UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 20-F
[ ] REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) or (g) OF THE
SECURITIES EXCHANGE ACT OF 1934
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, 2004.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition period from _____________ to ______________
Commission File Number: 0-23696
RADICA GAMES LIMITED
(Exact name of registrant as specified in its charter)
BERMUDA
(Jurisdiction of incorporation or organization)
SUITE V, 6/FL. 2-12 AU PUI WAN ST.
FO TAN, HONG KONG
(Address of principal executive offices)
Securities Registered Pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to section 12(g) of the Act:
Common Stock, Par Value $.01
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.
Title of each class Amount Outstanding
------------------- ------------------
Common Stock, Par Value $.01 18,738,112
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.
Yes X No
--------- ---------
Indicate by check mark which financial statement item the registrant has elected
to follow:
Item 17 Item 18 X
--------- ---------
RADICA GAMES LIMITED
INDEX TO ANNUAL REPORT ON FORM 20-F
YEAR ENDED DECEMBER 31, 2004
ITEMS IN FORM 20-F
Page
----
PART I 4
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS 4
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE 4
ITEM 3. KEY INFORMATION 4
ITEM 4. INFORMATION ON THE COMPANY 13
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS 23
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES 33
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS 39
ITEM 8. FINANCIAL INFORMATION 40
ITEM 9. THE OFFER AND LISTING 40
ITEM 10. ADDITIONAL INFORMATION 41
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT
MARKET RISK 45
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES 46
PART II 46
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES 46
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS
AND USE OF PROCEEDS 46
ITEM 15. CONTROLS AND PROCEDURES 46
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT 46
ITEM 16B. CODE OF ETHICS 47
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES 47
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES 47
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND
AFFILIATED PURCHASERS 47
PART III 47
ITEM 17. FINANCIAL STATEMENTS 47
ITEM 18. FINANCIAL STATEMENTS 47
ITEM 19. EXHIBITS 48
2
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
This report includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. For example, statements included in this report regarding
our financial position, business strategy and other plans and objectives for
future operations, and assumptions and predictions about future product demand,
supply, manufacturing, costs, marketing and pricing factors are all
forward-looking statements. We believe that the assumptions and expectations
reflected in such forward-looking statements are reasonable, based on
information available to us on the date hereof, but we cannot assure you that
these assumptions and expectations will prove to have been correct or that we
will take any action that we may presently be planning. Forward-looking
statements involve risks and uncertainties that could cause actual results to
differ materially from projected results. These risks include those set forth
elsewhere in this Annual Report on Form 20-F for the fiscal year ended December
31, 2004. See "Item 3. Key Information -- Risk Factors" in this report on Form
20-F. We are not undertaking to publicly update or revise any forward-looking
statement if we obtain new information or upon the occurrence of future events
or otherwise.
3
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
SELECTED FINANCIAL DATA
Set forth below is the selected income statement and balance sheet data
as of and for each of the years in the five-year period ended December 31, 2004.
This data is derived from the consolidated financial statements included herein
and from those previously reported for earlier periods. This summary should be
read in conjunction with "Operating and Financial Review and Prospects" and the
consolidated financial statements and notes thereto included elsewhere in this
document.
YEAR ENDED DECEMBER 31,
(in thousands, except per share data and margins) 2004 2003 2002 2001 2000
---- ---- ---- ---- ----
INCOME STATEMENT DATA:
Net sales $123,399 $105,200 $124,646 $98,554 $106,696
Cost of sales 81,576 65,350 78,138 65,332 83,674
-------- -------- -------- ------- --------
Gross profit 41,823 39,850 46,508 33,222 23,022
-------- -------- -------- ------- --------
Operating expenses:
Selling, general and administrative 30,071 25,000 27,038 25,645 31,689
Research and development 4,164 3,895 4,094 5,775 5,210
Depreciation and amortization of goodwill and 1,693 2,033 2,858 4,013 5,427
intangible assets
Impairment of goodwill 3,536 - - - -
Restructuring charge - 87 - 1,551 1,190
-------- -------- -------- ------- --------
Total operating expenses 39,464 31,015 33,990 36,984 43,516
-------- -------- -------- ------- --------
Operating income (loss) 2,359 8,835 12,518 (3,762) (20,494)
Other income 754 317 306 24 781
Foreign currency gain (loss), net 417 178 1,744 (219) 49
Net interest income 765 295 35 136 664
-------- -------- -------- ------- --------
Income (loss) before income taxes 4,295 9,625 14,603 (3,821) (19,000)
(Provision) credit for income taxes (839) 2,866 (2,669) (553) 901
-------- -------- -------- ------- --------
Net income (loss) $ 3,456 $ 12,491 $ 11,934 $(4,374) $(18,099)
======== ======== ======== ======= ========
Net income (loss) per share - basic $ 0.19 $ 0.69 $ 0.67 $ (0.25) $ (1.03)
======== ======== ======== ======= ========
Weighted average number of common shares 18,653 18,017 17,726 17,612 17,608
======== ======== ======== ======= ========
Net income (loss) per share - diluted $ 0.18 $ 0.66 $ 0.65 $ (0.25) $ (1.03)
Weighted average number of common shares
and common equivalent shares 19,526 19,060 18,336 17,612 17,608
(continued)
YEAR ENDED DECEMBER 31,
(in thousands, except per share data and margins) 2004 2003 2002 2001 2000
---- ---- ---- ---- ----
STATISTICAL DATA:
Gross margin 33.9% 37.9% 37.3% 33.7% 21.6%
Operating margin 1.9% 8.4% 10.0% (3.8%) (19.2%)
BALANCE SHEET DATA (AT PERIOD END):
Working capital $71,775 $65,616 $50,155 $36,709 $42,619
Total assets 109,941 102,214 95,302 88,407 99,315
Long-term debt - - - 1,825 5,473
Total debt - - 2,671 6,319 12,901
Common stock 187 182 178 176 176
Shareholders' equity 91,077 89,516 74,636 63,052 67,388
RISK FACTORS
Our common stock involves a significant degree of risk. You should
carefully consider the following risk factors and the other information
contained or incorporated by reference in this annual report before investing in
our common stock. Any of the following factors, depending upon the severity and
circumstances of a particular occurrence, could result in a material adverse
effect on our business, prospects, financial condition and results of
operations.
RISK OF MANUFACTURING IN CHINA
Our factory is in Southern China and our headquarters are in Hong Kong,
which is a Special Administrative Region of China.
Risk of China Losing Normal Trade Relations Status or of Changes in
Tariff or Trade Policies. We manufacture in China and export from Hong Kong and
China to the United States and worldwide. Our products sold in the United States
are currently not subject to U.S. import duties. On September 19, 2000, the U.S.
Senate voted to permanently normalize trade with China, which provides a
favorable category of U.S. import duties. In addition, on December 11, 2001
China was accepted into the World Trade Organization (WTO), a global
international organization of 144 countries that regulates international trade.
As a result of opposition to certain policies of the Chinese government
and China's growing trade surpluses with the United States, there has been, and
in the future may be, opposition to the extension of Normal Trade Relations, or
NTR, status for China. The loss of NTR status for China, changes in current
tariff structures or adoption in the United States of other trade policies
adverse to China could have an adverse effect on our business.
Chinese Political, Economic and Legal Risks. Our current and future
operations in China and Hong Kong are highly dependent on the Chinese
government's continued support of economic reform programs that encourage
private investment, and particularly foreign private investment. Although the
Chinese government has adopted an "open door" policy with respect to foreign
investment, we cannot assure you that this policy will continue. A change in
policies by the Chinese government could adversely affect our business by, among
other things, imposing confiscatory taxation, restricting currency conversion,
imports and sources of supplies, or expropriating private enterprises. Although
the Chinese government has been pursuing economic reform policies for many
years, we cannot assure you that the Chinese government will continue to pursue
these policies or that these policies may not be significantly altered,
especially in the event of a change in leadership or other social or political
disruption.
Our production and shipping capabilities could be adversely affected by
ongoing tensions between the Chinese and Taiwanese governments. In the event
that Taiwan does not adopt a plan for unifying with China, the Chinese
government has threatened military action against Taiwan. As of yet, Taiwan has
not indicated that it intends to propose and adopt a reunification plan. If an
invasion were to occur, our supply of components from Taiwanese suppliers,
including computer processing units (CPUs), could be cut off, potentially
limiting our production capabilities. Invasion could also lead to sanctions or
military action by the U.S. and/or European countries, which could materially
affect our sales to those countries.
China Does Not Have a Comprehensive System of Laws. Enforcement of
existing laws in China may be sporadic and implementation and interpretation of
laws may be inconsistent. The Chinese judiciary is relatively inexperienced in
enforcing the
5
laws that exist, leading to a higher than usual degree of uncertainty as to the
outcome of any litigation. Even where adequate law exists in China, it may be
impossible to obtain swift and equitable enforcement of such law, or to obtain
enforcement of a judgment by a court of another jurisdiction.
Dependence on Local Government. We operate our factory in China under
agreements with the local government. These agreements and our factory
operations are dependent on our relationship with the local government and
existing trade practices. This relationship could be subject to adverse change
in the future, especially in the event of a change in leadership or other social
or political disruption.
Chinese Taxation. We paid $596,000 in foreign enterprise tax on our
joint venture in China in 2004. This is the sixth year we have paid foreign
enterprise tax in China. We were granted 50% relief from foreign enterprise tax
through December 31, 2001 under the Foreign Enterprise Income Tax Law of The
People's Republic of China, or PRC, and were therefore taxed at 12%. In 2002 and
2003, we were taxed at the full rate of tax of 27%; however, we successfully
applied to be designated as an "Export Oriented Enterprise", which resulted in a
tax rebate which was received in 2003 and 2004 that reduced our China tax rate
applicable to 2002 and 2003 to 12% which does not include the local tax of 3%.
The application to be designated as an "Export Oriented Enterprise" is required
to be made on a yearly basis. We applied for the same designation for 2004 and
if our application is successful, it will result in the receipt of a tax rebate
in 2005.
The PRC assesses tax on us based on a joint venture contract. The joint
venture contract is a joint venture with the local township that lasts through
August 12, 2024 and tax is payable quarterly based on tax rates determined upon
entering the agreement.
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 in the future. In addition, the negotiation and settlement of tax
obligations with the local tax authorities are a normal occurrence.
Chinese Customs. We have intercompany invoicing whereby our Chinese
subsidiary invoices the Hong Kong and Macau entities who then invoice the U.S.
and U.K. entities for sales rendered. As required by Chinese customs and the
Chinese tax authority in each jurisdiction, our Chinese subsidiary seeks to
apply arms length pricing to this process. Should the customs or tax authority
in any jurisdiction consider the pricing not to be arms-length, it may deem the
prices charged to be different from those we have applied. If this decision were
to be applied unilaterally, it could lead to an increase in our overall customs
duties and taxes. In addition, we may have to expend resources in defending our
position, irrespective of the outcome determined.
Chinese Value Added Tax. China's turnover tax system consists of
value-added tax, or VAT, consumption tax and business tax. Export sales are
exempted under VAT rules and an exporter who incurs input VAT on purchase or
manufacture of goods should be able to claim a refund from Chinese tax
authorities. However, due to a reduction in the VAT export refund rate of some
goods, exporters might bear part of the VAT they incurred in conjunction with
the exported goods. In 2003, changes to the Chinese Value Added Tax system were
announced affecting the recoverability of input VAT beginning January 1, 2004.
Our VAT expense will depend on the reaction of both our suppliers and customers.
Continued efforts by the Chinese government to increase tax revenues could
result in revisions to tax laws or their interpretation, which could increase
our VAT and various tax liabilities.
We establish provisions for our known and estimated customs duties and
tax obligations. However, we may be exposed to additional taxation whether
through a challenge by one of the many tax authorities in international
jurisdictions of our transfer pricing, our claim regarding lack of permanent
establishment, or other interpretations regarding our tax obligations.
Limited Infrastructure. Electricity, water, sewage, telephone and other
infrastructure are limited in the locality of our factory. In the past, we have
experienced temporary shortages of electricity and water supply. We have
installed eight back-up electrical generators in our factory which can support
it in the event of a power shortage and are in the process of constructing a
water storage tank that will be put into service in early 2005. We cannot assure
you that the infrastructure on which our factory is dependent will be adequate
to operate the factory successfully.
Availability of Factory Workers. Due to increases in demand for workers
in South China, we cannot assure you that we can adequately staff the factory.
Labor shortages could have a material impact on production, which could lead to
missed sales, increased air freight costs and vendor fines.
6
DEPENDENCE ON CURRENT PRODUCT APPEAL AND NEW PRODUCT INTRODUCTIONS
Our operating results depend largely upon the appeal of our products to
consumers. Consumer preferences are highly subjective, and there can be no
assurance that consumers will continue to find existing products appealing or
will find new products appealing. Also, we continue to offer a relatively
limited range of products that are all in the categories of electronic toys and
games or video game accessories. This exposes us to the risks of any narrowly
focused business. Changes in consumer preferences away from the kinds of
products we offer could have an adverse effect on our business.
Some of our products have only recently been introduced and although
they may experience good initial sales growth, we cannot assure you that this
initial success is indicative of significant future sales. As a general matter,
we expect that the sales of these products will eventually decline. We cannot
predict how long the product cycle will last for any product. In order to
control costs and take advantage of the finite shelf space available to us, we
need to delete products from our line periodically. Our long-term operating
results will therefore depend largely upon our continued ability to conceive,
develop and introduce new appealing products at competitive prices.
Once a new product is conceived, the principal steps to the
introduction of the product include design, sourcing and testing of the
electronic 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 we
cannot assure you that products will be introduced in a timely fashion.
Future products may utilize different technologies and require
knowledge of markets in which we do not presently participate. Significant
delays in the introduction of, or the failure to introduce, new products or
improved products would have an adverse effect on our operating results.
We cannot assure you that retailers will react positively to new
product introductions which may result in termination of a product. There is
also a risk that the demand for new or existing products could drop suddenly. As
a result, we may build excess quantities of certain products and subsequently
have to make inventory provisions to markdown the value of excess inventory
quantities to their estimated market value.
There are often technical challenges in bringing a product into
production. We may announce and sell a product but later find it must be delayed
or abandoned due to difficulties in engineering and manufacturing. We cannot
assure you that an announced product will ship on time or not be abandoned.
NO ASSURANCE OF GROWTH
We cannot assure you that we will achieve future growth in net sales or
that we will be able to maintain our present levels of net sales or
profitability. Our current business strategy emphasizes the sale of a controlled
number of products, while representing a more diverse range of products than in
the past. Our products include casino and heritage electronic games, mechanical
slot banks, youth electronic games, tabletop games, Play TV(R) games, Girl
Tech(R) and Barbie(TM) girls electronic lines, the Twinkleberries(TM) and
Cupcakes(R) doll lines, the Nitro Battlerz(TM) and Big Trouble(TM) remote
control car products, the Street Muttz(TM) plush line and video game accessories
sold under the Gamester(R) brand. In any period, our financial results are
likely to vary with the success or lack of success of newly introduced products,
which are inherently uncertain. We cannot simply rely on continuing sales of
existing products.
DEPENDENCE ON MAJOR CUSTOMERS
Historically, a significant portion of our sales have been concentrated
with a few large retail customers. These customer concentrations are disclosed
in the notes to our consolidated financial statements in this annual report.
Most of our retail customers operate on a purchase order basis and we do not
have long-term contracts with our retail customers. While we believe we have
good relationships with our major retail customers, the loss of one or more of
these retail customers would have an adverse effect on our operating results.
On January 22, 2002, the Kmart Corporation filed for protection from
its creditors under Chapter 11 of the United States Bankruptcy Code. Our
receivable exposure to Kmart was entirely provided for during 2001 and no
additional write-downs or
7
expenses related to the bankruptcy were incurred during 2002. We continue to
sell our products to Kmart and closely monitor our account with them in order to
minimize future exposure.
During 2003, both FAO, the parent company of FAO Schwartz and Zany
Brainy stores, and KB Toys, Inc. filed for Chapter 11 protection. Our exposure
was limited in both of these cases and any outstanding receivables were provided
for during 2003. Currently, we are not selling to FAO Schwartz and are selling
in limited quantities to KB Toys. As with Kmart, the accounts will be closely
monitored in order to minimize future exposure.
During 2004, a significant portion of our OEM sales were sales to
Hasbro, which is also one of our competitors. We do not have a specific contract
with Hasbro regarding these projects and there is no assurance that we will
continue to receive orders from Hasbro, which could have an adverse effect on
our business.
Also during 2004, our profitability for the 4th quarter was affected by
the reduction in orders from a major customer that normally accounts for about
one third of 4th quarter sales. This reduction of orders was the result of a
reduction in the customer's stores carrying several of our basic electronic
handheld games in order to increase their inventories of seasonal items for
Christmas. The stores resumed carrying these items in Spring of 2005, but there
is no assurance that this customer won't reduce the number of stores carrying
these or other items in 2005 and subsequent years.
On March 17, 2005, Toys R Us announced that they had agreed to be
acquired for $6.6 billion by Kohlberg Kravis Roberts & Co., Bain Capital and
Vornado Realty Trust. The acquiring group has not announced any plans for the
future of Toys R Us, but a restructuring that included store closings or
liquidation of the company could have an adverse effect on our business.
DEPENDENCE ON SUPPLIERS AND SUBCONTRACTORS
We are dependent on suppliers for the components and parts that we
assemble to produce our products. An interruption of the supply of LCDs,
semiconductor chips or other supplies from a supplier could result in
significant production delays. Additionally, recent increases in oil prices have
resulted in significant price increases from suppliers of plastics. Most of our
products are primarily made from plastic. While our products also contain
significant electronics and the cost of the plastic may not be the most
significant material costs, if oil prices continue to rise, it could result in
additional increases in the price of plastic, which would increase our product
costs and subsequently reduce our profits.
We also rely on outside manufacturers for production of some of our
electronic games and video game accessories. While the majority of our
production occurs in our own factory, manufacturer delays or shutdowns could
have a significant impact on future sales of certain products.
CONCENTRATED MANUFACTURING FACILITIES
A disruption of operations at our China factory due to fire, labor
dispute, dispute with the local government or otherwise, would have an adverse
effect on our operating results. In such event, we believe that we could
partially mitigate the effect of a disruption by increasing the use of
subcontractors to assemble our products, but we cannot assure you that we would
be able to do so. In addition, our manufacturing facilities are dependent on our
relationship with the local government.
NO ASSURANCE OF SUCCESS IN NEW BUSINESS
From time to time, we expand into related or new businesses in order to
diversify and grow. Examples include the development of our ODM and OEM
operations and our expansion into the video game accessories market. We cannot
assure you that such businesses can be retained or that we will be successful in
such ventures.
NO ASSURANCE OF CONTINUED ODM/OEM BUSINESS
We manufacture goods for third parties, often without a contract. Our
contracts with ODM and OEM customers can generally be terminated by either party
on short notice; therefore we cannot assure you that such business can be
retained for an extended period of time. Loss of such business would materially
affect our revenues.
DEPENDENCE ON KEY PERSONNEL
Our success is substantially dependent upon the expertise and services
of our senior management personnel. The loss of the services of senior
executives would have an adverse effect on our business.
8
SEASONALITY
We experience a significant seasonal pattern in our operating results
and working capital requirements. We typically generate most of our sales in the
third and fourth quarters of our fiscal year, prior to the traditional gift
season. The high level of seasonality causes us to take large risks in the
purchase of inventory and extending credit to customers for the holiday season.
We cannot assure you that we or our customers will sell all their inventories.
Excess inventory at year-end may result in financial losses from obsolescence
writedowns, returns, markdowns and bad debts.
Our operating results may also fluctuate during the year due to other
factors such as the timing of the introduction of new products. The market price
of our common stock may be subject to significant fluctuations in response to
variations in quarterly operating results and other factors. These fluctuations
are reflected in our statement regarding selected quarterly financial data
attached as Exhibit 14.1 to this annual report.
INDUSTRY AND PRODUCT LINE VOLATILITY
The toy and game industry is known for a high level of volatility as a
result of changing consumer tastes, competition and over saturation of popular
products. We have experienced significant volatility in our results in our past
history. While we have diversified our business in recent years to reduce
volatility, there can be no guarantee that this history of volatility will not
continue.
COMPETITION
The electronic games and youth electronics and video game accessories
businesses are highly competitive. We currently face direct competition from a
number of other producers of handheld electronic games and video game
accessories. The barriers for new producers to enter into our markets are
relatively low and we expect that we will face increased competition in the
future. Some competitors offer products at lower prices, are better established
in the industry and are larger than we are. In addition, with respect to ODM and
OEM, we compete with a number of substantially larger and more experienced
manufacturers. As we enter other markets and businesses, we expect to face new
competition.
INTELLECTUAL PROPERTY RISKS
From time to time, other companies and individuals may assert exclusive
patent, copyright, trademark and other intellectual property rights to
technologies or marks that are important to our industry generally or to our
business specifically. We will evaluate each claim relating to our products or
other aspects of our business and, if appropriate, will seek a license to use
the protected technology. There can be no assurance that we will be able to
obtain licenses to intellectual property of third parties on commercially
reasonable terms, if at all. In addition, we could be at a disadvantage if our
competitors obtain licenses for protected technologies on more favorable terms
than we do. If we or our suppliers are unable to license protected technology
used in our products, we could be prohibited from marketing those products or
may have to market products without desirable features. We could also incur
substantial costs to redesign our products or to defend any legal action taken
against us. If our products or manufacturing methods should be found to infringe
protected technology, we could be enjoined from further infringement and
required to pay damages to the infringed party. Any of the foregoing could have
an adverse effect on our operating results and financial position.
In March 2005 we received a letter from a third party, and related
information, challenging the exclusivity of our manufacturing, vendor and
distributor agreement with Sega Toys, which was represented to give us exclusive
rights to the Play TV Sega Genesis games in the United States and certain other
countries. We are in the process of attempting to clarify this situation with
Sega Toys, and believe that we have a strong position on the merits of the
dispute as well as certain rights to indemnification from Sega Toys. This
illustrates an additional risk relating to intellectual property that, in
certain cases, the rights obtained may not be as originally represented to us.
In these instances, we may face additional unanticipated competition from
another party who may also have rights in the intellectual property that we are
using or intending to use, and this may have a material adverse effect on the
sales and profitability of the products concerned. We may also incur substantial
costs and management time in defending, or attempting to defend, our rights.
PRODUCT LIABILITY
Historically, we have received only minor complaints relating to
injuries or other damages caused by our products. However, in recent years we
have introduced products that involved more active play including our Play TV(R)
baseball, snowboard and boxing games. In fiscal 2000, we received a number of
consumer complaints that bats used in the Play TV baseball game could be broken
resulting in a projectile striking a game participant. We recalled the bats for
replacement with a reengineered bat. We currently have no known outstanding
claims resulting from damages from the recalled bat. We may be exposed to claims
for damages in these or other circumstances, some or all of which may not be
covered by insurance. We cannot guarantee you that current or future products
may not result in claims or that our insurance will be adequate.
INCREASED TAXATION
We cannot predict whether our tax rates will remain as low as they have
been in the past as tax regulations and the application or interpretation in the
various jurisdictions where we operate are always subject to change. Our taxes
are subject to audit by the taxing authorities. We cannot guarantee that
additional taxes will not be due as a result of audits or other factors.
9
PRODUCT "KNOCK-OFFS"
On occasion in the electronic games and video game accessories
industries, successful products are "knocked-off" or copied. While we strive to
protect our intellectual property we cannot guarantee that knock-offs will not
have a significant effect on our business. The costs incurred in protecting our
intellectual property rights could be significant and there is no assurance that
we will be able to successfully protect our rights.
BAD DEBTS AND RETURNS
While we perform full credit checks on all of our customers we cannot
be assured that any customer will not default on a payment of debt. A default
could have a significant effect on our operating results. It is our policy in
North America to only take back defective products and while we believe we will
be able to enforce this policy under normal industry conditions, it may not be
possible to enforce this policy in all cases. The video game accessories market
generally experiences a higher rate of defective and overstock returns than the
electronic and mechanical game market does. Generally, defective video game
accessories that are manufactured by third party manufacturers are returned to
the manufacturer or destroyed on site for credit. In such cases, there is no
guarantee that we will be paid by the manufacturer.
In certain instances, where retailers are unable to sell the quantity
of products which have been ordered from us, we may, in accordance with industry
practice, assist retailers to enable them to sell such excess inventory by
offering discounts or accepting returns. A portion of firm orders, by their
terms, may be canceled if shipment is not made by a certain date. We minimize
the related costs of such discounts and returns by engaging personnel to visit
selected customers and assist in the management of our product returns. We
establish provisions based on historical experience at the time of sale of the
related products. The return of non-defective products occurs infrequently in
the U.S. In the U.K. market, accepting non-defective product returns occurs more
frequently, requiring higher provisions.
CONTROL BY EXISTING SHAREHOLDERS
Our largest shareholders, including a group that consists of Dito
Devcar Corporation and certain related persons, and a group that consists of RAD
Partners 1999 LLC and certain related persons, own beneficially in the aggregate
a majority of our outstanding common stock. Assuming that they were in
agreement, such persons would have the power to elect our directors and to
approve or disapprove all other matters requiring shareholder approval
regardless of the vote of any other shareholders.
DIFFICULTIES IN ENFORCING CIVIL LIABILITIES
We are a Bermuda holding company, and a substantial portion of our
assets are located outside the United States. In addition, many of our directors
and officers and the experts named herein reside outside the United States
(principally in Hong Kong, the United Kingdom and the People's Republic of
China), and all or a substantial portion of their assets are or may be located
outside the United States. As a result, it may not be possible for investors to
effect service of process within the United States upon them, or to enforce
judgments against them or us obtained in the United States courts predicated
upon the civil liability provisions of the United States securities laws. Among
other things, we understand that there is doubt as to the enforceability in
Bermuda and other foreign jurisdictions, in original actions or in actions for
enforcement of judgments of United States courts, of civil liabilities
predicated solely upon the United States securities laws.
SHARES ELIGIBLE FOR FUTURE SALE
At December 31, 2004, we had 18,738,112 shares of common stock
outstanding. We estimate that most of these shares were previously sold in
registered offerings or in transactions under Rule 144, and therefore are
tradable without restriction, other than any shares purchased by our
"affiliates." The remaining shares owned by existing shareholders are restricted
securities under the Securities Act of 1933, as amended, and may be sold only
pursuant to a registration statement or an applicable exemption from the
registration requirements, including Rule 144. Most of these restricted shares
are currently eligible for sale pursuant to Rule 144, subject to the limitations
of that rule. Market sales of shares by existing shareholders or the
availability of shares for future sale may depress the market price of our
common stock.
LICENSES AND ROYALTIES
We have entered into various license and royalty agreements in which we
pay fees in exchange for rights to use product inventions or trademarked names,
shapes and likenesses for use in development of our product line. The agreements
generally
10
include minimum fee guarantees based on a reasonable expectation of the product
sales to be generated throughout the life of the agreement. We cannot assure you
that we will be able to meet these expectations and may be obligated to pay
unearned fees as a result. Our license and royalty agreements are for fixed
terms and often contain performance-related covenants. We cannot assure you that
we will be able to maintain or extend the rights to our existing licenses.
Several of our licenses apply to products that generate a large volume of sales.
Were we unable to maintain these licenses, the lost sales could have a
significant impact on future earnings.
LABOR
Labor disputes initiated by unions and trade groups could negatively
impact our business or the business of our vendors and customers. Such disputes
could ultimately cause shipping delays, increased costs and lost revenues
resulting from failure to deliver product to customers. We have no way of
anticipating when such actions will occur.
DEPENDENCE ON VIDEO GAME ACCESSORIES ("VGA") PLATFORM PROVIDERS
Our VGA product line (Gamester(R)), is dependent on first party
manufacturers of video game consoles such as Sony, Microsoft and Nintendo to
continue to support and market existing games platforms like PlayStation(R) 2,
Xbox(TM), Game Boy(R) Advance and Game Boy(R) Advance SP(TM), and to continue to
develop gaming formats and accompanying software in the future. We cannot
guarantee success in this category without the ongoing support of these platform
providers. If a platform is withdrawn from the market or fails to sell, we may
be forced to liquidate our inventories or accept returns resulting in
significant losses.
