-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, NZL//61kTiaN10fuvPs9AFyAtWT3Ytoshb5EE/gy/Y0ZSwdGRJcAxOBhDxa7sKTi O9kzfeI82Z+QwYEYfDy9gw== 0001144204-04-005149.txt : 20040420 0001144204-04-005149.hdr.sgml : 20040420 20040420154404 ACCESSION NUMBER: 0001144204-04-005149 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 20031231 FILED AS OF DATE: 20040420 FILER: COMPANY DATA: COMPANY CONFORMED NAME: INDUSTRIES INTERNATIONAL INC CENTRAL INDEX KEY: 0001128252 STANDARD INDUSTRIAL CLASSIFICATION: RADIO & TV BROADCASTING & COMMUNICATIONS EQUIPMENT [3663] IRS NUMBER: 870522115 STATE OF INCORPORATION: NV FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: 1934 Act SEC FILE NUMBER: 000-32053 FILM NUMBER: 04742874 BUSINESS ADDRESS: STREET 1: 1236 WIGWAM STREET CITY: MESQUITE STATE: NV ZIP: 89207 10-K/A 1 v02407_10k-a.txt ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K/A [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2003 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File No.: 000-32053 INDUSTRIES INTERNATIONAL INCORPORATED - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Nevada 3600 87-0522115 ------ ---- ---------- (State or other (Primary Standard (I.R.S. Employer jurisdiction Industrial Identification No.) of incorporation or Classification Code organization) Number) 4/F Wondial Building, Keji South 6 Road Shenzhen High-Tech Industrial Park, Shennan Road Shenzhen, China - -------------------------------------------------------------------------------- (Address of principal executive offices) 011-86-755-26520839 - -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None Title of each class Name of each exchange on which registered - ---------------------------------- ----------------------------------------- Securities registered pursuant to Section 12(g) of the Act: Common Stock - -------------------------------------------------------------------------------- (Title of class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (ss.229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10K or any amendment to this Form 10-K. [X] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). [ ] Yes [X] No State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of June 27, 2003: $10,350,524 The number of shares of common stock outstanding as of March 25, 2004 was 29,992,944 shares ================================================================================ Industries International Incorporated (the "Company") reported the historical financial information in US Dollars instead of RMB in the amendment. The Company will report all future audited financial information in US Dollars. TABLE OF CONTENTS NOTE REGARDING FORWARD-LOOKING STATEMENTS PART I ITEM 1. BUSINESS 5 Overview 5 Business Segments 7 Risks Attendant to the Company's Foreign Operations 22 ITEM 2. PROPERTY 26 ITEM 3. LEGAL PROCEEDINGS 26 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 26 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS 27 Equity Compensation Plan Information 27 ITEM 6. SELECTED FINANCIAL DATA 30 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS 30 Results of Operations 30 Liquidity and Capital Resources 36 Trends and Uncertainties 37 Off-Balance Sheet Arrangements 40 Contractual Obligations 40 Critical Accounting Policies and Estimates 40 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 41 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 41 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 42 ITEM 9A. CONTROLS AND PROCEDURES 43 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 43 ITEM 11. EXECUTIVE COMPENSATION 47 2 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 51 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 52 ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES 53 PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS OF FORM 8-K 53 3 NOTE REGARDING FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K contains "forward-looking statements" which are based on our current expectations, assumptions, estimates and projections about our business and our industry. Words such as "believe," "anticipate," "expect," "intend," "plan," "will," "may," and other similar expressions identify forward-looking statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in the section of this Annual Report titled "Management's Discussion and Analysis of Financial Condition and Results of Operation-Factors Affecting Business, Operating Results and Financial Condition", as well as other factors, such as a decline in the general state of the Chinese economy, which will be outside our control. You are cautioned not to place undue reliance on these forward-looking statements, which relate only to events as of the date on which the statements are made. We undertake no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date hereof. You should refer to and carefully review the information in future documents we file with the Securities and Exchange Commission. 4 PART I ITEM 1. BUSINESS OVERVIEW. Industries International, Incorporated ("Industries", "IDUL" or the "Company") is a holding company whose subsidiaries are focused on the research, development, manufacture and commercialization of telecommunication equipment, lithium and lithium-ion batteries, and battery testing equipment in the People's Republic of China ("PRC" or "China") and globally. IDUL's wholly-owned subsidiary Broad Faith Limited is a leading China-based company engaged in, through its subsidiaries, the research, development, production and distribution throughout China of communications terminal products such as corded and cordless telephones and their core components like printed circuit boards (PCB) and design and radio frequency modules. According to the 2002 "Market Research & Consultation Report on Telephones in Chinese Cities" provided by Beijing Guneng Market Research Center, the Company ranks among the top three companies in the Chinese cordless telephone market. The same report also listed the Company's WONDIAL(R) brand name as a well-established brand name in the Chinese telephone market. The Company, through Broad Faith and it subsidiaries, distributes its products through a network of over 5,100 points of sale in more than 200 cities and 28 provinces in China. HISTORY, REORGANIZATIONS AND CORPORATE STRUCTURE. Industries International, Incorporated was incorporated on January 11, 1991 under the laws of the state of Nevada. Its original business was in a field unrelated to its current operations, and was a public shell without operations. The telecommunication equipment manufacturer, Shenzhen Wonderland Communication Science and Technology Co. Limited ("Wonderland"), the operating company purchased in the Company's Broad Faith Limited reverse merger, was established in July 1993 as a Sino-Foreign Equity Joint Venture in the PRC. During the past five years neither Industries nor Wonderland experienced any bankruptcy proceedings or major reorganizations other than those described herein. Broad Faith Limited On February 10, 2003, the Company completed the acquisition of Broad Faith Limited, a company incorporated in the British Virgin Islands ("Broad Faith"). At the time of the acquisition, Broad Faith held a 95% interest in Shenzhen Kexuntong Industrial Co. Ltd. ("Kexuntong"), a Sino-Foreign Equity Joint Venture (a Chinese entity used as a vehicle for foreign investment in China) established in 1994. Kexuntong, in turn, holds 68.73% ownership in its consolidated PRC subsidiary, Wondial, which is engaged in the research, development, production and distribution of communication terminal products such as corded and cordless telephones and core components such as printed circuit boards and radio frequency modules in China. Kexuntong has a renewable 15-year operating tenure pursuant to regulations of Shenzhen Foreign Investment Bureau, which can be renewed at the Company's option by March 29, 2009. The acquisition of Broad Faith resulted in a change of control of the Company. Pursuant to an Amended and Restated Agreement and Plan of Share Exchange dated as of February 10, 2003 (the "Exchange Agreement") by and among Broad Faith, Dr. Kit Tsui, an Individual who was then the sole stockholder of Broad Faith ("Dr. Tsui"), the Company, Daniel Shuput, an Individual who was then the holder of at 5 least a majority of the Company's outstanding capital stock ("Shuput"), William Roberts ("Roberts") and Gayle Terry ("Terry"), each Individual stockholders of the Company, the Company agreed to issue to Dr. Tsui 7,032,986, shares of its common stock, par value $.01 per share (the "IDUL Common Stock"), in exchange for each share of Broad Faith's common stock, par value $1.00 per share (the "Broad Faith Common Stock"), issued and outstanding on the date of the consummation of the exchange. Prior to the closing, approximately 71% of all the Company's issued and outstanding shares were held directly by Shuput. At the closing, Dr. Tsui was issued an aggregate of 3,750,187 authorized and unissued shares of IDUL Common Stock, which shares represented approximately 75% of the total then issued and outstanding shares of the Company. As part of its obligations under the Exchange Agreement, the Company was required to increase its authorized capital stock to at least 100,000,000 shares and to issue to Dr. Tsui and his designees an additional 10,315,187 shares. The Company subsequently increased its authorized shares and issued the required additional shares to Dr. Tsui, resulting in Dr. Tsui's ownership of 92% of the Company, and Shuput's ownership of approximately 5.5% of the issued and outstanding shares of the Company. Pursuant to the Exchange Agreement, on the closing date, the Company's three officers, Shuput, Roberts and Terry, resigned as the Company's officers and appointed Dr. Tsui as the Chairman of the Board and Chief Executive Officer and Mr. Weijiang Yu as the President. In addition, Shuput, Roberts and Terry resigned as the Company's directors and nominated Dr. Tsui, Mr. Yu and Mr. Zhiyong Xu as the Company's new board of directors, the majority of the Company's Shareholders approved the nomination. On February 14, 2003 the Board of Directors appointed Mr. Xu as Secretary of the Company and Ms. Guoqiong Yu as the Chief Financial Officer and Treasurer of the Company. On June 10, 2003, the Company acquired an additional 4.24% interest in Wonderland from Shanghai Sanfeng Investment Management Co., Ltd. in exchange for 665,860 shares of the Company's common stock (par value of $4.00 per share), valued at $2.65 million, thereby increasing the Company's direct and Indirect ownership interest in Wonderland to 69.53%. Li Sun Power On March 10, 2003, the Company entered into a sale and purchase agreement for shares in Li Sun Power International Limited, a company incorporated in the British Virgin Islands ("Li Sun") with Dr. Kit Tsui, the Company's Chief Executive Officer, majority shareholder and a director. Dr. Tsui was then also the sole shareholder of Li Sun, as well as sole shareholder of four companies who collectively held a 72.84% Wuhan Lixing Power Sources Co., Ltd. ("Lixing Power") as trustees for the benefit of Li Sun. (These trustee companies are Wuhan Hanhai High Technology Limited, Wuhan City Puhong Trading Limited, Shenzhen City Xing Zhicheng Industrial Limited and Shenzhen Kexuntong Industrial Co. Ltd.) Dr. Tsui disclosed his interest in Li Sun to the Company's Board of Directors prior to conducting the acquisition. After review and consideration of the terms of the transaction, the Company's Board of Directors unanimously approved the transaction. Dr. Tsui abstained from the Board approval of the transaction. The Company's acquisition of Li Sun was completed on May 14, 2003, and consisted of the Company's purchase of 100% of the capital stock of Li Sun in exchange for 3,941,358 shares of the Company's common stock valued at $7,567,407.36 as well as an unwritten promissory note in the amount of $7,662,000, without expiration, maturity date or interest, payable in cash or the Company's common stock based on mutual agreement. As a result of this acquisition, the Company now holds a 72.84% interest in Lixing Power. Lixing Power was incorporated in China in 1993. According to the Lithium Battery Branch of Physical and Chemical Institute of China, Lixing Power is one of the 6 pioneers in China's battery industry, specializing in the production and distribution of lithium and lithium-ion batteries mainly through its subsidiary, Wuhan Lixing (Torch) Power Sources Co., Limited. Through its wholly-owned subsidiary, Li Sun Power, and its majority business interest in Lixing Power, the Company manufactures and markets lithium and lithium-ion batteries under its own Lixing(R) and Lisun(R) brand-names. It is also an original equipment manufacturer for more than 15 battery brands, including ASUSU, Maxon(Korea), Legend, MiTAC, Giga, and Panasonic. These brands are sold both domestically and overseas. The Company's batteries are marketed for use in various types of electronic products including calculators, personal digital assistants, laptop computers, mobile phones and hybrid electric vehicles. Additionally, the Company manufactures battery testing equipment, which is sold in both Chinese and global markets. Reverse split On May 12, 2003, the Board of Directors of the Company approved and declared a one-for-four reverse split of the Company's common stock, effective for all holders of record on June 2, 2003. As a result of the reverse split, the Company decreases the number of issued and outstanding shares and increased the market value of each share commensurately. CORPORATE STRUCTURE The Company's corporate structure is as follows:
---------------------------------- Industries International, Inc. ---------------------------------- | 100% | 100% | | | ------------------------------------------------------------------ | | | | | | | | | ------------------ ------------------------------ ------------------------------ Sunbest Industries Broad Faith Limited Li Sun Power International Limited Limited ------------------ ------------------------------ ------------------------------ | | | \ | 95% | 72.84 | 90% \ | ------------------------------ -------------------- ------------------------- | Shenzhen Kexuntong Wuhan Lixing Power Shenzhen Chuang Lixing |4.24% Industrial Co. Ltd. Sources Co. Ltd. Power Sources Co. Ltd. | ------------------------------ -------------------- ------------------------- | | | | 63.73% | 70.7% | | ------------------------------ ------------------------------ | Shenzhen Wonderland Wuhan Lixing (Torch)Power ----------- Communication Science Sources Co., Ltd. & Technology Co., Ltd. ------------------------------ ------------------------------
BUSINESS SEGMENTS The Company has three main business segments: Communications terminal products, battery products, and battery testing equipment. COMMUNICATIONS TERMINAL PRODUCTS Products The Company develops, produces and distributes corded and cordless telephones, walkie-talkies, hand-to-hand radios and digital voice repeaters that are sold under the trademark WONDIAL(R). According to statistics provided by The International Electronic Business Network of CHINA (www.ebnchina.com), Broad Faith is one of the largest telephone manufacturers in China. The Company's management believes it ranks among China's top three cordless telephone producers in terms of assets and production scale. CORDED TELEPHONES. The Company produces two series of corded telephones, the HA9000 series and the HCD9000 series of telephone, currently with a total of 17 models in the market ranging in price from $5 to $150. The HA9000 series include models with relatively little functionality. The HCD9000 series provides more functionality, including: caller identification display, time display, phone book, incoming and outgoing call history, a calculator, speed dialing, alarm and various other features. CORDLESS TELEPHONES. The Company produces a line of cordless telephones categorized under its HWCD series, currently offering 12 different models. The functionalities include channel selection, call history for incoming and outgoing phone calls, speed dialing, programmable International Direct Dialing 7 ("IDD") lock, auto redial, ringer selection, record and play handset options, intercom, caller identification display and multiple handset capability. The models are differentiated by their functions and by the number of handsets that come with the base unit. RADIOS AND REPEATERS. We also produce walkie-talkies and hand-to-hand radios under our WT series of products and, under our FW series of products, we produce digital voice repeaters for use by students of foreign languages. The digital voice repeaters are designed to play back words, phrases and sentences in foreign languages. AFTER-SALES SERVICE SUPPORT. The Company operates an after-sales service network in each province and in each major city within China. It also authorizes sales distributors to set up their own after-sales service networks in such distributors' business areas. The set up and operation of these service networks must be approved by the Company and must pass a strict review process. Wondial's service center and other branch organizations provide technical support to these networks. Currently there are 28 service centers with more than 200 service terminals. Market, Customers and Distribution Our products are targeted to consumers and businesses within the People's Republic of China. According to the National Bureau of Statistics of China, as of year end 2002, the number of fixed line telephone subscribers reached 214 million subscribers, an increased of 34 million subscribers from year end 2001. As of the end of the first quarter 2003, statistics revealed that the number of subscribers reached 225 million, an increase of 11.2 million during just the first three months of 2003. The Ministry of Information Industry of China anticipates that the number of fixed line telephone subscribers will be over 490 million by 2010. The Company supplies the products in this segment to both distributors and directly to end customers. Industries maintains a nationwide distribution network that includes 28 independent regional distributors that account for more than 5,100 points-of-sale in 200 major cities in China. The Company maintains a team of 40 Wondial primary sales representatives who directly communicate with Company and 300 secondary sales representatives who are working directly with primary representatives. The Company's Chinese distribution network includes major telecommunication companies, including China Telecom (the largest fixed line operator in China, as projected by CCID IT-economy Research Institute), China Unicom and China Railway Communications. Chain stores and supermarkets operating throughout China, such as Wal-Mart China, Sam's Club and Carrefour's, are also major accounts. Of these, all of our sales from distributors in this segment account for 24.8% of our total telecom sales in 2003, Wal-Mart, accounting for 3.2% of total telecom equipment sales in 2003, and Carrefour's, accounting for 0.2% of total telecom equipment sales in 2003. We also distribute our communications products to Hong Kong, Korea, and Singapore. through distributors in China. The Company maintains sales agreements with all of its distributors, which are renewed on an annual basis. The Company believes that it would be able to replace any of its distributors, if circumstances required. 8 The Company prices its products based on manufacturing costs plus a mark-up depending on numerous factors including order size, competition, inventory considerations and technical attributes. Regional sales agents will set the second-tier sales agent and end-user price based on the local market situation with reference to the retail price suggested by the Company. If a severe price gap occurs, the Company has the right to revise the ex-factory price. The Company may also change its prices in response to an acute price fluctuation of raw material, volatile market situations or breakpoint pricing mechanisms. No other distributors or end customers Individually or as an affiliated group account for more than 10% of our consolidated revenues. Raw materials The primary components used in manufacturing our products in this segment include transistors, integrated circuits (which account for 20% of the total cost), liquid crystal displays, printed circuit boards, antennas, adaptors and switches. The sources of these components are primarily electronics products suppliers located in or near Shenzhen City, although certain integrated circuit and micro-controller units are imported from Hong Kong. While we purchase these components from a few vendors, the components are produced by over 200 manufacturers in China. As of December 2003, we have outsourced our manufacturing capabilities and we don't purchase these raw materials directly. Intellectual property For the corded and cordless phone products, the Company has obtained three Chinese patents for its formal product design: o No.01331397.5 "HWCD9000(9C) P/TSDL" issued on June 21, 2001; o No.01331395.9 "HWCD9000(8E) P/TSDL" issued on June 21, 2001; and o No.01354789.5 "HWCD9000(9)P/TSDL" issued on December 14, 2001. All patents expire 10 years after issuance. We do not believe that the expiration of these patents will have a material adverse effect on our business, because we continually develop new product designs. While we may continue to file patent applications to protect our technology and products, we cannot be sure that our patents will provide commercially significant protection to our technology. We have also trademarked the name "Wondial". We attempt to avoid infringing known proprietary rights of third parties in our product development efforts. If we were to discover that our products violate third-party proprietary rights, we may not be able to offer these products without substantial re-engineering. Efforts to re-engineer might not be successful, licenses from the owners of the technology may be unavailable on commercially reasonable terms, if at all, and litigation may not be avoided or settled without substantial expense and damage awards. Seasonality and cyclicality This segment does not experience material fluctuations in sales or revenues on a seasonal or cyclical basis. 9 Working capital practices Our working practice represents the industry standard, and, to its knowledge, the Company does not experience any unusual working capital requirements. The Company is not required to maintain inventory allotments for any purpose, and neither customers nor external distributors are generally permitted to return merchandise after delivery. Company policy permits customer discount if there are product quality issues. Accounts receivable are generally carried for a period between 60 and 90 days, and accounts payable are generally carried for a period of 30 days. Backlog The Company did not have any backlog as of December 31, 2003. Government renegotiation There are no material portions of the Company's business that may be subject to renegotiation of profits or termination of contracts or subcontracts at the election of any government. Revenues For the fiscal year ended December 31, 2003, the communications terminal products segment revenues totaled $37.9 million, or 64.5% of net sales. BATTERY PRODUCTS Through Li Sun Power, the Company designs and manufactures disposable and rechargeable lithium and lithium-ion batteries that are used in instruments, meters, computers, cameras and similar battery-powered devices. With 47 models of disposable batteries and 33 models of rechargeable batteries, the Company currently produces over 20 million batteries annually. Li Sun Power is certified by International Organization for Standardization as an ISO 9001 and ISO 14001 manufacturers. Products DISPOSABLE LITHIUM BATTERIES. The Company produces 47 different models of disposable lithium batteries which can be generally divided into the following three categories: lithium manganese dioxide button-type, lithium manganese dioxide cylindrical and lithium thionyl chloride. 36 of the 47 models are currently being marketed . The remaining eleven models are currently in development stage, as additional engineering is still required. Lithium Manganese Dioxide Button-Type This type of battery provides 3 volts of power (double the amount of conventional dry batteries) with relatively stable and relatively reliable discharge of energy. It possesses fast pulse discharge characteristics as well as an operating temperature range from -20(degree)C to 60(degree)C. This battery also maintains good storage characteristics with a low self-discharge rate of less than 2%, which permits a shelf life of up to eight years. 