Unassociated Document
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
Form
20-F
(Mark
One)
OR
x |
ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
|
For
the fiscal year ended December 31, 2006.
OR
o |
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
|
OR
Date
of
event requiring this shell company report ______________
For
the transition period from ______________ to
_______________
Commission
File Number: 333-114220
GRAND
TOYS INTERNATIONAL LIMITED
(Translation
of registrant’s name into English)
HONG
KONG
(Jurisdiction
of incorporation or organization)
Suite
1501, 15th
Floor, Chinachem Golden Plaza, 77 Mody Road, Tsimshatsui East, Kowloon,
Hong
Kong
(Address
of principal executive offices)
Securities
registered or to be registered pursuant to Section 12(b) of the
Act:
Title
of each class
|
Name
of each exchange on which
registered
|
None
|
NASDAQ
|
Securities
registered or to be registered pursuant to Section 12(g) of the
Act:
American
Depositary Shares (as evidenced by American Depositary Receipts),
Each
representing one Ordinary Share
(Title
of
Class)
Securities
for which there is a reporting obligation pursuant to Section 15(d) of the
Act:
None
Indicate
the number of outstanding shares of each of the issuer’s classes of capital or
common stock as of the close of the period covered by the annual report
_______________________
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securities Act.
o Yes x
No
If
this
report is an annual or transition report, indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or 15(d)
of
the Securities Exchange Act of 1934.
Indicate
by check mark whether the registrant (1) has filed all reports required to
be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements
for
the past 90 days.
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule l2b-2 of the Exchange Act. (Check
one):
Large
accelerated filer o Accelerated
filer o Non-accelerated
filer x
Indicate
by check mark which financial statement item the registrant has elected to
follow.
o Item
17 x Item
18
If
this
is an annual report, indicate by check mark whether the registrant is a shell
company (as defined in Rule 12b-2 of the Exchange Act).
Table
of Contents
to
Annual
Report on Form 20-F
Fiscal
year ended December 31, 2006
|
|
|
Page
|
|
Introduction
and Use of Certain Terms
|
|
4
|
|
Forward-Looking
Statements
|
|
5
|
|
|
|
|
Part
I
|
|
|
|
|
|
|
|
Item 1 |
Identity
of Directors, Senior Management and Advisers
|
|
Not
applicable
|
Item 2 |
Offer
Statistics and Expected Timetable
|
|
Not
applicable
|
Item 3 |
Key
Information
|
|
6
-
22
|
|
Selected
Financial Data
|
|
|
|
Capitalization
and Indebtedness
|
|
|
|
Reasons
for the Offer and Use of Proceeds
|
|
|
|
Risk
Factors
|
|
|
Item 4 |
Information
on the Company
|
|
22
- 36
|
|
History
and Development of the Company
|
|
|
|
Business
Overview
|
|
|
|
Our
Organization Structure
|
|
|
|
Property,
Plant and Equipment
|
|
|
Item 4A |
Unresolved
Staff Comments |
|
Not
applicable
|
Item 5 |
Operating
and Financial Review and Prospects
|
|
37
- 55
|
|
Results
of Operations
|
|
|
|
Liquidity
and Capital Resources
|
|
|
|
Research
and Development
|
|
|
|
Trend
Information
|
|
|
|
Off-Balance
Sheet Arrangements
|
|
|
|
Contractual
obligations
|
|
|
|
Effects
of Inflation
|
|
|
|
Recently
Issued Accounting Standards
|
|
|
Item 6 |
Directors,
Senior Management and Employees
|
|
56
- 63
|
|
Directors
and Senior Management
|
|
|
|
Compensation
|
|
|
|
Board
Practices and Procedures
|
|
|
|
Employees
|
|
|
|
Share
Ownership
|
|
|
Item 7 |
Major
Shareholders and Related Party Transactions
|
|
63
- 69
|
|
Major
Shareholders
|
|
|
|
Related
Party Transactions
|
|
|
Item 8 |
Financial
Information
|
|
69
- 70
|
|
Consolidated
Statements and Other Financial Information
|
|
|
|
Legal
Proceedings
|
|
|
|
Dividend
Policy
|
|
|
|
Significant
Changes
|
|
|
Item 9 |
The
Offer and Listing
|
|
70
- 72
|
|
Offer
and Listing Details
|
|
|
|
Plan
of Distribution
|
|
|
|
Markets
|
|
|
|
Selling
Shareholders
|
|
|
|
Dilution
|
|
|
|
Expenses
of the Issue
|
|
|
Item 10 |
Additional
Information
|
|
72
- 82
|
|
Share
Capital
|
|
|
|
Memorandum
and Articles of Association
|
|
|
|
Material
Contracts
|
|
|
|
Exchange
Controls
|
|
|
|
Taxation
|
|
|
|
Dividends
and Paying Agents
|
|
|
|
Statements
by Experts
|
|
|
|
Documents
on Display
|
|
|
|
Subsidiary
Information
|
|
|
Item 11 |
Quantitative
and Qualitative Disclosures About Market Risk
|
|
82
|
Item 12 |
Description
of Securities Other than Equity Securities
|
|
Not
applicable
|
|
|
|
|
Part
II
|
|
|
|
|
|
|
|
Item 13 |
Defaults,
Dividends Arrearages and Delinquencies
|
|
83
|
Item 14 |
Material
Modifications to the Rights of Security Holders and Use of
Proceeds
|
|
Not
applicable
|
Item 15 |
Controls
and Procedures
|
|
83
- 84
|
Item 16A |
Audit
Committee Financial Expert
|
|
84
|
Item 16B |
Code
of Ethics
|
|
84
|
Item 16C |
Principal
Accountant Fees and Services
|
|
84
|
|
Audit
Committee Pre-Approval Policy
|
|
|
Item 16D |
Exemptions
from the Listing Standards for Audit Committees
|
|
Not
applicable
|
Item 16E |
Purchases
of Equity Securities by the Issuer and Affiliated
Purchasers
|
|
Not
applicable
|
|
|
|
|
Part
III
|
|
|
|
|
|
|
|
Item 17 |
Financial
Statements
|
|
Not
applicable
|
Item 18 |
Financial
Statements
|
|
85,
F1-F58
|
Item 19 |
Exhibits
List and Exhibits
|
|
86
- 88
|
INTRODUCTION
AND USE OF CERTAIN TERMS
Unless
otherwise indicated, throughout this report:
|
·
|
all
references to the “Company”, “we’, “our” and “Grand” refer to Grand Toys
International Limited and its
subsidiaries;
|
|
·
|
Grand
Toys International, Inc., a wholly-owned subsidiary of the Company
is
referred to as Grand US and,
where the context requires, includes its subsidiaries;
|
|
·
|
Playwell
International Limited, a wholly-owned subsidiary of the Company,
is
referred to as Playwell and, where the context requires, includes
its
subsidiaries;
|
|
·
|
Hua
Yang Holdings Co., Limited, a wholly-owned subsidiary of the Company,
is
referred to as Hua Yang and, where the context requires, includes
its
subsidiaries and a variable-interest
entity;
|
|
·
|
Kord
Holdings, Inc., a wholly-owned subsidiary of the Company, is referred
to
as Kord and, where the context requires, includes its subsidiaries
and
variable-interest entities;
|
|
·
|
International
Playthings, Inc., a wholly-owned subsidiary of Grand US, is referred
to as
International Playthings or IPI;
|
|
·
|
Centralink
Investments Limited, the owner of approximately 76.14% of the Company’s
American Depositary Shares, or ADSs, and 2,000,000 Series A Preference
Shares, as of August 31, 2007 is referred to as
Centralink;
|
|
·
|
Cornerstone
Beststep International Limited, the owner of 10,840,598 Series B
Preference Shares, is referred to as Cornerstone
Beststep;
|
|
·
|
Cornerstone
Overseas Investments, Limited, a company owned and controlled by
the
Company’s major beneficial shareholder, Jeff Hsieh Cheng, and the former
holding company of Centralink and Cornerstone Beststep, is referred
to as
Cornerstone Overseas;
|
|
·
|
Hong
Kong Toy Centre Limited, a subsidiary of Playwell, is referred to
as
HKTC;
|
|
·
|
ADSs
refer to the Company’s American depositary shares representing beneficial
ownership of the Company’s ordinary shares and evidenced by American
depositary receipts, or ADRs;
|
|
·
|
Hong
Kong refers to the Hong Kong Special Administrative Region of the
People’s
Republic of China;
|
|
·
|
China
and the PRC refers to the People’s Republic of China, except,
for the purposes of this annual report, Hong Kong, the Macau Special
Administrative Region of the PRC and Taiwan;
|
|
·
|
U.K.
refers to United Kingdom;
|
|
·
|
References
to “U.S. dollars”, “U.S. $” and “$” are to the lawful currency of the
United States of America;
|
|
·
|
References
to H.K. dollars and HK$ are to the lawful currency of Hong
Kong;
|
|
·
|
Series
A Preference Shares refer to the Company’s Series A Convertible Preference
Shares;
|
|
·
|
Series
B Preference Shares refer to the Company’s Series B Convertible Preference
Shares; and
|
|
·
|
Preference
Shares refer to the Company’s Series A Preference Shares and Series B
Preference Shares.
|
FORWARD-LOOKING
STATEMENTS
Our
disclosure and analysis in this report on Form 20-F contain some forward-looking
statements. Forward-looking statements give our current beliefs or expectations
or forecasts of future events. You can identify these statements by the fact
that they do not relate strictly to historical or current facts. Such statements
may include words such as “anticipate,” “estimate,” “expect,” “intend,” “plan,”
“believe” and other words and terms of similar meaning in connection with any
discussion of future operating or financial performance. In particular, these
statements include, among other things, statements relating to:
|
·
|
the
development of our products; and
|
Such
statements are not promises or guarantees and are subject to a number of known
and unknown risks and uncertainties that could cause our future results,
performance or achievements to differ significantly from the results,
performance or achievements expressed or implied by such forward-looking
statements. Important factors that could cause or contribute to such differences
include our ability to successfully develop and commercialize additional
products, the introduction of competing products, the impact of competition
from
customers that sell their own brand products under private-label brands, our
inability to successfully identify, consummate and integrate acquisitions,
our
potential exposure to product liability claims, the fact that we have operations
outside the United States that may be materially and adversely affected by
acts
of terrorism or major hostilities, fluctuations in currency, exchange and
interest rates, operating results and other factors that are discussed in this
report and in our other filings made with the SEC.
We
undertake no obligation to update any forward-looking statements or other
information contained in this report, whether as a result of new information,
future events or otherwise, except as required by law. You are advised, however,
to consult any additional disclosures we make in our 6-K reports periodically
filed with the SEC. Also note that we provide a cautionary discussion of risks
and uncertainties under “Risk Factors” beginning on page 10
of
this
report. These are factors that we think could cause our actual results to differ
materially from expected results. Other factors besides those listed here could
also adversely affect us. This discussion is permitted by the Private Securities
Litigation Reform Act of 1995.
PART
I
Item
1. Identity of Directors, Senior Management and
Advisors
Not
applicable.
Item
2. Offer Statistics and Expected Timetable
Not
applicable.
Item
3. Key Information
A.
Selected Financial Data
The
following selected financial data of the Company for each of the years in the
three-year period ended December 31, 2006 and at December 31, 2004, 2005 and
2006 are derived from the Company’s audited annual consolidated financial
statements for those years, which have been prepared in accordance with US
GAAP
and should be read in conjunction with those statements, which are included
in
this annual report beginning on page F-3.
The
Company acquired the shares of Hua Yang and Kord on December 23, 2005 from
a
related company, Cornerstone Beststep, which was under the control of the
Company’s majority beneficial
shareholder, Jeff Hsieh Cheng. As a result of these acquisitions involving
companies under common control, the Company’s financial statements for the year
ended December 31, 2004 were restated by including the results of Hua Yang
and
Kord as if they had been part of the Company since the original date that they
were acquired by Cornerstone Overseas, Cornerstone Beststep’s former parent
company. The Company’s financial statements for the fiscal year ended December
31, 2004 and 2005 have also been restated to account for the discontinuance
of
the operations of Gatelink, Asian World, Grand Toys Limited, Grand Toys
International, Inc. and the Crayola business conducted by Grand Toys (HK)
Ltd.
The
following data for the years ended December 31, 2002 and 2003 and as of December
31, 2002 and 2003 has also been derived from our audited consolidated financial
statements for those years, which were prepared in accordance with US GAAP
and
are not included in this annual report. The data relating to years 2002 and
2003
have been restated to take into account the discontinuance of the operations
of
Gatelink and Asian World in 2006.
For
the Twelve Months Ended December 31:
(The
amounts in the table below are expressed in thousands, except per ordinary
share
and per ADS data)
Statement
of Operations Data
|
|
2006
|
|
2005
|
|
2004
|
|
2003
|
|
2002
|
|
|
|
|
|
(as
restated)
|
|
(as
restated)
|
|
(as
restated)
|
|
(as
restated)
|
|
Net
sales
|
|
$
|
128,760
|
|
$
|
116,963
|
|
$
|
68,663
|
|
$
|
38,085
|
|
$
|
34,854
|
|
Gross
profit
|
|
|
27,067
|
|
|
27,798
|
|
|
13,147
|
|
|
5,151
|
|
|
6,695
|
|
(Loss)
earnings from continuing operations
|
|
|
(11,288
|
)
|
|
(893
|
)
|
|
163
|
|
|
2,550
|
|
|
2,367
|
|
(Loss)
earnings from discontinued operations
|
|
|
(8,385
|
)
|
|
(16,075
|
)
|
|
(222
|
)
|
|
1,711
|
|
|
22,498
|
|
Dividends
|
|
|
(2,782
|
)
|
|
(14,358
|
)
|
|
-
|
|
|
-
|
|
|
-
|
|
Net
(loss) earnings applicable to ADS holders
|
|
$
|
(22,455
|
)
|
$
|
(31,326
|
)
|
$
|
(59
|
)
|
$
|
4,261
|
|
$
|
24,865
|
|
(Loss)
earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Continuing
operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
(0.83
|
)
|
|
(0.95
|
)
|
|
0.01
|
|
|
0.26
|
|
|
0.24
|
|
Diluted
|
|
|
(0.83
|
)
|
|
(0.95
|
)
|
|
0.01
|
|
|
N/A
|
|
|
N/A
|
|
Discontinued
operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
(0.50
|
)
|
|
(1.00
|
)
|
|
(0.02
|
)
|
|
0.17
|
|
|
2.25
|
|
Diluted
|
|
|
(0.50
|
)
|
|
(1.00
|
)
|
|
(0.02
|
)
|
|
N/A
|
|
|
N/A
|
|
Net
(loss) earnings
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
(1.33
|
)
|
|
(1.94
|
)
|
|
-
|
|
|
0.43
|
|
|
2.49
|
|
Diluted
|
|
|
(1.33
|
)
|
|
(1.94
|
)
|
|
-
|
|
|
N/A
|
|
|
N/A
|
|
Weighted
average number of common equivalent shares
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
16,868
|
|
|
16,138
|
|
|
12,093
|
|
|
10,000
|
|
|
10,000
|
|
Diluted
|
|
|
48,820
|
|
|
18,191
|
|
|
12,807
|
|
|
10,000
|
|
|
10,000
|
|
As
at December 31:
Balance
Sheet Data |
|
2006
|
|
2005
|
|
2004
|
|
2003
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Working
capital
|
|
$
|
(9,252
|
)
|
$
|
5,196
|
|
$
|
9,011
|
|
$
|
3,755
|
|
$
|
(2,111
|
)
|
Long
term debt
|
|
|
-
|
|
|
5,111
|
|
|
789
|
|
|
-
|
|
|
-
|
|
Number
of shares:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ordinary
shares
|
|
|
17,494
|
|
|
16,310
|
|
|
15,587
|
|
|
10,000
|
|
|
10,000
|
|
Preference
shares
|
|
|
12,841
|
|
|
12,841
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Net
assets
|
|
|
29,110
|
|
|
48,662
|
|
|
58,430
|
|
|
5,858
|
|
|
4,236
|
|
Total
assets
|
|
$
|
102,678
|
|
$
|
118,629
|
|
$
|
106,148
|
|
$
|
11,788
|
|
$
|
34,460
|
|
N/A
means
not applicable.
Exchange
Rate Information:
On
September 30, 2007, the exchange rate of HK$ per US$ was $ 7.7760 as published
by www.oanda.com.
The
following table sets out the average exchange rate for HK dollars expressed
as
per one U.S. dollar for each year indicated calculated by using the average
of
the exchange rates on the last day of each month for each of the years
indicated.
Year
Ended December 31,
(HK$
per US$1.00)
|
|
Average
HK$
Exchange
Rate
|
|
|
|
|
|
2002
|
|
|
7.7997
|
|
2003
|
|
|
7.7875
|
|
2004
|
|
|
7.7905
|
|
2005
|
|
|
7.7533
|
|
2006
|
|
|
7.7689
|
|
The
following table sets forth the high and low exchange rates for H.K. dollars
expressed as per one U.S. dollars and average calculated by using the average
of
the exchange rates throughout each month for each of the months
indicated.
Month
ended,
|
|
|
|
|
|
Average
|
|
2007
|
|
High
|
|
Low
|
|
Exchange
Rate
|
|
|
|
|
|
|
|
|
|
January
|
|
|
7.8127
|
|
|
7.7755
|
|
|
7.7993
|
|
February
|
|
|
7.8158
|
|
|
7.8029
|
|
|
7.8117
|
|
March
|
|
|
7.9102
|
|
|
7.8081
|
|
|
7.8148
|
|
April
|
|
|
7.8222
|
|
|
7.8096
|
|
|
7.8163
|
|
May
|
|
|
7.8263
|
|
|
7.8005
|
|
|
7.8206
|
|
June
|
|
|
7.8206
|
|
|
7.8034
|
|
|
7.8145
|
|
July
|
|
|
7.8254
|
|
|
7.8109
|
|
|
7.8201
|
|
August
|
|
|
7.8301
|
|
|
7.7952
|
|
|
7.8175
|
|
September
|
|
|
7.8007
|
|
|
7.7556
|
|
|
7.7855
|
|
B.
Capitalization and Indebtedness
Not
applicable.
C.
Reasons for the Offer and Use of Proceeds
Not
applicable.
D.
Risk Factors
The
Company’s business faces significant risks. Investors should carefully consider
all of the information set forth in this Form 20-F and in the Company’s other
filings with the SEC, including the following risk factors which the Company
faces and which are faced by the toy, toy-related and packaging industries.
The
Company’s business, financial condition or results of operations could be
materially and adversely affected by any of these risks. This Form 20-F also
contains forward-looking statements that involve risks and uncertainties. The
Company’s results could materially differ from those anticipated in these
forward-looking statements as a result of many factors including those risks
described below and elsewhere in this Form 20-F.
The
Company is controlled by a single shareholder, who may take actions that are
not
in the Company’s other shareholders’ best interests.
Mr.
Jeff
Hsieh Cheng, the Company’s chief executive officer and a director, through
entities owned by him beneficially owns approximately 86.59% of the Company’s
outstanding ADSs on a fully diluted basis assuming conversion of all the
Company’s outstanding Preference Shares, all of which are beneficially owned by
Mr. Hsieh through Centralink and Cornerstone Beststep, and the exercise of
all
of the Company’s outstanding options and warrants. Accordingly, Mr. Hsieh has
the ability to control the Company and its affairs, including the outcome of
all
matters requiring shareholder approval such as the election and removal of
the
Company’s entire board of directors, and any merger, consolidation or sale of
all or substantially all of the Company’s assets. This concentrated control
gives Mr. Hsieh the right to decide whether the Company should proceed with
any
action, even if those actions might not be beneficial to all shareholders.
It
also could discourage others from initiating any potential merger, takeover
or
other change of control transaction. As a result, the Company’s other
shareholders could be disadvantaged by the actions that Mr. Hsieh chooses to
pursue.
The
majority beneficial shareholder of the Company, Mr. Jeff Hsieh, may be able
to
compel the other shareholders or ADS holders of the Company to sell their
ordinary shares, or the ordinary shares in which their ADSs represent beneficial
ownership, to him or one of his affiliates if he is able to acquire ownership
of
90% of the Company’s ordinary shares
Under
certain circumstances, Hong Kong law will permit Mr. Hsieh, through one or
more
of his holding companies, to make a general offer to acquire all outstanding
ordinary shares not already beneficially owned by him. If Mr. Hsieh or such
company acquires not less than 90% of the ordinary shares in respect of which
the offer is made, he or it may compel the owners of the remaining ordinary
shares or the ADSs representing beneficial ownership of the remaining ordinary
shares to transfer such shares to Mr. Hsieh or it. In such circumstances,
Mr. Hsieh could effectively force ADS holders of the Company to sell their
ADSs
to him. Assuming the outstanding options and warrants of the Company that
have exercise prices above the current market price are not exercised, Mr.
Hsieh
would have approximately 90% of the outstanding ADSs if he converts all of
the
Preference Shares owned by him. Should Mr. Hsieh initiate or support such
an effort in the future, minority ADS holders may be compelled to sell their
ADSs in the circumstances described above. For further information, please
refer
to “Item 10. B. Memorandum and articles of association”.