Both Microsoft and Nintendo have announced that during 2005 they will
introduce new versions of their respective Xbox and Game Cube platforms. There
is no guarantee that the new platforms will create a need for related
accessories. Additionally, there is no guarantee that we will be able to
successfully negotiate a new licensing agreement with Microsoft to manufacture
and distribute accessories for the Xbox platform.
UNPROFITABILITY OF THE VGA BUSINESS
Our VGA product line, Gamester(R), was profitable in 2004, at a minor
level, before deducting the goodwill impairment adjustment, but this was the
first recorded profit for the line since it was acquired in 1999. Several
factors contributed to losses incurred in prior years, including delays in
third-party platform introductions, slower than expected realization of full
U.S. distribution and price wars on certain commodity VGA items. While we
believe that we have taken measures to ensure that the line will be successful
going forward, we cannot guarantee that the VGA line will be profitable in the
future or that we will continue to manufacture and distribute the line in future
years. Insufficient future profits and positive cash flows or withdrawal from
the VGA business would result in significant write-downs of our assets,
including goodwill.
Effective January 1, 2002, we adopted SFAS No.142, Goodwill and Other
Intangible Assets. Goodwill is required to be tested on an annual basis for
impairment at the reporting unit level. Furthermore, goodwill is required to be
tested on an interim basis if an event or change in circumstances indicates that
the asset might be impaired. Our impairment testing included a discounted future
cash flow analysis based on a five-year financial projection of the Gamester(R)
line. At December 31, 2003, we had goodwill totaling $9.6 million related to the
acquisition of our Gamester(R) video game accessory business. Despite the
profitability of the VGA line in 2004 and assumed profitability of the line over
the next five years, the carrying value of the VGA Gamester(R) business line
exceeded its estimated fair value. As a result, we recorded a $3.5 million
impairment to goodwill as of December 31, 2004, for the excess of the carrying
value of the VGA's goodwill over its implied fair value. We believe that we are
making progress in making the Gamester(R) line consistently profitable going
forward by continuing to concentrate on the innovative, higher margin sector of
the market. However, we cannot assure you that the measures taken in 2004 will
equate to future profitability. If the VGA Gamester(R) business does not show
consistent profits going forward, further write-downs of related goodwill may
occur.
SEVERE ACUTE RESPIRATORY SYNDROME ("SARS") OR OTHER COMMUNICABLE DISEASES
In 2003, several economies in Asia, including Hong Kong and southern
China, where our operations are located, were affected by the outbreak of SARS.
If there is a recurrence of an outbreak of SARS, or similar infectious or
contagious diseases such as avian flu, it could adversely affect our business
and operating results. For example, a future SARS outbreak could result in
quarantines or closures to our factory, and our operations could be seriously
disrupted as the majority of our work force is housed in a single dormitory. In
addition, ongoing concerns regarding SARS, particularly its effect on travel,
could negatively impact our customers and suppliers, in particular their
willingness to travel to do business.
11
ADVERSE WORLDWIDE ECONOMIC CONDITIONS
Several factors, including the war in Iraq, increased worldwide
unemployment, threats of global terrorist attacks and softening global economies
have caused uncertainties in the U.S. and other countries. These uncertainties
make it difficult for us to estimate growth in the regional economies in which
we sell our products and therefore may negatively affect our sales, increase our
exposure to bad debt or increase our operating cost.
VOLATILE MASS MARKET RETAIL SECTOR
Most of our sales are made to mass-market retailers. The mass-market
retail channel in the U.S. has experienced significant shifts in market share
among competitors in recent years, causing several of our customers to
experience liquidity problems, including several customers that have filed for
bankruptcy during the past two years. While we attempt to minimize our credit
exposure, there is always a risk that our customers will not pay or that they
will delay payment, subjecting us to exposure to bad debt losses. In addition,
if these customers were to cease doing business as a result of bankruptcy, it
could have a material adverse effect on our sales.
HONG KONG REAL ESTATE
We own certain commercial properties in Hong Kong, some of which we
occupy and some of which we lease to third parties. Market values of Hong Kong
real estate had dropped significantly during 1997 to 2003 and subsequently only
the residential properties market has shown a strong recovery. While we expect
commercial real estate values to recover, we cannot assure you that our
commercial properties will do so. In general, we currently intend to retain
ownership of our properties and either occupy or lease them, but if we were to
decide to make any of the properties available for sale prior to a recovery of
the market, we could suffer permanent losses.
CUSTOMER COMPLIANCE
Periodically, our factory is inspected by auditors either employed by
or contracted by individual customers to ensure that we are in compliance with
various safety and social standards. These standards can vary widely by customer
and failure to meet customer standards can lead to fines and suspension or
termination of shipping from our factory to the customer. The management team
makes every reasonable effort to ensure that we are in compliance with all of
our customers' safety and social standards, but there is no assurance that
customer auditors will find us in compliance. Failure to comply could have a
significant adverse impact on our revenues.
CURRENCY VALUATION
Efforts to increase worldwide distribution have made our business
increasingly global. We expect that international sales may continue to
represent a significant portion of our revenue. Although most of our
international sales are denominated in the US dollars, fluctuations in foreign
currencies may have an impact on our financial results. We are prepared to hedge
against fluctuations in foreign currencies if the exposure is material, although
we have not engaged in hedging activities to date.
We have monetary asset and liability balances in foreign currencies
other than the U.S. dollar, including the Pound Sterling, the Canadian dollar,
the Hong Kong dollar and the Chinese Renminbi, or RMB. International
distribution and sales revenues usually are made by our subsidiaries in the
United States, United Kingdom and Canada, and are denominated typically in their
local currency. However, the expenses incurred by these subsidiaries are also
denominated in the local currency. As a result, our operating results are
exposed to changes in exchange rates between the United States Dollar and the
Pound Sterling or the Canadian dollar.
Currently China's currency, the RMB, is pegged to the U.S. dollar. The
Chinese Government is receiving pressure from other governments to trade its
currency on the open market. If the Chinese Government were to trade its
currency on the open market and the RMB were to increase in value relative to
the U.S. dollar, we would experience increased factory and production costs,
including labor and certain raw materials that could have a material impact on
the cost of our products.
EFFICACY OF ADVERTISING AND PROMOTION
Radica promotes some of its products through advertising and promotion.
This promotion occurs primarily in the second half of the year during the
traditional holiday season and includes television commercials, magazine and
newspaper advertisements, in-store displays and viral marketing campaigns
orchestrated by contracted public relations firms. During 2004, we spent $12.8
12
million on such programs. Our ability to sell products is dependent in part on
our ability to successfully advertise and promote our products. If the cost of
these programs increases or if we were unsuccessful in our efforts to advertise
and promote our products, it could have a material adverse affect on our
financial results.
ROHS COMPLIANCE
Per Directive 2002/95/EC (on the Restriction of Hazardous Substances)
of the European Parliament, effective 1 July 2006, new electrical and electronic
equipment put on the European market may not contain lead, mercury, cadmium,
hexavalent chromium, polybrominated biphenyls (PBB) or polybrominated dephenyl
ethers (PBDE). As lead is currently the main ingredient in our soldering process
we will need to change to 'lead free soldering'. In order to do this we have
purchased certain SMT equipment and are in the process of setting up a lead free
workshop within our Dongguan factory. Our goal is to have this workshop fully
operational by March 31, 2006. In the event that we are not successful either we
will have to have product assembled at another facility that can produce product
to this standard or stop shipping to the European Union in Q3 2006.
ITEM 4. INFORMATION ON THE COMPANY
DESCRIPTION OF BUSINESS
Founded in 1983 by Americans living in Hong Kong, Radica Games Limited
(NASDAQ: RADA) was incorporated in Bermuda in 1993. We are headquartered in Hong
Kong and manufacture our products in our factory in southern China. In 1994 we
went public when our shares began trading on the Nasdaq National Market.
We manufacture and market a diverse line of electronic entertainment
products covering multiple product lines - our products include casino and
heritage electronic games, mechanical slot banks, youth electronic games,
tabletop games, Play TV(R) games, Girl Tech(R) and Barbie(TM) girls electronic
lines, the Twinkleberries(TM) and Cupcakes(R) doll lines, the Nitro Battlerz(TM)
and Big Trouble(TM) remote control car products, the Street Muttz(TM) plush line
and video game accessories sold under the Gamester(R) brand. Our factory also
manufactures for other companies in the electronic game industry and provides
sourcing services for retail customers. We market our products through
subsidiaries in the United States, the United Kingdom, Canada and Hong Kong. Our
largest market is in the United States where in 2004 we had the third largest
market share in the electronic handheld and tabletop electronic games according
to industry data source, The NPD Group, Inc.
We employ about 4,500 people worldwide in our group of companies. Our
largest retail customers include Wal-Mart, Target, Toys`R'Us, Kmart, Kohl's,
Argos and Best Buy. Our largest manufacturing customer is Hasbro.
Internationally we sell products in approximately 35 countries.
HISTORY OF PRODUCT LINES
ELECTRONIC GAMES
We have operated as a marketer and manufacturer of games since 1983,
starting with a small operation in Hong Kong providing souvenir casino games for
the Las Vegas market including mechanical bank slot machines. We expanded into
the electronic game business setting up a factory in China in 1991 and a
distribution operation in the United States in 1992. The business grew
substantially from that point and we became the leading supplier of casino type
electronic handheld games in the U.S. market with games such as Video Poker and
Video Blackjack. Our electronic game products are sold under the Radica and Play
TV brand names.
In 1995 we began to diversify our product line into other electronic
handheld game areas beyond casino themed games. We began to offer classic games
such as Solitaire, Hearts and Gin Rummy, and sports games such as its World
Class Golf(TM) and Football. In addition to the casino and classic games that
helped build the company, in recent years we have expanded our electronic game
offerings to a very broad line of electronic games including virtual fishing
games such as Bass Fishin'(R), virtual hunting games such as Buckmasters(R) Deer
Huntin'(TM), a line of games based on popular EA SPORTS(TM) products, TETRIS(R)
and Rush Hour(TM), and other games such as Talking Bingo(TM) and Ultimate
Pinball(TM). In 2004 we introduced 20Q(TM), based on the classic guessing game.
20Q(TM) was named "The Number One Non-Television Promoted Toy" of 2004 according
to The Toy Book, an industry trade magazine. We will continue to expand the 20Q
line in 2005 with tabletop and big screen versions of the game.
During our history we have become known as a leader in the creative use
of technology. For example, our line of fishing games, one of the top-selling
product lines in the history of electronic games, revolutionized the electronic
handheld games category after its introduction in 1996. The games feature
virtual motion-sensing technology that allows the player to use the
13
physical game as a rod and reel. The player casts, feels the fish bite, sets the
hook with a jerk, and reels in the fish with a real handle. This product started
an industry trend in creating virtual reality games where the product provides
the feel of the real sport. This is delivered by uniquely realistic game shapes,
featuring motion sensors and tactile feedback. We have expanded our line of
virtual motion sensing games beyond the fishing category. An example of this is
our Buckmasters(R) Deer Huntin' 3(TM) game.
In 2000, we pioneered virtual reality further when we introduced
NASCAR(R) I-Racer(TM). The full headset complete with headphones, produces 3D
graphics and digital dimensional sound. The steering wheel provides vibration
feedback. In 1999, we also introduced a line of Tiger Woods licensed electronic
golf games shaped like a real golf club that were able to sense direction and
velocity of swing as an input to the game.
In 2000, we introduced Radica Play TV games featuring XaviX(R)
technology licensed from SSD. The technology provides consumers with easy-to-use
Play TV games, which are freestanding devices that plug directly into the TV and
use the screen as the display. This single-chip, multi-processor integrated
circuit is designed to generate high-quality graphics and sound on a television
set without the use of a video game console. Most importantly the technology
allows motion sensing control devices to interact with the TV images such as
using a physical baseball bat controller to hit video pitches or a physical
snowboard controller to control a race down a video ski slope. Play TV Baseball,
Play TV Snowboarder, and Play TV Buckmasters(R) Huntin' were successfully
introduced in 2000 and 2001. For 2004, we entered into a licensing agreement
with EA Sports(TM) to translate their popular Madden Football(TM) and SSX Tricky
video game titles into the Play TV format.
In 2004, we expanded the "plug and play" category with our Play TV
Legends line. We have a license to manufacture and distribute Play TV
Legends(TM) Sega(R) Genesis(TM). It is the first official Sega Genesis
multi-game unit, which replicates several of the original Sega Genesis games,
game codes and graphics and utilizes a replica of the original Genesis control
pad. All of the software and content are stored in the game pad. The Play TV
Legends line includes Space Invaders, licensed by Taito and Tetris. In 2005, we
will expand the line with another version of Play TV Legends Sega Genesis,
containing more games from the Genesis system and another Play TV Legends Sega
game, Street Fighter(R) II Special Champion Edition.
In 2001 we introduced Skannerz(R). Targeting boys 7-12, Skannerz
utilizes UPC scanner technology to create a collectible-driven, interactive
battle game. The game can be played alone or linked to battle with another unit.
Building on this success for 2003 we launched Skannerz Commander and Skannerz
Battle Orbz, two variations on the original version. In 2005, the Skannerz line
will be extended to include Skannerz(R) Racerz(TM), a racing game based on the
original Skannerz product.
In 2004, we introduced a line of multiplayer tabletop electronic games.
Total Meltdown is a skill and action game that challenges players to four
code-breaking games. Tetris(R) Tower 3D incorporates the Tetris game play into a
tabletop format. Mind Scrambler(TM) asks players to follow a series of lights to
match the pattern while the game turns and reverses itself.
GAMESTER VIDEO GAME CONTROLLERS & ACCESSORIES
In June 1999, we announced the acquisition of Leda Media Products, a UK
company that, with its Gamester brand, is a leader in video game controllers in
Europe (now known as Radica UK Ltd.). To date, we have established video game
controller and accessory products to enhance game play and performance on video
game consoles for Nintendo, Sony and Microsoft including game control pads,
steering wheels and memory cards. All Gamester products are designed to make the
game more fun or make the user a better player, bringing the unfair
advantage(TM) to the gamer.
We began shipping and selling the Gamester product line to the United
States and Canada during the second half of 2001 and have moved most of the
manufacturing of controllers to our factory in China. Product development is
designed and built in house for the Gamester brand, except for a few less
technically demanding items which are outsourced to officially approved third
parties.
In 2001 we signed a worldwide licensing agreement with Microsoft to
design, manufacture and market peripherals for the Xbox(TM) video game system.
Xbox peripherals include the Phoenix game pad, the Phoenix for Xbox Live pad,
which enables voice communication technology and the Race Pac(R) controller, a
functioning wheel, seat and pedals in a portable unit compatible with both the
Xbox and Sony Playstation 2 platforms.
The video game accessories segment expanded in 2001 with the
introduction of Nintendo's Game Boy(R) Advance (GBA). We have introduced
products for the GBA including the Flood Light(TM), which provides an
illumination of the GVA screen using a fluorescent light. The GBA line includes
a broad selection of cases, bags, chargers, adaptors and accessory packs. With
the 2003 introduction to Nintendo's Game Boy Advance SP, we have introduced
several products for the SP under the Gamester brand, including Game
Changer(TM), which allows gamers to switch games without removing cartridges.
14
YOUTH ELECTRONICS
In 1998 we acquired the start up Girl Tech Company. Girl Tech's product
line targets girls ages 8-12. These products are designed with girls' play
preferences in mind addressing issues that are important to them such as privacy
and communication.
In 1999, Girl Tech introduced a line of products for girls, including
the Password Journal(R), which uses voice recognition technology to unlock the
journal. In the years 2001-2004, Password Journal was among the top ten products
in the Youth Electronics market according to The NPD Group. In 2005, we will
update the Password Journal with a new Password Journal product. While
maintaining the voice recognition lock and other features of the two previous
versions of this product, the new Password Journal will include a light and a
calendar and will have an auto-opening tri-fold layout.
In 2003, Girl Tech introduced Dare Ya!(TM), an electronic version of
the children's game of "Truth or Dare". Girls can create their own dares by
recording them into the game. Dare Ya! has a "truth detector" to determine if
the girls are telling the truth.
In 2004, Friend Chips(TM) was introduced. Friend Chips uses instant
messaging lingo to create password protected, digitally encoded messages on the
four included chips that can be passed on and used in other units. Friend Chips
includes two reader units and four chips to share with a friend.
Another new addition to the Girl Tech line was My Photo Booth(TM). My
Photo Booth gives the photo booth experience at home. Girls set the timer, pose
in the mirror and watch the lights that countdown to the flash. My Photo Booth
uses Polaroid iZone film for refill.
In February of 2002 we received a license to bring to market electronic
girls lifestyle products and electronic games under the Barbie(TM) brand name.
The Barbie electronics product line was led by the Barbie Dance
Party(TM) game. This product allows girls to dance with Barbie on TV through the
use of the same technology that is used in our Play TV line. The player is asked
to follow Barbie's lead in dance moves and steps demonstrated on the TV set. In
2003, we introduced My Secret Diary(TM) for the Barbie age girl. My Secret Diary
opens electronically with a magnetic pen. For 2004, we introduced the Barbie
Doorbell(TM), a motion sensing door device allowing girls to personalize their
message and keep their room private. We also introduced Barbie Balance Beam(TM),
a game of lights and sounds designed to simulate a gymnastic balance beam
routine.
NEW CATEGORIES
We diversified our product line with two new category entries in 2004.
The first is Nitro Battlerz, a remote control racing game. Kids customize their
cars, and then race them in the "dome" track. The object of the game is to be
the last car in the dome, as you force others over the edge to crash to pieces
on the floor. The starter set includes the battle dome track, two cars and
controllers, extra body parts, and decorative decals.
In our second new category for 2004, we introduced Twinkleberries, a
new line of interactive dolls that respond to the "teacher/child". When the
child slides a card into the chalkboard and presses the chalk to the card, each
doll responds to the teacher. The starter set includes one interactive doll,
chalkboard, chalk and a set of cards. Add-on dolls with cards are sold
separately to expand the classroom.
MANUFACTURING SERVICES
Since 1996 we have designed, engineered and manufactured products for
other companies in the electronic games business. Our factory in Tai Ping,
Dongguan, Southern China has 524,000 square feet of factory space and 308,000
square feet of dormitory space, which has the capacity to house in excess of
5,000 people, currently employs approximately 3,500 people and employment
typically varies from 3,000 to 6,000 depending upon seasonal demands. The
factory is capable of manufacturing up to 800,000 units per week. We manufacture
for other companies on an ODM (original design and manufacture) basis. We
currently design and manufacture games for Hasbro, as well as other companies in
the U.S. and Japan. During 2005, we plan to complete an expansion of the factory
that will create an additional 141,000 square feet of factory space and will
cost $2.6 million, including machinery, to complete.
15
BUSINESS STRATEGY
As a result of our efforts toward diversification, we now have a
significant presence in four core product lines including electronic games,
youth electronics, other electronic games and video game accessories. We believe
that these product lines are significantly related to each other in terms of
their entertainment value and the expertise that is involved in delivering
products in each category of electronic entertainment. As a result there are
synergistic skills that can be used to benefit each area of our four core
product lines. Within these product lines we are focused on building five brands
including the Radica brand of electronic games, the Play TV brand of electronic
games, the Girl Tech and Barbie(TM) brands of youth electronics and game
products, and the Gamester brand of video game accessories. It is our strategy
to focus on building each of these product lines and brands through aggressive
product development and marketing programs.
We sell direct to retailers in North America and the United Kingdom and
while we may occasionally sell directly to retailers in other markets, we
usually sell through sub distributors which sell our products to retailers and
foreign distributors in certain other worldwide markets.
We also manufacture most of our own products in our factory in China in
order to maintain quality and to minimize inventories of long lead-time
electronic components. Some of our product sales come from products that are
sourced from other factories by our sourcing group. We utilize the excess
capacity of our factory to manufacture products of a similar nature to our own
products for other companies such as the Hasbro Games Group. We also provide
sourcing services to certain retailers such as Argos in the United Kingdom. By
providing such manufacturing and sourcing services to other companies we seek to
spread the overhead cost of our manufacturing and sourcing operations in order
to improve profitability.
PRODUCT LINE SALES
The following table sets forth a breakdown of our sales by major
product category for the last four fiscal years.
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------------------------------
2004 2003
------------------------------------------------ -----------------------------------------------
% OF NET NET UNITS NO. OF % OF NET NET UNITS NO. OF
PRODUCT LINES SALES VALUE SALES VALUE SOLD MODELS* SALES VALUE SALES VALUE SOLD MODELS*
-------------------------------------- ----------- ----- ------- ----------- ----------- ---- -------
(in thousands, except percentage and no. of models information)
Games and Youth Electronics Segment
Electronic Games 65.4% $ 80,640 7,761 100 59.3% $ 62,374 6,422 97
Youth Electronics 13.8% 17,038 1,443 28 14.5% 15,227 1,324 27
Other Electronic Games 2.8% 3,490 189 12
Manufacturing Services 7.3% 9,008 3,920 28 9.8% 10,386 3,924 23
----- -------- ------ --- ----- -------- ------ ---
89.3% 110,176 13,313 168 83.6% 87,987 11,670 147
VGA Segment
Video Game Accessories 10.4% 12,840 1,264 97 13.6% 14,294 2,150 152
Manufacturing Services 0.3% 383 N/A N/A 2.8% 2,919 N/A N/A
----- -------- ------ --- ----- -------- ------ ---
10.7% 13,223 1,264 97 16.4% 17,213 2,150 152
Total 100.0% 123,399 14,577 265 100.0% 105,200 13,820 299
===== ======== ====== === ===== ======== ====== ===
16
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------------------------------
2004 2003
------------------------------------------------ -----------------------------------------------
% OF NET NET UNITS NO. OF % OF NET NET UNITS NO. OF
PRODUCT LINES SALES VALUE SALES VALUE SOLD MODELS* SALES VALUE SALES VALUE SOLD MODELS*
-------------------------------------- ----------- ----- ------- ----------- ----------- ---- -------
(in thousands, except percentage and no. of models information)
Games and Youth Electronics Segment
Electronic Games 50.3% $ 62,684 6,277 101 53.0% $ 52,268 6,007 137
Youth Electronics 13.4% 16,744 1,208 22 11.9% 11,720 1,042 16
Manufacturing Services 19.8% 24,634 6,666 30 19.2% 18,941 3,973 15
----- -------- ------ --- ----- -------- ------ ---
83.5% 104,062 14,151 153 84.1% 82,929 11,022 168
----- -------- ------ --- ----- -------- ------ ---
VGA Segment
Video Game Accessories 12.7% 15,844 2,118 150 10.5% 10,335 2,070 130
Manufacturing Services 3.8% 4,740 N/A N/A 5.4% 5,290 N/A N/A
----- -------- ------ --- ----- -------- ------ ---
16.5% 20,584 2,118 150 15.9% 15,625 2,070 130
Total 100.0% 124,646 16,269 303 100.0% 98,554 13,092 298
===== ======== ====== === ===== ======== ====== ===
* Number of models includes new and continuing products as well as a significant
number of discontinued items often sold in small quantities from existing
closeout inventories.
LICENSING
During fiscal 2004, we engaged in several licensing agreements in which
we were given permission to use the name, logo, game concept and/or license of a
person, company or brand in exchange for a royalty fee.
Among the licensors were Electronic Arts(TM), Buckmasters, World Poker
Tour(TM), Codemasters(R), owners of the Sensible Soccer license, Leading Edge
Design, developers of Bunco Night(TM) and Multi Strike Poker(TM), SSD,
developers of XaviX(R) technology, the Tetris(R) Company, Microsoft, developers
of Microsoft Xbox(R), Mattel, makers of Barbie(TM), Taito(R) Corporation,
creators of Space Invaders, Sega(R), makers of the original Sega Genesis system,
Funimation(R), developers of Yu Yu Hakasho(R) and Dragon Ball GT(R) anime, and
20Q.Net Inc, developers of the "artificial intelligence" version of 20Q.
We intend to incorporate some of these licenses into our 2005 product
line and will pursue new licenses in instances where management feels it will
enhance the value and marketability of a particular product.
MANUFACTURING
Our manufacturing is generally limited to integrated chip bonding,
plastic injection, clamshell production, mold manufacture, surface mount
technology, or SMT, and assembly and packaging operations. We order customized
components and parts from suppliers and use subcontractors for more complicated
operations such as masking of our proprietary software onto the semiconductor
chips used in our games, LCD tooling and a proportion of tooling of molds for
plastic parts.
In 2004 we assembled most of the Radica and Girl Tech lines of products
in order to control our costs, quality, production and delivery schedules. VGA
were assembled both in-house and by third party manufacturers.
We are not required to obtain any quality approvals for our products
sold in the United States. However, we are required to have and have obtained CE
approval, Europe's toy safety standard, for products sold in Europe. We have
been granted a Chinese toy quality license from the Chinese Import and Export
Commodity Inspection Bureau, which is required of toy and game manufacturers in
China to export toys or games. In addition, we voluntarily comply with ASTM 963,
a U.S. toy safety standard.
We received renewal of our ISO 9001 quality certification from
Underwriters Laboratory on February 9, 2004 which runs through February 8, 2007.
The scope of the registration covers the design, sales and distribution of
electronic and electro-mechanical games and related gift products.
17
MANUFACTURING FACILITIES
We currently manufacture our products at our Tai Ping factory in
Dongguan, Southern China approximately 40 miles northwest of Hong Kong. The
factory was constructed with the cooperation of the local government according
to our design specifications on a 3.7 acre site and contains 524,000 sq. ft. of
factory space and 308,000 sq. ft. of dormitory space, capable of housing over
5,000 workers. An extension of the factory commenced in December 1999. As a
result of the drop in demand for our product in the U.S. during 2000, work
towards completion of this addition was postponed until the end of 2004. We
began completion of the expansion of the factory in late 2004 and expect the
expansion to be in service in mid 2005. The completed facility will create an
additional 141,000 square feet of factory space and will cost an estimated $2.6
million, including machinery, to complete. The unit capacity of the factory
depends on the product mix produced. In any event, there can be no assurance
that we will be able to operate at full capacity or have sufficient sales to
warrant doing so.
In June 1994 we entered into a joint venture agreement with the local
government to operate the factory. The joint venture agreement was established
for the construction and operation of the factory. We contributed the cost of
the construction of the factory to the joint venture while the local village
contributed the land use rights. The joint venture agreement term is 30 years
after which it may be renegotiated. We pay two types of costs to the China
Government under the joint venture agreement. The first was the payment for
construction of the factory. This cost is being treated as a prepaid 30-year
leasehold on the factory.
The second, which began upon commencement of production, are annual
fees made in the form of a fixed fee to the local government. The annual fee is
subject to increases every three years and had originally been set at a 20%
increase every 3 years but has been successfully renegotiated to be 10% every
three years. The scheduled increases of the annual payment are intended to
reflect the anticipated growth in our overall business. We continue to believe
that we will renegotiate any increases in this fee. As a result, we record the
fee as an expense in the income statement as incurred rather than on a
straight-line basis over the term of the agreement. If we were unable to
renegotiate the terms of the agreement and were forced to pay the scheduled
increases, the amount of the increases would be immaterial over the 30 years of
the contract and therefore accounting for the JV payment on a straight-line
basis would not have a material financial impact. In 2004, the fee was
approximately $117,000.
Aside from the fixed annual fee paid to the joint venture partner, we
are the sole beneficiary of the results of the joint venture, and we solely
control the joint venture's operations, including the operating and capital
decisions of the joint venture in the ordinary course of business. When the
30-year term expires (unless we negotiate an extension) or in the event that the
agreement is terminated, the local government will be entitled to the fixed
assets of the joint venture. At the time the 30-year lease expires, the assets
will have been fully depreciated.
Formerly, we also manufactured in the factory under a processing
agreement with the local government. A processing agreement provides by its
terms that the local government will provide manufacturing facilities and supply
workers to the company and that the company will pay a management fee and
processing fee and certain other charges. The management fee was paid to the
local government and was based on a negotiated sum per worker at the factory.
The processing fee was based on the value of raw materials shipped into the
factory and the value of products shipped from the factory and was established
in production agreements agreed upon with local government officials. We paid
the processing fees through the Bank of China in Hong Kong and the funds were
then placed in an operating account including other company funds in China, all
of which were used to pay the costs of the factory including fees due to the
local government as part of the processing agreement. Changes in PRC tax and
customs law have made it increasingly difficult to use the processing agreement.
During 2001, we made a decision to end our use of the processing agreement and
as of December 31, 2003, we had completely phased out use of the processing
agreement. We now operate exclusively under the cooperative joint venture
agreement.
