SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE PERIOD ENDED SEPTEMBER 30, 2004.
or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ___________ TO
_______________.
COMMISSION FILE NUMBER 0-27436
COMTECH GROUP, INC.
(Exact name of registrant as specified in its charter)
MARYLAND 94-3171940
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
ROOM 1001, TOWER C, SKYWORTH BUILDING
HIGH-TECH INDUSTRIAL PARK
NANSHAN, SHENZHEN 5180, PRC
(Address of Principal Executive Offices including zip code)
011-86-755-267-4327
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined on Rule 12B-2 of the Exchange Act). Yes |_| No |_|
There were 50,722,050 shares of the Registrant's Common Stock issued and
outstanding on November 15, 2004.
COMTECH GROUP, INC.
INDEX TO FORM 10-Q
PART I. FINANCIAL INFORMATION
Item 1. Condensed Financial Statements (unaudited)
Condensed Consolidated Balance Sheets
September 30, 2004 and December 31, 2003
Condensed Consolidated Statements of Operations Three and nine
months ended September 30, 2004 and 2003
Condensed Consolidated Statements of Cash Flows
Nine months ended September 30, 2004 and 2003
Notes to Condensed Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market
Risk
Item 4. Controls and Procedures
PART II. OTHER INFORMATION
Item 6. Exhibits
SIGNATURES
PART I - FINANCIAL INFORMATION
Item 1. Condensed financial statements (unaudited)
COMTECH GROUP INC. f/k/a TRIDENT ROWAN GROUP, INC. and SUBSIDIARIES
Unaudited Condensed Consolidated Balance Sheets
September 30, 2004 and December 2003
(In thousands of Renminbi and thousands of US Dollars)
Sep 30, 2004 Sep 30, 2004 Dec 31, 2003
US$'000 RMB'000 RMB'000
ASSETS
Current assets:
Cash 2,142 17,727 30,683
Trade accounts receivable, net of
allowance of doubtful accounts 18,248 151,043 92,259
Bills receivable 4,209 34,843 13,306
Other trade receivables and prepaid
expenses 1,081 8,940 2,297
Inventories 2,746 22,732 18,350
------ ------- -------
Total current assets 28,426 235,285 156,895
Property, plant and equipment, net 384 3,180 2,961
Other assets 41 344 344
------ ------- -------
425 3,524 3,305
------ ------- -------
TOTAL ASSETS 28,851 238,809 160,200
------ ------- -------
LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities:
Trade accounts payable 6,918 57,269 44,564
Amount due to other related party 265 2,192 1,592
Bank loans 8,757 72,482
Dividend payable -- -- 41,387
Income tax payable 135 1,114 902
Accrued expenses and other
liabilities 1,771 14,662 3,745
------ ------- -------
Total current liabilities 17,846 147,719 142,546
------ ------- -------
Minority interests 619 5,126 --
Stockholders' equity
Common stock and additional paid-in
capital 4,693 38,844 14,083
Retained earnings 5,693 47,120 3,571
------ ------- -------
Total stockholders' equity 10,386 85,964 17,654
------ ------- -------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY 28,851 238,809 160,200
====== ======= =======
3
COMTECH GROUP INC. f/k/a TRIDENT ROWAN GROUP, INC. and SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Operations
Three months ended September 30, 2004 and 2003
(In thousands of Renminbi and thousands of US Dollars)
Sep 30, 2004 Sep 30, 2004 Sep 30, 2003
US$'000 RMB'000 RMB'000
Revenue 17,808 147,403 96,243
Cost of revenue (15,083) (124,84) (82,582)
---------- ---------- ----------
Gross profit 2,725 22,554 13,661
Selling, R&D, general and
administrative expenses (1,047) (8,670) (3,335)
---------- ---------- ----------
Income from operations 1,677 13,884 10,326
Interest expense (102) (845) (273)
Interest income 16 132 3
Income before income tax 1,591 13,171 10,056
Income tax (44) (362) (607)
---------- ---------- ----------
Income before minority interests 1,547 12,809 9,449
Minority interests (110) (910) 0
---------- ---------- ----------
Net income 1,438 11,899 9,449
---------- ---------- ----------
US$ RMB RMB
Earnings per share
- - Basic 0.03 0.27 0.23
========== ========== ==========
- - Diluted 0.03 0.27 0.23
========== ========== ==========
Weighted average number of ordinary
shares outstanding,
- - Basic 43,484,683 43,484,683 40,502,150
========== ========== ==========
- - Diluted 43,527,006 43,527,006 40,502,150
========== ========== ==========
4
COMTECH GROUP INC. f/k/a TRIDENT ROWAN GROUP, INC. and SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Operations
Nine months ended September 30, 2004 and 2003
(In thousands of Renminbi and thousands of US Dollars)
Sep 30, 2004 Sep 30, 2004 Sep 30, 2003
US$'000 RMB'000 RMB'000
Revenue 56,174 464,970 246,324
Cost of revenue (47,742) (395,17) (210,29)
---------- ---------- ----------
Gross profit 8,433 69,799 36,034
Selling, R&D, general and
administrative expenses (2,402) (19,886) (11,836)
---------- ---------- ----------
Income from operations 6,030 49,913 24,198
Interest expense (202) (1,669) (500)
Interest income 19 159 34
---------- ---------- ----------
Income before income tax 5,848 48,403 23,732
Income tax (217) (1,799) (964)
---------- ---------- ----------
Income before minority interests 5,630 46,604 22,768
Minority interests (369) (3,055) 0
---------- ---------- ----------
Net income 5,261 43,549 22,768
---------- ---------- ----------
US$ RMB RMB
Earnings per share
- - Basic 0.13 1.05 0.56
========== ========== ==========
- - Diluted 0.13 1.05 0.56
========== ========== ==========
Weighted average number of ordinary
shares outstanding,
- - Basic 41,507,253 41,507,253 40,502,150
========== ========== ==========
- - Diluted 41,521,515 41,521,515 40,502,150
========== ========== ==========
5
COMTECH GROUP INC. f/k/a TRIDENT ROWAN GROUP, INC. and SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Cash Flows
Nine months ended September 30, 2004 and 2003
(In thousands of Renminbi and thousands of US Dollars)
Sep 30, 2004 Sep 30, 2004 Sep 30, 2003
US$'000 RMB'000 RMB'000
Cash flows from operating activities:
Net income 5,261 43,549 22,768
Adjustment to reconcile net income to
net cash (used in) provided by operating activities:
Depreciation expense 88 728 319
Minority interest 369 3,055 --
Changes in operating assets and liabilities:
Trade accounts receviable (6,481) (53,64) (39,63)
Bills receivable (2,602) (21,53) (1,917)
Inventories (325) (2,693) 5,186
Other trade receivables and prepaid expenses (125) (1,036) (12,72)
Amount due from other related party -- -- 298
Trade accounts payable 676 5,592 18,987
Accrued expenses and other liabilities 663 5,491 11,345
Amount due to other related party 72 600 (1,573)
Income tax payable 26 212 2,408
====== ====== ======
Net cash (used in) provided by operating activities (2,378) (19,68) 5,464
====== ====== ======
Cash flows from investing activities:
Net cash outflow from acquisition of a subsidiary (109) (906) --
Purchases of property and equipment (86) (711) (418)
Increase in other assets -- -- (300)
====== ====== ======
Cash used in investing activities (195) (1,617) (718)
====== ====== ======
Cash flows from financing activities:
New bank loans 8,757 72,482 --
Net cash inflow from share exchange transaction
(net of transaction cost) 3,335 27,603 --
Repayment of amount due to holding company (6,084) (50,35) --
Payment of 2003 dividend (5,000) (41,38) --
====== ====== ======
Net cash provided by financing activities 1,008 8,342 --
====== ====== ======
Net (decrease) increase in cash and cash equivalents (1,565) (12,95) 4,746
Cash at beginning of the period 3,707 30,683 12,194
====== ====== ======
Cash at end of the period 2,142 17,727 16,940
====== ====== ======
6
COMTECH GROUP INC. f/k/a TRIDENT ROWAN GROUP, INC. and SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
NOTE 1 BASIS OF PRESENTATION
The accompanying unaudited consolidated condensed financial statements have been
prepared in accordance with the instructions to Form 10-Q, and Rule 10-01 of
Regulation S-X. Certain information and footnote disclosures normally included
in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted. For a summary of the
Company's accounting principles, and other footnote information, reference is
made to the Registrant's 2001 to 2003 Audited Consolidated Financial Statements
on Item 7(a)(1) of the Company's Current Report on Form 8 K/A filed with the
Securities and Exchange Commission on September 23, 2004 (the "8-K/A"). The
interim financial statements and notes thereto should be read in conjunction
with the financial statements and notes included in the 8-K/A of Comtech Group
Inc. (the "Company") for the year ended December 31, 2003. All adjustments
necessary for the fair presentation of the results of operations for the interim
periods covered by this report have been included. All such adjustments are of a
normal and recurring nature. The results of operations for the nine months ended
September 30, 2004 are not necessarily indicative of the operating results for
the full year.
The consolidated financial statements are reported in Renminbi ("RMB") because
all of the Company's material operating entities are based in and operated
entirely within the People's Republic of China. The translation of RMB amounts
into U.S. dollar amounts is included solely for the convenience of the readers
of the financial statements and has been calculated at the rate of US$ 1 to RMB
8.2773, the approximate exchange rate at September 30, 2004. Such transactions
should not be constructed as representations that the RMB amounts could be
converted into US$ at that rate or any other rate.
When the actual currency of the transaction is denominated in US Dollars, then
the US Dollar amount has been shown in the relevant note and/or table and
indicated as "US Dollar, actual transaction currency".
NOTE 2 - SHARE EXCHANGE BETWEEN TRIDENT AND COMTECH
On May 25, 2004, the Company entered into a Share Exchange Agreement (the
"Exchange Agreement") with Comtech Group, a privately owned Cayman Islands
company ("Comtech"), and Comtech's shareholders, Comtech Global Investment Ltd.,
Purple Mountain Holding Ltd., and Ren Investment Ltd.(collectively, the
"Shareholders"), pursuant to which the Company was to acquire all of the issued
and outstanding shares of stock of Comtech in exchange for the issuance in the
aggregate of 42,000,000 of the Company's shares of common stock to the
Shareholders. The transaction contemplated by the Exchange Agreement was
consummated on July 22, 2004. Pursuant to certain provisions in the Exchange
Agreement, the number of shares issued to the Shareholders was adjusted at
closing to 40,502,150 (the "Shares").
7
As a result of the transaction, Comtech became a wholly-owned subsidiary of the
Company and, upon the issuance of the Shares, the Shareholders owned
approximately 91.2% of all of the Company's issued and outstanding stock. The
Company currently has a total of 44,422,050 shares of Common Stock issued and
outstanding on a non-fully diluted basis.
The transaction was accounted for as a reverse acquisition in which Comtech was
deemed to be the accounting acquirer and Trident Rowan Group, Inc. ("Trident")
the legal acquirer. Because Trident was a non-operating public shell company, no
goodwill has been recorded in connection with the transaction and the costs
incurred in connection with the transaction have been charged directly to
equity.
As a result of the share exchange transaction, (i) the historical financial
statements of Trident for periods prior to the date of the transaction are no
longer presented; (ii) the historical financial statements of the Company for
periods prior to the date of the transaction are those of Comtech, as the
accounting acquirer; (iii) all references to the financial statements of the
Company apply to the historical financial statements of Comtech prior to the
transaction and the financial statements of the Company subsequent to the
transaction; and (iv) the number of shares of the Company has been restated
retrospectively to reflect the share exchange ratio as at the date of the
transaction in a manner similar to a stock split.