The
Company may not be able to obtain sufficient funding for its working capital
needs
The
Company requires working capital for its operations. From time to time,
the Company’s plans may change due to changing circumstances, the development of
our business, new business or investment opportunities or unforeseen
contingencies. All of the Company’s loan facilities are uncommitted and
the lenders have the right to withhold credit in their discretion. If our
plans do change, we may need to obtain additional external financing to meet
our
capital expenditure plans, which may include commercial bank borrowings or
the
sale of equity or debt securities. If we decide to raise additional funds
through the incurrence of debt, our interest and debt repayment obligations
will
increase, and we may be subject to additional covenants, which could limit
our
ability to access cash flow from our operations. Our ability to raise
adequate financing to fund future capital requirements on acceptable terms,
on
time or at all is not assured. Furthermore, the Company's ability to raise
additional financing may be materially and adversely affected by its continuing
losses from operations since 2004, and the receipt of an audit opinion from
the
Company's independent auditors, which is included in the Company's financial
statements for the year ended December 31, 2006 contained in this Annual Report
on Form 20-F, that contains an expression of doubt regarding the Company's
ability to continue as a going concern. Any failure to obtain sufficient
financing could result in the delay or abandonment of our development and
expansion plans and have a material adverse effect on our business and financial
results.
Additionally,
the Company is currently in breach of certain of the restrictive covenants
relating to its banking facility with Hang Seng Bank due to the
Company's failure to maintain certain net asset levels set forth in the relevant
loan agreement. While Hang Seng Bank has not yet exercised its rights
to accelerate repayment of all amounts outstanding, the bank may
choose to do so at any time so long as the Company continues to be
non-compliant with the terms of the banking facility. In such case,
the Company's business and financial condition may be materially and adversely
affected.
The
Company’s credit facilities are dependent in part on guarantees extended by Mr.
Hsieh
The
Company’s credit facilities are guaranteed by Mr. Hsieh. A change in Mr. Hsieh’s
financial condition or his refusal to extend further guarantees could result
in
the Company’s lenders’ refusal to extend credit to the Company’s Asian
subsidiaries or demanding immediate repayment of outstanding credit balances.
Any change in the Company’s ability to borrow could result in the Company being
forced to curtail or delay its business activities, which could have a material
adverse effect on the Company’s business, financial condition and results of
operations.
The
Company is undergoing a restructuring to eliminate unprofitable operating
divisions and focus on profitable divisions which, in the immediate future,
will
result in significant restructuring costs and impact the Company’s cash flow,
profitability and earnings per ADS.
After
the
acquisition of Hua Yang and Kord in December 2005, the Company considered
restructuring the operating divisions to focus on the profitable divisions.
Subsequently, in June 2006, the Company terminated the operations of Playwell’s
Gatelink subsidiary. Playwell’s Gatelink subsidiary manufactured moulds for
products developed by Playwell and for third parties on an OEM basis.
Historically, a significant portion of Gatelink’s operations involved making
moulds for Marvel product lines licensed by Toy Biz Worldwide Ltd. (renamed
as
Worldwide Toys Limited), a company controlled by Mr. Hsieh. Toy Biz no longer
has the rights to develop and distribute the Marvel line of products, which
eliminated Gatelink’s primary source of revenue. In order to develop new
business required to operate Gatelink profitably, the Company would have had
to
invest significant capital in new tooling equipment for Gatelink without any
guarantee of success. Management concluded that such an investment is not in
the
best interests of the Company as future profitability was uncertain and even
if
profits were generated from future operations, they might not be sufficient
to
offset the investment costs. The termination of Gatelink’s operations resulted
in minimal charges for fiscal 2006.
In
July
2006, the Company decided not to renew an existing license agreement with Binney
& Smith for the Crayola dough product line beyond December 2006. The product
line had been unprofitable, and the Company could not foresee this changing
in
the near future. The Crayola dough line was a key element of the Company’s plan
to enter the US mass market for toys. The Company also discontinued certain
other product lines targeted towards the US mass market. As a result, the
Company de-emphasized all its efforts to enter the US mass market for toys.
The
termination of the Binney & Smith license as well as the other product lines
has resulted in charges of approximately $10.5 million as a result of the
write-off of goodwill and approximately $2.0 million as a result of early
amortization of intangibles relating to the Binney & Smith license in 2005
and approximately $71,000 of additional charges in 2006.
In
October 2006, the Company decided to
discontinue the distribution of
toy and
toy-related products to the mass market in Canada and cease the operations
of
its Canadian subsidiary, Grand Toys Ltd. (“Grand Canada”), which conducted the
Company’s Canadian mass market sales efforts. For the year ended December 31,
2005, Grand Canada’s sales were approximately $7.7 million and the operations
resulted in a loss of $334,000. Management determined that future profitability
of its Canadian mass market operations was uncertain. In 2006, the Company
recorded approximately $1.2 million of costs to close this operation, consisting
primarily of employee severance costs.
.
Also
in
December 2006, the Company decided to terminate the operations of Playwell’s
Asian World Enterprises Co., Ltd. (“Asian World”) subsidiary. Asian World had
licenses to develop toy and toy-related products, most of which had been further
sublicensed to, and manufactured and sold by, Playwell’s Hong Kong Toy Centre
Limited (“HKTC”) subsidiary. The costs to close the operations of Asian World
were minimal; Grand recorded charges of approximately $2.9 million in fiscal
2006 for minimum guarantee payments on certain license agreements held by Asian
World that would not have been renewed on expiry and were due in 2006 and
thereafter.
Although
management expects that the termination of these operations should enhance
the
Company’s profitability in the long run, there can be no assurance that the
Company will be able to successfully complete the restructuring and enhance
the
long-term profitability of its remaining operations.
The
market price of the Company’s ADSs is below $1.00 per ADS and, as a result, the
Company may be subject to future delisting from the Nasdaq Capital
Market
The
Company's ADSs are listed on the Nasdaq Capital Market. Nasdaq
marketplace rules for continued listing require the Company to maintain a
minimum bid price of not less than $1.00 per ADS. The Company failed to
maintain the required minimum bid price for a period of 30 consecutive trading
days prior to May 30, 2007 and received a Nasdaq Staff Deficiency Letter on
May
30, 2007. The Company has been provided a period of 180 calendar days
until November 26, 2007 to regain compliance by maintaining a minimum bid price
above $1.00 per ADS for ten consecutive trading days. On September 18,
2007, the Company announced that it would be changing the ratio of ordinary
shares per ADS from one ordinary share per ADS to five ordinary shares per
ADS,
effective as of October 1, 2007. If the Company does not maintain
the minimum bid price for ten consecutive trading days, but it meets compliance
with the initial Nasdaq listing criteria, except for the bid price requirement,
the Company will be granted an additional 180 calendar day period during which
to gain compliance. If the Company is not granted the additional
compliance period, the Company's securities will be delisted from the Nasdaq
Capital Market. At or before that time, the Company may appeal to a
Listing Qualifications Panel and provide a plan to regain compliance.
Companies which undergo an ADS ratio change have, in the past, suffered further
erosion in its market price even though an ADS ratio change does not change
the
financial position of the Company. Accordingly, the delisting of the
Company's ADSs or the change in Company's ADS ratio may have a material
adverse impact on the value and liquidity of the Company's ADSs.
The
Company’s relationships and transactions with entities affiliated with Mr. Hsieh
create various perceived, potential or actual conflicts of interest that could
materially and adversely affect the Company’s business or the market price or
liquidity of the Company’s ADSs
The
Company not only engages in business in the ordinary course with companies
that
are affiliated with Mr. Hsieh but, as in the case of the acquisitions of Kord
and Hua Yang, the Company has engaged in material transactions with businesses
owned by Mr. Hsieh. As a result, situations have in the past and may in the
future arise where Mr. Hsieh would have the right to vote on transactions with
affiliated companies that could benefit Mr. Hsieh and negatively impact the
Company, or vice versa. Although the board of directors of the Company works
to
ensure that all transactions between the Company and entities controlled by
Mr.
Hsieh are done on an arms-length basis to ensure that they are fair to and
in
the best interests of the shareholders of the Company, any perceived or actual
conflict of interest in the Company’s management and/or the companies affiliated
with Mr. Hsieh may discourage investors from investing in the Company’s ADSs,
which may negatively impact the stock price or liquidity of the Company’s
ADSs.
Centralink
and Cornerstone Beststep own all of the Company’s Preference Shares which could
further restrict the Company’s ability to secure additional
funding
In
May
2005, the Company issued to Centralink 2,000,000 Series A Preference Shares
and
in December 2005, the Company issued to Cornerstone Beststep 10,840,598 Series
B
Preference Shares. The terms of the Preference Shares contain provisions
protective to Centralink and Cornerstone Beststep, including liquidation
preferences and, in the case of the Series A Preference Shares, preemptive
rights to acquire shares of the Company if the Company determines to issue
additional shares. The existence of the Preference Shares could affect the
market price of the Company’s ADSs, may discourage potential investors from
investing in the Company or otherwise make it more difficult for the Company
to
issue additional equity or debt securities on acceptable terms, or at
all.
The
Company’s acquisition strategy has resulted in the Company incurring significant
acquisition costs and increased overhead costs that have had and will continue
to have an impact on the Company’s operating results
The
Company began a strategy of growth through acquisition in August 2004 when
it
completed the reorganization merger between Playwell and Grand Toys
International, Inc. Since the Company began its acquisition strategy, it has
incurred direct transactional acquisition costs of approximately $7,747,000,
including the costs associated with the reorganization merger and Playwell
acquisition in 2004. The Company’s ADS holders have incurred dilution as a
result of the issuance of the Preference Shares that were issued in connection
with the Company’s acquisitions of IPI, Kord and Hua Yang, and will continue to
incur further dilution as dividends on the Preference Shares are paid in
additional ordinary shares or ADSs. The Company’s acquisition strategy has also
required the Company to maintain certain levels of overhead required to follow
its acquisition strategy and to maintain the operations of the Company. For
the
years ended December 31, 2004, 2005 and 2006 and the eight months ended August
31, 2007, these transaction expenditures, some of which have not been
capitalized, and related overhead have negatively impacted the Company’s results
and will continue to do so in the near future. If the long-term benefits of
these acquisitions do not exceed the short-term costs associated with the
acquisitions and the associated overhead, the Company’s financial results,
including earnings per share, could continue to be negatively
impacted.
The
Company faces risks associated with potential acquisitions, investments or
other
ventures
The
Company has pursued an acquisition strategy to expand its business and product
offerings. Beginning with the Company’s acquisition of Playwell following the
Company’s reorganization merger in August 2004, the Company has made four
acquisitions in the past two years, including the Company’s acquisitions of Hua
Yang and Kord in December 2005.
The
Company believes that it may become increasingly important for it to acquire
or
make investments in complementary businesses, facilities, technologies or
products if appropriate commercial opportunities arise. The Company may not
be
able to identify suitable acquisition candidates or investment opportunities,
which may place the Company at a disadvantage if our competitors are able to
grow their market share through acquisitions.
If
the
Company does identify suitable candidates or opportunities, the Company may
not
be able to complete those transactions on commercially acceptable terms or
at
all. Furthermore, future acquisitions involve known and unknown risks that
could
adversely affect our future revenues and operating results. For
example:
|
·
|
The
Company may fail to successfully integrate its acquisitions in accordance
with our business strategy;
|
|
·
|
The
Company competes with others to acquire companies. This may result
in
decreased availability or increased prices for suitable acquisition
candidates;
|
|
·
|
The
Company may ultimately fail to consummate an acquisition but will
still
have to pay the costs associated with the potential
acquisition;
|
|
·
|
Potential
acquisitions may divert management’s attention away from the Company’s
primary product offerings, resulting in the loss of key customers
and/or
personnel and expose the Company to unanticipated
liabilities;
|
|
·
|
The
Company may not be able to retain the skilled employees and experienced
management that may be necessary to operate the businesses which
the
Company may acquire and, if the Company cannot retain such personnel,
the
Company may not be able to locate or hire new skilled employees and
experienced management to replace them;
and
|
|
·
|
The
Company may not realize economies of scale through the elimination
of
certain redundant administrative and overhead
costs.
|
The
realization of any such risks could disrupt the Company’s ongoing businesses,
distract management and employees and cause material increases in the Group’s
expenses.
The
Company’s business is subject to seasonality effects
The
business of the Company is seasonal and a majority of its sales take place
in
the third and fourth quarters of its fiscal year. Therefore, the Company’s
annual operating results will depend, in large part, on sales during the
relatively brief holiday season from September through December. Further, the
impact of seasonality is increasing as large retailers become more efficient
in
their control of inventory levels through quick response management techniques.
Rather than maintaining large on-hand inventories throughout the year to meet
consumer demand, these customers are timing reorders so that they are being
filled by suppliers closer to the time of purchase by retail customers, which
to
a large extent occur during September through December. While these techniques
reduce a retailer's investment in inventory, they increase pressure on suppliers
like the Company to fill orders promptly, thereby shifting a significant portion
of inventory risk and carrying costs to the supplier. The limited inventory
carried by retailers may also reduce or delay retail sales. Additionally, the
logistics of supplying more and more products within shorter time periods
increases the risk that the Company may fail to achieve tight and compressed
shipping schedules. This seasonal pattern requires significant use of working
capital mainly to manufacture inventory during the portion of the year preceding
the holiday season, and requires accurate forecasting of demand for products
during the holiday season. The Company’s failure to accurately predict and
respond to consumer demand could result in its under-producing popular items
and
overproducing less popular items, which could have a material adverse effect
on
the Company’s business and results of operations.
The
Company’s operating results may be highly volatile which could have a material
adverse impact on the Company’s results of operations
The
toy
and toy related industries in which the Company operates is known for a high
level of volatility as a result of changing consumer tastes, competition and
over-saturation of popular products. The Company has experienced significant
volatility in its results in the past. While the Company has diversified into
specialty toy distribution, packaging and party good categories to reduce
volatility, there can be no guarantee that this history of volatility will
not
continue.
The
recurring losses from the Company's operations and working capital
deficiency raise substantial doubt about the Company's ability to continue
as a going concern.
The
Company has incurred recurring losses since 2004. The Company's net
loss from continuing operations (as restated) for the years ended December
31, 2006 and 2005 amounted to $11.3 million and $0.9 million,
respectively. The Company's cumulative losses as of December 31,
2006 and 2005 were $48.0 million and $25.5 million, respectively.
Further, the Company's working capital deficiency amounted to $9.3 million
as of December 31, 2006.
The
Company's auditors believe that the foregoing conditions raise substantial
doubt
as to the Company's ability to continue as a going concern. The
Company's continued operation as a going concern is dependent on its
ability to generate sufficient cash flows from operations and/or seek other
sources of financing; however, there are no assurances that positive operating
results can be achieved or that any additional financing or refinancing can
be
obtained on favorable terms, or at all. The Company is implementing plans to
mitigate the going concern risk that include focusing on improving our
profitable business divisions, namely IPI, Hua Yang and Kord, promoting better
operating efficiencies, and reducing corporate overhead. In addition, the
Company has available to it the continuing financial support of Mr. Jeff Hsieh,
the Company's majority beneficial shareholder, and has continuing banking
facilities with a number of banks to provide for additional liquidity for
working capital purposes. The company has breached certain
covenants contained in its banking facility with Hang
Seng Bank. However, such facilities are fully secured and the
bank is aware of the breach. The bank has not yet taken any
action with respect to such breach. However, the company
cannot make any assurances that the bank will not avail of its rights under
the terms of the banking facility, including acceleration of repayment
of outstanding amounts.
The
Company is dependent upon key personnel whose loss may adversely impact the
Company's business
The
Company relies on the expertise, experience and continued services of its senior
management employees, including Jeff Hsieh, who is the Chief Executive Officer
and a director of the Company, Kevin Murphy who is the Chief Operating Officer
of the Company and the General Manager of Hua Yang, Li San Tung, who is General
Manager of Kord, and Michael Varda, who is the Chief Executive Officer of
International Playthings, Inc. Each of these individuals has acquired
specialized knowledge and skills with respect to the Company and its operations
and most decisions concerning the business of the Company or its subsidiaries
will be made or significantly influenced by them.
Growth
in
the Company's business is dependent, to a large degree, on the Company’s ability
to retain and attract such employees. The Company seeks to compensate and
motivate its key executives, as well as other employees, through competitive
salaries and stock option and bonus plans, but there can be no assurance that
these programs will allow it to retain key employees or hire new key employees.
As a result, if any of these individuals were to leave, the Company could face
substantial difficulty in hiring qualified successors and could experience
a
loss in productivity while any such successor obtains the necessary training
and
experience.
The
Company cannot assure you that it will be able to attract or retain such
personnel or that any personnel that we have in the future will successfully
integrate into the Company or ultimately contribute positively to the business.
The Company is not the beneficiary of any "key man" insurance on the life of
any
of these persons. The loss of some of these senior management employees without
a suitable replacement, or an inability to attract or retain other key
individuals, could materially and adversely affect the Company’s operations.
Certain
members of the Company’s management team do not perform duties exclusively for
the Company and, as a result, their attention may be diverted from the Company’s
business
Although
certain members of the Company’s management team are engaged by the Company
under written employment or consulting agreements, the terms of these employment
or consulting agreements may permit them to perform services for the Company
on
a non-exclusive basis. Mr. Hsieh does not have a written agreement with the
Company and devotes a significant portion of his time to Cornerstone Overseas,
its subsidiaries and other companies. In the future, the Company may make
similar non-exclusive arrangements with other senior management employees.
These
other business activities could divert their attention from or otherwise
interfere with their future availability to, and efforts on behalf of, the
Company.
The
Company depends on third party intellectual property
rights
The
Company has entered into various licenses and royalty agreements in which it
pays fees in exchange for rights to the use of product inventions or trademarked
names, shapes and likenesses for use in development of its toy and packaging
product lines. The Company seeks additional licenses and distribution agreements
on an ongoing basis. These agreements generally include minimum fee guarantees
based on a reasonable expectation of the product sales to be generated
throughout the life of the agreement. As is customary in the toy business,
some
of these projected expectations have not materialized and the Company pays
unearned fees as a result. In addition, when the business generated from third
party licenses does not meet expectations, the Company has to write-off all
or
part of the value of the licenses resulting in a charge against its net income.
Unrecouped license fees or minimum guarantees have recently become a more
significant problem as the Company wrote-off over $4.2 million in 2006 from
various licenses held by its Playwell and Grand US divisions.
License
and royalty agreements are also mostly for fixed terms and often contain
performance-related covenants. There is no assurance that the Company will
be
able to maintain or extend the rights of its existing licenses. The failure
to
renew these license agreements or any difficulty in entering into other license
agreements with other companies will have a material adverse effect on the
Company’s business and results of operations.
Because
the life cycle for toy products is usually very short and consumer preferences
are unpredictable, the Company’s business may be adversely affected by its
inability to develop or secure the right to distribute new
products
The
Company’s business and operating results will depend largely upon the appeal of
the products it manufactures and sells. Consumer preferences in the toy and
toy-related industries are highly subjective and can change quickly, and there
can be no assurance that consumers will continue to find existing or new
products of the Company appealing. As a result of changing consumer preferences,
many products are successfully marketed for only one or two years. The Company’s
continued success will depend on the ability of the Company to redesign, restyle
and extend its existing toy and fashion accessory products and to develop,
acquire the right to, introduce and gain customer acceptance of new products.
If
market acceptance of new or existing products does not meet expectations, the
Company may overproduce quantities of certain products and subsequently may
be
required to sell inventory of such products at discounts which may be
substantial or provide inventory provisions to mark the value of excess
inventory quantities down to their estimated market value.
A
decline
in the popularity of its existing products and product lines or the failure
of
new products and product lines to achieve and sustain market acceptance could
result in reduced overall revenues and margins, which could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Introduction
of new products by third parties whose products the Company distributes and
manufactures, and market acceptance of these products, will have a significant
impact on the success of the Company’s business
A
significant portion of the Company’s business involves the distribution of toy,
toy-related products and packaging for products developed by third parties
and
the contract manufacture of other companies’ products. The Company’s long-term
operating results therefore depend, in part, on the ability of third parties
to
continue to conceive, design and market new products and upon continuing market
acceptance of these third parties’ existing and future products. In the ordinary
course of their businesses, these third parties continuously develop new
products and create additions to their existing product lines. Significant
delays in the introduction of, or their failure to introduce or market, new
products or additions to their respective product lines could materially impair
the Company’s results of operations.
Some
of
the Company’s products have limited life cycles and may be discontinued by a
third party at any time. Accordingly, there can be no assurance that existing
or
future products of our customers will continue to receive substantial market
acceptance.
The
Company may fail to make new product introductions in a timely fashion, which
could negatively impact its operating results
The
Company designs and develops its own proprietary products as well as products
for third parties. Once a new product is conceived, the principal steps to
introduce the product include design, sourcing and testing of components,
tooling, and purchase and design of graphics and packaging. At any stage in
the
process, there may be difficulties or delays in completing the necessary steps
to meet the contemplated product introduction schedule. It is, for example,
common in new product introductions or product revisions to encounter technical
and other difficulties affecting manufacturing efficiency and, at times, the
ability to manufacture at all, that will typically be corrected or improved
over
a period of time with continued manufacturing experience and engineering
efforts. If one or more aspects necessary for introduction of products are
not
met in a timely fashion, or if technical difficulties take longer than
anticipated to overcome, the anticipated product introductions will be delayed,
or in some cases may be terminated. Therefore, no assurances can be given that
products will be introduced in a timely fashion. Significant delays in the
introduction of, or the failure to introduce, new products or improved products
would have a material adverse effect on the Company's operating
results.
Due
to the highly competitive nature of the industries in which the Company
operates, the Company may have difficulty retaining or increasing market share
IPI
operates primarily in the specialty retail distribution market by distributing
both proprietary toys and licensed toys in the North American market, focusing
on toys for infants to teenagers. There is no assurance that IPI can continue
to
maintain the same level of sales and shelf space for the specialty retail
market, as the barriers for other distributors to enter the specialty retail
toy
market are relatively low.