10 Lithium Manganese Dioxide Cylindrical Based on the Company's experimental results, this battery provides voltage ranging between 2.8 and 3.2, with a high current discharge and no voltage delay, and an operating temperature range between -40(degree)C and 70(degree)C. This battery also maintains a long storage life, averaging eight years, due to a low self-discharge rate, as well as and good safety and zero pollution characteristics. Lithium Thionyl Chloride This battery provides a voltage of 3.6 with a high specific capacity of 500wh/kg, 1000wh.dm3 and an operating temperature range between -40(degree)C and 85(degree)C. These batteries have a low self-discharge rate (no more than 1%) providing a shelf life of up to 10 years. - -------------------------------------------------------------------------------- DISPOSABLE LITHIUM BATTERIES - -------------------------------------------------------------------------------- TYPE COMMON APPLICATIONS - -------------------------------------------------------------------------------- Lithium Manganese Dioxide Watches, calculators, IC cards (plastic cards with Button-Type Battery semiconductor chips inside, commonly used as debit cards)and electronic dictionaries Lithium Manganese Dioxide Cameras, radios, CMOS memory backup and Cylindrical Battery communication devices for both civil and military use Lithium Thionyl Chloride Gas meters, clocks, CMOS memory backup and a wide Battery range of electronic devices such as alarms, night latches, range finders, and intelligence instruments - -------------------------------------------------------------------------------- RECHARGEABLE LITHIUM BATTERIES. The Company produces 33 different models of rechargeable lithium-ion batteries which can be generally divided into the following three categories: button type lithium-ion, prismatic lithium-ion and large capacity lithium-ion. 28 of the 33 models are currently being marketed. The remaining five models are currently in development stage, as additional engineering is still required. Button-Type Lithium-ion In 2002, the Company successfully developed a proprietary and patented button-type lithium-ion battery, which the Company believes is one of a few high capacity button-type batteries available in China. This battery provides an average voltage of 3.7, with a low self-discharge rate of less than 10%. These rechargeable batteries have an average of 500 life cycles, and do not have a "memory effect" (they do not require discharge before recharge). The batteries have an operating temperature range of -20(degree)C to 60(degree)C. Prismatic Lithium-ion This battery, which is larger than the button-type battery, possesses many of the same characteristics as the button-type but is packaged in a larger, high energy density battery pack. This battery provides average voltage of 3.7 with expedient discharge and charge cycles. This battery has a low self-discharge rate of less than 10%, no memory effect, and an operating temperature range of - -20(degree)C to 60(degree)C. 11 Large Capacity Lithium-ion The Company also produces and develops a wide range of large capacity lithium-ion batteries. These batteries have a wide range of continuous discharge current applications, ranging from small power applications of 3 amperes to high power applications of 120 amperes. These batteries also maintain an extremely long life cycle (500 or more times longer than standard capacity lithium-ion batteries) and an operating temperature range between -20(degree)C to 60(degree)C. - -------------------------------------------------------------------------------- RECHARGEABLE LITHIUM BATTERIES - -------------------------------------------------------------------------------- TYPE COMMON APPLICATIONS - -------------------------------------------------------------------------------- Button- Type Battery Mobile telephones, laptop computers, personal digital Lithium-Ion Battery assistants and electronic notebooks Prismatic Lithium-Ion Mobile telephones, laptop computers, personal digital Battery assistants and electronic notebooks Lithium-Ion Power Battery Motor scooters, miners' lamps, electric bicycles and hybrid electric vehicles - -------------------------------------------------------------------------------- Market As a result of its wide range of high-end battery products, the Company has developed a broad customer base in both Chinese and overseas markets. At present, about 20% of the Company's battery revenue is generated from export of products to Hong Kong, Taiwan, U.S., Singapore, New Zealand and other countries. As an OEM manufacturer of batteries under other brand names, the Company has established a long-term cooperative relationship with a number of locally and internationally well-known companies for manufacturing batteries customized to their specific design and functional requirements. Lithium Manganese Button-Type Battery The lithium manganese button-type battery has numerous applications, including electronic gift items, watches, electronic diaries and dictionaries. The Company estimates total lithium manganese button-type battery demand in China to be approximately 120 million pieces per year. In 2002, Lixing Power sold approximately 60 million pieces of lithium manganese button-type batteries to computer main board manufacturers and the Company anticipates its sales volume for this battery type will increase to 100 million and 150 million in 2003 and 2004 respectively. Lithium Manganese Dioxide Cylindrical Battery Major applications for this type of battery include radios, cameras, and civil and military telecommunication equipment. Based on statistics published by China Industrial Association of Power Sources (CIAPS) with respect to sales of such batteries in 2001 and 2002, the Company estimates global market demand for this type of battery to be about 200 million pieces per year. Lixing Power sold about 500,000 pieces of these batteries in 2002. However, according to sales orders received, the Company believes that sales volume of 2003 may increase to 1 million pieces. Prismatic Lithium-ion Batteries A major application for this type of battery is mobile phones. Customers include mobile phone manufacturers and battery pack manufacturers. According to the 20th International Seminar & Exhibit on Primary & Secondary Batteries on March 17, 2003 in Florida, USA, it is estimated that the global production of prismatic 12 lithium-ion batteries is approximately 1.255 billion batteries and the production of the prismatic lithium-ion batteries for cell phone use is approximately 700 million batteries in 2003. Lixing Power anticipates sales of approximately six million prismatic lithium-ion batteries in 2003. Additional applications for this type of battery are PDAs and other handheld devices. The Development Research Center of the State Council of China estimates that the production of prismatic lithium-ion batteries in China will reach 100 million pieces in 2003. While NiCh rechargeable batteries have traditionally been used in portable equipment, the prismatic lithium-ion battery is quickly replacing the NiCh rechargeable battery and, as a result, the Company believes that the market share of the prismatic lithium-ion battery will substantially increase. Lithium-ion Button Type Batteries These batteries are mainly used in such micro portable equipment as mobile phones, laptop computers, PDAs and electronic diaries. Lixing Power's patented batteries are also used to power wireless earphones. Lixing Power will upgrade its existing LIR2450 II battery (110 MAH) to LIR2450 [II] which has a capacity of 180 to 240 MAH. Lixing Power also plans to upgrade the capacity of its LIR2450 II battery from 110 MAH to 180~240 MAH. The Company has enjoyed proprietary technology and competitive advantage due to early entry into this market niche. With the increased use of blue tooth technology, the Company believes this market will increase rapidly. Lithium-ion Power Battery The applications of these batteries are categorized by application in (1) high capacity batteries which are mainly used in electric tools and bicycles; and (2) high power batteries which are mainly used for hybrid electric vehicles. According to a report on www.ntem.com.cn, it is estimated that approximately 300 million vehicles will use high power batteries by 2020. Lixing Power's new lithium-ion power batteries have passed Chinese national certification and are in the expansion phase of development. The Company's sales of lithium-ion power batteries for the first six months of 2003 are approximately 20,000 pieces. The Company believes that it is a leader in this technology, with more than 3 years of marketing experience and is the only company that has passed military certification for this type of battery. As a result, the Company believes there are very few competitors that can compete with the Company with respect to this technology. The Company believes that it can capture approximately 50% of the market share for this type of battery in the near future. The Company prices its products based on manufacturing costs plus a mark-up depending on numerous factors including order size, competition, inventory considerations and technical attributes. Regional sales agents will set the second-tier sales agent and end-user price based on the local market situation with reference to the retail price suggested by the Company. If a severe price gap occurs, the Company has the right to revise the ex-factory price. The Company may also change its prices in response to an acute price fluctuation of raw material, volatile market situations or breakpoint pricing mechanisms. Raw materials The primary components used in manufacturing our products in this segment include cobalt acid lithium, polymer organic foam, graphite and protection shields. The sources of these components are primarily chemical suppliers located in or near China. If a source for one or more of the components was to fail, we believe that we can find several other cobalt acid lithium suppliers in 13 China. We primarily import our cobalt from South Africa. In case there is a shortage of cobalt, all of the batteries manufactures will be affected negatively. One of the materials required for production is the protection shield, which is used in manufacturing rechargeable lithium-ion batteries. The protection shield is a common chemical material, but processing equipment requires a high investment, as it needs to be processed into a thinner shield with a high precision requirement. As a result, there are very few manufacturers in the world who are willing and able to produce this kind of shield, resulting in periodic supply shortages. In the event of a supply shortage, the Company can find alternative vendors who can provide us with the protection shield. With respect to all other materials required for the production of batteries, all materials are widely available, and restrictions in supply are generally not anticipated. None of the Company's suppliers accounts for 10% or more of inventory or 10% or more of expenditures. Intellectual property For the batteries products, the Company has obtained 12 Chinese patents for product design and production methodologies for making lithium and lithium-ion batteries: o No. 96211676 "Siren Lights for Bicycles" issued on May 10, 1996; o No. 97241178.X "Button- Type Lithium Ion Battery" issued on August 18, 1997; o No. 97241378.2 "Automatic Assembling Equipment for Button-Type Battery" issued on October 15, 1997; o No. 99238457.5 "Lithium Battery with Safety Shield" issued on September 8, 1999; o No. 99238456.7 "Safety Shield for Lithium Battery" issued on September 8, 1999; o No. 00229552.0 "Automatic Cleaning Machine for Button-Type Battery" issued on March 31, 2000; o No. 01250166.2 "Fixing Device for Mobile Phone Batteries" issued on July 25, 2001; o No. 01251640.6 "Button-Type Lithium-ion Battery" issued on August 22, 2001; o No. 01252383.6 "Explosion-Proof Lithium-ion Batteries" issued November 8, 2001; o No. 02228570.9 "Explosion-Proof Lithium Batteries" issued on March 7, 2002; o No. 02228572.5 "Cross-Folded Core for Button-Type Lithium Ion Batteries" issued on March 7, 2002; and o No. 02228571.7 "Electrode for Button-Type Batteries" issued on March 7, 2002. All patents expire 10 years after issuance. We do not believe that the expiration of these patents will have a material adverse effect on our business, because we continually develop new product designs. While we may continue to file patent applications to protect our technology and products, we cannot be sure that our patents will provide commercially significant protection to our technology. We attempt to avoid infringing known proprietary rights of third parties in our product development efforts. If we were to discover that our products violate third-party proprietary rights, we may not be able to offer these products without substantial re-engineering. Efforts to re-engineer might not be successful, licenses from the owners of the technology may be unavailable on commercially reasonable terms, if at all, and litigation may not be avoided or settled without substantial expense and damage awards. 14 Seasonality and cyclicality In general, there is no clear seasonality affect on our revenues. Sales are slightly lower during the first quarter due to Chinese New Year holiday. Export sales are usually higher in the second quarter. Sales generally increase in the fourth quarter due to the Christmas holiday. Working capital practices Our working practice represents the industry standard, and, to its knowledge, the Company does not experience any unusual working capital requirements. The Company is not required to maintain inventory allotments for any purpose, and neither customers nor external distributors are generally permitted to return merchandise after delivery. Company policy permits customer discount if there are product quality issues. Accounts receivable are generally carried for a period between 60 and 90 days, and accounts payable are generally carried for a period of 30 days. Customers and Distribution We supply the products in this segment to both distributors and directly to end customers. We have sales agreements with all of our distributors and contracts are usually renewed on an annual basis. Li Gao International Company d/b/a Team Sirplus Limited accounted for over 10% of our battery revenue in 2003. We believe that we would be able to replace this distributor, or any of our distributors, if circumstances required. No other distributors or end customers Individually or as an affiliated group account for more than 10% of our consolidated revenues. Backlog The Company did not have any backlog as of December 31, 2003. Government renegotiation There is no material portion of the company's business that may be subject to renegotiation of profits or termination of contracts or subcontracts at the election of any government Revenues For the fiscal year ended December 31, 2003, the batteries segment revenues totaled $13.4 million, or 22.7% of net sales. BATTERY TESTING EQUIPMENT Through Li Sun Power, the Company designs and manufactures program-controlled specialized testing equipment for use in laboratories and technology research institutes for high-precision testing of chemical composition and functioning capacity of batteries. The professional testing equipment is specially designed for use in laboratories and technology research institutes for high-precision testing of electrode and electric capacity. 15 Products - -------------------------------------------------------------------------------- BATTERY TESTING EQUIPMENT - -------------------------------------------------------------------------------- TYPE TESTING APPLICATIONS - -------------------------------------------------------------------------------- Professional Testing High precision electrode and electric capacity of use Equipment in laboratories and technology research institutes. Large-Scale Chemical Chemical composition and/or capacity testing of Composition Testing Lithium-ion and NiMH batteries. Equipment Mobile Phone Battery All prismatic Lithium-ion, NiCd and NiMH rechargeable Testing Equipment batteries. - --------------------------------------------------------------------------- Market and Distribution The Company markets its testing equipment to research institutes and batteries manufacturers. The Company also uses its testing equipment internally for its communications and battery operations. The Company prices its products based on manufacturing costs plus a mark-up depending on numerous factors including order size, competition, inventory considerations and technical attributes. Regional sales agents will set the second-tier sales agent and end-user price based on the local market situation with reference to the retail price suggested by the Company. If a severe price gap occurs, the Company has the right to revise the ex-factory price. The Company may also change its prices in response to an acute price fluctuation of raw material, volatile market situations or breakpoint pricing mechanisms. We distribute our products through local sales offices. Company sales offices are located in various cities around the country. The obtained the orders from customers or distributors and the Company deliver products directly to the distributors or customers. No distributor accounts for more than 10% of the Company's consolidated revenues. Raw materials The primary components used in manufacturing our products include frequency stabilizer, integrated circuit and other basic electronic components The sources of these components are primarily electronics products suppliers located in or near China. Battery testing equipment is composed of several basic electronic components and automation core software, therefore, we usually do not experience any shortage of supplies. With respect to all other materials required for the production of testing equipment, all materials are widely available, and restrictions in supply are generally not anticipated. There is no supplier contract accounting for more than 10% of the Company's inventory or expenditures. 16 Intellectual property For the testing equipment products, the Company has obtained 1 Chinese patent for battery testing equipment: o No. 01251641.4 "Digital Intelligent Battery Testing Instrument" issued on August 22, 2001. This patent expires 10 years after issuance. We do not believe that the expiration of these patents will have a material adverse effect on our business, because we continually develop new product designs. While we may continue to file patent applications to protect our technology and products, we cannot be sure that our patents will provide commercially significant protection to our technology. We attempt to avoid infringing known proprietary rights of third parties in our product development efforts. If we were to discover that our products violate third-party proprietary rights, we may not be able to offer these products without substantial re-engineering. Efforts to re-engineer might not be successful, licenses from the owners of the technology may be unavailable on commercially reasonable terms, if at all, and litigation may not be avoided or settled without substantial expense and damage awards. Seasonality and cyclicality This segment does not experience material fluctuations in sales or revenues on a seasonal or cyclical basis. Working capital practices Our working practice represents the industry standard, and, to its knowledge, the Company does not experience any unusual working capital requirements. The Company is not required to maintain inventory allotments for any purpose, and neither customers nor external distributors are generally permitted to return merchandise after delivery. Company policy permits customer discount if there are product quality issues. Accounts receivable are generally carried for a period between 60 and 90 days, and accounts payable are generally carried for a period of 30 days. Customers We supply the batteries testing equipment to research institutes and batteries manufacturers, as well as a number of our battery manufacturing competitors. No customers Individually or as an affiliated group account for more than 10% of our consolidated revenues. . Backlog The Company did not have any backlog as of December 31, 2003. Government renegotiation There is no material portion of the company's business that may be subject to renegotiation of profits or termination of contracts or subcontracts at the election of any government. 17 Revenues For the fiscal year ended December 31, 2003, the testing equipment segment revenues totaled $7.64 million, or 12.9% of net sales. FUTURE PRODUCTS The Company has its own in-house design team for new product development. The Company is currently developing new products, and it expects to introduce into a series of new products into the market during the next 12 months. These include: High-end Corded and Cordless Telephones The Company has designed and plans to develop Internet Phones that enable the user to surf the Internet, corded telephones with extended features and a number of new cordless phones with additional functionalities. The functionalities include a new model phone with message recorders, one with an integrated desk lamp for office use and a specialized 900MHz model for the export market. The Company also plans to introduce new models of voice dialing corded and cordless phones, which provide the user with the option to utilize voice activation functionality. Digital Cordless Telephones The Company designed and plans to develop a 2.4 GHz Digital Signal Spread ("DSS") cordless telephone for both residential and commercial users. For commercial users, the model will comply with the DSS-WPBX standard that will enable the users to communicate with each other within the same area PBX using his cordless headsets without incurring any charges, except when used to call an external number. The DSS digital cordless phones will provide users with higher quality communications and better security within a longer distance and wider range. Multi-Function Videophones The Company plans to design and develop a line of videophones. The phones will integrate the existing function of ordinary telephone networks and computer terminals by utilizing the PC as the operation platform and the USB connector to connect a telephone to such PC. In addition, software will be developed for the videophone and synchronizing data transmission. The Company believes that the design provides a low cost solution to the requirements of video transmission under the existing narrow band telecommunication network. New Walkie-Talkies The Company has designed and plans to develop three new models of walkie-talkies. The models include units with additional features, including a built-in radio for public radio broadcast, a weather forecast message display and an increased communication range of 15 kilometers. Polymer Lithium-ion Battery Polymer lithium-ion batteries use solid organisms as a medium. Its features include small size, easy to transform, large capacity and low weight. The Company believes that this type of battery will be widely used in the electric car, the mobile telephone, laptop, digital camera and other portable electric 18 products This battery's capacity is higher than the liquid lithium-ion battery, is easier to decrease, easier to transform and safer to use. High-Power Motor Battery The high-power motor battery is a type of the lithium-ion battery. This battery's monocase power can be over 2AH, making it useful for powering lighting and driving motors. High-power motor batteries are used in mine lamps, field lightening power, laptop computers, electric bikes, electric cars and military radios. With global trends leaning toward clean energy, the Company believes that this battery will replace small and medium-sized lead-acid batteries in the near future and will be widely used in consumer electronics, field telecommunications and lighting. Test equipment for high-power lithium-ion battery and fuel battery As high-power lithium-ion batteries and fuel batteries become the environmentally-friendly standard, battery manufacturers will require test equipment for these markets. QUALITY CONTROL The Company has always paid significant attention to the quality assurance systems and all performance Indicators meet international standards and pass the examination of the national level includes GB12196-90, GB/T15279-94, GB12198-90, and GB/T17113-1997. The GB2828-2829-87 standard was adopted for export goods. The Company's production is in compliance with ISO9002. During the production process, the Company pays significant attention to quality control and cost control. According to production flow requirements, quality control points have been set up in key production processes and professionals are assigned to monitor the quality and flow of these processes. The Company has employed significant labor and capital investment to set up the comprehensive quality control system to ensure the quality of its products. Production of primary lithium batteries is fully automated and performed by machineries, while secondary lithium battery production is performed by automated assembly lines, which are highly engineered and closely monitored to ensure product quality. The Company holds vendor qualification committee meetings every three months. The vendors are assessed according to their quality improvement notice, purchasing order and procure agreement in the previous three months to verify such terms as quality, delivery and co-operation status. All manufacturers are required to meet ISO9001 quality standards. Vendors meeting the Company's stringent requirements will be placed on a qualified vendor list. Unqualified vendors will be eliminated from the qualified vendor list temporarily or permanently. For the new vendors, the Company will have comprehensive assessments on their production scale, equipment and quality control. As soon as the sample material has been approved and confirmed by the testing, the vendor is listed in the qualified vendor list as a potential supplier. GOVERNMENTAL APPROVAL AND COMPLIANCE China has enacted regulations governing telephones and telephone communications. Pursuant to these regulations, Individuals or entities wanting to sell telephone equipment or connect to the telephone network in China must obtain certain permits from the Ministry of Posts and Telecommunications and all telecommunications equipment must have a network access license. In the past, the Company has not encountered any difficulty in obtaining such permits and licenses and is currently holding all the permits and licenses necessary for manufacturing and selling its products. 19 No other government regulations or compliance regimes, including environmental regulations, apply to the Company's business. It cannot be assured that new or additional regulations will not be enacted which might adversely impact its operations. COMPETITION Many of our competitors are substantially larger than we are and have significantly greater name recognition and financial, sales and marketing, technical, customer support, manufacturing and other resources. These competitors may also have more established distribution channels and may be able to respond more rapidly to new or emerging technologies and changes in customer requirements or devote greater resources to the development, promotion and sale of their products. Our competitors may enter our existing or future markets with products that may be less expensive, that may provide higher performance or additional features or that may be introduced earlier than our products. In the fiscal year ended December 31, 2003, we continued to be price competitive. We attempt to differentiate our company from our competitors by working to increase our brand name recognition, maintaining and enhancing product quality, providing adequate after-sale service, developing products with appealing functions, enhancing our distribution channels and keeping our production costs controlled. There can be no assurance that the Company will be able to compete successfully with its existing or new competitors. If the Company fails to compete successfully against current or future competitors, its business could suffer. Communications Terminal Products Competition in the communications equipment market in China is intense. The market is continually evolving and is subject to changing technology. Our competitors in China include TCL, Bu Bu Gao and Qiao Xing. The focus of the competition among these players has changed from one of advertising and price wars in the past to one of style, image and design today. The Company's competitive strategy is to focus on innovation in product design and quality customer services. Based on a market research conducted by Beijing Guneng Consultancy Co., Ltd., the Company estimates that it has captured approximately an 18% market share in the fixed-line telephone market in China. Battery Products According to the Lithium Battery Branch of Physical and Chemical Institute of China, the Company is one of the largest lithium and lithium-ion battery manufacturers in China. Its major competitors include Shenzhen BYD, Tianjin Lisen, Shenzhen Shun Wo and Shenzhen HYB. Shenzhen BYD is considered to be the largest battery manufacturer in China with daily production capacity of 300,000 units of Lithium-ion, NiCd and NiMH batteries (Source: Prospectus of Shenzhen BYD). The Company estimates that the major overseas competitors in the global market for batteries are Sanyo (about 25% global market share), SONY (about 20% global market share), Toshiba, Matsushita, NEC, Hitachi and Samsung. 