ITEM
2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION
The
following discussion should be read in conjunction with our consolidated
financial statements and related notes included elsewhere in this quarterly
report. This report contains forward-looking statements. The words
“anticipated,” “believe,” “expect, “plan,” “intend,” “seek,” “estimate,”
“project,” “could,” “may,” and similar expressions are intended to identify
forward-looking statements. These statements include, among others, information
regarding future operations, future capital expenditures, and future net cash
flow. Such statements reflect our management’s current views with respect to
future events and financial performance and involve risks and uncertainties,
including, without limitation, general economic and business conditions, changes
in foreign, political, social, and economic conditions, regulatory initiatives
and compliance with governmental regulations, the ability to achieve further
market penetration and additional customers, and various other matters, many
of
which are beyond our control. Should one or more of these risks or uncertainties
occur, or should underlying assumptions prove to be incorrect, actual results
may vary materially and adversely from those anticipated, believed, estimated
or
otherwise indicated. Consequently, all of the forward-looking statements made
in
this quarterly report are qualified by these cautionary statements and there
can
be no assurance of the actual results or developments.
Overview
We
are a
distributor of watch movements components used in the manufacture and assembly
of watches to a wide variety of timepiece manufacturers. There are two
categories of watch movements, quartz and mechanical. The main parts of an
analog quartz watch movement are the battery; the oscillator, a piece of quartz
that vibrates in response to the electric current; the integrated circuit,
which
divides the oscillations into seconds; the stepping motor, which drives the
gear
train; and the gear train itself, which makes the watch’s hands move. A digital
watch movement has the same timing components as an analog quartz movement
but
has no stepping motor or gear train. To a lesser extent we also distribute
complete analog-quartz and automatic watches with pricing between $20.00 to
$50.00. Manufacturing for these watches is currently outsourced to third party
factories in China.
Our
core
customer base consists primarily of large wholesalers, online retailers and
small and medium-sized watch manufacturers that produce watches primarily for
sale to customers in Hong Kong and China. To a lesser extent, we design watches
for manufacturers and exporters of watches and manufacture and distribute
complete watches primarily to online retailers and internet
marketers.
We
are
mainly engaged in watch movement distribution business in Hong Kong and China
which accounted for approximately 90% of our revenue for the six months ended
June 30, 2007. We have distribution centers and strategically located sales
offices throughout Hong Kong and the People’s Republic of China (“China” or
“PRC”). We distribute more than 350 products from over 30 vendors, including
such market leaders as Citizen Group, Seiko Corporation and ETA SA Manufacture
Horlogere Suisse, to a base of over 300 customers primarily through our direct
sales force. As a part and included in our sale of watch movements, we provide
a
variety of value-added services, including automated inventory management
services, integration, design and development, management, and support
services.
Recent
Events
January
2007 Private Placement
On
January 23, 2007, concurrently with the close of the Share Exchange, we
conducted an initial closing of a private placement transaction pursuant to
which we sold an aggregate of 1,749,028 shares of Series A Convertible Preferred
Stock at $1.29 per share. On February 9, 2007, we conducted a second and final
closing of the private placement pursuant to which we sold 501,320 shares of
Series A Convertible Preferred Stock at $1.29 per share. Accordingly, a total
of
2,250,348 shares of Series A Convertible Preferred Stock were sold in the
private placement for an aggregate gross proceeds of $2,902,946 (the “Private
Placement”). WestPark Capital, Inc. (“WestPark”) acted as the placement agent
for the Private Placement. For its services as placement agent, WestPark
received an aggregate fee of approximately $261,265, which consisted of a
commission equal to 9.0% of the gross proceeds from the financing. After
commissions and expenses, we received net proceeds of approximately $2.3 million
in the Private Placement.
In
connection with the Private Placement, Kwong Kai Shun, our Chairman of the
Board, Chief Executive Officer and Chief Financial Officer, entered into an
agreement (the “Escrow Agreement”) with the investors pursuant to which he
agreed to purchase all of the shares of Series A Preferred Stock then held
by
such investors at a per share purchase price of $1.29 if our common stock fails
to be listed or quoted for trading on the American Stock Exchange, the Nasdaq
Capital Market, the Nasdaq Global Market or the New York Stock Exchange on
or
before June 30, 2007, which has been subsequently extended to March 31, 2008.
In
addition, Mr. Kwong agreed to place 2,326,000 shares of his common stock in
escrow for possible distribution to the investors (the "Escrow Shares").
Pursuant to the Escrow Agreement, if our net income for 2006 or 2007, subject
to
specified adjustments, as set forth in our filings with the SEC is less than
$6.3 million or $7.7 million, respectively, a portion, if not all, of the Escrow
Shares will be transferred to the investors based upon our actual net income,
if
any, for such fiscal years. We have accounted for the Escrow Shares as the
equivalent of a performance-based compensatory stock plan between Mr. Kwong
and
us. Accordingly, during the three months and six months ended June 30, 2007,
we
recorded a charge to operations of $40,642 and $1,652,205, respectively, to
recognize the grant date fair value of stock-based compensation in conjunction
with the Escrow Shares.