Hua
Yang
faces significant competition in its business segments. In "pop up" books,
Hua
Yang competes with contract manufacturers located in Southeast Asia and South
America. In novelty and board games as well as specialty packaging, Hua Yang
competes with contract manufacturers located in Hong Kong and other parts of
the
PRC. In addition, Hua Yang competes with customers that have the capability
to
manufacture their products internally.
The
Company does not believe that there are any significant barriers to entry into
the light manufacturing business in which Hua Yang and Kord operate. Although
Hua Yang and Kord seek patent, trademark, trade name or copyright protection
for
some of their products, neither Hua Yang nor Kord characterizes its business
as
proprietary. Accordingly, additional participants may enter the market at any
time.
The
Company also competes with others for licenses for third party intellectual
property rights. Some of our competitors may have significantly greater
resources available to us. If we are unable to compete effectively, including
in
terms of obtaining third party licenses, pricing, providing quality products
and
attracting and retaining personnel, our market share may decline, which could
have a material adverse effect on our financial condition and results of
operations.
The
operation of Hua Yang’s production facility in the PRC is dependent on third
parties not under our control
Hua
Yang’s principal manufacturing facility in Shenzhen, the PRC is owned and
operated by a co-operative joint venture in which Hua Yang has a majority
interest. The other party to this contractual joint venture is an entity that
is
controlled by PRC governmental authorities. The efficient and cost-effective
operation of the Hua Yang facility depends upon the cooperation and support
of
PRC authorities and the joint venture partner. Should a dispute develop between
Hua Yang and its joint venture partner, there can be no assurance that Hua
Yang
would be able to enforce its understanding of its agreements or interests with
its joint venture partner, which could result in a significant loss of, or
depreciation in the value of, the Hua Yang facility. Hua Yang’s investment in
the Hua Yang facility is significant and it could not be replaced without
considerable new investment, if at all. The lack of cooperation by Hua Yang’s
joint venture partner could subject Hua Yang to additional risks and costs,
including the interruption or cessation of its present operations in the PRC,
all of which would have a material adverse effect on Hua Yang’s business,
financial condition and results of operations.
Hua
Yang’s and Kord’s operations depend on access to raw materials in significant
quantities and at reasonable prices
Hua
Yang
and Kord use various plastic resins, paper, ink and glue in their manufacturing
operations. Hua Yang’s and Kord’s financial performance is dependent, to a
substantial extent, on the cost of such raw materials. The supply and demand
for
both plastic resins and the petrochemical intermediates from which plastic
resins are produced are subject to cyclical and other market factors and may
fluctuate significantly. As a result, the cost of raw materials to Hua Yang
and
Kord is subject to substantial increases and decreases over which Hua Yang
and
Kord have no control except by seeking to time their purchases in order to
take
advantage of favorable market conditions. In the past , Hua Yang and Kord have
experienced significant increases in the price of certain raw materials, which
resulted in an increase in Hua Yang’s and Kord’s production costs that Hua Yang
and Kord were not able to pass on fully to their respective customers. To the
extent that future increases in the cost of raw materials cannot be passed
on to
customers, such increases could have a material adverse effect on Hua Yang’s and
Kord’s results of operations and financial condition.
Hua
Yang
and Kord purchase their raw materials from a limited number of suppliers. Hua
Yang and Kord have no formal written agreements with any of their suppliers.
No
assurance can be given that Hua Yang and Kord will be able to obtain sufficient
quantities of such raw materials at acceptable prices to meet their needs.
Any
failure to procure sufficient raw materials for their needs could have a
material adverse effect on Hua Yang’s and Kord’s business, financial condition
and results of operations.
The
Company’s production facilities depend on an adequate supply of
labor
There
have been instances of shortages of labor in Guangdong Province and the southern
parts of China generally, where the Company’s production facilities are located.
In the event that the shortage of labor continues or intensifies in the future,
the Company may have difficulties recruiting or retaining labor at relatively
low costs for its production facilities and, accordingly, the Company’s ability
to maintain sufficient labor levels to satisfy its production needs may be
impaired. In such event, the Company’s business and results of operations may be
materially and adversely affected.
The
Company may not be able to protect its intellectual
property
On
occasion in the toy industry, successful products are "knocked-off" or copied.
We rely on a combination of copyright, trademark and trade secret laws and
restrictions on disclosure to protect our intellectual property rights. While
the Company strives to protect its intellectual property, there can be no
guarantee that knock-offs will not have a significant negative effect on its
business. In addition, intellectual property laws are less developed in China
than in the U.S., and historically, China has not protected companies'
intellectual property rights to the same extent as the U.S. The costs incurred
in protecting the Company’s intellectual property rights could be significant
and there is no assurance that it will be able to successfully protect its
rights.
Failure
to achieve and maintain effective internal controls could have a material
adverse effect on the trading price of the Company’s ADSs
The
Company is subject to the reporting obligations under the U.S. securities laws.
The Securities and Exchange Commission, or the SEC, as required by Section
404
of the Sarbanes-Oxley Act of 2002, has adopted rules requiring public companies
to include a report of management on such companies’ internal control over
financial reporting in its annual report on Form 10-K or Form 20-F, as
applicable, that contains an assessment by management of the effectiveness
of
such company’s internal control over financial reporting. This requirement will
first apply to our annual report on Form 20-F for the fiscal year ending
December 31, 2007. In addition, an independent registered public accounting
firm
for a public company must attest to and report on management’s assessment of the
effectiveness of the Company’s internal control over financial reporting. This
requirement will first apply to our annual report on Form 20-F for the fiscal
year ending December 31, 2008.
Management
may not conclude that our internal control over our financial reporting is
effective. Even if the Company’s management concludes that our internal control
over financial reporting is effective, there is no assurance that the Company’s
independent registered public accounting firm will attest to the management’s
assessment. If the Company fails to achieve and maintain the adequacy of our
internal controls, the Company may not be able to ensure that it can conclude
on
an ongoing basis that it has effective internal controls over financial
reporting in accordance with the Sarbanes-Oxley Act. As a result, any failure
to
achieve and maintain effective internal control over financial reporting could
result in the loss of investor confidence in the reliability of the Company’s
financial statements, which in turn could negatively impact the trading price
of
the Company’s ADSs. Furthermore, the Company may incur significant costs and use
significant management and other resources in an effort to comply with Section
404 of the Sarbanes-Oxley Act and other requirements.
The
Company may be subject to product liability claims which, if not covered by
adequate insurance, could result in the Company becoming responsible for paying
substantial amount of damages, which could adversely impact its business,
financial condition and results of operations
The
Company is subject to product liability claims relating to the products it
manufactures and distributes. Since some of the Company’s products are
manufactured for infants and pre-school children, safety has been a major
concern in the products that the Company designs, develops and manufactures.
However, the Company cannot assure total safety of its products and therefore
can be subject to possible claims for injury or damage, some or all of which
may
not be covered by insurance. Although we maintain worldwide product liability
insurance, our financial condition and results of operations would be materially
and adversely affected if our insurance does not cover our liabilities, or
if we
are required to pay higher premiums in the future as a result of these
liabilities. Any
successful claim brought against the Company by a customer which is not
adequately covered by insurance or the adverse publicity that could accompany
any such claim could have a material adverse effect on the business, financial
condition and results of operations of the Company.
The
Company is subject to many U.S. regulations when exporting toy products into
the
U.S. that could result in the exclusion of some of its products from U.S.
markets
The
Company and its U.S. distribution customers are subject to the provisions of
the
U.S. Federal Hazardous Substances Act and the U.S. Federal Consumer Product
Safety Act when importing or producing toys to be sold in the U.S. These laws
empower the U.S. Consumer Product Safety Commission, or the CPSC, to protect
consumers from hazardous toys and other articles. The CPSC has the authority
to
exclude products from the market that are found to be unsafe or hazardous,
and
can require a recall of such products under certain circumstances. Similar
laws
exist in some states and cities in the U.S., as well as in foreign
jurisdictions. The Company designs and tests the products it purchases or
manufactures for compliance with regulatory standards. However, there can be
no
assurance that the Company's products will not be found to violate applicable
laws, rules and regulations, which could have a material adverse effect on
the
business, financial condition and results of operations of the Company. In
addition, there can be no assurance that more restrictive laws, rules and
regulations will not be adopted in the future, or that the Company's products
will not be marketed in the future in countries with more restrictive laws,
rules and regulations, either of which could make compliance more difficult
or
expensive, and which could have a material adverse effect on the Company's
business, financial condition and results of operations.
Negative
publicity concerning the toy industry generally or toys manufactured in China
could materially and adversely affect toy companies, including the Company,
result in a loss of business confidence and reputation and materially and
adversely affect our business, results of operations and financial condition.
Negative
publicity concerning the toy industry generally or toys manufacture in China,
such as the recent recalls by Mattel of toy products manufactured in China,
may
adversely affect the business confidence and reputation of toy companies
operating in China, which could materially and adversely affect our business,
results of operations and financial condition. Although we have not experienced
any recalls of toy products or other similar events, we cannot assure you that
our business will not be adversely affected by the recent events in the toy
business.
The
Company may be subject to tariffs and quotas that could restrict its ability
to
export products to the U.S.
A
substantial portion of the Company's products are expected to be shipped to
customers in the U.S. The U.S. 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. at the expected
or
increased levels. The Company cannot predict what regulatory changes may occur,
if any, or the type or extent of any financial impact on the Company that such
changes may have in the future. In addition, various forms of protectionist
trade legislation have been proposed in the U.S. Adverse changes in tariff
structures or other trade policies could have a material adverse effect on
the
Company's business, financial condition and results of operations.
The
market price of the Company’s ADSs has been and may continue to be
volatile
Market
prices of the shares of microcap stocks like the Company’s ADSs, as well as the
market price of stocks of toy and toy-related companies, are often volatile
and
the historical stock price of the Company has reflected this volatility. The
trading price of the Company's ADSs has been and may be subject to considerable
fluctuations. These broad market and industry fluctuations may result in the
decline of the market price of the Company's ADSs, regardless of its operating
performance.
The
Company expects that the market price of the Company’s ADSs will be, affected by
many factors, including:
|
·
|
fluctuations
in the Company's financial results;
|
|
·
|
the
actions of the Company's customers and
competitors;
|
|
·
|
new
regulations affecting foreign
manufacturing;
|
|
·
|
other
factors affecting the toy, printing and packaging industries in
general;
|
|
·
|
announcements
of new products by the Company or its
competitors;
|
|
·
|
the
operating and stock price performance of other companies that investors
may deem comparable;
|
|
·
|
news
reports relating to trends in its markets;
|
|
·
|
sales
of the Company’s ADSs into the public market;
and
|
|
·
|
volume
of trading of the Company ADSs on
NASDAQ.
|
Sale
of the Company’s ADSs at attractive prices may be
difficult
The
Company’s ADSs have generally experienced limited liquidity and trading volume
and there is no coverage of the Company by analysts and market makers. This
may
or may not affect the future performance of the Company’s ADSs. There can be no
assurance that a more active trading market for the Company’s ADSs will develop
or that, if developed, will be sustained. Further, there is no public market
for
the ordinary shares of the Company underlying the ADSs. Many foreign issuers
with market capitalization similar to that of the Company have been unable
to
sustain an active trading market for their securities.
In
addition, the stock market in general has experienced extreme volatility that
often has been unrelated to the operating performance of any company. These
broad market and industry fluctuations may result in the decline of the price
of
the Company’s ADSs, regardless of its operating performance.
Future
sales of the Company’s ADSs by existing ADS holders, option holders and warrant
holders could result in a decline of the price of the Company’s
ADSs
The
market price of the Company’s ADSs could decline as a result of sales of a large
number of its ADSs into the market, or the perception that these sales could
occur. As of August 31, 2007, there are options and warrants to purchase
2,579,039 of the Company’s ADSs outstanding. In addition, the Preference Shares
are convertible into 31,951,606 ADSs and the Company intends to issue additional
ordinary shares, being represented by ADSs, to satisfy the Company’s obligation
to pay dividends on the Preference Shares. Centralink and Cornerstone Beststep,
holding companies owned by Mr. Hsieh and the holders of the Preference Shares,
have the right to demand registration of the ordinary shares underlying these
ADSs. If and when these options and warrants are exercised or the Preference
Shares are converted and registered, there might be a depressive impact on
the
market price of the Company’s ADSs. This might make it more difficult for the
Company to sell equity securities in the future at a time and at a price that
it
deems appropriate.
The
Company does not expect to pay cash dividends on its stock
The
Company has not paid any cash dividends on the ordinary shares underlying the
ADSs and the Company does not expect to declare or pay any cash dividends in
the
foreseeable future.
Enforcing
judgments against the Company may be difficult
Grand
Toys International Limited is a Hong Kong company, and a substantial portion
of
its assets are located outside the U.S. In addition, certain of the Company's
directors and officers are residents outside the U.S., and all or a substantial
portion of the assets of such persons are or may be located outside the U.S.
As
a result, investors may not be able to effect service of process within the
U.S.
upon such persons, or to enforce against them or the Company judgments obtained
in the U.S. courts predicated upon the civil liability provisions of the U.S.
securities laws. The availability in Hong Kong, in original actions or in
actions for enforcement of judgments of U.S. courts, of remedies provided for
under the U.S. securities laws will depend on relevant Hong Kong laws.
Risks
Related to Doing Business in China
The
Company is organized and based in Hong Kong, which is a special administrative
region of the PRC, and a significant portion of the Company’s operations and
assets are located in the PRC. The following addresses some of the risks
associated with doing business in China.
Because
China does not have a well developed, comprehensive system of laws, it may
be
difficult for the Company and its subsidiaries to protect or enforce their
legal
rights
A
majority of the Company's assets and operations are located in China. The
Chinese legal system is a civil law system based on written statutes in which
decided legal cases have little value as precedents. Certain areas of the
Chinese legal system, such as aspects of business law, are less developed than
in common law jurisdictions like the U.S. As a result, the administration of
laws and regulations by government agencies may be subject to considerable
discretion and vary from locality to locality.
In
particular, the Chinese legal system relating to foreign investments is
relatively new and continually evolving, and there cannot always be certainty
as
to the application of specific laws and regulations in particular instances.
Statements regarding evolving policies on foreign investment have occasionally
been conflicting, and any such policies, as administered, are likely to be
subject to broad interpretation, discretion and modification, perhaps on a
case-by-case basis. As the legal system in China develops, foreign investors
may
be adversely affected by new laws, changes to existing laws (or interpretations
thereof) and the preemption of provincial or local laws by national laws.
Enforcement of existing laws may be sporadic and implementation and
interpretation thereof inconsistent. Furthermore, when compared with their
counterparts in other jurisdictions, the Chinese judiciary is relatively
inexperienced in enforcing the laws that exist, leading to a higher than usual
degree of uncertainty as to the outcome of any litigation. Even where adequate
laws exist in China, it may be impossible to obtain swift and equitable
enforcement of such laws, or to obtain enforcement of a judgment by a court
of
another jurisdiction. There can be no assurance that the Company's current
or
future activities in China will have a high degree of security under China's
legal system.
If
the Company is not able to obtain appropriate governmental support and approvals
in China, it may not be able to conduct its business activities as
planned
The
Company's activities in China may by law be subject, in some circumstances,
to
administrative review and approval by various national and local agencies of
the
Chinese government. Although the Company believes that the present level of
support from local, provincial and national governmental entities enjoyed by
the
Company benefits the Company’s operations in connection with administrative
review and the receipt of approvals, there is no assurance that such approvals,
when necessary or advisable in the future, will be forthcoming. The inability
to
obtain such approvals could have a material adverse effect on the Company's
business, financial condition and results of operations.
Changes
in foreign exchange regulations may materially and adversely affect our results
of operations and financial condition
The
Company’s corporate headquarters are located in Hong Kong and its production
facilities are principally located in China. Most of the Company’s sales are
made in the U.S., Europe and Asia. Therefore, the Company’s administrative and
business expenses are mostly denominated in Hong Kong dollars, its production
expenses are mostly denominated in Chinese renminbi and its revenue are mostly
denominated in U.S. dollars and Euros.
The
Hong
Kong dollar has remained relatively constant against the U.S. dollar due to
the
U.S. dollar peg and currency board system that has been in effect in Hong Kong
since 1983. One U.S. dollar is pegged to $7.80 HK dollar under that system.
There can be no assurance that such currency peg of the Hong Kong dollar to
the
U.S. dollar will be maintained in the future. Any cessation of or change in
the
currency peg of the exchange rate between the Hong Kong dollar and the U.S.
dollar could have a material and adverse effect on the Company's business and
results of operations.
In
2005,
China revalued the exchange rate of the Chinese renminbi to the U.S. dollar
and
abolished the renminbi to U.S. dollar peg applied in the past. There can be
no
assurance that in the future China will not revalue the renminbi or permit
its
substantial appreciation. Any increase in the value of the renminbi might
adversely affect the growth of the Chinese economy as well as the
competitiveness of various industries in China, including the industry in which
the Company operates. A rise in the value of the renminbi relative to the U.S.
dollar will increase the Company’s relative production costs and decrease the
relative value of its revenue, thereby reducing operating margins. Furthermore,
should the U.S. dollar weaken relative to foreign currencies, the Company's
products could become more expensive in the U.S. even if the prices of the
products in Hong Kong dollars remain unchanged, which could further materially
and adversely affect the Company's revenues. Currently, the Company has not
entered into agreements or purchase instruments to hedge its exchange rate
risks.
PRC
taxation and other government levies
The
Chinese tax system is subject to substantial uncertainties and has been subject
to recently enacted changes, the interpretation and enforcement of which are
also uncertain. We cannot assure you that changes in Chinese tax laws, their
interpretation or their application will not subject us to substantial Chinese
taxes or other levies in the future. In addition, the negotiation and
settlement of tax obligations with the local tax authorities are a normal
occurrence and practical application of such laws can vary from tax authority
to
tax authority and can change without notice with subsequent penalties
imposed for prior years after an authority changes its interpretation
of a rule or regulation. Examples include individual income tax, corporate
income tax and social insurance premiums. the new PRC corporate income
tax law was passed and announced by the national people's congress on March
16, 2007 and will become effective on January 1, 2008. While it is clear
that the intent of this law is to unify domestic and foreign invested
enterprises' income taxes by introducing a single income tax rate of 25%,
and therefore remove subsidies for foreign investments, there are a lot of
uncertainties pending clarification by the release of the implementation
rules of the corporate income tax law. There is no assurance as to when
such implementation rules will be promulgated and how such implementation rules
will affect us. As a result income tax rates in china from previous
years should not be seen as a guide to those in coming years.
Item
4. Information on the Company
A.
History and Development of the Company
Grand
Toys International Limited was incorporated in Hong Kong on October 15, 2003,
although it did not commence actual operations until the completion of the
reorganization merger of Grand US and the Playwell acquisition on August 16,
2004. The Company’s principal executive offices are located at Suite 1501,
15th
Floor,
Chinachem Golden Plaza, 77 Mody Road, Tsimshatsui East, Kowloon, Hong Kong.
Its
telephone number is (852) 2866 8323. The Company’s agent for service of process
in the United States is International Playthings, Michael Varda CEO, located
at
75D Lackawanna Ave Parsippany NJ 07438.
The
Company was formerly a subsidiary of Grand US. It became the parent of Grand
US
on August 16, 2004, pursuant to a reorganization merger. Immediately after
the
reorganization merger, the Company acquired Playwell.
The
Company developed its business through a number of strategic acquisitions,
including the following:
|
·
|
On
March 1, 2005, Grand US acquired International Playthings, Inc.,
a New
Jersey-based US toy distributor.
|
|
·
|
On
December 23, 2005, the Company purchased the shares of Hua Yang and
Kord,
which were owned by Cornerstone Beststep, a then subsidiary of Cornerstone
Overseas.
|
Beginning
in 2006, the Company implemented a plan to restructure the operating divisions
of the Company to focus on profitable divisions:
|
· |
In
August 2006, the Company terminated the operations of Playwell’s Gatelink
subsidiary.
|
|
· |
In
July 2006, the Company decided not to renew an existing license agreement
with Binney & Smith for the Crayola dough product line beyond December
2006. The Crayola dough line was a key element of the Company’s plan to
enter the US mass market for toys and was operated under the Grand
Toys
International, Inc. subsidiary. The Company also discontinued certain
other product lines targeted towards the US mass market and the Company
de-emphasized all its efforts to enter the US mass market for toys
and
discontinued the distribution operations of Grand Toys International,
Inc.
|
|
· |
In
October 2006, the Company decided to discontinue the distribution
of toy
and toy-related products to the mass market in Canada and ceased
the
operations of its Canadian subsidiary, Grand Toys Ltd. (“Grand Canada”),
which conducted the Company’s Canadian mass market sales
efforts.
|
|
· |
In
December 2006, the Company decided to terminate the operations of
Playwell’s Asian World Enterprises Co., Limited (“Asian World”)
subsidiary. Asian World had licenses to develop toy and toy-related
products, most of which had been further sublicensed to, and manufactured
and sold by, Playwell’s Hong Kong Toy Centre Limited (“HKTC”)
subsidiary.
|
B.
Business Overview
Grand
Toys International Limited, through its Hong Kong, PRC and US operating
subsidiaries, develops, manufactures and distributes toy and toy-related
products throughout the world; prints and assembles books and specialty
packaging; and develops and manufactures party goods. At the end of 2006, the
Company operated through four operating subsidiaries: Hua Yang, Kord, IPI and
HKTC.