All the results of our factory operations in the PRC, whether under the
joint venture or the previous processing agreement, are accounted for as
wholly-owned operations and included in our consolidated financial statements
since we operate all aspects of the factory, including hiring, paying and
terminating workers. Most of the factory workers are hourly employees, live in
the on site dormitories and eat in the on site canteen. In addition, we bear all
other costs of operating the factory, including utilities and certain employee
social welfare charges established by the local government. Many aspects of the
operation of the factory are dependent on our relationship with the local
government and existing trade practices. We believe that our relationship with
the local government is good.
Had we decided to curtail our manufacturing activities in China prior
to December 31, 2004, we would have been required to pay back certain tax
benefits we had received and may have been held liable for certain fees. Such
liabilities could have been substantial. Effective January 1, 2005 we are no
longer subject to these fees should we curtail manufacturing activities in
China.
18
MATERIALS
Major components used in our products are liquid crystal displays, or
LCDs, semiconductor chips, printed circuit boards, or PCBs, batteries, and
molded plastic parts. We purchase LCDs, PCBs, and semiconductor chips from
several suppliers. We generally provide six to twelve months order indications
to our semiconductor chip suppliers and must place firm orders a minimum of six
weeks in advance of delivery. This lead time in some cases extends to twenty
weeks when the market is in short supply. We generally try to maintain about two
months supply of semiconductor chips, which may constrain increased production
of our products on short notice. We pay for most of our materials in U.S.
dollars.
Our major suppliers of electronic and mechanical handheld and tabletop
game materials in fiscal 2004 included C & L Electric Mfg. Co., Ltd. (cables),
Golden Electrical Trading Co. (plastic resin), GPI International Limited
(batteries), Just Technology Co. Ltd. (keypads), Kingsonic PCB Co.(PCBs), Lead
Jump Development Limited (PCBs), Many Paint & Chemical Co., Ltd. (paints),
Mobicon Holdings Limited (electronic components), Polaroid Corporation (camera
and film), SSD Company Limited (semi-conductor chips), U Kwong Industrial Co.,
Ltd. (PVC materials), V-Tac Technology Co. Ltd. (semiconductor chips), Vbest
Electronics Ltd. (LCDs), Wintek Corporation (LCDs) and Yu Lee Printing Co. Ltd.
(printing).
Our major suppliers of VGA in fiscal 2004 included Hip Hing Cables &
Plug Mfy Ltd. (cables and plugs), Mascotte Industrial Associates (HK) Ltd. (bags
and cases) and Vanson Electronics Ltd. (battery charger and battery).
SALES AND DISTRIBUTION
Our products are sold in approximately 35 countries, with the United
States accounting for approximately 66% of net sales in fiscal 2004. We sell our
products directly to over 200 active retailers in the U.S. and U.K. and to
approximately 30 distributors worldwide. We participate in the electronic data
interchange ("EDI") program maintained by 15 customers in the U.S. including
Wal-Mart, Target, Kmart, Kohl's, Toys`R'Us and Best Buy, and 5 customers in the
U.K.: Argos, Comet, Dixon's, Asda Wal-mart and John Lewis. In fiscal 2004, our
largest customer, Wal-Mart, accounted for 24.5% of net sales. In general, all
sales to third party distributors and retail customers are final upon transfer
of title. The top five customers were as follows:
% OF SALES
-------------------
CUSTOMER NAME FOR THE FISCAL YEAR
------------- -------------------
2004 2003
---- ----
1. Wal-Mart (USA) 24.5% 31.9%
2. Toys`R'Us (USA) 10.0% 8.9%
3. Target (USA) 9.6% 5.5%
4. Argos (U.K.) 6.7% 8.0%
5. Hasbro (USA) 4.5% 8.2%
The following table sets forth certain of our major customers in 2004,
including distributors (in alphabetical order):
CATALOG SHOWROOMS DRUG/MASS MERCHANDISERS ELECTRONICS/GROCERY/ CONVENIENCE
----------------- ----------------------- --------------------------------
Argos Army Airforce Exchange About Time
Brookstone Boots Argos
Index Fred Meyer Asda/Wal-Mart
Sharper Image Kmart Best Buy
Meijer Biggs Hypermarket
Pamida Blockbuster
DEPARTMENT STORES QVC Circuit City
----------------- Target Comet
J.C. Penney's Wal-Mart Dixon's
John Lewis Woolworth's (U.K.) Electronics Boutique
Kohl's Zellers Game
May Co. Gamestop
Ingram Entertainment
MAIL ORDER/SPECIALTY GIFT SHOP OPERATORS SPORTING GOODS STORES Mill's Fleet Farm
---------------------------------------- ---------------------
Avon Bass Pro Shops Musicland
Buckmaster Dunham's Production Solutions
Figis Radioshack
19
Fingerhut Tesco
Hammacher Schlemmer TOY RETAILERS
-------------
Littlewoods Entertainer
Next Retail Kay Bee DISTRIBUTORS (RADICA)
Spillsbury Toymaster ---------------------
Starboard Cruise Services Toys"R"Us Amo oy (Finland)
Wish Book Youngsters Caesars Gauteng (South Africa)
Dorcy Irwin Pacific Pty, Ltd. (Australia)
ODM/OEM DISTRIBUTORS (VGA) Edu Toys (Russia)
------- ------------------ Giochi Preziosi (Italy)
Goliath (France/Belgium) John Hansen Co. (USA)
Importadora Maduro S.A. (Panama) Joker (Germany)
Bensussen Deutch & Associate, Inc. First Game (Korea) Koch (Germany)
Cranium, Inc. Forte Co., Ltd. (Japan) Lansay (France)
Forte Co., Ltd. Just for Fun Toys (South Africa) Newbay (Middle East)
Hasbro, Inc. Imbi Mario Trading (Malaysia) Planet Fun (New Zealand)
KEMCO Co., Ltd. Master Genius (Thailand) Playthings Pte Ltd. (Singapore)
Konami Corporation Nobilis (France) Sablon (Germany/Benelux)
Lexibook Limited Super Chi-Yuen (Taiwan) S. I. D. Cadeaux (France)
Sega Toys Tai Sing/Fowa (Singapore) Souvenirworld (USA)
WiZ Co. Ltd. Top Toy (Denmark) Top Toy (Denmark)
Universal Electronics (Lebanon) Universal Electronics (Lebanon)
Valid Trade (South Africa)
In the United States, we use regional sales managers working for us to
manage our customers as well as manufacturers representatives and brokers that
sell our products to certain retailers. These manufacturers' representatives are
not our employees and work on a commission basis. In the United Kingdom, we use
brand sales managers and manufacturers' representatives to sell our products in
the U.K. In the rest of the world, we use third-party distributors.
Our customers normally provide indications of interest, which may be
canceled at any time, from three to six months prior to scheduled delivery, but
only confirm orders approximately eight weeks in advance of requested delivery.
Accordingly we generally operate without a significant backlog of regular
orders.
In certain instances, where retailers are unable to sell the quantity
of products which have been ordered, we may, in accordance with industry
practice, assist retailers to enable them to sell such excess inventory by
offering discounts or accepting returns. We minimize the related costs of such
discounts and returns by engaging personnel to visit selected customers and
assist in the management of product returns. A portion of firm orders, by their
terms, may be canceled if shipment is not made by a certain date. We establish
provisions based on historical experience at the time of sale of the related
products. The return of non-defective products occurs infrequently in the U.S.
In the U.K. market, accepting non-defective product is regular industry practice
and we establish our return provisions on such sales based on experience.
In the US, Canada and the U.K., we store our products and pick and ship
orders for domestic sale in shared warehouse facilities owned by third party
logistics companies. We are assessed storage, labor, materials and freight
charges, as well as for capital costs such as fork lifts and computer equipment.
Our Radica, Girl Tech, Play TV and Connectv products carry a 90 days
consumer warranty from the date of sale. Our VGA products carry a one year
warranty from the date of sale. In each of the last three years, warranty costs
incurred have been less than 3% of net sales and substantially all warranty
claims are received within 90 days of invoice.
INDUSTRY
NPD Group, the service that has historically tracked our retail sales,
no longer provides this service. It does, however, continue to provide industry
data. According to NPD, the toy industry in the U.S. declined slightly in 2004.
Toy sales in gross dollars were down 2.7% in 2004 from 2003 among top 5
retailers and were also down 2.7% overall. Management believes that the declines
were the result of continuing weaker overall sales at the mass retailers. Our
U.S. sales of Electronic Games increased 13.5% from 2003. The increase in
Electronic Games is primarily due to the success of our PlayTV(R) line and
20Q(TM). Our U.S. sales of Youth Electronics decreased 5.5% from 2003 due to
soft sales of Barbie(R) branded products.
20
NPD's U.K. data showed no increase in the toy market in 2004 from 2003.
Electronic and tabletop games were down 10% and youth electronics did not
change. As of the reporting date, we do not have similar data for the rest of
Europe. Our U.K. sales of electronic games and youth electronics increased 94.3%
and 41.2%, year-on-year, respectively as a result of our strategic plan in the
U.K. to increase promotion and focus on electronic handheld and tabletop games.
Annual industry-wide video game accessory sales were down slightly in
the U.S. in 2004. According to the NPD Group, VGA sales in gross dollars were
down 1.2% in 2004 from 2003. Our U.S. sales of video game accessories were down
0.8% from 2003.
The U.K. and Europe do not have a reliable retail tracking service for
video game accessories. During 2003, our U.K. operations changed their
distribution strategy in the U.K. and Europe from providing a full line of VGA
product, including low-margin commodity items, to selling a smaller line of
innovative, higher margin products.
PRODUCT DEVELOPMENT
At the end of 2004, our engineering and development department had
approximately 92 staff worldwide. Our product development starts with a design
team in Dallas, Texas and continues through to the engineering teams in Shenzhen
and in the Dongguan factory. We have a formalized product development process
that includes quarterly meetings of its worldwide product development and sales
departments. In fiscal 2002, 2003 and 2004, we spent approximately $4.1 million,
$3.9 million and $4.2 million respectively, on research and development. Our
research and development is heavily oriented toward market demand. Based on our
ongoing contact with consumers, retailers and distributors worldwide, our sales
and marketing departments seek to understand and assist the product development
teams in responding to consumer and retailer preferences. The sales department
also targets certain retail price points for new products which drive our
product development, with designs, features, materials, manufacturing and
distribution all developed within the parameters of the target retail price. We
also review product submissions from a network of third party inventors that
have been approved by management. These submissions are subject to the same
product development process and market demand considerations as internal
submissions. Additionally, we use third-party developers in the creation of
software programs that are used in some of our products.
In January of 2002, we executed our December 2001 reorganization plan
that included the closure of the San Francisco research and development office
and the relocating of the Hong Kong engineering positions to offices in China.
During 2003, we eliminated our Hertfordshire, England design team. These
reorganizations significantly reduced costs without decreasing efficiency. We
expect to continue developing the majority of products internally during 2005.
However, changes in business philosophy or unforeseen circumstances may arise
that could force us to outsource a larger than expected amount of our
development work.
SEGMENT INFORMATION
See Note 17 of the Notes to the Consolidated Financial Statements
included herein.
ORIGINAL DESIGN MANUFACTURING AND ORIGINAL EQUIPMENT MANUFACTURING
In 1995, we were successful in establishing a relationship with the
Hasbro Games Group to design and manufacture products for them. We continue to
manufacture for Hasbro, which is also our largest competitor, as well as a
number of other customers including Lexibook, B, D&A and Kemco. We intend to
pursue other ODM and OEM business in the future. However it is uncertain whether
we can retain our current business on a long-term basis or successfully attract
additional ODM business or that it will be profitable.
INTELLECTUAL PROPERTY
We own a number of patents, trademarks and copyrights and we are in the
process of registering other intellectual properties. We will continue to apply
for intellectual property registrations on new products as management deems
necessary.
We anticipate that patents, trademarks, copyrights and other
intellectual property rights will become increasingly important in the
electronic entertainment industry in which we operate, particularly since we are
introducing a wider range of products. As the industry focuses on intellectual
property matters, there will be opportunities for us to protect our products
through patents, trademarks and other formalized filings, although the efficacy
of these protections is uncertain. By the same token, we will be exposed to
risks that our products or other aspects of our business will be found to
infringe the intellectual property rights of others. See "Item 3. Key
Information - Risk Factors - Intellectual Property Risks".
21
COMPETITION
The games business is highly competitive. We believe that we are one of
the leading sellers of electronic games and youth electronics. Our primary
competitor is the Hasbro Games Group ("Hasbro"), which is also an OEM customer.
Hasbro procures its products from manufacturers in China including Radica. Other
competitors include Jakks Pacific, Wild Planet and MGA. The barriers for new
producers to enter our markets are relatively low and we expect that we will
face strong competition. We compete for consumer purchases on the basis of
price, quality and game features and for retail shelf space also on the basis of
service, including reliability of delivery, and breadth of product line. Some
competitors offer products at lower prices than we do, are better established in
the toy and games industry and are larger than we are. Our products also compete
with other gifts and games for consumer purchases. In addition, with respect to
ODM/OEM activities, we compete with a number of substantially larger and more
experienced manufacturers. As we enter other markets and businesses, we expect
to face strong competition.
The VGA market is also highly competitive. The market share in the U.S.
is spread primarily amongst ten companies, including Radica, that have
approximately 60% of the market. We began significant distribution of VGA in the
U.S. market in 2001. Like the handheld electronic games market, we compete for
customer purchases on the basis of price, quality, and features and for retail
shelf space on the basis of service. Major competitors are MadCatz, Pelican,
Logitech and Joytech.
TAXATION OF OUR COMPANY AND OUR SUBSIDIARIES
There is currently no Bermuda income, corporation or profits tax
payable by our company. As an exempted company, we are liable to pay to the
Bermuda government an annual registration fee calculated on a sliding scale
basis by reference to our assessable capital, that is, our authorized share
capital plus any share premium on our issued shares of Common Stock currently at
a rate not exceeding $25,000 per annum.
The Hong Kong profits tax rate for 2004 is 17.5%. Currently, our
subsidiary Radica HK pays Hong Kong profits tax on service and sales income.
On July 1, 1994, our manufacturing operations were transferred to a
Sino-Foreign joint venture. The joint venture enjoyed a two year tax holiday
which expired in 1999. We paid $596,000 in foreign enterprise tax on our joint
venture in China in 2004. This is the sixth year we have paid foreign enterprise
tax in China. We were granted 50% relief from foreign enterprise tax through
December 31, 2001 under the Foreign Enterprise Income Tax Law of The People's
Republic of China, or PRC, and were therefore taxed at 12%. In 2002 and 2003, we
were taxed at the full rate of tax of 27%; however, we successfully applied to
be designated as an "Export Oriented Enterprise", which resulted in a tax rebate
which was received in 2003 and 2004 that reduced our China tax rate applicable
to 2002 and 2003 to 12% which does not include the local tax of 3%. The
application to be designated as an "Export Oriented Enterprise" is required to
be made on a yearly basis. We applied for the same designation for 2004 and if
our application is successful, it will result in the receipt of a tax rebate in
2005.
Our subsidiaries Radica USA, Radica Canada and Disc Inc. are fully
subject to U.S. and Canada federal taxation, as well as any applicable state or
local taxation, on their taxable income. Currently, the highest marginal rate of
U.S. federal corporate income tax is 35%; the highest marginal rate of Canada
federal corporate income tax is 25%. In addition, dividends paid by Radica USA
and Disc Inc. to our company will be subject to a 30% U.S. federal withholding
tax, resulting in an effective rate of U.S. federal taxation on distributed
profits of up to 54.5%.
Our subsidiary Radica U.K. is fully subject to U.K. corporate taxation.
The U.K. profits tax rate currently applying to corporations is 30%.
During 2003, we formed Radica (Macao Commercial Offshore) Ltd., a
company incorporated in The Special Administrative Region of Macau, for the
purpose of carrying on export trade activities. To the extent that Radica Macau
sells all of its products outside of Macau, it is exempt from tax in Macau.
22
EMPLOYEES
As of December 31, 2004 our workforce was comprised of the following:
-----------------------------------------------------------------------------------------------------------------
Production Sales and R&D Finance Operations Total by
Marketing & Admin location
-----------------------------------------------------------------------------------------------------------------
Asia 4,148 12 79 24 132 4,395
-----------------------------------------------------------------------------------------------------------------
USA 1 26 13 8 17 65
-----------------------------------------------------------------------------------------------------------------
Europe - 8 - 5 7 20
-----------------------------------------------------------------------------------------------------------------
Total 4,149 46 92 37 156 4,480
-----------------------------------------------------------------------------------------------------------------
At December 31, 2003 and 2002 our workforce comprised 3,640 persons and
4,332 persons, respectively.
None of our employees are subject to a collective bargaining agreement
and we have never experienced a work stoppage. Management believes that our
employee relations are good.
DESCRIPTION OF PROPERTIES
See "Manufacturing Facilities" above. We completed the first phase of
construction of our factory (241,000 sq. ft.) on a 3.7 acre parcel of land in
May 1995 and the second phase (223,000 sq. ft.) in August 1998. The factory
currently contains 524,000 sq. ft. of factory space and 308,000 sq. ft. of
dormitory space, capable of housing over 5,000 workers. An extension of the
factory commenced in December of 1999. As a result of the drop in demand for our
product in the U.S. during 2000, work towards completion of this addition was
postponed until the end of 2004. We began completion of the 141,000 square foot
expansion of the factory at the end of 2004 and expect the expansion to be put
into service in mid 2005. We own a long-term leasehold on our executive offices
(11,000 sq. ft. inclusive of two leased unit of 4,800 sq. ft.) and warehouse
space (7,900 sq. ft.) in Fo Tan, Hong Kong. We operate our factory under the
terms of the joint venture agreement. We lease additional office space in
Hertfordshire, U.K.; Macau and Shenzhen, China; Dallas, Texas and Pasadena,
California. We lease showrooms in Tsim Sha Tsui, Hong Kong and New York, New
York and provide individual offices for sales personnel employed in
Massachusetts and Illinois. During 2004, we leased one of our executive units in
Fo Tan, Hong Kong totaling 2,500 sq. ft. and sold one house that was leased out
in 2003. We are currently paying rent on two different houses for Mr. Howell and
Mr. Scott in Hong Kong. We also leased a flat in Macau which has been made
available to Mr. Chu, an officer of our company.
LEGAL PROCEEDINGS
We are subject to pending claims and litigation. On April 4, 2000 a
lawsuit was filed by the Lemelson Foundation ("Lemelson") against us in Arizona
Court for patent infringement. Lemelson claims to be owner of nearly 800 issued
and pending patents, including the patent on Machine Vision and Automatic
Identification (Auto ID) operations. The Auto ID operation is used in machines
that are part of our bonding and heat-sealing manufacturing processes. Lemelson
is contesting that the use of machines that incorporate this patented technology
infringes on their IP rights and therefore we are obligated to pay a royalty
based on the use of this technology.
The suit by Lemelson has been stayed pending the outcome of Lemelson
vs. Cognex, a similar suit filed by Lemelson, which had some bearing on our case
with Lemelson. On January 23, 2004, the U.S. District Court in Nevada issued a
ruling in favor of Cognex. The Court ruled that all of the Lemelson patent
claims at issue were invalid and unenforceable. Lemelson has appealed but the
outcome of the appeal has not yet been decided. We cannot predict the outcome of
the anticipated Lemelson appeals or the effect of such litigation on our
financial results. No accrual has been recorded at December 31, 2004 in respect
of the Lemelson case or other claims or legal actions, in accordance with SFAS
No. 5 Accounting for Contingencies.
During 2004, we were approached with an offer of license of a patent
portfolio from Immersion Corporation. Immersion asserts that manufacturers of
products employing vibration or feel such as those found in several of our
Gamester(R) products require a license and has gained licenses from several
companies within this industry. While Immersion has filed suit recently against
two companies, it is not known whether it will file suit against us if a license
agreement is not reached. We are considering the license offer while
investigating the validity and scope of the patents, but at this time we are
unable to determine the legitimacy of Immersion's claims or our potential
liability should we fail to enter into a licensing agreement with them.
Although there is none currently, from time to time we have other
litigation against us.
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
RESULTS OF OPERATIONS
FISCAL 2004 COMPARED TO FISCAL 2003
The following table sets forth items from our Consolidated Statements
of Operations as a percentage of net revenues:
23
Year ended December 31,
-----------------------
2004 2003
----- -----
Net sales 100.0% 100.0%
Cost of sales 66.1% 62.1%
----- -----
Gross profit 33.9% 37.9%
Selling, general and administrative expenses 24.4% 23.8%
Research and development 3.4% 3.7%
Depreciation and amortization 1.4% 1.9%
Impairment of goodwill 2.9% -
Restructuring charge - 0.1%
----- -----
Operating income 1.9% 8.4%
Other income 0.6% 0.3%
Foreign currency gain, net 0.3% 0.2%
Interest income, net 0.6% 0.3%
----- -----
Income before income taxes 3.5% 9.1%
(Provision) credit for income taxes (.7%) 2.7%
----- -----
Net income 2.8% 11.9%
===== =====
We reported a net profit for the year of $3.5 million or $0.18 per
diluted share compared to $12.5 million or $0.66 per diluted share for 2003. The
decline in net profit was in part the result of a pretax non-cash charge of $3.5
million for impairment of goodwill for the VGA or Gamester business acquired in
1999. Despite an increase in sales of $18.2 million that generated additional
gross profits of $6.2 million, pretax profit before goodwill impairment declined
by 19% ($1.8 million) due largely to a sales mix shift to lower margin Play TV
Legends sales, which accounted for $0.5 million of the decline, increased air
freight ($1.5 million of the decline), outsourcing costs due to increases in
demand in Q3 and Q4 ($1.5 million of the decline), and increased selling and
advertising expenses ($3.5 million of the decline). Other factors contributing
to the profit decline included a $0.6m charge against an underperforming license
guarantee and inventory writedowns for certain discontinued product lines. The
effective tax rate was 19.5% and due to a favorable tax adjustment recorded in
Q4 of 2003 resulted in a significant increase in tax expense compared to 2003 of
$3.2 million for the 4th quarter and $3.7 million for the full year.
Sales for the year increased by 17.3% to $123.4 million from $105.2
million in 2003 due to the success of Play TV Legends, 20Q and the Gamester(R)
Race Pac, among other items. The following table shows the detailed revenue
comparisons for the year by segment:
Year ended December 31,
-----------------------------
Product Lines 2004 2003
-------------
(US$ in thousands)
Games and Youth Electronics Segment
Electronic Games $ 80,640 $ 62,374
Youth Electronics 17,038 15,227
Other Electronic Toys 3,490 -
Manufacturing Services 9,008 10,386
-------- --------
$110,176 $ 87,987
VGA Segment
Video Game Accessories $ 12,840 $ 14,294
Manufacturing Services 383 2,919
-------- --------
$ 13,223 $ 17,213
TOTAL $123,399 $105,200
======== ========
24
Gross profit margin for the year was 33.9% compared to 37.9% for the
year ended December 31, 2003. This decrease in gross margin was in large measure
due to the impact of higher mix of our lower margin Play TV Legends line plus
the impact of the previously mentioned provision for an under-performing
license, inventory writedowns for certain discontinued product lines and
additional air freight and product outsourcing costs incurred to meet increased
demand in Q3 and Q4.
Operating expenses increased to $39.5 million for the year from $31.0
million in 2003. The increase was due to variable expenses resulting from
increased sales together with increased advertising expenditure ($8.8 million in
fiscal year ended 2004 compared to $6.2 million in fiscal year 2003), increased
research and development costs connected with external programming of software
for Play TV games and the $3.5 million charge for impairment of goodwill.
The following table shows the major operating expenses and income
taxes:
Year ended December 31,
------------------------
(US$ in millions) 2004 2003
------ ------
Advertising and co-op expenses $ 10.6 $ 7.6
Other selling and promotion expenses 2.2 1.8
Indirect salaries and bonus 8.8 8.3
Research and development expenses 4.2 3.9
Depreciation and amortization 1.7 2.0
Provision (credit) for income taxes 0.8 (2.9)
Impairment of goodwill 3.5 -
Other general and administrative expenses 8.4 7.4
CAPITAL RESOURCES AND LIQUIDITY
At December 31, 2004 we had $40.1 million of cash and investment
securities, and net assets of $91.1 million as compared to $42.0 million and
$89.2 million, respectively, at December 31, 2003. Inventories increased to
$26.8 million from $15.5 million at December 31, 2003, reflecting current sales
growth rates and the reduction in expected shipments to a large customer in the
4th quarter of 2004 of products that are largely expected to be reordered in the
first half by that same customer. Receivables increased to $18.4 million from
$15.4 million at December 31, 2003 also due to higher volume of sales in the
fourth quarter of 2004 compared to the same quarter in 2003.
In addition to our previously announced factory expansion, we plan to
significantly invest in new equipment for 2005 including major expansion of our
surface mount technology (SMT) capacity in compliance with European lead free
soldering regulations and replacement of certain factory equipment with more
efficient models. As a result, total capital expenditures for 2005 will be in
the range of $6 to $7 million.
Current liabilities were $18.9 million at December 31, 2004, an
increase from $13.1 million at December 31, 2003. This is primarily due to an
increase in payables for raw material for production of inventories needed to
meet Q1 2005 demand.
Cash flows from operating activities, adjusted for the impact on
proceeds and purchases of trading securities, decreased from $10 million to $0.8
million due primarily to increase in inventory levels at December 31, 2004
compared to December 31, 2003.
Cash used in investing activities was $1.2 million compared to a net
utilization of $10 million in 2003. This decrease was caused by $10 million in
investment securities in 2003 offset by an increase in capital purchases related
to the factory expansion.
Cash used in financing activities was $1.9 million in 2004, up from
$1.5 million of cash used in 2003. This was the result of $3.0 million in
dividends paid during the year offset by funds from stock options exercised by
directors and employees.
During the normal course of business, we enter into licensing
agreements and commitments with various third parties for the use of their
inventor concepts and intellectual property. Certain of these agreements and
commitments contain provisions for guaranteed or minimum royalty amounts during
the term of the contracts. Additionally, we lease certain offices, warehouses
and equipment under various operating lease arrangements. In the normal course
of business, leases that expire will be renewed or replaced. Under the terms of
a joint venture agreement with the local government in Dongguan, we are also
committed to pay fees
25
over the next 20 years, as described above under "Item 4. Information on the
Company - Description of Business - Manufacturing Facilities".
As of December 31, 2004, we were obligated under various licensing,
joint venture agreements, non-cancelable operating leases and capital
commitments requiring future minimum payments as follows:
(US$ in thousands)
Total 2005 2006 2007 2008 2009 Thereafter
---------------------------------------------------------------------------------------
Operating leases $ 3,116 $ 720 $ 601 $ 374 $ 318 $ 204 $ 899
Licensing commitments 1,861 1,294 106 231 10 210 10
Joint venture fees 3,317 125 129 129 137 142 2,655
Capital commitments 571 571 - - - - -
---------------------------------------------------------------------------------------
Total minimum payments $ 8,865 $ 2,710 $ 836 $ 734 $ 465 $ 556 $ 3,564
=======================================================================================
We had no derivative instruments or off-balance sheet financing
activities during fiscal years 2003 and 2004. We believe that our existing cash
and cash equivalents and cash generated from operations are sufficient to
satisfy the current anticipated working capital needs of our core business.
Management believes that our existing credit lines are sufficient to
meet future short-term cash demands, including seasonal build up of inventory.
We fund our operations and liquidity needs primarily through cash flow from
operations, as well as utilizing borrowings under secured and unsecured credit
facilities when needed. At December 31, 2004, we had general banking facilities
including overdraft and trade facilities totaling $3,798,000. During 2005, we
expect to continue to fund our working capital needs through operations and the
revolving credit facility and we believe that the funds are available to meet
our needs. However, unforeseen circumstances such as severe softness in, or a
collapse of, the retail environment may result in a significant decline in
revenues and operating results, thereby causing us to exhaust our cash
resources. If this were to occur, we may be required to seek alternative
financing of working capital.
FISCAL 2003 COMPARED TO FISCAL 2002
We reported net income for the year of $12.5 million or $0.66 per
diluted share compared to $11.9 million or $.65 per diluted share for the same
period in 2002. Sales for the year decreased by 15.6% to $105.2 million from
$124.6 million in 2002 due to the reduction in "one-off" manufacturing business
generated by the production of the "Ekara" karaoke product manufactured for
Takara in 2002, reduced sales in the United Kingdom which was impacted by a
particularly weak fourth quarter retail environment and weaker than expected
sales of Barbie(TM) licensed products.
