UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Form 20-F
or
Commission File Number: 0-16673
Nam Tai Electronics, Inc.
British Virgin Islands(Jurisdiction of incorporation or organization)
116 Main Street3rd FloorRoad Town, TortolaBritish Virgin Islands(Address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act:Common Shares, $0.01 par value per share
Securities registered pursuant to Section 12(g) of the Act: NONE
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: NONE
As of December 31, 2003, there were 41,231,272 common shares of the registrant outstanding.
Indicate by check mark whether the registrant: (i) 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 (ii) 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]
TABLE OF CONTENTS
SIGNATURES AND CERTIFICATIONS
Consents of Independent Accountants (to incorporation of their report on Financial Statements into the Company’s Registration Statements on Forms F-3 and S-8)
This Annual Report on Form 20-F contains forward-looking statements. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those anticipated in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in the section entitled Risk Factors under Item 3. Key Information.
Readers should not place undue reliance on forward-looking statements, which reflect management’s view only as of the date of this Report. The Company undertakes no obligation to publicly revise these forward-looking statements to reflect subsequent events or circumstances. Readers should also carefully review the risk factors described in other documents the Company files from time to time with the Securities and Exchange Commission.
FINANCIAL STATEMENTS AND CURRENCY PRESENTATION
The Company prepares its consolidated financial statements in accordance with accounting principles generally accepted in the United States of America and publishes its financial statements in United States dollars.
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PART I
Unless the context otherwise requires, all references in this annual report, or Report, to “Nam Tai”, or “we”, or “our”, or “us”, and the “Company” refer to Nam Tai Electronics, Inc. and its consolidated subsidiaries and their respective predecessors. References to “dollars” or $ are to United States dollars.
Item 1. Identity of Directors, Senior Management and Advisors
Not applicable.
Item 2. Offer Statistics and Expected Timetable
Item 3. Key Information
Selected Financial Data
Our historical consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States and are presented in U.S. dollars. The following selected statements of income data for each of the three years in the period ended December 31, 2003 and the balance sheet data as of December 31, 2002 and 2003 are derived from our consolidated financial statements and notes thereto included in this Report. The selected statements of income data for each of the two years in the period ended December 31, 1999 and 2000 and the balance sheet data as of December 31, 1999, 2000 and 2001 were derived from our audited financial statements, which are not included in this Report. The following data should be read in conjunction with the Section of the Report entitled Item 5. Operating and Financial Review and Prospects and our consolidated financial statements including the related footnotes. All reference to numbers of common shares, per share data and stock option data have been adjusted to give effect to a three-for-one stock split effective on June 30, 2003 on a retroactive basis and for the purposes of earnings per share calculation, all references to numbers of common shares, and per share data have been adjusted to reflect an issuance of a stock dividend to shareholders at a ratio of one dividend share for every ten shares, or a ten-for-one stock dividend, effective on November 7, 2003.
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Risk Factors
We may from time to time make written or oral forward-looking statements. Written forward-looking statements may appear in this document and other documents filed with the Securities and Exchange Commission, in press releases, in reports to shareholders, on our website, and other documents. The Private Securities Reform Act of 1995 contains a safe harbor for forward-looking statements on which the Company relies in making such disclosures. In connection with this “safe harbor”, we are hereby identifying important factors that could cause actual results to differ materially from those contained in any forward-looking statements made by us or on our behalf. Any such statements are qualified by reference to the following cautionary statements:
Risks Related to Our Business
We are dependent on a few large customers, the loss of any of which could substantially harm our business and operating results.
Historically, a substantial percentage of our sales have been to a small number of customers. During the years ended December 31, 2001, 2002 and 2003, sales to our customers accounting for 10% or more of our net sales aggregated approximately 44.1%, 60.2% and 46.7%, respectively, of our net sales. The loss of Epson Precision (HK) Ltd., Sony Ericsson Mobile Communications AB or Toshiba Matsushita Display Technology Co. Ltd., each of which accounted for more than 10% of our net sales during 2003, or a substantial reduction in orders from any of them, would materially and adversely impact our business and operating results.
Our quarterly and annual operating results are subject to significant fluctuations from a wide variety of factors.
Our quarterly and annual operating results are affected by a wide variety of factors that could materially and adversely affect our business and operating results during any period. This could result from any one or a combination of factors, such as:
The volume and timing of orders received during a quarter are difficult to forecast. From time to time, our customers encounter uncertain and changing demand for their products. Customers generally order based on their forecasts. If demand falls below such forecasts or if customers do not control inventories effectively, they may reduce, cancel or postpone shipments of orders.
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As a consequence of any of the above factors, results of operations in any period should not be considered indicative of results to be expected in any future period, and fluctuations in operating results may also result in fluctuations in the market price of our common shares. Our results of operations in future periods may fall below the expectations of public market analysts and investors. This failure to meet expectations could cause the trading price of our common shares to decline substantially.
Cancellations or delays in orders could materially and adversely affect our gross margins and operating income.
Sales to our original equipment manufacturer, or OEM, customers are primarily based on purchase orders we receive from time to time rather than firm, long-term purchase commitments. Although it is our general practice to purchase raw materials only upon receiving a purchase order, for certain customers we will occasionally purchase raw materials based on such customers’ rolling forecasts. Further, during times of potential component shortages we have purchased, and may continue to purchase, raw materials and component parts in the expectation of receiving purchase orders for products that use these components. In the event actual purchase orders are delayed, are not received or are cancelled, we would experience increased inventory levels or possible write-down of raw material inventory that could materially and adversely affect our business and operating results. In 2001, we wrote down inventory for $3.8 million for slow-moving raw materials relating to cancelled, reduced or delayed orders. Subsequently, we were able to use some of these raw materials in production or we received compensation for the unused raw materials from certain of our customers, and the gain of $2.0 million was recorded in cost of sales during 2002.
If we are unable to produce our new products in a high-quality and cost-effective manner, our gross margins and business and operating results could be materially and adversely affected.
We have experienced increased costs associated with developing advanced manufacturing techniques to produce our complex products on a mass scale and at a low cost. This has negatively impacted our gross margins. For example, our initial production runs of liquid crystal display, or LCD, modules experienced low production yields and other inefficiencies. We have commenced production of radio frequency, or RF, modules, thin film transistor, or TFT, modules, color LCD modules and complementary metal oxide semiconductor, or CMOS, sensor modules, in relation to which we have relatively limited manufacturing experience. We expect that a substantial portion of our growth will come from our manufacture of these products. While we expect and plan for such increased costs in our new product manufacturing cycle, we cannot precisely predict the time and expense required to overcome initial problems and to ensure reliability and high quality at an acceptable cost. The increased costs and other difficulties associated with manufacturing RF modules, TFT modules, color LCD modules, CMOS sensor modules and other new products could have a negative impact on our future gross margins. In addition, even if we develop capabilities to manufacture new products, there can be no guarantee that a market will exist for such products or that such products will adequately respond to market trends. If we invest resources to develop capabilities to manufacture new products, like the investment in our new factory, for which a market does not develop, our business and operating results would be seriously harmed. Even if the market for our services grows, it may not grow at an adequate pace.
Our inability to utilize capacity at our new factory could materially and adversely affect our business and operating results.
In order to expand production capacity, we intend to use approximately $40 million to construct and equip a new factory consisting of approximately 250,000 square feet on land adjacent to our principal manufacturing facilities in Shenzhen, People’s Republic of China, or China. Construction began in September 2003, and we expect it to be completed by the end of the fourth quarter in 2004. For the year ended December 31, 2003, we spent $1.2 million on this construction. Once our new factory is completed, we will have committed substantial expenditures and resources constructing and equipping this factory but cannot guarantee that we will fully utilize such additional capacity. Our factory utilization is dependent on our success in providing manufacturing services for new or other products that we intend to produce at that factory, including image capturing devices and their modules, such as CMOS sensor modules, RF modules, TFT and color LCD modules and handset assemblies for cellular phones, at a price and volume sufficient to absorb our increased overhead expenses. Demand for contract manufacturing of these products may not be as high as we expect, and we may fail to realize the expected benefit from our investment in our new factory.
We face increasing competition, which has had an adverse effect on our margins.
Competition in the electronics manufacturing services, or EMS, industry is intense and is characterized by price erosion, rapid technological change, and competition from major international companies. This intense competition has resulted in pricing pressures, lower sales and reduced margins. Over the last several years our margins have declined substantially, from 17.2% in 1999 to approximately 16.3% in 2003. Continuing competitive pressures could materially and adversely affect our business and operating results.
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We may not be able to compete successfully with our competitors, many of which have substantially greater resources than we do.
The electronics manufacturing services we provide are available from many independent sources as well as from our current and potential customers with in-house manufacturing capabilities. Our EMS competitors include Celestica, Inc., Flextronics International Ltd., Hon Hai Precision Industry Co., Ltd., Jabil Circuit, Inc., Sanmina-SCI Corporation and Solectron Corporation. Our principal competitors in the manufacture of our traditional product lines of calculators, personal organizers and linguistic products include Kinpo Electronics, Inc. and Inventec Co. Ltd. Our competitors in the manufacturing of image capturing devices and their modules include Lite-On Technology Corporation, The Primax Group and Logitech, Inc. Our competitors in the manufacturing of RF modules include Wavecom and WKK International (Holdings) Ltd. We have numerous competitors in the telecommunication, subassemblies and components product lines, including Philips, Samsung and Varitronix. Many of our competitors have greater financial, technical, marketing, manufacturing, regional shipping capabilities and logistics support and personnel resources than we do. As a result, we may be unable to compete successfully with these organizations in the future.
We must spend substantial amounts to maintain and develop advanced manufacturing processes and engage additional engineering personnel in order to attract new customers and business.
We operate in rapidly changing industries. Technological advances, the introduction of new products and new manufacturing and design techniques could materially and adversely affect our business unless we are able to adapt to those changing conditions. As a result, we are continually required to commit substantial funds for, and significant resources to, engaging additional engineering and other technical personnel and to purchase advanced design, production and test equipment.
Our future operating results will depend to a significant extent on our ability to continue to provide new manufacturing solutions that compare favorably on the basis of time to introduction, cost, and performance with the manufacturing capabilities of OEMs and competitive third-party suppliers. Our success in attracting new customers and developing new business depends on various factors, including:
We generally have no written agreements with suppliers to obtain components and our margins and operating results could suffer from increases in component prices.
We are typically responsible for purchasing components used in manufacturing products for our customers. We generally do not have written agreements with our suppliers of components. This typically results in our bearing the risk of component price increases because we may be unable to procure the required materials at a price level necessary to generate anticipated margins from the orders of our customers. Accordingly, increases in component prices could materially and adversely affect our gross margins and operating results.
Our business and operating results would be materially and adversely affected if our suppliers of needed components fail to meet our needs.
At various times, we have and continue to experience shortages of some of the electronic components that we use, and suppliers of some components lack sufficient capacity to meet the demand for these components. In some cases, supply shortages and delays in deliveries of particular components have resulted in curtailed production, or delays in production, of assemblies using that component, which contributed to an increase in our inventory levels and reduction in our gross margins. We expect that shortages and delays in deliveries of some components will continue. If we are unable to obtain sufficient components on a timely basis, we may experience manufacturing delays, which could harm our relationships with current or prospective customers and reduce our sales. We also depend on a small number of suppliers for certain of the components that we use in our business. For example, we purchase most of our integrated circuits from Toshiba Corporation and Sharp Corporation and certain of their affiliates. If we were unable to continue to purchase components from these limited source suppliers, our business and operating results would be materially and adversely affected.
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Factors affecting the electronics industry in general and our customers in particular could harm our operations.
Most of our sales are to customers in the electronics industry, which is subject to rapid technological change, product obsolescence and short product life cycles and has suffered from an industry-wide slowdown since 2000. The factors affecting the electronics industry in general, or any of our major customers or competitors in particular, could have a material adverse effect on our business and operating results. Our success will depend to a significant extent on the success achieved by our customers in developing and marketing their products, including their products that use RF modules, color straight-twisted nematic, or STN, LCD modules, TFT modules and CMOS sensor modules, some of which may be new and untested. If our customers’ products become obsolete, fail to gain widespread commercial acceptance or become the subject of intellectual property disputes, this could harm our business and operating results.
Future acquisitions or strategic investments may not be successful and may harm our operating results.
An important element of our strategy is to review prospects for acquisition or strategic investments that would complement our existing companies and products, augment our market coverage and distribution ability or enhance our technological capabilities.
Future acquisitions or strategic investments could have a material adverse effect on our business and operating results because of:
For example, in 1998, we made a provision for, and subsequently wrote off, our entire $10.0 million investment in Albatronics (Far East) Company Limited, or Albatronics.
Our customers are dependent on shipping companies for delivery of our products and interruptions to shipping could materially and adversely affect our business and operating results.
Typically, we sell our products F.O.B. Hong Kong and our customers are responsible for the transportation of products from Hong Kong to their final destinations. Our customers rely on a variety of carriers for product transportation through various world ports. A work stoppage, strike or shutdown of one or more major ports or airports could result in shipping delays materially and adversely affecting our customers, which in turn could have a material adverse effect on our business and operating results. Similarly, an increase in freight surcharges due to rising fuel costs or general price increases could materially and adversely affect our business and operating results.
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Because our operations are international, we are subject to significant worldwide political, economic, legal and other uncertainties.
We are incorporated in the British Virgin Islands and have subsidiaries incorporated in the Cayman Islands, Hong Kong and China. We have administrative offices in Hong Kong and our People’s Republic of China, or PRC, headquarters are located in Macao, China. We manufacture all of our products in China. As of December 31, 2003, approximately 76.5% of the net book value of our total fixed assets is located in China. We sell our products to customers in Hong Kong, North America, Europe, Japan, China and Southeast Asia. Our international operations may be subject to significant political and economic risks and legal uncertainties, including:
The occurrence or consequences of any of these factors may restrict our ability to operate in the affected region and decrease the profitability of our operations in that region.
Our operating results could be negatively impacted by seasonality.
Historically, our sales and operating results have been affected by seasonality. Sales of calculators, personal organizers and linguistic products are typically higher during the second and third quarters in anticipation of the start of the school year and the Christmas buying season. Similarly, our consumer services for electronics products have historically been lower in the first quarter from both the closing of our factories in China for the Chinese New Year holidays and the general reduction in sales following the holiday season. These sales patterns may not be indicative of future sales performance.
Our results could be harmed if we have to comply with new environmental regulations.
Our operations create some environmentally sensitive waste that may increase in the future depending on the nature of our manufacturing operations. The general issue of the disposal of hazardous waste has received increasing attention from the PRC national and local governments and foreign governments and agencies and has been subject to increasing regulation. Our business and operating results could be materially and adversely affected if we were to increase expenditures to comply with environmental regulations affecting our operations.
If there is an adverse outcome in a putative class action litigation that has been filed against us, our business could be seriously harmed.
On March 11, 2003, we were served with a complaint in an action captioned Michael Rocco v. Nam Tai, et al., 03 Civ. 1148 (S.D.N.Y.), or the Rocco Action. In addition to Nam Tai, certain directors are named as defendants. On or about April 9, 2003, a second complaint was filed in an action captioned A.J. & Celine Steigler v. Nam Tai, et al., 03 Civ. 2462 (S.D.N.Y.), or the Steigler Action, and together with the Rocco Action, the Actions. The Actions have been consolidated since July 2003 and purports to represent a putative class of persons who purchased the common stock of Nam Tai from July 29, 2002 through February 18, 2003. Plaintiffs in the Actions assert claims under Section 10(b) of the Securities Exchange Act of 1934 and allege that misrepresentations and/or omissions were made during the alleged class periods concerning the partial reversal of an inventory provision and a charge to goodwill related to Nam Tai’s LCD panels and transformers segment, or LPT segment. We have filed a motion to dismiss the lawsuit and the putative class action has not been certified as a class action by the court. In any event, our motion to dismiss was heard in November 2003 and we are awaiting the judgment of the court thereof. Nam Tai believes it has meritorious defenses and it intends to defend the case vigorously. Nam Tai is aware of no other actions that have been filed which relate to these matters. The ultimate outcome of this litigation cannot be presently determined. However, this litigation could be very costly and divert our management’s attention and resources. In addition, we have no insurance covering our liability, if any, or that of our officers and directors, and we will have to pay the costs of defense. Any adverse determination in this litigation could also subject us to significant liabilities, any or all of which could materially and adversely affect our business and operating results.
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We are dependent on certain members of our senior management.
We are substantially dependent upon the services of Mr. Tadao Murakami, our Chairman of the Board of Directors, Mr. Joseph Li, our Chief Executive Officer and President, and Mr. M. K. Koo, our Chief Financial Officer. We have employment agreements with each of Mr. Murakami, Mr. Koo and Mr. Joseph Li. Mr. Murakami’s employment may be terminated immediately and, pursuant to Mr. Koo’s and Mr. Joseph Li’s agreements, their employment may be terminated upon short notice. Mr. Koo’s and Mr. Li’s employment agreements provide that they may not compete with our business nor solicit any of our customers or employees for a period of six months following termination for any reason under the employment agreements. Mr. Murakami’s agreement does not have comparable provisions. Accordingly, Mr. Murakami may engage in a business that is in competition with us after his termination, which may have a material adverse effect on our business and operating results. We maintain no key person insurance on these individuals. The loss of the services of any of these officers could have a material adverse effect on our business and operating results.
We may be unable to succeed in recovering on our judgment debts against Tele-Art.
We have two judgments in our favor against Tele-Art, Inc. awarded by The High Court of Justice in the British Virgin Islands for approximately $35.0 million. Because Tele-Art, Inc. is in liquidation, we may not realize the entire amount of our judgments, and the actual amount of the recovery, if any, is uncertain and dependent on a number of factors. We may incur substantial additional costs in pursuing our recovery, and such costs may not be recoverable.
We could become involved in intellectual property disputes.
We do not have any patents, licenses, or trademarks material to our business. Instead, we rely on trade secrets, industry expertise and our customers sharing of intellectual property with us. We may be notified that we are infringing patents, copyrights or other intellectual property rights owned by other parties. In the event of an infringement claim, we may be required to spend a significant amount of money to develop a non-infringing alternative or to obtain licenses. We may not be successful in developing such an alternative or obtaining a license on reasonable terms, if at all. Any litigation, even without merit, could result in substantial costs and diversion of resources and could materially and adversely affect our business and operating results.
We may not pay dividends in the future.
Although we have declared dividends during each of the last ten years, we may not be able to declare them or may decide not to declare them in the future. Our China subsidiaries are required to reserve 10% of profits for future development, which may affect our ability to declare dividends. We will determine the amounts of the dividends when they are declared and even if dividends are declared in the future, we may not continue them in any future period.
Risks Related to Our Operations in China, Hong Kong and Macao
Our manufacturing facilities are located in China and some of our subsidiaries and several of our customers and suppliers are located in Hong Kong and China. Our PRC headquarters are located in Macao, China. As a result, our operations and assets are subject to significant political, economic, legal and other uncertainties associated with doing business in China, Hong Kong and Macao, which are discussed in more detail below.
The Chinese government could change its policies toward, or even nationalize, private enterprise, which could harm our business and operating results.
Over the past several years, the Chinese government has pursued economic reform policies including the encouragement of private economic activities and decentralization of economic regulation with a move towards a market economy. The Chinese government may not continue to pursue these policies or may significantly alter them to our detriment from time to time without notice. Changes in policies by the Chinese government resulting in changes in laws, regulations, or their interpretation, or the imposition of confiscatory taxation, restrictions on currency conversion or imports and sources of supply could materially and adversely affect our business and operating results. The nationalization or other expropriation of private enterprises by the Chinese government could result in the total loss of our investment in China.
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The Chinese legal system has inherent uncertainties that could materially and adversely impact our ability to enforce the agreements governing our factories and to do business.
We do not own the land on which our factories in China are located. We occupy our principal manufacturing facilities under land use agreements with agencies of the Chinese government and we occupy other facilities under lease agreements with peasant collectives or other companies. The performance of these agreements and the operations of our factories are dependent on our relationship with the local government. Our operations and prospects would be materially and adversely affected by the failure of the local government to honor these agreements or an adverse change in the law governing them. In the event of a dispute, enforcement of these agreements could be difficult in China. Unlike the United States, China has a civil law system based on written statutes in which judicial decisions have limited precedential value. The Chinese government has enacted laws and regulations dealing with economic matters such as corporate organization and governance, foreign investment, commerce, taxation and trade. However, its experience in implementing, interpreting and enforcing these laws and regulations is limited, and our ability to enforce commercial claims or to resolve commercial disputes in China is unpredictable. These matters may be subject to the exercise of considerable discretion by agencies of the Chinese government, and forces and factors unrelated to the legal merits of a particular matter or dispute may influence their determination.
Fire, severe weather, flood or earthquake could cause significant damage to our facilities in China and disrupt our business operations.
Our products are manufactured exclusively at our factories located in China. Fire fighting and disaster relief or assistance in China is not well developed. Material damage to, or the loss of, our factories due to fire, severe weather, flood, earthquake or other acts of God or cause may not be adequately covered by proceeds of our insurance coverage and could materially and adversely affect our business and operating results. In addition, any interruptions to our business caused by such disasters could harm our business and operating results.
Controversies affecting China’s trade with the United States could harm our results of operations or depress our stock price.
While China has been granted permanent most favored nation trade status in the United States through its entry into the World Trade Organization, controversies between the United States and China may arise that threaten the status quo involving trade between the United States and China. These controversies could materially and adversely affect our business by, among other things, causing our products in the United States to become more expensive resulting in a reduction in the demand for our products by customers in the United States. Political or trade friction between the United States and China, whether or not actually affecting our business, could also materially and adversely affect the prevailing market price of our common shares.
Changes to Chinese tax laws and heightened efforts by the Chinese tax authorities to increase revenues could subject us to greater taxes.