Unaudited condensed consolidated statements of shareholders' equity for the nine
months ended September 30, 2004 are set forth below:
8
Additional
paid-in Accumulated
Common Stock capital Profits Total
------------ ------- ------- -----
Shares Amount
RMB'000 RMB'000 RMB'000 RMB'000
Balance at January 1, 2004 40,502,150 405 14,000 3,571 17,976
(Note a)
Shares of stock held by Trident's 3,919,900 39 -- -- 39
shareholders
Recapitalisation in connection
with the share exchange
transaction -- -- 24,400 -- 24,400
Net Profit -- -- -- 43,549 43,549
----------------------------------------------------------
Balance at September 30, 2004
44,422,050 444 38,400 47,120 85,964
==========================================================
Balance at September 30, 2004
(USD'000) 54 4,639 5,693 10,386
==========================================================
Note a: Common stock issued and outstanding has been retroactively restated to
reflect the recapitalization which occurred as a result of the share exchange
transaction whereby the 10,000,000 shares of common stock of the accounting
acquirer were exchanged for 40,502,150 shares of Trident.
The assets and liabilities of Trident acquired under the share exchange
transaction are as follows:
Net assets acquired: RMB'000
-------
Cash 32,367
Other trade receivables and prepaid expenses 2,853
Accrued expenses and other liabilities (5,126)
Minority interests (917)
-------
29,177
Less: Transaction costs (4,764)
-------
24,413
=======
Comtech Group is a leading module design solutions provider in China
focused on the mobile handset and telecom equipment industries. Our team of
engineers works with leading manufacturers of mobile handset and telecom
equipment to design solutions that meet their need to provide state of the art
products to their customers. Our design solutions for mobile device products
include, LCD modules, camera modules, persistent storage modules, input/output
modules, sound system and power supply modules. In the telecom equipment
industry we currently target optical solutions, data communication solutions,
PSTN switching, and wireless base stations.
Since Comtech began operations in 1995, it has evolved from a distribution
company to a customized design solution provider. Its client base has grown to
serve over 200 companies representing most of the large manufacturers in the
mobile handset and telecom equipment industries in China. Comtech's largest
customer in the mobile handset market is TCL Mobile Communication (HK) Company
Ltd., or TCL, one of China's largest domestic mobile handset manufacturers. Its
top two revenue producing customers from the telecom equipment industry have
been Zhongxing International (Hong Kong) Trading Co. Ltd. (ZTE) and Huawei
Technology Investment Co. Ltd., or Huawei, which are China's two largest telecom
equipment vendors.
9
Comtech currently offers its clients over 500 design solutions and product
lines integrating components from many leading suppliers. Comtech's engineers
work with its customers' product development team to understand their needs for
each specific function module. Based on a customer's specific requirements,
Comtech's engineers provide a proposed customized module design solution. A
module design solution incorporates several components. If the customer accepts
the Comtech design, the customer agrees to purchase key specific components
outlined in Comtech's module design. Comtech purchases the specific components
from its suppliers.
Comtech does not charge its customers an independent design fee. Instead,
it generates revenue through the sale of the specific components that are
incorporated in its module design. The price mark-up between the purchase price
and the selling price of such components compensate its design, technical
support and distribution services.
Comtech's business model has proven to be profitable and sustainable
during our nine year operating history. It has had significant growth in both
revenues and profits since 1995. In 2003, Comtech had over $43 million in
revenues and $3.4 million in net income, which amounts to an increase of
approximately 72% and 209% respectively from $25 million in revenue and $1.1
million in profit in 2002. For the nine month period ended September 30, 2004,
Comtech had US$56.2 million in revenue and US$5.3 million in net income, which
amounts to an increase of approximately 89% and 91%, respectively, from US$29.8
million in revenue and US$2.8 million in net profit for the nine month period
ended September 30,2 003.
10
NOTE 3 - FINANCING ARRANGEMENTS
(a) Bank loans
On July 21, 2004, Comtech International (Hong Kong) Limited ("Comtech HK"), a
wholly-owned subsidiary of the Company, entered into a US$4,000,000 revolving
credit facility (the "Facility") with the Bank of Communications Hong Kong
branch (the "Bank"). On September 14, 2004, the amount of the Facility was
increased to US$10,000,000. During August and September 2004, Comtech HK drew
down approximately US$8,800,000 under the Facility. These bank borrowings were
raised for general working capital purposes of the Company and US$978 thousand
of them were directly used for settlement of amount to Comtech Global Investment
Ltd. The Facility is secured by funds on deposit with the Bank owned by Jeffrey
Kang, the Company's principal shareholder and Chief Executive Officer, in an
amount equal to the borrowings. The facility bears interest at the higher of
LIBOR or 1.5% over the deposit rate, payable monthly.
(b) Factoring arrangement
On August 24, 2004, Comtech Communication Technology (Shenzhen) Co.,
Ltd.("Comtech Communication"), a wholly-owned subsidiary of the Company, entered
into a factoring agreement (the "Agreement") with Guangdong Development Bank
Shenzhen branch (the "Bank"). Pursuant to the Agreement, accounts receivable
from UT Starcom with the maximum amount of RMB30 million can be transferred to
the Bank with recourse. An amount equal to 30% of the accounts receivable
transferred is secured by funds on deposit from Comtech Communication with the
Bank. The factoring arrangement bears interest at the PRC official loan interest
rate as of September 30, 2004, payable monthly. On October 20, 2004, Comtech
Communication transferred accounts receivable of approximately RMB11,449
thousand under the Agreement.
NOTE 4 - SETTLEMENT OF AMOUNT DUE TO COMTECH GLOBAL INVESTMENT LTD.
During August and September 2004, the Company satisfied all of its outstanding
obligations in the approximate amount of US$10,238,000 to Comtech Global
Investment Ltd., an entity owned by Jeffrey Kang, by repaying approximately
US$5,238,000 of outstanding loans and satisfying a US$5,000,000 dividend
obligation.