Our U.K. subsidiary experienced a large shift in its sales mix and
gross sales during 2003. Sales of video game accessories fell from $6.1 million
in 2002 to $2.2 million in 2003. This was primarily due to our decision to stop
selling less profitable commodity-type video game accessories such as memory
cards, cables and carrying bags and begin selling a more focused, profitable
line that includes products with unique, trademark and patent protected
features. In the fourth quarter of 2003, we wrote down our U.K. video game
accessory inventory by $1.25 million with plans to sell our remaining commodity
product in 2004. Our sales of electronic games in the U.K. were $8.0 million in
2003, up from $7.0 million in 2002. This was the result of management's focus on
broadening our electronic game distribution in the U.K., which was achieved
through increased promotional spending and pursuing new retail outlets.
Summary of sales achieved from each category of products:
26
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
2003 2002
% OF NET NET % OF NET NET
PRODUCT LINES SALES VALUE SALES VALUE SALES VALUE SALES VALUE
---------------------------------------- ----------- ----------- -----------
(US$ in thousands)
Games and Youth Electronics Segment
Electronic Games 59.3% $ 62,374 50.3% $ 62,684
Youth Electronics 14.5% 15,227 13.4% 16,744
Manufacturing Services 9.8% 10,385 19.8% 24,634
----- --------- ----- ---------
83.6% 87,986 83.5% 104,062
VGA Segment
Video Game Accessories 13.6% 14,294 12.7% 15,844
Manufacturing Services 2.8% 2,920 3.8% 4,740
----- --------- ----- ---------
16.4% 17,214 16.5% 20,584
Total 100.0% $ 105,200 100.0% $ 124,646
===== ========= ===== =========
Gross profit margin for the year was 38.6% compared to 37.8% for the
year ended December 31, 2002 as a result of a favorable product mix shifting
from lower margin OEM sales offset by a charge taken in the fourth quarter of
$1.25 million to reflect inventory write-downs related to our decision to exit
the commodity side of the video game accessories business and concentrate on the
higher margin, innovative product sector of the video game accessories market.
Operating expenses for the year decreased to $31.8 million from $34.6
million for the year ended December 31, 2002. The decrease was the result of a
decrease in variable expenses. In addition, depreciation and amortization
charges dropped by $0.8 million for the year due to certain fixed assets that
have become fully amortized during the year.
During the fourth quarter we released the valuation allowance
previously provided against deferred taxes in the U.S. This, combined with a
larger than expected tax reimbursement in China, resulted in a net tax credit
for the year of $2.9 million.
The following table shows the major operating expenses and income
taxes:
Year ended December 31,
-----------------------
(US$ in millions) 2003 2002
------ ------
Advertising and co-op expenses $ 7.6 $ 7.4
Other selling and promotion expenses 1.8 2.4
Indirect salaries and bonus 8.3 10.0
Research and development expenses 3.9 4.1
Depreciation and amortization 2.0 2.9
(Credit) provision for income taxes (2.9) 2.7
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We prepare our consolidated financial statements in accordance with
generally accepted accounting principles in the United States. Management is
required to make certain estimates and assumptions that affect the reported
amounts of assets and liabilities and the reported amounts of revenue and
expenses. Below is a listing of accounting policies that we consider critical in
preparing our consolidated financial statements. These policies include
estimates made by management using the information available to them at the time
the estimates are made, but these estimates could change considerably if
different information or assumptions were used.
BAD DEBT ALLOWANCE
The bad debt allowance is an adjustment to customer trade receivables
for amounts that are determined to be uncollectible or partially uncollectible.
The bad debt allowance reduces gross trade receivables and is computed based on
management's best assessment of the impact on trade receivables in respect of
the business environment, customers' financial condition, historical
27
trends and customer disputes. Management believes the accounting estimate
related to the allowance for doubtful accounts is a critical accounting estimate
because changes in the assumptions used to develop the estimate could have a
material effect on selling and administrative expenses, net income and accounts
receivable.
We have put controls in place to minimize bad debt exposure. Revenue is
recognized provided that there are no uncertainties regarding customer
acceptance, vendor agreements are put in place documenting the specific terms of
the customer sales relationship or order, the sales price is fixed or
determinable and credit checks are conducted periodically to ensure that
collectibility is reasonably assured. Credit limits and payment terms are
established based on the underlying criteria that collectibility must be
reasonably assured at the levels of credit being extended. For customers
experiencing financial difficulties, management performs additional analysis and
may reduce credit limits or revoke credit based on the findings of the analysis.
Management may also restrict credit terms of its customers if circumstances
warrant by restricting payment terms to cash in advance, wire transfer or
domestic letter of credit.
The movement of the doubtful accounts allowance by geographic region
was as follows for 2004:
Balance at Balance at
beginning Charged to Utilization / end of
(US$ in thousands) of year income statement write-offs year
--------- ---------------- ------------ ----------
Allowance for Doubtful Accounts
-------------------------------
North America $ 208 $ 1 $ (83) $ 126
Europe 43 5 (26) 22
----- --- ------ -----
$ 251 $ 6 $ (109) $ 148
===== === ====== =====
Asia sales are primarily to third-party distributors and manufacturing
services customers. These sales are generally secured by an irrevocable letter
of credit resulting in no historical bad debts writeoffs and therefore no
allowance for bad debts has been made. The North American utilization of the
provision was for the write off of unpaid receivables deemed uncollectible for
several small customers. The increase to the European provision was made through
the third quarter and was based on historical utilization rates as a percentage
of sales. At the end of Q3, an evaluation of the U.K. provision was made and
$26k of the provision was released, which consists of the all of the 2004
utilization of the European provision.
On a consolidated basis, our five largest customers, Wal-mart (US),
Toys R Us (US), Target (US), Argos (UK) and Hasbro (Asia), account for 55.3% of
2004 sales and 67% of total receivables at December 31, 2004. If any of these
retailers were to experience financial difficulties, it could expose us to
significant bad debt charges and related declines in earnings. Additionally,
deterioration in the retail environment or the economy could adversely impact
the trade receivables valuation which would increase our bad debt allowance,
thus decreasing our earnings.
The following table summaries our doubtful accounts provision at
December 31:
(US$ in thousands) 2004 2003 2002
----- ----- -----
Allowance for bad debts $ 148 $ 251 $ 315
As a percentage of net sales 0.1% 0.2% 0.3%
Management believes that the current doubtful accounts allowance is
adequate to provide for our expected probable bad debt losses.
ALLOWANCE FOR SALES RETURNS
A sales return allowance is recorded for estimated sales returns from
customers. The allowance is based on historical trends and management's best
assessment of sales returns as a percentage of overall sales. Management
believes this to be a critical accounting estimate because changes in the
assumptions used to develop this estimate could materially affect key financial
measures, such as sales, net income and receivables.
The movement in the allowance for estimated sales returns by geographic
region was as follows for 2004:
28
Balance at Balance at
beginning Charged to Utilization / end of
(US$ in thousands) of year income statement write-offs year
---------- ---------------- ------------ ----------
Allowance for Estimated Sales Returns
-------------------------------------
North America $ 284 $ 350 $ (333) $ 301
Europe 1,106 795 (1,278) 623
------- ------- -------- -----
$ 1,390 $ 1,145 $ (1,611) $ 924
======= ======= ======== =====
The utilization of the allowance was mostly related to the return of
various defective product (net of warranty cost) and over stock of products from
customers which were anticipated at the end of 2003 and during 2004. The
Company's U.S. sales terms and policies do not allow for the return of
non-defective products; however such a return may occur infrequently if the
Company can maintain the same economic benefit by reselling the product at a
similar margin. In keeping with industry practice, the Company does allow for
the return of non-defective products in the U.K. In the U.K., the return
allowance balance is adjusted monthly as a percentage of the prior six months of
sales; in the U.S., the return allowance is adjusted quarterly as a percentage
of the prior six months' sales. The percentage is based on historical data and
is reviewed quarterly. Defective product returns can be reliably estimated based
on past history and do not fluctuate widely from quarter to quarter.
Non-defective returns are much more difficult to estimate due to the
unpredictability of consumer tastes.
The following table summarizes our sales return provision at December
31:
(US$ in thousands) 2004 2003 2002
----- ------- -------
Allowance for sales returns $ 924 $ 1,390 $ 1,247
As a percentage of net sales 0.7% 1.3% 1.0%
The 2004 decline in the allowance as a percentage of net sales from
2003 is the result of quality improvement efforts and a strategic initiative in
the U.S. to move our customers from defective return programs to warranty
allowance programs. Defective return programs typically grant return credit to
customers for all products returned to their stores as defective. A warranty
allowance is a flat, negotiated allowance taken as a percentage of sales and is
typically preferable to defective returns because liberal customer return
policies generate higher return rates than the negotiated warranty allowances.
Additionally, sales to our third-party distributors, which have no right of
return, have increased significantly in 2004, reducing the need for the
allowance for returns.
Management believes that the current allowance for estimated sales
returns is adequate to provide for 2004 related sales returns expected to be
received during 2005. If defective returns were to exceed historical estimates,
or if we were to experience large overstock returns, then we may have to take
higher than anticipated charges in order to adequately increase the allowance
which would decrease our earnings. For example, if in 2005, we were to
experience returns resulting from a recall or overstocked product that caused a
25% increase from our estimated sales return provisions for 2004 that were based
on historical return data, the impact would be roughly $300,000. Although our
estimates were primarily based on historical data, there is no way to anticipate
such an increase as recalls and poor sell through cannot be reliably predicted.
ALLOWANCE FOR SALES, MARKETING AND ADVERTISING EXPENSES
We record an allowance for sales, marketing and advertising costs
agreed with certain customers. Management believes this to be a critical
accounting estimate because changes in the assumptions used to develop this
estimate could materially affect key financial measures, such as selling and
administrative expenses, net income and short-term liabilities. These allowances
are based on specific dollar-value programs or percentages of sales, depending
on how the program is negotiated with the individual customer. The largest of
these allowances is for accrued sales expenses; the movement of this allowance
by geographic region in 2004 was as follows:
29
Balance at Balance at
beginning Charged to Utilization / end of
(US$ in thousands) of year income statement write-offs year
---------- ---------------- ------------ ----------
Accrued Sales Expenses Allowance
North America $ 2,428 $ 1,826 $ (2,866) $ 1,388
Europe 465 1,008 (950) 523
------- ------- -------- -------
$ 2,893 $ 2,834 $ (3,816) $ 1,911
======= ======= ======== =======
The charges or provisions to the North American and European allowances
were recorded monthly based on the cumulative total of the amounts granted under
individual customer sales programs, including volume rebates and co-op
advertising credits. The utilization of the provisions related to sales
discounts subsequently provided and customer claims made under various sales
programs throughout the year. The utilization of the provision can be materially
impacted by sell-through of our product at retail because poor sell through can
result in increased markdown or co-operative advertising expenditures. We
request that all customers submit claims for annual sales and advertising
programs by no later than February 28th of the subsequent year but typically we
receive significant claims through June 30th of the subsequent year. At the end
of the third and fourth quarter, management assesses the remaining provisions
from the prior year and releases any provisions that we believe will not be
utilized. At the end of the third quarter and fourth quarters of 2004, we
released $174,000 and $313,000 respectively of prior year accrued balances into
the income statement that we believe will not be utilized or claimed.
The following table summarizes our sales expense allowance at December
31:
(US$ in thousands) 2004 2003 2002
------- ------- -------
Allowance for sales expenses $ 1,911 $ 2,893 $ 3,591
As a percentage of net sales 1.5% 2.8% 2.9%
The decrease in the allowances for sales expenses as a percentage of
total sales is the result of an effort by management to replace allowances that
were based on a certain percentage of sales with allowance that are based on
specific advertising and promotional targets agreed to at the beginning of the
year and applied to Radica products.
Management has reviewed its existing allowances for sales, marketing
and advertising and believes them to be adequate at year-end. Several factors,
including poor sell-through of our product at retail could result in management
having to authorize higher than anticipated increases to the allowance, which
would decrease our earnings. We make every effort to control the inventories of
individual products that we carry at retail in order to avoid overstocked
product and subsequent markdowns of those products. However, we cannot predict
consumer reaction to new products or if similar product introductions by
competitors will have an adverse reaction on sales of our existing products.
This unpredictability exposes us to potentially large charges to the allowance
for sales expense, the total impact of which depends on several variables. The
largest of these variables is the volume of slow-moving inventory at retail and
the per-unit markdown of the product. For example, there are collectively almost
6,500 individual Wal-mart, Kmart, Target and Toys R US stores in the US. If we
were to have a product that was fully distributed in those stores and the stores
ended up with unanticipated excess inventories of 20 pieces per store and we
offered a $5 markdown on each unit, the total impact of that charge would be a
decrease in pretax earnings of $650,000. However, if that product had
distribution in half of the total stores, the markdown would be $325,000. In
accruing for the sales expense allowance, we include a charge in anticipation of
such events. However, we typically are not aware that an overstock situation has
occurred until the fourth quarter of the year.
WARRANTY
We record a warranty allowance for costs related to defective product
sold to customers. Management believes warranty allowance to be a critical
accounting estimate because changes in the assumptions used to develop this
estimate could materially affect key financial measures, such as cost of sales
and net income. Additionally, the warranty allowance is based on historical
trends and management's best assessment of what the defective return percentage
will be for a given product. Projecting defective return percentages on new
products can lead to deviations between recorded warranty allowances and actual
defective returns. Significant negative deviations could have a material impact
on our financial results, if large amounts of finished goods were found to be
defective.
30
The movement of this allowance by geographic region is as follows:
Balance at Balance at
beginning Charged to Utilization / end of
(US$ in thousands) of year income statement write-offs year
---------- ---------------- ----------- ----------
Warranty Allowance
------------------
North America $ 841 $ 1,399 $ (1,469) $ 771
Europe 199 396 (405) 190
Other countries - 109 - 109
------- ------- -------- -------
$ 1,040 $ 1,904 $ (1,874) $ 1,070
======= ======= ======== =======
The following table summarizes our warranty allowance at December 31:
(US$ in thousands) 2004 2003 2002
------- ------- -------
Warranty allowance 1,070 $ 1,040 $ 1,040
As a percentage of net sales 0.9% 1.0% 0.8%
Warranty allowance as a percentage of total sales has remained
consistent over the past three years. Despite our continued efforts at improving
the quality of our products, there can be no assurance that we will continue to
see the same defective product rates. New product introductions, changes to
existing products or changes in material vendors and manufacturing
subcontractors could all have a negative impact on our defective rates that
could cause us to take additional charges to our allowance. For example, an
increase in defective returns and allowances of 1% of 2004 sales would have
decreased pretax earnings by roughly $1.2 million.
INVENTORIES
We value our inventory at the lower of cost or market. Inventory
write-downs are recorded for slow-moving and obsolete inventory. Management uses
estimates to record these write-downs. Management believes this to be a critical
accounting estimate because changes in the assumptions used to develop this
estimate could materially affect key financial measures, such as cost of sales,
net income and inventory. Slow-moving and obsolete inventories are written-down
to their estimated market value depending on the length of time the product has
been in inventory and the forecast sales for the product over the course of the
following year. Changes in public and consumer preferences and demand for
product or changes in the buying patterns and inventory management of customers
could adversely impact the level of inventory provision.
The following table summarizes our allowance for obsolete inventory at
December 31:
(US$ in thousands) 2004 2003 2002
------- ------- -------
Allowance for obsolescence $ 1,353 $ 2,228 $ 4,193
As a percentage of total inventory 4.8% 12.6% 17.1%
During 2002 and 2003, we took significant provisions against
slow-moving, commodity-type video game accessory products in the U.S., U.K. and
Asia, most of which have been sold. This resulted in higher allowances as a
percentage of total inventory than we experienced in 2004.
Orders are subject to cancellation or change at any time prior to
shipment since actual shipments of products ordered and order cancellation rates
are affected by customer acceptance of product lines, strength of competing
products, marketing strategies of retailers, changes in buying patterns of
retailers and consumers and overall economic conditions. Unexpected changes in
these factors could result in excess inventory in a particular product line,
which could cause management to make material adjustments to the allowance.
Management reviews its inventories at the end of each quarter on an
item by item basis and identifies products that it believes are obsolete or
slow-moving. Management records a provision for a specific item based on several
factors, including sell
31
through data, the level of inventory at customers' retail stores, sales price of
the item and length of time the item has been in inventory.
IMPAIRMENT OF GOODWILL
In accordance with SFAS No. 142, 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. At the end of the fiscal year ended December 31, 2004, we
completed testing of the goodwill related to Radica's Gamester(R) or video game
accessory (VGA) segment. In determining the fair value of the VGA segment, a
discounted cash flow analysis was performed in which the net present value of
cash flows were calculated based on a five-year projected profit and loss and
working capital requirements. The estimated net present value of the cash flows
was then added to an estimated residual value that was calculated by taking a
multiple of projected earnings before interest, taxes, depreciation and
amortization at the year end of year five to arrive at the fair value of the VGA
segment. Based on a comparison of the estimated fair value of the VGA segment to
the VGA's carrying value, including goodwill, a second step was performed which
compared the implied fair value of the reporting unit's goodwill to the book
value of goodwill. In determining the implied fair value of the reporting unit
goodwill, the fair values of the tangible net assets and recognized and
unrecognized intangible assets are deducted from the fair value of the reporting
unit. If the implied fair value of reporting unit goodwill is lower than its
carrying amount, goodwill is determined to be impaired and is written down to
its implied fair value. After performing this annual evaluation, we recognized
an impairment charge related to goodwill of $3.5 million for the year ended
December 31, 2004.
Despite the small profit for the VGA segment in 2004 before the
goodwill impairment adjustment, the reason for the decline in the estimated fair
value of the VGA's segment from the previous year was primarily the result of
lower sales forecasts for fiscal years 2005 through 2009. The adjustment to
projected annual sales from prior year was based on our current strategy of
concentrating on the innovative, higher margin sector of the market. This
improved the projected gross margins and operating margins as a percentage of
sales in our model, but decreased the total operating margin and cash flows. We
believe that this new model portrays a more accurate picture of our future cash
flows and that our new strategy limits the large closeout returns and price
pressures that made the VGA segment unprofitable from 1999 through 2003.
DEFERRED TAX ASSETS
We record valuation allowances against our deferred tax assets. In
determining the allowance, management considers all available evidence for
certain tax credit, net operating loss and capital loss carryforwards. The
evidence used in assessing the need for valuation allowances includes the use of
business planning, projections of future taxable income and corporate-wide tax
planning. Based primarily in our U.K. subsidiary's failure to generate profits,
we recorded our allowance against the entire U.K. deferred tax asset of $4.5
million. Differences in actual results from projections used in determining the
valuation allowances could result in future adjustments to the allowance.
During 2003, we put a new management team in place in the U.K. and
altered the distribution strategy in that market. We expect these moves to
return our U.K. operations to profitability. If this occurs, depending on the
level of actual and projected profitability, we would then reverse the valuation
allowance, potentially creating a one-time credit to income tax expense in the
future.
RECENTLY ISSUED ACCOUNTING STANDARDS
In November 2004, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards (SFAS) No. 151, Inventory
Costs -- An Amendment of ARB No. 43, Chapter 4 ("SFAS 151"). SFAS 151 clarifies
that abnormal amounts of idle facility expense, freight, handling costs and
spoilage should be expensed as incurred and not included in overhead. Further,
SFAS 151 requires that allocation of fixed and production facilities overhead to
conversion costs should be based on normal capacity of the production
facilities. The provisions in SFAS 151 are effective for inventory costs
incurred during fiscal years beginning after June 15, 2005. We do not believe
that the adoption of SFAS 151 will have a significant effect on its consolidated
financial statements.
In November 2004, the FASB issued SFAS No. 153, Exchanges of
Nonmonetary Assets -- An Amendment of APB Opinion No. 29 ("SFAS 153"). The
provisions of this statement are effective for non monetary asset exchanges
occurring in fiscal periods beginning after June 15, 2005. This statement
eliminates the exception to fair value for exchanges of similar productive
assets and replaces it with a general exception for exchange transactions that
do not have commercial substance -- that is, transactions that are not expected
to result in significant changes in the cash flows of the reporting entity. We
do not believe that the adoption of SFAS 153 will have a significant effect on
its financial statements.
32
In December 2004, the FASB issued SFAS No. 123 (revised 2004),
Share-Based Payment. The new pronouncement replaces the existing requirements
under SFAS No. 123 and APB 25. According to SFAS No. 123(R), all forms of
share-based payments to employees, including employee stock options and employee
stock purchase plans, would be treated the same as any other form of
compensation by recognizing the related cost in the statement of operations.
This pronouncement eliminates the ability to account for stock-based
compensation transactions using APB No. 25 and generally would require that such
transactions be accounted for using a fair-value based method. For the Company,
SFAS No. 123(R) is effective for awards and stock options granted, modified or
settled in cash in interim or annual periods beginning after June 15, 2005,
which for the Company will be its third quarter ending September 30, 2005. SFAS
No. 123(R) provides transition alternatives for public companies to restate
prior interim periods or prior years. We are in the process of evaluating the
impact of this standard on its financial statements and will adopt SFAS 123(R)
on July 1, 2005.
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
The following table sets forth the directors and executive officers of
the Company in fiscal 2004, as updated to reflect changes in January 2005.
Term
Name Expires Residency Position
---- ------- --------- --------
Jon N. Bengtson (3) 2005 USA Chairman of the Board and Director
Timothy R. Busch (1)(3) 2005 USA Director
Albert J. Crosson (1)(2) 2005 USA Director
Theodore J. Eischeid 2005 USA President, Chief Operating Officer and Director
Patrick S. Feely (3) 2005 USA Chief Executive Officer and Director
David C.W. Howell 2005 Hong Kong President Asia Operations, Chief Financial Officer and Director
James J. O'Toole (2) 2005 USA Director
Peter L. Thigpen (1)(2) 2005 USA Director
Jeanne M. Olson N/A USA President North American Operations
Denis Horton N/A U.K. President Radica Europe and Managing Director, Radica U.K.
James M. Romaine N/A USA Senior Vice President Sales
Laurence M. Scott Jr. N/A Hong Kong Senior Vice President of Asia Operations
Craig D. Storey N/A USA Vice President and Chief Accounting Officer
Larry C.N. Cheng N/A Hong Kong Vice President Engineering
Robert E. Esterbrook N/A U.K. Vice President, UK Finance & Operations
Paul Fogarty N/A U.K. Vice President U.K. Sales
Louis S.W. Kwok N/A Hong Kong General Manager, Factory
Eric K.W. Chan N/A Hong Kong Quality Director
Vincent K.M. Ching N/A Hong Kong Manufacturing Director
33
Rick C.K. Chu N/A Hong Kong Director of Customer Service
Martin Frain N/A U.K. U.K. Marketing Director
Sean C.W. Lee N/A Hong Kong Finance Director - Asia
Donny K.W. So N/A Hong Kong Director of Project Management
Hermen H.L. Yau N/A Hong Kong MIS Director
Kenneth K.C. Yu N/A Hong Kong Engineering Director
(1) Member of the Audit Committee.
(2) Member of the Corporate Governance, Nominations and Compensation Committee.
(3) Member of the Executive Committee.
We annually prepare a proxy statement/management information circular
for distribution to our shareholders in connection with the annual meeting of
shareholders. Additional information is contained in such proxy statement with
respect to the ownership of shares of our common stock by directors and
executive officers, the ages of such persons, and the functions or board
practices of the committees of our board of directors. The information contained
in such proxy statement for the current fiscal year is incorporated herein by
reference. Such proxy statement is furnished as part of our report on Form 6-K
for the period in which the proxy statement is sent to shareholders. The proxy
does not necessarily contain all the information required by the SEC for a
domestic registrant since such information is not required for foreign private
issuers.
Jon N. Bengtson, formerly the Executive Vice President and Chief
Operating Officer of the Company, became the Chairman of the Board of the
Company in January 1996, and has been a director of the Company since January
1994. He was Chief Financial Officer of the Company from January 1994 to
September 1995, and was appointed President and Chief Executive Officer of
Radica USA in December 1993. Mr. Bengtson joined The Sands Regent in 1984 and
served in various positions, including Vice President of Finance and
Administration, Chief Financial Officer, Treasurer and Director, Senior Vice
President and Director and Executive Vice President and Chief Operating Officer
and Director until December 1993. From 1980 to 1984, Mr. Bengtson was a director
and served in various positions with International Game Technology ("IGT"),
including Treasurer and Vice President of Finance and Administration and Vice
President of Marketing. Mr. Bengtson is currently the Chairman of The Sands
Regent.
Timothy R. Busch was appointed a director of the Company in May 2003.
Mr. Busch is CEO and founder of The Busch Firm. Founded in 1979, The Busch Firm
specializes in estate planning, asset protection, tax, corporate law,
partnership and real estate matters. He is also founder of Pacific Hospitality
Group, an Irvine-based hotel firm that constructs and operates hotels; St. Anne
School of Laguna Niguel, California, a private Christian elementary school; and
the new private JSerra High School. Mr. Busch serves on a number of private and
public boards in various industries, including Advanced Materials, Inc. of
Rancho Dominguez, California. Mr. Busch received his Juris Doctor degree from
the Wayne State University of Law, and his B.B.A., summa cum laude, degree from
Western Michigan University. He is an attorney licensed in Michigan, California,
Texas, and Washington, D.C., and a CPA licensed in Michigan, California, and
Nevada. He is a member of the Orange County and Palm Springs Chapters of
Legatus, an organization of Catholic CEOs.
Albert J. Crosson was appointed a director of the Company in May 2001.
He became a director of International Game Technology ("IGT") in 1988. He became
Vice Chairman of the Board of IGT in July 1996 and an employee of such company.
He resigned as an employee in December 2000 and as Vice Chairman of the Board of
IGT in August 2001. Mr. Crosson was employed for 34 years by ConAgra, Inc. and
its predecessor companies. He was President of ConAgra Grocery Products
Companies from 1993 until January 1996 when he retired. From 1986 until January
1993, he was President of Hunt-Wesson Foods, Inc., a ConAgra company.
Theodore J. Eischeid was appointed President and Chief Operating
Officer in January 2005. He has been a director of the Company since May 2003
and served as Chairman of the Audit Committee until January 2005. Most recently
Mr. Eischeid was Vice President - Global CDMA Partnership and Product Management
for Motorola, Inc., a global leader in wireless, automotive and broadband
communications. Prior to that, he was Senior Vice President and Chief Financial
Officer of K12 Inc., a developer of online curriculum for grades K-12; formerly
President and CEO of Educational Insights, Inc., a publicly traded developer,
manufacturer and marketer of educational products; and prior to that served as
President of Revell-Monogram, Inc., an international
34
manufacturer and marketer of plastic hobby kits, where he lead a successful
initial public offering in 1991 and continued as President when the company was
acquired by Hallmark Inc. in 1994. Mr. Eischeid also served as Chief Financial
Officer of Arvey Corporation, a manufacturer and retailer of paper and paper
products, and began his career with Arthur Andersen & Co. He is a Certified
Public Accountant, a member of the Illinois Bar and a past Chairman of the Toy
Manufacturers of America. Mr. Eischeid received his Juris Doctor, cum laude,
degree from the Loyola University of Chicago School of Law, his MBA from
Northwestern University's Kellogg Graduate School of Management, and his BS
degree from Iowa State University.
Patrick S. Feely has been Chief Executive Officer since April 1999. He
was Chief Operating Officer and President of the Company from July 1997 to
January 2005 and has been a director of the Company since July 1996. Prior to
joining Radica, he was President and CEO of Spectrum HoloByte, Inc. from 1993 to
1995; President of Bandai America, Inc. from 1991 to 1992; and founder and
President of Toy Soldiers, Inc. (which merged with Bandai America) from 1988 to
1991. Mr. Feely was an executive at Tonka, Inc. from 1982 to 1988, where he
served as President of the Tonka Products Division and a Director of the parent
company. At Tonka, in addition to his other responsibilities, he managed the
launch of the Sega video game system into the U.S. market. Mr. Feely was an
executive at Mattel Toys from 1977 to 1982 and began his career at RCA
Corporation in 1970. Mr. Feely is also an advisor to the Toy Industry
Association Board of Directors, where he was Chairman from 2000 to 2002. He is
also a director of the Board of Trustees of the Toy Industry Foundation. He has
a BA from Duke University and an MBA from the University of Michigan.