Under applicable Chinese law, we have been afforded a number of tax concessions by, and tax refunds from, the Chinese tax authorities on a substantial portion of our operations in China by reinvesting all or part of the profits attributable to our Chinese manufacturing operations. However, the Chinese tax system is subject to substantial uncertainties with respect to its interpretation and enforcement. Following the Chinese government’s program of privatizing many state-owned enterprises, the Chinese government has oftempted to augment its revenues through heightened tax collection efforts. Continued efforts by the Chinese government to increase tax revenues could result in decisions or interpretations of the tax laws by the Chinese tax authorities that would increase our future tax liabilities or deny us expected concessions or refunds. For example, the tax reform of reducing the VAT tax refund from 17% to 13%, with effect from January 1, 2004, may affect our margins.
Our results have been affected by changes in currency exchange rates. Changes in currency rates involving the Japanese yen, Hong Kong dollar or Chinese renminbi could increase our expenses.
Our financial results have been affected by currency fluctuations, resulting in total foreign exchange losses of $62,000 during the year ended December 31, 2003 and total foreign exchange losses of $345,000 during the year ended December 31, 2002 and total foreign exchange gains of $530,000 during the year ended December 31, 2001. We sell most of our products in United States dollars and pay our expenses in United States dollars, Japanese yen, Hong Kong dollars, and Chinese renminbi. While we face a variety of risks associated with changes among the relative value of these currencies, we believe the most significant exchange risk presently results from material purchases we make in Japanese yen. Approximately 16%, 8% and 16% of our material costs have been in yen during the years ended December 31, 2001, 2002 and 2003, respectively, but sales made in yen accounted for less than 11% of sales for each of the last three years. An appreciation of yen against the U.S. dollar would increase our expenses when translated into U.S. dollars and would materially and adversely affect our margins unless we made sufficient sales in yen to offset against material purchases made in yen.
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Approximately less than 1% and 8% of our revenue and 13% and 12% of our expenses were in Chinese renminbi and Hong Kong dollars, respectively, during the year ended December 31, 2003. Approximately 4% and 10% of our revenues and 18% and 15% of our expenses were in Chinese renminbi and Hong Kong dollars, respectively, during the year ended December 31, 2002. An appreciation of the Chinese renminbi or Hong Kong dollar against the U.S. dollar would increase our expenses when translated into U.S. dollars and could materially and adversely affect our margins. In addition, a significant devaluation in the Chinese renminbi or Hong Kong dollar could harm our business if it destabilizes the economy of China or Hong Kong, creates serious domestic problems or increases our borrowing costs.
We have suffered losses from hedging against our currency exchange risk.
From time to time, we have attempted to hedge our currency exchange risk. We did not engage in currency hedging transactions for fiscal year 2002 and 2003. We have experienced in the past and may experience in the future losses as a result of currency hedging.
Political and economic instability in Hong Kong could harm our operations.
Some of our subsidiaries’ offices and several of our customers and suppliers are located in Hong Kong, formerly a British Crown Colony. Sovereignty over Hong Kong was resumed by China effective July 1, 1997. Since then, Hong Kong has become a Special Administrative Region of China, enjoying a high degree of autonomy except for foreign and defense affairs. Moreover, China’s political system and policies are not practiced in Hong Kong. Under the principle of “one country, two systems,” Hong Kong maintains a legal system that is based on the common law and is different from that of China. It is generally acknowledged as an open question whether Hong Kong’s future prosperity in its role as a hub and gateway to China after China’s recent accession to the World Trade Organization (introducing a market liberalization in China) will be diminished. The continued stability of political, economic or commercial conditions in Hong Kong remains uncertain, and any instability could materially and adversely impact our business and operating results.
The spread of severe acute respiratory syndrome or similar illnesses may have a negative impact on our business and operating results.
In March 2003, several economies in Asia, including Hong Kong and southern China, where our operations are located, were affected by the outbreak of severe acute respiratory syndrome, or SARS. Since January 2004, there has been a total of six confirmed SARS cases in southern China, Taiwan and Singapore. If there is a recurrence of a serious outbreak of SARS, it may adversely affect our business and operating results. For example, the future SARS outbreak could result in quarantines or closures to some of our factories if our employees are infected with SARS and ongoing concerns regarding SARS, particularly its effect on travel, could negatively impact our China-based customers and suppliers and our business and operating results.
In addition, there has recently been an outbreak of avian influenza in humans in both Thailand and Vietnam, which has proven fatal in some instances. If such an outbreak were to spread to southern China, where our operation facilities are located, it may adversely affect our business operating results.
Risks Related to Our Industry
We are exposed to general economic conditions. The current slowdown in the technology products industry has affected and we expect it to continue to affect our business and operating results adversely.
As a result of the economic downturn in the United States and internationally, and reduced capital spending, sales to OEMs in the electronics industry declined beginning in the second quarter of fiscal year 2001 and continuing through 2002. Lower consumer
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demand and high customer inventory levels have resulted in the delay and cancellation of orders for nearly all types of electronic products. As a result of order cancellations in 2001, we were required to write-down slow-moving inventory, which materially and adversely impacted our net income in 2001. Although the industry experienced a recovery in 2003, we cannot assure that this recovery is sustainable or that the industry will not further decline. If the economic conditions in the United States or the other markets we serve worsen or in the electronics and contract manufacturing businesses particularly, or if a wider or global economic slowdown occurs, this could materially and adversely impact our business and operating results.
The current economic downturn in the EMS industry could continue to have a material adverse effect on our business and operating results.
In 2001 and 2002, the EMS industry was in an economic slowdown with an uncertain outlook. Some of the major contract manufacturers and OEMs worldwide had announced job reductions and plant closures aimed at reducing costs. Industry analysts had reduced their projections of the future growth of the EMS segment. Furthermore, Wall Street analysts had reduced earnings and revenue estimates across the entire EMS sector and had reported that the EMS industry had excess capacity. For example, the EMS industry in which we operate experienced a decrease in demand in 2001 and 2002. Softening demand for our products and services caused by the ongoing economic downturn was responsible in part for a decline in our operating income in 2001, as well as our write-down for slow-moving inventory. Although the industry experienced a recovery in 2003, we cannot assure that this recovery is sustainable or that the industry will not further decline.
The global economy may remain weak and market conditions continue to be challenging in the EMS industry. As a result, individuals and companies may continue delaying or reducing expenditures, including those for electronic products. Further delays or reductions in spending in our industry in particular, and economic weakness generally, could materially and adversely affect our business and operating results.
Risks Related to Ownership of Our Common Shares
The market price of our shares will likely be subject to substantial price and volume fluctuations.
The markets for equity securities have been volatile and the price of our common shares has been and could continue to be subject to wide fluctuations in response to variations in operating results, news announcements, trading volume, sales of common shares by our officers, directors and our principal shareholders, customers, suppliers or other publicly traded companies, general market trends both domestically and internationally, currency movements and interest rate fluctuations. Certain events, such as the issuance of common shares upon the exercise of our outstanding stock options could also materially and adversely affect the prevailing market price of our common shares.
Further, the stock markets have recently experienced extreme price and volume fluctuations that have affected the market prices of equity securities of many companies and that have been unrelated or disproportionate to the operating performance of such companies. These fluctuations may materially and adversely affect the market price of our common shares.
The concentration of share ownership in our senior management allows them to control or substantially influence the outcome of matters requiring shareholder approval.
On March 1, 2004, members of our management and Board of Directors as a group beneficially owned approximately 37.9% of our common shares. As a result, acting together they may be able to control and substantially influence the outcome of all matters requiring approval by our shareholders, including the election of directors and approval of significant corporate transactions. This ability may have the effect of delaying or preventing a change in control of Nam Tai, or causing a change in control of Nam Tai that may not be favored by our other shareholders.
Risks Related to Our Foreign Private Issuer Status
It may be difficult to serve us with legal process or enforce judgments against our management or us.
We are a British Virgin Islands holding corporation having our PRC headquarters in Macao, China and some of our subsidiaries in Hong Kong. We have appointed Stephen Seung, 2 Mott Street, Suite 601, New York, New York 10013 as our agent upon whom process may be served in any action brought against us under the securities laws of the United States. However, outside the United States, it may be difficult for investors to enforce judgments against us obtained in the United States in any of these actions, including actions based upon civil liability provisions of the Federal securities laws. In addition, all of our officers and most of our directors reside outside the United States and all of our assets, and the assets of those persons who reside outside of the United States, are located outside of the United States. As a result, it may not be possible for investors to effect service of process within the United States upon those persons, or to enforce against those persons or us judgments obtained in United States courts grounded upon the liability provisions of the United States securities laws. There is substantial doubt as to the enforceability against us or any of our directors and officers located outside of the United States in original actions or in actions for enforcement of judgments of United States courts of liabilities based solely on the civil liability provisions of the securities laws of the United States.
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No treaty exists between Hong Kong or the British Virgin Islands and the United States providing for the reciprocal enforcement of foreign judgments. However, the courts of Hong Kong and the British Virgin Islands are generally prepared to accept a foreign judgment as evidence of a debt due. An action may then be commenced in Hong Kong or the British Virgin Islands for recovery of this debt. A Hong Kong or British Virgin Islands court will only accept a foreign judgment as evidence of a debt due if:
Enforcement of a foreign judgment in Hong Kong or the British Virgin Islands may also be limited or affected by applicable bankruptcy, insolvency, liquidation, arrangement, and moratorium or similar laws relating to or affecting creditors’ rights generally, and will be subject to a statutory limitation of time within which proceedings may be brought.
No treaty exists between Macao and the United States providing for the reciprocal enforcement of foreign judgments. However, the courts of Macao are generally prepared to accept a foreign judgment as evidence of a debt due. An action may then be commenced in Macao for recovery of this debt. A Macao court will only accept a foreign judgment as evidence of a debt due if:
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Enforcement of a foreign judgment in Macao may also be limited or affected by applicable bankruptcy, insolvency, liquidation, arrangement, and moratorium or similar laws relating to or affecting creditors’ rights generally, and will be subject to a statutory limitation of time within which proceedings may be brought.
Future issuances of preference shares could materially and adversely affect the holders of our common shares or delay or prevent a change of control.
Our Board of Directors may amend our Memorandum and Articles of Association without shareholder approval to create from time to time and issue one or more classes of preference shares (which are analogous to preferred stock of corporations organized in the United States). While currently no preference shares are issued or outstanding, we may issue preference shares in the future. Future issuance of preference shares could materially and adversely affect the rights of the holders of our common shares or delay or prevent a change of control.
Our status as a foreign private issuer exempts us from certain of the reporting requirements under the Securities Exchange Act of 1934 and corporate governance standards of the New York Stock Exchange, or NYSE, limiting the protections and information afforded to investors.
We are a foreign private issuer within the meaning of rules promulgated under the Securities Exchange Act of 1934. As such, we are exempt from certain provisions applicable to United States public companies including:
In addition, because the Company is a foreign private issuer, certain of the corporate governance standards of the NYSE that are applied to domestic companies listed on that exchange may not be applied to us.
Because of these exemptions, investors are not afforded the same protections or information generally available to investors holding shares in public companies organized in the United States or traded on the NYSE.
Item 4. Information on the Company
History and Development of Nam Tai
Nam Tai Electronics, Inc. was founded in 1975 and moved its manufacturing facilities to the People’s Republic of China, or China, in 1980 to take advantage of lower overhead costs, lower material costs and competitive labor rates available and subsequently relocated to Shenzhen, China in order to capitalize on opportunities offered in Southern China. We were reincorporated as a limited liability International Business Company under the laws of the British Virgin Islands in August 1987. Our principal manufacturing and design operations are based in Shenzhen, China, approximately 30 miles from Hong Kong. Our PRC headquarters are located in Macao, China. Some of our subsidiaries’ offices are located in Hong Kong, which provides us access to Hong Kong’s infrastructure of communication and banking and facilitates management of our China operations and transportation of our products out of China through the port of Hong Kong.
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Our corporate administrative matters are conducted in the British Virgin Islands through our registered agent, McW. Todman & Co., McNamara Chambers, P.O. Box 3342, Road Town, Tortola, British Virgin Islands. Our agent for service of process in the United States is Stephen Seung, 2 Mott Street, Suite 601, New York, New York 10013. Our principal executive offices are located in the British Virgin Islands at 116 Main Street, 3rd Floor, Road Town, Tortola, British Virgin Islands, and the telephone number is (284) 494-7752.
In 1978, Mr. Koo, the founder of the Company, began recruiting operating executives from the Japanese electronics industry. These executives brought years of experience in Japanese manufacturing methods, which emphasize quality, precision, and efficiency in manufacturing. Senior management currently includes Japanese professionals who provide technical expertise and work closely with both our Japanese component suppliers and customers.
For a number of years, we specialized in manufacturing large-volume, hand-held digital consumer electronic products and established a leading position in electronic calculators and handheld organizers for OEMs such as Texas Instruments Incorporated and Sharp Corporation. Over the years, we have broadened our product mix to include a range of digital products for business and personal use, as well as key components and subassemblies for telecommunications and consumer electronic products. In August 1999, we established Nam Tai Telecom (Hong Kong) Co. Ltd., which targets the expanding market for telecommunications components including LCD modules as well as end products, including cordless phones and family radio systems. Nowadays, color and monochrome LCD modules to display information have become one of our major products. Since December 2002, we have also produced RF modules for integration into cellular phones and other hand-held consumer electronic products, such as personal digital assistants, or PDAs, laptop computers and other products with wireless connectivity. In 2003, we further diversified our product mix by manufacturing CMOS sensor modules for integration into various image capturing devices such as digital cameras for cellular phones, and home entertainment products, flexible printed circuit, or FPC, subassemblies for integration into various LCD modules, front light panels for handheld video game devices, digital camera accessories for use with the cellular phones and home entertainment products.
In September 2000, we acquired for $2.0 million a 5% indirect shareholding in both TCL Mobile Communication (HK) Co., Ltd. and Huizhou TCL Mobile Communication Co., Ltd., together known as TCL Mobile, through the acquisition of 25% of the outstanding shares of Mate Fair Group Limited, or Mate Fair, a privately held investment holding company incorporated in the British Virgin Islands with a 20% shareholding interest in TCL Mobile. TCL Mobile is engaged in manufacturing, distributing and trading of digital mobile phones and accessories in China as well as overseas markets. In October 2002, we began to provide TCL Mobile with mobile LCD modules used in its mobile phones.
In October 2000, we completed the acquisition of the J.I.C. Group (BVI) Limited. The J.I.C. Group (B.V.I.) Limited and its subsidiaries, or the J.I.C. Group, are principally engaged in the manufacture and marketing of transformers and LCD panels, a key component for a variety of consumer electronic products. Of the purchase price of $32.8 million, we paid $11.0 million in cash and issued 3.48 million of our common shares.
In November 2002, Mate Fair sold a portion of its equity interest in Huizhou TCL Mobile Communication Co., Ltd. for which we received proceeds of approximately $10.4 million, reducing our direct equity interest (held through Mate Fair) in TCL Mobile to approximately 3%. In November 2002, we invested $5.1 million of the proceeds in TCL International Holdings Limited’s 3% convertible notes that are due in November 2005. In August 2003, we disposed of those convertible notes to independent third parties and received proceeds of approximately $5.03 million in cash. TCL International Holdings Limited is another company in the TCL Group, which consists of the TCL Corporation and its subsidiaries, and is publicly listed on The Stock Exchange of Hong Kong Limited, or the Hong Kong Stock Exchange.
In January 2002, we acquired a 6% equity interest in TCL Corporation (formerly known as TCL Holdings Corporation Ltd.), for a consider of $12.0 million. TCL Corporation, an enterprise established in the PRC, is the parent company of the TCL Group of companies. TCL Corporation changed from a limited liability company to a company limited by shares in April 2002. In January 2004, TCL Corporation listed its A-shares on the Shenzhen Stock Exchange at Chinese renminbi 4.26 (equivalent to $0.52) per A-share. The Company’s interest in TCL Corporation has since been diluted to 3.69% and represents 95.52 million promoter’s shares of TCL Corporation after its initial public offering.
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In January 2002, we entered into a transaction which resulted in the listing of a company holding J.I.C. Group’s business on the Hong Kong Stock Exchange. To effect the transaction, we entered into an agreement with the liquidators of Albatronics, whose shares had been listed on the Hong Kong Stock Exchange and which was placed into voluntary liquidation in August 1999. Under the agreement, we agreed to transfer the J.I.C. Group into J.I.C. Technology Company Limited, a new company, for a controlling interest in J.I.C. Technology Company Limited. Albatronics’ listing status on the Hong Kong Stock Exchange was withdrawn and J.I.C. Technology Company Limited was listed on the Hong Kong Stock Exchange free from the liabilities of Albatronics. This arrangement was more cost effective than using an initial public offering. For our contribution to J.I.C. Technology Company Limited, we received a combination of ordinary and preference shares, which are analogous to common stock and convertible preferred stock, respectively, of companies organized under U.S. law and which upon their full conversion, could result in us, the creditors and the Hong Kong public owning approximately 92.9%, 5.8% and 1.3%, respectively, of the outstanding ordinary shares of J.I.C. Technology Company Limited. On June 4, 2002, the reverse merger was completed and all the shares of Albatronics were transferred to the liquidators for a nominal consideration. The preference shares are non-redeemable, non-voting shares that rank pari passu with ordinary shares of J.I.C. Technology Company Limited on the payment of dividends or other distribution other than on a winding-up. No holder of preference shares (including Nam Tai) may convert them if such conversion would result in the minimum public float of 25%, which required under the Hong Kong Stock Exchange Listing Rules, not being met. In August 2002, we acquired an additional 7,984,000 ordinary shares of J.I.C. Technology Company Limited for a cash consideration of $437,000. During the period from June to November 2003, we disposed of a total of 42,600,000 ordinary shares for cash consideration of $4.0 million. In November 2003, we converted 175,100,000 preference shares into 170,000,000 ordinary shares of J.I.C. Technology Company Limited. As of December 31, 2003, we held 263,900,688 ordinary shares of J.I.C. Technology Company Limited, equivalent to 74.86% of issued ordinary shares, and 423,320,000 preference shares. Upon full conversion of the preference shares owned, we will hold approximately 88.39% of J.I.C. Technology Company Limited.
In January 2003, we invested $10.0 million for a 25% equity interest in Alpha Star Investments Ltd., the ultimate holding company of JCT Wireless Technology Limited, or JCT. JCT is engaged in the design, development and marketing of wireless communication terminals and wireless application software and is using us to manufacture wireless communication terminals and their related modules for JCT. As of December 31, 2003, we recognized net sales of $20.8 million to JCT for 2003.
In January 2003, we disposed of 20% of our equity interest in Namtek Software Development Company Limited to a company that is owned by the management of Namtek Software Development Company Limited for a cash consideration of $160,000. As of the date of disposal, Namtek Software Development Company Limited was fair valued at $3.3 million.
On January 23, 2003, the listing of our shares was transferred to the NYSE from the NASDAQ National Market with symbol of “NTE”. On June 30, 2003, we implemented a three-for-one stock split with both the stock size and market price to be divided by three. As of December 31, 2003, there were 41,231,272 common shares outstanding.
In June 2003, one of our subsidiaries, J.I.C. Technology Company Limited, disposed of its transformers operation to a third party for a cash consideration of $2.4 million. The gain from disposal of this discontinued operation amounted to $2.0 million, net of $0.1 million shared by minority interest.
In August 2003, we set up our PRC headquarters in Macao, due to our continuous increase in investment in China. Macao, like Hong Kong, is a special administrative region of the China and has recently introduced an incentive program to attract investment in Macao.
In November 2003, our common shares were listed in the Regulated Unofficial Market (Freiverkehr) on the Frankfurt Stock Exchange, in Germany. The stocks are being traded on Xetra, the Deutsche Borse AG electronic trading system under the stock symbol of “884852”.
In December 2003, we placed approximately $5.3 million into an escrow account for an investment in Stepmind. The investment will be in two phases. For the first phase, approximately $2.64 million, representing 7.66% of the equity interest in Stepmind, was released to Stepmind in January 2004. The second phase amounting to approximately $2.65 million will be released to Stepmind in August 2004 subject to fulfillment of certain conditions. Upon successful subscription of the shares in the second phase, our total investment will represent 11.33% of the equity interest in Stepmind. Stepmind was founded in July 2000 and is a fabless solutions and components supplier, developing applications which require high performance and secured data links.
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Also refer to the section of this Report entitled Item 5. Operating and Financial Review and Prospects for a further discussion of our investments and acquisitions.
An important element of our strategy is to acquire companies that would complement our existing products and services, augment our market coverage and sales ability or enhance our technological capabilities. Accordingly, we may acquire additional businesses, products or technologies in the future or make investments in related businesses for strategic business purposes.
Capital Expenditures
Our principal capital expenditures and divestitures over the last three years include the following:
Our capital expenditures in 2003 included:
Our major capital expenditures in 2002 included:
Our major capital expenditures in 2001 included:
In order to expand production capacity, we are building a new factory consisting of approximately 250,000 square feet adjacent to our principal manufacturing facilities in Shenzhen, China. The construction commenced in September 2003 and we expect construction to be completed by the end of the fourth quarter in 2004. We have budgeted $40.0 million to cover the cost of construction and fixtures and equipment for the new factory, of which $1.2 million has already been spent in 2003. We plan to finance these improvements to our manufacturing facilities from cash resources and banking facilities.
Other capital expenditures we have planned for 2004 include:
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Our plans for capital expenditures are subject to change from time to time and could result from, among other things, our consummation of any significant amount of additional acquisition or strategic investment opportunities, which we regularly explore.
Business Overview
We are an electronics manufacturing and design services provider to a select group of the world’s leading OEMs of telecommunications and consumer electronic products. Through our electronics manufacturing services operations, we manufacture electronic components and subassemblies, including LCD panels, LCD modules, RF modules, FPC subassemblies and image sensors. These components are used in numerous electronic products, including cellular phones, laptop computers, digital cameras, copiers, fax machines, electronic toys, handheld video game devices and microwave ovens. We also manufacture finished products, including cellular phones, palm-sized PCs, personal digital assistants, electronic dictionaries, calculators and digital camera accessories for use with cellular phones.