Corporate
Structure
We
were
incorporated in the State of Delaware on January 3, 2006. We were originally
organized as a “blank check” shell company to investigate and acquire a target
company or business seeking the perceived advantages of being a publicly held
corporation. On January 23, 2007, we closed a share exchange transaction (“Share
Exchange”) pursuant to which we (i) issued 19,454,420 shares of our common stock
to acquire 100% equity ownership of Times Manufacture & E-Commerce
Corporation Limited, a British Virgin Islands corporation (“Times Manufacture”),
which has eight wholly-owned subsidiaries, (ii) assumed the operations of Times
Manufacture and its subsidiaries, and (iii) changed our name from SRKP 9, Inc.
to Asia Time Corporation. Times Manufacture also paid an aggregate of $350,000
to the stockholders of SRKP 9, Inc. Times Manufacture was founded in January
2002 and is based in Hong Kong.
In
2005,
we re-aligned the structure and business functions of our subsidiaries to
clearly define the scopes our business objectives in order to strengthen our
ability to effectively conduct our business operations. Billion Win
International Enterprise Limited, or Billion Win, is our central sourcing
component. Billion Win, which is held indirectly through Times Manufacture,
procures and imports watch movements and distributes them to suppliers, volume
users in China, and two of our subsidiaries, Goldcome Industrial Limited, or
Goldcome, and Citibond Industrial Limited, or Citibond. Goldcome mainly focuses
it distributions to wholesalers and large manufacturers and Citibond focuses
on
distributions to small to medium size manufacturers. Megamooch International
Limited is a complete watch distributor and exporter targeting overseas buyers.
Another two subsidiaries, TME Enterprise Ltd. and Citibond Design Ltd., are
responsible for complete watch design for manufacturers and exporters and
handles large volume watch movement transactions between buyers and sellers
solely on a commission basis. Megamooch Online Ltd. operations are focused
on
complete watch marketing and distribution, with manufacturing being outsourced,
and it concentrates on overseas markets.
Watch
Movement Segment
Presently,
Hong Kong does not generally have watch movement manufacturing. Watch movements
are largely imported from Japan and Switzerland. The revenue for the watch
movement segment of our business for the six months ended June 30, 2007 was
$38.2 million, with a gross profit $3.8 million, a 0.9% and 59.8% increase,
respectively, as compared to $37.9 million in revenue and $2.4 million in gross
profit for the six months ended June 30, 2006. The gross profit margin increased
to 10.0% for the six months ended June 30, 2007 from 6.3% for the same period
in
2006, primarily due to more diversified products being promoted to customers
and
higher selling prices as a result of extended credit terms to our customers.
We
provide a wide product spectrum of products carrying major brands as well as
middle-low end China movements. We believe carrying a wide product spectrum
enables us to provide a convenient one-stop provider for our customers, which
may result in higher sales per customer. We began to target small to medium
manufacturers in mid-2005 and our customer base has expanded to more than 300
watch manufacturers. In addition, we have extended our credit period from an
average to 30 days to 60 days to major customers that have maintained a history
of timely settlement of receivables. We believe that this extension lead to
an
increase of purchase orders from those customers. We review the credit status
of
each customer and periodically adjust the credit period to specific customers
in
an attempt to maximize business with each customer without suffering significant
credit risk.
Complete
Watch Segment
Revenue
of our complete watch segment was $3.8 million for the six months ended June
30,
2007, a 29.8% decrease compared to the same period in 2006 in which revenue
was
$5.3 million. This segment contributed approximately 8.9% of our revenue for
the
six months ended June 30, 2007, as compared to 12.4% of revenue for the period
ended June 30, 2006. Our main market positioning in China is on the middle-class
adult, daily, sporty and classy design.
Critical
Accounting Policies and Estimates
Financial
Reporting Release No. 60 recommends that all companies include a discussion
of
critical accounting policies used in the preparation of their financial
statements. The Securities and Exchange Commission (“SEC”) defines critical
accounting policies as those that are, in management's view, most important
to
the portrayal of our financial condition and results of operations and those
that require significant judgments and estimates.
The
preparation of these consolidated financial statements requires our management
to make estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses, as well as the disclosure of contingent
assets and liabilities at the date of our financial statements. We base our
estimates on historical experience, actuarial valuations and various other
factors that we believe to be reasonable under the circumstances, the results
of
which form the basis for making judgments about the carrying value of assets
and
liabilities that are not readily apparent from other sources. Some of those
judgments can be subjective and complex and, consequently, actual results may
differ from these estimates under different assumptions or conditions. While
for
any given estimate or assumption made by our management there may be other
estimates or assumptions that are reasonable, we believe that, given the current
facts and circumstances, it is unlikely that applying any such other reasonable
estimate or assumption would materially impact the financial statements. The
accounting principles we utilized in preparing our consolidated financial
statements conform in all material respects to generally accepted accounting
principles in the United States of America.