David C.W. Howell was appointed President Asia Operations in December
1998. He has been Executive Vice President and Chief Financial Officer and a
director of the Company since September 1995. Prior to that, he was Vice
President and Chief Accounting Officer and a director of the Company from
January 1994 to September 1995. 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. He 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 Society of Accountants.
James J. O'Toole has been a director of the Company since June 1994. He
is Research Professor in the Center for Effective Organization at the University
of Southern California's Marshall School of Business. He is the Mortimer J.
Adler Senior Fellow of the Aspen Institute.
Peter L. Thigpen has been a Director of the Company since June 1998. He
is a Lecturer in Ethics & Great Books in the Graduate Business School at the
University of California, Berkeley, a Senior Fellow & Moderator at the Aspen
Institute, and is on the Board of Trustees of the Kentfield, California School
District and the Board of Trustees of Branson High School in Ross, California.
Prior to 1992, Mr. Thigpen was Senior Vice President - U.S. Operations and a
member of the Executive Management Committee at Levi Strauss & Company, retiring
after 23 years with the San Francisco-based apparel company. During his tenure
at Levi Strauss, Mr. Thigpen held positions of President of European Operations,
President - Levi Strauss USA, President - The Jeans Company and was a member of
the Board of Directors.
Jeanne M. Olson was promoted to President North American Operations in
January 2004. She previously held the positions of Executive Vice President and
General Manager from 2002 to 2003, and Senior Vice President, Marketing from
2000 to 2002. Prior to joining the Company in 2000, she was Senior Vice
President of Sales & Marketing at Lyrick Studios, a privately-held children's
entertainment company. Ms. Olson has over 15 years of experience in the toy
industry, having held executive marketing and management positions at Mattel
Toys, Hasbro Inc., and Tonka Toys. She started her career in marketing research
with The Pillsbury Company and with Custom Research Inc.
Denis Horton has been Managing Director of Radica U.K. Ltd. since April
2003 and President Radica Europe since January 2005. He has over 18 years of
experience in the toy industry, previously having held Managing Director
positions at Mattel U.K., Fisher Price and Tonka Europe. Prior to entering the
toy industry, Mr. Horton worked in the food industry and held management
positions at United Biscuits and H J Heinz Co., Ltd. He received his BA (Honors)
degree in Business Studies from Nottingham Trent University, and is a Fellow of
the Chartered Institute of Marketing in the U.K.
James M. Romaine joined Radica USA in September 1999 as Senior Vice
President of Sales for Radica USA. He has been an executive in the Toy Industry
for over 32 years. He spent the 1980's and into the early 90's at Parker
Brothers where he was Senior Vice President of Sales. Mr. Romaine was the
President of Play Tech Inc., a VTech company, for seven years before joining
Radica USA. His most recent educational credentials include the completion of
the Executive Program for General Managers at the University of Michigan's
School of Business.
Laurence M. Scott, Jr. was appointed Senior Vice President Asia
Operations in April 2002. Previously he was Managing Director - Asian Operations
for iLogistix Singapore Supply Chain Management Pte. Limited. Prior to that he
was Managing
35
Director for MGA Entertainment (Hong Kong) Limited (1998 - 2000); Vice President
- Operations for Atari Corporation (1992 - 1996) and then Vice President -
Worldwide Materials for JTS Corporation (1996 - 1997) after Atari merged with
JTS; and President and Managing Director for Radofin Electronics (Far East)
Limited. (1975 - 1991). Mr. Scott has over 25 years experience with Asian
Manufacturing Operations. He has a BSc. and MBA from the University of Southern
California.
Craig D. Storey has been Vice President and Chief Accounting Officer of
the Company since July of 1999. Prior to that, he was the Financial Controller
of Radica USA from 1995 to 1999. From 1993 to 1995, Mr. Storey was employed by
Kafoury, Armstrong and Company in Reno, Nevada. He has a BS from Arizona State
University and is a member of the American Institute of Certified Public
Accountants and the Nevada Society of CPA's.
Larry C.N. Cheng has been Vice President Engineering of the Company
since April 2003. Prior to that, he was an Engineering Director from April 1999
to March 2003. Mr. Cheng joined the Company in 1991 and was an Engineering
Manager from April 1993 to March 1999. Mr. Cheng has more than 15 years
experience in ODM and the toy industry. He has a Higher Diploma in Marine
Electronics from the Hong Kong Polytechnic University.
Robert E. Esterbrook joined Radica U.K. as Finance Director and Company
Secretary during July 2001,becoming Vice President U.K. Finance and Operations
in 2004. He has held executive positions in the U.K. toy industry for over 25
years. He has previously worked at Tonka Toys, Playmates Toys and Ideal Toys as
Finance Director and was involved with the establishment of Mattel Toys in the
U.K. in 1980. He re-joined Invicta Plastics, Ltd, originators of the board game
Mastermind, as Managing Director from 1989 to 1991. He is a fellow member of the
Chartered Institute of Management Accountants and completed a program in legal
studies at Demontfort University.
Paul Fogarty commenced working as Sales Director for Radica U.K. in
January 2004 and was promoted to Vice President of U.K. Sales in January 2005.
He has over 10 years experience in the toy industry previously having held
senior management positions for Mattel U.K., Tyco Toys U.K. and JAKKS Pacific.
Prior to this Mr. Fogarty worked in the paper industry for Scott Paper Ltd. Mr.
Fogarty, who is originally from New Zealand, moved to England in 1989. He
received his Bachelor of Commerce degree in Marketing from the University of
Auckland.
Louis S.W. Kwok has been the General Manager, Factory from April 2004.
Prior to that, he was the Materials and Logistics Director of the Company from
March 2002 to March 2003 and the Plant Administration Director from January 2001
to February 2002. He has over 16 years experience in manufacturing plant
operations. Major companies he has worked with are Fymetics (Hong Kong) Limited,
Management, Investment and Technology Company Limited, and Sunciti Manufacturers
Limited. He has a Higher Diploma in Mechanical Engineering, Diploma in
Mechanical Engineering (Manufacturing Technology), and National Diploma in
Mechanical Engineering.
Eric K.W. Chan has been the Quality Director of the Company since July
2, 2001. Prior to that, he was Senior QA Manager/Quality Director in various
major toy companies such as Tonka Kenner Parker, Hasbro and Galoob. Mr. Chan has
over 20 years of solid experience in QA/QC operations in the toy industry. He
has a Diploma in Production and Industrial Engineering, Diploma in Management
Study and Diploma in Industrial Management (U.K.).
Vincent K.M. Ching joined the Company as the Manufacturing Director in
September 2002. He has over 16 years experience in research, consultancy and
manufacturing sectors, has been working in PRC for 10 years at a managerial
level with Philips, Procter & Gamble (P & G) and previously as Manufacturing
Director in Honeywell Consumer Products (H.K.) Ltd. from June 1999. He has
achieved a number of prizes and awards in both academic and industrial sectors
including the Ford Design Prize from Ford Motor (U.K.) Co. Ltd. in 1985, First
Class Honors degree in Mechanical Engineering in 1986, Overseas Research
Students Award from the Committee of Vice-Chancellors and Principals of
Universities (U.K.) in 1987, Postdoctoral Research Fellowship from the Croucher
Foundation of Hong Kong in 1990 and Hong Kong Productivity Council Productivity
Award for the 2002 Hong Kong Awards for Industry.
Rick C.K. Chu has been the Director of Customer Service of the Company
since January 2004. Prior to that, he was the International Sales Director of
the Company from April 1996 to December 2003 and the International Sales
Administration Manager of the Company from April 1994 to April 1996. He has more
than 17 years experience in international trade and business management. From
1988 to 1994, he was the Senior Manager managing the sales administration
function and marketing of industrial materials for a leading trading company in
Hong Kong.
Martin Frain joined Radica U.K. as Marketing Director in May 2004.
Prior to that he was marketing manager at Hasbro U.K., where he worked from
1999. He entered the toy industry in 1993 when he started a games and toys
distribution business in
36
Southern Africa. Prior to that he worked as a journalist on a daily newspaper in
Johannesburg. He is currently completing his Masters of Business Administration
at the University of Bath.
Sean C.W. Lee has been Finance Director - Asia of the Company since
September 2002. Prior to that, he was the Financial Controller of Dongguan
factory. He has more than 10 years experience in electronic manufacturing field.
He has a Professional Diploma in Accountancy from City University of Hong Kong.
He is also a member of HKICPA and ACCA.
Donny K.W. So joined the Company as Director of Project Management in
September 2002. Before joining the Company, he held management positions in
product development at VTech HK for 4 years. Mr. So has 17 years experience in
project management and product development in major appliances, electronics and
toys industries. He obtained his Six Sigma experience while working for General
Electric Company, and led the development of Total Cycle Time management skill
at VTech. He has a Postgraduate Certificate in Business Administration from the
Open University of Hong Kong, a BA in Industrial Design from the Hong Kong
Polytechnic University and a Diploma in Product Design from LWL Technical
Institute.
Hermen H.L. Yau has been the MIS Director of the Company since March 1,
1994. From 1982 to 1994, he worked in Outboard Marine Corporation Asia Ltd in
various positions in the Systems & Data Processing Department. He has more than
18 years experience in Information Technology and particular experience in IBM
mid-range computer systems and solutions. He has a Higher Diploma in Computer
Studies from the National Computing Center U.K. and a Diploma in Management
Studies from the Hong Kong Polytechnic and Hong Kong Management Association.
Kenneth K.C. Yu has been as Engineering Director - Asia of the Company
since June 2004. Prior to that, he was the engineering manager of a Dongguan
factory. He has seventeen years working experience in product engineering,
production and industrial engineering, product design, project management and
manufacturing of toys and computer accessories. His academic background is
engineering and he received a Master in Engineering Business Management in 2003.
He is a member of IEE and also a Chartered Engineer.
COMPENSATION OF OFFICERS AND DIRECTORS
COMPENSATION
In fiscal 2004, the aggregate amount of compensation paid to all
executive officers and directors for services in all capacities was
approximately $3.2 million. In addition, bonus payments of $0.2 million were
accrued in 2004 for 2004 performance and are expected to be paid in April 2005.
In fiscal 2004, each outside (i.e. non-employee and non-affiliated)
director of the Company received compensation according to the following
schedule:
o Board retainer $10,000 annually
o Quarterly board meeting fee $1,250 per meeting
o Committee retainer $4,000 annually (excluding
Executive Committee)
o Audit chair additional retainer $4,000 annually
o Other committee chairs additional retainer $2,000 annually
Payments were made quarterly. Any director may elect to receive some or
all of the above fees payable in shares of the Company's Common Stock valued at
the then current market price.
Directors who are employees or affiliates of the Company are not paid
any fees or additional remuneration for service as members of the Board of
Directors or its Committees.
Upon each annual re-election to the Board of Directors, each outside
director receives stock options to purchase 2,500 shares per quarter (i.e.
10,000 shares per annum) of Common Stock of the Company at an exercise price
equal to the then current market price of the Company's Common Stock. The
average exercise price was $9.02 per share in 2004. These options are
exercisable after one year from the date of grant.
The Company also follows the practice that upon the initial election or
appointment of a new outside director to the Board of Directors, such director
receives a stock option to purchase 30,000 shares of the Company's Common Stock
at an exercise price equal to the then-current market price, and these options
are exercisable after one year from the date of grant.
37
EMPLOYMENT AGREEMENTS
Messrs. Feely, Eischeid, Howell, Bengtson, Horton and Ms. Jeanne Olson
have each entered into individual employment agreements with the Company. After
giving effect to the latest renewals, the employment agreements are renewed
automatically on an annual basis unless 90 days notice is given by either party,
for periods of two years each, from July 2003 for Mr. Feely, from January 2005
for Mr. Eischeid, and from December 2002 for Messrs. Howell, Bengtson and Ms.
Olson. The employment agreement for Mr. Horton from April 2003 continues unless
12 months notice is given by the Company or 6 months notice is given by the
employee. Each employment agreement is terminable by the Company for cause.
Under their agreements Messrs. Feely, Eischeid, Howell, Bengtson, Horton and Ms.
Olson shall each receive minimum annual base salaries of $365,000, $315,000,
$250,000, $43,200, $238,500 and $275,000 (the amount for Mr. Horton is stated in
U.K. currency as (pound)132,500), respectively. The agreement with Mr. Bengtson,
in operation since December 1995, is for part-time services. Under the terms of
their employment agreements Messrs. Feely, Eischeid, Howell, Bengtson, Horton
and Ms. Olson are eligible to participate in the Company's bonus plan. The
employment agreements for Messrs. Feely, Eischeid, Howell, Horton and Ms. Olson
contain certain restrictions on their involvement in businesses other than the
Company during the course of their employment and certain provisions applicable
after termination of employment which prohibit the solicitation of customers and
other employees of the Company, employment or engagement with competing
entities, or the disclosure of proprietary information of the Company. The
Company provides residences for Mr. Howell and Mr. Scott in Hong Kong. In the
agreement for Mr. Feely, he was granted 300,000 stock options of the Company
common stock at the then market price of $3.625 per share, another 60,000 stock
options at the then market price of $14.125 per share in November 1998 and a
further 60,000 stock options at the then market price of $3.00 per share in May
2000, subject to the terms and conditions of the agreement and the 1994 Stock
Option Plan. Additionally, in May 2001, Mr. Feely would have been granted 60,000
stock options at the then market price provided he achieved certain conditions
as stated in the agreements; however, these were not achieved. In the agreement
for Mr. Eischeid, he was granted 60,000 stock options of the Company common
stock at the then market price of $7.90 per share and 25,000 restricted shares
at $7.91 per share in February 2005 subject to the terms and conditions of the
agreement and the Omnibus Plan, and provided certain conditions are achieved as
stated in the agreement. In the agreements for Mr. Howell, he was granted 25,000
stock options per annum of the Company common stock at the then market price of
$3.00 and $2.90 per share in May 2000 and 2001 respectively. In June 2002, Mr.
Howell was granted 25,000 stock options at the then market price, subject to the
terms and conditions of the agreement and the 1994 Stock Option Plan. In the
agreement for Ms. Olson, she had been granted 60,000 stock options upon initial
employment and was granted an additional 40,000 stock options at the then market
price of $3.45 per share in January 2002 subject to the terms and conditions of
the agreement and the 1994 Stock Option Plan. In the agreement for Mr. Horton,
he had been granted 60,000 stock options of the Company common stock at the then
market price of $4.43 in March 2003 upon initial employment subject to the terms
and conditions of the agreement and the 1994 Stock Option Plan. Additionally,
Messrs. Feely, Howell and Ms. Olson were granted 60,000, 25,000 and 25,000 stock
options at the then market price, respectively in February 2001. Mr. Howell was
granted 3,750 stock options in March 2002 for achieving certain requirements
under an incentive plan. Based upon 2002 performance the Company's Compensation
Committee voted in March 2003 to accelerate the vesting of 60,000 options for
Mr. Feely and 25,000 options for Ms. Olson and Mr. Howell. The acceleration of
the stock options was approved in accordance with the original terms of the
contract and these options would become vested in five years regardless of the
achievement of the performance goals and therefore the acceleration did not
result in a new measurement of the stock options for accounting purposes. In
March 2003, Mr. Feely was granted 120,000 options at the then market price of
$4.43 per the Company's prior practices. In September 2004, Ms. Olson was
granted 30,000 options at the then market price of $8.24 for long-term
compensation equalization.
OPTIONS TO PURCHASE SECURITIES FROM REGISTRANT OR SUBSIDIARIES
The Company's 1994 Stock Option Plan provided for the granting of stock
options to directors, officers and employees of the Company. The Stock Option
Plan is administered by the Compensation Committee of the Board of Directors.
The total number of shares of the Company's Common Stock that may be purchased
pursuant to stock options under the Stock Option Plan shall not exceed in the
aggregate 3.7 million shares. The Stock Option Plan terminated in October 2004
but continues in effect for outstanding options under such plan.
At the Annual Shareholders Meeting in May 2004, the 2004 Omnibus Equity
Incentive Plan which replaced the 1994 Stock Option Plan was approved. The 2004
Omnibus Equity Incentive Plan includes an authorization for a total of 500,000
shares of the Company's common stock to be issued under the plan and the plan
will expire in 2014 unless earlier terminated.
In fiscal year 2002, an aggregate of 448,150 options (exclusive of the
outside directors' options and net of stock options that were both issued and
forfeited in the year) were granted to directors, officers and other employees
under the Stock Option Plan to purchase the Company's shares at exercise prices
ranging from $2.74 to $4.51 per share.
38
In fiscal year 2003, an aggregate of 259,200 options (exclusive of the
outside directors' options and net of stock options that were both issued and
forfeited in the year) were granted to directors, officers and other employees
under the Stock Option Plan to purchase the Company's shares at exercise prices
ranging from $4.21 to $6.54 per share.
In fiscal year 2004, an aggregate of 137,000 options (exclusive of the
outside directors' options and net of stock options that were both issued and
forfeited in the year) were granted to directors, officers and other employees
under the Stock Option Plan to purchase the Company's shares at exercise prices
ranging from $7.15 to $9.11 per share.
As a result of the foregoing, at the end of fiscal year 2004, after
giving effect to all prior exercises and forfeitures of options, an aggregate of
1,317,886 options (exclusive of the outside directors' options) were outstanding
at exercise prices ranging from $1.09 to $19.63 per share, and of such amount a
total of 967,750 options were held by directors and executive officers of the
Company as a group. Also, an aggregate of 265,000 outside director's options
were outstanding at exercise prices ranging from $2.0 to $12.63 per share.
During 2004, a total of 510,636 shares were issued upon the exercise of options,
at exercise prices ranging from $1.09 to $6.78 per share. Prior to 2004, a total
of 1,636,042 shares had been issued upon the exercise of options at exercise
prices ranging from $0.57 to $11.0 per share.
Additional information with respect to stock options is contained in
Note 11 of the Notes to the Consolidated Financial Statements included in this
filing.
Information with respect to employees is contained in Item 4 above.
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
CONTROL OF REGISTRANT
(a) The registrant is not controlled by another corporation or any foreign
government.
(b) The following table is based on information available to the Company and
identifies the owners of more than five percent (5%) of the registrant's
common stock (based on their filings of Forms 13D or 13G) and the amount of
common stock beneficially owned by the officers and directors as a group,
as of January 31, 2005. The Company must rely on information provided by
individual shareholders and therefore cannot verify its accuracy:
Identity of
Title of Class Person or Group Amount Owned Percent of Class
-------------- --------------- ------------ ----------------
Common stock Dito Devcar Corporation, et al. (1) 8,728,888 46.4%
Common stock RAD Partners 1999 LLC, et al. (2) 1,093,700 5.8%
Common stock Royce & Associates, LLC (3) 972,250 5.2%
Common stock Officers & Directors as a Group 2,587,511 13.7%
(1) Includes shares of Common Stock owned by the following related
persons: Dito Devcar Corporation, DRP Charitable Unitrust, TMP
Charitable Unitrust, Dito Devcar, LP, Dito Caree, LP, Pickup Family
Trust, Pickup Charitable Unitrust II, TD Investments, LLC, Plus Four
Equity Partners LP, Dito Devcar Foundation and Richard H. Pickup. The
ownership percentages of this group as reported in the Company's 2003
and 2002 Forms 20-F were 46.8% and 44.1%, respectively.
(2) Includes shares of Common Stock owned by the following related
persons: RAD Partners 1999 LLC, Lenawee Trust, 92653 Trust, Busch
Family Foundation and Timothy R. Busch, who is a director of the
Company. The ownership percentages of this group as reported in the
Company's 2003 and 2002 Forms 20-F were 8.9% and 9.1%, respectively.
(3) This shareholder reported ownership in excess of 5% of the outstanding
Common Stock for the first time this year.
(c) There are no arrangements known to the registrant which may at a subsequent
date result in a change of control of the registrant.
(d) As of January 31, 2005, the Company had approximately 100 record holders of
its Common Stock, and over 90% of such stock was held by U.S. holders.
39
INTEREST OF MANAGEMENT IN CERTAIN TRANSACTIONS
At the time of the Company's IPO in 1994, certain members of management
who were also the principal shareholders of the Company, were parties to a
shareholders agreement (the "Shareholders Agreement") with the Company which
provided for certain matters relating to the management of the Company and
ownership of its Common Stock. In January 1998, the Shareholders Agreement was
amended to eliminate provisions respecting the election and removal of
directors, restrictions on transfer and a right of first refusal. The
registration rights provisions of the Shareholders Agreement remained operative.
Pursuant to the Shareholders Agreement, the Company agreed, at any time
after February 16, 1996 and subject to certain specified conditions, to use its
reasonable efforts to prepare and file one registration statement on behalf of
each shareholder that is a party to the Shareholders Agreement (collectively,
the "Shareholders") under the Securities Act of 1933, and to use its reasonable
efforts to qualify the shares for offer and sale under any applicable U.S. state
securities laws. The Shareholders Agreement also grants each Shareholder certain
"piggyback" registration rights entitling each Shareholder, at any time after
February 16, 1996, to sell Common Stock in certain registered offerings of
equity securities of the Company. These "piggyback" registration rights are
exercisable by each Shareholder only twice. The foregoing registration rights
are subject to other limitations set forth in the Shareholders Agreement.
In the Company's Form 20-F for 2003, we reported that Albert J.
Crosson, one of our directors, had a 1% beneficial interest in Crossfire, LLC,
which provided beneficial ownership of 450,000 shares of our common stock and
the right for Crossfire to acquire an additional 400,000 shares over time from a
limited liability company (RAD Partners 2001, LLC) which was controlled by RAD
Partners 1999 LLC, one of our principal stockholders. Mr. Crosson has reported
to the Company that in 2004 the additional 400,000 shares were acquired by
Crossfire and RAD Partners 2001 was liquidated, but Mr. Crosson sold his
interest in Crossfire to his four adult children. As a result, Mr. Crosson has
disclaimed any beneficial ownership in common stock of the Company, other than
through his ownership of stock options acquired as a director of the Company.
Additional information on management transactions is contained under
Item 6 above.
ITEM 8. FINANCIAL INFORMATION
FINANCIAL STATEMENTS
The Company's Consolidated Financial Statements are included herein.
ITEM 9. THE OFFER AND LISTING
The Company's common stock is traded on the Nasdaq National Market
under the symbol RADA. The Company's common stock is not traded on any foreign
trading market. The following table lists the high and low closing stock price
for each quarter of fiscal 2004 and fiscal 2003:
Fiscal year ended Fiscal year ended
December 31, 2004 December 31, 2003
------------------- ------------------
High Low High Low
---- ---- ---- ----
First Quarter 11.64 6.88 6.54 4.20
Second Quarter 9.86 8.00 8.00 5.54
Third Quarter 10.35 8.24 8.17 6.88
Fourth Quarter 10.92 7.52 7.95 6.30
The annual high and low closing stock prices in fiscal 2002 were $4.6
and $3.4; in fiscal 2001 were $4.9 and $1.625 and in fiscal 2000 were $10 and
$1.625.
The monthly high and low closing stock prices over the last six months
in fiscal 2004 were $9.1 and $8.24 in July 2004; $9.49 and $8.28 in August 2004;
$10.35 and $8.75 in September 2004; $10.92 and $9 in October 2004; $10.55 and
$8.93 in November 2004; and $9.7 and $7.52 in December 2004.
Radica Games Limited was formed in 1993 as a holding company and,
through fiscal 2003, had not paid any dividends. Except to the extent set forth
below, the Company intends to retain its earnings for operations and expansion
of its business for the foreseeable future.
40
On January 5, 2004, the Company announced a quarterly dividend program.
In fiscal 2004, the Company paid $3.0 million in dividends to its shareholders.
On January 4, 2005, our Board of Directors declared a dividend of $.045
per share payable on January 31, 2005, to shareholders of record as of January
20, 2005. The Board has also approved an initial target quarterly dividend of
$.045 per share for subsequent quarters; however, the actual amount of each
quarterly dividend, as well as each declaration date, record date and payment
date, is subject to the discretion of the Board, and the target dividend level
may be adjusted during the year at the discretion of the Board. The factors the
Board is expected to consider in determining the actual amount of each quarterly
dividend will include our financial performance and on-going capital needs, our
ability to declare and pay dividends in light of other financial requirements,
and other factors deemed relevant.
ITEM 10. ADDITIONAL INFORMATION
MEMORANDUM AND BY-LAWS
A summary of the Company's memorandum and by-laws and other provisions
pertaining to its common stock is contained in the Company's registration
statement on Form F-3 filed with the Securities and Exchange Commission on May
21, 1999 (file no. 33-79005). Such summary in that registration statement is
incorporated herein by reference.
EXCHANGE CONTROLS AND OTHER LIMITATIONS AFFECTING SECURITY HOLDERS
The Company has been designated as a non-resident of Bermuda for
exchange control purposes by the Bermuda Monetary Authority.
The transfer of shares of the Company between persons regarded as
non-resident of Bermuda for exchange control purposes and the issuance of shares
within the authorized share capital of the Company of US$1,000,000 to or by such
persons may be effected without specific consent under the Exchange Control Act
1972 and regulations thereunder subject to such shares being listed on the
National Association of Securities Dealers Automated Quotation System. Issues
and transfers of shares involving any person regarded as resident in Bermuda for
exchange control purposes require specific prior approval under the Exchange
Control Act 1972.
There are no limitations on the rights of non-Bermuda resident holders
of the Common Stock to hold or vote their shares. Because the Company has been
designated as non-resident for Bermuda exchange control purposes, there are no
restrictions on its ability to transfer funds in and out of Bermuda or to pay
dividends to United States residents who are holders of the Common Stock, other
than in respect of local Bermuda currency.
In accordance with Bermuda law, share certificates are only issued in
the names of corporations or individuals. In the case of an applicant acting in
a special capacity (for example, as an executor or trustee), certificates may,
at the request of the applicant, record the capacity in which the applicant is
acting. Notwithstanding the recording of any such special capacity, the Company
is not bound to investigate or incur any responsibility in respect of the proper
administration of any such estate or trust.
The Company will take no notice of any trust applicable to any of its
shares whether or not it had notice of such trust.
As an exempted company, the Company is exempt from the usual Bermuda
requirement which restricts the percentage of share capital that may be held by
non-Bermudians, but as an exempted company the Company may not, unless
authorized by its memorandum of association and with the consent of the Minister
of Finance, participate in certain business transactions, including: (1) the
acquisition and holding of land in Bermuda (except that required for its
business and held by way of lease or tenancy for terms of not more than 50 years
or with the Minister's consent, land by way of lease or tenancy agreement for a
term not exceeding 21 years in order to provide accommodation or recreational
facilities for its officers and employees); (2) the taking of mortgages on land
in Bermuda to secure an amount in excess of $50,000; (3) the acquisition of any
bonds or debentures secured on any land in Bermuda except bonds or debentures
issued by the Bermuda Government or a public authority; or (4) the carrying on
of business of any kind or type whatsoever in Bermuda, either alone or in
partnership, except the carrying on of business of the Company with persons
outside Bermuda or under a license granted by the Minister of Finance of
Bermuda.
TAXATION
The following discussion is a summary of certain anticipated tax
consequences of the ownership of Common Stock under Bermuda tax laws, Hong Kong
income tax laws, Macau income tax laws, and United States Federal income tax
laws. The
41
discussion does not deal with all possible tax consequences relating to the
Company's operations or to the ownership of Common Stock. In particular, the
discussion does not address the tax consequences under State, local and other
(e.g., non-Bermuda, non-Hong Kong, non-Macau and non-United States Federal) tax
laws. Accordingly, each owner should consult his tax advisor regarding the tax
consequences of the ownership of Common Stock. The discussion is based upon laws
and relevant interpretations thereof in effect as of the date of this report,
all of which are subject to change.
BERMUDA TAXATION
The Company is incorporated in Bermuda. At date of this filing, there
is no Bermuda income, corporation or profits tax, withholding tax, capital gains
tax, capital transfer tax, estate duty or inheritance tax payable by
shareholders of the Company other than shareholders ordinarily resident in
Bermuda. The Company is not subject to stamp or other similar duty on the issue,
transfer or redemption of its shares of Common Stock. Furthermore, the Company
has received from the Minister of Finance of Bermuda under The Exempted
Undertakings Tax Protection Act 1966, an assurance that, in the event that
Bermuda enacts any legislation imposing any tax computed on profits or income,
or computed on any capital assets, gain or appreciation, or any tax in the
nature of estate duty or inheritance tax, the imposition of such tax shall not
be applicable to the Company or any of its operations, or to the shares,
debentures or other obligations of the Company, until March 28, 2016. This
assurance does not, however, prevent the imposition of any such tax or duty on
such persons as are ordinarily resident in Bermuda and holding such shares,
debentures or obligations of the Company or on land in Bermuda leased or let to
the Company.