We assist our OEM customers in the design and development of their products and furnish full turnkey manufacturing services that utilize advanced manufacturing processes and production technologies. Our services include hardware and software design, component purchasing, assembly into finished products or electronic subassemblies and post-assembly testing. These services are value-added and assist us in obtaining new business but do not represent a material component of our revenue. We also provide original design manufacturing, or ODM, services, in which we design and develop proprietary products that are sold by our OEM customers using their brand name.
We were founded in 1975 as an electronic products trading company based in Hong Kong and shifted our focus to manufacturing of electronic products in 1978. We moved our manufacturing facilities to China in 1980 to take advantage of lower overhead costs, lower material costs and competitive labor rates available and subsequently relocated to Shenzhen, China in order to capitalize on opportunities offered in Southern China. We were reincorporated as a limited liability International Business Company under the laws of the British Virgin Islands in August 1987. Our principal manufacturing and design operations are based in Shenzhen, China, approximately 30 miles from Hong Kong. Our PRC headquarters are located in Macao, China. Some of our subsidiaries’ offices are located in Hong Kong, which provides us access to Hong Kong’s infrastructure of communication and banking and facilitates management of our China operations and transportation of our products out of China through the port of Hong Kong.
Our Customers
Historically, we have had substantial recurring sales from existing customers. About 89.1% of our 2003 net sales came from customers that also used our services in 2002. While we seek to diversify our customer base, a small number of customers currently generate a significant portion of our sales. Sales to our 10 largest customers accounted for 83.7%, 84.8% and 84.9% of our net sales during the years ended December 31, 2001, 2002 and 2003, respectively. Sales to customers accounting for 10% or more of our net sales in the year ended December 31, 2001, 2002 or 2003 were as follows:
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Our largest OEM customers based on net sales during 2003 include the following (listed alphabetically):
At any given time, different customers account for a significant portion of our business. Percentages of net sales to customers vary from quarter to quarter and year to year and fluctuate depending on the timing of production cycles for particular products.
Sales to our OEM customers are primarily based on purchase orders we receive from time to time rather than firm, long-term purchase commitments from our customers. Although it is our general practice to purchase raw materials only upon receiving a purchase order, for certain customers we will occasionally purchase raw materials based on such customers’ rolling forecasts. Uncertain economic conditions and our general lack of long-term purchase commitments with our customers make it difficult for us to accurately predict revenue over the longer term. Even in those cases where customers are contractually obligated to purchase products from us or repurchase unused inventory from us, we may elect not to immediately enforce our contractual rights because of the long-term nature of our customer relationships and for other business reasons, and instead may negotiate accommodations with customers regarding particular situations.
Our Products
The dollar amount (in thousands) and percentage of our net sales by business segment and product category for the years ended December 31, 2001, 2002 and 2003 were as follows:
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Please refer to page F-34 of the consolidated financial statements and Item 8. Financial Information — Export Sales, which sets forth the information of net sales to customers by geographic area.
Consumer Electronic Products
Component Assembly
We manufacture the following subassemblies and components:
LCD Consumer Products
The LCD-based consumer electronic products we manufacture are primarily finished products and include:
Software Development Services
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We offer our OEM customers software development services principally for the operation of electronic dictionary products, many of which are manufactured by us, as well as personal organizers and MP3 devices. In addition to generating revenue from our development services, our software design, which typically occurs at the product design stage, often results in our providing manufacturing services to the OEM assembly customers.
LCD Panels and Transformers
With the acquisition of J.I.C. Group in October 2000, we began producing LCD panels and transformers.
LCD Panels
LCD panels are information display components and are featured in numerous electronics products, including watches, clocks, calculators, pocket games, PDAs and cellular and wireless telephones. Currently, we use only a small portion of the LCD panels in our assembly operations. We plan to increase the volume of LCD panels we supply by approximately 50% to our assembly business in 2004.
Transformers
Transformers are generally used to increase or reduce the voltage of an electric power supply to allow a particular part of electrical equipment to be used. The transformers we produce are used in home appliances, telecommunications equipment, computers and computer peripherals. We sold our transformers operation to a third party in June 2003.
Our Manufacturing and Assembly Capabilities
We utilize the following production techniques:
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At December 31, 2003, we had three clean rooms at our principal manufacturing facilities, which housed COF and COG capabilities for LCD module manufacturing. We also had three clean rooms at another of our factories, which are used to manufacture LCD panels. Of our six clean rooms at December 31, 2003, three were class ten thousand and three were class thousand.
Quality Control
We maintain strict quality control programs for our products, including the use of total quality management, or TQM, systems and advanced testing and calibration equipment. Our quality control personnel test the quality of incoming raw materials and components. During the production stage, our quality control personnel also test the quality work-in-progress at several points in the production process. Finally, after the assembly stage, we conduct testing of finished products. In addition, we provide office space at our principal manufacturing facilities for representatives of our major customers to permit them to monitor production of their products and we provide them with direct access to our manufacturing personnel.
All of our manufacturing facilities are certified under ISO 9001 quality standards, the International Organization for Standardization’s, or ISO’s highest standards. The ISO is a Geneva-based organization dedicated to the development of worldwide standards for quality management guidelines and quality assurance. ISO 9000, which was the first quality system standard to gain worldwide recognition, requires a company to gather, analyze, document, monitor and make improvements where needed. Our certification under an ISO 9001 quality standard demonstrates that our manufacturing operations meet the most demanding of the established world standards. Our principal manufacturing facilities are also certified under an ISO 14001 quality standard, which was published in 1996 to provide a structured basis for environmental management control.
Our Suppliers
We purchase thousands of different component parts from numerous suppliers. We are not dependent upon any single supplier for any key component. We purchase components from suppliers in Japan, China and elsewhere. We generally base component orders on received purchase orders in an effort to minimize our inventory risk by ordering components and products only to the extent necessary although for certain customers we will occasionally purchase raw materials based on such customer’s rolling forecasts.
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The major component parts we purchase include the following:
Whenever practical, we use domestic China suppliers who are often able to provide items at low costs and with short lead times.
Certain components may be subject to limited allocation by certain of our suppliers. During 2000, there was an industry-wide shortage of components in the electronics industry as supply was unable to satisfy growing world demand. In some cases, supply shortages and delays in deliveries of particular components have resulted in curtailed production, or delays in production of assemblies using scarce components. These supply shortages have contributed to an increase in our inventory levels and reduction in our margins. We expect that shortages and delays in deliveries of some components will continue. If we are unable to obtain sufficient components on a timely basis, we may experience manufacturing delays, which could harm our relationships with current or prospective customers and reduce our sales.
The principal raw materials used by the Company are large scale integrated circuits or LSI circuits (CMOS), Semiconductors, LCD panels and batteries. At times the pricing and availability of these raw materials can be volatile, due to numerous factors beyond the Company’s control, including general economic conditions, currency exchange rates, industry cycles, production levels or a supplier’s tight supply. In the past, we have asked our customers to share in the increased costs of raw materials where such increased costs would adversely affect the Company’s business, results of operations and financial condition. Our customers have generally agreed when so requested in the past. We cannot assure you, however, that our customers will agree to share costs in the future and that our business, results of operations and financial condition would not be adversely affected by increased volatility of raw materials.
Production Scheduling
The typical cycle for a product to be designed, manufactured and sold to an OEM customer is one to two years, which includes the production period, the development period and the period for market research and data collection (which is undertaken primarily by our OEM customers). Initially an OEM customer gathers data from its sales personnel on products for which there is market interest, including features and unit costs. The OEM customer then contacts us, and possibly other prospective manufacturers, with forecasted total production quantities and design specifications or renderings. From that information, we in turn contact our suppliers and determine estimated component and material costs. We later advise our OEM customer of the development costs, charges (including molds, tooling and software design, if applicable) and unit cost based on the forecasted production quantities desired during the expected production cycle.
Once we and the OEM customer agree to the quotation for the development costs and the unit cost, we begin the product development if we are engaged to do so. This development period typically lasts less than six months, but may be longer if software design is included. During this time we complete all molds, tooling and software required to manufacture the product with the development costs generally borne by our customer. Upon completion of the molds, tooling and software, we produce samples of the product for the customer’s quality testing, and, once approved, commence mass production of the product. We recover the development costs in relation to molds, tooling and software from our customers.
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The production period usually lasts approximately six to twelve months. In some cases, our customer handles all product design and development and engages us only at the point of initial production. Typically, more advanced products have shorter production runs. If total production quantities change, the OEM customer often provides only limited notice before discontinuing orders for a product. At any point in time we are in different stages of the development and production periods for the various models under development or in production for our OEM customers.
Generally, our production is based on purchase orders received from OEM customers. Purchase orders are often supported by letters of credit or written confirmation from the OEM customer and generally may not be cancelled once confirmed without the mutual consent of the parties. Even in those cases where customers are contractually obligated to purchase products from us or repurchase unused inventory from us, we may elect not to immediately enforce our contractual rights because of the long-term nature of our customer relationships and for other business reasons, and instead may negotiate accommodations with customers regarding particular situations.
We did not suffer a material loss resulting from the cancellation of OEM customer orders in 2001 to 2003. In 2001, we wrote down our inventory for $3.8 million for slow-moving raw materials relating to cancelled, reduced or delayed orders. However, subsequently we were able to use some of these raw materials in production or we received compensation for the unused raw materials from certain of our customers, and the gain of $2.0 million was recorded in cost of sales during 2002.
Sales and Marketing
We focus on developing close relationships with our customers at the development and design phases and continuing throughout all stages of production. We identify, develop and market new technologies that benefit our customers and position us well as an EMS provider.
Sales and marketing operations are integrated processes involving direct salespersons, project managers and senior executives. We direct our sales resources and activities at several management and staff levels within our customers and prospective customers. We receive unsolicited inquiries resulting from word of mouth, from public relations activities, and through referrals from current customers. We evaluate these opportunities against our customer selection criteria and assign direct salespersons.
Seasonality
Historically, our sales and operating results are often affected by seasonality. Sales of calculators, personal organizers and linguistic products are often higher during the second and third quarters in anticipation of the start of the school year and the Christmas buying season. Similarly, our consumer services for electronics products have historically been lower in the first quarter resulting from both the closing of our factories in China for the Chinese New Year holidays and the general reduction in sales following the holiday season. As we have diversified our services for complex components, we expect that seasonality may be less of a factor affecting our business.
Transportation
Typically, we sell products F.O.B. Hong Kong, which means that our customers are responsible for the transportation of finished products from Hong Kong to their final destination. Transportation of components and finished products to and from Shenzhen is by truck. Component parts purchased from Japan are generally shipped by air. To date, we have not been materially affected by any transportation problems. However, transportation difficulties affecting air cargo or shipping, such as an extended closure of ports that materially disrupts the flow of our customers’ products into the United States, could materially and adversely affect our sales and margins if, as a result, our customers delay or cancel orders or seek concessions to offset expediting charges they incurred pending resolution of the problems causing the port closures.
Competition
General competition in the contract EMS industry is intense and characterized by price erosion, rapid technological change and competition from major international companies. This intense competition has resulted in pricing pressures, lower sales and reduced margins. We believe that the principal competitive factors in our targeted markets are product quality, pricing, flexibility and timeliness in responding to design and schedule changes, reliability in meeting product delivery schedules, technological sophistication and geographic location. Many of our competitors have greater financial, technical, marketing, manufacturing, regional shipping capabilities and logistics support and personnel resources than we do and we may not be able to continue to compete successfully.
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The EMS services we provide are available from many independent sources as well as from current and potential customers with in-house manufacturing capabilities. Our EMS competitors include Celestica, Inc., Flextronics International Ltd., Jabil Circuit, Inc., Sanmina-SCI Corporation, Hon Hai Precision Industry Co., Ltd. and Solectron Corporation. Our principal competitors in the manufacture of our traditional product lines of calculators, personal organizers and linguistic products include Kinpo Electronics, Inc. and Inventec Co. Ltd. Our principal competitors in the manufacture of image capturing devices and the CMOS sensor modules are Lite-On Technology Corporation, The Primax Group and Logitech, Inc. We have numerous competitors in the telecommunications, subassemblies and components product lines, including, Philips, Samsung and Varitronix.
Research and Development
We invest in research and development for manufacturing and assembly technology that provide us with the potential to offer better and more technologically advanced services to our OEM customers or assist us in working with our OEM customers in the design and development of future products. We plan to continue acquiring advanced design equipment and to enhance our technological expertise through continued training of our engineers and further hiring of qualified system engineers. These investments are intended to improve the speed, efficiency and quality of our assembly processes.
In our ODM business, we are responsible for the design and development of new products, the rights to which we own. We sell these products to OEM customers to be marketed to end users under the customers’ brand names. To date, we have successfully developed a number of electronic dictionaries, cordless telephones and calculator products. Our efforts to expand or maintain the ODM business may not be successful and we may not achieve material revenues or profits from our efforts. To date, our ODM design activities have not been a material portion of our research and development budget.
Patents, Licenses and Trademarks
We do not have any patents, licenses or trademarks on which our business is substantially dependent. Instead, we rely on our trade secrets, industry expertise and long-term relationships with our customers and suppliers.
Organizational Structure
We are a holding company for Nam Tai Investments Consultant (Macao Commercial Offshore) Company Limited, Nam Tai Group Management Ltd., Nam Tai Electronic & Electrical Products Limited, Nam Tai Telecom (Cayman) Company Limited, Namtek Software Development Company Limited and J.I.C. Technology Company Limited and their subsidiaries. The chart below illustrates the organizational structure of the Company and our principal operating subsidiaries at December 31, 2003.
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Our significant operating entities are described below:
J.I.C. Technology Company Limited
J.I.C. Technology Company Limited was formed in the Cayman Islands in January 2002 in connection with a reverse merger with Albatronics, of which we owned slightly more than 50% of the outstanding capital stock. J.I.C. Technology Company Limited was listed on the Hong Kong Stock Exchange in June 2002. We currently hold 74.86% of the ordinary shares of J.I.C. Technology Company Limited, and upon full conversion of the preference shares we own, we would own approximately 88.39% of J.I.C. Technology Company Limited.
J.I.C. Enterprises (Hong Kong) Ltd.
J.I.C. Enterprises, incorporated in Hong Kong, was established in 1983 and has been in the LCD business for almost 20 years. Originally a small trading company for LCD panels and electronics products, J.I.C. Enterprises is now strategically focused on the sales and marketing of LCD panels and is responsible for customer relationship development.
Jetup Electronic (Shenzhen) Co., Ltd.
Jetup Electronic was incorporated in 1993 in China and handles the manufacturing and processing works of LCD panels through its factory plants in Baoan County, Shenzhen.
Nam Tai Investments Consultant (Macao Commercial Offshore) Company Limited
Nam Tai Macao was established in August 2003 in Macao, China as our PRC headquarters, due to our continuous increase in investment in China. Macao, like Hong Kong, is a special region of China and has recently introduced an incentive program to attract investment in Macao. Its principal business is the provision of management and sales co-ordination and marketing services to other group companies.
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Nam Tai Group Management Limited
Nam Tai Group Management was established on March 9, 2001 in Hong Kong and provides management services to other group companies.
Nam Tai Telecom (Cayman) Company Limited
Nam Tai Telecom (Cayman) Company Limited was incorporated in June 2003 in the Cayman Islands, and is the holding company for Zastron Electronic (Shenzhen) Company Limited.
Zastron Electronic (Shenzhen) Company Limited
Zastron Electronic (Shenzhen) Company Ltd. was organized as Zastron Plastic & Metal Products (Shenzhen) Ltd. in March 1992 as a limited liability company pursuant to the relevant laws of China. Zastron engaged in production of metallic parts and PVC plastic products, much of which is used in products manufactured in our principal manufacturing facilities. In August 2002, Zastron Plastic & Metal Products (Shenzhen) Ltd. changed its name to Zastron Electronic (Shenzhen) Co. Ltd. and the nature of business was expanded to include manufacturing of telecommunication products and LCD modules and become one of our principal manufacturing arms. In June 2002, Zastron’s equity interest was transferred from Nam Tai Electronic & Electrical Products Limited (Hong Kong) to Nam Tai Group Management Limited. In October 2002, Zastron’s silk screening business was transferred to Jieyao Electronics (Shenzhen) Co. Ltd., a former subsidiary of J.I.C. Technology Company Limited and was sold in June 2003. In December 2002, the equity interest of Zastron was transferred from Nam Tai Group Management Limited to Nam Tai Telecom (Hong Kong) Company Limited. In December 2003, the equity interest of Zastron was transferred from Nam Tai Telecom (Hong Kong) Company Limited to Nam Tai Telecom (Cayman) Company Limited.
Nam Tai Electronic & Electrical Products Limited
Nam Tai Electronic & Electrical Products Limited was incorporated in June 2003 in the Cayman Islands, and is the holding company for Namtai Electronic (Shenzhen) Co., Ltd.
Namtai Electronic (Shenzhen) Co., Ltd.
Namtai Electronic (Shenzhen) Co., Ltd. was established as Baoan (Nam Tai) Electronic Co. Ltd. in June 1989 as a contractual joint venture company with limited liability pursuant to the relevant laws of China. The equity of Baoan (Nam Tai) Electronic Co. Ltd. was owned 70% by Nam Tai Electronic & Electrical Products Limited and 30% by a Chinese company. In 1992, the Chinese company transferred all of its equity interest in the contractual joint venture to Nam Tai Electronic & Electrical Products Limited and the company changed its name to Namtai Electronic (Shenzhen) Co., Ltd. Namtai Electronic (Shenzhen) Co., Ltd. became a wholly owned subsidiary of Nam Tai Electronic & Electrical Products Limited. Namtai Electronic (Shenzhen) Co., Ltd. is one of our principal manufacturing arms and is engaged in research and development, manufacturing and assembling our electronic products in China. In December 2003, the equity interest of Namtai Electronic (Shenzhen) Co., Ltd. was transferred from Nam Tai Electronic & Electrical Products Limited (Hong Kong) to Nam Tai Electronic & Electrical Products Limited (Cayman Islands).
Namtek Software Development Company Limited
Namtek Software Development Company Limited was incorporated in May 2002 in the Cayman Islands and was established as the holding company for Shenzhen Namtek Co., Ltd.
Shenzhen Namtek Co., Ltd.
Shenzhen Namtek Co., Ltd. was organized in December 1995 as a limited liability company pursuant to the relevant laws of China. Shenzhen Namtek Co., Ltd. commenced operations in early 1996 developing and commercializing software for the consumer electronics industry, particularly for our customers and for products we manufacture or we will manufacture in the future. At December 31, 2003, Shenzhen Namtek Co., Ltd employed approximately 77 software engineers and provides the facilities and expertise to assist in new product development and research, enabling us to offer our customers program design for microprocessors, enhanced software design and development services, and strengthening our ODM capabilities. In July 2002, Shenzhen Namtek Co., Ltd set up a branch office in Shanghai for employing more expertise to assist in new product development and research. As of December 31, 2003, Shenzhen Namtek Co., Ltd’s Shanghai office employed approximately 11 software engineers.
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Namtek Japan Company Limited
Namtek Japan Company Limited was incorporated in June 2003 in Tokyo, Japan and is the sales and marketing arm of software business of Namtek in Japan.
Property, Plant and Equipment
Our registered office and principal executive office in the British Virgin Islands is located at McNamara Chambers, P.O. Box 3342, Road Town, Tortola. Corporate administrative matters are conducted at this office through our registered agent, McNamara Corporate Services Limited. We do not own any property in the British Virgin Islands. The table below lists the locations, square footage, principal use and lease expiration dates of the facilities used in our principal operations.
In order to expand production capacity, we are building a new factory consisting of approximately 250,000 square feet on portions of the vacant land adjacent to our existing factory complex in Shenzhen, China. Construction began in September 2003 and we expect it to be completed by the end of the fourth quarter in 2004. After completion, the production capacity is expected to increase from 40% to 60%. We have budgeted $40.0 million to cover the cost of construction and fixtures and equipment for the new factory. As of December 31, 2003, the construction project has already incurred $1.2 million. We currently plan to finance these improvements to our manufacturing facilities from cash resources and banking facilities.
Hong Kong
In 2001, our Hong Kong offices relocated to 15/F, China Merchants Tower, Shun Tak Centre, 168-200 Connaught Road, Central, Hong Kong. The office is conveniently located above the ferry terminal and beside the highway, permitting easy transportation by sea or by land to and from the manufacturing facilities in Shenzhen. The purchase and renovation of the 24,200 square feet of contiguous prime office space, including transaction fees, cost $13.0 million.
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As of December 31, 2003, we own four residential flats in Hong Kong purchased for total consideration of $5,999,000. These properties are occupied by senior management and form part of their compensation.
Until 1996, we owned approximately ten acres of land in Hong Kong carried on our books at a cost of approximately $523,000. Between 1997 and 2003 we sold approximately 7.7 acres of land for net proceeds of $7,281,000, realizing a gain of $7,027,000. We plan to sell the remaining land and, pending the sale, to continue to carry the land at cost of approximately $134,000.
Macao
In August 2003, we set up our PRC headquarters in Macao, China due to our continuous increase in investment in China. Macao, like Hong Kong, is a special administrative region of China and has recently introduced an incentive program to attract investment in Macao.
