION>
1 9 9 7 1 9 9 8 1 9 9 9
----------------- ----------------- ------------------
$'000 $'000 $'000
<S> <C> <C> <C>
MBI Inc. 64.2% 36.7% 22.7%
Paul's Model Art GmbH - 8.2% 15.8%
Mattel Vendor Operations Asia Ltd. 14.8% 24.1% 9.3%
================= ================= ==================
</TABLE>
-F-25-
<PAGE>
22. BUSINESS SEGMENT AND GEOGRAPHIC ANALYSIS (Cont'd)
g. MAJOR SUPPLIERS
Details of individual suppliers accounting for more than 10% of the
Group's purchases are as follows:
<TABLE>
<CAPTION>
1 9 9 7 1 9 9 8 1 9 9 9
----------------- ----------------- ------------------
$'000 $'000 $'000
<S> <C> <C> <C>
Manfield Coatings Co., Ltd. 9.0% 9.4% 11.5%
Genesis Off-set Printing Co., Ltd. 8.5% 7.8% 11.1%
Trident Alloys Limited - - 10.0%
================= ================= ==================
</TABLE>
23. 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 stated in
the Basic Law of the Hong Kong SAR, 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 deterioration of any or all of these strategic
relationships may have an adverse effect on the operations of the
Group.
-F-26-
<PAGE>
23. OPERATING RISKS (Cont'd)
c. CONCENTRATION OF CREDIT RISK
Concentration of accounts receivable as of December 31, 1998 and 1999
is as follows:
<TABLE>
<CAPTION>
1 9 9 8 1 9 9 9
------------------ ------------------
<S> <C> <C>
Five largest accounts receivable 80.1% 65.9%
================== ==================
</TABLE>
The Group performs ongoing credit evaluation of each customer's
financial condition. It maintains reserves for potential credit losses
and such losses in the aggregate have not exceeded management's
projections.
24. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
a. 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>
$'000
<S> <C>
Deposits and prepayments 110
Inventories 223
Machinery, equipment and capital leases, net 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-27-
<PAGE>
24. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (Cont'd)
b. In July 1999, CML acquired a 55% interest in Sinar Industrial Limited
for a cash consideration of approximately $265,000. Details of assets
acquired and liabilities assumed were as follows:
<TABLE>
$'000
<S> <C>
Cash and bank deposits 396
Accounts receivable, net 1,032
Deposits and prepayments 190
Machinery, equipment and capital leases, net 143
Accounts payable (1,530)
Accrued liabilities (130)
Taxation payable (37)
------------------
Net assets of Sinar Industrial Limited 64
The Group's share 55%
------------------
Net assets acquired as of the date of acquisition 35
Goodwill 230
------------------
Consideration satisfied in cash 265
Less: Cash and bank deposits acquired (396)
------------------
Net cash inflow:
Cash received 131
==================
</TABLE>
c. Cash paid for interest and income taxes consisted of:
<TABLE>
<CAPTION>
1 9 9 7 1 9 9 8 1 9 9 9
----------------- ----------------- ------------------
$'000 $'000 $'000
<S> <C> <C> <C>
Interest 216 283 139
================= ================= ==================
Income taxes 75 70 207
================= ================= ==================
</TABLE>
d. Supplemental disclosure of investing activities:
During the years ended December 31, 1997, 1998 and 1999, the Group
entered into capital lease arrangements to purchase machinery and
equipment with a capital value of approximately $835,000, $757,000 and
$30,000, respectively.
-F-28-
<PAGE>
25. OTHER SUPPLEMENTAL INFORMATION
The following items were included in the consolidated statements of operations:
<TABLE>
<CAPTION>
1 9 9 7 1 9 9 8 1 9 9 9
----------------- ----------------- -----------------
$'000 $'000 $'000
<S> <C> <C> <C>
Depreciation of machinery and equipment
- owned assets 122 404 1,581
- assets held under capital leases 347 301 70
Provision for/write-off of doubtful accounts 15 553 320
Provision for (write-back) of slow-moving and
obsolete inventories 84 205 (178)
Interest expense for
- bank overdrafts and loans 107 152 90
- capital lease obligations 109 131 49
Operating lease rentals for rented premises 602 703 1,066
Repairs and maintenance expenses 266 356 399
================= ================= =================
</TABLE>
26. SUBSEQUENT EVENT
On February 17, 2000, the Company entered into a Share Exchange Agreement to
acquire all the outstanding capital stock of PacificNet.com LLC ("PNC"), a
company incorporated in the State of Minnesota. PNC is a privately-held Internet
start-up company headquartered in Minneapolis, Minnesota and Hong Kong that
focuses on trans-Pacific business-to-business electronic commerce. In
consideration for this acquisition, the Company expects to issue 21,000,000
shares of its common stock to the owners of PNC, which would represent
approximately 80% of the total number of shares expected to be outstanding
immediately following the acquisition.
The Company and PNC are currently preparing a supplement to the Share Exchange
Agreement to document the parties' understanding of certain details of the
proposed acquisition. The consummation of the proposed transaction is subject to
the execution of the supplement, receipt of a fairness opinion from the
Company's financial advisor, approval of the Company's shareholders and other
customary conditions.