The United States does not have a comprehensive income tax treaty with
Bermuda.
HONG KONG TAXATION
Under the laws of Hong Kong, a holder of shares of a company is not
subject to Hong Kong tax on dividends paid with respect to such shares. Further,
there is no tax on capital gain realized upon the disposal of investments,
including investments in Common Stock, except that Hong Kong profits tax may be
chargeable on assessable profits, to the extent that they arise in or derive
from Hong Kong, arising on the sale or disposal of such investments where the
transactions are or form part of a trade, profession or business carried on in
Hong Kong. Hong Kong does not impose a withholding tax on dividends paid by the
Company or its subsidiaries. In addition, the Company will not be subject to
Hong Kong taxes as a result of its receipt of dividends from any of its
subsidiaries.
Hong Kong stamp duty is levied on the transfer of Common Stock of Hong
Kong companies at the rate of 0.02% on the fair consideration of the transfer.
For companies not incorporated in Hong Kong, no stamp duty is chargeable on the
transfer so long as the shareholders' registers are kept outside of Hong Kong.
Hong Kong also levies an estate duty on the estate of a person who
holds Common Stock in a Hong Kong company at the time of his death. No such duty
is levied where the company is not incorporated in Hong Kong and where its share
register is kept outside of Hong Kong.
MACAU TAXATION
Under the Macau Offshore Law, there is no tax to be levied on the
profits of a company generated from its offshore activities, defined as economic
activities dedicated to foreign markets, pursued exclusively with non-residents,
and by means of transactions in currencies other than the Macau pataca.
UNITED STATES FEDERAL INCOME TAXATION
General. The following is a general discussion of the material U.S.
federal income tax consequences to a U.S. Holder (as defined below) of the
ownership of Common Stock and does not address the U.S. tax treatment of certain
types of investors (e.g., individual retirement and other tax-deferred accounts,
life insurance companies, tax-exempt organizations, dealers in securities,
traders in securities that elect to mark to market, persons liable for
alternative minimum tax, persons that hold common stock as part of a straddle or
a hedging or conversion transaction, persons whose functional currency is not
the U.S. dollar and persons owning directly or indirectly (under constructive
ownership rules) 10% or more of the Common Stock), all of whom may be subject to
tax rules that differ significantly from those summarized below.
A "U.S. Holder" is a beneficial owner of Common Stock that is a U.S.
citizen or resident, a domestic corporation, an estate subject to U.S. federal
income taxation on a net income basis, or a trust if a court within the United
States is able to exercise
42
primary supervision over the administration of the trust and one or more United
States persons have the authority to control all substantial decisions of the
trust.
Dividends. Under the United States federal income tax laws, and subject
to the passive foreign investment company, or PFIC, foreign personal holding
company, or FPHC and controlled foreign corporation, or CFC rules discussed
below, if you are a U.S. holder, the gross amount of any dividend we pay out of
our current or accumulated earnings and profits (as determined for United States
federal income tax purposes) is subject to United States federal income
taxation. If you are a noncorporate U.S. holder, dividends paid to you in
taxable years beginning before January 1, 2009 that constitute qualified
dividend income will be taxable to you at a maximum tax rate of 15% provided
that you hold the shares for more than 60 days during the 121-day period
beginning 60 days before the ex-dividend date and meet other holding period
requirements. Dividends we pay with respect to the shares generally will be
qualified dividend income provided that, in the year that you receive the
dividend, the shares are readily tradable on an established securities market in
the United States.
Distributions in excess of the earnings and profits of the Company will
be treated, for U.S. federal income tax purposes, as a nontaxable return of
capital to the extent of the U.S. Holder's basis in the Common Stock and then as
gain from the sale or exchange of a capital asset. A corporate shareholder will
not be eligible for the dividends-received deduction.
Sale or Exchange of Common Stock. Subject to the PFIC, FPHC and CFC
rules discussed below, if you are a U.S. holder and you sell or otherwise
dispose of your shares, you will recognize capital gain or loss for United
States federal income tax purposes equal to the difference between the U.S.
dollar value of the amount that you realize and your tax basis, determined in
U.S. dollars, in your shares. Capital gain of a noncorporate U.S. holder that is
recognized before January 1, 2009 is generally taxed at a maximum rate of 15%
where the holder has a holding period greater than one year.
PFIC Rules. We believe that shares should not be treated as stock of a
PFIC for United States federal income tax purposes, but this conclusion is a
factual determination that is made annually and thus may be subject to change.
In general, if you are a U.S. holder, we will be a PFIC with respect to
you if for any taxable year in which you held our shares:
o at least 75% of our gross income for the taxable year is passive
income or
o at least 50% of the value, determined on the basis of a quarterly
average, of our assets is attributable to assets that produce or
are held for the production of passive income.
Passive income generally includes dividends, interest, royalties, rents
(other than certain rents and royalties derived in the active conduct of a trade
or business), annuities and gains from assets that produce passive income. If a
foreign corporation owns at least 25% by value of the stock of another
corporation, the foreign corporation is treated for purposes of the PFIC tests
as owning its proportionate share of the assets of the other corporation, and as
receiving directly its proportionate share of the other corporation's income.
If we are treated as a PFIC, and you are a U.S. holder that did not
make a mark-to-market election, as described below, you will be subject to
special rules with respect to:
o any gain you realize on the sale or other disposition of your
shares and
o any excess distribution that we make to you (generally, any
distributions to you during a single taxable year that are
greater than 125% of the average annual distributions received by
you in respect of the shares during the three preceding taxable
years or, if shorter, your holding period for the shares).
Under these rules:
o the gain or excess distribution will be allocated ratably over
your holding period for the shares,
o the amount allocated to the taxable year in which you realized
the gain or excess distribution will be taxed as ordinary income,
o the amount allocated to each prior year, with certain exceptions,
will be taxed at the highest tax rate in effect for that year,
and
o the interest charge generally applicable to underpayments of tax
will be imposed in respect of the tax attributable to each such
year.
43
If you own shares in a PFIC that are treated as marketable stock, you
may also make a mark-to-market election. If you make this election, you will not
be subject to the PFIC rules described above. Instead, in general, you will
include as ordinary income each year the excess, if any, of the fair market
value of your shares at the end of the taxable year over your adjusted basis in
your shares. These amounts of ordinary income will not be eligible for the
favorable tax rates applicable to qualified dividend income or long-term capital
gains. You will also be allowed to take an ordinary loss in respect of the
excess, if any, of the adjusted basis of your shares over their fair market
value at the end of the taxable year (but only to the extent of the net amount
of previously included income as a result of the mark-to-market election). Your
basis in the shares will be adjusted to reflect any such income or loss amounts.
In addition, notwithstanding any election you make with regard to the
shares, dividends that you receive from us will not constitute qualified
dividend income to you if we are a PFIC either in the taxable year of the
distribution or the preceding taxable year. Dividends that you receive that do
not constitute qualified dividend income are not eligible for taxation at the
15% maximum rate applicable to qualified dividend income. Instead, you must
include the gross amount of any such dividend paid by us out of our accumulated
earnings and profits (as determined for United States federal income tax
purposes) in your gross income, and it will be subject to tax at rates
applicable to ordinary income.
If you own shares during any year that we are a PFIC, you must file
Internal Revenue Service Form 8621.
Foreign Personal Holding Company Rules. We believe that we were not a
foreign personal holding company for United States tax purposes in 2004 on the
basis that last year we did not meet the asset test. In general, the tax
consequences to equity holders of a foreign personal holding company include the
following:
o if you are a U.S. holder, you will be taxed currently on certain
categories of our undistributed passive income,
o a U.S. person who acquires shares from a decedent will not have a
stepped-up basis in the shares but will have a tax basis equal to
the lower of the fair market value of the shares or the
decedent's basis in the shares, and
o if you are a U.S. holder, any dividends that we pay in a taxable
year that we are a foreign personal holding company will be
taxable to you at rates applicable to ordinary income rather than
the special rates applicable to qualified dividend income.
The American Job Creation Act of 2004 has repealed the foreign personal
holding company rules for tax years beginning after December 31, 2004 and the
years of U.S. shareholders whose tax year ends with or within the FHPC's tax
year.
CFC Rules. A foreign corporation generally is treated as a controlled
foreign corporation ("CFC") for U.S. federal income tax purposes if more than
50% of its stock is owned by certain 10% shareholders. The Company believes that
it is not currently a CFC because such shareholder test is not met. The
treatment of the Company as a CFC would not in any event adversely affect any
person who owns (directly or indirectly or by attribution) less than 10% of the
Common Stock.
Backup Withholding and Information Reporting. If you are a noncorporate
U.S. holder, information reporting requirements, on Internal Revenue Service
Form 1099, generally will apply to:
o dividend payments or other taxable distributions made to you
within the United States, and
o the payment of proceeds to you from the sale of shares effected
at a United States office of a broker.
Additionally, backup withholding may apply to such payments if you are
a noncorporate U.S. holder that:
o fails to provide an accurate taxpayer identification number,
o is notified by the Internal Revenue Service that you have failed
to report all interest and dividends required to be shown on your
federal income tax returns, or
o in certain circumstances, fails to comply with applicable
certification requirements.
If you are a non-U.S. holder, you are generally exempt from backup
withholding and information reporting requirements with respect to:
o dividend payments made to you outside the United States by us or
another non-United States payor and
o other dividend payments and the payment of the proceeds from the
sale of shares effected at a United States office of a broker, as
long as the income associated with such payments is otherwise
exempt from United States federal income tax, and:
44
o the payor or broker does not have actual knowledge or reason to
believe that you are a United States person and you have
furnished the payor or broker:
o an Internal Revenue Service Form W-8BEN or an acceptable
substitute form upon which you certify, under penalties of
perjury, that you are a non-United States person, or
o other documentation upon which it may rely to treat the
payments as made to a non-United States person in accordance
with U.S. Treasury regulations, or
o you otherwise establish an exemption.
Payment of the proceeds from the sale of shares or effected at a
foreign office of a broker generally will not be subject to information
reporting or backup withholding. However, a sale of shares or that is effected
at a foreign office of a broker will be subject to information reporting and
backup withholding if:
o the proceeds are transferred to an account maintained by you in
the United States,
o the payment of proceeds or the confirmation of the sale is mailed
to you at a United States address, or
o the sale has some other specified connection with the United
States as provided in U.S. Treasury regulations,
unless the broker does not have actual knowledge or reason to believe that you
are a United States person and the documentation requirements described above
are met or you otherwise establish an exemption.
In addition, a sale of shares or effected at a foreign office of a
broker will be subject to information reporting if the broker is:
o a United States person,
o a controlled foreign corporation for United States tax purposes,
o a foreign person 50% or more of whose gross income is effectively
connected with the conduct of a United States trade or business
for a specified three-year period, or
o a foreign partnership, if at any time during its tax year:
o one or more of its partners are "U.S. persons", as defined
in U.S. Treasury regulations, who in the aggregate hold more
than 50% of the income or capital interest in the
partnership, or
o such foreign partnership is engaged in the conduct of a
United States trade or business,
unless the broker does not have actual knowledge or reason to believe that you
are a United States person and the documentation requirements described above
are met or you otherwise establish an exemption. Backup withholding will apply
if the sale is subject to information reporting and the broker has actual
knowledge that you are a United States person.
You generally may obtain a refund of any amounts withheld under the
backup withholding rules that exceed your income tax liability by filing a
refund claim with the United States Internal Revenue Service.
DOCUMENTS ON DISPLAY
The documents concerning the Company which are referred to in this
report may be inspected on-line at websites maintained by the Securities and
Exchange Commission and by private companies offering access to the SEC
database. See, e.g., www.sec.gov.
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
MARKET RISK DISCLOSURES
The following discussion about the Company's market risk disclosures
contains forward-looking statements. Forward-looking statements are subject to
risks and uncertainties. Actual results could differ materially from those
discussed in the forward-looking statements. The Company is exposed to market
risk related to changes in interest rates and foreign currency exchange rates.
The Company does not have derivative financial instruments for hedging,
speculative, or trading purposes.
45
INTEREST RATE SENSITIVITY
The Company currently has no debt and borrowings that are sensitive to
interest rate fluctuation. Our exposure to market rate risk for changes in
interest rates relates primarily to our investment securities. We manage our
interest rate risk by maintaining an investment portfolio primarily consisting
of debt instruments of high credit quality and relatively short average
maturities. We maintain sufficient cash and cash equivalent balances such that
we are typically able to hold our investments to maturity. However, there is no
assurance that we won't decide to retire any of these instruments early or that
they will not be called by the issuer. As there can be no assurance as to how
long these investments will be held, we classify these securities as short-term
investments.
As of December 31, 2004, our cash equivalents and short-term
investments included $12.5 million of debt securities, consisting primarily of
money market funds and certificates of deposit. Notwithstanding our efforts to
manage interest rate risks, there can be no assurances that we will be
adequately protected against the risks associated with interest rate
fluctuations.
FOREIGN CURRENCY RISK
The Company has net monetary asset and liability balances in foreign
currencies other than the U.S. dollar, including the Pound Sterling, the
Canadian dollar, the Hong Kong dollar and the Chinese RMB. International
distribution and sales revenues usually are made by the Company's subsidiaries
in the United States, United Kingdom and Canada, and are denominated typically
in their local currency and the expenses incurred by these subsidiaries are also
denominated in the local currency. As a result, the operating results of the
Company are exposed to changes in exchange rates between the United States
Dollar and the Pound Sterling or the Canadian dollar. The Company does not
currently hedge its foreign exchange risk, which is not significant at this
time. The Company will continue to monitor its exposure to currency
fluctuations, and, where appropriate, may use financial hedging techniques in
the future to minimize the effect of these fluctuations. If the Chinese
Government were to trade its currency on the open market and the RMB were to
increase in value relative to the U.S. dollar, we would experience increased
factory and production costs, including labor and certain raw materials that
could have a material impact on the cost of our products. See also "Item 3. Key
Information - Risk Factors - Currency Valuation".
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
Not Applicable
PART II
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
None
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF
PROCEEDS
None or Not Applicable
ITEM 15. CONTROLS AND PROCEDURES
An evaluation was carried out under the supervision and with the
participation of the Company's management, including our Chief Executive Officer
and Chief Financial Officer, of the effectiveness of our disclosure controls and
procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of
1934) at December 31, 2004. Based upon that evaluation, the Chief Executive
Officer and Chief Financial Officer concluded that these disclosure controls and
procedures were effective. In addition, no change in our internal control over
financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange
Act of 1934) occurred during the fiscal year ended December 31, 2004 that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
In 2004, our board of directors determined that Theodore J. Eischeid
qualified as an audit committee financial expert and that Mr. Eischeid was
independent within the meaning of the listing standards applicable to Radica as
a Nasdaq National Market company. However, on January 31, 2005, Mr. Eischeid was
named President and Chief Operating Officer of Radica and resigned from the
Audit Committee. Timothy R. Busch has been named Chairman of the Audit Committee
in replacement of Mr. Eischeid. The board has determined that Mr. Busch is an
independent director within the meaning of such listing standards but has made
no determination that Mr. Busch would qualify as an audit committee financial
expert. However, the board has determined that Mr. Busch meets the financial
sophistication requirement of such listing standards.
46
Therefore, the board of directors has determined that the registrant
does not have an audit committee financial expert serving on its Audit Committee
at the present time. This is due to the inability of the registrant to replace
Mr. Eischeid as audit committee financial expert in the short time frame
associated with his hiring as an officer. The registrant is hopeful that it will
be able to add a new member to the Audit Committee in connection with its annual
general meeting in May 2005 and that such person will be both independent and an
audit committee financial expert as defined in applicable rules.
ITEM 16B. CODE OF ETHICS
The Company has adopted a Code of Ethics that is applicable to all its
directors, senior management and employees. The Code of Ethics contains written
standards that are reasonably designed to deter wrongdoing and to promote honest
and ethical conduct and the other standards applicable to public companies. The
Company's Code of Ethics is maintained on the Company's internet website at
www.radicagames.com.
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
(US$ in thousands) Audit fees Audit-related fees Tax fees Total
---------- ------------------ -------- -----
2003 $ 250 $ 5 $ 137 $ 392
2004 283 4 91 378
AUDIT-RELATED FEES
Services provided primarily consist of statutory audit of pension
contributions to the Company's defined contribution plan.
TAX FEES
Services provided primarily consist of corporate tax advisory services
and preparation of corporate income tax returns.
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
None.
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED
PURCHASERS
None.
PART III
ITEM 17. FINANCIAL STATEMENTS
Not Applicable
ITEM 18. FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS PAGE
Report of Independent Registered Public Accounting Firm F-1
Consolidated Balance Sheets F-2
Consolidated Statements of Operations F-3
Consolidated Statements of Shareholders' Equity and Comprehensive Income (Loss) F-4
Consolidated Statements of Cash Flows F-5
Notes to the Consolidated Financial Statements F-6
ITEM 19. EXHIBITS
The exhibit index appears at page I-2 of this report, immediately
following the signature page.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Radica Games Limited:
We have audited the accompanying consolidated balance sheets of Radica Games
Limited and subsidiaries as of December 31, 2004 and 2003, and the related
consolidated statements of operations, shareholders' equity and comprehensive
income (loss), and cash flows for each of the years in the three-year period
ended December 31, 2004. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Radica Games Limited
and subsidiaries as of December 31, 2004 and 2003, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2004, in conformity with United States generally accepted
accounting principles.
/s/ KPMG
KPMG
HONG KONG
February 25, 2005, except for
footnote 16, which is as of March 17, 2005
F-1
RADICA GAMES LIMITED
CONSOLIDATED BALANCE SHEETS
December 31, 2004 and 2003
(US dollars in thousands, except share data) 2004 2003
-------- --------
ASSETS
Current assets:
Cash and cash equivalents $ 27,614 $ 13,944
Investment securities 12,456 28,009
Accounts receivable, net of allowances for doubtful accounts
of $148 ($251 in 2003) 18,359 15,360
Inventories 26,818 15,503
Prepaid expenses and other current assets 3,374 2,748
Income taxes receivable 168 1,404
Deferred income taxes and charges 1,850 1,706
-------- --------
Total current assets 90,639 78,674
-------- --------
Property, plant and equipment, net 11,480 11,908
Goodwill 6,015 9,551
Other assets 854 875
Deferred income taxes 953 1,206
-------- --------
Total assets $ 109,941 $ 102,214
-------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 10,770 $ 6,350
Accrued payroll and employee benefits 1,486 1,353
Accrued warranty expenses 1,070 1,040
Other accrued liabilities 5,251 3,976
Income taxes payable 287 339
-------- --------
Total current liabilities 18,864 13,058
-------- --------
Total liabilities 18,864 13,058
-------- --------
Shareholders' equity:
Common stock
par value $0.01 each, 100,000,000 shares authorized,
18,738,112 shares issued and outstanding (18,225,204 in 2003) 187 182
Additional paid-in capital 4,610 3,517
Retained earnings 85,909 85,437
Accumulated other comprehensive income 371 20
-------- --------
Total shareholders' equity 91,077 89,156
-------- --------
Commitments and contingencies
Total liabilities and shareholders' equity $ 109,941 $ 102,214
======== ========
See accompanying notes to the consolidated financial statements.
F-2
RADICA GAMES LIMITED
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended December 31, 2004, 2003 and 2002
(US dollars in thousands, 2004 2003* 2002*
except per share data) ---------- ---------- ----------
Revenues:
Net sales $ 123,399 $ 105,200 $ 124,646
Cost of goods sold
(exclusive of items shown separately below) (81,576) (65,350) (78,138)
---------- ---------- ----------
Gross profit 41,823 39,850 46,508
---------- ---------- ----------
Operating expenses:
Selling, general and administrative expenses (30,071) (25,000) (27,038)
Research and development (4,164) (3,895) (4,094)
Depreciation (1,693) (2,033) (2,438)
Amortization of goodwill and intangible assets - - (420)
Impairment of goodwill (3,536) - -
Restructuring charge - (87) -
---------- ---------- ----------
Total operating expenses (39,464) (31,015) (33,990)
---------- ---------- ----------
Operating income 2,359 8,835 12,518
Other income 754 317 306
Foreign currency gain, net 417 178 1,744
Interest income 765 344 253
Interest expense - (49) (218)
---------- ---------- ----------
Income before income taxes 4,295 9,625 14,603
(Provision) credit for income taxes (839) 2,866 (2,669)
---------- ---------- ----------
Net income $ 3,456 $ 12,491 $ 11,934
========== ========== ==========
Net income per share:
Basic $ 0.19 $ 0.69 $ 0.67
========== ========== ==========
Diluted $ 0.18 $ 0.66 $ 0.65
========== ========== ==========
Weighted average number of common and
common equivalent shares:
Basic 18,653,471 18,016,789 17,725,879
========== ========== ==========
Diluted 19,525,757 19,059,974 18,335,827
========== ========== ==========
Cash dividends paid per share
(4 cents declared and paid for each
quarter ended March 31, June 30,
September 30, and December 31, 2004) $ 0.16 $ - $ -
========== ========== ==========
* Reclassified to conform with 2004 presentation.
See accompanying notes to the consolidated financial statements.
F-3
RADICA GAMES LIMITED
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
AND COMPREHENSIVE INCOME (LOSS)
Years ended December 31, 2004, 2003 and 2002
(US dollars in thousands) Common stock Accumulated
----------------------- Additional Warrants to other Total
Number paid-in acquire Retained comprehensive shareholders'
of shares Amount capital common stock earnings income (loss) equity
--------- ------------ ---------- ------------ -------- -------------- ------------
Balance at December 31, 2001 17,646,740 $ 176 $ 1,549 $ 445 $ 61,012 $ (130) $ 63,052
Issuance of stock 4,945 1 20 - - - 21
Stock options exercised, inclusive 144,446 1 306 - - - 307
of nil tax
Expiration of stock warrants - - 445 (445) - - -
Net income - - - - 11,934 - 11,934
Foreign currency translation, - - - - - (678) (678)
net of nil tax
---------- ----- ------- ----- -------- ------ --------
Balance at December 31, 2002 17,796,131 $ 178 $ 2,320 $ - $ 72,946 $ (808) $ 74,636
Issuance of stock 3,073 - 20 - - - 20
Stock options exercised, inclusive 426,000 4 1,177 - - - 1,181
of $44 tax benefit
Net income - - - - 12,491 - 12,491
Unrealized loss on investment - - - - - (46) (46)
securities available-for-sale,
net of nil tax
Foreign currency translation, - - - - - 874 874
net of nil tax
---------- ----- ------- ----- -------- ------ --------
Balance at December 31, 2003 18,225,204 $ 182 $ 3,517 $ - $ 85,437 $ 20 $ 89,156
Issuance of stock 2,272 - 21 - - - 21
Stock options exercised, inclusive 510,636 5 1,072 - - - 1,077
of nil tax
Dividends paid - - - - (2,984) - (2,984)
Net income - - - - 3,456 - 3,456
Unrealized loss on investment - - - - - (90) (90)
securities available-for-sale,
net of nil tax
Foreign currency translation, - - - - - 441 441
net of nil tax
---------- ----- ------- ----- -------- ------ --------
Balance at December 31, 2004 18,738,112 $ 187 $ 4,610 $ - $ 85,909 $ 371 $ 91,077
========== ===== ======= ===== ======== ====== ========
The comprehensive income (loss) of the Company, which represents the aggregate
of the net income, unrealized loss on investment securities available for sale
and the foreign currency translation adjustments, was $3,807, $13,319 and
$11,256 for the years ended December 31, 2004, 2003 and 2002, respectively.
See accompanying notes to the consolidated financial statements.
F-4
RADICA GAMES LIMITED
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2004, 2003 and 2002
(US dollars in thousands) 2004 2003* 2002
------- ------- -------
Cash flow from operating activities:
Net income $ 3,456 $ 12,491 $ 11,934
Adjustments to reconcile net income to net cash
provided by operating activities:
Deferred income taxes 109 (2,947) 2,134
Depreciation 1,693 2,033 2,438
Amortization - - 420
Impairment of goodwill 3,536 - -
(Gain) loss on disposal and write off of property, plant and equipment (19) 102 57
Compensatory elements of stock issuances 21 20 21
Gain on trading securities (108) - -
Unrealized gain on trading securities (1) (55) -
Proceeds from sale of trading securities 15,572 - -
Purchases of trading securities - (18,000) -
Changes in current assets and liabilities:
Increase in accounts receivable (2,999) (221) (1,271)
(Increase) decrease in inventories (11,315) 4,882 (3,206)
(Increase) decrease in prepaid expenses and other current assets (626) (1,074) 609
Increase (decrease) in accounts payable 4,420 (1,624) (1,227)
Increase (decrease) in accrued payroll and employee benefits 133 (1,400) 1,810
Increase in accrued warranty expenses 30 - 140
Increase (decrease) in other accrued liabilities 1,275 (1,864) (1,645)
Increase (decrease) in net income taxes receivable 1,184 (443) (198)
------ ------- ------
Net cash provided by (used in) operating activities 16,361 (8,100) 12,016
------ ------- ------
Cash flow from investing activities:
Purchases of available-for-sale securities - (10,000) -
Proceeds from sale of property, plant and equipment 1,292 955 201
Purchase of property, plant and equipment (2,517) (943) (1,316)
------ ------- ------
Net cash used in investing activities (1,225) (9,988) (1,115)
------ ------- ------
Cash flow from financing activities:
Funds from stock options exercised 1,077 1,137 307
Dividends paid (2,984) - -
Decrease in short-term borrowings - (846) -
Repayment of long-term debt - (1,825) (3,648)
------ ------- ------
Net cash used in financing activities (1,907) (1,534) (3,341)
------ ------- ------
Effect of currency exchange rate change 441 874 (678)
------ ------- ------
Net increase (decrease) in cash and cash equivalents 13,670 (18,748) 6,882
------ ------- ------
Cash and cash equivalents:
Beginning of year 13,944 32,692 25,810
------ ------- ------
End of year 27,614 $ 13,944 $ 32,692
====== ======= ======
Supplementary disclosures of cash flow information:
Interest paid $ - $ 50 $ 220
Income taxes paid 1,084 538 1,314
* Reclassified to conform with 2004 presentation.
See accompanying notes to the consolidated financial statements.
F-5
RADICA GAMES LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002)
(US dollars in thousands)
1. ORGANIZATION AND BASIS OF FINANCIAL STATEMENTS
Radica Games Limited (the "Company") manufactures and markets a diverse
line of electronic entertainment products covering multiple product lines -
casino and heritage electronic games, mechanical slot banks, youth
electronic games, tabletop games, Play TV(R) games, Girl Tech(R) and
Barbie(TM) girls electronic lines, the Twinkleberries(TM) and Cupcakes(R)
doll lines, the Nitro Battlerz(TM) and Big Trouble(TM) remote control car
products, the Street Muttz(TM) plush line and video game accessories sold
under the Gamester(R) brand. The Company is headquartered in Hong Kong and
manufactures its products in its factory in Southern China. In 1994 the
Company went public when its shares began trading on the NASDAQ exchange.
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All significant intercompany transactions and
balances have been eliminated on consolidation. The accompanying
consolidated financial statements have been prepared in accordance with
United States generally accepted accounting principles and are presented in
US dollars.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, cash in bank accounts,
interest-bearing savings accounts, and time certificates with an initial
term of less than three months. For purposes of the consolidated statements
of cash flows, the Company considers all highly liquid debt instruments
with original maturities of three months or less to be cash equivalents.
Investment Securities
Investment securities at December 31, 2004 consist of certificates of
deposits and money-market mutual fund investments. The Company classifies
its investment securities in one of three categories: trading, available
for sale, or held to maturity. Trading securities are bought and held
principally for the purpose of selling them in the near term.
Held-to-maturity debt securities are those securities in which the Company
has the ability and intent to hold the security until maturity. All
securities not included in trading or held to maturity are classified as
available for sale.
Trading and available-for-sale securities are recorded at fair value.
Unrealized holding gains and losses on trading securities are included in
earnings. Unrealized holding gains and losses, net of the related tax
effect, on available-for-sale securities are excluded from earnings and are
reported as a separate component of other comprehensive income until
realized. Realized gains and losses from the sale of available-for-sale
securities are determined on a specific-identification basis.