Shenzhen, China
Principal Manufacturing Facilities
Our principal manufacturing facilities are located in Baoan County, Shenzhen, China. The lease for this land was purchased for approximately $2.45 million in December 1993 and has a term of 50 years. This facility consists of 160,000 square feet of manufacturing space, 39,000 square feet of offices, 212,000 square feet of new dormitories, 26,000 square feet of full service cafeteria and recreation facilities and a swimming pool. The total cost of this addition to our complex, excluding land, was approximately $21.8 million. In November 2000, we began construction of another addition to our factory complex. We completed construction in October 2002, adding a new five-story factory with 138,000 square feet of production facilities, including one floor for assembling, one floor of office space, one floor for warehouse use and two floors of class thousand clean room facilities. Prior to this addition, we had only one floor of class ten thousand clean room facilities at our factory complex. As of December 31, 2002, we had spent $9.1 million to complete the construction of the new facility. With the new addition, we had approximately 626,000 square feet of manufacturing space at our principal manufacturing complex as of December 31, 2002, with only minimal additions in 2003.
In July 1999, we purchased a vacant lot of approximately 280,000 square feet (approximately 6.5 acres) bordering our current manufacturing complex located in Shenzhen, China at a cost of approximately $1.2 million. We are building another factory consisting of approximately 250,000 square feet. Construction has began in September 2003 and we expect it to be completed by the end of the fourth quarter in 2004. We have budgeted $40.0 million to cover the cost of construction and fixtures and equipment for the new factory, of which $1.2 million has already been spent in 2003. We currently plan to finance these improvements to our manufacturing facilities from cash resources and banking facilities.
LCD Factory
Our LCD factory was leased since 1997 and has about 151,738 square feet of manufacturing space. The facility produces LCD panels to the specifications of our OEM customers and has an average monthly output of 12 to 14 million pieces. The lease of the facility will expire on August 31, 2004. In October 2003, Jetup Electronic (Shenzhen) Co. Ltd. entered into a tenancy agreement for new factory premises and plans to replace its existing factory premises in order to expand its manufacturing facilities to cope with future development. Also located in Baoan County, Shenzhen, China, the new factory premises, including dormitories, are about 600,000 square feet which are two times the size of the existing factory premises. Jetup Electronic (Shenzhen) Co. Ltd. plans to move into the new factory premises in the third quarter of 2004. The existing factory premises will then be returned to the landlord.
Software Development
We currently lease three offices in which we conduct software development. Our Shekou, Shenzhen, China office has approximately 8,931 square feet, which we lease under two one-year leases expiring in August and September 2004, respectively. The monthly rental is approximately $6,017. Our Shanghai, China office, has approximately 4,754 square feet, which we lease under a three-year lease expiring in July 2005. The monthly rental is approximately $4,033. In July 2003, we opened an office in Tokyo, Japan to further expand our sales and marketing team in Japan for our software development business. The Tokyo office has approximately 904 square feet, which we lease under a two-year lease expiring in June 2005. The monthly rental is approximately $1,900.
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Item 5. Operating and Financial Review and Prospects
Except for statements of historical facts, this section contains forward-looking statements involving risks and uncertainties. You can identify these statements by forward-looking words including “expect,” “anticipate,” “believe,” “seek,” “estimate,” “intends,” “should,” or “may.” Forward-looking statements are not guarantees of our future performance or results and our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under the section of this Report entitled Item 3. Key Information — “Risk Factors.” This section should be read in conjunction with our Consolidated Financial Statements included as Item 18 of this Report.
Operating Results
Overview
We are an electronics manufacturing and design services provider to OEMs of telecommunications and consumer electronic products. Through our EMS operations, we manufacture electronic components and subassemblies, including LCD panels, LCD modules, RF modules, FPC subassemblies and image sensors. These components are used in numerous electronic products, including cellular phones, laptop computers, digital cameras, copiers, fax machines, electronic toys, handheld video game devices and microwave ovens. We also manufacture finished products, including cellular phones, palm-sized PCs, PDAs, electronic dictionaries, calculators and digital camera accessories for use with cellular phones.
We assist our OEM customers in the design and development of their products and furnish full turnkey manufacturing services that utilize advanced manufacturing processes and production technologies. Our services include hardware and software design, component purchasing, assembly into finished products, or electronic subassemblies and post-assembly testing. These services are value-added and assist us in obtaining new business but do not represent a material component of our revenue. We also provide ODM services, in which we design and develop proprietary products that are sold by our OEM customers using their brand name.
Net Sales and Cost of Sales
We derive our net sales principally from manufacturing services that we provide to OEMs of telecommunications and consumer electronic products. The market for the products we manufacture is generally characterized by declining unit prices and short product life cycles. Sales to our OEM customers are primarily based on purchase orders we receive from time to time rather than firm, long-term purchase commitments from our customers. We recognize sales, net of product returns and warranty costs, typically at the time of product shipment or, in some cases, as services are rendered.
A substantial percentage of our net sales are to a small number of customers. During the years ended December 31, 2001, 2002 and 2003, sales to our ten largest customers were 83.7%, 84.8% and 84.9% of our net sales, respectively. Furthermore, our customers accounting for 10% or more of our net sales aggregated approximately 44.1%, 60.2% and 46.7% of our total sales, respectively, for the same three-year period. The loss of any of our largest customers or a substantial reduction in orders from any of them would materially and adversely affect our business and operating results.
We plan to continue to leverage on our solid customer relationships and to expand our business. During 2003, we were able to expand our product line to higher margin products and we were able to benefit from the increase in production capacity from the commencement of operation of our new factory premises.
For LCD Consumer Products, we will continue to focus on educational products, cellular phone accessories and home entertainment products. In 2004, we will begin delivery of new products, like bluetooth headsets for cellular phones and new home entertainment products, in addition to the Eyetoy USB Cameras for Playstation 2.
For Telecom Component Assembly, we will continue to focus on high end color LCD modules and CMOS sensor modules. We shall seek opportunities to expand our product line and customer base for these products.
We plan to relocate our existing production facility for the LPT segment to new factory premises. It is expected that the relocation to the new factory premises will be completed in the third quarter of 2004. The new premises, which are about 600,000 square feet, are two times the size of the existing factory premises. This new factory will provide room for future expansion of production capacity. We intend to spend approximately $6.5 million for this relocation and finance this amount with a combination of internal resources and bank financing.
Our production is typically based on purchase orders received from OEM customers. However, for certain customers we will occasionally purchase raw materials based on such customers’ rolling forecasts. Purchase orders are often supported by letters of credit or written confirmation from our OEM customers. We generally do not obtain firm, long-term commitments from our customers. Uncertain economic conditions and our general lack of long-term purchase commitments with our customers make it difficult for us to accurately predict our revenue over the longer term. Even in those cases where customers are contractually obligated to purchase products from us or to repurchase unused inventory from us, we may elect not to immediately enforce our contractual rights because of the long-term nature of our customer relationships and for other business reasons, and instead may negotiate accommodations with customers regarding particular situations.
We did not suffer a material loss resulting from the cancellation of OEM customer orders in 2001 to 2003. In 2001 however, we wrote down our inventory for $3.8 million to cost of sales for slow-moving raw materials relating to cancelled, reduced or delayed orders. Subsequently, we were able to use some of these raw materials in production or we received compensation for the unused raw materials from certain of our customers, and the gain of $2.0 million was recorded in cost of sales during 2002.
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Gross Margins
Our gross margins and operating income generally improve during periods of high-volume and high-capacity utilization in our manufacturing facilities and decline during periods of low-volume and low-capacity utilization. Over the last several years our gross profit margins have declined substantially, from 17.2% in 1999 to 14.8% in 2000 and 12.8% in 2001 before increasing to 16.1% in 2002 and 16.3% in 2003. The $3.8 million inventory write-down in 2001 has reduced the gross margin by 1.7% in 2001 and our subsequent gain of $2.0 million recorded in cost of sales during 2002, as discussed above, increased our gross margin by 0.8% for 2002.
An increased mix of more complex products that generally have relatively high material costs as a percentage of total unit costs has historically been a factor that has adversely affected our gross margins. This is the primary reason for the decline in our gross margins between 1999 and 2001. During this period, we diversified our product mix from predominantly low complexity electronic products, including calculators and electronic dictionaries, to include more complex components and subassemblies, like LCD modules and RF modules. We believe our gross margin improved in 2002 and 2003 as a result of the experience we acquired in manufacturing these more complex products as we changed our strategic focus. Despite the lower gross margin on more complex products, we believe that the opportunity for growth in the demand for these complex products justifies the shift in our strategic focus. Furthermore, we believe that the experience in manufacturing processes and know-how that we have developed from producing more complex products are a competitive advantage for us relative to many of our competitors.
The increased costs associated with developing advanced manufacturing techniques to produce complex products on a mass scale and at a low cost have also negatively impacted our gross margins. For example, in our initial production runs of LCD modules and RF modules we experienced low production yields and other inefficiencies that caused our gross margin to decrease. Although we believe we have improved the efficiency and quality of our manufacturing processes relating to LCD modules and RF modules, we may not be able to improve or maintain our gross margin for these products. Furthermore, in January 2003, we began to produce color and TFT LCD modules, each a complex component used in a variety of devices. The increased costs associated with manufacturing these products and other new complex products could have a negative impact on our future gross margins. The complex manufacturing processes involved in the production of complex products is also capital intensive, thereby increasing our fixed overhead costs.
Income Taxes
Under current BVI law, our income is not subject to taxation. Subsidiaries operating in Hong Kong and the PRC are subject to income taxes as described below, and our subsidiary operating in Macao is exempted from income taxes. This would be valid unless the Macao government changes its policy towards offshore companies.
Under current Cayman Islands law, Nam Tai Telecom (Cayman) Company Limited, Nam Tai Electronic & Electrical Products Limited and Namtek Software Development Company Limited are not subject to profit tax as they have no business operations.
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The provision for current income taxes of the subsidiaries operating in Hong Kong has been calculated by applying the current rate of taxation of 16% for 2001 and 2002 and 17.5% for 2003 to the estimated taxable income earned in or derived from Hong Kong during the applicable period.
The basic corporate tax rate for Foreign Investment Enterprises in China, such as our China subsidiaries, is currently 33% (30% state tax and 3% local tax). However, because all of our China subsidiaries are located in Shenzhen and are involved in production operations, they qualify for a special reduced state tax rate of 15%. In addition, the local tax authorities in the regions in which our subsidiaries operate in Shenzhen are not currently assessing any local tax. Moreover, several of our China subsidiaries are entitled to certain tax benefits and certain of our China subsidiaries have qualified for tax refunds as a result of reinvesting their profits earned in previous years in China for a minimum period of five years.
Efforts by the Chinese government to increase tax revenues could result in decisions or interpretations of the tax laws by the Chinese tax authorities that are unfavorable to us and which increase our future tax liabilities, or deny us expected refunds. Changes in Chinese tax laws or their interpretation or application may subject us to additional Chinese taxation in the future.
Our effective tax rates were 2%, 4% and 1% for 2001, 2002 and 2003, respectively. The significant factors that cause our effective tax rates to differ from the applicable statutory rates of 15% were as follows:
Strategic Investments
An important element of our strategy is to make investments in companies that provide the potential to complement our existing products and services, become new customers, augment our market coverage and sales ability, enhance our technological capabilities and expand our service offerings. We account for investments of less than 20% under the cost method and we account for investments between 20% and 50% under the equity method. Our material investments over the last five years include:
Stepmind. In December 2003, we placed approximately $5.3 million into an escrow account for an investment in Stepmind. The investment will be in two phases. For the first phase, approximately $2.64 million, representing 7.66% of the equity interest in Stepmind, was released to Stepmind in January 2004. The second phase amounting to $2.65 million will be released to Stepmind in August 2004 subject to fulfillment of certain conditions. Upon successful subscription of the shares in the second phase, our total investment will represent 11.33% of the equity interest in Stepmind. Stepmind was founded in July 2000 and is a fabless solutions and components supplier, developing applications which require high performance and secured data links.
Alpha Star/JCT Wireless. In January 2003, we invested $10.0 million for a 25% equity interest in Alpha Star Investments Ltd., the ultimate holding company of JCT. JCT is engaged in the design, development and marketing of wireless communication terminals and wireless application software and is using us to manufacture wireless communication terminals and their related modules.
TCL Group. Over the period from September 2000 through November 2002, we made three investments in the TCL Group of companies and disposed of some portions of the investment in 2002 and 2003, respectively. The TCL Group of companies is a leading OEM for numerous consumer electronic and telecommunications products in the domestic Chinese market.
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Deswell Industries. In September 2000, we purchased 500,000 common shares in Deswell Industries Inc., a Nasdaq-listed company, representing approximately 9% of the outstanding shares of Deswell at the time of the purchase for an aggregate of $7.5 million. Deswell is a manufacturer of injection-molded plastic parts and components, electronic products and subassemblies and metallic molds and accessory parts for OEMs and contract manufacturers. During the first quarter of 2002, we sold our Deswell shares in the open market for aggregate proceeds of $10.1 million.
The following details the impact of our strategic investments on our income statements for each of the years ended 2001, 2002 and 2003:
Toshiba Joint Venture
In March 2000, we formed a joint venture with Toshiba Battery Company Ltd. called BPC (Shenzhen) Co., Ltd., or BPC, to manufacture rechargeable lithium ion battery packs at our manufacturing complex in Shenzhen, China. Toshiba Battery Company Ltd. owned a 13% interest in BPC and we owned the balance of BPC for a cash investment of $1.3 million. During 2000 and 2001 and from January 1 to April 30, 2002, we recognized net sales of $6.2 million, $21.1 million, and $7.8 million, respectively, from Toshiba and its related companies. In 2002, we sold our 87% joint venture interest in BPC and a related manufacturing license to a Toshiba related company for an aggregate of $2.9 million, resulting in a gain of $77,000.
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Based on the 2001 full year results of BPC, we estimate that the sale of BPC will result in a reduction of annual revenues of approximately $21.1 million and a reduction in profits of $1.3 million. We further estimate that the BPC sale will result in a reduction of annual operating expenses of approximately $600,000. Future cash flows from operations will decline by approximately $1.7 million a year.
J.I.C. Group
We acquired the J.I.C. Group in October 2000 for $32.8 million. We paid a portion of the purchase price to the seller by issuing approximately 3.48 million of our common shares and paid $11.0 million in cash. The J.I.C. Group is principally engaged in the manufacture and marketing of transformers and LCD panels, a key component for a variety of consumer electronic products. We accounted for the acquisition of the J.I.C. Group under the purchase method of accounting and the results of the J.I.C. Group’s operations have been consolidated with our results since the date of its acquisition.
In June 2002, through a reverse merger, we arranged for the listing of the J.I.C. Group on the Hong Kong Stock Exchange. To effect the listing, we entered into an agreement with the liquidators of Albatronics to effect the restructuring proposal of Albatronics and the listing of J.I.C. Technology Company Limited as this arrangement was more cost effective than using an initial public offering.
Due to the reverse merger, our effective interest in the J.I.C. Group was reduced from 100% to 92.9%. As a result of this reduction in interest during 2002, we has released unamortized goodwill of $1.5 million, representing 7.1% of the goodwill that had previously been recorded upon purchasing the J.I.C. Group in October 2000. The release of unamortized goodwill is included as part of the loss on the reverse merger of the J.I.C. Group.
In August 2002, we acquired an additional 7,984,000 ordinary shares of J.I.C. Technology Company Limited for a cash consideration of $437,000, resulting in additional goodwill of $253,000. As of December 31, 2002, we held 93.97% of effective interest in J.I.C. Group, which represented 74.78% of the existing ordinary shares and 93.97% of the outstanding ordinary shares upon full conversion of the 598,420,000 preference shares.
During the period from June to November 2003, we disposed of a total of 42,600,000 ordinary shares of J.I.C. Technology Company Limited for cash consideration of $4.0 million. The disposal resulted in a net gain on partial disposal of a subsidiary of $1.8 million and the releasing of unamortized goodwill of $1.2 million. The release of unamortized goodwill is netted off with the gain on the partial disposal of a subsidiary. In November 2003, we converted 175,100,000 preference shares into 170,000,000 ordinary shares of J.I.C. Technology Company Limited. As of December 31, 2003, we held 263,900,688 ordinary shares of J.I.C. Technology Company Limited, equivalent to 74.86% of issued ordinary shares, and 423,320,000 preference shares. Upon full conversion of preference shares owned, we will hold approximately 88.39% of J.I.C. Technology Company Limited.
In June 2003, in order to concentrate its effort on its LCD panels reporting unit, J.I.C. Technology Company Limited disposed its transformers reporting unit to a third party for a cash consideration of $2.4 million. Sales of the transformers reporting unit for the years ended December 31, 2001, 2002 and 2003 were $11.0 million, $11.3 million and $6.3 million, respectively, and were insignificant compared to the sales as a whole. The net income from this discontinued operation for the years ended December 31, 2001 and 2002 were also immaterial. In 2003, the net income from discontinued operation represented the gain of $2.0 million, being the proceeds from the disposal less the carrying value of the net assets of the transformers reporting unit, and minority interests. Excluding this gain, the basic and diluted earnings per share for the year ended December 31, 2003 would have been $1.04 and $1.02 respectively.
Operating Segments
Our operations are generally organized in two segments, Consumer Electronics Products, or CEP, and LCD panels and transformers, or LPT. The activities of our LPT segment relate primarily to our J.I.C. subsidiary that we acquired in October 2000.
Consumer Electronics Products. Our CEP segment is primarily engaged in the manufacture and assembly of electronic components, subassemblies and finished products for OEMs of electronic and telecommunications products. The electronic components and subassemblies that our CEP segment produces are primarily LCD modules used in a wide variety of consumer electronic products including cellular phones, PDAs digital cameras, handheld video game devices and microwave ovens. In December 2002, our CEP segment also began producing RF modules, used in cellular phones and other electronic devices with wireless features. In September 2003, our CEP segment further started manufacturing of cellular phones in SKD form. The finished products that our CEP segment assembles include digital camera accessories for cellular phones and home entertainment products, like Playstation 2, handheld electronic calculators, dictionaries and linguistic products. Within our CEP segment, we also provide software development services to our OEM customers.
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LCD Panels and Transformers. Our LPT segment manufactures LCD panels for use in numerous electronic products, including watches, clocks, calculators, pocket games, PDAs and cellular and wireless telephones. The transformers produced by our LPT segment are used in home appliances, telecommunications equipment, computers and computer peripherals. We sold our transformer operations in June 2003 for cash consideration of $2.4 million and realized a gain of $2.0 million, net of $0.1 million shared by minority interest.
Application of Critical Accounting Policies
The preparation of our financial statements and related disclosures in conformity with generally accepted accounting principles in the United States requires management to make estimates and judgments that affect our reported amounts of assets and liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. On an on-going basis, we evaluate our estimates and assumptions based upon historical experience and various other factors and circumstances. Management believes that our estimates and assumptions are reasonable under the circumstances; however, actual results may vary from these estimates and assumptions under different future circumstances. We have identified the following critical accounting policies that affect the more significant judgments and estimates used in the preparation of our consolidated financial statements.
Revenue Recognition
We recognize revenue from product sales in accordance with Staff Accounting Bulletin (SAB) No. 101 “Revenue Recognition in Financial Statements”. SAB No. 101 requires that revenue be recognized when all of the following conditions are met:
Generally, we do not provide our customers with the right of return (except for quality), price protection, rebates or discounts. There are no customer acceptance provisions associated with our products, other than for quality. All sales are based on firm customer orders with fixed terms and conditions, which generally cannot be modified. This requires us to assess at the point of delivery whether these criteria have been met. Upon making such assessment, revenue is recognized.
Inventory Reserves
Our inventories are stated at the lower of cost or market value. We determine cost on the first-in, first-out basis. Our industry is characterized by rapid technological change, short-term customer commitments and rapid changes in demand, as well as many other market considerations. We write down inventory based on our regular reviews of inventory quantities on hand and the latest forecasts of product demand and production requirements from our customers. Generally, for our CEP reporting unit, we order inventory from our suppliers based on firm customer orders for product that is unique to each customer. The inventory is utilized in production as soon as all the necessary components are received.
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The only reason that inventory would not be utilized within six months is if a specific customer deferred or cancelled an order. As the inventory is typically unique to each customer’s product it is unusual for us to be able to utilize the inventory for other customers’ products. Therefore, our policy is to negotiate with the customer for the disposal of such inventory that remains unused for six months. We do not generally write down as these customers are held to their purchase commitments. However, there are cases where customers are contractually obligated to purchase the unused inventory from us but we may elect not to immediately enforce such contractual right for business reasons. In this connection, we will consider writing down for these inventory items which remain unused for over six months at our own cost. We determine if the inventory can be utilized in other products before writing down the inventory.
For our LPT reporting unit, due to the nature of the business, LPT customers do not always place orders far enough in advance to enable us to order inventory from suppliers based on firm customer orders. Nonetheless, we review our inventory balance on a regular basis and wrote all inventory over six months old.
We derive information concerning our customers’ inventory levels through constant communications with our significant customers. Customers that see indications of high inventory levels will communicate this fact to us and we will attempt to delay our production if we are able to reduce our own order commitments. Our ability to reduce orders from suppliers depends on the terms, conditions and timing of the request.
In 2001, we wrote down our inventory for $3.8 million for slow-moving raw materials relating to cancelled, reduced or delayed orders. However, subsequently, we were able to use some of these raw materials in production in 2002 or we received compensation for the unused raw materials from certain of our customers, and the gain of $2.0 million was recorded in cost of sales during 2002.
Goodwill
The excess of the purchase price over the fair value of net assets acquired is recorded on our consolidated balance sheet as goodwill. Prior to January 1, 2002, we amortized goodwill to expense on a straight-line basis over various periods ranging from 4 to 15 years.
In June 2001, the FASB issued Statement of Financial Accounting Standard (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”. This statement provides that goodwill and other intangible assets with indefinite lives will not be amortized, but will be tested for impairment at the reporting unit level on an annual basis. A reporting unit is an operating segment or one level below an operating segment (i.e. a component) as defined in SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information”. A component of an operating segment is a reporting unit if the component constitutes a business for which discrete financial information is available and segment management regularly reviews the operating results of that component. Through May 2002, we operated in two reporting units, which were the operating segments of “CEP” and “LPT”. Beginning in June 2002 we segregated our LPT segment into two reporting units: LCD panels and transformers. In June 2003, we sold our transformer operations.