Impairment
of long-lived assets
The
long-lived assets held and used by us are reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of assets
may not be recoverable. It is reasonably possible that these assets could become
impaired as a result of technology or other industry changes. Determination
of
recoverability of assets to be held and used is by comparing the carrying amount
of an asset to future net undiscounted cash flows to be generated by the
assets.
If
such
assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets exceeds the
fair value of the assets. Assets to be disposed of are reported at the lower
of
the carrying amount of fair value less costs to sell.
Inventories
Inventories
are stated at the lower of cost or market. Cost is determined on a first-in,
first-out basis and includes only purchase costs. There are no significant
freight charges, inspection costs and warehousing costs incurred for any of
the
periods presented. In assessing the ultimate realization of inventories,
management makes judgments as to future demand requirements compared to current
or committed inventory levels. We have vendor arrangements on the purchase
of
watch movements providing for price reduction paid in the form of additional
watch movements. The percentage of additional movements to be received by us
from these vendors is estimated and inventory costs are reduced to reflect
the
effect of these additional movements on the actual cost of the items in
inventory. During the six months ended June 30, 2007 and 2006, we did not make
any allowance for slow-moving or defective inventories.
We
evaluate our inventories for excess, obsolescence or other factors rendering
inventories as unsellable at normal gross profit margins. Write-downs are
recorded so that inventories reflect the approximate market value and take
into
account our contractual provisions with our suppliers governing price
protections and stock rotations. Due to the large number of transactions and
complexity of managing the process around price protections and stock rotations,
estimates are made regarding the valuation of inventory at market
value.
In
addition, assumptions about future demand, market conditions and decisions
to
discontinue certain product lines can impact the decision to write-down
inventories. If assumptions about future demand change and/or actual market
conditions are different than those projected by management, additional
write-downs of inventories may be required. In any case, actual results may
be
different than those estimated.
Trade
receivables
Trade
and
other receivables are recognized initially at fair value and subsequently
measured at amortized cost using the effective interest method, less provision
for impairment. A provision for impairment of trade and other receivables is
established when there is objective evidence that we will not be able to collect
all amounts due according to the original terms of receivables. The amount
of
the provision is the difference between the asset’s carrying amount and the
present value of estimated future cash flows, discounted at the effective
interest rate. The amount of the provision is recognized in the income
statement.
Foreign
currency translation
Our
consolidated financial statements are presented in United States dollars. Our
functional currency is the Hong Kong Dollar (HKD). Our consolidated financial
statements are translated into United States dollars from HKD at period-end
exchange rates as to assets and liabilities and average exchange rates as to
revenues and expenses. Capital accounts are translated at their historical
exchange rates when the capital transactions occurred.
Revenue
recognition
Sales
of
goods represent the invoiced value of goods, net of sales returns, trade
discounts and allowances. We recognize revenue when the goods are delivered
and
the customer takes ownership and assumes risk of loss, collection of the
relevant receivable is probable, persuasive evidence of an arrangement exists,
and the sales price is fixed or determinable. We provide pre- and post- sales
service to our customers related to inventory management information in order
to
facilitate and manage sales to customers. Our integration, design and
development and management services provide customers with watch design
assistance, components outsourcing or other project support, and are generally
completed prior to a sale and do not continue post-delivery. There is no
requirement that these services be provided for a sale to take place, nor is
there any objective or reliable evidence of a separate fair value, or if no
longer offered or ceased to be offered would a right of return be created for
the goods sold. We believe these services are part of the sales process and
are
not a customer deliverable, and are therefore charged to selling expense or
cost
of sales, as appropriate.
Deferred
income tax
Deferred
income tax is provided in full, using the liability method, on temporary
differences arising between the tax bases of assets and liabilities and their
carrying amounts in the consolidated financial statements. However, if the
deferred income tax arises from initial recognition of an asset or liability
in
a transaction other than a business combination that at the time of the
transaction affects neither accounting nor taxable profit or loss, it is not
accounted for. Deferred income tax is determined using tax rates (and laws)
that
have been enacted or substantially enacted by the balance sheet date and are
expected to apply when the related deferred income tax assets is realized or
the
deferred income tax liability is settled.
Stock-based
compensation
Effective
January 1, 2006, we adopted SFAS No. 123 (revised 2004), “Share-Based Payment”
(“SFAS 123R”), a revision to SFAS No. 123, “Accounting for Stock-Based
Compensation”. SFAS 123R requires that we measure the cost of employee services
received in exchange for equity awards based on the grant date fair value of
the
awards, with the cost to be recognized as compensation expense in our financial
statements over the vesting period of the awards. Accordingly, we recognize
compensation cost for equity-based compensation for all new or modified grants
issued after December 31, 2005. We account for stock option and warrant grants
issued and vesting to non-employees in accordance with EITF 96-18, “Accounting
for Equity Instruments that are Issued to Other Than Employees for Acquiring,
or
in Conjunction with Selling, Goods or Services”, and EITF 00-18, “Accounting
Recognition for Certain Transactions involving Equity Instruments Granted to
Other Than Employees”, whereas the value of the stock compensation is based upon
the measurement date as determined at either (a) the date at which a performance
commitment is reached or (b) at the date at which the necessary performance
to
earn the equity instruments is complete.