20 As noted by the China Battery Industry Association, competition in the battery industry is intense, with Japanese products currently dominating the global market, especially in the high-end categories. Domestic rivals are principally manufacturers of conventional nickel batteries. Battery Testing Equipment With respect to the lithium-ion testing equipment, the Company believes its primary competitors to be Guangzhou Qingtian Industrial co., Ltd. (Qingtian), Hangzhou Hanke (Hanke) and Lixing Power. The Company believes that Qingtian's market share is shrinking due to substantial loss of personnel and Hanke just entered this market. The Company believes that it is the only enterprise manufacturing both batteries and formation & testing equipment in China which gives the Company technical and marketing advantages. Based on actual sales orders, the Company estimates that its market share in providing equipment for testing lithium battery by manufacturers is approximately 15% in 2002 and 30% in 2003. The Company anticipates its market share to reach 50% within 3 years. Other possible target markets for battery testing equipment include quality inspection authorities, research institutes, universities and mobile phone retailers. With respect to such markets, the only competitor is Tshinghua University, which the Company believes has limited marketing resources. According to actual sales, the Company estimates that its market share in China for providing battery testing equipment to quality inspection authorities, research institutes, universities and mobile phone retailers is approximately 60%. EMPLOYEES We presently have approximately 1,271 employees, of which approximately 1,271 are full time employees. We consider our relations with our employees to be good. FINANCIAL INFORMATION ABOUT REPORTING SEGMENTS For a summary of the Company's net revenue, earnings from operations and total assets for each of the Company's business segments in each of the last three fiscal years, please refer to Note 16 to the Consolidated Financial Statement in Item 8, which is incorporated herein by reference. GEOGRAPHIC FINANCIAL INFORMATION During the 2003 fiscal year, 94.2% ($55.7 million) of the Company's revenue was derived from China. 5.8% ($3.4 million) was derived from all other foreign markets in the aggregate. Of the Company's foreign sales, no single country generated a material amount of revenues for the Company. During the 2002 fiscal year, 95.3% ($52.5 million) of the Company's revenue was derived from China. 4.7% ($2.6 million) was derived from all other foreign markets in the aggregate. Of the Company's foreign sales, no single country generated a material amount of revenues for the Company. During the 2001 fiscal year, 96% ($40.3 million) of the Company's revenue was derived from China. 4.0% ($1.7 million) was derived from all other foreign markets in the aggregate. Of the Company's foreign sales, no single country generated a material amount of revenues for the Company. 21 All of the Company's long-lived assets (excluding financial instruments, long-term customer relationships of a financial institution, mortgage and other servicing rights, deferred policy acquisition costs, and deferred tax assets) are located in China. RISKS ATTENDANT TO THE COMPANY'S FOREIGN OPERATIONS The following is a summary of risk factors which result from the Company's operations overseas. Note that these statements relate to future events or future financial performance. In some cases, forward-looking statements can be identified by terminology such as "may," "will," "should," "could," "expects," "hopes," "believes," "plans," "anticipates," "estimates," "predicts," "projects," "potential," or "continue," or the negative of such terms and other comparable technology. These statements are only predictions. In evaluating these statements, actual or potential investors should specifically consider such factors, including the risks outlined below. These factors may cause the Company's actual results to differ materially from any forward-looking statement contained herein. THE COMPANY'S OPERATIONS ARE PRIMARILY LOCATED IN CHINA AND MAY BE ADVERSELY AFFECTED BY CHANGES IN THE POLICIES OF THE CHINESE GOVERNMENT. The Company's business operations may be adversely affected by the political environment in the PRC. The PRC has operated as a socialist state since 1949 and is controlled by the Communist Party of China. In recent years, however, the government has introduced reforms aimed at creating a "socialist market economy" and policies have been implemented to allow business enterprises greater autonomy in their operations. Changes in the political leadership of the PRC may have a significant effect on laws and policies related to the current economic reforms program, other policies affecting business and the general political, economic and social environment in the PRC, including the introduction of measures to control inflation, changes in the rate or method of taxation, the imposition of additional restrictions on currency conversion and remittances abroad, and foreign investment. These effects could substantially impair the Company's business, profits or prospects in China. Moreover, economic reforms and growth in the PRC have been more successful in certain provinces than in others, and the continuation or increases of such disparities could affect the political or social stability of the PRC. THE CHINESE GOVERNMENT EXERTS SUBSTANTIAL INFLUENCE OVER THE MANNER IN WHICH THE COMPANY MUST CONDUCT ITS BUSINESS ACTIVITIES. The PRC only recently has permitted greater provincial and local economic autonomy and private economic activities. The government of the PRC has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in the PRC or particular regions thereof, and could require the Company to divest the interests it then holds in Chinese properties or joint ventures. Any such developments could have a material adverse effect on the business, operations, financial condition and prospects of the Company. In addition, while the Company believes that it is unlikely, the Chinese government may decide not to grant a renewal of Kexuntong's renewable operating tenure upon its expiration on March 29, 2009. While the Company believes that renewing the operating tenure is a simple administrative matter, a failure to renew Kexuntong's renewable operating tenure could have material adverse effect on the business, operations, financial condition and prospects of the Company. 22 In the event the Company is unable to fulfill all of its obligations (e.g. make timely payments when due, etc.) to banks owned and operated by the Chinese government that have loaned money to the Company, the Chinese government may significantly interfere with the business and ultimately take steps to liquidate the Company to pay the debts. The Company believes, however, that liquidation is the very last resort and happens fairly rarely. Thus, the failure of the Company to fulfill all of its obligations to such banks could have material adverse effect on the business, operations, financial condition and prospects of the Company. FUTURE INFLATION IN CHINA MAY INHIBIT ECONOMIC ACTIVITY IN CHINA AND ADVERSELY AFFECT THE COMPANY'S OPERATIONS. In recent years, the Chinese economy has experienced periods of rapid expansion and high rates of inflation which have led to the adoption by the PRC government, from time to time, of various corrective measures designed to restrict the availability of credit or regulate growth and contain inflation. While inflation has moderated since 1995, high inflation may in the future cause the PRC government to impose controls on credit and/or prices, or to take other action, which could inhibit economic activity in China, and thereby adversely affect the Company's business operations and prospects in the PRC. THE COMPANY MAY BE RESTRICTED FROM FREELY CONVERTING THE RENMINBI TO OTHER CURRENCIES IN A TIMELY MANNER. The Renminbi is not a freely convertible currency at present. The Company will receive nearly all of its revenue in Renminbi, which may need to be converted to other currencies, primarily U.S. dollars, and remitted outside of the PRC. Effective July 1, 1996, foreign currency "current account" transactions by foreign investment enterprises, including Sino-foreign joint ventures, are no longer subject to the approval of State Administration of Foreign Exchange ("SAFE," formerly, "State Administration of Exchange Control"), but need only a ministerial review, according to the Administration of the Settlement, Sale and Payment of Foreign Exchange Provisions promulgated in 1996 (the "FX regulations"). "Current account" items include international commercial transactions, which occur on a regular basis, such as those relating to trade and provision of services. Distributions to joint venture parties also are considered a "current account transaction." Other non-current account items, known as "capital account" items, remain subject to SAFE approval. Under current regulations, the Company can obtain foreign currency in exchange for Renminbi from swap centers authorized by the government. The Company does not anticipate problems in obtaining foreign currency to satisfy its requirements; however, there is no assurance that foreign currency shortages or changes in currency exchange laws and regulations by the Chinese government will not restrict the Company from freely converting Renminbi in a timely manner. If such shortages or change in laws and regulations occur, the Company may accept Renminbi, which can be held or re-invested in other projects. FUTURE FLUCTUATION IN THE VALUE OF THE RENMINBI MAY NEGATIVELY AFFECT THE COMPANY'S ABILITY TO CONVERT ITS RETURN ON OPERATIONS TO U.S. DOLLARS IN A PROFITABLE MANNER AND ITS SALES GLOBALLY. Until 1994, the Renminbi experienced a gradual but significant devaluation against most major currencies, including U.S. dollars, and there was a significant devaluation of the Renminbi on January 1, 1994 in connection with 23 the replacement of the dual exchange rate system with a unified managed floating rate foreign exchange system. Since 1994, the value of the Renminbi relative to the U.S. Dollar has remained stable and has appreciated slightly against the U.S. dollar. Countries, including the U.S., have argued that the Renminbi is artificially undervalued due to China's current monetary policies and have pressured China to allow the Renminbi to float freely in world markets. If any devaluation of the Renminbi were to occur in the future, the Company's returns on its operations in China, which are expected to be in the form of Renminbi, will be negatively affected upon conversion to U.S. dollars. The Company attempts to have most future payments, mainly repayments of loans and capital contributions, denominated in U.S. dollars. If any increase in the value of the Renminbi were to occur in the future, the sales of the Company's products in China and in other countries may be negatively affected. THE COMPANY MAY BE UNABLE TO ENFORCE ITS RIGHTS DUE TO POLICIES REGARDING THE REGULATION OF FOREIGN INVESTMENTS IN CHINA. The PRC's legal system is a civil law system based on written statutes in which decided legal cases have little value as precedents, unlike the common law system prevalent in the United States. The PRC does not have a well-developed, consolidated body of laws governing foreign investment enterprises. As a result, the administration of laws and regulations by government agencies may be subject to considerable discretion and variation, and may be subject to influence by external forces unrelated to the legal merits of a particular matter. China's regulations and policies with respect to foreign investments are evolving. Definitive regulations and policies with respect to such matters as the permissible percentage of foreign investment and permissible rates of equity returns have not yet been published. Statements regarding these evolving policies have been conflicting and any such policies, as administered, are likely to be subject to broad interpretation and discretion and to be modified, perhaps on a case-by-case basis. The uncertainties regarding such regulations and policies present risks that the Company will not be able to achieve its business objectives. There can be no assurance that the Company will be able to enforce any legal rights it may have under its contracts or otherwise. THE COMPANY MUST OBTAIN LICENSES OR PERMITS FOR ITS PRODUCTS FROM THE CHINESE GOVERNMENT. China has enacted regulations governing telephones and telephone communications. Pursuant to these regulations, individuals or entities desiring to sell telephone equipment or connect to the telephone network in China must obtain certain permits from the Ministry of Posts and Telecommunications and all telecommunications equipment must have a network access license. In the past, the Company has not encountered any difficulty in obtaining such permits and licenses and is currently holding all the permits and licenses necessary for manufacturing and selling its products. The Company intends to work diligently to assure compliance with all applicable government regulations that impact its business. The Company cannot assure you, however, that additional regulations will not be enacted which might adversely impact the Company's operations. RISKS FROM THE RECENT OUTBREAK OF SEVERE ACUTE RESPIRATORY SYNDROME IN VARIOUS PARTS OF MAINLAND CHINA, HONG KONG AND ELSEWHERE. Since early 2003, mainland China, Hong Kong and certain other countries, largely in Asia, have been experiencing an outbreak of a new and highly contagious form of atypical pneumonia, now known as severe acute respiratory syndrome, or SARS. 24 This outbreak has resulted in significant disruption to the lifestyles of the affected population and business and economic activity generally in the affected areas. Areas in mainland China that have been affected include areas where the Company has business and management operations. Although the outbreak is now generally under control in China, the Company cannot predict at this time whether the situation may again deteriorate or the extent of its effect on the Company's business and operations. The Company cannot assure that this outbreak, particularly if the situation worsens, will not significantly disrupt the Company's staffing or otherwise generally disrupt the Company's operations, result in higher operating expenses, severely restrict the level of economic activity generally, or otherwise adversely affect products, services and usage levels of the Company's products and services in affected areas, all of which may result in a material adverse effect on the Company's business and prospects. CONTROVERSIES AFFECTING CHINA'S TRADE WITH THE UNITED STATES COULD HARM THE COMPANY'S RESULTS OF OPERATIONS OR DEPRESS THE COMPANY'S 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 the Company's business by, among other things, causing the Company's 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 the Company's common shares. IT MAY BE DIFFICULT FOR SHAREHOLDERS TO ENFORCE ANY JUDGMENT OBTAINED IN THE UNITED STATES AGAINST THE COMPANY, WHICH MAY LIMIT THE REMEDIES OTHERWISE AVAILABLE TO THE COMPANY'S SHAREHOLDERS. Substantially all of the Company's assets are located outside the United States. Almost all of its current operations are conducted in China. Moreover, most of the Company's directors and officers are nationals or residents of countries other than the United States. All or a substantial portion of the assets of these persons are located outside the United States. As a result, it may be difficult for shareholders to effect service of process within the United States upon these persons. In addition, there is uncertainty as to whether the courts of China would recognize or enforce judgments of United States courts obtained against the Company or such officers and/or directors predicated upon the civil liability provisions of the securities law of the United States or any state thereof, or be competent to hear original actions brought in China against the Company or such persons predicated upon the securities laws of the United States or any state thereof. REPORTS TO SECURITY HOLDERS AND WHERE YOU CAN FIND MORE INFORMATION The Company is subject to the informational requirements of the Securities Exchange Act of 1934 and must file annual and quarterly reports, proxy statements and other information with the Securities and Exchange Commission. Accordingly, the Company files such reports with the U.S. Securities and Exchange Commission (SEC). In addition, the Company files reports for matters such as material developments or changes within us, changes in beneficial ownership of officers and director, or significant shareholders. These filings are a matter of public record and interested members of the public may read and copy any materials filed by the Company with the SEC at the SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549, and may obtain 25 information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site at http://www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers, including the Company, that file electronically with the SEC. The Company maintains an administrative office located at 111 Pavonia Avenue, Suite 615, Jersey City New Jersey. The purpose of the office to maintain investor relationships in the U.S. and work with corporate and securities attorneys to comply with SEC rules. No person is authorized to give you any information or make any representation other than those contained or incorporated by reference in this Form 10-K. Any such information or representation must not be relied upon as having been authorized. Delivery and/or filing of this Form 10-K shall, under no circumstances, create any implication that there has been no change in the Company's affairs since the date of filing. ITEM 2. PROPERTY The Company owns the six-story Wondial Building located at Keji South 6 Road, Shenzhen High-Tech Industrial Park, Shennan Road, Shenzhen, China in which our headquarters offices are located. 72,000 square feet of this building, representing approximately 72% of its capacity, is rented out to a private company affiliated with a government agency, Shanghai Sheng Bang Inspection Ltd., for administrative offices. This lease was executed in September 16, 2003 and expires in November 15, 2006, for which the Company receives a monthly rent of $17,742. This lease renews at the option of both parties. The Company has rented a more than 15,000 square feet of manufacturing capacity for battery production in Shenzen, China. The annual capacity for the facility is to produce 12 million units of prismatic lithium-ion batteries used on cell phone. The Company believes the building will be suitable for our needs during the next twelve months, with annual projected sales of approximately $15 million. The Company also owns and maintains three operating and manufacturing facilities: one testing equipment production facility with about 3000 square feet of manufacturing capacity, and two batteries production facilities for batteries production with a total of 5000 square feet of manufacturing capacity. All of the three facilities are located in located in Wuhan City, Hubei Province of China. In 2003 we produced 94.6 million units of batteries and 16,258 sets of testing equipment and 6.6 million lithium-ion batteries. In 2002, the Company produced 82.5 million pieces of primary lithium batteries, 54,000 sets of battery testing equipment and 3.5 million pieces of lithium-ion batteries. ITEM 3. LEGAL PROCEEDINGS The Company is not subject to either threatened or pending litigation, actions or administrative proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On November 18, 2003, the Company filed an information statement on Form 14C authorizing the Company to increase its authorized preferred stock from 2,500,000 to 15,000,000. The matter was approved by joint written consent by the Board of Directors by a majority of the stockholders on October 29, 2003. The consenting stockholders consisted of 4 stockholders owning an aggregate of 12,234,929 shares, or 51.52%, of the 23,748,292 shares of common stock issued and outstanding as of October 29, 2003. 26 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Our common stock is traded on OTC Bulletin Board under the symbol "IDUL.OB". The following table sets forth the range of high and low bid quotations for each of quarter of the last two fiscal years, adjusted to reflect the one-for-four reverse split effected May 12, 2003. These quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions. HIGH LOW ---- --- FISCAL YEAR ENDED 2002 March 31, 2002......................................... June 30, 2002.......................................... September 30, 2002..................................... December 31, 2002...................................... HIGH LOW ---- --- FISCAL YEAR ENDED 2003 March 31, 2003......................................... 4.84 0.20 June 27, 2003 (June 30 is a holiday).................. 6.00 1.01 September 30, 2003..................................... 3.50 1.30 December 31, 2003...................................... 3.17 2.05 Note: Industries International Inc.'s reverse merger was completed on February 10, 2003. Holders As of March 23, 2004, there were approximately 2100 stockholders of record of our common stock and no stockholders of record of our Preferred Stock. Dividends The Company has never declared dividends or paid any cash dividends on our capital stock and currently intends to retain all future earnings, if any, for use in the operation and development of our business. Shareholders should not expect the Company to declare or pay any cash dividends on our common stock in the foreseeable future. Equity Compensation Plan Information As of December 31, 2003, our equity compensation plans were as follows: During the fiscal year 2003, IDUL has granted various stock options and stock-based awards under (1) the EI Plan and (2) the PS Plan. 27 EI Plan The EI Plan is an equity incentive plan approved by the Company's stockholders on April 7, 2003 and registered on Form S-8 on May 9, 2003 (File No.: 333-105117). The EI Plan is intended to provide incentives to attract, retain and motivate both eligible employees and directors of the Company, as well as consultants, advisors and independent contractors who provide valuable services to the Company. Initially, 3,750,000 shares of IDUL's common stock were reserved for issuance under the EI Plan. On October 2, 2003, a further 5,000,000 shares of IDUL are reserved under the EI Plan. Under the EI Plan, awards may consist of grants of options to purchase our common stock (either Incentive Stock Options (for eligible persons) or Non-Qualified Stock Options, as each is defined in the Internal Revenue Code), grants of restricted common stock, or grants of unrestricted common stock. Stock options have been granted to officers, other employees and directors to purchase shares of common stock pursuant to the EI Plan at or above 85% of the market price of IDUL's common stock at the date of issuance. Generally, these options, whether granted from the current plans, become exercisable over staggered periods, but expire after 10 years from the date of the grant. On May 13, 2003, 425,000 and 125,000 unrestricted stock options were issued to directors of the Company and a non-employee respectively. PS Plan The PS Plan refers to a plan devised by Dr. Kit Tsui, the Company's principal stockholder, pursuant to which he may grant stock awards to various parties, including employees and business associates, to enhance or maintain the value of his investment. This unwritten, informal program was set up solely by Dr. Tsui to award the Company employees, consultants, middle agents such as accounts, counsels and professional service providers, and shares are granted from restricted shares previously issued to Dr. Tsui in conjunction with the reverse merger. The employee candidates are proposed by management in different areas to the top management team. The final award decisions are made by Dr. Kit Tsui and other members of management. None of the shares granted pursuant to the PS Plan are issued by the Company. Please refer to Note 15 (2) of the Company's consolidated financial statements for details. Equity Compensation Plan Table The following table sets forth information regarding our compensation plans and Individual compensation arrangements under which our equity securities are authorized for issuance to employees or non-employees (such as directors, consultants, advisors, vendors, customers, suppliers or lenders) in exchange for consideration in the form of goods or services. 28 Plan Category Number of securities to be issued upon exercise of Weighted-average Number of outstanding exercise price of securities options, outstanding remaining warrants and options, warrants available for rights and rights future issuance Equity Compensation Plans 8,750,000 5.6 786,115 approved by security holders. Equity Compensation Plans not approved by security holders. TOTAL 8,750,000 786,115 Restricted Offerings On February 25, 2004, the Company completed a private equity financing pursuant to which it raised gross proceeds of $5,800,000. The financing was arranged by HPC Capital Management Corporation, an investment banking firm and fund manager, which received a net commission of 6.5% of the total gross proceeds. The transaction was a unit offering, pursuant to which each investor received a unit comprised of one share of restricted common stock and warrants convertible into 0.3 shares of restricted common stock, resulting in the placement of an aggregate of 2,521,745 shares of restricted common stock and warrants convertible into an additional 756,530 shares of restricted common stock. The warrants have an exercise price of $2.70 per share and expire on February 25, 2007. Twelve investors participated in the transaction. On March 1, 2004, the Company filed a current report on Form 8-K disclosing that it had completed a private equity financing pursuant to which it raised gross proceeds of $5,800,000. In that report, the Company correctly reported that it had issued a total of 2,521,745 shares of common stock together with warrants to purchase an additional 756,530 shares of common stock. The price per unit was correctly reported as $2.30, but the warrant exercise price was incorrectly reported as $2.70 per share. The warrant exercise price is $2.7601 per share. Each and all of the investors were accredited, as defined in the Securities Act of 1933, as amended (the "Securities Act"), and this transaction was conducted pursuant to Section 4(2) and Regulation D of the Securities Act. Neither the Company nor HPC Capital Management Corporation conducted a public solicitation in connection with the offer, purchase and/or sale of these securities, no advertisement was conducted with respect to this issuance in any public medium or forum, HPC offered the shares on behalf of the Company only to investors who (1) qualified as "accredited investors" within the meaning of the Securities Act of 1933, as amended, and (2) had previously expressed an interest in participating in an offering of the type and manner conducted, and none of the shares issued were offered in conjunction with any public offering. Repurchase Plan On December 9th 2003, the Company announced its plan to buy back 500,000 shares of its outstanding common shares. Subsequently, the Company entered into a purchase agreement with a shareholder who owned 200,000 shares. Agreement is attached as an exhibit. The Company purchased the shares and reduced the number of shares outstanding. The average price paid by the Company is $2.9. 29 ITEM 6. SELECTED FINANCIAL DATA The following selected financial data should be read in conjunction with the Company's Consolidated Financial Statements. The information set forth below is not necessarily indicative of results of future operations, and should be read in conjunction with Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and the Consolidated Financial Statements and notes thereto included in Item 8, "Financial Statements and Supplementary Data," of this Form 10-K in order to understand fully factors that may affect the comparability of the financial data presented below.