We evaluate the goodwill for impairment in two steps: (1) we identify potential impairment by comparing the fair value of a reporting unit with its carrying amount, including goodwill and (2) we measure the amount of goodwill loss by comparing the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill and recognizing a loss by the excess of the latter over the former. We measure the fair value of a reporting unit based on the quoted market prices, if available, internal models based on present value of future cash flows or independent valuations. The estimation of fair value requires that we make judgments concerning future cash flows and appropriate discount rates. Our estimate of the fair value of goodwill could change over time based on a variety of factors, including the actual operating performance of the underlying reporting units.
SFAS No. 142 was effective for fiscal years beginning after December 15, 2001. We adopted SFAS No. 142 on January 1, 2002. Upon adoption of SFAS No. 142, we evaluated goodwill for impairment at the reporting unit level and determined that there was no impairment at January 1, 2002. Later in 2002, we determined that goodwill was impaired by $339,000 related to Micro Business Systems Industries Company Limited (“MBS”). All remaining and future acquired goodwill will be subject to an annual impairment test on December 31st of each year or earlier if indications of a potential impairment exist. As of December 31, 2003, we completed our annual impairment evaluation and determined that there was no impairment.
We provide for all taxes based on profits whether due at year end or estimated to become due in future periods but based on profits earned to date. However, under the current tax legislation in the PRC, we have reasonable grounds to believe that income taxes paid
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by Namtai Electronic (Shenzhen) Co., Ltd., Zastron Electronic (Shenzhen) Co., Ltd (formerly known as Zastron Plastic & Metal Products (Shenzhen) Ltd), Shenzhen Namtek Co. Ltd. and Jetup Electronic (Shenzhen) Co., Ltd. in respect of any year would be refunded after the profits earned in that year are reinvested in the business by way of capital injection. PRC taxes paid by subsidiaries during the year are recorded as amounts recoverable at the balance sheet date when we intend to file an application for reinvestment of profits and a refund is expected unless there is an indication from the PRC tax authority that the refund will be refused.
We provide deferred income taxes using the asset and liability method. Under this method, we recognize deferred income taxes for all significant temporary differences and classified as current or non-current based upon the classification of the related asset or liability in the financial statements. We provide a valuation allowance to reduce the amount of deferred tax assets if it is considered more likely than not that some portion, or all, of the deferred tax asset will not be realized.
Investments
We apply the equity method of accounting for investments in affiliates when we have the ability to exercise a significant influence, which is normally indicated by a 20% to 50% interest in those entities. Under the equity method, original investments are recorded at cost and adjusted by our share of undistributed earnings or losses of these entities. Non-marketable investments in which we have a less than 20% interest and in which we do not have the ability to exercise significant influence over the investee are accounted for using the cost method and are initially recorded at cost and periodically reviewed for impairment. Income from these investments are recognized to the extent of dividends received and gains or losses are recognized upon disposition or impairment of the investments.
Accruals and Provisions for Loss Contingencies
We make provisions for all loss contingencies when information available to us prior to the issuance of the financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements and the amount of loss can be reasonably estimated.
For provisions or accruals related to litigations, we make provisions based on information from legal counsels and the best estimation of management. As discussed in Note (19b) to our consolidated financial statements, we are involved in various legal proceedings and contingencies. We have recorded a liability for the Tele-Art matter in accordance with Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies” (“FAS 5”). FAS 5 requires a liability to be recorded based on our estimate of the probable cost of the resolution of a contingency. The actual resolution of this contingency may differ from our estimates. If the contingency were settled for an amount greater than our estimate, a future charge to income would result. Likewise, if the contingency were settled for an amount that is less than our estimate, a future credit to income would result.
The following table presents selected consolidated financial information stated as a percentage of net sales for the years ended December 31, 2001, 2002, and 2003 (certain amounts may not calculate due to rounding and amounts may not add due to rounding).
Year ended December 31, 2003 Compared to Year ended December 31, 2002
Net Sales. Our net sales increased significantly by 72.2% to $406.3 million for 2003 compared to $236.0 million for 2002. Sales in the CEP segment increased by 81.8% to $365.0 million for 2003 compared to $200.8 million for 2002. The increase was primarily attributable to sales of the component assembly products of approximately $236.8 million in 2003 compared to $103.6 million in 2002, an increase of $133.2 million.
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This increase was mainly as a result of an increase in sales of telecom LCD and PCB modules and the launch of new products in 2003 like RF modules, SKD handset, Front Light Panel Assembly, and flash light for cellular phones. In addition, we also experienced increased sales in the LCD consumer products segment. Sales of LCD consumer products amounted to approximately $124.1 million in 2003 compared to $94.2 million in 2002, an increase of $29.9 million. This increase was mainly driven by the PC camera, which was first launched in 2003.
Sales in the LPT segment increased by 17.2% to $41.3 million for 2003 compared to $35.3 million for 2002. The primary reason for the increase in sales was the increase in the sales of LCD panels of approximately $35.0 million for 2003 compared to $23.9 million for 2002, which was partially offset by a decrease in the sales of transformers due to the disposal of the transformers operation in June 2003.
Gross Profit. Our gross profit increased by 74.2% to $66.3 million for 2003 compared to $38.1 million for 2002. Our gross profit margin also increased slightly in 2003 to 16.3% from 16.1% in 2002.
Gross profit in the CEP segment increased 78.8% to $59.6 million, or 16.3% of net sales, for 2003 compared to $33.3 million, or 16.6% of net sales, for 2002. The primary reason for this increase was the increase in sales as described above in explanation of fluctuation of “Net Sales”. We were also able to keep our product gross margin relatively stable in 2003. The increase in gross profit margin was offset by the gain of a $2.0 million due to recovery of inventory written down to cost of sales in 2002. In addition to these specific factors, our gross profit margin increased in 2003 due to our ability to negotiate advantageous price terms with certain of our suppliers and our focus on reducing overhead costs.
Gross profit in the LPT segment increased 41.9% to $6.7 million, or 16.3% of net sales, for 2003 compared to $4.8 million, or 13.5% of net sales, for 2003. This increase in gross profit in the LPT segment was as a result of increases in sales proportion of high margin products and the disposal of the transformers operation in June 2003. The impact of the discontinued operations of transformers on gross profit contribution was insignificant as the margin of transformers products was low.
Selling, general and administrative expenses. SG&A expenses for 2003 increased approximately $6.9 million to $24.9 million, or 6.1% of net sales, from $18.0 million, or 7.6% of net sales, in 2002.
SG&A expenses in the CEP segment increased 39.9% to $20.9 million, or 5.7% of net sales, for 2003 compared to $14.9 million, or 7.4% of net sales, for 2002. This increase was primarily due to an approximately $4.9 million increase in salaries and benefits expenses, due to an increase in headcount, an approximately 10% increase in salary for certain employees and $3.7 million incentive bonus due to the implementation of a new incentive bonus scheme in January 2003, which was calculated based on operating profit, as well as a $0.8 million increase in selling expenses, which was primarily due to more sales commission paid as sales increased.
SG&A expenses in our LPT segment also increased in 2003 to $4.0 million, or 9.5% of net sales, from $3.0 million, or 8.6% of net sales, in 2002. The increase in SG&A expenses in our LPT segment in 2003 was primarily related to salaries and benefits expenses as a result of the implementation of a new incentive bonus program scheme in January 2003 and hence $0.2 million in incentive bonuses incurred during 2003 and general expenses due to an increase in business activities.
Our SG&A expenses include provisions for bad debt expenses, which decreased from $138,000 in 2002 to $91,000 in 2003. On a segment basis, the provision for bad debt expenses decreased in the CEP segment from $89,000 in 2002 to zero in 2003 and increased in the LPT segment from $49,000 in 2002 to $91,000 in 2003. For the CEP segment, the decrease in allowance has been attributable to the implementation of tighter credit controls. For the LPT segment, the increase in the allowance was due to the increase in accounts receivable and a resulting increase in our general provision due to a delay in payment from some customers.
Research and development expenses. Research and development expenses for 2003 increased to $4.0 million, or 1.0% of net sales, from $2.7 million, or 1.1% of net sales, in 2002. On a segment basis, research and development expenses increased in the CEP segment by $1,385,000, or 64.1%, due to an increase in staff related to the expansion of our production capacity and the products we manufacture.
Goodwill impairment. In 2002, we determined that $339,000 of unamortized goodwill related to our 1999 acquisition of a telecommunications company was impaired as the technology of the acquired company had become obsolete.
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Income from Operations. Income from operations increased by approximately $20.3 million to $37.4 million, or 9.2% of net sales, for 2003 compared to $17.1 million, or 7.2% of net sales, for 2002. On a segment basis, the operating income of our CEP segment increased $19.2 million to $35.1 million, or 9.6% of net sales, in 2003 compared to $15.9 million, or 7.9% of net sales, in 2002. The operating income of our LPT segment increased $1.1 million to $2.3 million, or 5.5% of net sales, for 2003 compared to $1.2 million, or 3.4% of net sales, in 2002. This increase in operating income is attributable to the increase in gross profit described above.
Equity in Income of Affiliated Companies. Equity in income of affiliated companies was $0.5 million in 2003 compared to $10.7 million in 2002. The income in 2003 represents our share of the net earnings of our proportional 25% investment in Alpha Star Investments Limited for the twelve months end December 31, 2003. The income in 2002 represents our proportional share of the net earnings of our 25% investment in Mate Fair.
Other Income/(Expense), net. Other income, net, during the year ended December 31, 2003 was $5.5 million. This amount included dividend income of $2.0 million from our indirect investment in Huizhou TCL Mobile Communication Co., Ltd, dividend income of $1.7 million from TCL Corporation, $1.8 million of gain on partial disposal of interest in our J.I.C. Group and income of $0.5 million related to the recovery of a non-trade receivable which had been written off previously. This income was partially offset by a $0.3 million bank charge during 2003.
Interest Expense. Interest expense decreased to $121,000 for 2003 compared to $790,000 for 2002. The decrease in interest expenses is the result of the early repayment of a $12.9 million bank loan in January 2003.
Income Taxes. Income tax expenses decreased to $399,000 for 2003 compared to $773,000 for the prior year. The decrease is primarily the result of our receipt of tax refunds for several of our PRC entities for taxes paid in previous years.
Minority Interest. Minority interest increased $903,000, or 550.6%, to $1,067,000 in 2003 from $164,000 in 2002. Minority interest in 2003 included $211,000 from the minority shareholders’ share of profits of J.I.C. Group for the year ended December 31, 2003, $560,000 from the minority shareholders’ share of profits of Mate Fair for the year ended December 31, 2003, and $296,000 from the minority shareholders’ share of profits of Namtek Software Development Company Ltd. for the year ended December 31, 2003.
Discontinued Operation. Discontinued operation in 2003 represents $2.0 million gain on disposal of our entire transformers operation, net of $0.1 million shared by minority interest.
Net Income. Net income increased by $23.8 million, or 118.8%, to $43.8 million or 10.8% of net sales, for 2003 compared to $20.0 million, or 8.5% of net sales, for 2002. Net income of $43.8 million for 2003 represents $41.8 million income from normal operation, and $2.0 million income from discontinued operation. Diluted earnings per share for 2003 of $1.07 ($1.09 basic) was contributed by $1.02 ($1.04 basic) from normal operations, and $0.05 ($0.05 basic) from discontinued operation. This resulted in diluted earnings per share for 2003 of $1.07 ($1.09 basic) compared to $0.57 ($0.57 basic) for 2002. Net income for the CEP segment increased 103.3% to $41.1 million for 2003 compared to $20.2 million for 2002. The increase in CEP’s net income is the result of higher sales, higher gross profit margin, and the increase in other income, which was offset by the decrease in equity in income from affiliated companies and increased general and administrative expenses described above. Net income for the LPT segment increased by $2.9 million, or 1513.6%, to a income of $2.7 million in 2003 compared to net loss of $191,000 for 2002. The increase in the LPT segment’s net income is the result of the $2.0 million gain from the disposal of the transformers operation, net of $0.1 million shared by minority interest, in June 2003, increase in sales and higher gross profit margin.
Year ended December 31, 2002 Compared to Year ended December 31, 2001
Net Sales. Our net sales remained flat, increasing by 0.9%, to $236.0 million for 2002 compared to $234.0 million for 2001. Sales in the CEP segment increased by 1.4% to $200.8 million for 2002 compared to $198.0 million for 2001. The primary reason for the increase was sales of digital camera accessories for cellular phones that we first produced in 2001 of approximately $39.8 million in 2002 compared to only $3.2 million in 2001, an increase of $36.6 million. This increase was partially offset by the sale of our joint venture interest in BPC (Shenzhen) Co., Ltd. to a Toshiba related company on April 30, 2002, resulting in a decrease in our sales of approximately $13.2 million in 2002 as compared to sales in 2001. We also experienced decreased sales in 2002 of calculators, personal digital assistants and linguistics products and LCD modules of $9.6 million, $6.7 million and $3.5 million, respectively, as compared to levels in 2001. We believe that these decreases resulted from pricing pressures and the completion of the lifecycle or obsolescence of certain of these products that were not replaced by comparable devices.
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Sales in the LPT segment decreased by 1.9% to $35.3 million for 2002 compared to $36.0 million for 2001. The primary reason for the decrease in sales was the reduction in LCD panel selling prices caused by market competition, which was partially offset by an increase in the number of LCD panels sold.
Gross Profit. Our gross profit increased by 26.7%, to $38.1 million for 2002 from $30.0 million for 2001. Our gross profit margin also increased in 2002 to 16.1% from 12.8% in 2001. Before the inventory write-down of $3.8 million in 2001 for slow-moving raw materials relating to cancelled, returned or delayed orders and our gain of $2.0 million recorded in cost of sales during 2002 discussed below, our consolidated gross margin was 14.5% in 2001 and 15.3% in 2002.
Gross profit in the CEP segment increased by 43.7% to $33.3 million, or 16.6% of net sales, for 2002 compared to $23.2 million, or 11.7% of net sales, for 2001. The primary reason for this increase was our inventory write-down in 2001 of $3.8 million for slow-moving raw materials relating to cancelled, reduced or delayed orders within the CEP segment that was recorded in our cost of sales. In 2002, we were able to use some of these raw materials in production or we received compensation for the unused raw materials from certain of our customers, resulting in our gain of $2.0 million to cost of sales in 2002. For the inventory that we were able to use, we sold the related products to customers at our normal prices. Also contributing to the increase in gross profit in 2002 is a $300,000 charge to our cost of sales in 2001 related to employee severance charges for direct labor in the CEP segment. In addition to these specific factors, our gross profit increased in 2002 due to our ability to negotiate advantageous price terms with certain of our suppliers and our focus on reducing overhead costs.
Gross profit in the LPT segment decreased by 30.7% to $4.8 million, or 13.5% of net sales, for 2002 compared to $6.8 million, or 19.0% of net sales, for 2001 as a result of lower selling prices for LCD panels driven by increased competition as well as increased depreciation charges in relation to a new STN LCD panel line that commenced operations in June 2002.
Selling, general and administrative expenses. SG&A expenses for 2002 decreased approximately $4.0 million to $18.0 million, or 7.6% of net sales, from $22.0 million, or 9.4% of net sales, in 2001.
SG&A expenses in the CEP segment decreased by 9.6% to $14.9 million, or 7.4% of net sales, for 2002 compared to $16.5 million, or 8.3% of net sales, for 2001. This decrease was driven primarily by our cost realignment and tightened cost controls that reduced salaries and benefits to $6.0 million from $8.1 million in 2001. Our salaries and benefits expense in 2001 included $700,000 of restructuring expenses primarily related to severance for certain administrative positions that we eliminated. The decreases in our CEP segment were partially offset by increases in selling expenses of $600,000 due to implementation of a new commission incentive program in January 2002.
SG&A expenses in our LPT segment also decreased in 2002 to $3.0 million, or 8.6% of net sales, from $5.5 million, or 15.2% of net sales, in 2001. The decrease in SG&A expenses in our LPT segment in 2002 is primarily related to terminating the amortization of goodwill as a result of our adoption of the new accounting rule, SFAS No. 142, effective January 1, 2002. During the year ended December 31, 2001, our amortization of goodwill in the LPT segment was approximately $1.6 million. SG&A expenses in our LPT segment were also lower in 2002 due to a stock option compensation expense of $839,000 in 2001, but none in 2002.
Our SG&A expenses include provisions for bad debt expenses, which increased from $86,000 in 2001 to $138,000 in 2002. On a segment basis, the provision for bad debt expenses increased in the CEP segment from $55,000 in 2001 to $89,000 in 2002 and increased in the LPT segment from $31,000 in 2001 to $49,000 in 2002. Our policy for the allowance for doubtful amounts is to provide for all invoices that are 30 days overdue from their original credit terms and for which settlement is not assured. The increase in the allowance was due to the increase in accounts receivable and a resulting increase in our general provision and a delay in payment from some customers.
Research and development expenses. Research and development expenses for 2002 decreased to $2.7 million, or 1.1% of net sales, from $3.0 million, or 1.2% of net sales, in 2001. On a segment basis, research and development expenses decreased in the CEP segment by $584,000, or 21.3%, due to a reduction in related staff, which was partially offset by an increase in the LPT segment of $316,000 in relation to the addition of a new STN LCD line for the development of new products, including LCD panels for TCL Mobile.
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Income from Operations. Income from operations increased by approximately $11.9 million to $17.1 million, or 7.2% of net sales, for 2002 compared to $5.1 million, or 2.2% of net sales, for 2001. On a segment basis, the operating income of our CEP segment increased $12.0 million to $15.9 million, or 7.9% of net sales, in 2002 compared to $3.9 million, or 2.0% of net sales, in 2001. This increase in operating income is attributable to the increase in gross profit and decrease in SG&A expenses and R&D expenses described above. The operating income of our LPT segment remained constant at $1.2 million in both 2002 and 2001.
Equity in Income of Affiliated Companies. Equity in income of affiliated companies was $10.7 million in 2002 compared to $1.9 million in 2001. The income in 2002 includes $8.6 million, which represents our share of the gain from the sale by Mate Fair of a portion of its interest in TCL Mobile, and $2.1 million for our proportional share of the net earnings of our 25% investment in Mate Fair for the five months ended May 31, 2002.
Other Income/(Expense), net. Other expense, net, during the year ended December 31, 2002 was $6.0 million. This amount included expenses of $5.2 million for our provision of legal contingencies related to the liquidation of Tele-Art Inc., $2.7 million of loss related to the creation of a minority interest in our J.I.C. Group subsidiary, including the release of unamortized goodwill, $1.4 million of legal and professional fees related to the J.I.C. minority interest transaction, $610,000 of finance charges related to the early repayment of a $12.9 million fixed term loan, $520,000 for release of unamortized goodwill of an affiliated company, Mate Fair, $307,000 of finance charges and $771,000 of miscellaneous expenses primarily related to non-operating legal fees. These expenses were partially offset by gains of $3.3 million related to the partial recovery of a judgment debt in the Tele-Art case, net of expenses, $917,000 of dividend income primarily from our indirect investment in TCL Corporation, $799,000 of interest income and $642,000 of realized gain from the disposal of marketable securities. The costs of defending the recently announced securities class action litigation could substantially increase our expenses in future periods and any adverse determination could be significant.
Interest Expense. Interest expenses increased to $790,000 for 2002 compared to $178,000 for 2001. The increase in interest expenses was the result of $15 million in long-term debt that we obtained in the fourth quarter of 2001 and $4.5 million obtained in the second quarter of 2002.
Income Taxes. Income tax expenses of $773,000 for 2002 compares to $227,000 for 2001. The increase was primarily the result of not receiving tax refunds for two of our PRC entities for taxes paid in previous years that we have normally been eligible to receive in the past.
Minority Interest. Minority interest decreased $66,000, or 28.7%, to $164,000 in 2002 from $230,000 in 2001. Minority interest in 2002 included $107,000 from the minority shareholders’ share of profits of BPC from January 1, 2002 through April 30, 2002, the date we sold BPC and $57,000 from the minority shareholders’ share of profits of J.I.C. Group from June 4, 2002, the date of listing on the Hong Kong Stock Exchange, through December 31, 2002. Minority interest in 2001 represented an entire year of the minority shareholder’s share of BPC’s profit.
Net Income. Net income increased by $11.0 million, or 121.4%, to $20.0 million or 8.5% of net sales, for 2002 compared to $9.0 million, or 3.9% of net sales, for 2001. This resulted in diluted earnings per share for 2002 of $0.57 ($0.57 basic) compared to $0.26 ($0.27 basic) for 2001. Net income for the CEP segment increased 230% to $20.2 million for 2002 compared to $6.1 million for 2001. The increase in CEP’s net income is the result of a higher gross profit margin, the increase in equity in income from affiliated companies, and decreased general and administrative expenses described above. Net income for the LPT segment decreased by $3.1 million or 106.6% to a loss of $191,000 compared to net income of $2.9 million for 2001. The net loss position in year 2002 for the LPT segment was the result of lower gross profit margin, and the release of unamortized goodwill as described above.
Liquidity and Capital Resources
Liquidity
We have financed our growth and cash needs to date primarily from internally generated funds, proceeds from the sale of our strategic investments, sales of our stock and bank debt. We do not use off-balance sheet financing arrangements, such as securitization of receivables or obtaining access to assets through special purpose entities, as sources of liquidity. Our primary uses of cash have been to fund expansions and upgrades of our manufacturing facilities, to make strategic investments in potential customers and suppliers and to fund increases in inventory and accounts receivable resulting from increased sales.
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We had positive net working capital of $96.8 million at December 31, 2003 compared to positive net working capital of $87.4 million at December 31, 2002. We believe that our cash flows from operations, our current cash balance and funds available under our working capital and credit facilities will be sufficient to meet our working capital needs and planned capital expenditures for the next 12 months.