A decline in the fair value of an investment security below cost that is
deemed to be other-than-temporary results in a reduction in carrying amount
to fair value. The impairment is charged to earnings and a new cost basis
for the security is established. In determining whether impairment is
other-than-temporary, the Company considers whether it has the ability and
intent to hold the investment for a reasonable period of time sufficient
for a forecasted recovery of fair value up to (or beyond) the cost of
investment and considers whether evidence indicating the cost of the
investment is recoverable within a reasonable period of time outweighs
evidence to the contrary. Evidence considered in this assessment includes
the cause of the decline, the severity and duration of the decline, changes
in value subsequent to year-end and forecast performance of the investment.
Premiums and discounts are amortized or accreted over the life of the
related held-to-maturity or available-for-sale security as an adjustment to
yield using the effective-interest method. Dividend and interest income are
recognized when earned.
F-6
RADICA GAMES LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002)
(US dollars in thousands)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Trade Receivables
Trade accounts receivable 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 have any off-balance-sheet credit exposure
related to its customers.
Inventories
Inventories are stated at the lower of cost, determined by the weighted
average method, or market. Write-downs are provided for potentially slow
moving and obsolete inventory or inventory of which estimated net
realizable value is below its carrying value based on management's analysis
of inventory levels and future expected sales.
Depreciation and Amortization of Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation of plant and
equipment is provided on the straight-line method over the following
estimated useful lives of the assets:
Plant equipment and machinery 4 to 5 years
Furniture and equipment 3 to 7 years
All of the Company's land and building holdings in the PRC and Hong Kong
are considered to be leasehold property and are amortized on a
straight-line basis over the term of the lease, ranging from 30 to 50
years. The buildings on the land are also depreciated over the same period.
Costs of leasehold improvements are amortized over the economic life of the
asset (ranging from 3 to 5 years) or the term of the lease, whichever is
shorter. Upon sale or retirement of property, plant and equipment, the
costs and related accumulated depreciation or amortization are eliminated
and any resulting gain or loss is included in the statement of operations.
The Company's real property in Hong Kong consists of purchased office space
in an office building that was built on land that is owned by the Hong Kong
government. When the Company purchased the office space, there was no
separate amount paid to the government for land use rights because the land
continues to be owned by the Hong Kong government. Also, there is no
ongoing obligation to the government to pay any land use right fee. In Hong
Kong, substantially all properties or buildings are built on land owned by
the Hong Kong Government for which a developer or owner is required to pay
a land premium fee to the government for the land use rights. This fee is
paid by the developer at the time the developer commences the construction
of the building. The developer is solely responsible for the payment.
Properties, including office space, in Hong Kong are purchased and sold at
their current market value with no additional lease payment required to be
made. The Company amortizes its properties in Hong Kong over a fifty-year
period as all leases are set at fifty years since 1997, when Hong Kong was
handed back to the Chinese government.
The Company expenses all mold costs in the year of purchase or, for
internally produced molds, in the year of construction.
F-7
RADICA GAMES LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002)
(US dollars in thousands)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Goodwill
Goodwill represents the excess of costs over fair value of assets of
businesses acquired. The Company follows the provisions of Statement of
Financial Accounting Standards (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 or if
certain circumstances indicate a possible impairment may exist, in
accordance with the provisions of SFAS No. 142. The Company evaluates the
recoverability of goodwill and indefinite lived intangible assets using a
two-step impairment test approach at the reporting unit level at the end of
each year. In the first step, the fair value of the reporting unit is
compared to its carrying value including goodwill. The fair value of the
reporting unit is determined based upon a combination of multiple of
earnings, discounted future cash flows and the projected profitability of
the market in which it operates. In the case that the fair value of the
reporting unit is less than the carrying value, a second step is performed
which compares the implied fair value of the reporting unit's goodwill to
the book value of the goodwill. In determining the implied fair value of
the reporting unit goodwill, the fair values of the tangible net assets and
recognized and unrecognized intangible assets is deducted from the fair
value of the reporting unit. If the implied fair value of reporting unit
goodwill is lower than its carrying amount, goodwill is impaired and is
written down to its implied fair value.
In connection with SFAS No. 142's transitional goodwill impairment
evaluation in 2002, the Company performed the required transitional
impairment review of goodwill as of January 1, 2002. For each of the
reporting units, the estimated fair value of the reporting unit exceeded
their carrying value and therefore no writedown of goodwill was required.
Impairment of Long-lived Assets
The Company evaluates the recoverability of long-lived assets 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, 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 amount by which the carrying amount of the asset exceeds the fair
value of the asset which is the amount at which the asset can be bought and
sold in a current transaction between willing parties.
Revenue Recognition
Revenue from product sales is recognized at the time of shipment and
passage of title, which is in accordance with the terms of the sale, FOB
shipping point. This represents the point at which the customer takes
ownership and assumes risk of loss. Prior to 2003, the Company had
consignment agreements with certain European distributors and recorded
these shipments as revenues upon confirmation of sell-through by the
distributor.
The Company records reductions to gross revenue for customer incentive
programs, such as discounts to retailers and volume-based cash incentives.
Volume-based cash incentives are determined based on the sale agreement
with each individual customer. The Company also records provisions against
the gross revenue for estimated product returns and allowances in the
period when the related revenue is recorded. These estimates are based on
factors that include, but are not limited to, historical sales returns,
analyses of credit memo activities and current known trends. Should these
actual product returns and allowances exceed those estimates, additional
reductions to the Company's revenue would result.
F-8
RADICA GAMES LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002)
(US dollars in thousands)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Shipping and Handling Costs
The Company records costs incurred for the shipping and handling of the
products as cost of goods sold in the consolidated statement of operations.
Warranty
The Company provides reserves for the estimated cost of product warranties
at the time revenue is recognized. The estimated cost of warranty
obligations is based on historical experience of known product failure
rates and the terms of product warranties.
Advertising
Advertising costs are expensed as incurred. The cost of media related
advertising is incurred by the Company at the earlier of the first time
that the advertising takes place or the invoice date for the media
purchase. In addition, the Company offers discounts to customers who
advertise Radica products through cooperative advertising programs. The
cooperative advertising costs associated with customer benefit programs are
accrued as the related revenues are recognized. The cooperative advertising
costs are characterized as a cost if the Company receives a benefit that is
sufficiently separable from the retailer's purchase of the Company's
products and the fair value of the cooperative advertising benefit is
determinable and greater than or equal to the cooperative advertising
allowance provided to the retailer. Cooperative advertising costs not
meeting these criteria are recorded as reductions in revenue. Advertising
and cooperative advertising expenses are recorded as selling, general and
administrative expenses in the consolidated statement of operations and
amounted to approximately $10,620, $7,614 and $7,350 for the years ended
December 31, 2004, 2003 and 2002, respectively.
Research and Development
Research and development costs are expensed as incurred. Research and
development costs amounted to $4,164, $3,895, and $4,094 for the years
ended December 31, 2004, 2003 and 2002, respectively.
Foreign Currency Translation
Asset and liabilities of foreign subsidiaries whose functional currency is
not the US dollars are translated into US dollars using the exchange rate
on the balance sheet date. Revenues and expenses are translated at average
rates prevailing during the year. The gains and losses resulting from
translation of financial statements of foreign subsidiaries are recorded as
a separate component of accumulated other comprehensive income (loss)
within shareholders' equity. Cumulative translation adjustments are
recognized as income or expense upon disposal or liquidation of a foreign
subsidiary.
Post-retirement and Post-employment Benefits
The Company does not have any post-retirement or post-employment benefit
plans. The Company makes contributions to certain defined contribution
arrangements with groups of employees. The Company's contributions and any
related costs and are expensed as incurred.
F-9
RADICA GAMES LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002)
(US dollars in thousands)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Income Taxes
Income taxes are accounted for under the asset and liability method for
financial accounting. Deferred income tax liabilities and assets are
recorded to reflect the tax consequences in future years of differences
between the taxable bases of assets and liabilities and the respective
financial statement carrying amounts at each period end and operating loss
carryforwards using enacted tax rates expected to apply in the year
temporary differences are expected to be recovered or settled. A valuation
allowance is recognized for any portion of the deferred tax asset for which
realization is not deemed to be more likely than not. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized
in income in the period that includes the enactment date.
Stock-based Compensation
The Company applies the intrinsic-value-based method of accounting
prescribed by Accounting Principles Board (APB) Opinion No. 25, Accounting
for Stock Issued to Employees, and related interpretations including
Financial Accounting Standards Board (FASB) Interpretation No. 44,
Accounting for Certain Transactions involving Stock Compensation, an
interpretation of APB Opinion No. 25, issued in March 2000, to account for
its fixed-plan stock options. Under this method, compensation expense is
recorded on the date of grant only if the then market price of the
underlying stock exceeded the exercise price. SFAS No. 123, Accounting for
Stock-based Compensation, established accounting and disclosure
requirements using a fair-value-based method of accounting for stock-based
employee compensation plans. As allowed by SFAS No. 123, the Company has
elected to continue to apply the intrinsic-value-based method of accounting
described above, and has adopted only the disclosure requirements of SFAS
No. 123 (See Note 11). The following table illustrates the effect on net
income if the fair value based method had been applied to all outstanding
and unvested awards in the period:
2004 2003 2002
-------- -------- --------
Net income as reported $ 3,456 $ 12,491 $ 11,934
Deduct total stock-based employee compensation
expense determined under fair-value-based method
for all rewards, net of tax (551) (496) (746)
-------- -------- --------
Pro forma net income $ 2,905 $ 11,995 $ 11,188
======== ======== ========
Earnings Per Share
Basic earnings per share is based on the weighted average number of shares
of common stock, and with respect to diluted earnings per share, also
includes the effect of all dilutive potential common stock outstanding.
Dilutive potential common stock results from dilutive stock options and
warrants. The effect of such dilutive potential common stock on earnings
per share is computed using the treasury stock method. All potentially
dilutive securities are excluded from the computation in loss making
periods as their inclusion would be anti-dilutive.
Comprehensive Income
Other comprehensive income refers to revenues, expenses, gains and losses
that under United States generally accepted accounting principles are
included in comprehensive income but are excluded from net income as these
amounts are recorded as a component of shareholders' equity. The Company's
other comprehensive income represented foreign currency translation
adjustments and unrealized gains and losses on available-for-sale
securities, net of tax.
F-10
RADICA GAMES LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002)
(US dollars in thousands)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Use of Estimates
The preparation of financial statements in conformity with United States
generally accepted accounting principles requires management to make
estimates and assumptions that affect reported amounts of certain assets,
liabilities, revenues and expenses and the disclosure of contingent assets
and liabilities as of and during the reporting periods. Significant items
subject to such estimates and assumptions include the carrying amount of
goodwill, property, plant and equipment and inventories, allowances for
doubtful receivables and deferred income tax assets and reserves for
warranties, product returns and customer sale incentives. Actual results
may differ from such estimates. Differences from those estimates are
recorded in the period they become known.
Commitments and Contingencies
Liabilities for loss contingencies arising from claims, assessments,
litigation, fines and other sources are recorded when it is probable that a
liability has been incurred and the amount of the assessment can be
reasonably estimated.
Recently Issued Accounting Standards
In November 2004, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 151, Inventory Costs
-- An Amendment of ARB No. 43, Chapter 4 ("SFAS 151"). SFAS 151 clarifies
that abnormal amounts of idle facility expense, freight, handling costs and
spoilage should be expensed as incurred and not included in overhead.
Further, SFAS 151 requires that allocation of fixed and production
facilities overhead to conversion costs should be based on normal capacity
of the production facilities. The provisions in SFAS 151 are effective for
inventory costs incurred during fiscal years beginning after June 15, 2005.
The Company does not believe that the adoption of SFAS 151 will have a
significant effect on its consolidated financial statements.
In November 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary
Assets -- An Amendment of APB Opinion No. 29 ("SFAS 153"). The provisions
of this statement are effective for non monetary asset exchanges occurring
in fiscal periods beginning after June 15, 2005. This statement eliminates
the exception to fair value for exchanges of similar productive assets and
replaces it with a general exception for exchange transactions that do not
have commercial substance -- that is, transactions that are not expected to
result in significant changes in the cash flows of the reporting entity.
The Company does not believe that the adoption of SFAS 153 will have a
significant effect on its financial statements.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based
Payment. The new pronouncement replaces the existing requirements under
SFAS No. 123 and APB 25. According to SFAS No. 123(R), all forms of
share-based payments to employees, including employee stock options and
employee stock purchase plans, would be treated the same as any other form
of compensation by recognizing the related cost in the statement of
operations. This pronouncement eliminates the ability to account for
stock-based compensation transactions using APB No. 25 and generally would
require that such transactions be accounted for using a fair-value based
method. For the Company, SFAS No. 123(R) is effective for awards and stock
options granted, modified or settled in cash in interim or annual periods
beginning after June 15, 2005, which for the Company will be its third
quarter ending September 30, 2005. SFAS No. 123(R) provides transition
alternatives for public companies to restate prior interim periods or prior
years. The Company is in the process of evaluating the impact of this
standard on its financial statements and will adopt SFAS 123(R) on July 1,
2005.
F-11
RADICA GAMES LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002)
(US dollars in thousands)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Reclassifications
Certain reclassifications have been made to prior year amounts to conform
to the current year's presentation. The purchase of trading investments in
2003 was reclassified from investing activities to operating activities in
order to conform to the provisions of SFAS No. 115. The reclassification
resulted in a reduction of $18,000 in the amount of net cash flow provided
by operating activities from $9,900 (as originally reported) to net cash
flow used in operating activities of $8,100 and a corresponding change in
the amount of net cash flows used in investing activities from $27,988 (as
originally reported) to net cash flows used in investing activities of
$9,988.
3. INVESTMENT SECURITIES
At December 31, 2004, investment securities represent municipal fixed
income and money market funds with readily determinable fair market values
and original maturities in excess of three months. Investments classified
as available for sale with maturities beyond one year have been classified
as short-term based on their highly liquid nature and because it can be
sold at anytime and the Company intends to liquidate the investments within
the year from the balance sheet date.
Management classifies investments in marketable securities at the time of
purchase and reevaluates such classification at each balance sheet date. At
December 31, 2004, investments in certificates of deposits of $9,864 were
classified as "available-for-sale" and accordingly are reported at fair
value with unrealized losses of approximately $136 reported as a component
of accumulated other comprehensive income (loss) in shareholders' equity.
The fair value of these investments is based on market information
available to management as of the balance sheet date presented. Unrealized
losses are charged against income when a decline in the fair market value
of an individual security is determined to be other than temporary.
Realized gains and losses on investments are included in other income.
The amortized cost, gross unrealized holding gains, gross unrealized
holding losses, and fair value of available-for-sale securities at December
31, 2004 and 2003 were as follows:
Gross Gross
Amortized unrealized unrealized
cost holding gains holding losses Fair value
----------- ------------- -------------- -----------
At December 31, 2004
Available for sale:
Certificates of deposits $10,000 $-- $ (136) $ 9,864
At December 31, 2003
Available for sale:
Certificates of deposits $10,000 $-- $ (46) $ 9,954
F-12
RADICA GAMES LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002)
(US dollars in thousands)
3. INVESTMENT SECURITIES (Continued)
The following table shows the gross unrealized losses and fair value of the
Company's available for sale investments with unrealized losses that are
not deemed to be other-than-temporarily impaired, aggregated by investment
category and length of time that individual securities have been in a
continuous unrealized loss position, at December 31, 2004:
Less than 12 months 12 months or greater Total
--------------------- ---------------------- -----------------------
Unrealized Unrealized Unrealized
Fair value losses Fair value losses Fair value losses
---------- ------ ---------- ------ ---------- ------
Certificate of deposits $ -- $ -- $9,864 $ (136) $9,864 $ (136)
The unrealized losses on the investments in certificates of deposits were
caused by interest rate changes. The fair value amount above reflects the
market price provided by the issuer of the security, assuming an early sale
was to occur. The contractual terms of these securities do not permit the
issuer to settle the securities at a price less than amortized cost of the
investment. Because the Company has the ability and intent to hold these
investments until a market price recovery or maturity, these securities are
not considered other-than-temporarily impaired.
The Company also maintains an investment portfolio of $2,592 and $18,055
portfolio of investment classified as trading securities as of December 31,
2004 and 2003, respectively. These investments represent primarily
municipal fixed income and money market funds subject to price volatility
associated with any interest-bearing instrument.
Net realized investment gains and net changes in unrealized gains (losses)
on investments for the years ended December 31, 2004, 2003 and 2002 are
summarized as follows:
2004 2003 2002
----- ----- -----
Net realized investment gains
Available-for-sale $ -- $ -- $ --
Trading 108 -- --
----- ----- -----
$ 108 $-- $ --
Net changes in unrealized gains (losses) on investment
Available-for-sale $ (90) $ (46) $ --
Trading 1 55 --
----- ----- -----
$ (89) $ 9 $ --
Net realized investment gains and changes
in unrealized gains (losses) on investment $ 19 $ 9 $ --
===== ===== =====
F-13
RADICA GAMES LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002)
(US dollars in thousands)
3. INVESTMENT SECURITIES (Continued)
Following is a summary of the disposition and purchases of investment
securities for the years ended December 31, 2004, 2003 and 2002:
Gross realized
----------------------- Net realized
Amount Gains Losses Gain
-------- --------- -------- ------------
Sales:
2004 - Available-for-sale $ -- $ -- $- $ --
Trading 15,572 108 - 108
2003 - Available-for-sale $ -- $ -- $- $ --
Trading -- -- - --
2002 - Available-for-sale $ -- $ -- $- $ --
Trading -- -- - --
Purchases:
2004 - Available-for-sale $ -- $ -- $- $ --
Trading -- -- - --
2003 - Available-for-sale $10,000 $ -- $- $ --
Trading 18,000 -- - --
2002 - Available-for-sale $ -- $ -- $- $ --
Trading -- -- - --
F-14
RADICA GAMES LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002)
(US dollars in thousands)
4. INVENTORIES
Inventories by major categories, net of provisions are summarized as
follows:
2004 2003
------------ -----------
Raw materials $ 4,017 $ 1,554
Work in progress 6,830 2,758
Finished goods 15,971 11,191
------------ -----------
$ 26,818 $ 15,503
============ ===========
5. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following:
2004 2003
---------- ----------
Land and buildings $ 9,431 $ 10,953
Plant and machinery 8,142 7,754
Furniture and equipment 8,196 7,514
Leasehold improvements 3,067 2,943
Construction-in-progress 265 --
---------- ----------
Total $ 29,101 $ 29,164
Less: Accumulated depreciation and amortization (17,621) (17,256)
---------- ----------
Total, net $ 11,480 $ 11,908
========== ==========
In November 2002, the AICPA International Practices Task Force (the "Task
Force") discussed an issue relating to accounting for land use rights in
the People's Republic of China ("PRC"). The Task Force view is that PRC
land use rights are considered operating leases, as they are long-term
leases of lands, which do not transfer title. As of December 31, 2004 and
2003, other assets of $854 and $875 respectively, comprise of prepaid land
use rights. The prepaid land use rights have a term of 50 years.
F-15
RADICA GAMES LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002)
(US dollars in thousands)
6. GOODWILL
At December 31, 2004 and 2003, the Company's cost in excess of fair value
of net assets purchased (goodwill) related primarily to the 1999
acquisition of Leda Media Products Limited, now called Radica UK Limited
("Radica UK"). On June 24, 1999, the Company purchased Radica UK for
approximately $15,970. During the quarter ended June 30, 2000, upon
claiming certain breaches of warranty at Radica UK, the Company and the
ex-shareholders of Radica UK mutually agreed to cancel certain loan notes
such that the purchase price was reduced by $1,399. The Company recorded
goodwill of approximately $12,069 resulting from the adjusted purchase
price. The goodwill was allocated to the VGA reporting unit and is not tax
deductible. Accumulated amortization related to goodwill of $2,518 arose
prior to the adoption of SFAS No. 142.
Effective January 1, 2002, the Company adopted SFAS No. 142, Goodwill and
Other Intangible Assets. Upon implementation of SFAS 142, and annually
thereafter, the Company tested goodwill for impairment. The goodwill
arising from the purchase of Radica UK was allocated to the Video Games
Accessories ("VGA") reporting unit and the Company has undertaken goodwill
impairment testing as follows to determine whether the goodwill was
impaired and the extent of such impairment.
The methods used in the Company's testing of goodwill impairment were as
follows: 1) the Company determined the fair market value of the VGA segment
by estimating the expected discounted future cash flows of the VGA
reporting unit. In estimating the discounted future cash flows, the Company
followed FASB Concepts Statement No. 7, Using Cash Flow Information and
Present Value in Accounting Measurements, by taking into account the
Company's expectations about possible variations in the amount or timing of
those cash flows, the risk-free rate of interest and the discounted
interest rate. 2) The Company then compared the estimated fair value of the
VGA reporting unit with the carrying value of the VGA reporting unit,
including goodwill. 3) Since the fair value of the VGA reporting unit was
less than the carrying value, the second step was performed which compared
the implied fair value of the VGA reporting unit's goodwill to the book
value of the goodwill. After performing this annual evaluation, the Company
recognized an impairment charge related to goodwill of $3,536 for the year
ended December 31, 2004. The impairment charge recorded at December 31,
2004 adjusted the carrying value of the VGA reporting unit's goodwill to
its implied fair value. The reason for the impairment was primarily the
result of lower sales forecasts for fiscal years 2005 through 2009. The
adjustment to projected annual sales from prior year was based on the
Company's current strategy of concentrating on the innovative, higher
margin sector of the market. This improved the projected gross margins and
operating margins as a percentage of sales, but decreased the total
operating margin and cash flows. Management believes that the revised
forecast portrays a more accurate picture of the Company's future cash
flows and that the new strategy limits the large closeout returns and price
pressures that made the VGA business unprofitable from 1999 through 2003.
F-16
RADICA GAMES LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002)
(US dollars in thousands)
7. OTHER ACCRUED LIABILITIES
Other accrued liabilities consist of the following:
2004 2003
------ ------
Accrued advertising expenses $ 910 $1,091
Accrued license and royalty fees 1,963 1,062
Commissions payable 93 166
Other accrued liabilities 2,285 1,657
------ ------
Total $5,251 $3,976
====== ======
8. INCOME TAXES
The components of income before income taxes are as follows:
2004 2003 2002
-------- -------- --------
United States $ 3,472 $ 9,964 $ 10,807
International 823 (339) 3,796
-------- -------- --------
$ 4,295 $ 9,625 $ 14,603
======== ======== ========
The Company's subsidiary in the People's Republic of China ("PRC") is a
Sino-foreign joint venture enterprise. The statutory tax rate of the joint
venture is 27%. The joint venture successfully applied for the designation
as an "Export Oriented Enterprise", which resulted in a 12% tax rate in
2003 and 2004.
F-17
RADICA GAMES LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002)
(US dollars in thousands)
8. INCOME TAXES (Continued)
The provisions (credits) for income taxes consist of the following:
2004 2003 2002
------- ------- -------
Current:
US federal and state $ 274 $ 39 $ 51
International 456 42 950
------- ------- -------
Total current income tax provision $ 730 $ 81 $ 1,001
------- ------- -------
Deferred:
US federal $ 900 $(2,857) $ --
International (791) (90) 1,668
------- ------- -------
Total deferred income tax provision (credit) $ 109 $(2,947) $ 1,668
------- ------- -------
Total income taxes (credit) provision $ 839 $(2,866) $ 2,669
======= ======= =======
The income taxes for the years ended December 31, 2004, 2003 and 2002 were
allocated as follows:
2004 2003 2002
------- ------- -------
Income from continuing operations $ 839 $(2,866) $ 2,669
Shareholders' equity - compensation expense for
tax purposes in excess of amounts recognized
for financial reporting purposes -- 44 --
------- ------- -------
$ 839 $(2,822) $ 2,669
======= ======= =======
A reconciliation between income tax expense (benefit) and amounts
calculated using the US statutory rate is as follows:
2004 2003 2002
------- ------- -------
The US statutory rate 35% 35% 34%
Computed "expected" tax expense
at the US statutory rate $ 1,503 $ 3,369 $ 4,965
State tax, net of federal tax benefit 127 1 4
Tax rate differential (1,028) (807) (763)
Change in valuation allowance 380 (4,476) (1,282)
Effect on opening deferred tax balances resulting -- (478) --
from an increase in tax rate during the year
China tax rebates (212) (472) --
Other, net 69 (3) (255)
------- ------- -------
Income tax provision (credit) $ 839 $(2,866) $ 2,669
======= ======= =======
The US statutory rate has been used since the majority of the Company's
taxable income arises in the US. Other, net in the tax reconciliation above
primarily includes the tax effect of non-deductible and non-taxable items.
F-18
RADICA GAMES LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002)
(US dollars in thousands)
8. INCOME TAXES (Continued)
The tax effects of the Company's temporary differences that give rise to
significant portions of the deferred tax assets and liabilities are as
follows:
2004 2003
------- -------
Deferred tax assets:
Property, plant and equipment $ 479 $ 386
Net operating loss carryforwards 4,441 4,169
Advertising allowances 322 399
Accounts receivable 43 75
Inventories 416 232
Sales allowance and returns 580 968
Alternative minimum tax credit 519 324
Other 10 42
------- -------
Total gross deferred tax assets 6,810 6,595
Valuation allowance (4,510) (3,683)
------- -------
Net deferred tax assets $ 2,300 $ 2,912
Deferred tax liabilities:
Other (17) --
------- -------
Total gross deferred tax liabilities (17) --
Net deferred tax assets $ 2,283 $ 2,912
======= =======
Deferred tax charge on unrealized profits
on intercompany sales $ 520 $ --
======= =======
The valuation allowance was $9,441 at January 1, 2002. The increase
(decrease) in the valuation allowance during the years ended December 31,
2002, 2003 and 2004 were $(1,282), $(4,476) and $827, respectively.
F-19
RADICA GAMES LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002)
(US dollars in thousands)
8. INCOME TAXES (Continued)
The following table represents the classification of the Company's net
deferred tax assets:
2004 2003
------ ------
Current deferred tax assets $1,330 $1,706
Long-term deferred tax assets 953 1,206
------ ------
Total net deferred tax assets $2,283 $2,912
====== ======
As of December 31, 2004, the Company's US subsidiary had approximately $647
of tax operating loss carryforwards which will begin to expire after 2020.
In addition, as of December 31, 2004, the Company's United Kingdom (UK)
subsidiary had approximately $14,000 tax net operating loss carryforwards
which will carryforward indefinitely. The Company has alternative minimum
tax credit carryforwards in the US of approximately $519, which are
available to reduce future US Federal regular income taxes, if any, over an
indefinite period.
Under the provisions of SFAS No. 109, Accounting for Income Taxes, the
realization of the future tax benefits of a deferred tax asset is dependent
on future taxable income against which such tax benefits can be applied and
the consideration of any available tax strategies. All available evidence
must be considered in the determination of whether sufficient future
taxable income will exist. Such evidence includes, but is not limited to,
the Company's financial performance, the market environment in which the
Company operates, the utilization of past tax credits, and the length of
relevant carryback and carryover periods. Sufficient negative evidence,
such as cumulative net losses during a three-year period that includes the
current year and the prior two years, may require that a valuation
allowance be established with respect to existing and future deferred tax
assets. Differences in actual results from available evidence used in
determining the valuation allowances could result in future adjustments to
the allowance.
Based on management's assessment of the need for a valuation allowance as
at the balance sheet dates, the Company views the recoverability of the
deferred tax assets, net of existing valuation allowances, as more likely
than not to be realizable. Movement in the valuation allowance during the
year ended December 31, 2004 primarily reflected the net effect of the
change in deferred tax assets in respect of tax losses carried forward of
the Company's UK subsidiary.
The Company's operations involve a significant amount of transactions which
cross a number of international borders. In addition, the Company's
manufacturing operations are in China, where the negotiation and settlement
of tax obligations with the local tax authorities are a normal occurrence.
The Company establishes provisions for its known and estimated income tax
obligations. However, whether through a challenge by one of the many tax
authorities in international jurisdictions where the Company and its
subsidiaries operate of the Company's transfer pricing, the Company's claim
regarding lack of permanent establishment, or other matters that may exist,
the Company is exposed to possible additional taxation that has not been
accrued. Management believes that any potential tax obligations for these
items will not have a material adverse effect on the financial statements.