NOTE 5 - SETTLEMENT OF IMI FEE DISPUTE
On June 21, 2004 the Company entered into an out-of-court settlement with Banca
di Intermidiazione Mobiliare IMI S.p.A ("IMI") to settle a fee dispute in
connection with the sale of the subsidiaries of Centerpoint (a former subsidiary
of the Company) to Aprilia S.p.A. The settlement was for Euro700 thousand, of
which the Company received Euro373 thousand, its share of the settlement. In
connection with agreeing to the settlement, the Company paid Euro115 thousand to
TCMP 3 Partners LLC to settle certain claims against former Centerpoint
directors. (See Notes 7 and 8 below).
11
NOTE 6 - RELEASE OF LITA S.P.A. GUARANTEE
On March 31, 2004 the purchasers of LITA S.p.A. agreed to release the Company
from any further obligations under an escrow pertaining to potential tax
liabilities in connection with the Company's sale of LITA, which had been due to
expire on December 31, 2004. For this release, the Company paid Euro30,000 in
2004 and has recorded a gain of Euro486 thousand in the first quarter of 2004.
NOTE 7- INVESTMENTS
Aprilia Claims under the Share Purchase Agreement; Payment by IMI; Request for
Arbitration; Settlement
In 2000, Aprilia asserted various claims against Centerpoint relating to
Centerpoint's representations and warranties under the Share Purchase Agreement
(the "Alleged Claims") for the sale of its Moto Guzzi operations. In 2001, IMI,
the escrow agent under an Escrow Agreement, paid Euro3,931 thousand from the
escrow account (see Note 5) to Aprilia in respect of the Alleged Claims.
Centerpoint disputed the Alleged Claims and requested arbitration. In October
2003, Centerpoint and OAM entered into a settlement agreement with Aprilia,
pursuant to which Aprilia paid Euro1,420,256 to Centerpoint, including
Euro206,583 of legal fees. In 2003, an equivalent of 65% of the net proceeds of
this settlement was recorded by OAM in "other income", as the right to the 35%
of the proceeds was owed to Centerpoint (no longer a related party of the
Company as of December 31, 2003).
The residual balance of approximately Euro600 thousand remaining in the escrow
account relates to possible claims regarding taxes and social security
contributions and such balance, if any in the event Aprilia is successful in any
future claims, will be released in September 2007. OAM is entitled to 65% of
amounts eventually released. This contingent asset has been valued at zero since
2000.
Bion transaction
In January 2004 Centerpoint distributed all of the shares of Bion that it owned
pro-rata to the holders of its Common Stock. As a result, the Company received
an additional 44,240 Bion shares, which are considered to be of no value.
12
NOTE 8 - LITIGATION
SETTLED:
(a) Legal Action by TCMP 3 against Directors of Centerpoint
On January 16, 2004, a civil action was initiated by TCMP 3 Partners LLC in the
Chancery Court of Delaware against the former directors of Centerpoint accusing
them of wasting Centerpoint's assets in undertaking the Bion transaction. The
action was mutually settled in July 2004 with the Company paying US$140,000 to
the Plaintiffs in return for a full release of all potential claims against the
Company, its directors, its representatives and other indemnified parties in
connection with the Bion transaction.
(b) Legal action by Shenzhen Comtech against a customer
On September 14, 2004, a civil action was initiated by Shenzhen Comtech in the
Court of Beijing of China against a corporate customer in which Shenzhen Comtech
claimed payments owed totaling approximately RMB801 thousand, comprising
outstanding accounts receivable amounting to approximately RMB438 thousand,
penalty for overdue accounts receivable amounting to approximately RMB328
thousand and interest of outstanding balance amounting to approximately RMB35
thousand. The action was mutually settled on October 19, 2004 with the defendant
paying RMB500 thousand to Shenzhen Comtech in return for a full release of all
potential claims against the defendant.
PENDING:
CSD Srl
In 1999 CSD Srl ("CSD") caused a leasing company to purchase from OAM, S.p.A., a
subsidiary of the Company ("OAM") real estate in via Baronia, Rome and entered
into a leasing arrangement with the leasing company. Subsequently, on October 9,
1999, CSD brought a claim against OAM in the Rome Civil Court alleging that the
commercial designation of the property in 1998 was not properly disclosed and
consequently its lease payments were excessive and sought reimbursement of the
lease payments that it considered excessive from OAM in an aggregate amount of
approximately Euro800 thousand.
13
The proceedings have continued intermittently over the years. On March 25, 2004,
the Court requested that the parties present their conclusions in order for it
to render a final verdict. It is management's opinion that the risk of a
negative judgment is low and the potential liability remote.
NOTE 9 - STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation using the intrinsic value
method in accordance with Accounting Principles Board ("APB") Opinion No.25,
"Accounting for Stock Issued to Employees", and its related interpretations.
Under this method, compensation cost for stock options, warrants and stock
awards is measured as the excess, if any, of the quoted market price of the
Company's common stock at the date of the grant over the amount an employee must
pay to acquire the stock.