Grand
Toys International Limited is the holding company of a group of operating
subsidiaries, which includes manufacturing and distribution segments, currently
defined as:
Manufacturing:
|
·
|
Hua
Yang and subsidiaries - Printing &
Packaging
|
|
·
|
Kord
- Manufacture and distribution of Paper Party
Goods
|
Distribution:
|
·
|
International
Playthings, Inc. - North America toy
distribution
|
|
·
|
HKTC
- Toy distribution
|
The
Company’s overall strategy is to:
|
·
|
Sustain
and maintain current profitable business
segments;
|
|
·
|
Grow
through the development, distribution and sale to global retail markets
of
innovative products at competitive prices;
and
|
|
·
|
Grow
through the acquisition of complementary companies that fit into
the
Company’s vertically-integrated
structure.
|
Operating
Subsidiaries
International
Playthings, Inc.
International
Playthings, Inc. is a New Jersey corporation and wholly-owned subsidiary of
Grand US. IPI has been engaged in the toy business for over 30 years and was
acquired by the Company on March 1, 2005. The acquisition by Grand US of IPI
substantially increased Grand US’ distribution capabilities to the specialty toy
retailers throughout North America. Through IPI, Grand US distributes
proprietary and licensed toys to the specialty market in North America. Prior
to
that acquisition, Grand US’ focus was mainly the distribution of toys throughout
Canada through its Canadian subsidiary, Grand Toys Ltd., and expanding product
offerings through the development of proprietary products and expanding
geographically outside of Canada. In 2006, Grand US discontinued its efforts
for
distribution to mass retailers in North America and closed its Canadian
operations and its US mass-market business. Grand US' current business consists
solely of the operations of IPI.
Hong
Kong Toy Centre Limited (HKTC)
HKTC
is a
subsidiary of Playwell International Limited and has operated since 1969. HKTC
develops product for sale under the Playwell brand and supervises the outsourced
manufacture in the PRC of Playwell branded products and products designed by
customers of HKTC for sale under their own brands.
Hua
Yang Holdings Co., Limited
Hua
Yang
is a Cayman Islands company which, through its operating subsidiaries and
predecessors in Hong Kong and China, has engaged since 1935 in specialty
printing for children’s books and games, and produces toy and gift
marketing-related specialty printing and packaging. The Company acquired Hua
Yang on December 23, 2005. Hua Yang has an established track record in the
printing and packaging business and is recognized as a high-quality industry
leader in southern China. Its two operating segments can be broken into
sub-segments, as follows:
Books
and
Board Games:
|
·
|
Design
and production of a range of paper-based novelty items such as pop-up
books, touch-and-feel books, and board books for major publishers
in the
U.K., U.S. and Europe; and
|
|
·
|
Production
of jigsaw puzzles and board games primarily on an OEM basis (e.g.,
Cranium™).
|
Packaging
Products:
|
·
|
Design
and production of high-end promotional parfumerie packaging, value-added
gift packaging, fashion packaging, and confectionary packaging for
luxury
branded goods customers such as LVMH;
and
|
|
·
|
Design
and production of low-end packaging of toy products for the mass
market
(e.g., Barbie™ and Leap Frog™).
|
In
February 2005, Hua Yang acquired the business and certain assets of Eastern
Raiser Printing Company Limited, a former subcontractor of Hua Yang which
specializes in printing and packaging of toys, action figures, games,
recreational products and other toy-related products for third
parties.
Kord
Holdings, Inc.
Kord
Holdings, Inc. is a British Virgin Islands company which, through its Hong
Kong
operating subsidiaries and the PRC factories, is one of the largest party good
manufacturers in the world with over 3,000 employees and over 500,000 square
feet of manufacturing space. Founded in 1972, Kord produces a broad range of
party and paper goods and offers comprehensive lines of party products and
accessories to major importers and superstores overseas, either under its own
“KORD” brand (approximately 50% of sales) or on a OEM basis (approximately 50%
of sales).
Kord
has
over 20,000 designs in key product groups including generic party products,
decorative products, disposable products and latex masks. Generic, decorative,
and disposable products account for more than 90% of total sales and include
paper cups, paper plates, table covers, napkins, hats, horns, banners,
invitations and decorations.
Kord
is
also a licensed manufacturer of party products related to certain Disney-branded
characters. Kord works closely with importers, distributors, party superstores
and international retail chains on ODM and OEM projects all over the world.
Global
Business Strategy
The
Company's goal is to be a leading seller of toy and toy-related products for
children ranging from infants to pre-teens. The Company’s acquisitions of Hua
Yang and Kord have expanded the Company into different niches both within and
beyond the toy-related industries. Hua Yang’s printing division gives the
Company a presence in children’s books and puzzles and allows the Company to
package the toys that the Company manufactures. Hua Yang’s business also offers
the Company other specialty packaging opportunities. Kord’s party goods business
allows the Company to reach its core demographic with different product lines.
Both Hua Yang and Kord enable the Company to approach licensors and retail
stores as a more diversified company that can provide more services, goods
and
opportunities to our customers. The Company seeks to maximize its potential
with
its new product base and continues to look for other opportunities that will
further expand its product base within the toy and toy-related industry.
For
purposes of clarity, we separate the discussion of the Company’s business
into:
|
·
|
Toy
products (IPI and HKTC)
|
|
·
|
Printing
and packaging (Hua Yang)
|
TOY
PRODUCTS (IPI and HKTC)
Business
Strategy
In
the
toy-products area, the Company looked for opportunities that would help it
achieve a premiere status in the specialty toy industry. To achieve its goals,
the Company’s strategy called for increasing cooperation with proprietary toy
concept licensors, diversifying its product range, strengthening its marketing
network and relationships with its multi-national customers, expanding its
distribution channels and increasing and diversifying its customer base. The
Company is focusing on its pursuit to develop new relationships and strengthen
existing relationships with top toy industry licensors for the specialty toy
market.
Competitive
Strengths
The
Company believes that its main competitive strengths in the toy products area
include:
|
·
|
its
vertical integration of capabilities throughout the toy production
cycle;
|
|
·
|
its
executives' extensive experience in the toy industry and familiarity
with
the United States and Canadian
markets;
|
|
·
|
its
client service expertise and competitive pricing
ability;
|
|
·
|
its
stable relationships with licensors of proprietary names, characters and
other toy industry intellectual
properties;
|
|
·
|
its
demonstrated cost-management
abilities;
|
|
·
|
its
diversified core product base; and
|
|
·
|
its
flexibility in adapting to the fast changing and trend-based toy
industry.
|
Products,
Markets & Marketing Channels
The
Company distributes toy, toy related and recreational products through IPI
and
HKTC to retailers and consumers.
The
three
largest customers of IPI are: Ross Stores, Newton Buying/TJ Maxx and The
Discovery Channel, which for the year ended December 31, 2006 accounted for
approximately 4%, 3% and 2%, respectively, of IPI’s net sales. The three largest
customers of HKTC are: Netcam, Target and ASDA Stores which accounted for
approximately 19%, 16% and 7%, respectively, of HKTC’s net sales for the year
ended December 31, 2006. No other customer in the toy product segment accounted
for more than 2% of the Company’s gross sales in 2006.
Net
sales
of toy products by geographical areas in 2004, 2005 and 2006 were as follows.
(in
$000’s)
|
|
2006
|
|
2005
|
|
2004
|
|
US
|
|
$
|
32,908
|
|
$
|
25,341
|
|
$
|
11,755
|
|
Asia
|
|
|
2,021
|
|
|
1,911
|
|
|
4,296
|
|
Europe
|
|
|
2,897
|
|
|
8,392
|
|
|
5,619
|
|
Canada
|
|
|
2,686
|
|
|
1,778
|
|
|
205
|
|
Africa
|
|
|
-
|
|
|
178
|
|
|
423
|
|
Other
|
|
|
152
|
|
|
37
|
|
|
297
|
|
Total
net sales
|
|
$
|
40,664
|
|
$
|
37,637
|
|
$
|
22,595
|
|
International
Playthings
International
Playthings distributes a broad range of toys for infants through teenagers
primarily to the specialty market in North America. IPI’s mission is to develop
and distribute innovative and entertaining products with integrity, superior
play value and child developmental qualities. IPI’s offerings include puzzles,
games, infant and preschool toys, dolls and girls’ products, educational toys
and activity toys.
IPI
buys
finished goods from various Asian manufacturers and ships the goods to its
warehouses in Parsippany, New Jersey. The goods are then shipped to over 3,000
customer locations in the United States.
IPI
employs a sales and marketing staff of 13, including two senior managers, one
employee sales representative and 65 independent sales agents who make on-site
visits to customers for the purpose of soliciting orders for products. IPI
markets products at major and regional toy trade shows in the United States
and
Hong Kong. In addition, IPI maintains showrooms in New Jersey and Hong Kong.
Purchasers of the products include regional retail stores, toy specialty stores
and wholesalers and regional retail stores.
IPI,
in
its regular business operations, does not have long term order commitments
from
its customers. IPI enters into one-year term agreements with the majority of
its
customers. These agreements stipulate payment terms, shipping terms, allowances
and rebates (i.e., advertising allowances, allowances for defective product
returns or volume allowances, if applicable). Payment terms typically vary
between 30 and 90 days with certain incentives granted for a dating program.
Allowances and rebates are deducted from gross sales. The Company sells to
its
customers on open account, allowing customers to purchase products up to certain
pre-established credit limits.
In
certain instances, where retailers are unable to sell the quantity of products
which have been ordered from the Company, the Company may, in accordance with
industry practice, assist retailers in selling such excess inventory by offering
discounts or accepting returns. A portion of firm orders, by their terms, may
be
canceled if the shipment is not made by a certain date. With the shift to the
specialty toy market, the Company’s discounts and allowances have been
significantly reduced as a percentage of sales. The Company establishes sales
reserves at the time of sale based on historical experience of discounts and
returns on related products. The return of non-defective product occurs
infrequently in the U.S. Customers receiving defective products (in accordance
with their term agreements) could claim product returns against the rebates.
If
a defective return is material, IPI has recourse against the manufacturer of
the
product.
IPI
directly, or through outside salespersons, accepts written orders for products
from customers and submits the orders to IPI’s vendors who then arrange for
manufacture of the products. Customer order cancellations are generally made
in
writing and IPI will then notify the appropriate vendors of customer
cancellations who in turn notify the manufacturers. This procedure allows IPI
to
avoid adding products to inventory as a result of customer cancellations of
orders. Customers generally have the right to cancel purchase orders for which
goods have been purchased. IPI attempts to minimize this possibility by ensuring
that customer orders are matched to product purchases.
HKTC
HKTC
is
an international designer and supplier of plastic and wooden toys in the infant,
preschool and activity toy categories, with distribution capabilities in key
markets worldwide. It also supervises outsourced manufacturing of toy products
of its own design for sale under the "Playwell" brand or designed by its
customers for sale under those customer's own brand names.
HKTC
supplies several lines of plastic toys - toys for preschool children, water
toys
and toys for infants. Many of these plastic toys require sophisticated
injection-mold production of specialty cartoon characters, such as Disney
licensed characters. These character replicas come in various scales and are
medium and high-feature products that must meet exacting standards. Many of
these character replicas have complex designs, which require high-quality
workmanship and decorative details. HKTC also supplies wooden toys, doll
furniture, children's furniture and rockers. HKTC sells its products directly
to
retailers in the U.S. and the U.K. and to distributors worldwide. HKTC has
dedicated sales staff, a long standing commission-based network of sales
representatives in Europe and the U.S. and access to another sales network
in
the U.S.
Sources
of Product
Approximately
36% of the Company’s toy product net sales in 2006 were from products supplied
by the following five vendors: Epoch, Tomy, Kiddieland Toys, Densfine Industries
Ltd. and Early Learning Centre. Products from these vendors accounted for 13%,
9%, 5%, 5% and 5%, respectively, of 2006 toy product net sales. Other than
the
products from the above-mentioned vendors, no products from any other vendor
or
from the Company’s proprietary products accounted for more than 3% of the
Company’s toy product net sales in 2006.
The
products distributed by IPI are manufactured for the Company by unaffiliated
third parties principally located in China. For the products distributed by
HKTC, approximately $2.5 million worth of goods are manufactured by related
parties Zhejiang Playwell Toy Co. Ltd. and Playwell Industry Ltd.
For
its
proprietary product lines, the Company orders products from its vendors which
in
turn select product manufacturers on the basis of factors standard in the toy
industry including price, payment terms, product quality, reliability and the
ability of a manufacturer to meet delivery requirements. For products using
licensed properties, the licensors may have the right to approve the
manufacturers selected by the vendors. The use of third-party manufacturers
enables the Company to avoid incurring fixed manufacturing costs, but also
reduces its ability to control the timing and quality of the manufacturing
process.
For
the
product lines distributed for third parties, the Company does not supervise
the
day-to-day manufacturing of these products. However, prior to the commencement
of manufacturing, the Company, the vendor and the manufacturer work together
to
design a prototype of the specific product and its packaging. The manufacturer
is contractually obligated to manufacture the products in accordance with those
prototype specifications. For licensed products, some licensors may be required
to approve the prototype prior to production.
Overseas
manufacturers are generally paid by either letter of credit or wire transfer.
Payment is made only upon the proper fulfillment of terms established by the
Company for each purchase order. These terms include adherence to product
quality, design, packaging and shipping standards, as well as proper
documentation relating thereto. Most product purchases are paid for in U.S.
dollars.
The
Company is not a party to any long-term supply or requirements agreements with
any specific manufacturer. Generally, under IPI’s distribution agreements, IPI
is responsible for paying shipping and other related costs upon the purchase
of
goods from the vendor.
License
and Distribution Agreements
Many
of
IPI’s products are based on properties licensed from third parties. Pursuant to
license and distribution agreements for such properties, IPI obtains either
the
exclusive or non-exclusive right to import and distribute the covered products
throughout North America, depending on the contract terms. License agreements
generally have terms of one to three years and are usually exclusive for a
specified product or product line within a specific territory.
Seasonality
The
Company’s toy business is seasonal, with a majority of sales occurring during
the period from September through December in advance of the holiday season.
Therefore, the annual results of the Company’s toy product segment depend, in
large part, on sales during the relatively brief holiday season.
Further,
the effects of seasonality are increasing as large retailers become more
efficient in their control of inventory levels through quick response management
techniques. These retailers are timing reorders so that they are being filled
by
suppliers closer to the time of purchase by retailer, rather than maintaining
large on-hand inventories throughout the year to meet consumer demand. While
these techniques reduce a retailer's investment in inventory, they increase
pressure on suppliers like the Company to fill orders promptly and shift a
significant portion of inventory risk and carrying costs to the supplier. The
limited inventory carried by retailers may also reduce or delay retail sales.
Additionally, the logistics of supplying more and more product within shorter
time periods increase the risk that the Company may fail to achieve tight and
compressed shipping schedules.
Management
of the Company attempts to offset the seasonal nature of the industry by seeking
out non-seasonal product lines. The addition of the year-round specialty retail
business from IPI has helped to offset the typical sales and inventory
concentration for the third and fourth quarters.
Toy
Products Competition
The
toy
products industry in which the Company competes is highly competitive. The
Company competes with other smaller scale toy companies including Melissa and
Doug, Small World Toys, Alex Toys, Briar Patch and other small manufacturers
and
distributors are also competitors of the Company. The Company remains
competitive by offering full service to its customers, including marketing
programs and customer service. The toy industry’s highly competitive environment
continues to place cost pressures on manufacturers and distributors.
Discretionary spending among potential toy consumers is limited and the toy
industry competes for those dollars along with the makers of computers and
video
games.
PRINTING
AND PACKAGING (HUA YANG)
Hua
Yang,
through its subsidiaries’ manufacturing facilities located in Shenzhen and
Dongguan, China, is a contract manufacturer of a variety of paper and board
products, including books, specialty packaging and other paper products.
Products
Books
Hua
Yang
book manufacturing capabilities include the following types of
books:
|
·
|
"Pop-up"
books containing custom die-cut, folded and glued paper pieces that,
when
the book is opened, "pop" out of the book in three dimensions. These
products typically retail in the U.S. for between $5 and $50. Most
of Hua
Yang's "pop-up" books are targeted at children, but there is a small
segment that targets the adult and young adult
markets.
|
|
·
|
Novelty
books, sometimes also referred to as "book-plus", incorporate an
extra or
unusual element. These elements often make the book interactive or
provide
play value. For example, novelty books may include an electronic
device, a
noisemaker, plastic, vinyl, textured or scented materials, or a plush
toy.
|
|
·
|
Board
books are usually die-cut or punched into an unusual shape, thus
requiring
hand-assembly. These books are made of heavyweight, stiff paperboard,
are
durable in nature, and usually target the children's market. Often
board
books come in a set of three or more titles and are grouped together
in a
hand-assembled slip case, sleeve or custom made box.
|
Hua
Yang’s books are sold through toy and bookstores, authorized dealers and other
channels.
Specialty
packaging
Most
of
the specialty packaging produced by Hua Yang is for Motorola phones, perfume
and
luxury product manufacturer customers. Specialty packaging requires high quality
paper and board and, to a lesser extent, blister cards and vac tray inserts.
Box
packaging often requires advanced printing techniques, including five- and
six-color printing, foil hot stamping, spot or total coating, varnishing,
embossing and lamination. After printing, boxes are die-cut to shape with a
dropout window often including PVC sheets, which also are cut to shape and
often
incorporate some silk screen printing, are glued in place by hand in the dropout
windows. Blister cards are simple backing boards used in a plastic blister
pack
while insert cards are printed pieces of board used as backing or filler inside
a larger packaging box.
Other
paper products
Other
paper products manufactured by Hua Yang include puzzles, board games, and
activity packs, all of which require hand assembly.
These
products are targeted at children, young adults and adults. These products
are
sold through hobby shops, authorized dealers, book and gift stores, as well
as
through other channels.
Market
for Products
Sales
of
Hua Yang’s products are divided among the United States, Asia and Europe. Major
customers for Hua Yang include Motorola, Cranium Inc., PR Services, Early Light,
Macmillan and Mattel.
The
buying and ordering cycles for specialty packaging and books differ. With regard
to specialty packaging, in November or December, Hua Yang reviews with its
core
packaging customers anticipated packaging needs for the upcoming year. By the
beginning of the calendar year, the core packaging customers will provide Hua
Yang with indicative dollar and unit allocations for the year. These allocations
will be based on Hua Yang's past performance, capacity and technical capability
vis-a-vis the designs requested by the customer. Every week thereafter, Hua
Yang
will receive purchase orders covering the next four to six weeks. Firm orders
and packaging planning rarely extend beyond six weeks.
The
buying and ordering cycles for books varies and is generally much longer than
specialty packaging, with most activity grouped around the Frankfurt Book Fair
held in Germany every October and the Children's Book Fair held in Bologna,
Italy every April. The fairs are a time for customers of Hua Yang to present
their new book concepts to potential buyers and confirmed sales are usually
realized three to 12 week after each fair. Once these customers have confirmed
sales, they turn to contract printers, such as Hua Yang, to reserve production
capacity. Orders for reprints of old titles, however, can be booked anytime
during the year, but generally fall outside of the peak summer production
months.
Competitive
Strengths
Hua
Yang
believes its customers seek suppliers that can manufacture high-quality products
in both large quantities and limited runs in a timely and cost-effective manner.
These customers seek to eliminate the cost, time and complexity of identifying
and managing multiple vendors to develop and produce a product. For example,
book customers often must turn to trading houses, brokers or service
intermediaries for component sourcing, product development and engineering.
The
need to coordinate several different companies in the manufacturing process
can
cause production delays, inefficiencies in the management of multiple
contractors and quality and reliability problems. Hua Yang's full service
approach to manufacturing offers the following solutions to address these
customers needs:
High-quality
production
Hua
Yang
uses modern computer-aided design and manufacturing equipment to produce
high-quality products. Hua Yang also employs a highly trained workforce,
including skilled, technically trained craftsmen and other competent but
relatively inexpensive labourers for its manufacturing and assembly operations
under the guidance of experienced management. Hua Yang ensures quality through
rigorous quality control procedures at each step of the production process.
Hua
Yang has an employee training program geared specifically toward inspection
and
quality control. Hua Yang’s manufacturing facilities are ISO9001 and BPI9004
certified.
Turnkey
manufacturing service
Hua
Yang
offers a fully integrated turnkey manufacturing service. Hua Yang integrates
component sourcing, product development and engineering, design, model and
mould
making, and manufacturing, assembling and packaging of the finished product.
This enables Hua Yang to meet all of a customer's needs and eliminates the
need
for intermediaries. This integrated approach allows Hua Yang to shorten the
lead-time from design to product delivery and to lower product cost while
maintaining high quality and reliability.
Commitment
to efficiency
Hua
Yang
continually strives to increase efficiency and reduce costs, which allows Hua
Yang to offer competitive pricing to its customers. To date, Hua Yang has been
able to achieve efficiencies by locating its production facilities in the PRC,
vertically integrating its production processes and working in close cooperation
with its customers.
Business
Strategy
Hua
Yang’s goal is to be the leading contract manufacturer of books, specialty
packaging and other paper products for the premier designers and marketers
of
these items. Hua Yang’s strategy calls for continuous strengthening of its
relationships with its multi-national customers and increasing and diversifying
its customer base. To achieve these goals, Hua Yang has focused on the
following:
Developing
additional major customers
Currently,
Hua Yang has a core group of large customers, but it also manufactures products
for many other smaller customers. Hua Yang expects that it may be able to
develop several of these smaller customers into major customers as they become
more familiar with the benefits of Hua Yang’s turnkey manufacturing service. Hua
Yang offers major customers a dedicated production team and dedicated production
space, which can provide such customers with attractive advantages. For example,
Hua Yang can customize its production facilities to meet the specific needs
of
its customers, and the customers are able to exercise greater control over
the
production process, thereby enhancing quality control and cost efficiency,
increasing confidentiality and expediting scheduling and delivery timetables.