F-20
RADICA GAMES LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002)
(US dollars in thousands)
9. RESTRUCTURING CHARGE
In the second quarter of 2003, the Company recorded a restructuring charge
of $87 for personnel costs relating to the closure of the UK R&D office,
Radica Innovations (UK) Limited. The restructuring resulted in a workforce
reduction of approximately 5 positions. The reductions in workforce are
permanent and affected the Company's VGA segment. During the year ended
December 31, 2003, the Company completed the process of closing the UK R&D
office as of December 31, 2003. No restructuring reserve remained as at
December 31, 2003.
In December 2001, the Board of Directors approved a restructuring plan to
transfer its R&D operations in the US and Hong Kong to China for
implementation in February 2002. The estimated costs related to this
restructuring were accrued in December 2001. These accrued restructuring
charges were substantially disbursed during 2002. The total restructuring
charges consisted of $1,514 of cash outlays, the majority of which were
incurred in fiscal 2002, and $40 of non-cash charges, primarily for
leasehold improvements write-offs. The remaining restructuring reserve as
at December 31, 2002 consisted of $34, primarily related to certain
termination benefits which were paid in 2003.
The components of restructuring charges are as follows:
Balance Balance
at beginning Charges / Amount at end
of year (release) incurred of year
------- ------- ------- -------
2003
Severance and other compensation $ 34 $ 87 $ (121) $ --
======= ======= ======= =======
2002
Severance and other compensation $ 1,389 $ (78) $(1,277) $ 34
Lease termination costs and 199 78 (277) --
related asset writedowns
------- ------- ------- -------
$ 1,588 $ -- $(1,554) $ 34
======= ======= ======= =======
F-21
RADICA GAMES LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002)
(US dollars in thousands, except per share data)
10. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted net
income per share as of December 31:
2004 2003 2002
----------- ----------- -----------
Numerator for basic and diluted
earnings per share:
Net income $ 3,456 $ 12,491 $ 11,934
=========== =========== ===========
Denominator:
Basic weighted average shares 18,653,471 18,016,789 17,725,879
Effect of dilutive options and warrants 872,286 1,043,185 609,948
----------- ----------- -----------
Diluted weighted average shares 19,525,757 19,059,974 18,335,827
=========== =========== ===========
Basic net income per share: $ 0.19 $ 0.69 $ 0.67
=========== =========== ===========
Diluted net income per share: $ 0.18 $ 0.66 $ 0.65
=========== =========== ===========
Options and warrants on 54,000, 136,500 and 441,700 shares of common stock
for the years ended December 31, 2004, 2003 and 2002, respectively were not
included in computing diluted earnings per share since their effects were
antidilutive.
11. STOCK-BASED COMPENSATION
The Company's 1994 Stock Option Plan and 2004 Omnibus Equity Incentive Plan
for employees and directors (together, the "Stock Option Plan") provides
for options to be granted for the purchase of an aggregate of 1,600,000
shares of common stock at per share prices not less than 100% of the fair
market value at the date of grant as determined by the Compensation
Committee of the Board of Directors. Following shareholders' approval, the
total number of shares of the Company's common stock that may be purchased
pursuant to options under such plan has been increased to 4,200,000 shares.
Options to employees are generally exercisable over three to five years
from the date of grant and vest, or are exercisable, in equal installments,
the period beginning one year after the date of grant unless otherwise
provided. Options granted to employees under the stock option plan must be
exercised no later than ten years from the date of grant. The Company also
maintains plans under which it offers stock options to directors. Pursuant
to the terms of the plans under which directors are eligible to receive
options, each director is entitled to receive options to purchase common
stock upon initial election to the Board and at each subsequent quarterly
Board meeting. Options are exercisable during the period beginning one year
after the date of grant.
In 2001, the Company issued stock options to management based on the terms
of various employment contracts. Based upon 2002 performance, the Company's
Compensation Committee voted in March 2003 to accelerate the vesting of
110,000 options. The acceleration of the stock options was approved in
accordance with the original terms of the contract and these options would
vest in five years regardless of the achievement of the performance goals
and therefore the acceleration did not result in a new measurement of the
stock options.
F-22
RADICA GAMES LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002)
(US dollars in thousands, except share and per share data)
11. STOCK-BASED COMPENSATION (continued)
A summary of option activity is as follows:-
2004 2003 2002
------------------------ ------------------------- -------------------------
Weighted Weighted Weighted
average average average
exercise exercise exercise
(Shares in thousands) Shares price Shares price Shares price
------ ----- ------ ----- ------ -----
Outstanding at
beginning of year 1,947 $ 3.41 2,313 $ 4.05 2,191 $ 3.88
Options granted 187 8.36 370 5.10 585 3.75
Options exercised (510) 2.11 (426) 2.67 (145) 2.13
Options forfeited (41) 4.19 (310) 11.24 (318) 3.21
-------- -------- --------
Outstanding at end of year 1,583 $ 4.39 1,947 $ 3.41 2,313 $ 4.05
======== ======== ========
Options exercisable
at year end 1,091 $ 3.80 1,232 $ 2.88 1,352 $ 4.52
======== ======== ========
The following is additional information relating to options outstanding as
of December 31, 2004:
Options outstanding Options exercisable
------------------------------------------------------ -----------------------------
Weighted average
Weighted average remaining Weighted average
Exercise Number exercise price contractual Number exercise price
price range of shares per share life (years) of shares per share
----------- --------- --------- ------------ --------- ---------
(Shares in thousands)
$ 1.090 to 2.000 76 $ 1.83 5.07 76 $ 1.83
$ 2.001 to 4.000 880 3.27 5.08 760 3.26
$ 4.001 to 6.000 304 4.37 7.93 127 4.33
$ 6.001 to 8.000 139 6.81 8.24 104 6.76
$ 8.001 to 10.000 167 8.56 9.25 7 8.57
$ 12.001 to 14.000 16 12.63 4.31 16 12.63
$ 18.001 to 20.000 1 20.00 3.00 1 20.00
--------- --------
1,583 $ 4.39 6.34 1,091 $ 3.80
========= ========
Pro forma information regarding net income and earnings per share is
required by SFAS No. 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method of
SFAS No. 123. The weighted average fair value of stock options at date of
grant were $2.70, $1.47 and $1.51 per option for the years ended December
31, 2004, 2003 and 2002, respectively. The values were estimated using the
Black-Scholes option pricing model with the following weighted average
assumptions:
F-23
RADICA GAMES LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002)
(US dollars in thousands, except share and per share data)
11. STOCK-BASED COMPENSATION (continued)
2004 2003 2002
----------- ----------- -----------
Expected life of options 3.5 years 3.6 years 3.4 years
Risk-free interest rate 3.6% 2.8% 4.1%
Expected volatility of underlying stock 45% 33% 51%
Dividends 1.9% -- --
The Black-Scholes option pricing models require the input of highly
subjective assumptions, including the expected volatility of stock price.
Because changes in subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing model does not
necessarily represent the estimated fair value of freely tradable fully
transferable options without vesting restrictions which differ from the
Company's stock option awards.
If the Company had accounted for its stock option plans by recording
compensation expenses based on the fair value at grant date for such awards
consistent with the method of SFAS No. 123, the Company's net income and
earnings per share would have been adjusted to the pro forma amounts as
follows:
2004 2003 2002
--------- ---------- ---------
Reported net income $ 3,456 $ 12,491 $ 11,934
Pro forma net income 2,905 11,995 11,188
Reported net income per share
Basic $ 0.19 $ 0.69 $ 0.67
Diluted 0.18 0.66 0.65
Pro forma net income per share
Basic $ 0.16 $ 0.66 $ 0.63
Diluted 0.15 0.62 0.61
12. RETIREMENT PLAN
In Hong Kong, the Company has both mandatory provident fund and defined
contribution retirement plans covering substantially all employees. Under
these plans, eligible employees contribute amounts through payroll
deductions which are 5% or more of individual salary, supplemented by
employer contributions ranging from 5% to 10% of individual salary
depending on the years of service. The expenses related to these plans were
$198, $253 and $142 for the years ended December 31, 2004, 2003 and 2002,
respectively.
Radica's US and UK employees are eligible to participate in savings plans
administered by independent trustees, all of which are defined contribution
plans. The Company makes company contributions and both individual and
company contributions are invested into a balanced variety of investment
funds. The Company contributed approximately $118, $74 and $60 to these
plans for the years ended December 31, 2004, 2003 and 2002, respectively.
F-24
RADICA GAMES LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002)
(US dollars in thousands)
13. FAIR VALUE OF FINANCIAL INSTRUMENTS
The amounts reported for cash and cash equivalents, trade accounts
receivable and trade accounts payable are considered to approximate fair
values because of the short duration of these instruments.
Investment securities (both available-for-sale and trading securities) are
carried at fair values which are based on quoted prices at the reporting
date.
14. PLEDGE OF ASSETS
At December 31, 2004, the Company has general banking facilities including
overdraft and trade facilities totaling $3,798 available to be drawn upon.
The facilities are collateralized by leasehold land and buildings and bank
balances with an aggregate net book value of $3,232.
15. COMMITMENTS AND CONTINGENCIES
Leases
The Company leases certain offices, warehouses and equipment under various
operating lease arrangements. The rental expense under the operating leases
was approximately $761, $589 and $509 for the years ended December 31,
2004, 2003 and 2002, respectively. In the normal course of business, leases
that expire will be renewed or replaced by leases on other properties. As
of December 31, 2004, the Company was obligated under non-cancelable
operating leases requiring future minimum rental payments as follows:
Operating leases
---------------
2005 720
2006 601
2007 374
2008 318
2009 204
Thereafter 899
---------------
Total minimum lease payments $ 3,116
===============
Joint Venture Agreement
Under the terms of a joint venture agreement with the local government in
Dongguan as of December 31, 2004, the Company is committed to pay a total
of $3,317 in varying amounts over the next 20 years.
Warranties
The Company provides product warranties to its customers for a period of 90
days from the date of purchase for games and one year for VGA products.
Details of the movement in the warranty provision during the year are set
out in note 18.
F-25
RADICA GAMES LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002)
(US dollars in thousands)
15. COMMITMENTS AND CONTINGENCIES (Continued)
Licensing Commitments
In the normal course of business, the Company enters into certain licensing
agreements and commitments with various third parties for the use of their
inventor concepts and intellectual property. Certain of these agreements
and commitments contain provisions for guaranteed or minimum royalty
amounts during the term of the contracts. Under the terms of agreements
which contain provisions for future minimum payments, the Company is
obligated to pay royalty amounts as follows:
Minimum
Payments
------------
2005 $ 1,294
2006 106
2007 231
2008 10
2009 210
Thereafter 10
------------
$ 1,861
============
Capital Commitments
The Company has capital commitments of $571 at December 31, 2004 in respect
of the expansion of its manufacturing facilities in Dongguan, PRC. The
Company expects the expansion to be fully completed in 2005.
Litigation
On April 4, 2000 a lawsuit was filed by the Lemelson Foundation
("Lemelson") against the Company in Arizona Court for patent infringement.
Lemelson claims to be owner of nearly 800 issued and pending patents,
including the patent on Machine Vision and Automatic Identification (Auto
ID) operations. The Auto ID operation is used in machines that are part of
the Company's bonding and heat-sealing manufacturing processes. Lemelson is
contesting that the use of machines that incorporate this patented
technology infringes on their IP rights and therefore the Company is
obligated to pay a royalty based on the use of this technology. The suit by
Lemelson has been stayed pending the outcome of Lemelson vs. Cognex, a
similar suit filed by Lemelson, which will have some bearing on the Radica
case with Lemelson. On January 23, 2004 a declaratory judgment was given in
the Cognex case that the Lemelson's patent claims are invalid. If this
judgment is upheld following appeal, the Company believes that this result
is favorable to the Company's defense of the Lemelson lawsuit. On June 29,
2004, Lemelson filed its notice of appeal to the Court of Appeals for the
Federal Circuit. The briefing is not expected to be completed until the
first half of 2005 and a decision from the Court will likely not be issued
until 2006.
The Company cannot predict the outcome of the Lemelson case or the effect
of such litigation on the financial results of the Company. No accrual has
been recorded at December 31, 2004 and December 31, 2003 in respect of the
Lemelson case or other claims or legal actions, in accordance with SFAS No.
5 Accounting for Contingencies. Management does not believe that the
ultimate disposition of the other matters will have a material adverse
effect on the Company's consolidated financial position, results of
operations or liquidity.
F-26
RADICA GAMES LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002)
(US dollars in thousands)
16. CONCENTRATIONS OF CREDIT RISK, MAJOR CUSTOMERS AND MAJOR SUPPLIERS
Accounts receivable of the Company are subject to a concentration of credit
risk with customers in the North American and the United Kingdom retail
sector and customers in the Company's manufacturing services. This risk is
somewhat limited due to the large number of customers composing the
Company's customer base and their geographic dispersion, though the
Company's Games business had one customer which accounted for more than
twenty-four percent of consolidated net sales for the year ended December
31, 2004, one customer which accounted for more than thirty-one percent of
consolidated net sales for the year ended December 31, 2003 and one
customer which accounted for more than twenty-four percent of consolidated
net sales for the year ended December 31, 2002. The Company's top five
customers accounted for 55% and 42% of the Company's net sales in 2004 and
2003 respectively. The Company performs ongoing credit evaluations of its
customers' financial condition and, generally, requires no collateral from
its customers. Several of the Company's licenses apply to products that
generate a large volume of sales. To the extent, the Company is unable to
maintain these licenses, the lost sales could have a significant impact on
future sales. On March 17, 2005, a significant customer that accounted for
approximately 10% of the Company's sales in 2004, announced that it had
agreed to be acquired. The acquiring group has not commenced any plans for
the future of this customer, but a restructuring that includes store
closings or liquidation of the company could have an adverse effect on the
Company's business.
17. SEGMENT INFORMATION
The Company is a worldwide designer, producer and marketer of electronic
entertainment devices. The Company has two reportable segments from which
it derives its revenues: the Games and Youth Electronics business that
sells product under the Company's different brand names, and the Video Game
Accessory ("VGA") business that sells product under the Company's
Gamester(R) brand name. The reportable segments are strategic businesses
that offer different products, and have different production processes and
different type of customers. The Company also sources certain VGA and other
electronic products through third party manufacturers for retailers
("Manufacturing Services") to sell under their own brands; this is also
included in the Games and Youth Electronics and VGA segments. Manufacturing
Services is not considered a separate business segment because the nature
of the products and services provided under a manufacturing service order
is always either Games and Youth Electronics or VGA. Except for certain
small tools that are expensed in the year of service, the Company did not
acquire additional machines or equipment to manufacture these products. As
such, the chief operating decision maker has not analyzed or assessed the
performance of Manufacturing Services as a separate line of business or a
reportable operating segment, but rather as a type of service that
generates auxiliary income to the Company to the extent if it has excessive
production capacity to fill the order. Revenue and costs related to the
Manufacturing Services are allocated between Games and Youth Electronics
and VGA based on product type.
The accounting policies of the reportable segments are the same as those
described elsewhere in these Notes to the Company's consolidated financial
statements for the year ended December 31, 2004. The Company measures
segment performance based on net income before foreign currency gain,
income taxes, interest, other income and allocable corporate expenses.
Unallocable corporate expenses such as costs related to business
integration and other general and administrative expenses are managed
outside of the operating segments and are included as corporate costs. All
other indirect costs have been apportioned on the basis of corresponding
sales and direct costs. Inter-segment sales and transfers have been
eliminated and are not included in the following table.
A large proportion of the Company's assets are utilized by both segments
and are therefore not suitable for allocating to specific assets. The
segment assets are comprised of accounts receivable, inventories and
goodwill. Other assets included in corporate principally are cash and cash
equivalents, investment securities, deferred tax assets, property, plant
and equipment, and all other insignificant assets not reportable under
other segments. Information by segment and a reconciliation to reported
amounts for the year ended December 31, 2004, 2003 and 2002 are as follows:
F-27
RADICA GAMES LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002)
(US dollars in thousands)
17. SEGMENT INFORMATION (Continued)
A summary of the Company's two reportable segments is set forth below.
2004 2003 2002
--------- --------- ---------
Revenues from external customers
Games and Youth Electronics $ 110,176 $ 87,986 $ 104,062
VGA 13,223 17,214 20,584
--------- --------- ---------
Total revenues from external customers $ 123,399 $ 105,200 $ 124,646
========= ========= =========
Depreciation and amortization
Games and Youth Electronics $ 1,505 $ 1,671 $ 2,446
VGA 188 362 412
--------- --------- ---------
Total depreciation and amortization $ 1,693 $ 2,033 $ 2,858
========= ========= =========
Impairment of goodwill
Games and Youth Electronics $ -- $ -- $ --
VGA 3,536 -- --
--------- --------- ---------
Total impairment of goodwill $ 3,536 $ -- $ --
========= ========= =========
Segment income (loss)
Games and Youth Electronics $ 8,833 $ 13,788 $ 18,004
VGA (3,527) (2,547) (3,636)
--------- --------- ---------
Total segment income $ 5,306 $ 11,241 $ 14,368
Corporate
Unallocated corporate expenses $ (2,947) $ (2,406) $ (1,850)
Net interest and other income 1,936 790 2,085
(Provision) credit for income taxes (839) 2,866 (2,669)
--------- --------- ---------
Total consolidated net income $ 3,456 $ 12,491 $ 11,934
========= ========= =========
Segment assets
Games and Youth Electronics $ 38,134 $ 23,061 $ 26,037
VGA 13,058 17,353 19,038
Corporate 58,749 61,800 50,227
--------- --------- ---------
Total consolidated assets $ 109,941 $ 102,214 $ 95,302
========= ========= =========
F-28
RADICA GAMES LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002)
(US dollars in thousands)
17. SEGMENT INFORMATION (Continued)
Revenues from external customers by segment and product category and
manufacturing services within the segment are summarized as follows:
2004 2003 2002
-------- -------- --------
Games and Youth Electronics Segment
Electronic Games $ 80,640 $ 62,374 $ 62,684
Youth Electronics 17,038 15,227 16,744
Other Electronic Toys 3,490 -- --
Manufacturing Services 9,008 10,386 24,634
-------- -------- --------
110,176 87,987 104,062
VGA Segment
Video Games Accessories 12,840 14,294 15,844
Manufacturing Services 383 2,919 4,740
-------- -------- --------
13,223 17,213 20,584
Total net revenues $123,399 $105,200 $124,646
======== ======== ========
Information about the Company's operations in different geographic areas is
set forth in the table below. Net sales are attributed to countries based
on the location of customers, while long-lived assets are reported based on
their location. Long-lived assets principally include property, plant and
equipment and intangible assets:
2004 2003 2002
-------- -------- --------
Net sales:
United States $ 81,542 $ 72,520 $ 76,926
United Kingdom 18,156 13,189 17,888
New Zealand 1,094 152 --
Japan 1,591 930 14,832
Europe 3,744 3,292 1,863
Canada 3,471 2,191 2,279
Australia 4,387 1,970 465
Other countries 9,414 10,956 10,393
-------- -------- --------
$123,399 $105,200 $124,646
======== ======== ========
Long-lived assets:
United States $ 6,534 $ 9,937 $ 771
United Kingdom 147 114 9,733
China and Hong Kong 11,668 12,283 13,977
-------- -------- --------
$ 18,349 $ 22,334 $ 24,481
======== ======== ========
F-29
RADICA GAMES LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002)
(US dollars in thousands)
18. VALUATION AND QUALIFYING ACCOUNTS
Balance at Balance at
beginning Charged to Utilization / end of
of year income statement write-offs year
------- ---------------- ---------- ----
2004
Allowance for doubtful accounts $ 251 $ 6 $ (109) $ 148
Allowance for estimated product returns 1,390 1,145 (1,611) 924
Accrued warranty expenses 1,040 1,903 (1,873) 1,070
Accrued sales allowance 2,893 2,834 (3,816) 1,911
------- ------- ------- -------
$ 5,574 $ 5,888 $(7,409) $ 4,053
======= ======= ======= =======
2003
Allowance for doubtful accounts $ 315 $ 114 $ (178) $ 251
Allowance for estimated product returns 1,247 1,079 (936) 1,390
Accrued warranty expenses 1,040 2,495 (2,495) 1,040
Accrued sales allowance 3,591 2,809 (3,507) 2,893
------- ------- ------- -------
$ 6,193 $ 6,497 $(7,116) $ 5,574
======= ======= ======= =======
2002
Allowance for doubtful accounts $ 2,207 $ 60 $(1,952) $ 315
Allowance for estimated product returns 1,555 390 (698) 1,247
Accrued warranty expenses 900 1,771 (1,631) 1,040
Accrued sales allowance 3,912 1,864 (2,186) 3,590
------- ------- ------- -------
$ 8,574 $ 4,085 $(6,467) $ 6,192
======= ======= ======= =======
F-30
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange
Act of 1934, the registrant certifies that it meets all of the requirements for
filing on Form 20-F and has duly caused this annual report to be signed on its
behalf by the undersigned, thereunto duly authorized.
RADICA GAMES LIMITED
Date: March 24, 2005 /s/ Craig D. Storey
------------------------ ------------------------------------
Craig D. Storey
Chief Accounting Officer
I-1
EXHIBIT INDEX
-------------
1.1 Memorandum of Association (incorporated by reference
to exhibit 3.1 to the filing of the registrant
identified in footnote 1 below).
1.2 Bye-Laws (incorporated by reference to exhibit 3.2 to
the filing of the registrant identified in footnote 1
below).
1.3 Certificate of Incorporation on Change of Name
(incorporated by reference to exhibit 3.3 to the
filing of the registrant identified in footnote 1
below)
2.1 Specimen Certificate for the Shares of Common Stock
(incorporated by reference to exhibit 4.1 to the
filing of the registrant identified in footnote 1
below).
4.1 Cooperative Joint Venture Contract of D.G. Radica
Games Manufacturing Co., Ltd., dated June 24, 1994
(incorporated by reference to exhibit 10.16 to the
filing of the registrant identified in footnote 2
below).
4.2 Shareholders Agreement, dated January 12, 1994, among
the Company and the shareholders parties thereto
(incorporated by reference to exhibit 10.4 to the
filing of the registrant identified in footnote 1
below)
4.3 Amendment to Shareholders Agreement, dated as of
February 16, 1994, among the Company and the
shareholders party thereto (incorporated by reference
to exhibit 10.5 to the filing of the registrant
identified in footnote 1 below).
4.4 Amendment to Shareholders Agreement, dated as of
September 5, 1997, among the Company and the
shareholders party thereto (incorporated by reference
to exhibit 10.5(a) to the filing of the registrant
identified in footnote 5 below).
4.5 Employment Agreement, dated as of December 15, 2001,
between Radica USA and Jeanne Olson (incorporated by
reference to exhibit 10.6 to the filing of the
registrant identified in footnote 7 below).
4.6 Amendment No. 1 to Employment Agreement, dated as of
March 31, 2003, between Radica USA and Jeanne Olson
(incorporated by reference to exhibit 4.6 to the
filing of the registrant identified in footnote 8
below).
*4.6(a) Amendment No. 2 to Employment Agreement, dated as of
February 1, 2005, between Radica USA and Jeanne Olson
4.7 Change in Control Bonus Agreement, dated as of March
31, 2003, between Radica USA and Jeanne Olson
(incorporated by reference to exhibit 4.7 to the
filing of the registrant identified in footnote 8
below).
4.8 Agreement (in connection with Executive's sale of
shares), dated as of March 31, 2003, between Radica
USA and Jeanne Olson (incorporated by reference to
exhibit 4.8 to the filing of the registrant
identified in footnote 8 below).
4.9 Employment Agreement, dated as of November 28, 1993,
among Radica HK, Radica USA and Jon N. Bengtson
(incorporated by reference to exhibit 10.8 to the
filing of the registrant identified in footnote 1
below).
4.10 Form of Amendment to Employment Agreement among
Radica Games Limited, Radica HK, Radica USA and Jon
N. Bengtson (incorporated by reference to exhibit
10.8(a) to the filing of the registrant identified in
footnote 1 below).
I-2
4.11 December 1995 Amendment to such Employment Agreement
(incorporated by reference to exhibit 10.8(b) to the
filing of the registrant identified in footnote 3
below).
4.12 December 1997 Amendment to such Employment Agreement
(incorporated by reference to exhibit 10.8(c) to the
filing of the registrant identified in footnote 4
below).
4.13 1994 Stock Option Plan, most recent amendment
restated in May 2000 to increase options
(incorporated by reference to exhibit 10.9 to the
filing of the registrant identified in footnote 6
below).
4.14 2004 Omnibus Equity Incentive Plan (incorporated by
reference to exhibit 4.14 to the filing of the
registrant identified in footnote 8 below).
4.15 Amendment and Restatement to Employment Agreement
among Radica USA, Radica Games Limited and Patrick
Feely dated September 27, 2000 (incorporated by
reference to exhibit 10.11 to the filing of the
registrant identified in footnote 6 below).
4.16 Amendment No. 1 to Employment Agreement, dated as of
March 31, 2003, among Radica USA, Radica Games
Limited and Patrick Feely (incorporated by reference
to exhibit 4.16 to the filing of the registrant
identified in footnote 8 below).
* 4.16(a) Amendment No. 2 to Employment Agreement dated as of
January 31, 2005 among Radica USA, Radica Games
Limited and Patrick Feely.
4.17 Change in Control Bonus Agreement, dated as of March
31, 2003, among Radica USA, Radica Games Limited and
Patrick Feely (incorporated by reference to exhibit
4.17 to the filing of the registrant identified in
footnote 8 below).
4.18 Agreement (in connection with Executive's sale of
shares), dated as of March 31, 2003, among Radica
USA, Radica Games Limited and Patrick Feely
(incorporated by reference to exhibit 3.2 to the
filing of the registrant identified in footnote 1
below).
4.19 Amendment and Restatement to Employment Agreement
between Radica Games Limited and David C.W. Howell
dated September 29, 2000 (incorporated by reference
to exhibit 10.13 to the filing of the registrant
identified in footnote 6 below).
4.20 Amendment No. 1 to Employment Agreement, dated as of
March 31, 2003, between Radica Games Limited and
David C.W. Howell (incorporated by reference to
exhibit 4.20 to the filing of the registrant
identified in footnote 8 below).
* 4.20(a) Amendment No. 2 to Employment Agreement, dated as of
February 18, 2005, between Radica Games Limited and
David C.W. Howell.
4.21 Change in Control Bonus Agreement, dated as of March
31, 2003, between Radica Games Limited and David C.W.
Howell (incorporated by reference to exhibit 4.21 to
the filing of the registrant identified in footnote 8
below).
4.22 Employment Agreement, dated as of April 7, 2003,
between Radica UK Limited, Radica Games Limited and
Denis Horton (incorporated by reference to exhibit
4.22 to the filing of the registrant identified in
footnote 8 below).
* 4.23 Employment Agreement among Radica USA, Radica Games
Limited and Theodore J. Eischeid dated January 7,
2005.
* 6.1 Statement re Computation of Per Share Earnings.
I-3
* 8.1 List of subsidiaries
* 12.1 Section 302 Certification of Patrick S. Feely
* 12.2 Section 302 Certification of David C.W. Howell
* 13.1 Section 906/1350 Certification of Patrick S. Feely
* 13.2 Section 906/1350 Certification of David C.W. Howell
* 15.1 Statement re Selected Quarterly Financial Data
* 15.2 Consent of KPMG
----------
1 Incorporated by reference to Registration Statement on Form F-1, File No.
33-75794, filed by the Registrant.
2 Incorporated by reference to Form 20-F for the year ended October 31, 1994.
3 Incorporated by reference to Form 20-F for the year ended October 31, 1996.
4 Incorporated by reference to Form 20-F for the year ended October 31, 1997.
5 Incorporated by reference to Form 20-F for the year ended October 31, 1998.
6 Incorporated by reference to Form 20-F for the year ended December 31,
2000.
7 Incorporated by reference to Form 20-F for the year ended December 31,
2001.
8 Incorporated by reference to Form 20-F for the year ended December 31,
2003.
The file number for each of the above reports on Form 20-F is 0-23696.
The exhibits marked with an asterisk are included as part of this filing.
The registrant is not required to file blackout trading restriction notices
under part 10 of Item 19 of Form 20-F, because the registrant does not maintain
any individual account plans that permit participants or beneficiaries to
acquire or hold equity securities of the registrant.
I-4