At the board of directors' meeting held on August 3, 2004, the Company adopted
the Comtech Group, Inc. 2004 Stock Incentive Plan providing for the grant of
incentive and non-statutory stock options and the issuance of restricted stock
up to 5,000,000 shares of common stock, in the aggregate. The compensation costs
for the 420,000 options granted under the Company's share option plan for the
period ended September 30, 2004 are insignificant as calculated under APB
Opinion No. 25. The compensation costs for the 420,000 options granted under the
Company's stock option plan for the period ended September 30, 2004, had they
been accounted for using the fair value of awards at the grant date in
accordance with the method of Statement of Financial Accounting Standards
No.123, "Accounting for Stock-Based Compensation", the Company's net income and
earnings per share would have been as follows:
For the nine month period ended September 30, 2004:
RMB'000
Net income, as reported 43,549
Less: Stock based compensation costs under fair (389)
Value based method for all awards
Net income, pro forma 43,160
Earnings per share - basic As reported RMB1.05
Pro forma RMB1.04
Earnings per share - diluted As reported RMB1.05
Pro forma RMB1.04
For the three month period ended September 30, 2004:
RMB'000
Net income, as reported 11,899
Less: Stock based compensation costs under fair (389)
Value based method for all awards
Net income, pro forma 11,510
Earnings per share - basic As reported RMB0.27
Pro forma RMB0.26
Earnings per share - diluted As reported RMB0.27
Pro forma RMB0.26
14
The weighted average fair value of options granted during 2004 was US$1.17,
using the Black-Scholes option-pricing model based on the following assumptions:
Risk-free interest rate 4.25%
Expected life 10 years
Expected volatility 59%
Expected dividend yield --
NOTE 10 - EARNINGS PER SHARE
Basic earnings per share are computed by dividing net income by the weighted
average number of shares of common stock outstanding for the period. Diluted
earnings per share are computed by dividing net income by the sum of (a) the
weighted average number of shares of common stock outstanding during the period
and (b) the dilutive effect of potential common stock equivalents during the
period. As of September 30, 2004, there are 420,000 stock options outstanding
and the weighted average number of shares used for the computation of diluted
earnings per share is as follows:
Nine month Three month
period ended period ended
September 30 September 30
2004 2004
Weighted average number of shares
outstanding - basic 41,507,253 43,484,683
Dilutive effect of employee stock
options 14,262 42,323
--------------------------------------
Weighted average number of shares
outstanding - diluted 41,521,515 43,527,006
=======================================
15
NOTE 11 - COMPREHENSIVE INCOME
Comprehensive income represents total non-shareholder changes in equity during a
period except those resulting from investments by and distributions to
shareholders. For the three and nine months ended September 30, 2003 and 2004,
comprehensive income is the same as net income.
NOTE 12 - SUBSEQUENT EVENTS
On October 26, 2004, the Company entered into definitive purchase agreements for
the sale of an aggregate of 6,300,000 shares of common stock to institutional
and individual investors for gross proceeds of approximately US$11 million,
before deducting a 6% placement fee and other expenses of the offering. C.E.
Unterberg Towbin acted as lead placement agent for the transaction, with W.R.
Hambrecht & Co. acting as co-placement agent. A closing was held on the first
5,040,000 shares on October 27, 2004. A second closing on the balance of the
shares occurred on November 5, 2004.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Portions of the discussion and analysis below contain certain "forward looking"
statements that involve risks and uncertainties. The Company's actual results
may differ significantly from the results discussed in the forward-looking
statements. Factors that might cause such a difference include, but are not
limited to, lack of adequate capital to continue operations, changes in currency
exchange rates, other factors discussed in the report as well as factors
discussed in other filings made with the Securities and Exchange Commission.
Although the Company believes that the assumptions underlying the forward
looking statements contained herein are reasonable, any of the assumptions could
prove inaccurate, and therefore, there can be no assurance that the forward
looking statements included herein will prove to be accurate.
16
THREE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2003
REVENUE
Details of revenue for the three month period ended September 30 are as follows:
2004 2003
---- ----
RMB'000 RMB'000
------- -------
Mobile handset 82,625 36,633
Telecom equipment 63,693 57,698
Lightning protection devices 1,085 1,912
--------------------
147,403 96,243
Revenue was RMB51,160 thousand or 53.2% higher than that of the same period of
the prior year. The increase was mainly attributed to the increase in revenues
from both mobile handset and telecom equipment sales which increased by
RMB45,992 thousand or 125.5% and RMB5,995 or 10.4% respectively. The increase in
mobile handset revenue was due to the fact that the demand for mobile handsets
has been growing in China and domestic mobile handset vendors have continued to
penetrate the market and capture additional market share. The increase in
telecom equipment revenue was attributed to growth in China's telecom equipment
industry driven by an increase in investment from telecom operators.
GROSS MARGIN
Gross margin increased from RMB13,661 thousand or 14.2% in the third quarter of
2003 to RMB22,556 thousand or 15.3% in the same period of 2004. The increase was
principally due to the change in revenue mix, where revenues from mobile handset
sales had a higher margin than those from telecom equipment. The ratio of margin
contribution from mobile handset sales for the third quarter of 2003 and 2004
were 43.5% and 61.0% respectively, representing an increase of 17.5%. In terms
of margin amount, the mobile handset sales contribution increased by
approximately RMB7,826 thousand.
SELLING, R&D, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, R&D, general and administrative expenses of RMB8,670 thousand were
RMB5,335 thousand or 160% higher than those of the same period last year. The
details of the expenses for the three month period ended September 30 are as
follows:
17
2004 2003
---- ----
RMB'000 RMB'000
------- -------
Selling expenses 1,673 676
R&D expenses 3,481 225
General and administrative expenses 3,516 2,434
-----------------
8,670 3,335
The increase in the selling expenses by RMB997 thousand or 147.5% was mainly
attributed to the increase in marketing and business development expenses of
approximately RMB400 thousand. Other indirect selling expenses such as freight
charges and salesperson expenses contributed to the balance of the increase and
consistent with the same period of last year, they represented about one percent
of revenue.
R&D expenses increased by RMB3,256 thousand or 1,447.1%. The increase was
comprised of additional costs incurred in developing new product lines for
telecom equipment, handset and consumer electronics. (about RMB2.6 million) and
additional personnel costs associated with strengthening our engineering team
(about RMB600 thousand).
General and administrative expenses increased by RMB1,082 thousand or 44.5%. The
principal factor for the increase was additional corporate expenses of about
RMB1 million, which were incurred as a result of expanding our management team
and additional administrative expenses incurred as a result of the increased
operation of the Company and an increase in legal and other expenses.
INTEREST EXPENSE
Interest expense in the third quarter of 2004 amounted to RMB845 thousand as
compared to RMB273 thousand in the same period of 2003. The increase of RMB572
thousand or 209.5% was due to new bank loans totaling RMB72,482 thousand
obtained in August and September of 2004. The interest rate was overnight LIBOR
or 1.5% per annum above the deposit rate for the charged deposit, whichever is
the highest. No such loans were outstanding in 2003.