2003 2002 2001 2000 1999 USD USD USD USD USD For year ended December 31: Net sales ................. 58,977 54,007 41,941 30,570 28,481 Operating income .......... 5,820 10,224 7,310 4,259 4,492 Net income ................ 1,182 5,026 3,786 1,378 1,077 Basic net income per common stock (1) 0.05 0.28 0.21 0.08 0.08 At year end December 31: Total assets .............. 70,907 64,050 69,323 48,433 43,317 Long-term debts ........... 2,419 -- -- -- 3,502
(1) Basic net income per common stock has been restated to reflect the recapitalization, merger under common control and one-for-four reverse split. As of December 31, 2003, the total number of shares of common stock issued and outstanding was 27,061,290 (27,511,291 on a fully diluted basis) ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION The following is a discussion and analysis of the Company's financial position and results of operations for each of the three years in the period ended December 31, 2003. This commentary should be read in conjunction with the consolidated financial statements and the notes thereto which appears under Item 8: Financial Statements and Supplementary Data. RESULTS OF OPERATIONS Fiscal Year ended December 31, 2003 Compared to Fiscal Year Ended December 31, 2002 Revenues Total revenues for the Company, which include revenues from communications terminal products, battery products, battery testing equipment and lease income, totaled $59,093,000 and $55,077,000 in 2003 and 2002, respectively, an increase 30 of 7.3%. Revenues generated by our communications terminal products operations totaled $34,865,000 and $34,865,000 in 2003 and 2002, respectively, an increase of 8.9%, as a result of growth from the release of three new phone products, which generated sales of $3,875,000, and growth in existing phone sales of $1,010,000. Revenues generated by our battery products operations totaled $13,360,000 and $10,680,000 in 2003 and 2002, respectively, an increase of 25.1%, as a result of (i) establishing a new production base in Shenzhen. The new factory is occupying a total of 15,000 square feet which was designed to produce an annual capacity of 8 million lithium-ion cell phone batteries. The facilities were completed in November 2003. (ii) new product introduction and (iii) decreasing product prices in order to obtain increased unit volume sales. Revenues generated by our battery testing equipment operations totaled $7,640,000 and $8,607,000 in 2003 and 2002, respectively, a decrease of 11.2%, as a result of that the Company's focus on developing high profit margin products. The company also focused on the battery production because the market is experience rapid growth and easier to expand its market position. The company generated lease income from the leasing of telephone production equipment to Shenzhen Yu Da Fu Electronic Company Limited in 2003. We sold the asset to the leaser in December 2003. The company generated lease income of $116,000 and $987,000 during 2003 and 2002, respectively, a decrease of $871,000. The Company leased some capital equipment to its suppliers, who produces communication terminal products for the Company since 2001. At the beginning of 2003, the Company sold the equipment and reduced lease income and depreciation expense both by $871,000. Capital Expenditures Capital expenditures for the company totaled $830,000 and $1,786,000 during 2003 and 2002, respectively. Expenditures relating to our communications terminal products operations totaled $383,000 and $829,000 during 2003 and 2002, respectively. During the year of 2003, we have gradually outsourced our manufacturing capabilities to other companies. As a result, our product cost reduced by 14.2% in 2003. As of forth quarter of 2004, we have completely outsourced our communications terminal products manufacturing capabilities. We are not planning on making any significant investment on capital assets. Our strategy is to leverage on our strength in distribution capabilities in China and open the European and U.S. market. Expenditures relating to our battery products operations totaled $394,000 and $724,000 during 2003 and 2002, respectively. The battery factory we established in Shenzhen was leased and the equipment was transferred from Wuhan. We did not make significant capital investment in expanding our production capabilities. Expenditures relating to our battery testing equipment operations totaled $53,000 and $233,000 during 2003 and 2002, respectively. The Company has decided on not to focus our resources on further developing this relatively low profit margin product line. Operating Expenses Total operating expenses, which include manufacturing and other costs of sales, sales and marketing expense, general and administrative expense, research and development expense, depreciation and amortization expense, and other operating costs and expenses, totaled $53,273,000 and $44,838,000 in 2003 and 2002, respectively, an increase of 18.8%. Manufacturing and other costs of sales totaled $42,598,000 and $37,400,000 in 2003 and 2002, respectively, an increase of 13.9%. 31 Sales and marketing expenses, which include salesperson salaries and benefits, advertising expenses, and miscellaneous salespersons' expenses, totaled $2,199,000 and $2,039,000 in 2003 and 2002, respectively, an increase of 7.8%, mainly due to a $203,000 increase in advertising expenses that was partially offset by a decrease in other sales expenses. General and administrative expenses, which include wages, administrative benefits and miscellaneous expenses, communication and office equipment, employee retirement plan fees and medical insurance, products sales tax, utilities, property insurance, middle agency expenses and bad debt reserve, totaled $2,495,000 and $2,190,000 in 2003 and 2002, respectively, an increase of 13.9%. The company spent $245,000 on promotion expenses in 2003, while other expenses all increased slightly at different levels. Research and development expenses, which include wages and benefits of development personnel and raw material expenses during research and development, totaled $1,028,000 and $1,439,000 in 2003 and 2002, respectively, a decrease of 28.6%. The main reason for the decrease is that the production method has transformed to the method of OEM, and stop using 3% of the total sales revenue for research and development since November of 2003. The technology we used in the communications terminal products are mature technologies. We have grasped the core technologies for new products before 2003. During the year of 2003, we primarily used the R&D to improve existing products. Depreciation and amortization expense totaled $557,000 and $1,384,000 in 2003 and 2002, respectively, a decrease of $827,000. During the year of 2003, we shift our production strategy to OEM methodology. As of December 2003, we outsourced all of our manufacturing capabilities. At the beginning of 2003, we sold some of our telephone manufacturing equipment that was leased to the supplier, S-M EGGA Tele. Communications for 7.82 million at its net the book value of the asset. No gain or loss was recorded. It reduced our annual depreciation expenses by $821,000. At the end of 2003, the Company also sold some telephone manufacturing assets for $726,000. The net book value of the asset was $695,000. We realized a gain of $31,000 on this transaction. Other operating costs and expenses, which include stocks issuance costs, totaled $4,396,000 and $385,000 in 2003 and 2002, respectively. Please see the section on STOCK-BASED COMPENSATION herein for a discussion of the company's stock and stock option plans. Operating Income Total operating income for 2003 totaled $5,820,000, or 9.8% of total revenue, compared to $10,239,000, or 18.6% of total revenue, for 2002. Communication terminal products operating income for 2003 totaled $4,750,000 compared to $4,308,000 for 2002. Battery products operating income for 2003 totaled $3,510,000 compared to $2,480,000 in 2002. Battery testing equipment operating income for 2003 totaled $1,108,000 compared to $2,144,000 in 2002. Operating Profit Margin Communication terminal products operating profit margin for 2003 totaled 12.5% of communication terminal products revenue, compared to 12.4% of communication terminal products revenue for 2002. Battery products operating profit margin for 2003 totaled 26.3% of battery products revenue, compared to 23.2% of battery 32 products revenue, for 2002. Battery testing equipment operating profit margin for 2003 totaled 14.5% of battery testing equipment revenue, compared to 24.9% of battery testing equipment revenue, for 2002. The profit margin for testing equipment decreased as a result of low demand and decreased price. Interest Expense Interest expense totaled $1,023,000 and $1,602,000 during 2003 and 2002, respectively, a decrease $579,000. This decrease was due to reduced borrowed amount. The interest rate did not vary very much each year. Other Income, Net Other net income, which includes rental revenue, bank deposit interest, bank service charges and remittance of the net income, sales income of raw material, and sales of fixed assets, totaled $707,000 and $295,000 in 2003 and 2002, respectively. The increase of $412,000 was due to increased rental income from leasing part of the building to other companies. Provision for Income Taxes Provision for income taxes totaled $1,008,000 and $888,000 during 2003 and 2002, respectively, due to increased net income of our operation entities. Please refer to footnote 14 of the financial statements for a comprehensive discussion of the company's tax policies and benefits. Minority Interest Minority interest expense totaled $3,314,000 and $3,010,000 in 2003 and 2002, respectively, as a result of increase in operating income from our operating subsidiaries. Please refer to the company's financial statements for a complete discussion of minority interests in its consolidated subsidiaries. Net Profit Net profit for the fiscal year ended December 31, 2003 totaled $1,182,000, or 2.0% of revenue, as compared to $5,034,000, or 9.1% of revenue, for the fiscal year ended December 31, 2002. The decrease is due to reduced profit margin in our testing equipment and the stock/option grant program established by the Company. The total non-cash compensation expense under the PS Plan was $3,997,000 and reduced our net income by $3,997,000. Fiscal Year ended December 31, 2002 Compared to Fiscal Year Ended December 31, 2001 Revenues Total revenues for the Company, which include revenues from communications terminal products, battery products, battery testing equipment and lease income, totaled $55,077,000 and $42,006,000 in 2002 and 2001, respectively, an increase of 31.1%. Revenues generated by our communications terminal products operations totaled $34,865,000 and $33,513,000 in 2002 and 2001, respectively, an increase of 4.0%, as a result of new product introduction. We introduced five new models of cordless phones and twelve new models of corded phones to the market place in 2002. We also reduced the price of our phone products by 23.3% and increased our sales volume by 41.3%. 33 Revenues generated by our battery products operations totaled $10,680,000 and $2,301,000 in 2002 and 2001, respectively, an increase of 364%, as a result of rapidly growing demand for lithium and lithium-ion batteries and battery testing equipment. We also have quickly established our distribution network all around in China. Revenues generated by our battery testing equipment operations totaled $8,607,000 and $6,301,000 in 2002 and 2001, respectively, an increase of 36.6%, as a result of increased number of battery manufactures and their demand for testing equipment. The company generated lease income from the leasing of production machines of communication products. We acquired these machines for production use in 2001 and started to lease them to other manufacturers in 2002. The leaser was S-MEGGA Tele. Communications. The lease generates $987,000 annual lease income. The lease was for one year and renewable annually. The lease income for 2002 and 2001 are $987,000 and $0 respectively. Capital Expenditures Total capital expenditures for the Company totaled $1,786,000 and $10,298,000 during 2002 and 2001, respectively. Expenditures relating to our communications terminal products operations totaled $829,000 and $9,486,000 during 2002 and 2001, respectively, a decrease of 91.3%. A significant decrease was a result of purchase production machine in 2001 for $8,640,000. Expenditures relating to our battery products operations remained fairly steady, totaling $724,000 and $733,000 during 2002 and 2001, respectively. Expenditures relating to our battery testing equipment operations totaled $233,000 and $79,000 during 2002 and 2001, respectively, and increase of 195%. This increase was the result of purchasing production equipment. Operating Expenses Total operating expenses, which include manufacturing and other costs of sales, sales and marketing expense, general and administrative expense, research and development expense, depreciation and amortization expense, and other operating costs and expenses, totaled $44,838,000 and $34,685,000 in 2002 and 2001, respectively, an increase of 29.3%. Manufacturing and other costs of sales totaled $37,400,000 and $28,146,000 in 2002 and 2001, respectively, an increase of 32.9%. Sales and marketing expenses, which include salesperson salaries and benefits, advertising expenses, and miscellaneous salespersons' expenses, totaled $2,039,000 and $2,665,000 in 2002 and 2001, respectively, a decrease of 23.5%, due to the fact that we installed customer service centers in every primary sales representative's office. General and administrative expenses, which include wages, administrative benefits and miscellaneous expenses, communication and office equipment, employee retirement plan fees and medical insurance, products sales tax, utilities, property insurance, professional expenses and bad debt reserve, totaled $2,190,000 and $1,648,000 in 2002 and 2001, respectively, an increase of 32.9%, due to increased uncollectible accounts receivables and increased wages and benefits. Research and development expenses, which include wages and benefits of development personnel and raw material expenses during research and development, 34 totaled $1,439,000 and $1,516,000 in 2002 and 2001, respectively, a decrease of 5.1%, due to the technology we used for our products are generally mature technology. Our R&D expenses are generally used for improving our existing technology. Depreciation and amortization expense totaled $1,384,000 and $258,000 in 2002 and 2001, respectively. The increase of $1,126,000 is primarily due to the equipment purchased in 2001. Other operating totaled $385,000 and $451,000 in 2002 and 2001, respectively, a decrease of 14.6%, due to penalties of the Company's drivers violating traffic rules. Operating Income Total operating income for 2002 totaled $10,239,000, or 18.6% of total revenue, compared to $7,321,000, or 17.4% of total revenue, for 2001. Communication terminal products operating income for 2002 totaled $4,308,000 compared to $4,011,000 for 2001. Battery products operating income for 2002 totaled $2,480,000 compared to $596,000 for 2001. Battery testing equipment operating income for 2002 totaled $2,144,000 compared to $2,574,000 for 2001. Profit Margin Total profit margins remained relatively stable with respect to the Company's communication terminal products and battery products. Communication terminal products operating profit margin for 2002 totaled 12.4% of communication terminal products revenue, compared to 12.0% of communication terminal products revenue for 2001. Battery products operating profit margin for 2002 totaled 23.2% of battery products revenue, compared to 25.9% of battery products revenue for 2001. Battery testing equipment operating profit margin for 2002 totaled 24.9% of battery testing equipment revenue, compared to 41.6% of battery testing equipment revenue for 2001. During 2001, we experience very high demand of testing equipment and we are the only few companies who can make the testing equipment. As the competition getting intense, we had to lower our price to maintain volume of sales. As a result, our profit margin decreased. Interest Expense Interest expense totaled $1,602,000 and $1,740,000 during 2002 and 2001, respectively, a decrease of 7.9%. This decrease was due to reduced borrow amount. Interest rate did not change very much from 2001 to 2002. Other Income, Net Other net income, which includes rental revenue, bank deposit interest, bank service charges and remittance of the net income, sales income of raw material, and sales of fixed assets, totaled $295,000 and $1,603,000 in 2002 and 2001, a decrease of 81.6%. This decrease was due to change in special tax benefit in China. The returned tax benefit from the government is recorded in the other income section. Provision for Income Taxes Provision for income taxes totaled $888,000 and $503,000 during 2002 and 2001, respectively, due to the discontinuation of certain tax benefits. Please refer to footnote 14 of the financial statements for a comprehensive discussion of the company's tax policies and benefits. 35 Minority Interest Minority interest expense totaled $3,010,000 and $2,890,000 in 2002 and 2001, respectively, as a result of increased net income from operating subsidiaries . Net Profit Net profit for the fiscal year ended December 31, 2002 totaled $5,034,000, or 9.1% of revenue, compared to $3,791,000, or 9.0% of revenue, for the fiscal year ended December 31, 2001. LIQUIDITY AND CAPITAL RESOURCES During the year of 2003, the Company generated cash of more than $32.6 million, which will be used to fund operation. The Company holds short-term debt of $11.8 million and long-term debt of $2.4 million maturing at the end of 2005. Over the last three years, the Company has maintained a policy of reducing outstanding debt, and has successfully reduced its outstanding debt balance each year. The short-term debt has to be repaid within twelve months each year and can generally be reborrowed for another twelve months. As of December 31, 2003, the Company has not made any additional, significant capital commitments payable over the next twelve months. The Company entered into a two-year operating lease agreement with Shenzhen OCT Real Estate Limited, with an annual rental payment of $28,747. The total rental space is approximately 12,000 square feet, with a maximum capacity of 8 million lithium-ion cell phone battery units. The Company does not anticipate experiencing significant liquidity problems in the next twelve months. The Company has one outstanding promissory note in the amount of $7,662,000 with Dr. Kit Tsui, described in the discussion entitled "Certain Relationships and Related Party Transactions." The terms of the note do not provide for expiration or maturity, bearing no interest rate, and is payable in cash or the Company's common stock based on mutual agreement. The Company currently has debt obligation with six PRC banks. BORROWING AMOUNT BANK (US$ 000) MATURITY INTEREST RATE - -------------------------------------------------------------------------------- Shenzhen Development Bank 2,965 5 Months 6.75% China Industries and Commerce 726 4 Months 6.03% Bank China Enterprise Trust Bank 1,814 9 Months 5.36% Guangdong Development Bank 3,266 2 Months 5.84% Xingye Bank 3,024 3 Months 5.25% Huaxia Bank 2,419 13 Months 5.49% Total 14,214 All of the above debt has no amortization schedule before maturity. The Company usually enters into another agreement with the banks when the debt is mature. The lenders are not affiliate of the Company. 36 The Company is not currently invested in any marketable securities. During the quarter ended December 31, 2003, it sold all of its the marketable securities, receiving $1,541,000, in order to pay down the Company's short-term debt. . As of December 31, 2003, the Company had a current ratio of 1.58, net working capital of $21,383,000 and net equity of $18,983,000. During the fiscal year 2003, our net cash and cash equivalents increased by approximately $17,243,000, from approximately $15,364,000 as of December 31, 2002 to $32,607,000 as of December 31, 2003, an increase of approximately 212%. This increase was mainly attributable to the acquisition of Li Sun Power, which provided us with $12,579,000 in cash. Net cash provided by operating activities during the fiscal year 2003 totaled approximately $10,505,000. The Company's primary use of cash was for the purchase of inventory and for the payment of the Value Added Tax that was imposed as a result of the decision of the government of Shenzhen to abolish a preferential tax policy. Cash used in financing activities for the fiscal year 2003 totaled approximately $2,845,000, representing repayment of short-term debt. The Company used additional cash to pay interest of approximately $1,023,000 during the fiscal year 2003. On September 21, 2003, the Company entered into a two-year operating lease with Shenzhen HuaQiao City Real Estate Limited, and is Estate Limited, leasing manufacturing space for an annual rental payment of $28,747. The total rental space is about 12,000 square feet, with a maximum capacity of approximately 12 million lithium-ion battery units. The annual revenue potentially generated by this facility is approximately $17,000,000. Our goal of this year is to further reduce our debt. We are currently going through an asset divestiture plan. The Company will further sell some of it telephone manufacturing machines to pay back Dr. Kit Tsui's promissory note. Other than as described above, on a recapitalization basis, there were no material changes in financial condition from the end of the preceding fiscal year to December 31, 2003. Trends and Uncertainties The Company's future resources will be focused primarily on the growing domestic and overseas battery products market, as it is increasing and presents a high profit margin for the Company. Specifically, the Company notes that the demand for lithium-ion batteries for cell phone usage has increased rapidly, and anticipates continued growth in 2004. Accordingly, it has established a factory in Shenzhen to meet the growing demand for lithium batteries. The Company intends to maintain its current interest in its communication products segment, and, noting intense competition in the domestic market, anticipates expanding in the U.S. and European markets. In this regard, the Company has executed an agreement with Unical Enterprise Inc. valued at $20 million for the manufacture of Bell Phones. The Company has further outsourced its production capabilities, and has improved its profit margin commensurately. The Company notes that demand for battery testing equipment decreased in 2003. Although the Company reduced the price for testing equipment, the Company did not experience offsetting sales volume. The Company notes further that this segment represents a product which is expensive to manufacture and maintains a more limited market, and, as a result, presents a lower profit margin. Accordingly, the Company has decided that it will not allocate additional capital in developing this segment and will gradually exit the battery testing market. The timing and rate of this exit has not yet been determined by the Company. 37 The Company is subject to a number of uncertainties which may affect the business and/or its operations adversely. The following is a generalized summary of risks and uncertainties faced by the Company, which may directly or Indirectly impact the Company's liquidity. Sovereign Risk At present, substantially all of our operations, income, resources and personnel are located in or obtained from China and neighboring countries; our resources are denominated in Renminbi and converted to U.S. Dollars for financial reporting purposes; and our customers are located in Asia, North America, Europe and elsewhere. We face risks of nationalization, restrictions on currency exchange and asset transfer and similar sovereign risks over which we have no control. We believe that the probability of these risks being realized is highly unlikely. However, we intend to develop a plan for operating under those adverse circumstances to the extent possible, though we have not developed such plan as yet. Macroeconomic Factors We are subject to macroeconomic factors such as interest rates, exchange rates, inflation rates, trade deficits and surpluses, budget deficits and surpluses, development of trading blocs such as the European Union, and similar factors over which we have no control. Changes in these factors could have material adverse effects on our financial performance and condition. We intend to implement adequate processes and controls as soon as possible so that we may plan for and operate under adverse conditions, though we have not made substantial progress in this area yet due to a lack of infrastructure and resources. Industry and Competitor Risks Our annual revenue and operating results may fluctuate due to market conditions in the telecommunications industry. Products such as ours are often discretionary purchases, which consumers who are concerned about job losses or other economic factors may decide not to buy. We are uncertain about the extent, severity, and length of the economic downturn. If the economic conditions globally do not improve, or if we experience a worsening in the global economic slowdown, we may experience material negative effects on our business, operating results, and financial condition. Our market is highly competitive, and we may not have the resources to compete adequately. If we are not competitive, it will affect our financial condition and results of operations. We face competition from companies providing corded and cordless telephones in China. Our principal competitors are TCL, Bu Bu Gao and Qiao Xing. Some of our competitors are substantially larger than we are and have significantly greater name recognition and financial, sales and marketing, technical, manufacturing and other resources. These competitors may also have more established distribution channels and may be able to respond more rapidly to new or emerging technologies and changes in customer requirements or devote greater resources to the development, promotion and sale of their products. These competitors may enter our existing or future markets with products that may be less expensive, provide higher performance or additional features or be introduced earlier than our products. The market for our communications equipment is rapidly evolving and highly competitive. We expect competition to intensify in the future as existing competitors develop new products and new competitors enter the market. 