We
did
not recognize any stock-based compensation during the three months or six months
ended June 30, 2006. During the three months and six months ended June 30,
2007,
we recorded $40,642 and $1,652,205, respectively, as a charge to operations
to
recognize the grant date fair value of stock-based compensation in conjunction
with the Escrow Agreement, as described above.
Results
of Operations
The
following table sets forth certain items in our statement of operations as
a
percentage of net sales for the periods shown:
|
|
|
Three
months ended June 30,
|
|
Six
months ended June 30,
|
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
Net
Sales
|
|
|
100.00
|
%
|
|
100.00
|
%
|
|
100.00
|
%
|
|
100.00
|
%
|
|
Cost
of Sales
|
|
|
88.7
|
%
|
|
87.8
|
%
|
|
86.7
|
%
|
|
88.5
|
%
|
|
Gross
Profit
|
|
|
11.3
|
%
|
|
12.2
|
%
|
|
13.3
|
%
|
|
11.5
|
%
|
|
Other
Income form Operation
|
|
|
0.2
|
%
|
|
0.2
|
%
|
|
0.2
|
%
|
|
0.2
|
%
|
|
Depreciation
|
|
|
0.3
|
%
|
|
0.4
|
%
|
|
0.3
|
%
|
|
0.4
|
%
|
|
Administrative
and other operating expenses, including stock-based
compensation
|
|
|
2.7
|
%
|
|
1.3
|
%
|
|
6.2
|
%
|
|
1.4
|
%
|
|
Income
from Operations
|
|
|
8.5
|
%
|
|
10.7
|
%
|
|
10.7
|
%
|
|
9.9
|
%
|
|
Fees
and Costs related to Reverse Merger
|
|
|
-
|
|
|
-
|
|
|
1.8
|
%
|
|
-
|
|
|
Other
Income
|
|
|
0.2
|
%
|
|
0.3
|
%
|
|
0.2
|
%
|
|
0.3
|
%
|
|
Interest
Expenses
|
|
|
1.3
|
%
|
|
1.3
|
%
|
|
1.2
|
%
|
|
1.2
|
%
|
|
Profit
before Tax
|
|
|
7.4
|
%
|
|
9.7
|
%
|
|
4.2
|
%
|
|
9.0
|
%
|
|
Taxation
|
|
|
1.5
|
%
|
|
1.7
|
%
|
|
1.7
|
%
|
|
1.6
|
%
|
|
Net
Income
|
|
|
5.9
|
%
|
|
8.0
|
%
|
|
2.5
|
%
|
|
7.4
|
%
|
Comparison
of the three months ended June 30, 2007 with the three months ended June 30,
2006
Net
sales
for the three months ended June 30, 2007 was $20.9 million as compared to $22.9
million for the same period in 2006, a decrease of $2.1 million, or 9.0%. This
decrease was primarily due to the decrease in sales of completed watches, which
went down from $3.2 million to $1.9 million for the comparable period. The
watch
movement segment remained almost the same from $19.7 million for the three
months ended June 30, 2006 to $19.0 million for the three months ended June
30,
2007. The decrease in sales of completed watches was due to the delay in new
product launches, which affected new order placements during the period.
Cost
of
sales for the three months ended June 30, 2007 was $18.5 million, or 88.7%
of
net sales, as compared to $20.1 million, or 87.8% of net sales, for the same
period in 2006. The slight increase as a percentage of sales in 2007 is due
to
changes between the periods in our sales mix.
Gross
profit for the three months ended June 30, 2007 was $2.3 million, or 11.3%
of
net sales, compared to $2.8 million, or 12.2% of net sales for the same period
in 2006. The change in our gross profit margin was primarily attributable to
the
changes in cost as a the sales mix changed in three months ended June 30, 2007
from the same period in 2006. Gross profit margins are usually a factor of
product mix and demand for product. The gross profit of watch movements as
a
percentage of net sales had increased from 6.3% for the period ended June 30,
2006 to 8.0% of net sales as compared to same period in 2007. There was only
a
slight decrease of gross profit for completed watches for the period ended
June
30, 2007, which was 44.4% of net sales as compared to 48.4% of net sales for
the
same period in 2006 as the product mix had no significant change.
Other
income from operations was $48,281, or 0.2% of net sales for the three months
ended June 30, 2007, as compared to $41,875, or 0.2% of net sales for the three
months ended June 30, 2006. The slight increase was primarily due to an increase
in rental income, which was $15,710 for the three months ended June 30, 2007,
partially offset by a decrease in income received from the license fees of
intangible assets, which was $32,571 for the three months ended June 30, 2007,
as compared to $41,875 for the same period in 2006.