INTEREST INCOME
Interest income in third quarter of 2004 amounted to RMB132 thousand, compared
to RMB3 thousand in the same period of 2003. The increase was attributed to
higher net cash inflows generated from revenue and the resulting increase in
deposit balances.
18
INCOME TAX
The effective tax rate for the three months ended September 30, 2004 was 2.7%
compared to 6.0% for the comparable period in the prior year. The decrease in
the effective tax rate was mostly due to the Company's mix of subsidiaries'
earnings. More income was earned by the Company's subsidiaries with tax benefits
granted from the local tax authorities.
MINORITY INTERESTS
Minority interests comprises 40% of the outstanding shares in Shanghai E&T
System Co., Ltd. and 1.6% shares in OAM S.p.A..
NET INCOME
As a result of the above items, net income for the quarter ended September 30,
2004 was RMB11,899 thousand compared to net income of RMB9,449 thousand in the
corresponding period of 2003.
EARNINGS PER SHARE
The Company reported a basic per share earnings of RMB0.27 for the third quarter
of 2004 based on 43,484,683 outstanding weighted average shares and a diluted
per share earnings of RMB0.27 based on 43,527,006 outstanding weighted average
shares, compared to basic and diluted per share earnings of RMB0.23 for the same
period of 2003, based on 40,502,150 outstanding weighted average shares.
NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2003
REVENUE
Details of revenue for the nine month period ended September 30 are as follows:
2004 2003
---- ----
RMB'000 RMB'000
------- -------
Mobile handset 279,473 76,100
Telecom equipment 179,327 167,188
Lightning protection devices 6,170 3,036
-----------------------------
Total 464,970 246,324
19
Revenue was RMB218,646 thousand or 88.8% higher that that of the same period of
the prior year. The increase was mainly attributed to the increase in revenues
from both mobile handset and telecom equipment sales, by RMB203,373 thousand or
267.2% and RMB12,139 or 7.3% respectively. The increase in mobile handset
revenue was due to the fact that the demand for mobile handsets has been growing
in China and domestic mobile handset vendors have continued to penetrate the
market and capture market share. The increase in telecom equipment revenue was
attributed to growth in China's telecom equipment industry driven by an increase
in investment from telecom operators. Contribution of mobile handset revenue to
total revenue increased from RMB76,100 thousand or 30.9% to RMB279,473 thousand
or 60.1%. Whereas contribution of telecom equipment revenue to total revenue
decreased from 67.9% to 38.6%, though revenue amount slightly increased from
RMB167,188 thousand to RMB179,327 thousand.
GROSS MARGIN
Gross margin increased from RMB36,034 thousand or 14.6% in the first three
quarters of 2003 to RMB69,799 thousand or 15.0% in the same period of 2004. The
increase was principally due to the change in revenue mix, where revenues from
mobile handset sales had a higher margin than those from telecom equipment. The
ratio of margin contribution from mobile handset sales for the three quarters
ended September 30, 2003 and 2004 were 33.8% and 66.5% respectively,
representing an increase of 32.7%. In terms of margin amount, the mobile handset
sales contribution increased by approximately RMB34,264 thousand.
SELLING, R&D, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, R&D, general and administrative expenses of RMB19,886 thousand were
RMB8,050 thousand or 68.0% higher than those of the same period last year. The
expenses for the nine month period ended September 30 are as follows:
2004 2003
---- ----
RMB'000 RMB'000
------- -------
Selling expenses 6,059 1,913
R&D expenses 5,613 638
General and administrative expenses 8,214 9,285
--------------------------
19,886 11,836
20
The increase in the selling expenses by RMB4,146 thousand or 216.7% was mainly
attributed to the increase in marketing and business development expenses of
approximately RMB1.4 million for promoting new product lines and gaining larger
customer base. Other indirect selling expenses such as freight charges and
salesperson expenses contributed to the balance of the increase and consistent
with the same period of last year, they represented about one percent of
revenue.
R&D expenses increased by RMB4,975 thousand or 779.78%. The increase was
comprised of additional costs incurred in developing new product lines for
telecom equipment, handset and consumer electronics (about RMB2.6 million) and
additional personnel cost associated with strengthening our engineering team in
2004(about RMB2.4 million for the nine months ended September 30, 2004).
General and administrative expenses decreased by RMB1,071 thousand or 11.5%. The
decrease was attributable to the bad debt provision of RMB2 million recorded in
the nine months ended September 30, 2003, whereas no such provision was
additionally made in the same period of 2004. However, the decrease was offset
in part by additional corporate expenses of about RMB1 million in the first nine
months of 2004, which incurred as a result of our expanding management team and
additional administrative expenses incurred as a result of the increase of
operation of the Company and an increase in legal and other expenses.
INTEREST EXPENSE
Interest expense for the nine months ended September 30, 2004 amounted to
RMB1,669 thousand as compared to RMB500 thousand in the same period of 2003. The
increase of RMB1,169 thousand or 233.8% was due to new bank loans totaling
RMB72,482 thousand obtained in August and September of 2004. The interest rate
was overnight LIBOR or 1.5% per annum above the deposit rate for the charged
deposit, whichever is the highest. No such loans were outstanding in 2003.
INTEREST INCOME
Interest income for the nine months ended September 30, 2004 amounted to RMB159
thousand, compared to RMB34 thousand in the same period of 2003. The increase
was owing to higher net cash inflows generated from revenue and the resulting
increase in deposit balances.
21
INCOME TAX
The effective tax rate for the nine months ended September 30, 2004 was 3.7%
compared to 4.0% for the comparable period in the prior year. The decrease in
the effective tax rate was mostly due to the Company's mix of subsidiaries'
earnings. More income was earned in the subsidiaries with tax benefits granted
from their respective local tax authorities.
MINORITY INTERESTS
Minority interests comprises 40% of the outstanding shares in Shanghai E&T
System Co., Ltd. and 1.6% shares in OAM S.p.A..