Net cash provided by operating activities was $41.2 million in 2003. Cash provided by operating activities in 2003 was primarily attributable to net income of $43.8 million plus depreciation and amortization expense of $12.3 million, offset by the gain on disposal of a transformers operation, net of minority interests of $2.0 million and gain on the partial disposal of our JIC Group for $1.8 million. Our working capital related to operating activities net of the effect of the disposal of a subsidiary decreased, driven by an increase of $11.1 million in accounts receivables, $6.1 million in other receivables and prepaid expenses, $2.7 million in the amount due from a related party and $8.5 million in inventories, which was offset by increases in accounts payable of $18.0 million, and other payables and accrued expenses of $1.2 million.
Our inventories increased in 2003 as a result of our anticipation of increases in sales. Accounts receivable increased due to an increase in sales in the fourth quarter relative to sales in the prior year period. The increase in prepaid expenses and other receivables was mainly due to a $3.1 million increase in deposits for the acquisition of property, plant and equipment related to our business operation. Accounts payable increased due to increased inventory purchases. Accrued expenses increased due to the provision of an incentive bonus in this year.
Net cash provided by operating activities was $39.5 million in 2002. Cash provided by operating activities in 2002 was primarily attributable to net income of $20.0 million plus depreciation and amortization expense of $10.6 million, dividend income from affiliated companies of $10.5 million and the non-cash loss on the reverse merger transaction related to our JIC Group of $2.7 million, non-cash equity in income of affiliated companies of $10.7 million, release of unamortized goodwill of affiliated companies of $520,000, realized gain on marketable securities of $642,000 and non-cash shares redemption and dividend withheld in settlement of a receivable of $3.5 million. Our working capital related to operating activities net of the effect of the disposal of a subsidiary also decreased, driven by an increase of $17.0 million in accounts payable and accrued expenses and $10.1 million of proceeds from marketable securities, offset by increases in accounts receivable of $8.5 million and inventory of $7.6 million.
Our inventory increased in 2002 as a result of our anticipation of increases in sales. Accounts receivable increased due to increased sales in the fourth quarter relative to sales in the prior year period. The increase in accrued expenses was primarily related to a $5.2 million provision for legal contingencies. Accounts payable increased due to support for higher inventory levels. The proceeds from marketable securities relates to the disposal of our holdings in Deswell Industries, Inc. during 2002.
Net cash used in investing activities was $18.6 million in 2003. Cash used in investing activities primarily related to our $10.0 million and $0.4 million strategic investments in Alpha Star Investments Limited and iMagic Infomedia Technology Limited, respectively, and $5.3 million prepayment for long term investment in Stepmind, as well as capital expenditures of $17.1 million, offset by $2.6 million proceeds on disposal of property, plant and equipment, $2.4 million proceeds on disposal of transformers operation to a third party, $4.0 million proceeds on partial disposal of our J.I.C. Group, and $5.0 million proceeds on disposal of convertible notes of TCL International Holdings Ltd.
Net cash used in investing activities was $33.8 million in 2002. Cash used in investing activities primarily related to our $12.0 million strategic investment in TCL Corporation and $5.1 million in convertible notes of TCL International Holdings Ltd., as well as capital expenditures of $18.5 million, offset by proceeds of $1.7 million related to the disposal of our joint venture interest in BPC. Our capital expenditures in 2002 included a $12.3 million new STN LCD panel production line and $4.0 million for completion of the new factory expansion.
In the past three years, we have invested significant amounts of cash to expand our manufacturing capacity and to upgrade our equipment to produce increasingly complex products. We believe that we will continue to make significant cash investments in the future to broaden our manufacturing capabilities and increase our capacity. In this regard, we intend to spend approximately $40.0 million to construct and equip another factory consisting of approximately 250,000 square feet on land adjacent to our principal manufacturing facilities in Shenzhen, China, of which $1.2 million has already been spent in 2003.
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Net cash used in financing activities was $43.3 million in 2003. Cash used in financing activities for 2003 primarily resulted from $37.8 million paid to shareholders as dividends and $14.0 million bank loans repayment offset by $8.5 million received from the exercise of options.
Net cash provided by financing activities was $18.1 million for 2002. Cash provided by financing activities for 2002 primarily resulted from net proceeds of $36.5 million received from the exercise of options and warrants and $4.5 million received from a four-year variable rate term loan, offset by $16.7 million paid to shareholders as dividends, $2.7 million for the repayment of bank loans and $3.5 million for the repurchase of our common shares pursuant to our share buy-back program.
Except as discussed above, there are no material transactions, arrangements and relationships with unconsolidated affiliated entities that are reasonably likely to affect liquidity.
For the years ended December 31, 2002 and 2003, the Company has made guarantees for debt, loans and credit facilities held by various wholly owned subsidiaries aggregating to a maximum guarantee of $62,616,000 and $49,756,000, respectively. The terms of the guarantees correspond with the terms of the underlying debt, loan and credit facility agreements.
Capital Resources
In July 2003, we filed a registration statement on Form F-3 with the Securities and Exchange Commission relating to a proposed offering of 9,000,000 common shares, of which 6,000,000 common shares were to be offered by us and 3,000,000 common shares were to be offered by selling shareholders. We intended to use a portion of the net proceeds to construct and equip a new factory of approximately 250,000 square feet adjacent to our principal manufacturing facilities in Shenzhen, China. We intended to use the balance of the net proceeds for working capital and other general corporate purposes.
In September 2003, we withdrew the registration statement. Despite our capital expenditures proceeding as scheduled, we believe that our cash on hand, future cash generated from operation, together with other income and outstanding banking facilities, should be sufficient for both our long-term and short-term capital needs.
As of December 31, 2003, we had $61.8 million in cash and cash equivalents, consisting of cash and short-term deposits, compared to $82.5 million at December 31, 2002. Our short-term debt was $3.0 million and $15.0 million at December 31, 2003 and December 31, 2002, respectively.
At December 31, 2003, we had in place general banking facilities with two financial institutions aggregating $62.3 million. The maturity of these facilities is generally up to 90 days. These banking facilities are guaranteed by us and there is an undertaking not to pledge any assets to any other banks without the prior consent of our bankers. However, these covenants do not have any impact on our ability to undertake additional debt or equity financing. Interest rates are generally based on the banks’ reference lending rates. Our facilities permit us to obtain overdrafts, lines of credit for forward exchange contracts, letters of credit, import facilities, trust receipt financing, shipping guarantees and working capital. No significant commitment fees are required to be paid for the banking facilities. These facilities are subject to annual review and approval. As of December 31, 2003, we had utilized approximately $8.3 million under such general credit facilities and had available unused credit facilities of $54.0 million.
We had a seven-year term loan in October 2001 totaling $15.0 million at a fixed interest rate of 5.05% in the first four years and at a rate of 1% over the Singapore Interbank Money Market Offer Rate for the following three years. The loan was secured by a property with net book value of $11.4 million. At December 31, 2002, the bank loan had an outstanding balance of $12,860,000. On January 3, 2003, we repaid the entire outstanding balance due to the bank, resulting in a finance charge on early repayment of $610,000, which was expensed in 2002.
As of December 31, 2003, we had bank borrowing of $2.8 million, including the current portion of $1.1 million, compared to bank borrowing of $16.8 million, including the current portion of $14.0 million at December 31, 2002.
Our bank borrowing as of December 31, 2003 represents unsecured long-term bank borrowing of $4.5 million that we obtained in May 2002. This bank borrowing has a term of four years and bears interest of 1.5% over three-month LIBOR (with a cap at 7.5%), with principal repayments of $281,250 due on a quarterly basis.
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A summary of our contractual obligations and commercial commitments as of December 31, 2003 is as follows:
There are no material restrictions (including foreign exchange controls) on the ability of our non-China subsidiaries to transfer funds to us in the form of cash dividends, loans, advances or product or material purchases. With respect to our China subsidiaries, with the exception of a requirement that 10% of profits be reserved for future developments, there are no restrictions on the payment of dividends and the removal of dividends from China once all taxes are paid and assessed and losses, if any, from previous years have been made good. In the event that dividends are paid by our China subsidiaries, such dividends will reduce the amount of reinvested profits and accordingly the refund of taxes paid will be reduced to the extent of tax applicable to profits not reinvested.
Impact of Inflation
Inflation and deflation in China and Hong Kong has not had a material effect on our past business. During times of inflation, we have generally been able to increase the price of its products in order to keep pace with inflation.
Exchange Controls
There are no exchange control restrictions on payments of dividends, interest, or other payments to nonresident holders of our securities or on the conduct of our operations in Hong Kong and Macao, where the offices of some of our subsidiaries are located, or in the British Virgin Islands, where we are incorporated. Other jurisdictions in which we conduct operations may have various exchange controls. With respect to our China subsidiaries, with the exception of a requirement that 10% of profits be reserved for future developments, there are no restrictions on the payment of dividends and the removal of dividends from China once all taxes are paid and assessed and losses, if any, from previous years have been made good. We believe such restrictions will not have a material effect on our liquidity or cash flows.
Recent changes in accounting standards
In January 2003, the FASB issued Interpretation No. 46 (Revised), “Consolidation of Variable Interest Entities”. FIN 46 requires that if a business enterprise has a controlling financial interest in a variable interest entity, the assets, liabilities and results of the activities of the variable interest entity should be included in consolidated financial statements of the business enterprise. FIN 46 (Revised) applies immediately to variable interest entities created after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 (Revised) are effective beginning January 1, 2004. The adoption of FIN 46 (Revised) is not expected to have a material impact on the Company’s financial position, results of operation, or cash flows.
In April 2003, the FASB issued SFAS No. 149, “Amendments of Statement 133 on Derivative Instruments and Hedging Activities”, which establishes accounting and reporting standards for derivative instruments, including derivatives embedded in other contracts and hedging activities. SFAS No. 149 amends SFAS No. 133 for decisions made by the FASB as part of its Derivatives Implementation Group process. SFAS No. 149 also amends SFAS No. 133 to incorporate clarifications of the definition of a derivative. SFAS No. 149 is effective for contracts entered into or modified and hedging relationships designated after June 30, 2003. The provisions of SFAS No. 149 did not have a material impact on the Company’s financial position, results of operations, or cash flows.
In May 2003, the FASB issued Statement No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”. SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective for the third quarter of 2003. The adoption of SFAS No. 150 did not have a material impact on the Company’s financial position, results of operations, or cash flows.
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QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Currency Fluctuations
We sell a majority of our products in U.S. dollars and pay for our material components in Japanese yen, U.S. dollars, Hong Kong dollars, and Chinese renminbi. We pay labor costs and overhead expenses in Chinese renminbi, the currency of China (the basic unit of which is the yuan), Hong Kong dollars and Japanese yen. The exchange rate of the Hong Kong dollar to the U.S. dollar has been fixed by the Hong Kong government since 1983 at approximately HK$7.80 to US$1.00, through the currency issuing banks in Hong Kong and accordingly has not in the past presented a currency exchange risk. This could change in the future if those in Hong Kong arguing for a floating currency system prevail in the ongoing debate over whether to continue to peg the Hong Kong dollar to the US dollar.
We believe our most significant foreign exchange risk results from material purchases made in Japanese yen. Approximately 16%, 8% and 16% of our material costs have been in Japanese yen during the years ended December 31, 2001, 2002, and 2003. Sales made in Japanese yen account for less than 11% of sales for the years ended December 31, 2001, 2002 and 2003. Our business and operating results could be materially and adversely affected in the event of a severe increase in the value of the Japanese yen to the US dollar at a time when our sales made in Japanese yen are insufficient to cover our material purchases in Japanese yen.
Beginning on December 1, 1996, the Chinese renminbi became fully convertible under the current accounts. There are no restrictions on trade-related foreign exchange receipts and disbursements in China. Capital account foreign exchange receipts and disbursements are subject to control, and organizations in China are restricted in foreign currency transactions that must take place through designated banks.
We may elect to hedge our currency exchange risk when we judge such action may be required. In an attempt to lower the costs of expenditures in foreign currencies, we will periodically enter into forward contracts or option contracts to buy or sell foreign currency(ies) against the U.S. dollar through one of our banks. As a result, we may suffer losses resulting from the fluctuation between the buy forward exchange rate and the sell forward exchange rate, or from the price of the option premium.
At December 31, 2003 we held no option or future contracts and during the year we did not purchase or sell any commodity or currency options. We are continuing to review our hedging strategy and there can be no assurance that we will not suffer losses in the future as a result of hedging activities.
Foreign Currency Risk
As of December 31, 2003 we had no open forward contracts or option contracts to purchase or sell foreign currencies.
Cash on hand at December 31, 2003 of $61,827,000 was held in the following currencies.
Interest Rate Risk
Short-term interest rate risk
Our interest expenses and income are sensitive to changes in interest rates. All of our cash reserves and short-term borrowings are subject to interest rate changes. Cash on hand of $61.8 million as of December 31, 2003 was invested in short-term interest bearing investments having a maturity of three months or less. As such, interest income will fluctuate with changes in short term interest rates. In 2003, we had $788,000 in interest income and $121,000 in interest expense.
As of December 31, 2003, we had utilized approximately $8.3 million of our credit facilities, including $1,879,000 in short-term notes payable resulting in minimal interest rate risk.
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Long-term interest rate risk
As of December 31, 2003, we had $2.8 million in long-term bank borrowing including the current portion of $1.1 million.
Our long term bank borrowing was obtained in May 2002, has a term of four years and bear interest at a rate of 1.5% over three months LIBOR repayable in 16 quarterly installments of $281,250 beginning August 2002. The initial amount of this term loan was $4.5 million and the outstanding balance as of December 31, 2003 was $2.8 million.
We obtained a seven-year $15.0 million term loan in the fourth quarter of 2001 with a fixed rate of interest of 5.05% for the first four years and 1% over the SIBOR rate for the last three years. The term loan had an outstanding balance of $12.9 million as of December 31, 2002. We repaid this term loan on January 3, 2003.
The potential effect of a hypothetical 1% increase in interest rates for 2003 indebtedness would be insignificant to our cash flows and net income.
Item 6. Directors, Senior Management and Employees
Directors and Senior Managers
Our current directors and senior management and their ages as of February 29, 2004 are as follows:
Tadao Murakami. Mr. Murakami has served Nam Tai in various executive capacities since 1984. He became our Secretary and a Director in December 1989. Since June 1989, he has been employed as the President of our Hong Kong subsidiary. In July 1994, Mr. Murakami succeeded Mr. Koo as President and, in June 1995, became our Chief Executive Officer until September 1998. Mr. Murakami assumed the position of Vice-Chairman in January 1996, and Chairman from September 1998 until March 1, 2001 and again starting February 1, 2002. He is in charge of our manufacturing and marketing operations. Mr. Murakami studied technology in Japan Electronic Technology College in 1964.
Joseph Li. Mr. Li, co-founder of the J.I.C. Group, has served in various senior executive positions since we acquired the J.I.C. Group in October 2000. Mr. Li assumed the position of Chief Executive Officer in May 2002. Mr. Li has directed J.I.C. Group’s business development since founding J.I.C. Group in 1980. Mr. Li resigned as a member of the Board of Directors in July 2003.
M.K. Koo. Mr. Koo has served as Chairman of the Board of Nam Tai and its predecessor companies from inception until September 1998. He then became our Senior Executive Officer, responsible for corporate strategy, finance and administration and also serves as the Company’s Chief Financial Officer. In addition to his current roles as Chief Financial Officer and a director, he remains responsible for mergers and acquisitions, and administrative matters. Mr. Koo received his Bachelor’s of Laws degree from National Taiwan University in 1970.
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Guy Bindels. Mr. Bindels took up the post of Research and Development Director of Nam Tai Group in March 2003. He is responsible for the research and development activities of the group. He has worked with the research and development unit of Alcatel for 19 years before joining Nam Tai. He obtained a Master’s Degree in Electronics Engineering in June 1983 from the Government Department for National Education in France.
George Shih. Mr. Shih took up the post of Chief Operating Officer of Nam Tai Group in June 2003. He is responsible for ensuring the smooth operation of manufacturing services of the group. Before joining Nam Tai, he had 19 years of experience in electronics manufacturing services in various management roles with Solectron Corporation. Mr. Shih has obtained a Bachelor’s Degree in Materials Science and Engineering from National Tsing Hua University, Taiwan in 1978. In 1980, he also obtained a Master’s Degree in Industrial Engineering from University of Texas, USA. He further obtained a Master’s Degree in Electrical and Computer Engineering from University of Texas, USA in 1983.
Karene Wong. Ms. Wong joined us in March 1989 and was promoted to Managing Director of our subsidiary Nam Tai Electronic & Electrical Products Ltd. on January 1, 2001 and in September 2003, became the Chairman of the Board of Namtai Electronic (Shenzhen) Co. Ltd.. Before joining us, Ms. Wong was Assistant to the Sales Manager at Wright Joint & Co. Ltd. Ms. Wong is responsible for our sales and marketing operations and supporting employee recruitment and training.
Patinda Lei. Ms. Lei assumed the position of Managing Director of our subsidiary Nam Tai Telecom (Hong Kong) Company Limited since June 2002 and in September 2003, became the Chairman of the Board of Zastron Electronic (Shenzhen) Co. Ltd. Ms. Lei has worked with Nam Tai Group for eight years specializing in promoting, generating and monitoring sales revenues on various high-end electronics products. Ms. Lei graduated from the Science University of Tokyo in 1990, majoring in Industrial Engineering.
Lee Kwok Wai, Patrick. Mr. Lee took up the post of Managing Director of Zastron Electronic (Shenzhen) Co. Ltd. in February 2004. He is responsible for managing the overall operation of Zastron Electronic (Shenzhen) Co. Ltd. Before joining Zastron Electronic (Shenzhen) Co. Ltd., he has worked for Nokia for 10 years covering engineering, manufacturing operation and general management. His first career after graduation was of Technophone where he started his engineering career. He had worked with Technophone for four years before it was acquired by Nokia. He obtained his Bachelor’s Degree in Electrical and Electronic Engineering from University of Surrey, England in 1989 and a Master’s Degree in Advanced Manufacturing Systems from Brunel University, England in 1997.
L.P. Wang. Mr. Wang assumed the position of Managing Director of our subsidiary Zastron Electronic (Shenzhen) Co. Ltd. from August 2002 to February 2004. Mr. Wang has since resumed the position of Assistant Managing Director of Zastron Electronic (Shenzhen) Co. Ltd. He has more than 23 years of experience in the electronics industry. He joined Nam Tai in 1997 as production engineering manager and was promoted to vice managing director in 2002. He was further promoted to Managing Director of Zastron Electronics (Shenzhen) Co. Ltd. in August of the same year. Prior to joining Nam Tai, Mr. Wang held several management positions in various companies in Taiwan and China. Mr. Wang graduated from Chinese Military Academy in Taiwan.
Chen Yee, William. Mr. Chen assumed the post of Managing Director of Nam Tai Electronic (Shenzhen) Co. Ltd. in September 2003. Before joining Nam Tai, he had 15 years of experience in plant and production management with Jabil Circuits (China) Limited, Dongguan Nokia Mobile Phones Limited, China and Marine Engine Rebuilders, Inc., Philippines. He obtained a Bachelor’s Degree in Industrial Psychology from Far Eastern University in Philippines in 1982 and a Master’s Degree in Business Administration from University of Southern Queensland, Australia in 1999.
Kazuhiro Asano. Mr. Asano assumed the position of Managing Director of our subsidiary Namtek Software Development Co. Ltd. in June 2002. Mr. Asano joined Nam Tai in 1995 as a general manager and was promoted to Managing Director of Shenzhen Namtek Company Limited in 1997. In his current position, he is responsible for the overall corporate management and business development for our software business. Prior to joining Nam Tai, Mr. Asano was the general manager of Seiko Instruments Inc., a private Japanese consumer electronics company, and was responsible for its electronic dictionary division. Mr. Asano graduated from Tsuyama Government Industrial College, Japan with a degree in electrical engineering in 1972.
Seitaro Furukawa. Mr. Furukawa assumed the position of Chairman of the Board and Managing Director of our subsidiary J.I.C. Technology Company Limited in March 2002. He has extensive experience in international operational management. He held
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management positions in the Japan offices of General Electric, Admiral International Company and Thompson CSF. After joining the J.I.C. Group in 1992 as a Managing Director, he assumed responsibility for production management and monitoring daily operations of the LCD plant in Shenzhen. Mr. Furukawa received his Bachelor’s of English Literature degree from Aoyama University in 1965 and his Bachelor’s of Technology and Metallurgy degree from Kogakuin University in 1967.
Ivan Chui. Mr. Chui is the co-founder and Managing Director of our subsidiary J.I.C. Enterprises (Hong Kong) Ltd. Mr. Chui has directed J.I.C. Group’s marketing activities since founding J.I.C. Group in 1980.
Charles Chu. Mr. Chu originally served as a Director from November 1987 to September 1989. He was reappointed a Director in November 1992. Since July 1988, Mr. Chu has been engaged in the private practice of law in Hong Kong. Mr. Chu serves on our audit committee. Mr. Chu received his Bachelor’s of Laws degree and Post-Graduate Certificate of Laws from the University of Hong Kong in 1980 and 1981, respectively.
Peter R. Kellogg. Mr. Kellogg was elected to our Board of Directors in June 2000. Mr. Kellogg was a Senior Managing Director of Spear, Leeds & Kellogg, a registered broker-dealer in the United States and a specialist firm on the New York Stock Exchange until the firm merged with Goldman Sachs in 2000 when Mr. Kellogg became a Senior Advisory Director. Mr. Kellogg served on our audit committee until July 8, 2003. Mr. Kellogg is also a member of the Board of the Ziegler Companies.