Administrative
and other operating expenses were $558,875, or 2.7% of net sales for the three
months ended June 30, 2007, as compared to $298,113, or 1.3% of net sales for
comparable period in 2006. The increase in amount and as a percentage of net
sales was primarily due to the recognition of $40,642 of stock-based
compensation during the three months ended June 30, 2007 related to the Escrow
Shares provided by our CEO, Kwong Kai Shun, which are subject to the achievement
of defined annual net income for 2006 and 2007 pursuant to the Private Placement
agreement entered into with our investors. The increase was also attributable
to
the increase in professional fees related to reporting requirements as a public
company and additional employees and upgraded staff benefits in the comparable
period in 2007. Management considers these expenses as a percentage of net
sales
to be a key performance indicator in managing our business.
Other
income from non-operating activities was $48,452, or 0.2% of net sales, for
the
three months ended June 30, 2007, as compared to $67,383, or 0.3% of net sales,
for the three months ended June 30, 2006. The decrease was primarily due to
a
decrease in bank interest income, which was $47,904 for the three months ended
June 30, 2007, as compared to $57,661 for the same period in 2006 and a lack
of
other interest income in the comparable period in 2007.
Interest
expense for the three months ended June 30, 2007 was $274,990, or 1.3% of net
sales, which was consistent as compared to $297,298, or 1.3% of net sales,
in
2006.
Income
taxes for the three months ended June 30, 2007 were $314,204, or 1.5% of net
sales, as compared to $389,366 for the three months ended June 30, 2006, or
1.7%
of net sales. The decrease in income taxes were primarily due to a decrease
in
the operating profit from $2.2 million for the three months ended June 30,
2006
to $1.6 million for the same period in 2007.
Net
income for the three months ended June 30, 2007 was $1.2 million, or 5.9% of
net
sales, as compared to $1.8 million, or 8.0% of the net sales for the comparable
period in 2006. Net income for the three months ended June 30, 2007 included
a
stock-based compensation charge of $40,642 related to the Escrow Shares provided
by our CEO, Kwong Kai Shun, as discussed above.
Comparison
of the six months ended June 30, 2007 with the six months ended June 30,
2006
Net
sales
for the six months ended June 30, 2007 was $42.0 million as compared to $43.2
million for the comparable period in 2006, a decrease of $1.2 million, or 2.9%.
This decrease was primarily due to the decrease in sales of completed watches,
which went down from $5.3 million for the six months ended June 30, 2007 to
$3.8
million for the comparable period, partially offset by the increase in sales
of
watch movements from $37.9 million for the six months ended June 30, 2007 to
$38.2 million for the comparable period. The decrease in sales of completed
watches was due to the delay in new product launches, which affected new order
placements in the period.
Cost
of
sales for the six months ended June 30, 2007 was $36.4 million, or 86.7% of
net
sales, as compared to $38.3 million, or 88.5% of net sales, for the same period
in 2006. The decrease in cost of sales as a percentage of net sales was largely
attributable to the improved economies of scale and the increased level of
price
reduction received in the form of additional watch movements from the
manufacturers.
Gross
profit for the six months ended June 30, 2007 was $5.6 million, or 13.3% of
net
sales, compared to $5.0 million, or 11.5% of net sales for the same period
in
2006. The increase in our gross profit margin was primarily attributable to
the
increase in sales of higher-margin products as a result of diversification
of
products, a decrease in costs in the six months ended June 30, 2007 due to
improved economies of scale. Gross profit margins are usually a factor of
product mix and demand for product. The gross profit of watch movements as
a
percentage of net sales had increased from 6.3% for the period ended June 30,
2006 to 10.0% of net sales for the same period in 2007. The increase in gross
profit margin was primarily due to an increase in sales of higher-margin items.
There was only a slight increase of gross profit for completed watch for the
six
months ended June 30, 2007, which was 46.4% of net sales as compared to 48.0%
of
net sales for the comparable period in 2006 as the product mix had no
significant change.
Other
income from operations was $96,778, or 0.2% of net sales for the six months
ended June 30, 2007, as compared to $83,780, or 0.2% of net sales for the six
months ended June 30, 2006. The slight increase was primarily due to an increase
in rental income, which was $31,491 for the six months ended June 30, 2007,
partially offset by a decrease in income received from the license fees of
intangible assets, which was $65,287 for the six months ended June 30, 2007,
as
compared to $83,780 for the same period in 2006.
Administrative
and other operating expenses were $2,605,263, or 6.2% of net sales for the
six
months ended June 30, 2007, as compared to $612,245, or 1.4% of net sales for
comparable period in 2006. The increase in amount and as a percentage of net
sales was primarily due to the recognition of $1,652,205 of stock-based
compensation for the six months ended June 30, 2007 related to the Escrow Shares
provided by our CEO, Kwong Kai Shun, which are subject to the achievement of
defined annual net income for 2006 and 2007 pursuant to the Private Placement
agreement entered into with our investors. The increase was also attributable
to
the increase in professional fees related to reporting requirements as a public
company and additional employees and upgraded staff benefits in the comparable
period in 2007. Management considers these expenses as a percentage of net
sales
to be a key performance indicator in managing our business.
Fees
and
costs related to the reverse merger for the six months ended June 30, 2007
were
$736,197, which included the shell cost $317,000 paid to the shareholders of
SRKP 9, Inc., the shell company. There were no such expenses in the same period
in 2006.