If the transaction is consummated, it is anticipated that the Company's primary
business focus will be business-to-business electronic commerce instead of its
current focus as set forth in Note 22. PNC has indicated its interest in
disposing of the Company's current business following completion of the
acquisition. In light of this, a management group led by the Company's Chief
Executive Officer, Mr. Carl Ka Wing Tong, has indicated an interest in
negotiating a purchase of the current business. However, neither the Company or
PNC have entered into any formal understanding or arrangement with respect to a
disposition of the current business, nor is it expected that any such
disposition will be a condition to the acquisition of PNC.
-F-29-
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
CREATIVE MASTER INTERNATIONAL
Date: March 28, 2000 By: /s/ CARL KA WING TONG
---------------------
Carl Ka Wing Tong,
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- --------- ----- ----
<S> <C> <C>
/s/ CARL KA WING TONG Chairman of the Board, President, March 28, 2000
- ------------------------------------
Carl Ka Wing Tong and Chief Executive Officer (principal
executive officer)
/s/ JOHN REMPEL Chief Financial Officer (principal March 28, 2000
- ------------------------------------
John Rempel financial officer)
/s/ SHING KAM MING Controller (principal accounting March 28, 2000
- ------------------------------------
Shing Kam Ming officer)
/s/ LEO SHECK PUI KWOK Chief Operating Officer and March 28, 2000
- ------------------------------------
Leo Sheck Pui Kwok Director
/s/ CLAYTON K. TRIER Director March 28, 2000
- ------------------------------------
Clayton K. Trier
/s/ STEVE GORDON Director March 28, 2000
- ------------------------------------
Steve Gordon
</TABLE>
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
NUMBER DESCRIPTION
<S> <C>
3.3 Amendment to the By Laws of the Company.
23 Consent of Arthur Andersen & Co.
27 Financial Data Schedule.
</TABLE>
<PAGE>
EXHIBIT 3.3
CERTIFICATE OF SECRETARY
I, the undersigned, do hereby certify that:
(1) I am the duly elected and acting Secretary of Creative Master
International, Inc., a Delaware corporation (the "Company"); and
(2) Attached hereto as Exhibit A is a copy of a resolution duly adopted
by the Board of Directors at a meeting held on March 8, 2000.
IN WITNESS WHEREOF, I have hereunto subscribed my name this 28th day of
March, 2000.
/s/ Shing Kam Ming
---------------------------
Shing Kam Ming
Secretary
EXHIBIT A
WHEREAS: The Board is authorized under Article IX of the Company's by-laws, as
amended, to adopt amendments to the by-laws; and
WHEREAS: The Board has determined that it is in the best interests of the
Company and its stockholders that the Company's by-laws be amended to permit the
Board to designate committees of the Board consisting of one or more directors
of the Company;
NOW, THEREFORE, BE IT RESOLVED: That Article III, Section 16 of the Company's
by-laws is hereby amended to read in its entirety as follows:
"16. COMMITTEES. The Board, by resolution adopted by a majority of the
entire Board, may from time to time designate one or more committees,
each committee to consist of one or more directors, with such powers and
authority (to the extent permitted by law) as may be provided in such
resolution. Each such committee shall remain in existence at the pleasure
of the Board. Participation of any one or more members of a committee by
means of a conference telephone or similar communications equipment
allowing all persons participating in the meeting to hear each other at
the same time shall constitute a director's presence in person at any
such meeting. Any action authorized in writing by all of the members of a
committee and filed with the minutes of the committee shall be the act of
the committee with the same force and effect as if the same had been
passed by unanimous vote at a duly called meeting of the committee."
<PAGE>
EXHIBIT 23
March 29, 2000
The Directors
Creative Master International, Inc.
8/F., Casey Industrial Building
18 Bedford Road
Taikoktsui
Kowloon
Hong Kong
Dear Sirs,
As independent public accountants, we hereby consent to the incorporation by
reference in the Registration Statement on Form S-8 (Reg. No. 333-87929) of our
report dated February 14, 2000 (except with respect to the matter discussed in
Note 26 as to which the date is February 18, 2000) included herein.
Very truly yours,
/s/ Arthur Andersen & Co.
Arthur Andersen & Co.
Certified Public Accountants
Hong Kong
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 1,500
<SECURITIES> 0
<RECEIVABLES> 5,820
<ALLOWANCES> 1,102
<INVENTORY> 4,691
<CURRENT-ASSETS> 12,293
<PP&E> 13,196
<DEPRECIATION> 3,880
<TOTAL-ASSETS> 22,450
<CURRENT-LIABILITIES> 7,608
<BONDS> 0
0
0
<COMMON> 1
<OTHER-SE> 12,858
<TOTAL-LIABILITY-AND-EQUITY> 22,450
<SALES> 40,668
<TOTAL-REVENUES> 40,688
<CGS> 30,740
<TOTAL-COSTS> 30,740
<OTHER-EXPENSES> 5,961
<LOSS-PROVISION> 320
<INTEREST-EXPENSE> 139
<INCOME-PRETAX> 4,146
<INCOME-TAX> 437
<INCOME-CONTINUING> 2,882
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 201
<NET-INCOME> 2,681
<EPS-BASIC> 0.54
<EPS-DILUTED> 0.54
</TABLE>