Stephen Seung. Mr. Seung was appointed a Director of Nam Tai in 1995. Mr. Seung is an attorney and a C.P.A. and has been engaged in the private practice of law in New York since 1981. Mr. Seung received a B.S. degree in Engineering from the University of Minnesota in 1969, an M.S. degree in Engineering from the University of California at Berkeley in 1971, an MBA degree from New York University in 1973 and a J.D. degree from New York Law School in 1979. Mr. Seung acts as our authorized agent in the United States and serves on our audit committee until October 2003. With effect from October 15, 2003, Mr. Seung also assumed the role of Secretary of the Company.
Dr. Wing Yan (William) Lo. Dr. Lo was elected to our Board of Directors at our annual meeting of shareholders on July 8, 2003. Dr. Lo is currently the Executive Director and Vice President of China Unicom Ltd., a telecommunications operator in China that is listed on both the Hong Kong and New York Stock Exchanges. Dr. Lo is currently also the non-executive Chairman of WPP Greater China, a division of WPP Group plc., a communications services group having its shares listed on both the London Stock Exchange and the Nasdaq National Market. From 1998 to 1999, Dr. Lo was the chief executive appointment at Citibank. Dr. Lo was the founding Managing Director of Hongkong Telecom IMS Ltd. Dr. Lo holds an M. Phil. degree in molecular pharmacology and a Ph.D. degree in genetic engineering, both from Cambridge University, England. He is also member of the Board of the Hong Kong Applied Science and Technology Research Institute and the Hong Kong Jockey Club Institute of Chinese Exchange. In 1998, Dr. Lo was appointed as a Justice of the Peace of Hong Kong. Dr. Lo serves on our audit committee.
Mark Waslen. Mr. Waslen was elected to our Board of Directors in July 2003 and currently serves on the audit committee acting as Chairman. Previously, Mr. Waslen was employed with Nam Tai during the periods 1990 to 1995 and June 1998 to October 1999 in various capacities including Financial Controller, Secretary and Treasurer. Mr. Waslen has been employed with various accounting firms including Peat Marwick Thorne, Deloitte Touche Tohmatsu and is currently employed with BME + Partners Chartered Accountants. Mr. Waslen is a C.F.A., C.A. and a C.P.A. and received a Bachelor’s of Commerce (Accounting Major) from the University of Saskatchewan in 1982.
No family relationship exists among any of the named directors, executive officers or key employees. No arrangement or understanding exists between any of our directors or executive officers and any other person pursuant to which any director or executive officer was elected as a director or executive officer of Nam Tai. Directors are elected each year at our annual meeting of shareholders and serve until their successors take office or until their death, resignation or removal. Executive officers serve at the pleasure of the Board of Directors.
Compensation of Directors and Senior Managers
The aggregate compensation we and our subsidiaries paid during the year ended December 31, 2003 to all directors and officers as a group for services in all capacities was approximately $2.74 million, including compensation in the form of housing in Hong Kong for our Chairman of the Board, our Chief Executive Officer and President, and our Chief Financial Officer.
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Directors who are not employees of Nam Tai nor any of its subsidiaries are paid $3,000 per month for services as a director, $750 per meeting attended in person and $500 per meeting attended by telephone. In addition they are reimbursed for all reasonable expenses incurred in connection with their services as a director.
Members of our key staff are eligible for annual cash bonuses based on their performance and that of the division in which they are assigned for the relevant period. Key staff members of a division will be entitled to share up to 15% of the operating income from that division during the year. Our executive officers in charge of the business unit recommend the participating staff members and the amount, if any, to be allocated from the division’s profit pool to an eligible individual.
According to the relevant laws and regulations in the PRC, we are required to contribute 8% to 9% of the stipulated salary set by the local government of Shenzhen, the PRC, to the retirement benefit schemes to fund the retirement benefits of our employees. Our principal obligation with respect to these retirement benefit schemes is to make the required contributions under the scheme. No forfeited contributions may be used by us to reduce the existing level of contributions.
Prior to December 2000, we maintained staff contributory retirement plans (defined contribution pension plans), which covered certain of our employees in Hong Kong. From December 2000 onwards, we terminated our existing staff contributory retirement plans and enrolled all of our eligible employees in Hong Kong into a Mandatory Provident Fund, or MPF, program. In August 2003, we set up our PRC headquarters, Nam Tai Investments Consultant (Macao Commercial Offshore) Company Limited, in Macao, China. We enrolled all of our eligible employees in Macao into a retirement benefit scheme, or RBS. Both the MPF and RBS are available to all employees aged 18 to 64 and with at least 60 days of service under the employment of Nam Tai in Hong Kong and Macao. Contributions are made by us at 5% based on the staff’s relevant income. The maximum relevant income for contribution purpose per employee is $3 per month. Staff members are entitled to 100% of the Company’s contributions together with accrued returns irrespective of their length of service with us, but the benefits are required by law to be preserved until the retirement age of 65 for employees in Hong Kong while the benefit can be withdrawn by the employees in Macao at the end of employment contracts.
The cost of our contribution to the staff retirement plans in Hong Kong, Macao and PRC amounted to $561,000, $617,000 and $982,000 for the years ended December 31, 2001, 2002 and 2003, respectively.
In August 1990, we fixed compensation for loss of office at $500,000 for Mr. M.K. Koo and $300,000 for Mr. Tadao Murakami. We also fixed the age of retirement for directors, including Messrs. Koo and Murakami, at age 65 years. We have accrued the entire $800,000 on account of this compensation for loss of office.
Board Practices
All directors hold office until our next annual meeting of shareholders, which generally is in June of each calendar year, or until their respective successors are duly elected and qualified or their positions are earlier vacated by resignation or otherwise. All executive officers are appointed by the Board and serve at the pleasure of the Board. There are no director service contracts providing for benefits upon termination of employment. Our Board of Directors has determined, effective December 31, 2002, to grant future options under our stock option plans only to our outside, non-employee directors.
Audit Committee
Nam Tai has established an audit committee whose primary duties consist of reviewing, acting on and reporting to the Board of Directors with respect to various auditing and accounting matters, including the selection of auditors, the scope of the annual audits and the fees to be paid to the auditors and the performance of the independent auditors and accounting practices. The audit committee currently consists of three independent non-executive directors, Messrs. Waslen, Chu and Lo. Mr. Waslen, who was elected by the full Board of Directors, currently acts as the Chairman of the Audit Committee
Meetings
Meetings of the audit committee, as chaired by the Chairman of Audit Committee, shall be held at least once per quarter with external and internal auditors.
Authority and Duties
The audit committee shall assist the Board of Directors in fulfilling is “oversight and monitoring” responsibilities.
The duties of the audit committee are to:
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The audit committee last met on February 5, 2004.
The Compensation Committee of the Board of Directors determines the salaries and incentive compensation of the officers of Nam Tai (other than Messrs. Murakami and Koo, whose salaries are decided each year by our Board’s outside directors), provides recommendations for the salaries and incentive compensation of all employees and consultants and administers various compensation, stock and benefit plans of Nam Tai. The Compensation Committee consists of Messrs. Murakami and Koo.
The Investment Committee of the Board of Directors may make strategic investments in companies of amounts less than $5 million with approval of other members of the Board. The Investment Committee consists of Messrs. Murakami and Koo.
Options of Directors and Senior Management
The following table provides information concerning options owned by our current Directors and Senior Management at March 1, 2004. All share numbers subject to options and exercise price per share have been adjusted to give effect to a three-for-one stock split effective on June 30, 2003 and a ten-for-one stock dividend effective on November 7, 2003.
Please refer to page 52 of this Report, which sets forth the shareholding information of each of the director and senior management of the Company.
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Employee Stock Option and Incentive Plan
Our 1993 and 2001 stock option plans provide for the grant of stock options to directors, employees, (including officers) and consultants. The terms and conditions of individual grants may vary subject to the following: (i) the exercise price of incentive stock options may not normally be less than market value on the date of grant; (ii) the term of incentive stock options may not exceed ten years from the date of grant; (iii) the exercise price of an option cannot be altered once granted; and (iv) every non-executive director who is not our employee shall, on an annual basis upon their election to the Board of Director at the Annual General Meeting, be automatically granted 16,500 options, with an exercise price equal to 100% of the fair market value of the common shares on the date of grant. At March 1, 2004, options to purchase 108,550 shares were outstanding under our Stock Options Plans and 1,904,869 shares were available for future grant under them.
Our Board of Directors has determined, effective December 31, 2002, to grant future options under our stock option plans only to our non-employee directors. Thereafter, incentive compensation paid to management and other key employees was in the form of either cash bonuses or stock options.
Employees
As of December 31, 2003, we employed 4,476 persons on a full-time basis, of which 4,385 were employed in China, 62 were employed in Hong Kong, 24 were employed in Macao, 4 were employed in Japan and 1 was employed in the British Virgin Islands. Of these employees, approximately 3,415 were engaged in manufacturing, approximately 1,061 were engaged in administrative, research and development, quality control, engineering and marketing positions, and the balance in supporting jobs such as security, janitorial, food and medical services.
As of December 31, 2002, we employed 4,246 persons on a full-time basis, of which 4,173 were employed in China and 73 were employed in Hong Kong. Of these employees, approximately 2,915 were engaged in manufacturing, approximately 1,331 were engaged in administrative, research and development, quality control, engineering and marketing positions, and the balance in supporting jobs such as security, janitorial, food and medical services.
As of December 31, 2001, we employed 3,947 persons on a full-time basis, of which 3,866 were employed in China and 81 were employed in Hong Kong. Of these employees, approximately 2,728 were engaged in manufacturing, approximately 1,096 were engaged in administrative, research and development, quality control, engineering and marketing positions, and the balance in supporting jobs such as security, janitorial, food and medical services.
We are not a party to any material labor contracts. The nature of our arrangement with our manufacturing employees is such that we can increase or reduce staffing levels without significant difficulty, cost or penalty. Although we have experienced no significant labor stoppages and believe relations with our employees are satisfactory, this situation may not continue in the future, and any labor difficulties could lead to increased costs and/or interruptions in our production.
It is the practice of one of our subsidiaries to enter into a collective agreement with its trade union. The collective agreement usually sets out the minimum standard for the wages, working hours and other benefits of the workers. The current collective agreement between our subsidiary and its trade union expires on April 17, 2004 and will be renewed.
Item 7. Major Shareholders and Related Party Transactions
The following table sets forth certain information known to us regarding the beneficial ownership of our common shares as of March 1, 2004, by:
We are not directly owned or controlled by another corporation or by any foreign government, natural or legal person.
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All of the holders of our common shares have equal voting rights with respect to the number of common shares held. As of March 1, 2004, there were approximately 808 holders of record of our common shares. According to information supplied by our transfer agent, 774 holders of record with addresses in the United States held 30,822,026 of our outstanding common shares.
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The following table reflects the percentage ownership of our common shares beneficially owned by our major shareholders during the past three years:
There are no arrangements that may, at a subsequent date, result in a change of control of the Company.
Certain Relationships and Related Transactions
In January 2003, we invested $10.0 million for a 25% equity interest in Alpha Star Investments Ltd., the ultimate parent of JCT. JCT is engaged in the design, development and marketing of wireless communication terminals and wireless application software. In connection with our investment, Mr. Koo has been appointed as a director to Alpha Star Investment Ltd’s Board of Directors. We are manufacturing wireless communication terminals and related modules for JCT. As part of our investment, Alpha Star Investment Ltd agreed to have us manufacture the RF modules for at least 50 percent of the orders it, or any of its subsidiaries, receives for RF modules provided we perform such manufacturing services at a price comparable to the market. In March 2003, we agreed to support JCT in the production of 1 million cellular phones by providing assembling services and support for the manufacturing of LCD modules and RF modules. As of December 31, 2003, we were owed $2.7 million from JCT. For the year ended December 31, 2003, we recognized net sales of $20.8 million to JCT and purchased raw materials of approximately $5.5 million from JCT and its related companies.
On February 16, 2004, by unanimous consent following resolutions without meeting, the Board of Directors adopted a resolution for the sale of a residential property located in Hong Kong by a wholly owned subsidiary of the Company, Nam Tai Group Management Limited, to Mr. Tadao Murakami, Chairman of the Board of Directors, for consideration of approximately $1.8 million, which is similar to the original acquired cost and appraised market value of the property as of January 31, 2004. The agreement for the sale of the property was entered into between Nam Tai Group Management Limited and Mr. Tadao Murakami on March 10, 2004.
Item 8. Financial Information
Financial Statements
Our Consolidated Financial Statements are set forth under Item 18. Financial Statements. From year end dated December 31, 2003 to our reporting date of March 5, 2004 there has been no significant changes on our consolidated Financial Statements, except subsequent events as shown under the Financial Statement.
Change in Public Accountants
In May of 2002, upon consideration and to reduce our professional fees, our Board of Directors, including our Audit Committee, recommended that HLB Hodgson Impey Cheng replace Deloitte Touche Tohmatsu as our independent auditors. This change was included in our proxy statement and approved by our shareholders at our annual meeting on June 14, 2002. Deloitte Touche Tohmatsu did not resign or refuse to stand for re-election, and none of Deloitte Touche Tohmatsu’s reports on the financial statements for either of the two years prior to the change and included in this Report contained an adverse opinion, disclaimer, modification or qualification.
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In November 2002, HLB advised us that they could not meet our audit requirements for the agreed fees and on a cost-effective basis because the increasingly complex regulatory guidelines for the auditing of public companies would require them to perform a significant portion of the final audit work with personnel from a U.S. affiliate. HLB submitted their resignation accordingly. There were no disagreements with HLB on any matter or accounting principle, practice, financial statement disclosure, or auditing scope or procedure.
In December 2002, in contemplation of our intention to list on the NYSE, we sought a replacement firm with a strong U.S. and Asian presence and an ability to handle our audit requirements. Accordingly, our Board of Directors appointed Grant Thornton as our independent public accountants based on Grant Thornton’s ranking among accounting firms in the U.S. and our Board’s belief that Grant Thornton would be acceptable to our shareholders. The appointment of Grant Thornton was accepted by our shareholders at our annual meeting held on July 8, 2003. Accordingly, Grant Thornton issued the audited account for 2002.
In August 2003, we set up the PRC’s headquarters in Macao, China, due to our continuous increase in investment in PRC. Since Grant Thornton does not have an office in Macao and does not have a licence to handle Macao statutory tax filings, Grant Thornton tendered its resignation as our auditors. Deloitte Touche Tohmatsu, who had been our auditors from 1998-2001, was hired to audit for both 2002 and 2003. Deloitte Touche Tohmatsu has been appointed as our auditors as of October 24, 2003. Grant Thornton will, however, continue to provide tax advisory services to us, other than with respect to Macao.
Legal Proceedings
We are not a party to any legal proceedings other than routine litigation incidental to our business and there are no material legal proceedings pending with respect to our property, other than as described below.
Tele-Art Litigation
In June 1997, we filed a petition in the British Virgin Islands for the winding up of Tele-Art, Inc. on account of an unpaid judgment debt owed to us. The High Court of Justice granted an order to wind up Tele-Art, Inc. in July 1998 and the Eastern Caribbean Court of Appeal upheld the decision on January 25, 1999. On January 22, 1999, pursuant to our Articles of Association, we redeemed and cancelled 415,500 (Note 1) shares of Nam Tai registered in the name of Tele-Art, Inc. at a price of $3.73 per share to offset substantially all of the judgment debt of $799,000 plus interest and legal costs totaling approximately $1.7 million, including dividends that we had withheld and credited against the judgment debt.
Following the completion of the redemption, we received notice that the liquidator had obtained an ex-parte injunction preventing us from redeeming Nam Tai shares beneficially owned by Tele-Art, Inc. On February 4, 1999, the liquidator of Tele-Art, Inc. filed a further summons in the British Virgin Islands on its behalf seeking, among other matters:
On March 26, 2001, we filed a summons seeking to remove the liquidator for failing to act diligently in the performance of his duties and for knowingly misleading the court. On September 3, 2002, the liquidator submitted a letter of resignation prior to the scheduled removal hearing. A new liquidator was appointed by the BVI court on July 11, 2003.
On July 5, 2002, upon our application, the court ordered the removal of the liquidator’s ex-parte injunction and ordered an inquiry into damages. On August 9, 2002, the court delivered a decision awarding us a judgment against Tele-Art, Inc. for approximately $34.0 million. On August 12, 2002, we redeemed and cancelled, pursuant to its Articles of Association, the remaining 509,181 (Note 2) shares beneficially owned by Tele-Art, Inc. at a price of $6.14 per share. Including the dividends which we had withheld and credited against the judgment, this offset a further $3.5 million, approximately, in judgment debts owed to us by Tele-Art, Inc. We recorded the $3.3 million redemption net of expenses as other income in 2002.
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On January 21, 2003, judgment was delivered on the liquidators’ February 4, 1999 summons declaring that the redemption and set off of dividends on the 415,500 (Note 1) shares be set aside and that all Tele-Art Inc. property withheld by us be delivered to Tele-Art, Inc. in liquidation. The orders granted in the judgment were substantially different from the relief sought in the February 4, 1999 application. On February 4, 2003, we filed an application for a stay of execution and leave to appeal the decision listing eight grounds of appeal, which was granted on June 23, 2003. The case was heard on January 12, 2004 and the judgment was reserved.
Our legal representatives have advised us that we have real prospects of success on appeal against the January 21, 2003 decision and we plan to vigorously fight for such an outcome. However, due to the uncertainty of the final outcome of the litigation as a result of the January 21, 2003 judgment and in accordance with SFAS No. 5, “Accounting for Contingencies”, we have recorded a provision for $5.2 million as a component of accrued expenses pending a final determination of this matter by the courts as of December 31, 2002, represented the then best estimate of the net monetary expense we would incur if our appeal is unsuccessful and the two judgment debts in the total amount of $38.0 million (including interest, costs, and related expenses) is determined as having the lowest priorities in recovering from the estate of Tele-Art Inc. As of November 7, 2003, apart from Nam Tai, a total of four other creditors of Tele-Art, Inc., including Bank of China, had submitted their proof of debt to the liquidator for the total claim amount of approximately $3.4 million. Together with the outstanding legal charge as of December 31, 2003, the total potential future obligation to us would only be approximately $3.9 million. The 2002 provision for $5.2 million had been reduced to $3.9 million in the fourth quarter of 2003. If our appeal is successful and all legal matters related to Tele Art, Inc. are finalized, including the final determination of other creditors’ position, then the remaining portion of $3.9 million provision consequently will also be reversed into income in the related period.
If our appeal is not successful, and the 1,017,149 (adjusted for ten-for-one stock dividend) share redemption is set aside, we believe that these shares would be sold by Tele-Art, Inc.’s liquidator in the open market at the market price prevailing at the time of sale. For example, if these shares had been sold at the March 1, 2004 closing price of $28.09 per share, the proceeds the liquidator would have realized before commissions, plus withheld dividends of $518,000, would have been approximately $29.1 million for the estate of Tele-Art, Inc. (in liquidation). Furthermore, according to the information provided by existing liquidator as of November 7, 2003, the estimated liabilities for all other unsecured creditors are approximately $353,000. The Bank of China is claiming to be a secured creditor in the amount of approximately $2.7 million, and the January 21, 2003 judgment found that the Bank of China is secured and we are unsecured. We dispute that finding, and among other matters, have argued that the proof of debt of Bank of China was incomplete and invalid. The former liquidator is claiming to have incurred approximately $383,000 in costs for work as the liquidator. Accordingly, if we are not successful on our appeal of the January 21, 2003 judgment, we will seek to recover our $38.0 million in judgment debts from the estate of Tele-Art, Inc. Accordingly, any amount recovered from the state of Tele-Art Inc. in settlement of the claimed judgment debt would be recognized as other income.
However, there is no assurance that we may realize the entire amount of our judgment debts as Tele-Art Inc. is in liquidation. The actual amount of the recovery, if any, is uncertain, and is dependent on a number of factors including the value of our shares when sold in the market, and the final determination of other creditors’ positions. We plan to continue to pursue vigorously all legal alternatives available to seek to recover the maximum amount of the outstanding debt from Tele-Art, Inc. (in liquidation) as well as to pursue other parties that may have assisted in any transfers of the assets from Tele-Art, Inc. We may incur substantial additional costs in pursuing our recovery and such costs may not be recoverable.
Note
Putative Class Actions
On March 11, 2003, we were served with a complaint in an action captioned Michael Rocco v. Nam Tai, et al., 03 Civ. 1148 (S.D.N.Y.), or the Rocco Action. In addition to Nam Tai, certain directors are named as defendants. On or about April 9, 2003, a second complaint was filed in an action captioned A.J. & Celine Steigler v. Nam Tai, et al., 03 Civ. 2462 (S.D.N.Y.), or the Steigler Action, and together with the Rocco Action, the Actions. The Actions have been consolidated since July 2003 and purports to represent a putative class of persons who purchased the common stock of Nam Tai from July 29, 2002 through February 18, 2003. Plaintiffs in the Actions assert claims under Section 10(b) of the Securities Exchange Act of 1934 and allege that misrepresentations and/or omissions were made during the alleged class periods concerning the partial reversal of an inventory provision and a charge to goodwill related to Nam Tai’s LPT segment. We have filed a motion to dismiss the lawsuit and the putative class action has not been certified as a class action by the court. In any event, our motion to dismiss was heard in November 2003 and we are awaiting the judgment of the court thereof. Nam Tai believes it has meritorious defenses and intends to defend the case vigorously.
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Export Sales
Geographic Markets
Approximate percentages of net sales to customers by geographic area based upon location of product delivery are set forth below for the periods indicated:
Dividend Policy
We have paid an annual dividend for the last ten consecutive years. On February 6, 2004, we announced that we were increasing our regular annual dividend to $0.48 per share to be declared and paid quarterly commencing with the first quarter 2004 dividend of $0.12 per share. The following table sets forth the total cash dividends and dividends per share we have declared for each of the five years in the period ended December 31, 2003, adjusted to give effect to a three-for-one stock split effective on June 30, 2003.