38 Technological Risks We expect our competitors to continue to improve the performance of their current products and introduce new products. If our competitors successfully introduce new products or enhance their existing products, this could reduce the sales or market acceptance of our products and services, increase price competition or make our products obsolete. To be competitive, we must continue to invest significant resources in research and development, sales and marketing and customer support. We may not have sufficient resources to make these investments or to make the technological advances necessary to be competitive, which in turn will cause our business to suffer. Our success depends, to a certain extent, upon our proprietary technology. We currently rely on a combination of patent, trade secret, copyright and trademark law, together with non-disclosure and invention assignment agreements, to establish and protect the proprietary rights in the technology used in our products. Although we have filed patent applications, we are not certain that any patents issued will provide commercially significant protection to our product design. In addition, others may independently develop substantially equivalent proprietary information not covered by patents to which we own rights, may obtain access to our know-how or may claim to have issued patents that prevent the sale of one or more of our products. Also, it may be possible for third parties to obtain and use our proprietary information without our authorization. If we fail to protect our proprietary information effectively, or if third parties use our proprietary technology without authorization, our competitive position and business will suffer. We are dependent on the development and acceptance of various technologies and standards, including those pertaining to the processes and methods upon which our products and services are made, operate or used. If our products fail to meet consumer, regulatory or other technologies, standards or expectations or we fail to keep pace with changes in consumer, regulatory or other technologies, standards or expectations, it may have a material adverse effect on our financial performance or condition. Political and Regulatory Risks We are subject to federal, state and local regulatory risks, including, but not limited to, securities, antitrust, environmental, labor, permit/license, tax and other laws, ordinances and regulations. In the event that regulatory oversight or requirements were to increase or our ability to maintain or conform to the requirements was impaired or insufficient, the added operational and financial costs to meet such requirements may have a material adverse effect on our financial performance or condition. We have had the benefit of certain tax incentives, including a tax holiday, in the past, but we may not always be eligible for such programs or the programs may be modified or discontinued altogether. The modification or discontinuance of these tax incentives may have a material effect on our operating performance. At present, substantially all of our income is generated in the People's Republic of China by our subsidiary, Shenzhen Wonderland Communication Science and Technology Co., Ltd. ("Wonderland"), an enterprise established in the Special Economic Zone of Shenzhen, China. Businesses in the Special Economic Zone of Shenzhen are subject to income taxes at a rate of 15%. However, 39 Wonderland qualified for an exemption from income tax for a two year period, starting on January 1, 1997 and ending on January 1, 1999. Following the expiration of the exemption, Wonderland qualified for a 50% reduction in income tax for a period of eight years. This reduction in income tax will expire in the year 2006. Additionally, any sales made in the People's Republic of China are generally subject to a value-added tax at the rate of 17% ("output VAT"). The output VAT is payable after offsetting VAT paid on purchases ("input VAT"). Under the preferential policy in Shenzhen, any products produced and sold within Shenzhen are exempted from VAT. Upon verification by the Shenzhen National Tax Bureau, the percentages of Wonderland's sales exempt from VAT under this preferential policy for 1999, 2000 and 2001 were 70%, 56% and 56%, respectively. There is no guarantee that Wonderland will be entitled to these tax incentives in the future. Any change in the tax policies of the People's Republic of China or Shenzhen may have a material effect on the Company's operating performance. OFF-BALANCE SHEET ARRANGEMENTS There were no off-balance sheet arrangements. CONTRACTUAL OBLIGATIONS ======================================================================== CONTRACTUAL OBLIGATIONS (US$ IN MILLION) PAYMENTS DUE BY PERIOD ======================================================================== TOTAL LESS MORE THAN 1-3 3-5 THAN 5 1 YEAR YEARS YEARS YEARS ======================================================================== Long term Debt 2.42 -- 2.42 ======================================================================== Operating Lease 0.069 0.042 0.027 Obligations ======================================================================== Other Long-Term Liabilities Reflected on the 0 0 0 ======================================================================== Company's Balance Sheet under GAAP ======================================================================== TOTAL 2.49 0.042 2.45 ======================================================================== CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our discussion and analysis of our financial condition and results of operations are based upon our combined financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. 40 The following discussion addresses our critical accounting policies, which are those that require management's most difficult and subjective judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Goodwill on consolidation Goodwill represents the excess of the cost of companies acquired over the least fair value of their net assets at date of acquisition and is evaluated at lease annually for impairment. In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142 requires that goodwill be tested for impairment using a two-step process. The first step is to identify a potential impairment, and the second step measures the amount of the impairment loss, if any. Goodwill is deemed to be impaired if the carrying amount of a reporting unit exceeds its estimated fair value. SFAS No. 142 requires that indefinite-lived intangible assets be tested for impairment using a one-step process, which consists of a comparison of the fair value to the carrying value of the intangible asset. Intangible assets are deemed to be impaired if the net book value exceeds the estimated fair value. The estimates of future cash flows, based on reasonable and supportable assumptions and projections, require management's judgment. Any changes in key assumptions about the Company's businesses and their prospects, or changes in market conditions, could result in an impairment change. No impairment loss was recognized as of December 31, 2003. Equity compensation plan The Company operates an equity compensation plan. Details of the accounting policies can be found in Note 3 to the consolidated financial statements. Foreign currency translation The Company considers Renminbi as its functional currency as a substantial portion of the Company's business activities are based in Renminbi. Transactions in currencies other than functional currency during the year are translated into the functional currency at the applicable rates of exchange prevailing at the time of the transactions. Monetary assets and liabilities denominated to currencies other than functional currency are translated into functional currency at the applicable rates of exchange in effect at the balance sheet date. Exchange gains and losses are dealt with in the consolidated statement of operation. For the convenience of the readers, translation of amounts from Renminbi (Rmb) into United States dollars (USD) has been made at the exchange rate of USD 1.00 = RMB 8.287. No representation is made that the Renminbi amounts could have been or could be converted into the United States dollars at the rates or at any other rates on December 31, 2003. Stock compensation plan, please refer to note 3 to financial statement. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our operations are located in China and most of our sales revenues are earned in China, therefore we are not exposed to risks relating to fluctuating currencies or exchange rates. As of December 31, 2003, our bank debt earned interest at a fixed rate. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 41 Consolidated Financial Statements Industries International, Incorporated Years ended December 31, 2003, 2002 and 2001 Industries International, Incorporated Index to Consolidated Financial Statements - -------------------------------------------------------------------------------- Report of Independent Certified Public Accountants F-1 Consolidated Statements of Operations F-2 Consolidated Balance Sheets F-3 Consolidated Statements of Changes in Stockholders' Equity and F-4 Comprehensive Income / Loss Consolidated Statements of Cash Flows F5 Notes to Consolidated Financial Statements F6 - F35 Report of Independent Certified Public Accountants To the Board of Directors and Stockholders of Industries International, Incorporated We have audited the accompanying consolidated balance sheets of Industries International, Incorporated and its subsidiaries (the "Company") as of December 31, 2003 and 2002, and the related consolidated statements of operations, consolidated statements of changes in stockholders' equity and comprehensive income / loss and consolidated statements of cash flows for each of the years in the three-year period ended December 31, 2003. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with 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 consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Industries International, Incorporated and its subsidiaries as of December 31, 2003 and 2002 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. Moores Rowland Mazars Chartered Accountants Certified Public Accountants Hong Kong Date: March 30, 2004 F-1 Industries International, Incorporated Consolidated Statements of Operations - -------------------------------------------------------------------------------- (amount in thousands, except per share data)
Years ended December 31, Note 2003 2002 2001 USD USD USD Operating revenues Net sales 58,977 54,090 42,006 Rental income 116 987 - -------------- -------------- -------------- Total operating revenues 16 59,093 55,077 42,006 -------------- -------------- -------------- Operating expenses Manufacturing and other costs of sales 42,598 37,400 28,146 Sales and marketing 2,199 2,039 2,665 General and administrative 2,495 2,190 1,648 Research and development 1,028 1,439 1,516 Depreciation and amortization 557 1,384 258 Other operating costs and expenses 4,396 384 451 -------------- -------------- -------------- Total operating expenses 53,273 44,836 34,684 -------------- -------------- -------------- Operating income 5,820 10,241 7,322 Interest expenses (1,023) (1,602) (1,740) Other income, net 707 295 1,603 -------------- -------------- -------------- Income before income taxes and minority interest 5,504 8,934 7,185 Provision for income taxes 14 (1,008) (888) (503) -------------- -------------- -------------- Income before minority interest 4,496 8,046 6,682 Minority interest in income of consolidated subsidiaries (3,314) (3,010) (2,890) -------------- -------------- -------------- Net income 1,182 5,036 3,792 ============== ============== ============== Earnings per share: Basic weighted average number of common stock outstanding 21,623 18,007 18,007 ============== ============== ============== Basic net income per common stock 0.05 0.28 0.21 ============== ============== ==============
The accompanying notes are an integral part of these consolidated financial statements. F-2 Industries International, Incorporated Consolidated Balance Sheets - -------------------------------------------------------------------------------- (amount in thousands)
As of December 31, --------------------------------- 2003 2002 Note USD USD ASSETS Current assets: Cash and cash equivalents 32,607 15,359 Marketable securities 6 - 1,524 Guaranteed investment contract 1,210 1,210 Accounts receivable, net 19,034 16,643 Due from related parties 1,821 1,691 Due from director and employees - 22 Inventories 7 3,064 4,450 Plant and equipment held for sales - 7,819 Prepaid expenses and other current assets 2,274 4,101 -------------- -------------- Total current assets 60,010 52,819 Goodwill 2 (c) 1,761 71 Property, plant and equipment, net 8 9,136 11,254 -------------- -------------- Total assets 70,907 64,144 ============== ============== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Debts maturing within one year 10 11,795 17,053 Accounts payable - trade 7,142 6,565 Due to related parties 19 182 Due to principal stockholder 7,821 8,026 Other payable 5,420 5,418 Tax payable 967 1,421 Accrued expenses and other accrued liabilities 4,883 5,313 -------------- -------------- Total current liabilities 38,047 43,978 -------------- -------------- Non-current liabilities Long-term debts 10 2,419 - -------------- -------------- Minority interests in consolidated subsidiaries 10,878 8,496 -------------- -------------- Commitments and contingencies 18 - - Stockholders' equity: Common stock 11 1,102 725 Additional paid-in capital 18,750 - Deferred stock compensation 15 (12,500) - Dedicated reserves 3,479 2,580 Retained earnings 8,732 8,449 Accumulated other comprehensive loss - (84) -------------- -------------- Total stockholders' equity 19,563 11,670 -------------- -------------- Total liabilities and stockholders' equity 70,907 64,144 ============== ==============
The accompanying notes are an integral part of these consolidated financial statements. F-3 Industries International, Incorporated Consolidated Statements of Changes in Stockholders' Equity and Comprehensive Income / Loss - -------------------------------------------------------------------------------- (amount in thousands, except share data)
Common stock ------------------------------ Additional Number of paid-in Deferred stock shares Amount capital compensation ------------- ------------ ---------------- ------------------ USD USD USD Balance at January 1, 2001 18,007,330 725 - - Comprehensive income: Net income - - - - Other comprehensive loss Net unrealizable loss on marketable securities - - - - Total comprehensive income Transfer to dedicated reserves - - - - ------------- ------------ ---------------- ------------------ Balance at December 31, 2001 18,007,330 725 - - Comprehensive income: Net income - - - - Other comprehensive loss Net unrealizable loss on marketable securities - - - - Total comprehensive income Transfer to dedicated reserves - - - - ------------- ------------ ---------------- ------------------ Balance at December 31, 2002 18,007,330 725 - - Comprehensive income: Net income - - - - Other comprehensive loss Realization of loss on disposal of marketable securities - - - - Total comprehensive loss Transfer to dedicated reserves - - - - Acquisition of net liabilities of IDUL (Note 4) 1,249,215 50 (66) - Issuance of stock for acquisition of minority interest in subsidiary 665,860 27 2,643 - Issuance of stock to employee under Equity Incentive Plan 2003 2,525,500 100 8,297 (8,397) Issuance of stock to non-employee under Equity Incentive Plan 2003 5,013,385 200 1,453 - Issuance of stock & stock option under principal stockholder plan - - 6,423 (5,301) Amortization of deferred stock compensation - - - 1,198 ------------- ------------ ---------------- ------------------ Balance at December 31, 2003 27,461,290 1,102 18,750 (12,500) ============= ============ ================ ================== Accumulated other Dedicated Retained comprehensive reserves earnings income (loss) Total --------------- --------------- ------------------- ---------------- USD USD USD USD Balance at January 1, 2001 931 1,270 48 2,974 ---------------- Comprehensive income: Net income - 3,792 - 3,792 Other comprehensive loss Net unrealizable loss on marketable securities - - (94) (94) ---------------- Total comprehensive income 3,698 ---------------- Transfer to dedicated reserves 829 (829) - - --------------- --------------- ------------------- ---------------- Balance at December 31, 2001 1,760 4,233 (46) 6,672 Comprehensive income: Net income - 5,036 - 5,036 Other comprehensive loss Net unrealizable loss on marketable securities - - (38) (38) ---------------- Total comprehensive income 4,998 ---------------- Transfer to dedicated reserves 820 (820) - - --------------- --------------- ------------------- ---------------- Balance at December 31, 2002 2,580 8,449 (84) 11,670 ---------------- Comprehensive income: Net income - 1,182 - 1,182 Other comprehensive loss Realization of loss on disposal of marketable securities - - 84 84 ---------------- Total comprehensive loss 1,266 ---------------- Transfer to dedicated reserves 899 (899) - - Acquisition of net liabilities of IDUL (Note 4) - - - (16) Issuance of stock for acquisition of minority interest in subsidiary - - - 2,670 Issuance of stock to employee under Equity Incentive Plan 2003 - - - - Issuance of stock to non-employee under Equity Incentive Plan 2003 - - - 1,653 Issuance of stock & stock option under principal stockholder plan - - - 1,122 Amortization of deferred stock compensation - - - 1,198 --------------- --------------- ------------------- ---------------- Balance at December 31, 2003 3,479 8,732 - 19,563 =============== =============== =================== ================
The accompanying notes are an integral part of these consolidated financial statements. F-4 Industries International, Incorporated Consolidated Statements of Cash Flows - -------------------------------------------------------------------------------- (amount in thousands)
Years ended December 31, ----------------------------------------------- 2003 2002 2001 USD USD USD Cash flows from operating activities Net income 1,182 5,036 3,792 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,880 2,846 1,506 Minority interest in net income of consolidated subsidiaries 3,314 3,010 2,890 Non-cash compensation costs 3,979 - - Provision for doubtful accounts 213 111 - Net loss on sales, disposal or impairment of long-lived assets and marketable securities, net 128 325 548 Changes in assets and liabilities, net of effects from acquisitions: Accounts receivable, net (2,605) (1,177) 313 Inventories, net 1,386 2,253 2,925 Due from related parties (130) 415 6,601 Due from directors and employees 22 498 (315) Prepaid expenses and other current assets 1,827 (1,457) 176 Accounts payable - Trade 577 (585) (2,198) Due to principal stockholder (205) - (158) Due to related parties (163) (880) (8,735) Tax payable (454) 406 (649) Accrued expenses and other accrued liabilities (446) (167) 551 ------------- ------------- ------------ Net cash provided by operating activities 10,505 10,634 7,247 ------------- ------------- ------------ Cash flows provided by (used in) investing activities Acquisition of subsidiaries, net of cash - - 4,964 Acquisition of marketable securities - - (116) Acquisition of guaranteed investment contract - (1,210) - Purchase of property, plant and equipment (830) (1,787) (10,298) Proceeds on disposal of marketable securities 1,541 - - Proceeds on disposal of property, plant and equipment 8,877 10 - ------------- ------------- ------------ Net cash provided by (used in) investing activities 9,588 (2,987) (5,450) ------------- ------------- ------------ Cash flows used in financing activities Borrowings of short-term debt 11,799 2,978 5,465 Repayments of short-term debt (17,064) (12,313) - Borrowings of long-term debt 2,420 - - ------------- ------------- ------------ Net cash from (used in) financing activities (2,845) (9,335) 5,465 ------------- ------------- ------------ Net increase (decrease) in cash and cash equivalents 17,248 (1,688) 7,262 Cash and cash equivalents, beginning of fiscal year 15,359 17,047 9,785 ------------- ------------- ------------ Cash and cash equivalents, end of fiscal year 32,607 15,359 17,047 ============= ============= ============ Supplemental disclosure of cash flow information Cash paid during the fiscal year for: Income tax 374 1,080 408 Interest 1,023 1,590 1,858 ============= ============= ============
The accompanying notes are an integral part of these consolidated financial statements. F-5 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 1. DESCRIPTION OF BUSINESS Industrial International, Inc., ("IDUL"), a Nevada corporation, incorporated under the laws of the state of Nevada on January 11, 1991. IDUL was accepted for quotation on the OTC Bulletin Board on December 7, 2001 and organized originally for the purpose of proposing, planning and developing a golf course in either Moapa area or Overton Valley area in Nevada. As described in Note 2 below, prior to the reorganization with Broad Faith Limited ("BFL"), a company incorporated under the International Business Companies Act of the British Virgin Islands on February 10, 2003, IDUL was a development stage company, which, other than a proposed golf course project in Nevada, has had no operations. After recapitalization, IDUL exited the development stage in the quarter ended March 31, 2003. IDUL and its subsidiaries (collectively referred to as the "Company") are principally engaged in the development, production and distribution throughout China of communications terminal products, mainly corded and cordless telephones which are sold under the trademark, Wondial (TM) through a 69.5296% owned affiliate, Shenzhen Wonderland Communication Science & Technology Company Limited ("Wondial") and battery testing equipment and battery products through a 72.84% owned affiliate, Wuhan Lixing Power Sources Company Limited ("WLPS"). 2. BASIS OF PRESENTATION AND REORGANIZATION a) Recapitalization Effective February 10, 2003, pursuant to an Amended and Restated Agreement and Plan of Share Exchange, IDUL merged with an operating entity, BFL, resulting in the stockholders and management of BFL having actual and effective control of IDUL. For accounting purposes, the transaction has been treated as a recapitalization of BFL with IDUL being the legal survivor and BFL being the accounting survivor and the operating entity. These transactions are considered as capital transactions in substance rather than business combinations. That is, the historical financial statements prior to February 10, 2003 are those of BFL, even though they were labeled as those of IDUL. The recapitalization transaction was effected by an exchange of stock under which the sole stockholder of BFL, Mr. Tsui Kit, had exchanged all of the outstanding shares (2 shares) of BFL for 14,065,972 new shares of IDUL. In the recapitalization, historical stockholders' equity of the accounting acquirer, BFL, prior to the merger was retroactively restated for the equivalent number of shares received (14,065,972 shares) in the merger with an offset to additional paid-in capital. Retained earnings of the accounting survivor, BFL, is carried forward after the recapitalization. Operations prior to the recapitalization are those of the accounting survivor, BFL. Earnings per share for periods prior to the recapitalization are restated to reflect the equivalent number of shares. Upon completion of the transaction, the financial statements become those of the operating company, with adjustments to reflect the changes in equity structure and receipt of the assets/liabilities of the public shell, IDUL. Following the recapitalization, IDUL held 100% of the issued and outstanding shares of BFL and Mr. Tsui Kit (and/or his designees) became the principal stockholder of IDUL. F-6 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 2. BASIS OF PRESENTATION AND REORGANIZATION (Continued) b) Merger under common control On May 14, 2003, IDUL acquired all issued and outstanding shares of Li Sun Power International Limited ("LPI"), a company incorporated in the British Virgin Islands on September 19, 2000, from Mr. Tsui Kit, who is the majority stockholder of IDUL as well as the Chief Executive Officer and a director of IDUL. By acquiring the capital stock of LPI, IDUL becomes the beneficial owner of LPI's approximately 72.84% interest in WLPS, a leading lithium and lithium-ion battery manufacturer in PRC. The acquisition of LPI is intended to enhance the Company's consolidated competitive position in both telephone and battery markets in PRC. The consideration for the merger was 3,941,358 restricted shares of common stock of IDUL and obligation of USD7,662, which shall be in the form of a promissory note payable in cash or common stock of IDUL at the discretion of IDUL. Since IDUL acquired shares in LPI from its controlling stockholder, Mr. Tsui Kit, the transaction was considered a transfer among companies under common control. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 141 "Business Combination" (Appendix D), the method of accounting for such transfer of equity interests was similar to pooling of interest method and the acquisition is reflected as if it had occurred at the beginning of the earliest period presented. The entire 3,941,358 restricted shares of common stock of IDUL was considered outstanding from the beginning of the period and recorded at the carrying amount of the net assets of LPI, without regard to the fair value of the stock. The obligation of USD7,662 to Mr. Tsui Kit was recorded as due to a principal stockholder of the Company as of the beginning of the earliest period presented. See "Recent issued accounting pronouncements" within Note 3 below for the adoption of SFAS No. 150. F-7 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 2. BASIS OF PRESENTATION AND REORGANIZATION (Continued) c) Business combination The following combination occurred during the fiscal year 2003: Purchase acquisition On June 10, 2003, IDUL's ownership in Wondial increased from 65.2924% to 69.5296%, as a result of IDUL acquiring 4,000,000 outstanding shares of Wondial's common stock from a third party. IDUL issued 665,860 restricted shares of common stock of IDUL, for a value of USD2,670, which was based on closing market price of USD4 on March 28, 2003 and recorded a premium in excess of fair value of net assets of Wondial of USD1,690. The changes in the carrying amount of goodwill as of December 31, 2003 are as follows:
Communication Battery and terminal products related products Total USD USD USD ------------------- ------------------ ------------------- Balance as of January 1, 2003 - 71 71 Goodwill acquired during the period 1,690 - 1,690 ------------------- ------------------ ------------------- Balance as of December 31, 2003 1,689 71 1,761 =================== ================== ===================
In accordance with SFAS No. 142, goodwill is required to be tested for impairment at the reporting unit, which is defined as a company's operating segment or one level below the operating segment. For the purposes of applying SFAS No. 142, the Company has assigned the goodwill to Wondial as a whole, which comprises of only one reporting segment of communication terminal products, and tested for impairment using two-step process. The first step is to identify a potential impairment, and the second step measures the amount of the impairment loss, if any. Goodwill is deemed to be impaired if the carrying amount of a reporting unit exceeds its estimated fair value. The estimates of future cash flows, based on reasonable and supportable assumptions and projections, require management's judgment. Any changes in key assumptions about the Company's businesses and their prospects, or changes in market conditions, could result in an impairment change. No impairment loss was recognized as of December 31, 2003. The additional interests of 4.2372% Wondial, as described above, is held by a wholly-owned affiliate of IDUL, Sunbest Industrial Limited ("SIL"), a limited liability company incorporated in the British Virgin Islands on February 3, 2003. SIL has authorized and outstanding common stock of 50,000 shares and 1 share of United States one dollar par value each respectively. The outstanding common stock was issued to IDUL on March 10, 2003. SIL has had no operation since its incorporation up to June 10, 2003 and is used as an investment holding company of the 4.2372% interest in Wondial. F-8 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Accounting principles The consolidated financial statements and accompanying notes are presented in Renminbi and prepared in accordance with generally accepted accounting principles in the United States of America ("USGAAP"). Basis of consolidation The accompanying consolidated financial statements include the accounts of IDUL and its subsidiaries in which IDUL has a controlling financial interest. See "Basis of financial statements presentation and reorganization" within Note 2 above for more information on the basis of presentation of the consolidated financial statements. All significant intercompany accounts and transactions have been eliminated upon combination. Revenue recognition Net sales represent the invoiced value of goods, net of value-added tax ("VAT"), returns and sales incentive. Wondial makes sales to distributors in first-tier distribution channels. These distributors then arrange to sell products to second-tier distribution channels or directly to consumer. These first-tier distributors are generally given privileges to good credit terms but at the same time they are responsible for marketing and repairing the products. The Company generally recognizes product revenue when persuasive evidence of an arrangement exists, delivery has occurred, fee is fixed or determinable, and collectibility is probable. The Company adopts a policy of including handling costs incurred for finished goods, which are not significant, in the sales and marketing expenses. The handling costs for the fiscal years ended December 31, 2003, 2002 and 2001 were USD85, USD173 and USD118, respectively. The Company accrues for warranty costs, sales returns and other allowances based on its experience. During 2003 and 2002, Wondial offers a customer ("distributor") a rebate ("sales incentive") of a specified amount of cash consideration that is redeemable only if the customer completes a specified cumulative level of purchases. The Company recognizes the cost of the offer in a systematic and rational manner over the period in which the underlying revenue transactions that qualify the distributor for the sales incentive take place. According to EITF Issue No.01-9, "Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor's Products)", such sales incentive is treated as a reduction of revenue. Research and development All cost of research and development activities are expensed as incurred. F-9 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Advertising and promotion costs Advertising and promotion costs are expensed when the advertisement or commercial appears in the selected media. Advertising and promotion expenses for the fiscal years ended December 31, 2003, 2002 and 2001 were USD927, USD812 and USD1,868, respectively and are included in sales and marketing expense in the consolidated statements of operations. Income taxes Provision for income and other related taxes has been provided in accordance with the tax rates and laws in effect in PRC. The Company did not carry on any business and did not maintain any branch office in the United States of America. No provision for withholding or U.S. federal income taxes or tax benefits on the undistributed earnings and / or losses of the Company has been provided as the earnings of the Company, in the opinion of the management, will be reinvested indefinitely. Income tax expense is computed based on pre-tax income included in the consolidated statement of operation. Income taxes have been provided, using the liability method, which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and tax bases assets and liabilities and their reported amounts. The tax consequences of those differences are classified as current or non-current based upon the classification of the related assets or liabilities in the consolidated financial statements. Cash equivalents Cash equivalents include all highly liquid investments, generally with original maturities of three months or less that are readily convertible to known amount of cash and are so near maturity that they represent insignificant risk of changes in value because of changes in interest rates. Marketable securities Marketable securities designated as available-for-sale, whose fair values are readily determinable, are carried at fair value with unrealized gains or losses included are a component of accumulated other comprehensive income. Equity securities classified as trading securities as carried at fair value with unrealized gains or losses included in income. Realized gains and losses are determined on the average cost method and reflected in income. Inventories All inventories are stated at the lower of weighted average cost or market. Potential losses from obsolete and slow-moving inventories are provided for when identified. Costs of work-in-progress and finished goods are composed of direct materials, direct labor and an attributable portion of manufacturing overheads. F-10 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Property, plant and equipment Property, plant and equipment is stated at original cost less accumulated depreciation and amortization. The cost of an asset comprises its purchase price and any directly attributable costs of bringing the asset to its present working condition and location for its intended use. Expenditures incurred after the assets have been put into operation, such as repairs and maintenance, overhaul and minor renewals and betterments, are normally charged to operating expenses in the period in which they are incurred. In situations where it can be clearly demonstrated that the expenditure has resulted in an increase in the future economic benefits expected to be obtained from the use of the assets, the expenditure is capitalized. When assets are sold or retired, their costs and accumulated depreciation are eliminated from the consolidated financial statements and any gain or loss resulting from their disposal is recognized in the year of disposition as an element of other income, net. Depreciation is provided to write off the cost of property, plant and equipment using straight-line method at rates based on their estimated useful lives of assets from the date on which they become fully operational and after taking into account their estimated residual values. Accounting for the impairment of long-lived assets The long-lived assets held and used by the Company are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of assets may not be recoverable. It is reasonably possible that these assets could become impaired as a result of technology or other industry changes. Determination of recoverability of assets to be held and used is by comparing the carrying amount of an asset to future net undiscounted cash flows to be generated by the assets. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Operating leases Leases where substantially all the rewards and risks of ownership of assets remain with the leasing company are accounted for as operating leases. Rental receivables and payables under operating leases are recognized as income and expenses respectively on the straight-line basis over the lease terms. Earnings per share The basic earnings per share are computed by dividing income available to common stockholders by the weighted-average number of common stocks outstanding during each period as restated as a result of the recapitalization, merger under common control and one-for-four reverse split, as described in Notes 2 and 11 respectively. The computation of diluted earnings per share is same to the computation of basic earnings per share except that the weighted-average number of shares outstanding is adjusted to include estimates of additional shares that would be issued if potentially dilutive common stocks had been issued. In addition, income available to common stockholders is adjusted to include any changes in income or loss that would result from the assumed issuance of the dilutive common stocks. There were no dilutive securities outstanding during any of the years. F-11 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Foreign currency translation The Company considers Renminbi as its functional currency as a substantial portion of the Company's business activities are based in Renminbi. However, the Company has chosen the United States dollar as its reporting currency. Transactions in currencies other than functional currency during the year are translated into the functional currency at the applicable rates of exchange prevailing at the time of the transactions. Monetary assets and liabilities denominated in currencies other than functional currency are translated into functional currency at the applicable rates of exchange in effect at the balance sheet date. Exchange gains and losses are dealt with in the consolidated statement of operation. For translation of financial statements into the reporting currency, assets and liabilities are translated at the exchange rate at the balance sheet date, equity accounts are translated at historical exchange rates, and revenues, expenses, gains and losses are translated at the weighted average rates of exchange prevailing during the period. Translation adjustments resulting from this process are recorded in accumulated other comprehensive income (loss) within stockholders' equity. Use of estimates The preparation of the consolidated financial statements in conformity with USGAAP requires the Company's management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of financial statements and the reported amounts of revenues and expenses during the reported periods. Actual amounts could differ from those estimates. Estimates are used for, but not limited to, the accounting for certain items such as allowance for doubtful accounts, depreciation and amortization, inventory allowance, taxes and contingencies. Allowance for doubtful accounts Accounts receivable are stated at the amount billed to customers plus any accrued and unpaid interest. The Company recognizes allowance for doubtful accounts to ensure trade and other receivables are not overstated due to uncollectible. The Company's estimate is based on a variety of factors, including historical collection experience, existing economic conditions and a review of the current status of the receivable. Interest income and late fees on impaired receivables are recognized only when payments are received. Accounts receivable are presented net of an allowance for doubtful accounts of USD1,752 and USD1,539 as of December 31, 2003 and 2002 respectively. F-12 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Stock-based compensation The Company accounts for employee stock-based compensation using the intrinsic value method prescribed in APB 25 whereby the options are granted at market price, and therefore no compensation costs are recognized. Compensation cost for stock-based compensation is measured as the excess, if any, of the market price of its common stock at the date of grant over an amount that must be paid to acquire the stock. Deferred compensation cost on restricted stock awards is shown as a reduction to stockholder's equity and recognized over the requisite vesting periods. The Company accounts for non-employee stock-based compensation in accordance with SFAS No. 123 "Accounting for Stock-Based Compensation" and EITF 96-18 "Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services". The stock-based awards are measured on the earlier of (1) the performance commitment date or (2) the date the services required under the arrangement have been completed and recognized on the cliff vesting basis. Restricted stocks are nontransferable and subject to forfeiture for periods prescribed by the Company. The employee's right to the full enjoyment of the stock is conditioned on future performance of services or on continued employment. When restricted stock is forfeited (the employee terminates prior to the lapsing of restrictions), compensation cost previously recognized is reversed and any unrecognized compensation is charged back to additional paid-in capital. SFAS No.123, "Accounting for Stock-Based Compensation," established accounting and disclosure requirements using a fair-value based method of accounting for stock-based employee compensation plans. The Company has elected to retain its current method of accounting as described above and has adopted the disclosure requirements of SFAS No.123 as follows.
Year ended December 31, 2003 2002 2001 USD USD USD Net income: As reported 1,182 5,036 3,792 Total stock-based compensation expense (45) - - ----------- ------------ ------------ Pro forma 1,137 5,036 3,792 =========== ============ ============ Basic net income per share As reported 0.05 0.28 0.21 =========== ============ ============ Pro forma 0.05 0.28 0.21 =========== ============ ============
F-13 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Related parties Parties are considered to be related if one party has the ability, directly or indirectly, to control the other party or exercise significant influence over the other party in making financial and operating decisions. Parties are also considered to be related if they are subject to common control or common significant influence. Recently issued accounting pronouncements In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. SFAS No. 150 establishes standards for how a company classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. As described in Note 2(b), the consideration for the acquisition of LPI includes an amount of USD 7,662, which shall be settled either in the form of promissory note payable in cash or common stock of IDUL at the discretion of IDUL and this obligation to Mr. Tsui Kit was recorded as due to a principal stockholder of IDUL. On the adoption of SFAS No. 150, the carrying amount of such consideration was measured at their fair values. 4. EARNINGS PER SHARE Basic earnings per share is computed based upon the weighted average number of shares of common stock outstanding during each period as restated as a result of the recapitalization, merger under common control and one-for-four reverse split, as described in Notes 2 and 11. The 14,065,972 and 3,941,358 shares, in connection with the recapitalization and merger under common control were included in the computation of earnings per share as if outstanding at the beginning of each period presented and 1,249,215 shares, being the outstanding stock of IDUL as of February 10, 2003, were treated as issued on February 10, 2003 for the historical net monetary liability of IDUL before recapitalization, USD16. Diluted earnings per share is computed based upon the weighted average number of shares of common stock and dilutive common stock equivalents outstanding during the periods presented. The diluted earnings per share computations also include the dilutive impact of options to purchase common stock which were outstanding during the period calculated by the "treasury stock" method. The performance-based unvested stock which is contingent upon satisfying conditions are not included in the computation of diluted earnings per share until all conditions for issuance are met. As described in Note 15(1)(a), options to purchase 425,000 shares of common stock of IDUL was not included in the computation of diluted earnings per share becacuse the options' exercise prices were greater than the average market price of the common shares and, therefore, the effect of employee stock options is anti-dilutive as to earnings per share. IDUL had no common equivalent shares with a dilutive effect for any period presented, therefore basic and diluted earnings per share are the same. F-14 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 5. OPERATING RISKS (a) Country risks The Company may be exposed to the risks as a result of its sales operation being related in PRC. These include risks associated with, among others, the political, economic and legal environmental and foreign currency exchange. The Company's results may be adversely affected by change in the political and social conditions in PRC, and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things. The Company's management does not believe these risks to be significant. There can be no assurance, however, those changes in political and other conditions will not result in any adverse impact. (b) Cash and time deposits The Company maintains its cash balances and investments in time deposits with various banks and financial institutions located in PRC. In common with local practice, such amounts are not insured or otherwise protected should the financial institutions be unable to meet their liabilities. There has been no history of credit losses. There are neither material commitment fees nor compensating balance requirements for all outstanding loans of the Company. 6. MARKETABLE SECURITIES The aggregate cost, gross unrealized losses and fair value pertaining to available-for-sales securities are as follows: As of December 31, ------------------------------ 2003 2002 USD USD Cost - 1,569 Gross unrealized losses - (45) ------------- ------------- Fair value - 1,524 ============= ============= During the fiscal year 2003, all marketable securities were sold for proceeds of USD1,541 and resulted in an insignificant realized gain. The realized and unrealized loss of USD84 and USD38 was recorded for the years ended December 31, 2003 and 2002 respectively. Net unrealized loss reported as a separate component of accumulated other comprehensive income (loss) was USD38 at of December 31, 2002. F-15 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 7. INVENTORIES Inventories comprise the following: As of December 31, ------------------------------ 2003 2002 USD USD Raw materials 891 3,001 Work-in-progress 634 706 Finished goods 1,539 743 ------------- ------------- 3,064 4,450 ============= ============= 8. PROPERTY, PLANT AND EQUIPMENT, NET Property, plant and equipment is summarized as follows:
Estimated useful life (in years) As of December 31, --------------------------------- 2003 2002 USD USD Buildings 35 5,613 5,496 Moulds 3 - 5 1,802 2,288 Plant and machinery 5 - 10 5,949 7,529 Electronic equipment 5 1,633 1,634 Motor vehicles 5 - 8 935 922 -------------- -------------- 15,932 17,869 Accumulated depreciation (6,796) (6,615) -------------- -------------- 9,136 11,254 ============== ==============
F-16 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 9. BANKING FACILITIES The Company had various lines of credit under banking facilities as follows: As of December 31, ---------------------------------- 2003 2002 USD USD Facilities granted Committed credit lines 14,210 18,389 =============== =============== Utilized Committed credit lines 14,210 17,058 =============== =============== Unutilized facilities Committed credit lines - 1,331 =============== =============== There are no significant commitment fees or requirements for compensating balances associated with any lines of credit. Under the banking facilities arrangements, the Company's banking facilities amounted to USD1,814 as of December 31, 2003 and 2002 were collateralized by guarantees of a Shenzhen city government sponsored corporation, namely Shenzhen Hi-Tech Investment Company Limited ("SHTI", which assists hi-tech companies in Shenzhen to obtain working capital). Each year, Wondial has to report their financial positions for the year to SHTI which will assess the extent of assistance to Wondial. As of December 31, 2003 and 2002, the short-term loans of USD726 and USD3,508 were collateralized by corporate guarantees provided by a company controlled by Mr. Tsui Kit and pledge of the Company's property at a carrying value of USD3,331 respectively. Details of guarantees with related party were disclosed in Note 17 below. 10. DEBTS a) Debts maturing within one year Debts maturing within one year represented mainly short-term bank loans and were summarized as follows:
Weighted-average interest Outstanding debts maturing rates within one year ---------------------------- -------------------------------- % USD As of December 31, 2003 5.80 11,795 2002 6.92 17,053
F-17 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 10. DEBTS (Continued) b) Long-term liabilities Long-term debts consisted primarily of bank loans and were summarized as follows
Outstanding loan Interest rate Maturity amounts ---------------------- -------------- ------------------------- % USD As of December 31, 2003 5.49 2003 - 2005 2,419 2002 - -