Other
income from non-operating activities was $78,381, or 0.2% of net sales, for
the
six months ended June 30, 2007, as compared to $110,296, or 0.3% of net sales,
for the six months ended June 30, 2006. The decrease was primarily due to a
decrease in bank interest income, which was $76,906 for the six months ended
June 30, 2007, as compared to $94,004 for the same period in 2006 and a lack
of
other interest income in the comparable period in 2007.
Interest
expense for the six months ended June 30, 2007 was $514,419, or 1.2% of net
sales, which was consistent as compared to $497,854, or 1.2% of net sales,
in
2006.
Income
taxes for the six months ended June 30, 2007 were $716,871, or 1.7% of net
sales, as compared to $684,311 for the six months ended June 30, 2006, or 1.6%
of net sales. The decrease in income taxes was primarily due to a decrease
in
the operating profit due to stock compensation expense that will not give rise
to a future tax deduction. In addition operating profits wee also less than
the
2006 period.
Net
income for the six months ended June 30, 2007 was $1.0 million, or 2.5% of
net
sales, as compared to $3.2 million, or 7.4% of the net sales for the comparable
period in 2006. Net income for the six months ended June 30, 2007 included
a
stock-based compensation charge of $1,652,205 related to the Escrow Shares
provided by our CEO, Kwong Kai Shun, as discussed above.
Off-Balance
Sheet Arrangements
Other
than the Escrow Agreement and Escrow Shares, as described above, we do not
have
any off-balance sheet debt, nor do we have any transactions, arrangements or
relationships with any special purpose entities.
Contractual
Obligations
Other
than those commitments and obligations being entered into in the normal course
of business, we do not have any additional, material capital commitments and
obligations due to other parties.
Inflation
and Seasonality
Inflation
and seasonality have not had a significant impact on our operations during
the
last two fiscal years.
New
Accounting Pronouncements
In
February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid
Financial Instruments, which amends SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities (“SFAS No. 155”), and SFAS No. 140,
Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities. SFAS No. 155 simplifies the accounting for certain derivatives
embedded in other financial instruments by allowing them to be accounted for
as
a whole if the holder elects to account for the whole instrument on a fair
value
basis. SFAS No. 155 also clarifies and amends certain other provisions of SFAS
No. 133 and SFAS No. 140. SFAS No. 155 is effective for all financial
instruments acquired, issued or subject to a remeasurement event occurring
in
fiscal years beginning after September 15, 2006. Earlier adoption is permitted,
provided we have not yet issued financial statements, including for interim
periods, for that fiscal year. We do not believe the adoption of SFAS No. 155
will have a material impact on our consolidated financial position or results
of
operations.
The
FASB
released SFAS No. 156, “Accounting for Servicing of Financial Assets,” to
simplify accounting for separately recognized servicing assets and servicing
liabilities. SFAS No. 156 amends SFAS No. 140, “Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities.” SFAS No. 156
permits an entity to choose either the amortization method or the fair value
measurement method for measuring each class of separately recognized servicing
assets and servicing liabilities after they have been initially measured at
fair
value. SFAS No. 156 applies to all separately recognized servicing assets and
liabilities acquired or issued after the beginning of an entity’s fiscal year
that begins after September 15, 2006. SFAS No. 156 will be effective for us
as
of December 31, 2006, the beginning of our 2007 fiscal year. We do not believe
the adoption of SFAS No. 156 will have a material impact on our consolidated
financial position or results of operations.
In
July
2006, the FASB issued FIN 48 “Accounting for Uncertainty in Income Taxes.” This
interpretation requires that we recognize in our financial statements, the
impact of a tax position, if that position is more likely than not of being
sustained on audit, based on the technical merits of the position. The
provisions of FIN 48 are effective as of the beginning of our 2007 fiscal year,
with the cumulative effect of the change in accounting principle recorded as
an
adjustment to opening retained earnings. We are currently evaluating the effect
of FIN 48 on our financial statements and do not believe the adoption of FIN
No.
48 will have a material impact on our consolidated financial position or results
of operations.
In
September 2006, the FASB issued SFAS No. 157 “Fair Value Measurement” (“SFAS
157”). SFAS 157 defines fair value, establishes a framework for measuring fair
value, and expands disclosures about fair value measurements. This Statement
shall be effective for financial statements issued for fiscal years beginning
after November 15, 2007, and interim periods within those fiscal years. Earlier
application is encouraged, provided that the reporting entity has not yet issued
financial statements for that fiscal year, including any financial statements
for an interim period within that fiscal year. The provisions of this statement
should be applied prospectively as of the beginning of the fiscal year in which
this Statement is initially applied, except in some circumstances where the
statement shall be applied retrospectively. We are currently evaluating the
effect, if any, of SFAS 157 on our financial statements. Although we will
continue to evaluate the provisions of SFAS No. 157, management currently
does not believe the adoption of SFAS No. 157 will have a material
impact on our consolidated financial statements.