Hua Yang believes that its ability to offer such dedicated production services
has led to enhanced relationships with its core customer base.
Diversifying
product offerings
Hua
Yang
intends to diversify its product offerings to include the manufacture of other
consumer products that utilize its current competitive advantages and production
expertise. Further, new product lines are expected to decrease seasonality
that
Hua Yang has historically experienced. By diversifying into product lines in
which the demand timing is seasonal, the utilization of manufacturing facilities
can improve, thereby improving profitability.
Deploying
advanced management information systems
Hua
Yang
seeks to enhance its manufacturing and business processes by deploying advanced
management information Oracle-based systems that enable the real-time monitoring
and management of its operating and financial performance and resources.
Seasonality
Hua
Yang’s operating results in the past have fluctuated, and will likely continue
to fluctuate, in part based on seasonal factors.
Hua
Yang
ceases production for a two-week period during January or February of each
year
due to the Chinese New Year holiday, which is partially responsible for net
sales during the first fiscal quarter of each year being lower than net sales
during the other three fiscal quarters.
Hua
Yang
may also experience fluctuations in quarterly revenues and related net income
due to the timing of receipt of orders from customers and the shipment of
products. Sales of books are weighted toward the Christmas season; as a result,
book sales in the second half of the fiscal year are generally higher than
in
the first half.
Manufacturing
Hua
Yang's manufacturing operations are conducted in a production facility located
in Shenzhen, PRC. The Shenzhen Facility includes: a pre-press area, press rooms
and print finishing area, die-cut, trimming, guillotining and punching areas,
packaging and book hand assembly areas, a warehouse and dormitory and dining
facilities. The press rooms operate on a two-shift basis with seven advanced
German presses delivering up to six-color printing capability. The die-cut
department also runs on a two-shift basis during the peak season. Hand
assemblers for both packaging and books generally work one shift, adding an
additional shift during the peak season. Packaging and books account for most
of
the total work force and production areas. In addition, Hua Yang has a
production facility in Dongguan, PRC that is used mainly for manufacturing
specialty packaging.
Raw
Materials
Paper,
ink and glue are the principal raw materials used by Hua Yang. Hua Yang uses
many types of coated paper and board in a variety of grades, depending on
customers' quality and price requirements. Hua Yang purchases a majority of
its
paper from U.S., Asian and European suppliers, but generally places orders
through trading companies or agents in Hong Kong. Additionally, Hua Yang
acquires a small amount of paper from local sources in Hong Kong and PRC. Ink
and glue are ordered locally in Hong Kong.
Intellectual
Property
Hua
Yang
has no registered trademarks in respect of its manufacturing businesses. Hua
Yang owns a utility patent in the U.S. on a novelty book product.
Books
and Specialty Product Packaging Competition
Hua
Yang
faces significant competition in its business. In "pop-up" books, Hua Yang
principally competes with contract manufacturers located in Southeast Asia
and
South America. In novelty and board books as well as specialty packaging, Hua
Yang principally competes with contract manufacturers located in Hong Kong
and
other parts of the PRC. In addition, certain of Hua Yang’s customers have the
capability to manufacture their products internally.
Hua
Yang
believes that there are several factors that provide the basis of competition
in
the manufacturing of its products, including: price, quality, technical
capabilities, production capabilities and on-time delivery. Hua Yang believes
that it can maintain its competitive advantage through the effective use of
its
facilities. Hua Yang also expects increased competition from other industry
participants that may seek to enter one or more of Hua Yang's high margin
product segments.
Hua
Yang
does not believe that there are any significant barriers to entry into the
light
manufacturing business and its business is not based on the ownership of
proprietary patents, trademarks or copyright. Accordingly, additional
participants may enter the market at any time.
PARTY
GOODS (KORD)
Kord
is
one of the world’s largest party goods manufacturers with over 3,000 employees
and over 500,000 square feet of manufacturing space.
Products
Kord
produces a broad range of party and paper goods and offers comprehensive lines
of party products and accessories to major importers and superstores, either
under its proprietary Kord brand, or as a contract manufacturer for well known
brands. Kord has over 20,000 ready-for-manufacture designs in key product
groups, including
|
·
|
generic
party products like hats, horns, blowouts, noise makers;
|
|
·
|
decorative
products like banners, garlands and honeycomb decorations;
|
|
·
|
disposable
tableware products like paper cups, paper plates, napkins and table
covers; and
|
Kord's
proprietary products cover all major party occasions, themes and seasons,
including birthdays, Halloween, Thanksgiving, Christmas, New Year, Valentine’s
Day, St Patrick's Day and Easter.
The
generic, decorative, and disposable products accounted for more than 90% of
total sales in 2006. Kord is also a licensed manufacturer of Disney-branded
party products. Kord works closely with importers, distributors, party
superstores and international retail chains on ODM and OEM projects all over
the
world.
Market
for Products
Approximately
51%, 38% and 11% of Kord’s sales revenue in 2006 was from products distributed
in the US, Europe and the rest of the world, respectively. Kord’s major
customers include Creative Expressions, Hallmark, Tesco Stores and American
Greetings.
Business
Strategy
Kord’s
strategy is to develop its own brand party products and to design party products
for customers on an OEM basis. Kord has its own in house design department
to
create new designs. Kord seeks to increase the quality of its products by
investing in new equipment, and constantly reviews its own manufacturing
processes with a view to making improvements.
Manufacturing
Kord’s
manufacturing operations are located in Dongguan, PRC. Kord's printing equipment
includes Heidleberg and Roland offset printers, gravure printers, flexographic
printers, and printing peripherals such as plate making, varnishing,
calendaring, laminating, silk screening, pad stamping and hot stamping setups.
Kord’s equipment enables Kord to add patterns onto a wide range of party items
and maintain a high standard of printing quality and short printing lead-time
for its products.
Plastic
toys and party accessories are manufactured with Kord's injection moulding
and
blow-moulding machines. Moulds and tooling are also made in house. Polyethylene
extruding machines extrude plastic bags and plastic sheets for packaging and
products such as tablecovers, lootbags and banners.
Kord
uses
other specialized equipment to produce paper cups, plates and lunch boxes.
Kord
also has setups for making latex masks and paper honeycombs and garlands, and
special machines for products such as blowouts, Hawaiian leis and serpentines.
Seasonality
Kord’s
birthday party products enjoy continuous sales throughout the year because
birthdays occur year-round. Kord’s production peaks in July, August and
September in advance of delivery deadlines for Halloween, Christmas and the
New
Year. With the exception of the Chinese New Year holidays, Kord’s sales and
production operations are relatively constant during the remaining months of
the
year.
Raw
Materials
Kord’s
main raw materials are paper, ink, glue, latex, and plastic resin. Different
types of paper are used for different products. Paper is purchased by Kord
from
suppliers in Finland, the US, Japan, Korea, Indonesia and China; plastic resins
are sourced from Saudi Arabia and Thailand. Ink and glue are sourced from Japan,
Korea and China and latex is supplied from Malaysia. Kord has not entered into
long term supply agreements with any of its suppliers. Kord is not reliant
on
any particular supplier.
Intellectual
Property
Kord
has
registered the “Kord” trademark in the US, Germany, China and Hong Kong. Kord
also owns eight US copyright registrations in respect of party hats, one UK
registered design in respect of “Party Blowout”, and two US design patents in
respect of noisemakers.
Party
Goods Competition
Kord
does
not believe that its business is currently threatened by any single competitor
because, as far as its directors are aware, no other global manufacturer has
a
product range as varied and capacity as large.
Product
Liability
The
Company maintains product liability coverage for the Company’s operations in the
aggregate amount of $10,000,000. The Company believes that this coverage is
adequate for its risks.
Government
Regulation
The
Company is subject to the provisions of various laws, including those of PRC,
Hong Kong, the EU and the United States Federal Government and various states
in
the United States, and the Federal Government of Canada, the Government of
the
Province of Quebec, Canada and other Canadian provinces.
The
Company is required to comply with PRC laws governing the protection of the
environment and occupational health and safety, including laws regulating the
generation, storage, handling, use and transportation of waste materials; the
emission and discharge of waster materials into soil, air and water; and the
health and safety of employees. We are also required to obtain and comply with
environmental permits for certain operations.
The
Company is subject to the provisions of, among other laws, the U.S. Federal
Hazardous Substances Act and the U.S. Consumer Product Safety Act. Those laws
empower the U.S. Consumer Product Safety Commission (the “CPSC") to protect
children from hazardous toys and other articles. The CPSC has the authority
to
exclude from the market articles that are found to be hazardous. Similar laws
exist in Hong Kong and in some states and cities in the United States, Canada
and Europe.
The
Company is also subject to the Consumer Packaging and Labeling Act enacted
by
the Government of Canada, which regulates the sale, importation, or advertising
in Canada of items, which have misleading information on their
label.
For
products sold into Canada, the Company is also subject to the Charter of the
French Language, which requires that all labeling and instructions appear in
the
French language, as well as the Upholstery and Stuffed Articles Act, which
requires that stuffed articles conform to hygienic norms, and obligates
companies to take measures against contamination during transportation and
storage. Similar laws exist in several cities and provinces throughout Canada
and in many jurisdictions throughout the world.
The
Company maintains a quality control program to ensure compliance with all
applicable laws in all jurisdictions in which the Company operates.
C.
Our Organizational Structure
The
Company conducts its businesses solely through wholly-owned operating
subsidiaries, IPI, Hua Yang, Kord and HKTC.
D.
Property, Plant and Equipment
The
Company and/or its subsidiaries, occupy the following properties:
Hong
Kong
The
Company’s principal executive offices were originally located in an
approximately 6,308 square foot space located at Room UG202, Floor UG2,
Chinachem Golden Plaza, 77 Mody Road, Tsimshatsui East, Kowloon, Hong Kong.
The
lease for the premises is held in the name of Asian World Enterprises, a
subsidiary of Playwell. HKTC occupies a portion of this space pursuant to a
facilities sharing agreement. The facilities sharing agreement expires on
September 30, 2007 and the current monthly rent is $16,300. A new tenancy
agreement has been signed with a term of two years commencing from August 15,
2007 with a monthly rental of $10,200. The new principal executive office,
with
approximately 3,618 square foot, is now located at Suite 1501, 15th
Floor,
Chinachem Golden Plaza, 77 Mody Road, Tsimshatsui East, Kowloon, Hong Kong.
The
premises are also the principal place of business for Playwell and its
subsidiaries.
China
|
·
|
Hua
Yang has two manufacturing locations that include office space. Hua
Yang’s
Shenzhen facility has an aggregate of approximately 451,870 feet
of
manufacturing space and approximately 248,300 feet of dormitory space.
A
co-operative joint venture was established between Hua Yang and an
entity
controlled by a PRC governmental entity to own and operate the Shenzhen
facility. Hua Yang leases its factory buildings at the Shenzhen facility
from the joint venture. The joint venture has a term of 15 years,
expiring
in October 2010. Under the joint venture agreement, Hua Yang possesses
substantive participating rights and is entitled to all of the joint
venture's profits, after paying the joint venture partner a pre-determined
annual fee. At the end of the joint venture term, Hua Yang will continue
to own the other assets of the joint venture, but the land and factory
buildings currently used to conduct the business of the joint venture
will
revert to Hua Yang’s joint venture partner. The term of this lease is from
April 2005 to March 2008 and the monthly cost is $83,000. Hua Yang’s
Dongguan facility is approximately 250,000 square feet and includes
office, warehouse and dormitories. The lease expires in July 2010
and the
monthly rent is approximately
$28,000.
|
|
·
|
Kord
maintains five locations in China. The total square footage occupied
for
office, manufacturing, dormitories and storage is approximately 992,000
square feet for an aggregate monthly rental cost of approximately
$83,600.
The terms of the leases for the various facilities end between the
years
2006 and 2010.
|
In
January 2006, the Company began renting office space from Cornerstone Management
(Shenzhen) Limited, an affiliate of the Company’s controlling shareholder. The
Company’s subsidiaries, HKTC, Hua Yang and Kord, occupy approximately 9,000
square feet, which represents a portion of the total space pursuant to a
facilities sharing agreement. The monthly rent is approximately $11,400 and
is
based on head count usage. There is no formal written agreement between the
parties.
U.S.
IPI
maintains an office and warehouse facility in an approximately 119,400 square
foot facility at 75D Lackawanna Avenue in Parsippany, New Jersey. The term
of
the lease, including a renewal period, extends to May 31, 2010. The current
monthly rent is $54,700.
Canada
The
Company’s Canadian subsidiary, Grand Toys Ltd., occupied an approximately
105,000 square foot facility located at 1710 Route Trans-Canada, Dorval, Quebec,
Canada. The Company used part of this facility for offices, showroom,
warehousing and distribution, and sublet the balance. The lease for the premises
expires on September 30, 2009. The current monthly rent is $29,050 and is
increased each year by a percentage that is equal to 75% of the percentage
increase in the consumer price index for the greater Montreal, Canada area.
In
2007, the Company sub-let the entire building through the balance of the term
of
the lease to an unrelated third party at substantially the same rent that the
Company pays.
The
Company believes that its current facilities are adequate for its present needs
and that its insurance coverage is adequate for the premises.
Item
4A. Unresolved Staff Comments
None.
Item
5. Operating and Financial Review and Prospects:
The
following discussion and analysis of our financial condition and results of
operations is based upon and should be read in conjunction with the Company’s
Audited Consolidated Financial Statements for the fiscal years ended December
31, 2004, 2005 and 2006 which are included as part of this annual report, the
Company’s Registration Statement on Form F-4 which was declared effective by the
Securities and Exchange Commission on July 29, 2004 and Playwell’s audited
financial statements for the fiscal year ended December 31, 2003, which were
included in the Company’s Form F-4. As discussed below, the Company’s financial
statements for the fiscal year ended December 31, 2005 and 2004 have been
restated to give effect to the acquisition of Hua Yang and Kord and the
discontinuance of the operations of Gatelink, Asian World, Grand Toys Ltd.
and
Grand Toys International, Inc. and the Crayola business conducted by Grand
Toys
(HK) Ltd. This discussion may contain forward-looking statements based upon
current expectations that involve risks and uncertainties. Our actual results
may differ materially from those anticipated in these forward-looking statements
as a result of various factors, including those set forth under “Item 3. Key
Information - D. Risk Factors” or in other parts of this annual report on Form
20-F.
A.
Operating Results
Overview
The
Company develops, manufactures and distributes toy and toy-related products
throughout the world; prints and assembles books and specialty packaging; and
develops and manufactures party goods. The Company conducts its business through
its four operating subsidiaries: Hua Yang, Kord, IPI and HKTC.
Corporate
History
On
November 14, 2003, Grand US and Centralink entered into the Subscription and
Exchange Agreement pursuant to which, among other matters:
·
|
Grand
US undertook a corporate reorganization pursuant to which Grand US
and its
operating subsidiaries became subsidiaries of the Company, with each
issued and outstanding share of Common Stock of Grand US being converted
into one ADS, evidenced by one ADR, representing beneficial ownership
of
one ordinary share of the Company, and each outstanding option and
warrant
to purchase Grand US’s Common Stock being converted into one option or
warrant to purchase the Company’s ADSs representing beneficial ownership
of one ordinary share of the
Company.
|
·
|
The
Company acquired from Centralink all of the issued and outstanding
capital
stock of Playwell in exchange for the issuance to Centralink of 5,000,000
ADSs; and
|
·
|
Centralink
subscribed for 5,000,000 of the Company’s ADSs for cash and other
consideration in a total amount of
$11,000,000.
|
The
transaction consummated on August 16, 2004. For accounting
purposes, Playwell was deemed to be the acquirer, therefore the results of
Grand
US are only included from August 16, 2004 and the 2003 comparative numbers
reflect Playwell’s results only.
On
March
1, 2005, the Company acquired the assets of IPI. IPI’s results from March 1,
2005 are included in the Company’s 2005 results.
On
December 23, 2005, the Company purchased the shares of Hua Yang and Kord, which
were owned by Cornerstone Beststep. The Company, Hua Yang and Kord, through
Cornerstone Beststep were under the common control of the Company’s majority
shareholder, Jeff Hsieh, who was the sole beneficial owner of Hua Yang and
Kord.
The purchase method of accounting for the business combination was used;
however, due to the common control of the entities, the Company is required
to
restate its financial statements back to the date of common control as if Hua
Yang and Kord were part of the Company on May 24, 2004 and June 30, 2004,
respectively, the dates that they were acquired by Cornerstone Beststep’s former
parent company, Cornerstone Overseas. Under this method of accounting, the
excess of the value paid to Cornerstone Beststep over the original cost of
Hua
Yang and Kord is reflected as a non-recurring deemed dividend in the 2005
financial statements. Further, the Company’s acquisition costs are treated as
restructuring costs and recorded as an expense in the 2005 financial
statements.
As
a
result of these and certain other acquisitions the Company made during 2004
and
2005, any comparison of the year ended December 31, 2006 to the year ended
December 31, 2005 and from the year ended December 31, 2005 to the year ended
December 31, 2004 must consider the following acquisition dates when the
financial performance of each new entity begins to be included in the financial
statements of the Company:
|
·
|
May
24, 2004 - inclusion of Hua Yang
|
|
·
|
June
18, 2004 - inclusion of Kord
|
|
·
|
August
16, 2004 - inclusion of Grand Toys Ltd., Canadian subsidiary of Grand
US
|
|
·
|
February
1, 2005 - inclusion of the business of Eastern Raiser, Hua Yang’s Dongguan
operations
|
|
·
|
March
1, 2005 - inclusion of IPI
|
Net
Sales
Net
sales
include gross revenues, freight charged to clients and FOB commissions, net
of
allowances and discounts such as defectives, returns, volume rebates,
cooperative advertising, cash discounts, customer fines, new store allowance,
markdowns, freight and warehouse allowances.
The
pricing of the Company’s goods is affected by the price it obtains from its
vendors (cost of goods sold), which dictates the selling price the Company
can
charge its customers. Other factors that influence the Company’s setting of the
selling price include the condition of the current market and the demand for
the
item itself.
Cost
of Goods Sold
The
cost
of goods sold for products imported by the Company as finished goods includes
the cost of the product in the appropriate domestic currency, duty and other
taxes, and freight and brokerage charges. Royalties payable to the Company’s
licensor-vendors which are not contingent upon the subsequent sales of the
licensor-vendors’ products are included in the price paid for such products.
Royalties include payments by the Company’s subsidiaries to licensors of
character properties and to manufacturers of toy products if such payments
are
contingent upon subsequent sales of the products. Royalties are usually a
percentage of the price at which the product is sold and are payable once a
sale
is made. The cost of goods sold for products manufactured by the Company
includes raw materials, direct labor, machinery depreciation and
overhead.
Other
Operating Income
The
Company’s other operating income includes bad debt recovery, rental income,
service/agency fee income, and sales of scrap products and sundry
income.
Operating
Costs and Expenses
The
Company’s operating costs and expenses principally consist of general and
administrative expenses, selling and distribution expenses and depreciation
and
amortization.
General
and administrative expenses
The
major
components of the Company’s general and administrative expenses include salaries
for administrative personnel and related costs, rent, insurance, consulting
fees, legal fees and audit fees.
Selling
and distribution expenses
Selling
and distribution expenses principally consist of outbound shipping and handling
costs, sales commissions and salaries and fringe benefits for sales
personnel.
Non-Operating
Expenses (Income)
The
Company’s non-operating expenses (income) principally consist of interest paid
by the Company on its bank and other borrowings and interest received by the
Company on bank deposits.
Critical
Accounting Policies and Estimates
The
Company’s consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the US. The preparation of
these consolidated financial statements requires the Company’s management to
make estimates and assumptions that affect the reported amounts of certain
assets, liabilities, revenue and expenses and the disclosure of contingent
assets and liabilities at the date of and during the consolidated financial
statements. On an on-going basis, the Company’s management evaluates its
estimates and judgments, including those related to sales reserve for returns
and allowances and inventory
obsolescence. The Company’s management bases its estimates
and judgments
on the customer term agreements, historical experience, retail performance
of the products
sold and on various other factors that are believed to be reasonable under
the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent
from
other sources. Actual results may differ from these estimates.
Principles
of consolidation:
The
consolidated financial statements include the financial statements of the
Company and all its majority-owned subsidiaries and the variable interest
entities in which the Company is deemed to be the primary beneficiary. All
significant intercompany accounts, transactions and cash flows have been
eliminated on consolidation.
Revenue
recognition:
Sales
are
recognized at the time of transfer of ownership, which is upon the shipment
of
products. The Company estimates liabilities and records provisions for customer
allowances as a reduction of revenue when such revenue is recognized.
Cooperative advertising expense for the years ended December 31, 2006, 2005
and
2004 were $250,000, $420,000, and $60,000, respectively, and are shown as a
reduction of gross sales in the financial statements. Slotting fees are recorded
as a deduction of gross sales. These fees are determined annually on a customer
by customer basis.
Trade
receivables:
Trade
receivables are recorded at the invoiced amount and do not bear interest. The
allowance for doubtful accounts is the Company’s best estimate of the amount of
probable credit losses in the Company’s existing accounts receivable. The
Company determines the allowance based on historical write-off experience.
The
Company reviews its allowance for doubtful accounts monthly. Past due balances
over 90 days and over a specified amount are reviewed individually for
collectibility. Account balances are charged off against the allowance after
all
means of collection have been exhausted and the potential for recovery is
considered remote. The Company does not any off-balance sheet credit exposure
related to its customers.