The interests on amounts borrowed under the various loan agreements are at market rates. 11. COMMON STOCK As of December 31, 2002, the authorized capital of IDUL is USD200 divided into 5,000,000 shares of common stock, par value US dollar 0.04 par value, with one vote for each share. As described in Notes 2(a) and 4 above, on February 10, 2003, 1,249,215 shares, represented by the outstanding shares of IDUL before recapitalization, were issued and offset against the additional paid-in capital, for the historical book value of net monetary liability of IDUL before recapitalization, USD16. On April 10, 2003, IDUL amended and restated its Articles of Incorporation to authorize 125,000,000 shares of common stock and 2,500,000 shares of preferred stock. On May 12, 2003, the board of directors of IDUL approved and declared a one-for-four reverse split of IDUL's common stock, thereby decreasing the number of issued and outstanding shares and increasing the par value of each share. The number of common shares and per-share amounts shown in these financial statements have been retroactively restated to reflect the reverse split. The reverse stock split become effective on June 2, 2003. On May 14, 2003, 3,941,358 restricted shares of common stock of IDUL, at par value, were issued for the acquisition of 100% interest in LPI and was considered outstanding from the beginning of the period as described in Note 2(b) above. During the fiscal year 2003, the total number of shares issued, under Equity Incentive Plan 2003 ("EI Plan") was 7,538,885, par value US dollar 0.04 per share, for a value of USD22,166. These shares are granted to the Company's employees (2,525,000 shares) for a value of USD8,397 at the date of the grant and external consultants (5,013,385 shares) for a value of USD13,769 measured at their then-current fair value as of the financial reporting dates and fair value of services. See Note 15 below for deferred compensation cost under EI Plan. F-18 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 11. COMMON STOCK (Continued) As described in Note 3 above, on June 10, 2003, IDUL issued 665,860 restricted shares of common stock of IDUL, for a value of USD2,670, to acquire an additional 4.2372% interest in an affiliate, Wondial. As described in Note 15 below, during the fiscal year 2003, the principal stockholder of IDUL, Mr. Tsui Kit, established a stock plan ("PS Plan") to grant restricted stock awards of 1,281,519 shares, which was issued to him for recapitalizaton and acquisition of LPI, to employee (1,057,666 shares), for a value of USD5,301 and his business associates (223,853 shares), which are suppliers and customers of the Company, for a value of USD1,122 at the date of the grant. 12. DISTRIBUTION OF INCOME The Company's income is substantially contributed by two majority-owned subsidiaries, Wondial and WLPS, limited companies incorporated in PRC. Income of Wondial and WLPS is distributable to their stockholders after transfer to dedicated reserves as required under relevant PRC rules and regulations and their articles of association. Dedicated reserves include statutory surplus reserve and statutory public welfare fund. In accordance with the relevant PRC Companies Law and rules and regulations, Wondial and WLPS, are required to transfer amounts equal to 10% and 5% of its income after taxation to the statutory surplus reserve and statutory public welfare fund respectively. The statutory surplus reserve can only be utilized to offset prior years' losses or for capitalization as paid-in capital, whereas the statutory public welfare fund shall be utilized for collective staff welfare benefits such as building of staff quarters or housing. No distribution of the remaining reserves shall be made other than on liquidation of Wondial and WLPS. 13. PENSION COSTS As stipulated by PRC regulations, the Company maintains a defined contribution retirement plan for all of its employees who are residents of PRC. All retired employees of the Company are entitled to an annual pension equal to their basic annual salary upon retirement. The Company contributed to a state sponsored retirement plan approximately 9% of the basic salary of its employees and has no further obligations for the actual pension payments or post-retirement benefits beyond the annual contributions. The state sponsored retirement plan is responsible for the entire pension obligations payable to all employees. The pension expense for the years ended December 31, 2003, 2002 and 2001 was USD92, USD89 and USD38, respectively. F-19 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 14. TAXATION The Company are subject to income taxes on an entity basis on income arising in or derived from the tax jurisdictions in which they operate. As of December 31, 2003 and 2002, IDUL had a net operating loss carry-forward for income tax reporting purposes of approximately USD475 that might be offset against future taxable income. Current tax laws limit the amount of loss available to be offset against future taxable income when a substantial change in ownership occurs. Therefore, following the recapitalization as mentioned before, the amount available to offset future taxable income might be limited. No tax benefit has been reported in the financial statements, because the Company believes there is more likely than not the carry-forwards will be limited. Accordingly, the potential tax benefits of the loss carry-forwards are offset by a valuation allowance of the same amount. No provision for withholding or United States federal or state income taxes or tax benefits on the undistributed earnings and/or losses of the Company's subsidiaries has been provided as the earnings of these subsidiaries, in the opinion of the management, will be reinvested indefinitely. Determination of the amount of unrecognized deferred taxes on these earnings is not practical, however, unrecognized foreign tax credits would be available to reduce a portion of the tax liability. Among the Company's subsidiaries, BFL, SIL and LPI, are not liable for income taxes. The tax holidays of the Company are comprised of the following: a) Income taxes The PRC operating subsidiaries are subject to income taxes at a rate of 15% and the sino-foreign equity joint ventures and Wondial are entitled to be exempted from income tax for two years starting from the year profits are first made, followed by a 50% exemption for the next three to eight years. If the tax holiday of the income tax had not existed, the Company's income tax expenses would have been increased by approximately USD1,008, USD888 and USD503 for the years ended December 31, 2003, 2002 and 2001 respectively. Basic earnings per common stock share would have been decreased by approximately USD0.05, USD0.05 and USD0.03 for the fiscal year ended December 31, 2003, 2002 and 2001 respectively. b) VAT Sales made in PRC are subject to PRC value-added tax at a rate of 17% ("output VAT"). Such output VAT is payable after offsetting VAT paid by the Company on purchases ("input VAT"). Before the fiscal year 2003, under the preferential policy in Shenzhen, any products produced and sold within the Shenzhen is exempted from VAT. Upon verification by Shenzhen National Tax Bureau on an annual basis, the sales proportion exempt from VAT under such preferential policy for 2002 and 2001 was 36% and 56%. Such preferential policy was abolished in 2003. If such tax holiday had not existed, the Company would have an additional VAT payable of approximately USD1,683 and USD2,053 for the years ended December 31, 2002 and 2001, respectively. Basic and diluted earnings per common stock would have been decreased by approximately USD0.09 and USD0.11 for the years ended December 31, 2002 and 2001, respectively. F-20 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 14. TAXATION (Continued) Income tax expense is comprised of the following Years ended December 31, --------------------------------------------- 2003 2002 2001 USD USD USD Current tax 1,008 888 503 ============ ============= =========== The reconciliation of PRC statutory income to the effective income tax rate based on income stated in the statements of operations is as follows:
Years ended December 31, ------------------------------------------ 2003 2002 2001 % % % Statutory rate 15.0 15.0 15.0 Effect of tax holiday (9.4) (5.4) (7.3) Non-taxable activities - (0.6) (0.9) Non-deductible activities 10.7 2.1 0.2 Under (over) provision in prior years - (1.9) - Loss with no tax benefits 1.8 1.0 0.8 Others 0.2 (0.3) (0.8) ----------- ----------- ----------- Effective tax rate 18.3 9.9 7.0 =========== =========== ===========
Taxation payable is comprised of the following: As of December 31, ---------------------------------- 2003 2002 USD USD PRC value-added tax 375 1,018 PRC income tax 586 399 PRC other taxes 6 5 --------------- --------------- 967 1,422 =============== =============== F-21 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 15. STOCK-BASED COMPENSATION During the fiscal year 2003, IDUL has granted various stock options and stock-based awards under (1) EI Plan and (2) PS Plan which are described below. (1) EI Plan EI Plan was approved by IDUL's board of directors and stockholders on February 28, 2003 and April 7, 2003 respectively. EI Plan is intended to provide incentives to attract, retain and motivate both eligible employees and directors of the Company, as well as consultants, advisors and independent contractors who provide valuable services to the Company (any such person hereinafter called a "Participant"). The EI Plan will be administered by the board or by a committee of the board. Within certain limits, the administrator of the EI Plan, whether the board or a committee thereof, will be authorized to select eligible Participants to receive awards under the EI Plan, determine the number of shares included in such awards, determine the form, term, vesting, exercisability, and required payment, if any, of such awards, and to make any other determinations necessary or useful for the administration of the EI Plan. The administrator of the EI Plan may issue options with an exercise price equal to or above 85% of the market price of our common stock at the date of issuance, except that (i) Incentive Stock Options must have an exercise price equal to or above the market price as of the date of issuance, and (ii) options issued to Participants who beneficially own at least 10% of IDUL's issued and outstanding common stock must have an exercise price equal to or above 110% of the market price on the date of issuance. The administrator of the EI Plan may set any period of time, up to ten years, for the expiration of options, except that options issued to Participants who beneficially own at least 10% of our issued and outstanding common stock must expire within five years from the date of issuance. Options granted under the EI Plan can only be exercised by delivery to the administrator of an exercise agreement in a form approved by the administrator. Initially, 3,750,000 shares of IDUL's common stock are reserved for issuance under EI Plan. On October 2, 2003, a further 5,000,000 shares of IDUL are reserved under EI Plan. Under EI Plan, awards may consist of grants of options to purchase IDUL's common stock (either Incentive Stock Options (for eligible persons) or Non-Qualified Stock Options, as each is defined in the Internal Revenue Code), grants of restricted common stock, or grants of unrestricted common stock. a) Stock options Stock options under EI Plan have been granted to officers, other employees and directors to purchase shares of common stock at or above 85% of the market price of IDUL's common stock at the date of issuance. Generally, these options, whether granted from the current plans, become exercisable over staggered periods, but expire after 10 years from the date of the grant. On May 13, 2003, 425,000 and 125,000 unrestricted stock options were issued to directors of the Company and a non-employee respectively. F-22 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 15. STOCK-BASED COMPENSATION (Continued) (1) EI Plan (Continued) a) Stock options (Continued) As described above, the Company adopted the disclosure requirements of SFAS No. 123, but elected to continue to measure compensation expense in relation to options granted to employees in accordance with APB No. 25. Accordingly, no compensation expense is recorded for the 425,000 stock options granted to employees because the exercise price of IDUL's stock options is equal to or greater than the market price of the underlying stock on the date of grant. Had compensation expense been determined based on the estimated fair value of options granted in the second quarter of fiscal 2003, consistent with the methodology in SFAS No. 123, net income and earnings per share would have been reduced. See "Stock-based compensation" within Note 3 above for the disclosure under SFAS No. 123. The options granted had a weighted average "fair value" per share on date of grant of USD4.16. For purposes of pro forma disclosure, the estimated fair value of the options is amortized to expense over the options' vesting periods, i.e., 5 years as prescribed under EI Plan. The fair value of the option grant is estimated on the date of the grant using the Black-Scholes option pricing model, assuming no dividends and the following weighted average assumptions used for grants in the fiscal year 2003: Risk-free interest rate 4.61% Expected volatility 99.14% Contractual life 10 years On May 13, 2003, 125,000 stock options were granted to a non-employee for her five years of service from July 1, 2003. Consistent with the methodology in SFAS No. 123 and according to EITF D-90 "Grantor Balance Sheet Presentation of Unvested, Forfeiture Equity Instruments Granted to a Nonemployee", those unvested and forfeitable equity instruments was treated as unissued for accounting purposes until the future services are received. In the third quarter of fiscal year 2003, the non-employee failed to fulfill an obligation under the service agreement and the option will be cancelled. F-23 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 15. STOCK-BASED COMPENSATION (Continued) (1) EI Plan (Continued) a) Stock options (Continued) Information concerning options issued under EI Plan of the Company in the fiscal year 2003 is presented in the following table:
Number of Weighted Average Options Exercise Price -------------- --------------------- Outstanding at beginning of period: - - - Stock option granted on May 13, 2003 550,000 5.6 - Stock option granted on June 24, 2003 (Note 15(1)(b)(ii)) 712,500 6.0 Exercised - - Cancelled (Note 15(1)(b)(ii)) and - will be cancelled (Note 15(1)(a)) (837,500) --------------- Outstanding at end of period 425,000 ===============
b) Stock awards During the fiscal year 2003, under EI Plan, the Company has granted stock awards to employees and various external consultants and advisors of the Company. i) Stock awards to employees The Company applies the provisions of APB No. 25, in accounting for its stock awards. 732,500 and 1,793,000 restricted and unrestricted stock awards respectively, issued at a market value of USD8,397, were granted to employees with total vesting periods of up to five years as prescribed in EI Plan. Recipients are not required to provide consideration for these stock awards to the Company other than rendering service. The awards are recorded at their intrinsic value on the date of grant. Initially, the fair value of the shares is treated as deferred compensation (USD8,397) and is charged to expense over the respective vesting period. As described in Note 16, the Company has changed its business strategy, in the last quarter of the fiscal year 2003, employees related to manufacturing operation of Wondial forfeited their stock restricted awards (67,500 shares) due to termination of employment. The deferred compensation cost and previously recognized compensation expenses of USD297 and USD41 respectively were not reversed in the fiscal year 2003 as these stocks will be returned to the Company and cancelled subsequent to the balance sheet date. F-24 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 15. STOCK-BASED COMPENSATION (Continued) (1) EI Plan (Continued) b) Stock awards (Continued) ii) Stock awards to external consultants and advisors According to SFAS No. 123, all equity instruments transferred to non-employees in exchange for goods and services are measured at fair value. Fair value can be measured based on either the fair value of the goods or services received or the fair value of the equity instrument -- whichever is more reliably determinable. As with APB Opinion No. 25, compensation expense is recognized by amortizing total compensation cost over the periods in which the related external consultants and advisors services are rendered. In consideration of an external consultant's (the "Consultant") past services, the Company agreed to pay USD600 and expensed it in the second quarter of fiscal year 2003. Instead of paying the agreed consideration, the services were settled by granting 712,500 shares and 712,500 stock options to the Consultant. On May 21, 2003, 356,250 shares were issued. The remaining 356,250 stocks and 712,500 stock options were subsequently cancelled and compensation expenses previously recognized (USD600) was not reversed. For other external consultants, during the fiscal year 2003, 30,187 stock awards were granted for their past services for USD94, measured and expensed all at the approximately quoted market price at the date of grant. During the fiscal year 2003, the Company also issued 4,626,948 stock awards of common stocks for services with a period of one to five years. There were no performance commitment date, as defined in EITF 96-18, prior to the completion of performance, thus, all these stock awards (USD1,653) were measured at their then-current fair value as of December 31, 2003 and were recognized on the cliff vesting basis. Approximately USD959 were recognized as expenses for the year ended December 31, 2003. (2) PS Plan During the fiscal year 2003, the principal stockholder of the Company, Mr. Tsui Kit, granted stock awards to various parties, including employees and business associates, to enhance or maintain the value of his investment and the Company implicitly benefits from the plan by retention of, and possibly improved performance by, the employee and maintenance of business relationship with various business associates of Mr. Tsui Kit and the Company. In accordance with the AICPA Accounting Interpretations of APB No. 25, Stock Plans Established by a Principal Stockholder, a company should account for plans, if they have characteristics otherwise established similar to compensatory plans adopted by the company, that are established or financed by a principal stockholder. The economic substance of this type of plan is substantially the same for the company and the employee, whether the plan is adopted by the company or a principal stockholder. This type of plan should be treated as a contribution to capital by the principal stockholder with the offsetting charge accounted for in the same manner as compensatory plans adopted by the company. The fair value of the share-based awards and stock option, as described below, will be the total compensation cost, which will be expensed over the vesting period. F-25 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 15. STOCK-BASED COMPENSATION (Continued) (2) PS Plan (Continued) On June 13, 2003, under PS Plan, the principal stockholder had granted stock awards to employees and various related business parties of the principal stockholder. a) Stock awards i) Stock awards to employees Stock awards to employees under PS Plan have been granted to officers, other employees and directors who have been employed with the Company and its subsidiaries at least three years or above and were selected by the president of IDUL. Recipients are not required to provide consideration for the stock awards to the Company but are required to rendering service for three years from the date of grant. In the last quarter of fiscal year 2003, the vesting period was extended from three years to five years. The Company applies the provisions of APB No. 25, in accounting for its stock awards. In June 2003, 1,057,666 restricted stock awards were granted at a market value of USD6,423 at the date of grant, to employees of the Company. Initially, the total market value of the shares is treated as deferred compensation and is charged to expense over the period of expected services. After the extension of vesting period, the remaining unrecognized original intrinsic value (USD4,834) was recognized over the remaining vesting period from the date of modification. As described in Note 16, the Company has changed its business strategy, in the last quarter of the fiscal year 2003, employees related to manufacturing operation of Wondial forfeited their restricted stock awards (80,250 shares) due to termination of employment. The deferred compensation cost and previously recognized compensation expenses were USD341 and USD62 respectively were not reversed in the fiscal year 2003 as these stocks will be returned to the principal stockholder subsequent to the balance sheet date. ii) Stock awards to various related business parties of the principal stockholder Consistent with the methodology in SFAS No. 123 for equity instruments transferred to non-employees, in June 2003, 223,853 stock awards granted to various business associates, which are suppliers and customers of the Company, at a value of USD1,122, measured at the fair value of the share award grant, were expensed in the second quarter of fiscal year 2003. The fair value of the stock awards granted is estimated on the date of the grant using the Black-Scholes option pricing model, assuming no dividends and the weighted average assumptions described in Note 15(a) above. The value of unearned compensation under EI Plan (USD8,397) and PS Plan (USD5,301) are included as a separate component of stockholders' equity. The total compensation expense recognized for all stock awards was USD3,977 respectively for the fiscal year 2003. F-26 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 16. REPORT ON SEGMENT INFORMATION The Company's operations are classified into three reportable business segments: communication terminal products, mainly corded and cordless telephone which are sold under the trademark, Wondial (TM), battery testing equipment and battery products. The Company's three reportable business segments are identified separately based on fundamental differences in their operations. In last quarter of the fiscal year 2003, Wondial outsourced the manufacturing operations to various subcontractors. There are no material intersegment sales. The Company's products are mainly sold to PRC so no geographical segment information is presented. In 2001, sales to an external customer of the Company's communication terminal products segment totaled approximately USD5,113 (12%) of the Company's consolidated sales. None of the customers constitute more than 10 percent of the Company's total revenue for the fiscal year 2003 and 2002. Summarized below are the Company's segment information by business segment for the years ended December 31, 2003, 2002 and 2001:
Year ended December 31, ----------------------------------------------- 2003 2002 2001 USD USD USD Segment revenues Communication terminal products 37,977 34,865 33,513 Battery testing equipment 7,640 8,607 6,193 Battery products 13,360 10,680 2,300 --------------- -------------- -------------- Segment totals 58,977 54,152 42,006 Rental income 116 987 - Other, adjustment and elimination items - (62) - --------------- -------------- -------------- Total consolidated 59,093 55,077 42,006 =============== ============== ============== Segment operating earnings (loss) Communication terminal products 4,750 4,309 4,011 Battery testing equipment 1,108 2,145 2,574 Battery products 3,510 2,480 597 --------------- -------------- -------------- Segment totals 9,368 8,934 7,182 Recognized compensation expenses (3,974) - - Other, adjustment and elimination items 110 - 3 --------------- -------------- -------------- Total consolidated 5,504 8,934 7,185 =============== ============== ============== Depreciation and amortization Communication terminal products 1,305 2,308 1,281 Battery testing equipment 321 112 115 Battery products 384 512 183 --------------- -------------- -------------- Segment totals 2,010 2,932 1,579 =============== ============== ============== Interest expenses Communication terminal products 686 1,218 1,485 Battery testing equipment 121 14 29 Battery products 216 369 227 --------------- -------------- -------------- Segment totals 1,023 1,601 1,741 =============== ============== ==============
F-27 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 16. REPORT ON SEGMENT INFORMATION (Continued)
As of December 31, 2003 2002 USD USD Total assets Communication terminal products 35,666 37,520 Battery testing equipment 14,944 10,135 Battery products 19,892 17,834 --------------- --------------- Segment totals 70,502 65,489 Other, adjustment and elimination items 405 (1,345) --------------- --------------- Total consolidated 70,907 64,144 =============== ===============
17. RELATED PARTY TRANSACTIONS Name and relationship of related parties
Name Relationship with the Company ---- ----------------------------- Shenzhen Ligaofa Electronic Company Limited Joint venturer of a PRC affiliate and ("SLFE") under control of cousin and mother of Tsui Kit Wonderland Telecommunication Industrial Under common control of Tsui Kit (Hong Kong) Company Limited ("WTI") LPI Under common control of Tsui Kit WLPS Under common control of Tsui Kit Wuhan Lixing (Torch) Power Sources Company Limited ("WLTPS") Under common control of Tsui Kit Tsui Kit Principal stockholder and director of IDUL BTUEG Stockholder of Wondial Yu Weijiang Brother-in-law of Tsui Kit Xu Dong Sister of Tsui Kit Xu Zhiyong Brother of Tsui Kit Zhang Ernong General manager of Wondial Minority shareholder of an affiliate of WLPS Director and shareholder of WLPS Director of an affiliate of WTLPS
F-28 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 17. RELATED PARTY TRANSACTIONS (Continued) Summary of related party transactions
As of December 31, ---------------------------------- 2003 2002 USD USD Due from related parties (Note (i)) SLFE 650 577 BTUEG 1,114 1,114 WTI 57 - --------------- --------------- 1,821 1,691 =============== =============== Due from director and employees (Note (i)) Yu Weijiang - 9 Xu Dong - 4 Xu Zhiyong - 4 Zhang Ernong - 5 Other employees - - --------------- --------------- - 22 =============== =============== Due to related parties (Note (ii)) WTI - 49 - 121 12 12 7 - --------------- --------------- 19 182 =============== =============== Due to principal stockholder (Note (ii)) Tsui Kit 7,821 8,026 =============== =============== Guarantor of short term loans 725 - =============== ===============
F-29 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 17. RELATED PARTY TRANSACTIONS (Continued) Summary of related party transactions (Continued)
Year ended December 31, ----------------------------------------------- 2003 2002 2001 USD USD USD Sale of goods SLFE 1,421 2,773 - ============= ============= ============