The
FASB
released SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and
Other Postretirement Plans: an amendment of FASB Statements No. 87, 88, 106,
and
132(R),” which requires an employer to recognize the over funded or under funded
status of defined benefit and other postretirement plans as an asset or
liability in its statement of financial position and to recognize changes in
that funded status in the year in which the changes occur through an adjustment
to comprehensive income. This statement also requires an employer to measure
the
funded status of a plan as of the date of its year-end statement of financial
position, with limited exceptions. We are required to initially recognize the
funded status of our defined benefit and other postretirement plans as of
December 31, 2006, and to provide the required disclosures in our 2006 annual
report on Form 10-KSB. The adoption of SFAS No. 158 has no material effect
on
our financial statements.
On
February 15, 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities - Including an Amendment of SFAS
No.
115.” The fair value option established by SFAS No. 159 permits all entities to
choose to measure eligible items at fair value at specified election dates.
A
business entity will report unrealized gains and losses on items for which
the
fair value option has been elected in earnings (or another performance indicator
if the business entity does not report earnings) at each subsequent reporting
date. The fair value option: (a) may be applied instrument by instrument, with
a
few exceptions, such as investments otherwise accounted for by the equity
method; (b) is irrevocable (unless a new election date occurs); and (c) is
applied only to entire instruments and not to portions of instruments. SFAS
No.
159 is effective as of the beginning of an entity’s first fiscal year that
begins after November 15, 2007. Early adoption is permitted as of the beginning
of the previous fiscal year provided that the entity makes that choice in the
first 120 days of that fiscal year and also elects to apply the provisions
of
SFAS. No.157. We have chosen not to adopt this statement early. Although we
will
continue to evaluate the provisions of SFAS No. 159, management currently
does not believe the adoption of SFAS No. 159 will have a material
impact on our consolidated financial statements.
Liquidity
and Capital Resources
To
provide liquidity and flexibility in funding our operations, we borrow amounts
under bank facilities and other external sources of financing. As of June 30,
2007 we had general banking facilities amounted to $15.61 million for overdraft,
letter of credit, trust receipt, invoice financing and export loans granted
by
nine banks. The amount increased by $2.40 million compared to $13.20 million
as
at June 30, 2006. Interest on the facilities ranged from minus 2.0 to 0.75%
over
the Bank’s Best Lending Rate of Hong Kong (Prime Rate) or Hong Kong Inter Bank
Offered Rate (HIBOR). These banking facilities were secured by the leasehold
properties, time deposits and held-to maturity investments of the group and
personal guarantees executed by our Chairman of the Board.
On
January 23, 2007, concurrently with the close of the Share Exchange, we
conducted an initial closing of a private placement transaction pursuant to
which we sold an aggregate of 1,749,028 shares of Series A Convertible Preferred
Stock at $1.29 per share. On February 9, 2007, we conducted a second and final
closing of the private placement pursuant to which we sold 501,320 shares of
Series A Convertible Preferred Stock at $1.29 per share. Accordingly, a total
of
2,250,348 shares of Series A Convertible Preferred Stock were sold in the
private placement for an aggregate gross proceeds of $2,902,946 (the “Private
Placement”). Of the gross proceeds, $50,000 is represented by a subscription
receivable from one investor. WestPark Capital, Inc. (“WestPark”) acted as the
placement agent for the Private Placement. For its services as placement agent,
WestPark received an aggregate fee of approximately $261,265, which consisted
of
a commission equal to 9.0% of the gross proceeds from the financing. After
commissions and expenses, we received net proceeds of approximately $2.3 million
in the Private Placement.
Pursuant
to Subscription Agreements entered into with the investors in the Private
Placement, each share of the Series A Convertible Preferred Stock is convertible
into shares of common stock at a conversion price equal to the per share
purchase price. However, if we, at any time prior to the first trading day
on
which our common stock is quoted on the American Stock Exchange, Nasdaq Capital
Market, Nasdaq Global Market or New York Stock Exchange (each a “Trading
Market”) sell or issue any shares of common stock in one or a series of
transactions at an effective price less than such conversion price where the
aggregate gross proceeds to us are at least $1.0 million, then the
aforementioned conversion price shall be reduced to such effective price. Each
share of the Series A Convertible Preferred Stock shall automatically convert
into shares of common stock if (i) the closing price of our common stock on
the
Trading Market for any 10 consecutive trading day period exceeds $3.00 per
share, (ii) the shares of common stock underlying the Series A Convertible
Preferred Stock are subject to an effective registration statement, and (iii)
the daily trading volume of the common stock on a Trading Market exceeds 25,000
shares per day for 10 out of 20 prior trading days. Upon liquidation, the
holders of the Series A Convertible Preferred Stock shall receive $1.29 per
share of the Series A Convertible Preferred Stock then held prior to any other
distribution or payment made to holders of the common stock.
We
agreed
to file, and did file, a registration statement covering the common stock
underlying the Series A Convertible Preferred Stock sold in the Private
Placement within 30 days of the closing of the Share Exchange pursuant to the
subscription agreement with each investor.