NET INCOME
As a result of the above items, net income for the nine months ended September
30, 2004 was RMB43,549 thousand compared to a net income of RMB22,768 thousand
in the corresponding period of 2003.
EARNINGS PER SHARE
The Company reported a basic per share earnings of RMB1.05 for the first three
quarters ended September 30, 2004 based on 41,507,253 outstanding weighted
average shares and a diluted per share earnings of RMB1.05 based on 41,521,515
outstanding weighted average shares, compared to basic and diluted per share
earnings of RMB0.56 for the same period of 2003, based on 40,502,150 outstanding
weighted average shares.
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically financed its operations primarily through a
combination of cash generated from sales, borrowings from shareholders and
available credit facilities. As of September 30, 2004, the Company had working
capital of RMB88,542 thousand as compared with working capital of RMB14,349
thousand at December 31, 2003.
Operating activities used cash of RMB19,681 thousand for the nine months ended
September 30, 2004 compared to cash provided of RMB5,464 thousand in 2003.
The decrease in cash provided by operating activities as compared to the prior
year is primarily due to the increase in receivables and investments in
inventories, partially offset by the increase in trade payables and accrued
liabilities. Net income provided RMB43,549 thousand for operating activities for
the nine months ended September 30, 2004 compared to RMB22,768 thousand in 2003.
22
The overall decrease in cash flow from operating activities for the nine months
ended September 30, 2004 as compared to 2003 was primarily due to changes in
trade accounts receivable and bills receivable. It was because of increase in
revenue for the three quarters ended September 30, 2004, as compared to 2003.
Trade accounts receivable turnover approximated 89 days for the nine months
ended September 30, 2004 compared to 119 days for the comparable period in the
prior year. Overall collections of trade accounts receivables and credit quality
of customers has improved.
The decrease in cash provided by operating activities for the nine months ended
September 30, 2004 was partially compensated by increase in trade accounts
payable. It was also due to increase in purchases of inventories. Owing to
change in supplier mix between the two periods as a result of enlargement of
sourcing base, trade accounts payable turnover was shorter from about 97 days
for the nine months ended September 30, 2003 to about 40 days for the same
period of 2004; however, the shorter of trade accounts payable turnover was
mainly due to additions of new suppliers which usually provide us very short
accounts payable term, and trade accounts payable turnover for previous existing
suppliers have been consistent with previous terms.
In addition, cash flow from operating activities for the nine months ended
September 30, 2004 was impacted by an increase in purchases of inventories,
primarily resulted from increase in revenue for that period. Inventory turnover
was relatively consistent.
Investing activities used RMB1,617 thousand during the first three quarters of
2004, mainly from the purchase of property and equipment.
Financing activities provided net cash flow of RMB8,342 thousand during the
first three quarters of 2004. Cash was provided by new bank loans amounting to
RMB72,482 thousand, proceeds of RMB27,603 thousand obtained from Trident as a
result of the share exchange. These financing cash inflows were partially
off-set by repayment of amounts due to the holding company of RMB50,356 thousand
and the dividend payment for the prior year amounting to RMB41,387 thousand.
23
Apart from operations, the Company's principal source of liquidity is its US$10
million revolving credit facility with the Bank of Communications, Hong Kong
branch. The Company is currently in the process of negotiating an additional
credit facility with another bank to fund the working capital needs of the
Company.
During the nine months ended September 30, 2004, the Company also entered into
an accounts receivable factoring agreement with Guangdong Development Bank
Shenzhen branch. Pursuant to the Agreement, accounts receivable from UT Starcom
with the maximum amount of RMB30 million can be transferred to the Bank with
recourse.
FUTURE LIQUIDITY NEEDS
As of September 30, 2004, the Company had approximately RMB17,727 thousand in
cash. On October 26, 2004, the Company completed a private placement of US$5.04
million shares of common stock of aggregate proceeds of approximately US$8.8
million with a group primarily consisting of institutional investors. The
Company sold an additional 1.26 million shares of common stock for aggregate
proceeds of approximately US$2.2 million in a second closing on November 5,
2004. The Company regularly reviews its cash funding requirements and attempts
to meet those requirements through a combination of cash on hand, cash provided
by operations, available borrowings under bank lines of credit and possible
future public or private equity offerings. At times, the Company evaluates
possible acquisitions of, or investments in, businesses that are complementary
to those of the Company, which transactions may require the use of cash. The
Company believes that its cash, other liquid assets, operating cash flows,
credit arrangements, access to equity capital markets, taken together, provide
adequate resources to fund ongoing operating expenditures. In the event that
they do not, the Company may require additional funds in the future to support
its working capital requirements or for other purposes and may seek to raise
such additional funds through the sale of public or private equity as well as
from other sources.
CRITICAL ACCOUNTING POLICIES
The methods, estimates and judgments we use in applying our most critical
accounting policies have a significant impact on the results we report in our
financial statements. The U.S. Securities and Exchange Commission, or SEC, has
defined critical accounting policies as those that are most important to the
portrayal of our financial condition and results of operations and require us to
make our most difficult and subjective judgments, often as a result of the need
to make estimates of matters that are inherently uncertain. Based on this
definition, our critical policies include revenue recognition, allowance for
doubtful accounts, sales returns and allowances, asset impairment, and inventory
valuation including product obsolescence. We believe that we consistently apply
judgments and estimates and such consistent application results in financial
statements and accompanying notes that fairly represent all periods presented.
However, any factual errors or errors in these judgments and estimates may have
a material impact on our statement of operations and financial conditions. For a
discussion of our general accounting policies, please see the discussion in our
Current Report on Form 8-K/A filed on September 23, 2004.