Inventories:
Inventories,
consisting of raw materials, work in progress and finished goods, is valued
at
the lower of cost, determined by the first in, first out method or market
value.
Goodwill:
Goodwill
represents the excess of costs over fair value of assets of businesses acquired.
The Company adopted the provisions of SFAS No.142, Goodwill and Other Intangible
Assets. Goodwill and intangible assets acquired in a purchase business
combination and determined to have an indefinite useful life are not amortized,
but instead tested for impairment at least annually in accordance with the
provisions of SFAS No. 142. SFAS No. 142 also requires that intangible assets
with finite useful lives be amortized over their respective estimated useful
lives to their estimated residual values, and reviewed for impairment in
accordance with SFAS No. 144, Accounting for the Impairment or Disposal of
Long-lived Assets.
The
management evaluated the impairment of goodwill in two steps: (1) the
identification of potential impairment by comparing the fair value of a
reporting unit with its carrying amount, including goodwill and (2) the
measurement of the amount of goodwill impaired by comparing the implied fair
value of the reporting unit goodwill with the carrying amount of that goodwill
and recognizing a loss by the excess of the latter over the former. For
assessment of impairment loss, the Company will measure fair value based either
on internal models or independent valuations.
Impairment
of long-lived assets:
The
Company evaluates the recoverability of long-lived assets with finite lives
in
accordance with SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets. SFAS No. 144 requires long-lived assets, such as property,
plant and equipment, and purchased intangibles subject to amortization, to
be
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Recoverability
of
assets to be held and used is measured by a comparison of the carrying amount
of
an asset to estimated undiscounted future cash flows expected to be generated
by
the asset. If the carrying amount of an asset exceeds its estimated future
cash
flows, an impairment charge is recognized by the mount by which the carrying
amount of the asset exceeds the fair value of the asset.
Goodwill
and intangible assets not subject to amortization are tested annually for
impairment, and are tested for impairment more frequently if events and
circumstances indicate that the asset might be impaired. An impairment loss
is
recognized to the extent that the carrying amount exceeds the asset’s fair
value.
Incomes
taxes:
The
Company follows the asset and liability method of accounting for income taxes.
Under the asset and liability method, the change in the net deferred tax asset
or liability is included in the computation of net income. Deferred tax assets
and liabilities are measured using enacted or substantively enacted tax rates
expected to apply to taxable income in the years in which temporary differences
are expected to be recovered or settled. Deferred tax assets are evaluated
and,
if realization is not considered to be “more likely than not”, a valuation
allowance is provided.
Foreign
currency translation:
All
transactions in currencies other than functional currencies during the year
are
translated at the exchange rates prevailing on the respective transaction dates.
Monetary assets and liabilities existing at the balance sheet date denominated
in currencies other than functional currencies are measured at the exchange
rates existing on that date. Exchange differences are recorded in the
consolidated statement of operations.
The
functional currencies of the Company and its subsidiaries and variable interest
entities include Renminbi, Canadian dollars, United States dollars or Hong
Kong
dollars. The consolidated financial statements of the Company are presented
in
United States dollars. The financial statements of the Company and all of its
subsidiaries and variable interest entities with functional currencies other
than the United States dollars, the reporting currency, are translated in
accordance with SFAS No. 52, “Foreign Currency Translation”. All assets and
liabilities are translated at the rates of exchange ruling at the balance sheet
date and all income and expense items are translated at the average rates of
exchange over the year. All exchange difference arising from the translation
of
financial statements are recorded as a component of accumulated other
comprehensive income.
Accounting
for Stock-Based Compensation:
Effective
January 1, 2006, the Company adopted Statement of Financial Accounting Standards
No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which amends
Statement of Financial Accounting Standards No. 123, as amended by No. 148,
and
Statement of Financial Accounting Standards No. 95, “Statement of Cash Flows”.
The Company adopted SFAS 123R under the modified prospective basis as defined
in
the statement. In 2006, the Company recorded stock option expense based on
all
unvested stock options as of the adoption date as well as all stock-based
compensation awards granted subsequent to the adoption date. Prior to 2006,
as
permitted by Statement of Financial Accounting Standards No. 123, as amended
by
No. 148, “Accounting for Stock-Based Compensation”, (collectively “SFAS 123”),
the Company accounted for those plans under the recognition and measurement
principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock
Issued to Employees”, and related interpretations. As required by the Company’s
existing stock plans, stock options are granted at or above the fair market
value of the Company’s stock and, accordingly, no compensation expense was
recognized for these grants in the consolidated statements of operations in
2006, 2005 and 2004.
Variable
interest entities:
Under
US
GAAP, when an entity holds variable interest in another entity and that entity
does not have sufficient equity or the equity security lacks decision-making
authority or the rights to expected residual returns or exposure to expected
losses, the entity is required to consolidate this variable interest entity
(“VIE”) under FASB Interpretation No. 46 “Consolidation of Variable Interest
Entities” (“FIN46R”). Consolidation under the variable interest model does not
consider voting rights or governance provisions and does not require the
ownership of any common stock. Where FIN46R is applicable, the holder of a
variable interest(s) that shares in the majority of the economic risks and
rewards (measured using the expected losses and expected residual returns of
the
VIE) must consolidate the VIE.
On
December 23, 2005, the Company acquired Kord which together with its
subsidiaries is principally engaged in trading and manufacturing of party
products and accessories. As Kord does not directly own resources to perform
the
manufacturing process of the party products and accessories, it subcontracts
the
manufacturing process to five entities that have been established in the PRC
and
are beneficially owned by the related companies of the Company. During the
manufacturing process, Kord will provide the machinery and inventories to these
entities and also reimburse the direct overhead costs incurred by these PRC
entities by means of subcontracting fee. Hence, the losses incurred by these
entities are expected to be absorbed by Kord as a result of the sub-contracting
arrangement. In view that Kord is the primary beneficiary of these entities
and
also will absorb the expected losses incurred by these entities, the Company
has
consolidated these entities since the date that Cornerstone Overseas had
acquired Kord, i.e. July 1, 2004.
Through
Hua Yang, on February 1, 2005 the Company acquired the business and certain
assets of Eastern Raiser Printing Company Limited (“Eastern Raiser”), a Hong
Kong incorporated company that engages in the printing and assembling of books
and specialty packaging in the PRC. The operations of the aforesaid business
have been taken up by Dongguan Hua Xing Printing Manufactory (“Dongguan Hua
Xing”), a company owned by a PRC individual, and via subcontracting agreement
with Dongguan Hua Xing, Hua Yang takes up all the benefits and costs incurred
by
Dongguan Hua Xing. In view that Hua Yang is the primary beneficiary and will
absorb the expected losses incurred by Dongguan Hua Xing, the Company
consolidated Dongguan Hua Xing since the date Hua Yang had acquired the business
and certain assets of Eastern Raiser, i.e. February 1, 2005.
Consolidated
Results
of Operations
The
following table sets forth a summary of the Company’s consolidated operations
data in U.S. dollars and as a percentage of net sales for the periods
indicated:
|
|
For
the Twelve Months Ended December 31,
|
|
|
|
2006
|
|
2005
|
|
2004
|
|
|
|
|
|
|
|
(as
restated)
|
|
(as
restated)
|
|
|
|
$000’s
|
|
%
|
|
$000’s
|
|
%
|
|
$000’s
|
|
%
|
|
Net
sales
|
|
|
128,760
|
|
|
100.00
|
|
|
116,963
|
|
|
100.00
|
|
|
68,663
|
|
|
100.00
|
|
Cost
of goods sold
|
|
|
101,693
|
|
|
78.98
|
|
|
89,165
|
|
|
76.23
|
|
|
55,516
|
|
|
80.85
|
|
Gross
profit
|
|
|
27,067
|
|
|
21.02
|
|
|
27,798
|
|
|
23.77
|
|
|
13,147
|
|
|
19.15
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
operating income
|
|
|
3,649
|
|
|
2.83
|
|
|
1,340
|
|
|
1.15
|
|
|
309
|
|
|
0.45
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
costs and expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General
and administrative
|
|
|
23,739
|
|
|
18.44
|
|
|
17,137
|
|
|
14.65
|
|
|
7,959
|
|
|
11.59
|
|
Selling
and distribution
|
|
|
12,356
|
|
|
9.60
|
|
|
8,656
|
|
|
7.40
|
|
|
2,919
|
|
|
4.25
|
|
Depreciation
and amortization
|
|
|
1,358
|
|
|
1.05
|
|
|
1,735
|
|
|
1.49
|
|
|
1,278
|
|
|
1.86
|
|
Impairment
on intangible assets and goodwill
|
|
|
194
|
|
|
0.15
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Total
operating costs and expenses
|
|
|
37,647
|
|
|
29.24
|
|
|
27,528
|
|
|
23.54
|
|
|
12,156
|
|
|
17.70
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
(loss) income
|
|
|
(6,931
|
)
|
|
(5.39
|
)
|
|
1,610
|
|
|
1.38
|
|
|
1,300
|
|
|
1.90
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss)
earnings before interest, taxes, depreciation and amortization
(EBITDA)
|
|
|
(1,500
|
)
|
|
(1.16
|
)
|
|
6,399
|
|
|
5.47
|
|
|
3,951
|
|
|
5.75
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-operating
expense (income):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
expense
|
|
|
2,424
|
|
|
1.88
|
|
|
1,930
|
|
|
1.65
|
|
|
450
|
|
|
0.66
|
|
Interest
income
|
|
|
(28
|
)
|
|
(0.02
|
)
|
|
(33
|
)
|
|
(0.03
|
)
|
|
(31
|
)
|
|
(0.05
|
)
|
Impairment
loss on investment securities
|
|
|
6
|
|
|
0.01
|
|
|
25
|
|
|
0.02
|
|
|
32
|
|
|
0.05
|
|
Total
non-operating expense
|
|
|
2,402
|
|
|
1.87
|
|
|
1,922
|
|
|
1.64
|
|
|
451
|
|
|
0.66
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
taxes
|
|
|
1,955
|
|
|
1.51
|
|
|
581
|
|
|
0.50
|
|
|
686
|
|
|
1.00
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss)
earnings from continuing operations
|
|
|
(11,288
|
)
|
|
(8.77
|
)
|
|
(893
|
)
|
|
(0.76
|
)
|
|
163
|
|
|
0.24
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Discontinued
operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from discontinued operations
|
|
|
(10,737
|
)
|
|
(8.34
|
)
|
|
(16,421
|
)
|
|
(14.04
|
)
|
|
(116
|
)
|
|
(0.17
|
)
|
Income
taxes
|
|
|
(2,352
|
)
|
|
(1.83
|
)
|
|
(346
|
)
|
|
(0.30
|
)
|
|
106
|
|
|
0.15
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss from discontinued operations
|
|
|
(8,385
|
)
|
|
(6.51
|
)
|
|
(16,075
|
)
|
|
(13.74
|
)
|
|
(222
|
)
|
|
(0.32
|
)
|
Net
loss from operations
|
|
|
(19,673
|
)
|
|
(15.28
|
)
|
|
(16,968
|
)
|
|
(14.50
|
)
|
|
(59
|
)
|
|
(0.08
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends
|
|
|
(2,782
|
)
|
|
(2.16
|
)
|
|
(14,358
|
)
|
|
(12.28
|
)
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss available to ADS shareholders
|
|
|
(22,455
|
)
|
|
(17.44
|
)
|
|
(31,326
|
)
|
|
(26.78
|
)
|
|
(59
|
)
|
|
(0.08
|
)
|
Grand
discusses financial measures in accordance with GAAP and also on a non-GAAP
basis. Grand’s definition of EBITDA is (loss) earnings before interest, income
taxes, depreciation and amortization. All references in this report to EBITDA
are to a non-GAAP financial measure. EBITDA, a measure widely used among toy
related businesses, is used because management believes that it is an effective
way of monitoring the operating performance of the Company relative to the
industry. Additionally, the Company believes that the use of non-GAAP financial
measures enables it and investors to evaluate, and compare from period to
period, the results from ongoing operations in a more meaningful and consistent
manner.
Reconciliations
of GAAP to Non-GAAP financial measures are provided below
Reconciliation
of (loss) earnings before interest, taxes, amortization and depreciation
(EBITDA):
(The
amounts in the table below are expressed in thousands)
|
|
2006
|
|
2005
|
|
2004
|
|
|
|
|
|
(as
restated)
|
|
(as
restated)
|
|
|
|
|
|
|
|
|
|
Net
(loss) earnings from continuing operations
|
|
$
|
(11,288
|
)
|
$
|
(893
|
)
|
$
|
163
|
|
Interest
expense, net
|
|
|
2,396
|
|
|
1,897
|
|
|
419
|
|
Depreciation
and amortization - G&A
|
|
|
1,358
|
|
|
1,735
|
|
|
1,278
|
|
Depreciation
- Cost of Goods Sold
|
|
|
4,079
|
|
|
3,079
|
|
|
1,405
|
|
Income
tax expense
|
|
|
1,955
|
|
|
581
|
|
|
686
|
|
EBITDA
|
|
$
|
(1,500
|
)
|
$
|
6,399
|
|
$
|
3,951
|
|
Comparison
of the year ended December 31, 2006 to the year ended December 31, 2005
Net
sales:
Net
sales
increased during 2006 by $11.8 million, or by 10.1%, from $117.0 million in
2005
to $128.8 million in 2006. The increase is mainly due to increased sales of
packaging boxes of Motorola phones from the packaging division of Hua Yang
and
additional toy sales by IPI, which was partially offset by declining OEM sales
from HKTC and
a
decrease in sales of party products and accessories by Kord. The sales breakdown
by category for 2006 and 2005 and as a percentage of net sales is as
follows:
|
|
2006
|
|
2005
(as
restated)
|
|
|
|
Net
sales
|
|
%
of net sales
|
|
Net
sales
|
|
%
of net sales
|
|
|
|
($000’s)
|
|
|
|
($000’s)
|
|
|
|
Printing
and Packaging:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Books
and board games
|
|
|
27,208
|
|
|
21.1
|
|
|
27,734
|
|
|
23.7
|
|
Packaging
products
|
|
|
33,490
|
|
|
26.0
|
|
|
22,691
|
|
|
19.4
|
|
Total
printing and packaging
|
|
|
60,698
|
|
|
47.1
|
|
|
50,425
|
|
|
43.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Party
Products and accessories
|
|
|
27,398
|
|
|
21.3
|
|
|
28,901
|
|
|
24.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Toy
Products:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
American distribution, net
|
|
|
33,778
|
|
|
26.2
|
|
|
25,490
|
|
|
21.8
|
|
HKTC
- OEM products
|
|
|
4,391
|
|
|
3.4
|
|
|
8,940
|
|
|
7.7
|
|
HKTC
- Playwell brand products
|
|
|
2,495
|
|
|
2.0
|
|
|
3,207
|
|
|
2.7
|
|
Total
toy products
|
|
|
40,664
|
|
|
31.6
|
|
|
37,637
|
|
|
32.2
|
|
Net
sales
|
|
|
128,760
|
|
|
100.0
|
|
|
116,963
|
|
|
100.0
|
|
Sales
from the book and board game division of Hua Yang remained constant from 2005
to
2006.
Hua
Yang’s packaging products division’s sales increased by $10.8 million, or 47.6%
from 2005 to 2006, which was mostly due to the addition of the Motorola phone
packaging business, which began in late 2005.
Sales
for
party products and accessories from the Kord manufacturing division decreased
$1.5 million, or 5.2% from 2005 to 2006,
principally because certain customers did not repeat orders for promotional
purposes in 2006.
Sales
by
IPI for North American distribution are consolidated beginning in March 2005
after the Company acquired IPI on March 1, 2005. Accordingly, the period to
period comparison of IPI sales is limited. The additional two months of sales
in
2006 and other sales growth resulted in an overall sales increase of $8.3
million, or 32.5% from 2005 to 2006 for North American distribution.
OEM
product sales decreased $4.5 million, or 50.9%, from $8.9 million in 2005 to
$4.4 million in 2006, which was principally due to the discontinuance of the
distribution of Toy Biz items. Playwell brand product sales decreased $0.7
million, or 22.2%, from $3.2 million in 2005 to $2.5 million in 2006 due to
the
decrease in demand of HKTC’s Playwell brand products.
Cost
of goods sold:
Cost
of
goods sold increased $12.5 million, or 14.1%, from $89.2 million in 2005 to
$101.7 million in 2006, as compared to the 10.1% increase in net sales over
the
same period. The primary driver of the cost of goods sold increase was the
increased sales activities of the Hua Yang and IPI businesses, as well as a
shift in product mix from 2005 to 2006 and the increased cost of labor in PRC,
which affected the cost of goods sold for the Hua Yang and Kord businesses.
Gross
profit:
As
a
result of the foregoing, gross profit for the Company decreased 2.6% from $27.8
million in 2005 to $27.1 million in 2006. The Company’s overall gross
profit margin decreased from 23.8% in 2005 to 21.0% in 2006, due primarily
to
the shift in product mix from 2005 to 2006, as detailed above in the Net Sales
description. Also, the increased cost of labor in PRC caused reductions in
gross profit margins for both Hua Yang and Kord from 2005 to 2006. For
2006, IPI had margins of 41.2%, Hua Yang had margins of 16.7%, Kord had margins
of 14.4% and the Playwell and OEM divisions had margins near 0.0%.
Other
operating income:
Other
operating income increased by $2.3 million, or 172.3%, from $1.3 million in
2005
to $3.6 million in 2006. Hua Yang recorded $2.4 million of other operating
income for the year ended December 31, 2006, including recovery of a previously
written-off bad debt of approximately $1.9 million and claims of other income
of
approximately $0.4 million from the same debtor. In 2006, $0.8 million of the
other operating income was attributable to Kord, of which $0.5 million related
to the provision of design, filming and set up fees received from certain
customers, and $0.4 million was attributable to HKTC, which included services
fees of about $0.3 million received from certain related companies for
administrative services provided to them in 2006.
General
and administrative expenses:
General
and administrative expenses increased by $6.6 million, or 38.5%, from $17.1
million in 2005 to $23.7 million in 2006. The incremental increase in these
expenses from each operating subsidiary was as follows:
|
|
$1.0
million for Hua Yang due to increased staff costs in the PRC in
2006;
|
|
|
$0.7
million for Kord due primarily from increased staff costs in
2006;
|
|
|
$4.5
million for HKTC due primarily to write-offs and payment of minimum
guarantee of various licenses of $3.8 million, bad debt provision
of $0.7
million in 2006; and
|
|
|
$0.4
million for IPI which was included for the full year in 2006 as compared
to ten months in 2005.
|
Selling
and distribution expenses:
Selling
and distribution expenses increased $3.7 million, or 42.7%, from $8.7 million
in
2005 to $12.4 million in 2006.
The
incremental increase in these expenses was principally due to a $2.6 million
increase by IPI related to the increase in its sales activities from 2005 to
2006 and a $1.6 million increase by Hua Yang related to the increase in its
sales activities from 2005 to 2006. These increases were partially offset by
decreases by Kord of $0.5 million.
Depreciation
and Amortization:
Depreciation
and amortization decreased from $0.4 million, or 21.7%, from $1.7 million in
2005 to $1.3 million in 2006. The incremental decrease in these costs derived
from each operating subsidiary was as follows:
|
|
($0.4
million) reduction for HKTC due to the full depreciation of a number
of
tools recognized in 2005;
|
|
|
$0.2
million increase for Hua Yang; and
|
|
|
($0.2
million) reduction for Kord.
|
Interest
expense:
Interest
expense increased $0.5 million, or 25.6%, from $1.9 million in 2005 to $2.4
million in 2006. The incremental increase in these expenses was due to increased
borrowings by the Company’s subsidiaries in 2006, which led to increased
interest payments by Hua Yang, Kord and IPI of $0.3 million, $0.1 million and
$0.1 million, respectively.
Income
taxes:
Income
taxes increased $1.4 million, or 236.5%, from $0.6 million in 2005 to $2.0
million in 2006. The increase in income taxes was principally due to an increase
in income taxes paid by Hua Yang and IPI,
which
was partially offset by a decrease in income taxes paid by Kord.
Net
loss from continuing operations:
As
a
result of the foregoing, the Company had a net loss from continuing operations
of $11.3 million in 2006 as compared to a net loss from continuing operations
of
$0.9 million in 2005. EBITDA from continuing operation was a loss of $1.5
million for 2006 as compared to a positive EBITDA from continuing operation
of
$6.4 million in 2005.
Discontinued
Operations:
Discontinued
operations consist of operations of Gatelink, Asian World, Grand Canada, Grand
Toys International, Inc. and the Crayola business conducted by Grand Toys (HK)
Ltd. For 2006, the aggregate sales from and net loss attributable to such
discontinued operations were $12.4 million and $8.4 million, respectively.
For
2005, the aggregate sales and net loss attributable to such discontinued
operations were $14.4 million and $16.1 million, respectively.
Net
loss available to ADS holders:
As
a
result of the foregoing, net loss charged to ADS holders for 2006 was
approximately $22.5 million, as compared to net loss of approximately $31.3
million for 2005.
Dividends:
The
2006
period includes $0.8 million of dividends paid on the Series A Preference Shares
and $2.0 million of dividends paid on the Series B Preference
Shares
Dividends
for 2005 include $1.0 million of deemed dividends which resulted from the
difference between the conversion price of the Series A Preference Shares into
Grand ADSs, based on the average closing stock price for the 40 days preceding
the share issuance, and the actual market price on the date of issuance of
the
Series A Preference Shares; and $12.8 million of deemed dividends which resulted
from the difference between the total value of the Series B Preference Shares
at
the date of issuance plus other value granted to Cornerstone Beststep and the
original cost paid by Cornerstone Overseas for the shares of Hua Yang and
Kord.