For
the
six months ended June 30, 2007, net cash used by operating activities was
approximately $3.9 million, as compared to net cash used in operating activities
of $821,651 for the comparable period in 2006. The increase in net cash used
by
operating activities was primarily attributable to a decrease in net income
of
$1.0 million for the six months ended June30, 2007 as compared to $3.2 million
in the comparable period, an increase in accounts receivable of $6.3 million
for
the six months ended June 30, 2007 as comparable to $3.5 million in the same
period in 2006, and an increase in prepaid expenses and other receivables of
$3.9 million for the six months ended June 30, 2007 as comparable to $963,218
in
the same period in 2006, partially offset by a decrease in inventories of $2.2
million for the six months ended June 30, 2007 as comparable to $1.1 million
in
the same period in 2006, an adjustment related to stock-based compensation
to
our CEO, Kwong Kai Shun of $1.7 million and the lack of unearned revenue. The
increase in accounts receivable was due to an increase in sales and extended
aging in the completed watches segment. The increase in prepaid expenses and
other receivables was attributable to the deposit of potential acquisition
of
plant facilities to our intermediate. However, no solid acquisition plan was
carried out as of the time of this quarterly report.
Net
cash
used in investing activities was $3,504 for the six months ended June 30, 2007,
compared to $1.2 million in the comparable period in 2006. The decrease in
net
cash used was primarily due to the decrease in expenditures for acquiring plant
and equipment from $1.2 million for the six months ended June 30, 2006 to
$$3,824 in the comparable period in 2007, and no significant investment was
made
during this period.
Net
cash
provided by financing activities was $3.7 million for the six months ended
June
30, 2007 and $1.6 million for the comparable period in 2006. The increase in
net
cash provided by financing activities for the six months ended June 30, 2007
was
primarily attributable to an increase in our issuance of equity securities
in a
private placement in the amount of $2.6 million and the lack of dividends paid,
partially offset by a an increase in recapitalization costs.
For
the
six months ended June 30, 2007 and the same period in 2006, our average
inventory turnover were 26 days and 27 days, respectively. The average days
outstanding of our accounts receivable for the six months ended June 30, 2007
was 49 days, as compared to 28 days for the same period in 2006. The increase
in
accounts receivable was due to the change in our credit policy. Since January
2007, we have extended our credit terms from 30 days to 60 day to customers
who
have a good credit history in order to improve our profit margin and
competitiveness. Inventory turnover and average days outstanding are key
operating measures that management relies on to monitor our business.
For
fiscal year 2006, 2005 and 2004, our inventory turnover was 10.8, 10.8 and
13.2
times, respectively. During 2004, our stock level was kept at a relatively
low
level to improve cash flow however, we also risked stock shortage. In 2005
and
2006 we increased our stock level and, thus, the turnover ratio to a more
optimal level of 10.8. We expect the turnover ratio will further decrease in
2007 as the order delivery cycle time of our supplies has shortened, possibly
allowing us to keep a lower stock level with a decreased risk of stock
shortages. The average days outstanding of our accounts receivable at December
31, 2006 were 29 days, as compared to 24 days and 10.8 days at December 31,
2005
and 2004. The increase in accounts receivable was due to the change in credit
policy since 2005 where credit terms of up to 30 days were given to customers
who had good credit history in order to improve our profit margin and
competitiveness.
In
an
attempt to reduce our reliance on third-party watch movement manufacturers,
we
have plans to manufacture our own brands of quartz movements and mechanical
movements in-house. To manufacture our own brands of quartz and mechanical
movements in-house, we would need to acquire watch movement facilities in China
and invest in new equipment and research and development. We expect that up
to
$5.5 million will be required to obtain the equipment and facilities to
manufacture branded proprietary watch movements. Our plan to acquire
manufacturing facilities and equipment to manufacture our own brand of quartz
and mechanical movements in-house will not take place until after the completion
of our initial public offering, the proceeds of which will give us a portion
of
the required capital. We will be required to raise the appropriate amount of
capital needed for our future operations from future equity sales or through
debt financings. Failure to obtain funding when needed may force us to delay,
reduce, or eliminate our plans to manufacture our own watch movement parts.
We
may not be able to obtain additional financial resources when necessary or
on
terms favorable to us, if at all, and any available additional financing may
not
be adequate. Moreover, new equity securities issued in financings, including
any
shares of Series A Convertible Preferred Stock or any new series of preferred
stock authorized by our Board of Directors, may have greater rights, preferences
or privileges than our existing common stock. To the extent stock is issued
or
options and warrants are exercised, holders of our common stock will experience
further dilution.
Based
on
our current plans, we believe that cash on hand, cash flow from operations
and
funds available under our bank facilities will be sufficient to fund our capital
needs for the next 12 months. However, our ability to maintain sufficient
liquidity depends partially on our ability to achieve anticipated levels of
revenue, while continuing to control costs. If we did not have sufficient
available cash, we would have to seek additional debt or equity financing
through other external sources, which may not be available on acceptable terms,
or at all. Failure to maintain financing arrangements on acceptable terms would
have a material adverse effect on our business, results of operations and
financial condition.