24
Item 3. Quantitative and Qualitative Disclosures about Market Risk
FOREIGN EXCHANGE RISK
The functional currency of the Company is the RMB. Transactions in other
currencies are recorded in RMB at the rates of exchange prevailing when the
transactions occur. Monetary assets and liabilities denominated in other
currencies are translated into RMB at rates of exchange in effect at the balance
sheet dates. Exchange gains and losses are recorded in the Company's statements
of operations as a component of current period earnings. The Company believes
that its exposure to foreign currency exchange rate risk is not material and
does not currently engage in hedging activities to reduce its exposure to
exchange rate fluctuations.
INTEREST RATE RISK
The Company is exposed to interest rate risk arising from having variable rate
obligations. The Company does not have any derivative financial instruments and
believes its exposure to interest rate risk and other relevant market risks is
not material.
Item 4. Controls and procedures
We maintain "disclosure controls and procedures," as such term is defined under
Exchange Act Rule 13a-15(e), that are designed to ensure that information
required to be disclosed in our Exchange Act reports is recorded, processed,
summarized, and reported within the time periods specified in the SEC's rules
and forms, and that such information is accumulated and communicated to our
management, including our Chief Executive Officer and Chief Financial Officer,
as appropriate, to allow timely decisions regarding required disclosures. In
designing and evaluating the disclosure controls and procedures, our management
recognized that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives and in reaching a reasonable level of assurance our management
necessarily was required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures. We have carried out an
evaluation under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures as of September 30, 2004. Based upon their evaluation and subject to
the foregoing, the Chief Executive Officer and Chief Financial Officer concluded
that as of September 30, 2004 our disclosure controls and procedures were
effective at the reasonable assurance level in ensuring that material
information relating to us, is made known to the Chief Executive Officer and
Chief Financial Officer by others within our company during the period in which
this report was being prepared. There were no changes in our internal controls
or in other factors during the most recent quarter that has materially affected,
or is reasonably likely to materially affect, our internal controls over
financial reporting.
25
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The following legal proceedings were settled during the quarter ended September
30, 2004
Aprilia Claims under the Share Purchase Agreement; Payment by IMI; request for
Arbitration; Settlement
In 2000, Aprilia asserted various claims against Centerpoint relating to
Centerpoint's representations and warranties under the Share Purchase Agreement
(the "Alleged Claims") for the sale of its Moto Guzzi operations. In 2001, IMI,
the escrow agent under the Escrow Agreement, paid Euro3,931 thousand from the
escrow account to Aprilia in respect of the Alleged Claims. Centerpoint disputed
the Alleged Claims and requested arbitration. Centerpoint and Aprilia, in
October 2003, entered into an agreement to settle the matter with Aprilia,
paying Euro1,420,256 including Euro206,583 of legal fees. The right to 35% of
the net proceeds of this settlement is owned by Centerpoint (which is no longer
a related party of the Company at the time of the settlement).
26
IMI Fees - settled in June 2004
In connection with the sale of Moto Guzzi to Aprilia, IMI was paid Euro5,888
thousand in fees and expenses it claimed under its engagement letter with the
Company. The Company disputed the calculation of IMI's fees and on February 7,
2002 brought a suit in the Milan Court in Italy seeking reimbursement of
Euro4,527 thousand (approximately US$ 5.7 million at 2003 year-end exchange
rates). The judge handling the lawsuit has heard the case several times in 2002
and 2003. On June 21, 2004, an out-of-court settlement was reached, with IMI
paying Euro700 thousand, of which the Company received Euro373 thousand.
Legal Action by TCMP 3 against Directors of Centerpoint - initiated in January
2004 and settled in July 2004
On January 16, 2004, a civil action was initiated by TCMP 3 Partners LLC in the
Chancery Court of Delaware against the former directors of Centerpoint accusing
them of wasting Centerpoint's assets in undertaking the Bion transaction. The
action was mutually settled in July 2004 with the Company paying US$ 140,000 to
the Plaintiffs in return for a full release of all potential claims against the
Company, its directors, its representatives and other indemnified parties in
connection with the Bion transaction.
Legal action by Shenzhen Comtech against a customer
On September 14, 2004, a civil action was initiated by Shenzhen Comtech in the
Court of Beijing of China against a corporate customer claiming a total amount
of approximately RMB801 thousand, comprising outstanding accounts receivable
amounting to approximately RMB438 thousand, penalty for overdue accounts
receivable amounting to approximately RMB328 thousand and interest of
outstanding balance amounting to approximately RMB35 thousand. The action was
mutually settled on October 19, 2004 with the defendant paying RMB500 thousand
to the Shenzhen Comtech in return for a full release of all potential claims
against the defendant.
27
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds -
Information to be disclosed under this Item 2 was previously furnished in a
Current Report on Form 8-K filed with the Securities and Exchange Commission on
October 27, 2004.
Item 3. Defaults upon Senior Securities - None
Item 4. Submission of Matters to a Vote of Securities Holders
On October 12, 2004, the Company filed a definitive Information Statement on
Schedule 14C with the Securities and Exchange Commission. The Information
Statement was mailed to the Company's stockholders solely for the purpose of
informing the stockholders of the approval and consent by the Board of Directors
of the Company and at least two thirds of the Company's stockholders to amend
the Company's Articles of Incorporation to increase its authorized shares of
common stock from 50,000,000 to 200,000,000 shares. Of the 44,422,050 shares of
the Company issued and outstanding a vote of at least two-thirds, totaling
29,614,700 shares, was required to approve the amendment. The amendment received
the approval by written consent of holders owning 37,261,978 shares. The
amendment to the Articles of Incorporation was filed and effective with the
Secretary of State of Maryland on November 3, 2004. The Company did not solicit
proxies to vote at a stockholders' meeting with respect to the amendment.
Item 5. Other Information - None
28
Item 6. Exhibits
(b) Exhibits
31 Rule 13a-14(A) Certifications.
32 Section 1350 Certifications.
29
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
COMTECH GROUP, INC.
November 15, 2004 By: /s/ Jeffrey Kang
------------------------------------
Jeffrey Kang
Chief Executive Officer and
Chairman of the Board
November 15, 2004 By: /s/ Hope Ni
------------------------------------
Hope Ni
Chief Financial Officer
30