Also
included in 2005 were $0.6 million of dividends paid on the Series A Preference
Shares for the period from April 15, 2005 - December 31, 2005; and $0.04 million
of dividends paid on the Series B Preference Shares for the period December
22,
2005 - December 31, 2005.
Comparison
of the year ended December 31, 2005 to the year ended December 31, 2004
Net
sales:
Net
sales
increased during 2005 by $48.3 million, or 70.3%, from $68.7 million in 2004
to
$117.0 million in 2005. The increase was principally due to the addition of
sales from IPI, Hua Yang and Kord, which was partially offset by declining
OEM
sales and Playwell brand product sales by HKTC. The sales breakdown by category
for 2005 and 2004 and as a percentage of net sales is as follows:
|
|
2005
(as
restated)
|
|
2004
(as
restated)
|
|
|
|
Net
sales
|
|
%
of net sales
|
|
Net
sales
|
|
%
of net sales
|
|
|
|
($000’s)
|
|
|
|
($000’s)
|
|
|
|
Printing
and Packaging:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Books
and board games
|
|
|
27,734
|
|
|
23.7
|
|
|
22,069
|
|
|
32.2
|
|
Packaging
products
|
|
|
22,691
|
|
|
19.4
|
|
|
10,450
|
|
|
15.2
|
|
Total
printing and packaging
|
|
|
50,425
|
|
|
43.1
|
|
|
32,519
|
|
|
47.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Party
Products and accessories
|
|
|
28,901
|
|
|
24.7
|
|
|
13,549
|
|
|
19.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Toy
Products:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
American distribution, net
|
|
|
25,490
|
|
|
21.8
|
|
|
-
|
|
|
-
|
|
HKTC
- OEM products
|
|
|
8,940
|
|
|
7.7
|
|
|
16,541
|
|
|
24.1
|
|
HKTC
- Playwell brand products
|
|
|
3,207
|
|
|
2.7
|
|
|
5,112
|
|
|
7.4
|
|
Others
|
|
|
-
|
|
|
-
|
|
|
942
|
|
|
1.4
|
|
Total
Toy Products
|
|
|
37,637
|
|
|
32.2
|
|
|
22,595
|
|
|
32.9
|
|
Net
sales
|
|
|
116,963
|
|
|
100.0
|
|
|
68,663
|
|
|
100.0
|
|
Sales
from the book and board game division and the packaging division of Hua Yang
increased primarily due to the full year consolidation of Hua Yang’s results of
operations in 2005 as compared to the seven months of consolidated results
in
2004.
Sales
for
party products and accessories from the Kord manufacturing division increased
primarily due to the full year consolidation of Kord’s results of operations in
2005 as compared to the six months of consolidated results in 2004.
Sales
from IPI for North American distribution began to be consolidated with the
Company’s consolidated financial statements beginning on March 1, 2005 when the
Company acquired IPI.
OEM
product sales decreased $7.6 million, or 46.0%, from $16.5 million in 2004
to
$8.9 million in 2005 due to a decrease in the HKTC-designed Toy Biz products
from 2004 to 2005. Playwell brand product sales decreased $1.9 million, or
37.3%, from $5.1 million in 2004 to $3.2 million in 2005 due to the decrease
in
demand for HKTC’s products.
Cost
of goods sold:
Cost
of
goods sold increased $33.6 million, or 60.6%, from $55.5 million in 2005 to
$89.1 million in 2006, as compared to the 70.3% increase in net sales over
the
same period. The primary driver of the cost of goods sold increase was the
increased sales of the Hua Yang, Kord and IPI businesses, as well as a shift
in
product mix from 2004 to 2005.
Gross
profit:
As
a
result of the foregoing, gross profit for the Company increased by $14.7
million, or 111.4%, from $13.1 million in 2004 to $27.8 million in 2005. The
Company’s overall gross profit margin increased from 19.2% in 2004 to 23.8% in
2005. The increased gross profit margin is due to the shift in product mix
from
2004 to 2005. For 2005, IPI had margins of 42.9%, Hua Yang had margins of 19.4%,
Kord had margins of 19.4% and the Playwell and OEM had margins of 12.2%.
Other
operating income:
Other
operating income increased threefold from $0.3 million in 2004 to $1.3 million
in 2005. In 2005, $0.5 million of the increase in other operating income is
attributable to Hua Yang and $0.3 million of the increase amount is attributable
to Kord.
Other
income in 2005 resulted primarily from sales of scrap products and sundry
income.
General
and administrative expenses:
General
and administrative expenses increased by $9.2 million, or 115.3%, from $7.9
million in 2004 to $17.1 million in 2005. The incremental increase in these
expenses from each operating subsidiary was as follows:
|
|
$3.3
million for IPI for 10 months in
2005;
|
|
|
$1.9
million for full-year operations at Hua
Yang;
|
|
|
$2.3
million in corporate recurring expenses for full-year operations
in 2005;
and
|
|
|
$1.7
million for full-year operations at
Kord.
|
Selling
and distribution expenses:
Selling
and distribution expenses increased $5.7 million, or 196.5%, from $2.9 million
in 2004 to approximately $8.6 million in 2005. The incremental increase in
these
expenses derived from each operating subsidiary was as follows:
|
|
$4.8
million for IPI for 10 months in
2005;
|
|
|
$0.6
million for full-year operations at Kord;
and
|
|
|
$0.4
million for full-year operations at Hua
Yang.
|
There
was
a reduction in costs of $0.1 million for Playwell’s operations in
2005.
Depreciation
and Amortization:
Depreciation
and amortization increased $0.4 million, or 35.8%, from $1.3 million in 2004
to
$1.7 million in 2005. The incremental increase in these costs derived from
each
operating subsidiary was as follows:
|
|
$0.4
million for IPI for 10 months in
2005;
|
|
|
($0.3
million) reduction for full-year operations at Hua
Yang;
|
|
|
$0.2
million for full-year operations at Kord;
and
|
|
|
$0.1
million increase in depreciation and amortization for Playwell operations
in 2005.
|
Interest
expense:
Interest
expense increased threefold from $0.4 million in 2004 to $1.9 million in 2005.
The incremental increase in these expenses was due to increased borrowings
by
the Company’s subsidiaries in 2005, which led to increased interest payments by
Hua Yang, IPI and Kord of $1.0 million, $0.2 million and $0.1 million,
respectively. In addition, the Company paid interest of $0.2 million on an
exchangeable note from March 1, 2005 - April 15, 2005, which was issued in
connection with the financing of the acquisition of IPI.
Income
taxes:
Income
taxes increased $0.1 million, or 15.3%, from $0.7 million in 2005 to $0.6
million in 2006. The incremental increase in income taxes was principally due
to
the increase in income taxes paid by IPI, Hua Yang and Kord following the full
year consolidation of their results of operations, which was partially offset
by
a decrease in income taxes paid by Playwell.
Net
(loss) earnings from continuing operations:
As
a
result of the foregoing, the Company had a net loss from continuing operations
of $0.9 million in 2005 as compared to net earnings from continuing operations
of $0.2 million in 2005. EBITDA from continuing operation increased to
approximately $6.4 million for 2005 from approximately $4.0 million in
2004.
Discontinued
Operations:
Discontinued
operations consist of Gatelink, Asian World, Grand Canada and Grand Toys
International, Inc. operations. For 2005, the aggregate sales from and net
loss
attributable to such discontinued operations were $14.4 million and $16.1
million, respectively. For 2004, the aggregate sales and net loss attributable
to these discontinued operations were $6.9 million and $0.2 million,
respectively.
Net
loss available to ADS holders:
As
a
result of the foregoing, net loss available to ADS holders for 2005 was
approximately $31.3 million, as compared to net loss of approximately $0.06
million for 2004.
Dividends:
Dividends
for 2005 include $1.0 million of deemed dividends which resulted from the
difference between the conversion price of the Series A Preference Shares into
Grand ADSs, based on the average closing stock price for the 40 days preceding
the share issuance, and the actual market price on the date of issuance of
the
Series A Preference Shares; and $12.8 million of deemed dividends which resulted
from the difference between the total value of the Series B Preference Shares
at
the date of issuance plus other value granted to Cornerstone Beststep and the
original cost paid by Cornerstone Overseas for the shares of Hua Yang and
Kord.
Also
included in 2005 were $0.6 million of dividends on the Series A Preference
Shares for the period from April 15, 2005 - December 31, 2005; and $0.04 million
of dividends on the Series B Preference Shares for the period December 22,
2005
- December 31, 2005.
B.
Liquidity and Capital Resources
Cash
Flows and Working Capital
The
Company generally finances its operations through its cash flow from operations
and the existence of working capital facilities in North America and in Hong
Kong.
Net
cash
provided from operating activities from continuing operations was approximately
$6.7 million in 2006 compared to $2.2 million of cash used for continuing
operations in 2005, mostly as a result of the decrease in inventories, increase
in payables to related parties, increase in other accounts payable and accrued
liabilities and a lower increase in trade receivables in 2006, which was
partially offset by the $10.4 million increase in net loss from continuing
operations in 2006 as compared to 2005.
In
2006,
net cash used in investing activities from continuing operations was $1.0
million compared to $8.5 million in 2005. In 2006, the net cash used in
investing activities principally consisted of the payment of $1.2 million for
the purchase of fixed assets and an increase of $0.2 million in pledged time
deposits, offset by the settlement of a note receivable in the amount of $0.5
million. In 2005, net cash used in investing activities principally consisted
of
the payment of $7.6 million, which was used mostly for the acquisition of the
business and assets of Eastern Raiser, and the payment of $2.5 million for
the
purchase of fixed assets.
In
2006,
net cash used for financing activities from continuing operations was $8.0
million compared to net cash provided by financing activities of $9.6 million
in
2005. In 2006, the Company repaid $0.9 million in bank borrowings, $3.7 million
in trust receipt loans,
$2.6
million of obligations under capital leases and $1.1 million in notes. In 2005,
cash provided by financing activities was primarily attributed to net proceeds
of $11.1 million from bank borrowings and $1.2 million from trust receipt loans.
These proceeds were partially offset by $2.8 million in repayment of obligations
under capital leases.
Net
cash
provided from operating activities from discontinued operations was
approximately $1.8 million in 2006 compared to $2.3 million of cash used for
operating activities from discontinued operations in 2005. Investing activities
from the discontinued operations generated cash of $0.1 million in 2006 and
used
$0.04 million of cash in 2005. Financing activities for the discontinued
operations provided cash of $0.2 million in 2006 and used $0.4 million of cash
in 2005.
As
at
December 31, 2006, the Company had cash and cash equivalents of $4.5
million.
Working
capital decreased from $5.2 million at December 31, 2005 to negative $9.3
million at December 31, 2006.
The
Company has financed its acquisitions, in part, through borrowings and the
sale
of Preference Shares and the issuance of its equity securities. The purchase
price for the acquisition of IPI on March 1, 2005 was approximately $8.9
million, of which $7.3 million was paid in cash and $1.6 million was paid by
the
delivery of 582,730 ADSs. Acquisition costs relating to this acquisition were
approximately $853,000. In order to finance the cash portion of the purchase
price and to provide ongoing working capital for IPI, the Company sold to
Centralink an Exchangeable Note in the principal amount of $7.675 million for
proceeds of $7.4 million. The Exchangeable Note was sold at a $275,000 discount
in order to compensate Mr. Hsieh for providing the sellers of IPI with the
option to require Centralink to purchase the portion of the purchase price
paid
in ADSs after the first anniversary of the closing of the IPI acquisition.
The
Exchangeable Note bore interest at 15% per annum and was exchanged for 2,000,000
Series A Preference Shares of the Company when the issuance of the Series A
Preference Shares was approved by the Company’s shareholders at the Company’s
2005 Annual General Meeting on April 15, 2005.
The
acquisition of Hua Yang and Kord on December 23, 2005 was accomplished through
the issuance of 10,840,598 Series B Preference Shares of the Company and an
offset of approximately $2.4 million of related-party receivables and did not
involve any cash payments to Cornerstone Beststep. Acquisition costs relating
to
this acquisition were approximately $500,000.
The
Company believes that the existing cash and cash equivalents, cash generated
from operations and cash available from the existing and proposed credit
facilities may not be sufficient to meet the Company’s present requirements. The
Company is currently seeking financing alternatives to enable it to meet its
cash requirements, which could include project-specific financing, additional
public or private debt or equity financing. Any sale of additional equity would
result in further dilution to the Company’s ADS holders. The incurrence of
indebtedness would result in fixed obligations and could result in operating
covenants that would restrict the Company’s operations. There can be no
assurance that financing will be available in amounts or on terms acceptable
to
the Company, if at all.
From
time
to time, the Company evaluates possible investments, acquisitions or divestments
and may, if a suitable opportunity arises, make an investment or acquisition
or
conduct a divestment, which may have a material adverse effect upon our
liquidity and capital resources.
Indebtedness
North
America:
On
December 21, 2006, IPI entered into a $13.0 million revolving credit
facility to finance IPI’s working capital needs with Citicapital Commercial
Corporation. The facility is a committed line of credit collateralized by all
of
IPI’s assets and a guarantee from Grand US and has a term of 24 months, expiring
on December 21, 2008. The interest rate on the revolving loan payable
was
8.25%
per annum at December 31, 2006 and
equal to
either London Interbank Offered Rate (“LIBOR”) plus 175 basis points or the U.S.
prime rate, at the Company’s election. Borrowing is limited based on
a borrowing base formula consisting of eligible receivables and inventory.
As of December 31, 2006 and 2005, the amount outstanding was approximately
$6.3
million and $5.7 million, respectively.
As
of
December 31, 2005 IPI failed to satisfy certain covenants of its credit facility
and received a waiver from Citibank N.A. through May 15, 2006. As of May 15,
2006, the covenants were not satisfied and on June 30, 2006 Citibank N.A. stated
that they would not extend the revolving credit facility and issued a
reservation of rights letter on July 21, 2006. In the reservation of rights
letter, Citibank N.A. stated that, they would not demand immediate repayment
of
all sums owing under the credit facility at this time. The balance of
$10,484,000, which was all converted to a prime rate loan with a maturity date
of September 30, 2006, remained outstanding until a new credit line with
Citicapital Commercial Corporation was completed on December 21,
2006.
Hong
Kong and China:
The
Company finances its Hong Kong and China operations through facilities provided
by Hang Seng Bank Limited, DBS Bank (Hong Kong) Limited (“DBS”), Industrial and
Commercial Bank of China (Asia) Limited, (“ICBC”) and East Asia GE Commercial
Finance. The borrowings carry variable-rate interest at Hong Kong Interbank
Offered Rate (“HIBOR”) or LIBOR or prime rate plus/minus certain percentage of
up to a maximum of 1.5% per annum.
At
December 31, 2006 the bank borrowings of the Company’s Hong Kong subsidiaries
were secured by the following:
|
|
guarantees
by certain subsidiaries, as well as guarantees by the Company, Cornerstone
Overseas and Jeff Hsieh;
|
|
|
pledge
of the Company’s time deposits of $263,000 and time deposits of $306,000
owned by the spouse of Jeff Hsieh;
|
|
|
certain
inventories acquired and released under the trust receipt
loans;
|
|
|
floating
charge over certain debtors of Hua Yang, Kord and
Playwell;
|
|
|
monies
debentures over certain assets of the Company and certain properties
owned
by Jeff Hsieh or companies controlled by Jeff Hsieh and/or his spouse
and/or their son; and
|
|
|
for
certain bank loans granted to Hua Yang, corporate guarantees from
Zindart
Limited, the previous owner of Hua Yang.
|
As
of
December 31, 2006 and 2005, the Hong Kong-based subsidiaries of the Company
had
approximately $16.0 million and $16.7 million of short-term bank indebtedness
outstanding, respectively. As of December 31, 2005, there was approximately
$5.1
million of long-term debt.
Hua
Yang:
As
at
December 31, 2006, Hua Yang has short-term indebtedness including bank
overdrafts, secured trust receipt loans and secured bills receivable under
recourse amounting to an aggregate of $12.4 million. As of December 31, 2005
the
amount outstanding was $19.2 million.
In
2005,
ICBC ceased extending credit to Hua Yang at the time of the Company’s
acquisition of Hua Yang, but ICBC agreed to allow Hua Yang to gradually pay
down
the then existing balances by October 2006. These amounts were being repaid
through cash generated from operations and through replacement facilities at
other banking institutions. As of October 31, 2006, the $2.6 million outstanding
balance on an overdraft facility with ICBC was linked with availability on
another facility at ICBC used by Jeff Hsieh with the understanding that this
would be paid down by the end of 2006. However, as of November 6, 2006, the
$4.5
million balance on the ICBC term loan owed by Hua Yang was assumed by
Cornerstone Overseas for a loan to be repaid by Hua Yang to Cornerstone Overseas
in monthly installments beginning January 2007 and ending June 2008 at an
interest rate equal to the Hong Kong dollar prime rate plus 1% per annum.
Accordingly, $3.1 million and $1.4 million of such loan from Cornerstone
Overseas will be repayable in 2007 and 2008, respectively.
Kord:
As
at
December 31, 2006, Kord has secured short term indebtedness including trust
receipt loans and bills receivable under recourse amounting to an aggregate
of
$1.6 million. As
of
December 31, 2005, Kord had short term indebtedness and an unsecured term loan
of $791,000, which bore
an
interest rate of 5.75% per annum and repayable by 60 monthly installments
commencing from October, 2004. This bank loan has been replaced with a capital
lease agreement with DBS and was classified as obligations under capital leases
at December 31, 2006.
As
at
July 27, 2007, Centralink agreed to provide the Company a revolving loan
facility of $2 million for one year up to 31 July 2008. The revolving loan
facility is secured by a pledge of the Company’s equity interest in Kord and IPI
and any outstanding payable and unpaid balance bears interest at the rate of
15%
per annum.
Accounts
Receivable
Accounts
receivable at December 31, 2006 were $30.1 million compared to $27.5 million
at
December 31, 2005. Inventory at December 31, 2006 decreased to $17.1 million
from $20.3 million at December 31, 2005.
The
Company’s accounts receivable level is subject to significant seasonal
variations due to the seasonality of sales. As a result, the Company’s working
capital requirements are greatest during its third and fourth quarters. In
addition, to the extent accounts receivable, inventories, guarantees and advance
payments increase as a result of growth of the Company’s business, the Company
could require additional working capital to fund its operations.
Capital
Expenditures
The
Company made capital expenditures of $2.9 million, $2.5 million and $1.2 million
in 2004, 2005 and 2006, respectively. The Company’s capital expenditures for
2006 principally consisted of purchases of fixed assets for Hua Yang’s and
Kord’s manufacturing operations in the PRC for a total of approximately $1.2
million. The Company has made additional capital expenditures of approximately
$0.4
million
from January 1, 2007 until August
31,
2007 for
purchases of fixed assets in connection with Hua Yang’s and Kord’s manufacturing
operations in the PRC, leasehold improvements, computer equipment and tooling.
Capital expenditures in 2007 and obligations under capital leases have been,
and
are expected to continue to be, funded through operating cash flows and our
existing capital resources.
C.
Research and Development
Not
applicable.
D.
Trend Information
Other
than as disclosed elsewhere in this annual report, the directors are not aware
of any trends, uncertainties, demands, commitments or events for the period
from
January 1, 2004 to December 31, 2006 that are reasonably likely to have a
material effect on our net sales, income, profitability, liquidity or capital
resources, or that caused the disclosed financial information to be not
necessarily indicative of future operating results or financial
condition.
E.
Off-Balance Sheet Arrangements
We
do not
have any outstanding derivative financial instruments, off-balance sheet
guarantees, interest rate swap transactions or foreign currency forward
contracts. We have not entered into any financial guarantees or other
commitments to guarantee the payment obligations of any unconsolidated entity.
We do not engage in trading activities involving non-exchange traded
contracts.
F.
Contractual Obligations
As
of
December 31, 2006, the Company has entered into long-term leases with minimum
annual rental payments approximately as follows:
The
amounts of the operating lease obligations reflect the lease for the premises
and the office equipment.
(in
000’s)
|
|
Within
|
|
|
|
|
|
More
than
|
|
|
|
Contractual
Obligations
|
|
1
year
|
|
1
- 3 years
|
|
4
-5 years
|
|
5
years
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
lease obligations
|
|
$
|
3,071
|
|
$
|
3,771
|
|
$
|
585
|
|
$
|
61
|
|
$
|
7,488
|
|
Operating
lease obligations under the agreement for Shenzhen Hua
Yang
|
|
|
613
|
|
|
1,318
|
|
|
525
|
|
|
-
|
|
|
2,456
|
|
Minimum
guarantee of royalties
|
|
|
152
|
|
|
121
|
|
|
4
|
|
|
-
|
|
|
277
|
|
G.
Effects of Inflation
The
Company does not believe that inflation has had a significant impact on its
financial position or results of operations in the past three years.
H.