It is our general policy to determine the actual annual amount of future dividends, if any, based upon our growth during the preceding year. Future dividends, if any, will be in the form of cash or stock or a combination of both. We may not be able to pay dividends in the future or may decide not to declare them in any event. We will determine the amounts of the dividends when they are declared and even if dividends are declared in the future we may not continue them in any future period.
We declared special dividends in 2002 and 2003 for the reasons described below:
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Item 9. The Listing
Our common shares are traded in the United States on the NYSE. On January 23, 2003, our common shares were listed on the NYSE under the symbol “NTE.” Prior to that, our common shares were quoted on the Nasdaq National Market under the symbol “NTAI.”
The following table sets forth the high and low closing sale prices for our common shares for the quarters in the three-year period ended December 31, 2003, adjusted to give effect to a three-for-one stock split effective on June 30, 2003:
The following table sets forth the high and low closing sale prices for each of the last five years ended December 31, adjusted to give effect to a three-for-one stock split effective on June 30, 2003:
The following table sets forth the high and low closing sale prices during each of the most recent six months:
On March 9, 2004, the last reported sale price of our common shares on the NYSE was $25.17 per share. As of March 1, 2004, there were 808 holders of record of our common shares.
Item 10. Additional Information
Share Capital
Our authorized capital consists of 200,000,000 common shares, $0.01 par value per share. On June 20, 2003, we announced a three-for-one stock split effective on June 30, 2003 and a ten-for-one stock dividend effective November 7, 2003. As of March 1, 2004, 41,231,272 common shares were outstanding.
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Memorandum and Articles of Association
Holders of our common shares are entitled to one vote for each whole share on all matters to be voted upon by shareholders, including the election of directors. Holders of our common shares do not have cumulative voting rights in the election of directors. All of our common shares are equal to each other with respect to liquidation and dividend rights. Holders of our common shares are entitled to receive dividends if and when declared by our Board of Directors out of funds legally available under British Virgin Islands law. In the event of our liquidation, all assets available for distribution to the holders of our common shares are distributable among them according to their respective holdings. Holders of our common shares have no preemptive rights to purchase any additional, unissued common shares. All of our outstanding common shares are, and the newly issued common shares we are offering pursuant to this prospectus, will be when issued and paid for, duly authorized, validly issued and nonassessable. All of our outstanding common shares are, and the newly issued common shares we are offering pursuant to this prospectus, will be, registered rather than bearer shares.
Pursuant to our Memorandum and Articles of Association and pursuant to the laws of the British Virgin Islands, our Board of Directors without shareholder approval may amend our Memorandum and Articles of Association. This includes amendments to increase or reduce our authorized capital stock. Our ability to amend our Memorandum and Articles of Association without shareholder approval could have the effect of delaying, deterring or preventing a change in control of Nam Tai, including a tender offer to purchase our common shares at a premium over the then current market price.
We have never had any class of stock outstanding other than our common shares nor have we ever changed the voting rights with respect to our common shares.
Our registered office is at 3rd floor 116 Main Street, Road Town, Tortola, British Virgin Islands and we have been assigned company number 3805. Our object or purpose is to engage in any act or activity that is not prohibited under British Virgin Islands law as set forth in Clause 4 of the Memorandum of Association. As an International Business Company, and as set forth in Clause 6, we are prohibited from doing business with persons resident in the British Virgin Islands, owning real estate in the British Virgin Islands, or accepting banking deposits or contracts of insurance. We do not believe these restrictions materially affect our operations.
Paragraph 60 of our Amended Articles of Association, or Articles, provides that a director may be counted as one of a quorum in respect of any contract or arrangement in which the director is materially interested or makes with the Company; however, if the agreement or transaction cannot be approved by a resolution of directors without counting the vote or consent of any interested director, the agreement or transaction may only be validated by approval or ratification by a resolution of the shareholders, who are referred under the law of the British Virgin Islands as “members.” Paragraph 53 of the Articles allows the directors to vote compensation to themselves in respect of services rendered to us. Paragraph 69 of the Articles provides that the directors may by resolution exercise all the powers on our behalf to borrow money and to mortgage or charge our undertakings and property or any part thereof, to issue debentures, debenture stock and other securities whenever we borrow money or as security for any of our debts, liabilities or obligations or those of any third party. These borrowing powers can be altered by an amendment to the Articles. There is no provision in our Articles for the mandatory retirement of directors; however, we have fixed 65 as the mandatory age of retirement for our directors. Directors are not required to own our shares in order to serve as directors.
Paragraph 85 of the Articles allows us to deduct from any shareholder’s dividends amounts owing to us by that shareholder. Paragraph 13.1 provides that we can redeem shares at fair market value from any shareholder against whom we have a judgment debt.
Paragraph 12 of the Articles provides that without prejudice to any special rights previously conferred on the holders of any existing shares, any of our shares may be issued with such preferred, deferred or other special rights or such restrictions, whether in regard to dividends, voting, return of capital or otherwise as the directors may from time to time determine.
Paragraph 14 of the Articles provides that if at any time the authorized share capital is divided into different classes or series of shares, the rights attached to any class or series may be varied with the consent in writing of the holders of not less than three fourths of the issued shares of any other class or series of shares which may be affected by such variation.
Provisions in respect of the holding of general meetings and extraordinary general meetings are set out in Paragraphs 27 to 46 of the Articles and under the International Business Companies Act. The directors may convene meetings of our shareholders at such times and in such manner and places as the directors consider necessary or desirable, and they shall convene such a meeting upon the written request of shareholders holding more than 30 percent of the votes of our outstanding voting shares. Other than providing, if
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requested, reasonable proof of a holder’s status as a holder of our shares as of the applicable record date, there is no condition to the admission of a shareholder or his or her proxy holder to our meetings of shareholders.
British Virgin Islands law and our Memorandum and Articles of Association impose no limitations on the right of nonresident or foreign owners to hold or vote our securities.
There are no provisions in our Memorandum of Association or Articles of Association governing the ownership threshold above which shareholder ownership must be disclosed.
As a result of the issuance of additional common shares in 2003 pursuant to the three-for-one stock split and increase in the number of Common Shares reserved for issuance under the Company’s 1993 Stock Option Plan and 2001 Stock Option Plan, the authorized share capital of the Company was enlarged from $200,000 to $2,000,000 and number of shares was increased from 20,000,000 to 200,000,000. The full text of our Amended Articles and Memorandum, amended on June 26, 2003, we hereby file as Exhibit 1.1 with the Annual Report on Form 20-F for 2003.
Transfer Agent
Registrar and Transfer Agent Company, 10 Commerce Drive, Cranford, New Jersey 07016-3572, U.S.A., is the United States transfer agent and registrar for our common shares.
Material Contracts
The following summarizes each material contract, other than contracts entered into in the ordinary course of business, to which Nam Tai or any subsidiary of Nam Tai is a party, for the two years immediately preceding the filing of this report:
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60
There are no exchange control restrictions on payments of dividends, interest, or other payments to nonresident holders of Nam Tai’s securities or on the conduct of our operations in Hong Kong and PRC headquarters in Macao, China or where our principal executive offices are located in the British Virgin Islands, where Nam Tai is incorporated. Other jurisdictions in which we conduct operations may have various exchange controls. With respect to our China subsidiaries, with the exception of a requirement that 10% of profits be reserved for future developments, there are no restrictions on the payment of dividends and the removal of dividends from China once all taxes are paid and assessed and losses, if any, from previous years have been made good. We believe such restrictions will not have a material effect on our liquidity or cash flow.
Taxation
United States Federal Income Tax Consequences
The discussion below is for general information only and is not, and should not be interpreted to be, tax advice to any holder of our common shares. Each holder or a prospective holder of our common shares is urged to consult his, her or its own tax advisor.
General
This section is a general summary of the material United States federal income tax consequences to U.S. Holders, as defined below, of the ownership and disposition of our common shares as of the date of this report. This summary is based on the provisions of the Internal Revenue Code of 1986, as amended, or the Code, the applicable Treasury regulations promulgated and proposed thereunder, judicial decisions and current administrative rulings and practice, all of which are subject to change, possibly on a retroactive basis. The summary applies to you only if you hold our common shares as a capital asset within the meaning of Section 1221 of the Code. The United States Internal Revenue Service, or the IRS, may challenge the tax consequences described below, and we have not requested, nor will we request, a ruling from the IRS or an opinion of counsel with respect to the United States federal income tax consequences of acquiring, holding or disposing of our common shares. This summary does not purport to be a comprehensive description of all the tax considerations that may be relevant to the ownership of our common shares. In particular, the discussion below does not cover tax consequences that depend upon your particular tax circumstances nor does it cover any state, local or foreign law, or the possible application of United States federal estate or gift tax. You are urged to consult your own tax advisors regarding the application of the United States federal income tax laws to your particular situation as well as any state, local, foreign and the United States federal estate and gift tax consequences of the ownership and disposition of the common shares. In addition, this summary does not take into account any special United States federal income tax rules that apply to a particular holder of our common shares, including, without limitation, the following:
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For purposes of the discussion below, you are a “U.S. Holder” if you are a beneficial owner of our common shares who or which is:
Distributions on Our Common Shares
Subject to the passive foreign investment company, or PFIC, considerations discussed below, the gross amount of any cash distribution or the fair market value of any property distributed that you receive with respect to our common shares generally will be subject to tax as ordinary dividend income to the extent such distribution does not exceed our current or accumulated earnings and profits, or E&P, as calculated for United States federal income tax purposes. Such income will be includable in your gross income on the date of receipt. Subject to certain limitations, dividends paid to noncorporate U.S. Holders, including individuals, may be eligible for a reduced rate of taxation if we are a “qualified foreign corporation” for U.S. federal income tax purposes. A qualified foreign corporation includes (i) a foreign corporation that is eligible for the benefits of a comprehensive income tax treaty with the United States that includes an exchange of information program, and (ii) a foreign corporation if its stock with respect to which a dividend is paid is readily tradable on an established securities market within the United States, but does not include an otherwise qualified corporation that is a PFIC. We believe that we will be a qualified foreign corporation for so long as we are not a PFIC and our common shares are considered to be readily tradable on an established securities market within the United States. No assurances can be made that our Company’s status as a qualified foreign corporation will not change. To the extent any distribution exceeds our E&P, such distribution will first be treated as a tax-free return of capital to the extent of your adjusted tax basis in our common shares and will be applied against and reduce such basis on a dollar-for-dollar basis (thereby increasing the amount of gain and decreasing the amount of loss recognized on a subsequent disposition of such shares). To the extent that such distribution exceeds your adjusted tax
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basis in our common shares, the distribution will be treated as capital gain. Because we are not a United States corporation, no dividends-received deduction will be allowed to corporations with respect to dividends paid by us.
For United States foreign tax credit limitation purposes, dividends received on our common shares will be treated as foreign source income and generally will be “passive income,” or in the case of certain holders, “financial services income.” You may be eligible, subject to a number of complex limitations, to claim a foreign tax credit in respect of foreign withholding taxes, if any, imposed on dividends received on our common shares. The rules governing United States foreign tax credits are complex, and we recommend that you consult your tax advisor regarding the applicability of such rules to you.
Sale, Exchange or Other Disposition of Our Common Shares
Subject to the PFIC considerations discussed below, generally, in connection with the sale, exchange or other taxable disposition of our common shares:
PFIC Considerations
A foreign corporation will be treated as a PFIC for United States federal income tax purposes if, after applying relevant look-through rules with respect to the income and assets of subsidiaries, 75% or more of its gross income consists of certain types of passive income or 50% or more of the gross value of its assets is attributable to assets that produce passive income or are held for the production of passive income. For this purpose, passive income generally includes dividends, interest, royalties, rents (other that rents and royalties derived in the active conduct of a trade or business), annuities and gains from assets that produce passive income. We presently believe that we are not a PFIC and do not anticipate becoming a PFIC. This is, however, a factual determination made on an annual basis and is subject to change. If we were to be classified as a PFIC in any taxable year, (i) U.S. Holders would generally be required to treat any gain on sales of our shares held by them as ordinary income and to pay an interest charge on the value of the deferral of their United States federal income tax attributable to such gain and (ii) distributions paid by us to our U.S. Holders could also be subject to an interest charge. In addition, we would not provide information to our U.S. Holders that would enable them to make a “qualified electing fund” election under which, generally, in lieu of the foregoing treatment, our earnings would be currently included in their United States federal income.
Backup Withholding and Information Reporting
Payments, including dividends and proceeds of sales, in respect of our common shares that are made in the United States or by a United States related financial intermediary will be subject to United States information reporting rules. In addition, such payments may be subject to United States federal backup withholding tax. You will not be subject to backup withholding provided that:
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Amounts withheld under the backup withholding rules may be credited against your United States federal income tax, and you may obtain a refund of any excess amounts withheld under the backup withholding rules by filing the appropriate claim for refund with the IRS in a timely manner.
BRITISH VIRGIN ISLANDS TAX CONSIDERATIONS
Under the International Business Companies Act of the British Virgin Islands as currently in effect, a holder of common equity, such as our common shares, who is not a resident of the British Virgin Islands is exempt from British Virgin Islands income tax on dividends paid with respect to the common equity and is not liable to the British Virgin Islands for income tax on gains realized on sale or disposal of such shares. Furthermore, there are no capital gains, gift or inheritance taxes levied by the British Virgin Islands on persons who are not residents of the British Virgin Islands. The British Virgin Islands does not impose a withholding tax on dividends paid by a company incorporated under the International Business Companies Act.
Our common shares are not subject to transfer taxes, stamp duties or similar charges. There is no income tax treaty or convention currently in effect between the United States and the British Virgin Islands.
Documents on Display
Nam Tai Electronics, Inc. is subject to the information requirements of the Securities and Exchange Act of 1934, and, in accordance with the Securities Exchange Act of 1934, Nam Tai Electronics, Inc. files annual reports on Form 20-F within six months of its fiscal year end, and submit other reports and information under cover of Form 6-K with the SEC. You may read and copy this information at the SEC’s public reference room at 450 Fifth Street, N.W., Washington, D.C. 20549. Recent filings and reports are also available free of charge though the EDGAR electronic filing system at www.sec.gov. You can also request copies of the documents, upon payment of a duplicating fee, by writing to the public reference section of the SEC. Please call the SEC at 1-800-SEC-0330 for further information on the operation of the public reference room or accessing documents through EDGAR. As a foreign private issuer, Nam Tai Electronics, Inc. is exempt from the rules under the Securities Exchange Act of 1934 prescribing the furnishing and content of proxy statements to shareholders.
Item 11. Quantitative and Qualitative Disclosure About Market Risk
See Exchange Rate Fluctuation discussion in Item 3. Key Information — Risk Factors and Item 5. Operating and Financial Review and Prospects on pages 10 and 45, respectively.
See Foreign Currency Risk discussion in Item 5. Operating and Financial Review and Prospects on page 45.
See Interest Rate Risk discussion in Item 5. Operating and Financial Review and Prospects on page 45.
Item 12. Description of Securities Other Than Equity Securities
Not applicable
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PART II
Item 13. Defaults, Dividend Arrearages and Delinquencies
Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds
Item 15. Controls and Procedures
Evaluation of disclosure controls and procedures
As required by Rule 13a-14 under the Securities Exchange Act of 1934, as of December 31, 2003, the Company carried out an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15(d)-15(e) of the Securities Exchange Act of 1934. This evaluation was carried out under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, the Company’s controls and procedures were designed and provided reasonable assurance of preventing errors and irregularities.
Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in the Company’s reports filed or submitted under the Securities Exchange Act of 1934 recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed in Company reports filed under the Exchange Act is accumulated and communicated to management, including the Company’s Chief Executive Officer and Chief Financial Officer as appropriate, to allow timely decisions regarding disclosures.
The Company has confidence in its internal controls and procedures and has expanded its efforts to develop and improve its controls. Nevertheless, the Company’s management, including the Chief Executive Officer and Chief Financial Officer, does not expect that the Company’s disclosure procedures and controls, or its internal controls, will necessarily prevent all error or intentional fraud. An internal control system, no matter how well-conceived and operated, can provide only reasonable, but not absolute, assurance that the objectives of such internal controls are met. Further, the design of an internal control system must reflect the fact that the Company is subject to resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all internal control systems, no evaluation of controls can provide absolute assurance that all internal control issues or instances of fraud, if any, within the Company be detected.
Changes in internal controls
There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls subsequent to the date the Company carried out this evaluation.
Item 16. [Reserved]
Item 16 A. Audit Committee Financial Expert
The Company’s Board of Directors has determined that one member of the Audit Committee, Mark Waslen, qualifies as “audit committee financial expert” as defined by Item 401(h) of Regulation S-Km adopted pursuant to the Securities Exchange Act of 1934. Mr. Waslen has a degree in Accounting and is a C.F.A., C.A. and a C.P.A. In addition to serving in various financial positions, including Nam Tai Group Financial Controller from 1990 to 1995 and Treasurer from 1998 to 1999, at Nam Tai, Mr. Waslen has worked at Peat Marwick Thorne, Deloitte Touche Tohmatsu and BME+ Partners Chartered Accountants.
All three members of the audit committee, Messrs. Waslen, Chu and Lo, are independent non-executive directors.
Item 16 B. Code of Ethics
The Company has adopted a Code of Ethics for the Chief Executive Officer and Chief Financial Officer, which applies to the Company’s principal executive officer and to its principal financial and accounting officers. A copy of the Code of Ethics is attached as Exhibit 14.1 to this Annual Report on Form 20-F.
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Item 16 C. Principal Accountant Fees and Services
Deloitte Touche Tohmatsu has served as our independent public accountant for each of the fiscal years in the three-year period ended December 31, 2003, for which audited financial statements appear in this annual report on Form 20-F. The auditor is elected annually at the Annual General Meeting. The Audit Committee will propose to the Annual General Meeting convening on June 11, 2004 that Deloitte Touche Tohmatsu be elected as the auditor for 2004.
The following table presents the aggregate fees for professional services and other services rendered by Deloitte Touche Tohmatsu to us in 2003 and 2002.
(2) Audit-related Fees consist of fees billed for assurance and related services that are reasonably related to the performance of the audit or review of our financial statements or that are traditionally performed by the external auditor.
(3) Tax Fees include fees billed for tax compliance services, including the preparation of original and amended tax returns and claims for refund; tax consultations, such as assistance and representation in connection with tax audits and appeals, tax advice related to mergers and acquisitions, transfer pricing, and requests for rulings or technical advice from tax authorities; tax planning services; and expatriate tax compliance, consultation and planning services.
(4) All Other Fees includes business advisory service fee.
Audit Committee Pre-approval Policies and Procedures
The Audit Committee of our Board of Directors is responsible, among other matters, for the oversight of the external auditor subject to the relevant regulations of the SEC and NYSE. The Audit Committee has adopted a policy, or the Policy, regarding pre-approval of audit and permissible non-audit services provided by our independent auditors..
Under the Policy, the Chairman of the Audit Committee is delegated the authority to grant pre-approvals in respect of all auditing services including non-audit service, but excluding those services stipulated in Section 201 “Service Outsider the Scope of Practice of Auditors”. Moreover, if the Audit Committee approves an audit service within the scope of the engagement of the audit service, such audit service shall be deemed to have been pre-approved. The decisions of the Chairman of the Audit Committee made under delegation authority to pre-approve an activity shall be presented to the Audit Committee at each of its scheduled meetings.
Requests or applications to provide services that require specific approval by the Audit Committee are submitted to the Audit Committee by both the external auditor and the Chief Financial Officer.
During 2003, services provided to us by Deloitte Touche Tohmatsu representing less than 8.2% of the total fees were approved by the Audit Committee pursuant to the de minima is exception to the pre-approval requirement provided by paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X.
Item 16 D. Purchases of Equity Securities by the Issuer and Affiliated Purchasers
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PART III
Item 17. Financial Statements
Not Applicable
Item 18. Financial Statements
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
The information required within the schedules for which provisions are made in the applicable accounting regulations of the Securities and Exchange Commission is either not applicable or is included in the notes to the Consolidated Financial Statements.
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INDEPENDENT AUDITORS’ REPORT
To the Shareholders and the Board of Directors of Nam Tai Electronics, Inc.:
We have audited the accompanying consolidated balance sheets of Nam Tai Electronics, Inc. and subsidiaries as of December 31, 2002 and 2003, and the related consolidated statements of income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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, such consolidated financial statements referred to above present fairly, in all material respects, the financial position of Nam Tai Electronics, Inc. and subsidiaries at December 31, 2002 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America.
As discussed in note 2(f) to the consolidated financial statements, in 2002, the Company changed its method of accounting of goodwill and other intangibles.
DELOITTE TOUCHE TOHMATSU
Hong KongMarch 5, 2004
F-1
NAM TAI ELECTRONICS, INC.
CONSOLIDATED STATEMENTS OF INCOME(In thousands of US dollars, except per share data)
See accompanying notes to consolidated financial statements.
F-2
CONSOLIDATED BALANCE SHEETS(In thousands of US dollars, except share data)
F-3
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY(In thousands of US dollars, except share and per share data)
F-4
CONSOLIDATED STATEMENTS OF CASH FLOWS(In thousands of US dollars)
F-5
NAM TAI ELECTRONICS. INC.
F-6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(In thousands of US dollars, except share and per share data)
F-7
F-8
F-9
F-10
F-11
F-12
F-13
F-14
F-15
F-16
F-17
F-18
F-19
F-20
F-21
F-22
F-23
F-24
F-25
F-26
F-27
F-28
F-29
F-30
F-31
F-32
F-33
F-34
F-35
Item 19 Exhibits.
The following exhibits are filed as part of this annual report:
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SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange Act of 1934, the registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and has duly caused and authorized the undersigned to sign this annual report on its behalf.
Date: March 10, 2004
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EXHIBIT INDEX
71
72
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