Recently Issued Accounting Standards
In
July
2006, the FASB issued Final Interpretation No. (“FIN”) 48, Accounting for
Uncertainty in Income Taxes, an interpretation of SFAS No. 109. FIN 48
clarifies the accounting for income taxes by prescribing the minimum recognition
threshold an uncertain tax position is required to meet before tax benefits
associated with such uncertain tax positions are recognized in the financial
statements. FIN 48 also provides guidance on derecognition, measurement,
classification, interest and penalties, accounting in interim periods,
disclosure and transition. In addition, FIN 48 excludes income taxes from the
scope of SFAS No. 5, Accounting for Contingencies. FIN 48 is effective for
fiscal years beginning after December 15, 2006. Differences between the
amounts recognized in the consolidated balance sheets prior to the adoption
of
FIN 48 and the amounts reported after adoption are accounted for as a
cumulative-effect adjustment to the beginning balance of retained earnings
upon
adoption of FIN 48. FIN 48 also requires that amounts recognized in the balance
sheet related to uncertain tax positions be classified as a current or
non-current liability, based upon the timing of the ultimate payment to a taxing
authority. The Company has not completed its evaluation of FIN 48. The Company
will adopt FIN 48 as of January 1, 2007.
In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements,
which provides guidance for using fair value to measure assets and liabilities.
The standard also responds to investors’ requests for expanded information about
the extent to which companies measure assets and liabilities at fair value,
the
information used to measure fair value, and the effect of fair value
measurements on earnings. SFAS No. 157 applies whenever other standards
require (or permit) assets or liabilities to be measured at fair value. The
standard does not expand the use of fair value in any new circumstances. Under
SFAS No. 157, fair value refers to the price that would be received to sell
an asset or paid to transfer a liability in an orderly transaction between
market participants in the market in which the reporting entity transacts.
SFAS
No. 157 clarifies the principle that fair value should be based on the
assumptions market participants would use when pricing the asset or liability
and establishes a fair value hierarchy that prioritizes the information used
to
develop those assumptions. The fair value hierarchy gives the highest priority
to quoted prices in active markets and the lowest priority to unobservable
data,
for example, the reporting entity’s own data. Fair value measurements would be
separately disclosed by level within the fair value hierarchy. SFAS No. 157
is effective for financial statements issued for fiscal years beginning after
November 15, 2007, and interim periods within those fiscal years. The
Company has not completed its evaluation of SFAS No. 157.
In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities, which provides companies with an
option to report selected financial assets and liabilities at fair value. The
objective of SFAS No. 159 is to reduce both complexity in accounting for
financial instruments and the volatility in earnings caused by measuring related
assets and liabilities differently. SFAS No. 159 also establishes
presentation and disclosure requirements designed to facilitate comparisons
between companies that choose different measurement attributes for similar
types
of assets and liabilities. SFAS No. 159 is effective for the Company
as of January 1, 2008. The Company has not completed its evaluation
of SFAS No. 159.
Item
6. Directors, Senior Management and Employees
A.
Directors and Senior Management
Directors:
Set
forth
below is the name, age, principal occupation and other information concerning
each director. The information presented with respect to each director has
been
furnished by that person.
Name
|
|
Age
|
|
Director
Since
|
Jeff
Hsieh Cheng
|
|
57
|
|
December
2005
|
Douglas
Van
|
|
50
|
|
April
2005
|
Kevin
Murphy
|
|
48
|
|
December
2006
|
Francis
K. Au
|
|
37
|
|
July
2007
|
Kenneth
B. Fowler
|
|
48
|
|
July
2007
|
David
C.W. Howell
|
|
44
|
|
July
2007
|
Matthew
T. Baile
|
|
43
|
|
July
2007
|
Jeff
Hsieh Cheng has
served as Chief Executive Officer and a Director of the Company since December
2005. Mr. Hsieh is the beneficial owner of a majority of the Company’s
ADSs. Mr. Hsieh has over 25 years of experience in the toy and toy-related
business. Mr. Hsieh is the owner of various PRC-based manufacturing operations,
including Zhejiang Playwell Toy Co Ltd., and various retail operations in the
PRC and various toy distribution companies throughout the world. Mr. Hsieh
holds
a bachelor’s degree from Soochow University, Taiwan. For a description of Mr.
Hsieh’s other principal directorships, please refer to the section titled “Item
7B. - Related Party Transactions.”
Douglas
Van has
served as a Director of the Company since April 2005. Mr. Van has, since 1988,
operated a venture company and acted in a capacity of advisor, fund raiser,
project financer, asset manager and investor for projects and ventures ranging
from real estate in the United States and China to manufacturing projects in
China across different industries. Until 1988, Mr. Van worked for Exxon
Chemicals in Hong Kong and the United States in various disciplines ranging
from
sales and marketing, plant operations and research and development. Mr. Van
attended Wah Yan College in Hong Kong before attending McGill University in
Montreal, Canada, where he received a Bachelor of Science degree in chemical
engineering. Mr. Van also has a Masters of Business Administration degree from
University of Michigan, Ann Arbor.
Kevin
Murphy has
served as a Director of the Company since December 2006. Mr. Murphy has been
the
President and Chief Executive Officer of Hua Yang since November 2001 and,
prior
to that, was Vice President of Operations of Hua Yang from 1998 to 2001. Prior
thereto, Mr. Murphy was Managing Director of a Malaysian production facility.
Mr. Murphy holds a Masters Degree (M Sc) in Manufacturing System Engineering
from Cranfield University in the UK.
Francis
K. Au
has
served as a Director of the Company since July 2007. Mr. Au is a Managing
Director and founding partner of Latitude Capital Group, an Asian boutique
investment bank specializing in cross-border China M&A and private
placements. Mr. Au is responsible for managing all aspects of deal origination
and execution for Latitude. He is based in Latitude's Hong Kong office. Mr.
Au
currently focuses on covering the technology, general industries and healthcare
sectors. Mr. Au is also an independent Board Director of CDC Software, CDC
Games
and CDC Mobile, which are wholly owned subsidiaries of NASDAQ listed CDC
Corporation. Previously, Mr. Au was the Head of Media Investment Banking in
Greater China for Lehman Brothers Asia. Mr. Au has extensive investment banking
experience across all areas of corporate finance including equity and debt
capital raising, as well as mergers and acquisition advisory having worked
in
both Lehman's New York and Hong Kong offices from 1992 to 2000. Mr. Au holds
a
Masters of Business Administration degree from Harvard Business School and
a BA
in Economics/East Asian Studies from Columbia University.
Kenneth.
B. Fowler
has
served as a Director of the Company since July 2007. Mr. Fowler is the Chief
Financial Officer for Hong Kong International School. Prior to this,
Mr. Fowler had been the Chief Financial Officer for Corgi International Limited
(Corgi), a Nasdaq-listed entity that designed, manufactured and marketed
brand name toys and collectible products. Prior to joining Corgi, Mr.
Fowler served as Chief Financial Officer for DeliriumCyberTouch Corporation
(formerly Delirium Corporation), a leading pan-Asian Web solutions company
with
operations in five Asian countries. He also served as senior vice
president of finance for Chinadotcom Corporation, a Nasdaq-listed company.
Prior
to Chinadotcom, Mr. Fowler spent seven years with SkyTel Corporation ("SkyTel"),
then a Nasdaq-listed international wireless messaging service provider (acquired
by MCI Worldcom in October 1999). Prior to SkyTel, Mr. Fowler spent almost
10 years in the audit and consulting arms of Price Waterhouse (now
PriceWaterhouseCoopers) and Ernst & Young, where he provided strategic
management consulting services as well as operations and information systems
consulting services. Mr. Fowler received a Masters of Business
Administration degree from the Owen School at Vanderbilt University and a
Bachelors of Accountancy degree from the University of Mississippi.
David
C.W. Howell
has
served as a Director of the Company since July 2007. Mr. Howell is currently
Executive Vice President - Finance of the Company and will assume the role
of
Chief Financial Officer following the 2007 Annual General Meeting. Mr. Howell
was an Executive Vice President and Chief Financial Officer of Radica Games
Limited, then a Nasdaq-listed company from September 1995 through to its
acquisition by Mattel Inc. in 2006. He was also President Asian Operations
from
December 1998 to October 2005, Vice President and Chief Accounting Officer
of
Radica Games Limited from January 1994 to September 1995 and a director from
January 1994 until May 2005 when he did not stand for re-election to the Board.
From 1992 to 1994, Mr. Howell was the Finance Director and Company Secretary
of
Radica HK. From 1984 to 1991, Mr. Howell was employed by Ernst & Young in
London, Hong Kong and Vietnam. Mr. Howell has a B.Sc. from Nottingham
University, is a Fellow of the Institute of Chartered Accountants in England
and
Wales, and is a Fellow of the Hong Kong Institute of Certified Public
Accountants. Mr. Howell is based in Hong Kong.
Matthew
T. Baile
has 20
years experience in consumer electronics product development, manufacturing
and
sales. As well as running his own product development consultancy firm,
Centaurus Limited, he has worked with companies such as Philips, BMW and Rover
Group as well as established consumer electronics brands such as Franklin and
Lexibook. He has undertaken diverse management roles including product
management, outsourcing consultancy, chief operating officer of Lexibook and
Vice President of Product Development at Franklin Electronic Publishers Inc.
He
specializes in strategic planning, rapid product development and outsourcing.
In
his spare time he collaborates with the Hong Kong Government and the University
of Science and Technology in research into micro fuel cells. Mr. Baile has
served as a Director of the Company since July 2007.
There
are
no family relationships among any of our directors and executive
officers.
Executive
Officers and Senior Management
Our
executive officers and other members of senior management are:
Name
|
|
Age
|
|
Title
|
Jeff
Hsieh Cheng
|
|
57
|
|
Chief
Executive Officer
|
Kevin
Murphy
|
|
48
|
|
Chief
Operating Officer and President and Chief Executive Officer, Hua
Yang
|
Li
San Tung
|
|
62
|
|
President,
Kord
|
Michael
Varda
|
|
48
|
|
Chief
Executive Officer, International Playthings, Inc.
|
David
J. Fremed
|
|
47
|
|
Chief
Financial Officer
|
David
C.W. Howell
|
|
44
|
|
Executive
Vice President - Finance
|
Li
San Tung is
the
founder of Kord and currently serves as its President. Mr. Li began the business
in 1972 and grew Kord from a one-man start-up to a 2,000 employee company
supplying local and international customers.
Michael
Varda has
served as Chief Executive Officer of International Playthings since March 2007.
Mr. Varda joined International Playthings in 1993 as Chief Financial Officer,
and was promoted to Chief Operating Officer in January 2004. Throughout his
career at International Playthings, Mr. Varda has played an integral role in
setting and implement the short and long term strategic plans for the company.
In addition he has been directly responsible for all the financial functions,
including budgeting, reporting and banking activities. As Chief Operating
Officer, Mr. Varda had complete oversight of the company's operational and
administrative activities, including warehousing, purchasing, credit, and
personnel. Prior to joining International Playthings, Mr. Varda was Director
of
Finance, at Miller Harness Company, an importer and distributor of English
riding equipment. Mr. Varda is a graduate of Rutgers University, with a B.A.
in
Accounting.
David
Fremed
has
served as Executive Vice President and Chief Financial Officer of the Company
since August 16, 2004. As we announced in December 2006, Mr. Fremed will step
down from the position of Chief Financial Officer when his contract expires
at
the 2007 Annual General Meeting. From February 2004 to August 2004, Mr. Fremed
was a consultant to Cornerstone Overseas, an affiliate of Grand, serving in
the
role of its principal financial officer. Prior to being engaged by Cornerstone
Overseas, Mr. Fremed was the chief financial officer of Atari, Inc., a
Nasdaq-listed company, from May 2000 to February 2004, where he was responsible
for all treasury, budgeting, SEC reporting and compliance functions. In
addition, Mr. Fremed was responsible for seeking potential acquisition
candidates, negotiating terms of acquisition transactions, and integrating
the
newly acquired companies into Atari. From 1990 to 2000, Mr. Fremed held various
financial positions at Marvel Enterprises, Inc., including serving as its chief
financial officer, where he was responsible for arranging both debt and equity
financings as well as managing the financial reporting, MIS, tax, and human
resource departments. Mr. Fremed is a certified public accountant and holds
a
Masters of business administration degree from New York University and a
bachelor of science degree from Albany State University.
B.
Compensation
All
directors of the Company receive an annual director’s fee of $25,000 and
quarterly grants of options to purchase 1,250 ADSs, or 5,000 options per year,
at an exercise price equal to the market price of the ADSs on the date of grant.
In addition, non-employee directors receive additional quarterly grants of
options to purchase 6,250 ADSs, or 25,000 options per year, at an exercise
price
equal to the market price of the ADSs on the date of grant. The quarterly
director option grants during 2006 were: March 31st @ $1.74, June 30th
@ $1.41,
September 30th
@ $0.83
and December 31st
@ $1.32.
Except for the foregoing, directors receive no other regular compensation for
serving as a director.
The
aggregate direct compensation paid or accrued on behalf of all directors and
executive employees as a group during 2006 was $2,427,000. This amount includes
directors’ fees and expenses for non-employee directors of $144,000. This amount
does not include expenses (including business travel, professional and business
association dues and expenses) reimbursed to officers and directors and other
fringe benefits commonly reimbursed. None of the non-employee directors have
agreements with the Company that provide for benefits upon termination of
service.
The
Company has adopted a number of stock option programs in the past covering
ADSs.
All employees of the Company are eligible to participate in the Company’s stock
option programs. In 2006 the Company’s directors and executive officers were
granted options to purchase an aggregate of 430,000 ADSs, at an average exercise
price of $1.332 per ADR and all of which will expire in 2016. During the first
six months of 2007, the Company’s directors and executive officers were granted
options to purchase an aggregate of 42,500 ADSs, at an average exercise price
of
$0.865 per ADR and all of which will expire in 2017.
As
of
December 31, 2006, options for an aggregate of 2,467,933 ADSs, with an average
exercise price of $2.13 per ADR, are outstanding under the Company’s stock
option programs, with options for an aggregate of approximately 440,000 ADSs
available for future grant. For further information regarding the Company’s
outstanding options, see Note 10 to the Notes to Consolidated Financial
Statements.
Employment
Agreements
Jeff
Hsieh is
the
chief executive officer and a director of the Company and he does not have
an
employment agreement with the Company. Other than the annual director fee of
$25,000, Mr. Hsieh received monthly salary of about $18,600 from the
Company.
Kevin
Murphy
is party
to an employment agreement with Cornerstone Overseas Investments, Limited dated
November 2004 that was assumed by Grand Toys International Limited upon the
acquisition of Hua Yang in December 2005. Under Mr. Murphy's employment
agreement, Mr. Murphy is employed as president and chief executive officer
of
Hua Yang Printing Holdings Co., Limited. Mr. Murphy's employment agreement
with
the Company entitles him to receive an annual base salary of $250,000 and a
bonus equal to 2% of the annual audited earnings before interest and taxes
of
the Hua Yang group. Upon the transfer of Hua Yang into the Company, Mr. Murphy
was granted options to purchase 300,000 of the Company’s ADSs at a price of
$1.36 per ADS, which price is equal to the closing market price of the Company’s
ADSs on the last trading day prior to the date of the grant. The options will
vest as to 100,000 ADSs on each of the first, second and third anniversaries
of
the option grant date and shall expire on the tenth anniversary of such date.
Mr. Murphy is also given the use of a car and driver for business use in China,
mobile phone and participation in a medical insurance plan.
The
agreement provides for a five year term of employment until May 26, 2009.
However, the agreement can be terminated at any time by Mr. Murphy by giving
one
month’s written notice, or by the Company without cause by giving seven month’s
written notice.
Mr.
Murphy's employment agreement also provides that, during its term and for one
year following the termination of Mr. Murphy's employment, Mr. Murphy may not
become associated with competitive entities that are actively engaged in the
Company’s business.
Li
San Tung
is party
to an employment agreement with Kord Holdings, Inc. dated July 30, 2004 that
was
assumed by Grand Toys International Limited with the acquisition of Kord in
December 2005. Under Mr. Li's employment agreement, Mr. Li is employed as
managing director of Kord Holdings, Inc. Mr. Li's employment agreement with
the
Company entitles him to receive an annual base salary of $277,000 and a
performance-based annual bonus at the discretion of the Board. Mr. Li is also
entitled to participate in any pension or medical insurance plan operated by
Kord.
The
agreement provides for a five year term of employment until July 30, 2009 and
shall continue thereafter unless and until terminated by either the Company
or
Mr. Li giving to the other such period of notice in writing as may be mutually
agreed between the parties, but not on or before July 30, 2006.
Mr.
Li's
employment agreement also provides that, during its term and for two years
following the termination of Mr. Li's employment, Mr. Li may not become
associated with competitive entities that are actively engaged in the Company’s
business.
In
conjunction with Cornerstone Overseas’s acquisition of Kord Holdings, Inc. from
Li San Tung in June 2004, Cornerstone Overseas issued a promissory note to
Mr.
Li in the principal amount of HK$23.3 million (US$3.0 million) which is
convertible into 746,795 Grand ADSs that are owned by a Cornerstone subsidiary.
Subsequent to the acquisition of Kord, on March 14, 2005, audited accounts
revealed a purchase price adjustment which resulted in Cornerstone issuing
an
additional promissory note to Mr. Li in the principal amount of HK$2,243,941
(US$288,000) which is convertible into 71,921 Grand ADSs owned by a Cornerstone
subsidiary. These promissory notes have a maturity date of July 30, 2006. As
of
August 31, 2007, Mr. Li has not exercised the notes and converted them into
Grand ADSs.
David
Howell
is party
to an employment agreement with Grand Toys International Limited dated July
19,
2007. Under Mr. Howell’s employment agreement, Mr. Howell is employed as
Executive Vice President - Finance as of July 6, 2007 and as Chief Financial
Officer of the Company following the expiration of Mr. Fremed’s contract at the
2007 AGM. Mr. Howell’s employment agreement entitles him to receive an annual
base salary of $375,000. Mr. Howell was granted options to purchase 300,000
of
the Company’s ADSs at the closing market price of the Company’s ADSs on July 19,
2007 and will be granted another 300,000 options on July 19, 2008. Each grant
of
300,000 options will vest as to 100,000 ADSs on each of the first, second and
third anniversaries of the option grant date and shall expire on the tenth
anniversary of such date.
The
agreement provides for a two year term of employment until July 6, 2009.
However, the agreement can be terminated at any time after the first anniversary
by either party by giving six month’s written notice.
Mr.
Howell's employment agreement also provides that, during its term and for one
year following the termination of Mr. Howell's employment, Mr. Howell may not
become associated with competitive entities that are actively engaged in the
Company’s business.
Michael
Varda
is party
to an employment agreement with International Playthings, Inc. dated March
1,
2007. Under Mr. Varda’s employment agreement, Mr. Varda is employed as
Chief Executive Officer of International Playthings, Inc. as of March 1,
2007. Mr. Varda’s employment agreement entitles him to receive an annual
base salary of $230,000. Mr. Varda will be granted options to purchase
200,000 of the Company’s ADSs at the closing market price of the Company’s ADSs
on the date of the next meeting of the Board of Directors following the
execution of the employment agreement on August 14, 2007. The options will
vest as to 66,667, 66,667 and 66,666 ADSs on each of the first,
second and third anniversaries of the option grant date,
respectively, and shall expire on the tenth anniversary of such date.
The
agreement provides for a three year term of employment until February 28,
2010. The agreement can be terminated at any time by either party.
Mr.
Varda's employment agreement also provides that, during its term and for six
months following the termination of Mr. Varda's employment, Mr. Varda may not
become associated with competitive entities that are actively engaged in IPI’s
business. For a period up to two years after the termination of Mr.
Varda’s employment agreement, Mr. Varda may not solicit any business from IPI’s
clients, customers, vendors or accounts.
C.
Board Practices and Procedures
The
Company’s board of directors is currently comprised of seven persons, of which
three, Messrs. Van, Fowler and Baile have been determined to be independent
within the meaning of applicable Nasdaq regulations. The Company’s Board is not
comprised of a majority of independent directors as required by Nasdaq
Marketplace Rule 4350(c)(i) because it is exempt from the requirement by virtue
of the fact that it is a “controlled company” within the meaning of Nasdaq
Marketplace Rule 4350 (c)(5) as a result of Mr. Hsieh’s beneficial ownership of
more than 50% of the Company’s ordinary shares. All directors are entitled to
review and retain copies of the Company’s documentation and examine the
Company’s assets, as required to perform their duties as directors and to
receive assistance, in special cases, from outside experts at the expense of
the
Company (subject to approval by the Board or by court).
For
information regarding the period during which our current directors have served
in their respective positions, please refer to “Item 6A. Directors and Senior
Management” above. The Company’s Board members are elected for terms of one
year. The Company believes that shareholders should have the opportunity to
elect or re-elect all directors at each annual general meeting and that annual
election of directors is an effective way to maintain and enhance the
accountability of the Board.
No
director has a contract with the Company providing for benefits upon
termination, except for Mr. Murphy and Mr. Howell whose employment agreements
provide for severance payments upon termination of employment. The severance
provisions are described in Item 7 below.
Board
Meetings
Meetings
of the board of directors are held throughout the year, with additional special
meetings scheduled when required. The Board held two meetings in 2006 and
acted by unanimous written consent on eighteen occasions.
Audit
Committee Meetings
Meetings
of the Audit Committee are held throughout the year, with additional special
meetings scheduled when required. The Audit Committee held 2 meetings in
2006 and acted by unanimous written consent on one occasion.
Executive
Sessions of the Board
The
independent members of the Board did not meet in executive session (without
management or non independent directors’ participation) during
2006.
Home
Country Practice
The
Company is in compliance with corporate governance standards as currently
applicable to the Company under Hong Kong, U.S., SEC and Nasdaq laws and
regulations. As further described below, the Company has adopted an audit
committee charter formalizing its procedures and duties, each pursuant to
applicable laws and regulations.
Communications
with the Board
Any
holder of ADSs who desires to communicate directly with the Board may do so
by
mail addressed to any individual director, a group of directors, the Board
or
any Committee by either name or ti