Notes: (i) The amounts due from related parties, director and employees represent unsecured advances made to those parties from time to time. These amounts are interest free and repayable on demand. (ii) The amounts due to director and related parties represent unsecured advances made from those parties from time to time. These amounts are interest free and repayable on demand. (iii) Pursuant to an agreement entered into between Mr. Tsui Kit and SKI on November 25, 1997, Mr. Tsui Kit disposed of certain properties to SKI at their original purchase costs but he still held the properties as the registered owners. SKI, being beneficial owner of these properties, recorded these properties as its assets. As of December 31, 2003 and 2002, the change of the registered owners of these properties (with a net carrying value of USD1,466) from Mr. Tsui Kit to the Company was still in progress. 18. COMMITMENTS (a) Capital commitments The outstanding capital commitments of the Company are as follow: As of December 31, ---------------------------- 2003 2002 USD USD Acquisition of moulds and other machinery - 24 =========== ============= F-30 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 18. COMMITMENTS (Continued) (b) Operating leases i) Operating lease expense The Company leases certain staff quarters and offices premises under non-cancelable operating leases. Rental expenses under operating leases were USD62, USD274 and USD384 for the fiscal year ended December 31, 2003, 2002 and 2001 respectively. There was no capital lease currently in effect. The following table summarizes the approximate future minimum rental payments under non-cancelable operating leases in effect: As of December 31, 2003 --------------------------- USD Year ending December 31 2004 42 2005 27 2006 - 2007 - 2008 - Thereafter - --------------------------- Total 69 =========================== ii) Operating lease income Operating leases arise from the leases for machinery and equipment to various subcontractors. The lease terms are generally 12 months. Depreciation expense for assets subject to operating leases is provided primarily on the straight-line method over the estimated useful life of the assets. Depreciation expense relating to machinery and equipment held as investments in operating leases was USD262, USD966 and USD9 for the years ended December 31, 2003, 2002 and 2001 respectively. Investments in operating leases are as follows: As of December 31, ------------------------------- 2003 2002 USD USD Machinery and equipment 3,812 10,498 Accumulated depreciation (887) (1,690) --------------- ------------ Net investment in operating leases 2,925 8,808 =============== ============ F-31 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 18. COMMITMENTS (Continued) (b) Operating leases (Continued) Future minimum rental payments to be received on non-cancelable operating leases are contractually due as follows: As of December 31, 2003 ------------------------------ USD Year ending December 31 2004 377 2005 531 2006 - 2007 - 2008 - Thereafter - ------------------------------ Total 908 ============================== There were no contingent rentals under the respective lease contracts. 19. SUBSEQUENT EVENTS a) Acquisition of treasury stock On December 9, 2003, IDUL announced that it has initiated a program to buy back up to 500,000 shares of its outstanding common stock. Before the end of fiscal year 2003, IDUL has entered into an agreement with a third party to repurchase 200,000 shares of common stock of IDUL at USD2.93 per share. The consideration was settled in January 2004. b) Discontinued operation In January 2004, IDUL's wholly-owned subsidiary, BFL entered into an agreement to dispose its 95% owned affiliate, Shenzhen Kexuntong Industrial Company Limited ("SKI") which owned 68.7288% shareholdings in Wondial to its principal stockholder, Mr. Tsui Kit, for a purchase price equal to 105% of the appraised value of net assets of SKI as of December 31, 2003 (the "Purchase Price"). The Purchase Price shall be payable by the cancellation of amount of USD7,662 due to Mr. Tsui Kit in connection with the acquisition of LPI, as described in Note 2 (b) above and the transfer to IDUL of such number of shares of restricted common stock of IDUL owned by Mr. Tsui Kit (the aggregate fair market value of which shall be set at the closing price of such shares as of the date of the execution of the acquisition agreement) equal to the difference between the Purchase Price and the obligation of USD7,662. The disposal is expected to close after March 2004. F-32 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 19. SUBSEQUENT EVENTS (Continued) c) Private placement On February 25, 2004, IDUL completed a private equity financing pursuant to which it raised gross proceeds of USD5,800. The transaction was a unit offering pursuant to which IDUL issued a total of 2,521,745 shares of common stock together with warrants to purchase an additional 756,530 shares of common stock. The price per unit was $2.30 and the warrant exercise price is $2.70 per share. F-33 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 20. QUARTERLY FINANCIAL INFORMATION (Unaudited)
Three Months Ended --------------------------------------------------------- March 31 June 30 September 30 December 31 Total Year USD USD USD USD USD 2003 Operating revenues Net sales 11,454 14,355 15,766 17,402 58,977 Rental income 29 29 29 29 116 ------------ ------------ -------------- -------------- ------------ Total operating revenues 11,483 14,384 15,795 17,431 59,093 ------------ ------------ -------------- -------------- ------------ Operating expenses Manufacturing and other costs of sales 8,015 10,209 11,817 12,557 42,598 Sales and marketing 540 729 592 338 2,199 General and administrative 457 471 427 1,140 2,495 Research and development 290 457 386 (105) 1,028 Depreciation and amortization 136 132 121 168 557 Other operating costs and expenses 152 2,480 1,025 739 4,396 ------------ ------------ -------------- -------------- ------------ Total operating expenses 9,590 14,478 14,368 14,837 53,273 ------------ ------------ -------------- -------------- ------------ Operating income 1,893 (94) 1,427 2,594 5,820 Interest expenses (262) (308) (248) (205) (1,023) Other (expenses) income, net 27 (22) 58 644 707 ------------ ------------ -------------- -------------- ------------ Income (loss) before income taxes and minority interest 1,658 (424) 1,237 3,033 5,504 Provision for income taxes (174) (222) (242) (370) (1,008) ------------ ------------ -------------- -------------- ------------ Income before minority interest 1,484 (646) 995 2,663 4,496 Minority interest in income of consolidated subsidiaries (587) (854) (719) (1,154) (3,314) ------------ ------------ -------------- -------------- ------------ Net income (loss) 897 (1,500) 276 1,509 1,182 ============ ============ ============== ============== ============ Earnings (loss) per share: Basic weighted average number of common stock outstanding 18,695 20,216 22,332 24,661 21,623 ============ ============ ============== ============== ============ Basic net income (loss) per common stock 0.05 (0.07) 0.01 0.06 0.05 ============ ============ ============== ============== ============
F-34 Industries International, Incorporated Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (amount in thousands, except share data) 20. QUARTERLY FINANCIAL INFORMATION (Unaudited) (Continued)
Three Months Ended --------------------------------------------------------- March 31 June 30 September 30 December 31 Total Year USD USD USD USD USD 2002 Operating revenues Net sales 10,292 13,625 16,549 13,624 54,090 Rental income 247 247 247 246 987 ------------ ------------ -------------- -------------- ------------ Total operating revenues 10,539 13,872 16,796 13,870 55,077 ------------ ------------ -------------- -------------- ------------ Operating expenses Manufacturing and other costs of sales 7,352 9,071 10,697 10,280 37,400 Sales and marketing 554 480 685 320 2,039 General and administrative 536 510 530 614 2,190 Research and development 316 327 389 407 1,439 Depreciation and amortization 129 539 325 391 1,384 Other operating costs and expenses 8 8 28 340 384 ------------ ------------ -------------- -------------- ------------ Total operating expenses 8,895 10,935 12,654 12,352 44,836 ------------ ------------ -------------- -------------- ------------ Operating income 1,644 2,937 4,142 1,518 10,241 Interest expenses (449) (456) (307) (390) (1,602) Other (expenses) income, net 85 89 (23) 144 295 ------------ ------------ -------------- -------------- ------------ Income before income taxes and minority interest 1,280 2,570 3,812 1,272 8,934 Provision for income taxes (102) (230) (376) (180) (888) ------------ ------------ -------------- -------------- ------------ Income before minority interest 1,178 2,340 3,436 1,092 8,046 Minority interest in income of consolidated subsidiaries (479) (874) (1,245) (412) (3,010) ------------ ------------ -------------- -------------- ------------ Net income 699 1,466 2,191 680 5,036 ============ ============ ============== ============== ============ Earnings per share: Basic weighted average number of common stock outstanding 18,007 18,007 18,007 18,007 18,007 ============ ============ ============== ============== ============ Basic net income per common stock 0.04 0.08 0.12 0.04 0.28 ============ ============ ============== ============== ============
F-35 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Randy Simpson, CPA, P.C., the independent accountant who had been engaged by the Company as the principal accountant to audit the Company's consolidated financial statements for the period prior to its merger with Broad Faith, was dismissed effective May 6, 2003. On May 6, 2003, the Company engaged Moores Rowland, Chartered Accountants, Certified Public Accountants as the Company's new principal independent accountants to audit the Company's consolidated financial statements for the year ending December 31, 2003. The Company selected Moores Rowland Mazars solely due to the fact that it is one of the largest accounting firms with offices in Hong Kong and United States, and it served as the auditor for Broad Faith prior to its merger with the Company. The decision to change the Company's independent accountants from Randy Simpson, CPA, P.C. to Moores Rowland Mazars was approved by the Company's Board of Directors. 42 The report of Randy Simpson, CPA, P.C. on the financial statements of the Company as of and for the years ended December 31, 2002 and December 31, 2001 did not contain an adverse opinion or a disclaimer of opinion, nor was it modified as to uncertainty, audit scope, or accounting principles. During the periods ended December 31, 2001 and December 31, 2002, and the interim period from January 1, 2003 through the date of dismissal of Randy Simpson, CPA, P.C., the Company did not have any disagreements with Randy Simpson, CPA, P.C. on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of Randy Simpson, CPA, P.C., would have caused it to make a reference to the subject matter of the disagreements in connection with its reports. Prior to engaging Moores Rowland Mazars, the Company had not consulted Moores Rowland Mazars regarding the application of accounting principles to a specified transaction, completed or proposed, or the type of audit opinion that might be rendered on the Company's financial statements. The Company did not experience any other changes in or disagreements with, its independent accountants within the past two fiscal years. ITEM 9A. CONTROLS AND PROCEDURES Evaluation of disclosure controls and procedures Under the supervision and with the participation of the Company's senior management, including its chief executive officer and chief financial officer, the Company conducted an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this annual report (the "Evaluation Date"). Based on this evaluation, the Company's chief executive officer and chief financial officer concluded as of the Evaluation Date that the Company's disclosure controls and procedures were effective such that the information relating to the Company, including its consolidated subsidiaries, required to be disclosed in the Company's Securities and Exchange Commission ("SEC") reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to the Company's management, including its chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure. There were no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to the date of their evaluation. PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND SIGNIFICANT EMPLOYEES OF THE REGISTRANT The following table sets forth the names, ages, and positions of our directors, officers and significant employees. 43 Name Age Position Held Officer/Director/ Significant Employee since Kit Tsui 40 Chief Executive Officer, 2003 Chairman of the Board Weijiang Yu 32 President and Director (former) 2003 (1) Hongyan Sun 30 President and Director (current) 2004 Zhiyong Xu 28 Secretary and Director 2003 Guoqiong Yu 45 Chief Financial Officer and 2003 Treasurer Bin Xu 45 Chairman and General Manager 1993 of Lixing Power (1) Mr. Yu retired in January 2004, and Ms. Hongyan Sun has been appointed as President and Director until her successor is elected and qualified or until her earlier resignation or removal. The directors named above will serve until the next annual meeting of our stockholders or until their successors are duly elected and have qualified. Directors will be elected for one-year terms at the annual stockholders meeting. Officers will hold their positions at the pleasure of the board of directors, absent any employment agreement, of which none currently exists. There is no arrangement or understanding between any of our directors or officers and any other person pursuant to which any director or officer was or is to be selected as a director or officer, and there is no arrangement, plan or understanding as to whether non-management stockholders will exercise their voting rights to continue to elect the current board of directors. There are also no arrangements, agreements or understandings between non-management stockholders that may directly or Indirectly participate in or influence the management of our affairs. BIOGRAPHICAL INFORMATION DR. KIT TSUI has served as Chairman of the Board of Directors and Chief Executive Officer since February 2003. Prior to the merger, Dr. Tsui served as the Chairman of Shenzhen Kexuntong Industrial Company Limited ("Kexuntong"), a subsidiary of the Company from January 1999 until September 2003. He was also the Chairman of Shenzhen Wonderland Communication Science and Technology Company Limited ("Wonderland"), a subsidiary of Kexuntong since January 1999 until July 2002. Dr. Tsui served as Chairman and Chief Executive Officer of Broad Faith from February 2003 to present. Dr. Tsui has been an entrepreneur since 1991 and he was the founder of Wonderland and Kexuntong and Broad Faith Limited. Dr. Tsui is primarily responsible for the Company's strategic planning and corporate development. Prior to establishing Wonderland, where he acted as its Chairman of the Board of Directors from its inception in 1993, Dr. Tsui served as General Manager of Shenzhen Jinkong Chaoying Industry Co., Ltd., one of the earliest portable game player manufacturers in China, from 1991 to 1993. Dr. Tsui also held a management position at the U.S. Trade Department of Shenzhen Electronics Group from 1989to 1991, where he was responsible for merchandising, management of customer relationship and export to the United States, as well as an executive position with the Planning Commission of Huangshi City Government, Hubei Province, China from 1987 to 1989. 44 MR. WEIJIANG YU served as President and Director to the Company from February 2003 to February 2004. Prior to the reverse merger, Mr. Yu served as the deputy General Manager of Wonderland since January 1999. He was the General Manager of Shenzhen Yixiang Chemical Engineering Company in Hubei, China. Mr. Yu resigned as the Company's President on February 2004 on a voluntary basis, and without disagreement with the Company. MS. HONGYAN SUN has served as President to the Company since February 2004. Ms. Sun was concurrently appointed as a Director in February 2004, upon the resignation of Mr. Yu, and will serve as a Director until her successor is elected and qualified or until her earlier resignation or removal. Ms. Sun has served as the Executive Director (an appointed officer of the Company) since December 2003. From May 2003 to November 2003, Ms. Sun served as the Director of the Company, Resident Mission in China (an appointed officer position). From February 2001 to April 2003, she served as both Assistant of Investment Management Center and Director (an appointed officer position) of the President's Office of Shenzhen Kexuntong Industrial Co., Ltd., both of which are currently affiliates of the Company. From June 1996 to January 2001, Ms. Sun served as Assistant of the Law Department of Shenzhen Wonderland Communication Science and Technology, currently an affiliate of the Company. Ms. Sun received her Bachelor of Law degree from Hubei Normal University and her Master of Law degree from Hubei University. MR. ZHIYONG XU has served as Secretary and Director to the Company since February 2003. Mr. Xu maintains primary responsibility for the Company's corporate administration. Mr. Xu also serves a Vice President of Wonderland, an affiliate of the Company, since December 2003. From February 2002 to December 2003, he served as the President of Shenzhen Chuangli Xing Cable Limited. From July 2001 to February 2002, he served as an assistant to management of Wonderland. From March 2000 to July 2001, he was a Purchasing Manager with Wonderland. From 1998 to 2000, Mr. Xu was a Vice President of Hubei Erzhou Yiyi Chemical Company. MS. GUOQIONG YU has served as Chief Financial Officer and Treasurer to the Company since February 2003. Ms. Yu maintains primary responsibility for the Company's accounting and reporting compliance, and hold fifteen years of experience in accounting and financial management. Ms. Yu served as the Chief Financial Officer of Wonderland, an affiliate of the Company, since July 2002 prior to the reverse merger. From March 1994 to February 2002, Ms Yu was a Financial Supervisor at Jintian Industry Company Limited. MR. BIN XU has served as Chairman and General Manager of Lixing Power since February 1993. Mr. Xu maintains primary responsibility for the Company's battery business development and strategic planning of that business. Mr. Xu is the founder of Lixing Power in 1993, and has more that 12 years of experience in power supply for telecommunication devices. Additionally, Mr. Xu held a Director position with Lithium Battery Branch of Physical and Chemical Institute of China since 1997 to present focusing on power sources, and is the inventor of the Company's patented Bicycle Siren Lamp. Family Relationships Mr. Zhiyong Xu and Dr. Kit Tsui are brothers. Mr. Weijiang Yu is Mr. Zhiyong Xu's brother-in-law. There are no other family relationships among the officers and directors. 45 Certain Legal Proceedings None of the directors or executive officers has, during the past five years: (a) Had any bankruptcy petition filed by or against any business of which such person was a general partner or executive officer either at the time of the bankruptcy or within two years prior to that time; (b) Been convicted in a criminal proceeding or subject to a pending criminal proceeding; (c) Been subject to any order, judgment, or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction, permanently or temporarily enjoining, barring, suspending or otherwise limiting his involvement in any type of business, securities, futures, commodities or banking activities; and (d) Been found by a court of competent jurisdiction (in a civil action), the Securities and Exchange Commission or the Commodity Futures Trading Commission to have violated a federal or state securities or commodities law, and the judgment has not been reversed, suspended, or vacated. Audit Committee Financial Expert The Company does not currently have an Audit Committee Financial Expert, as defined in ss.229.401h(2) of this chapter. Ms. Yu, the Company's Chief Financial Officer and Treasurer serves as the Company's financial expert regarding US generally accepted accounting principals and general application of such principles in connection with the accounting for estimates, accruals and reserves, including an understanding of internal control procedures and policies over financial reporting, and with maintains sufficient experience preparing auditing, analyzing or evaluating financial statements in such depth and breadth as may be required of an audit committee financial expert. However, Ms. Yu is not an elected Director of the Company and, accordingly, is precluded from membership on the Company's audit committee. The Company has undergone a significant change in management since the consummation of the Broad Faith Exchange Agreement. According to the Company's by-laws, the Board of Directors was restricted to three. The Company has obtained written consent from its majority shareholder to amend the by-laws to increase the number of positions on our Board of Directors, and intends to file an information statement in order to effectuate this change as soon as possible. The Company is actively seeking qualified independent Directors in the U.S., at least one of which will be deemed a "financial expert" pursuant to the US Securities Acts. Changes in Nominee Recommendation Procedures There are no material changes to the procedures by which shareholders can nominate directors. Compliance with Section 16(a) of the Exchange Act Based solely upon a review of Forms 3, 4 and 5 furnished to the Company pursuant to Section 16(a)-3e of the Securities Act of 1934, the Company notes the following delinquencies for the period ended December 31, 2003: 46 Dr. Kit Tsui filed a Form 4 and amendment thereto late for a transaction dated April 30, 2003. Mr. Weijiang Yu filed Forms 4 late for a transaction dated April 30, 2003, and a second transaction dated May 13, 2003. Mr. Zhiyang Yu filed a Form 4 late for a transaction dated April 30, 2003 and a second transaction dated May 13, 2003. None of the parties subject to Section 16(a) have filed a Form 5. The Company is not aware of the requirement or exemption of any of such individuals to file a Form 5, but notes the absence of any written representation identified in paragraph (b)(2)(i) of Item 405 of Regulation S-K. Code of Ethics The Company has adopted a code of ethics, the Code of Business Ethics and Conduct (the "Code"), that applies to the every officer of and Director to the Company, including its principal executive officer, principal financial officer and controller (principal accounting officer). The Code is attached hereto as an exhibit, and is available free of charge, upon request, to Industries International, 4/F Wondial Building, Keji South 6 Road Shenzhen High-Tech Industrial Park, Shennan Road Shenzhen, China, Attention: Hongyan Sun. Any amendment to, or waiver from, the Code will be publicly filed on Form 8-K as required by the Securities Exchange Act of 1934, as amended (the "Exchange Act"), during the time periods allocated by the Exchange Act.. ITEM 11. EXECUTIVE COMPENSATION Summary of Compensation The following executive compensation disclosure reflects all compensation awarded to, earned by or paid to the executive officers below, for the fiscal years ended December 31, 2003, 2002 and 2001.
SUMMARY COMPENSATION TABLE =================================================================================================== ANNUAL COMPENSATION LONG-TERM COMPENSATION =================================================================================================== AWARDS PAYOUTS =================================================================================================== OTHER SECURITIES NAME AND ANNUAL RESTRICTED UNDERLYING LTIP ALL OTHER PRINCIPAL YEAR SALARY BONUS COMPENSATION STOCK AWARDS OPTIONS/SARS PAYOUTS COMPENSATION POSITION ($) ($) ($) ($) (#) ($) ($) (A) (B) (C) (D) (E) (F) (G) (H) (I) =================================================================================================== Dr. Kit Tsui, Chief 2003 0 (2) Executive 2002 $57.971 0 0 0 0 0 0 Officer (1) 2001 $57,971 ===================================================================================================
47 (1) Dr. Kit Tsui was appointed Chief Executive Officer on February 10, 2003. His predecessor, Mr. Dan Shuput, an unaffiliated party, served as Chief Executive Officer of Industries from January 28, 1994 until the reverse merger became effective on February 10, 2003. As reported in previous filings, Mr. Shuput did not receive any compensation for his services as Chief Executive Officer. The Company is not aware of any facts or circumstances which may indicate otherwise. (2) Dr. Tsui holds 10,259,929 shares of common stock, received as a result of his position as primary shareholder in Broad Faith at the time of the merger with the Company. Dr. Tsui has not received any compensation in the most recent fiscal year as a result of his position as an elected officer or Director to the Company. See the discussion in "Certain Relationships and Related Party Transactions" and "Security Ownership of Certain Beneficial Owners and Management." Dr. Kit Tsui has been the Company's Chief Executive Officer and Chairman since February 10, 2003. Dr. Tsui served as Chief Executive Officer of Broad Faith prior to the merger with the Company. The following table shows all grants during the fiscal year ended December 31, 2003 of stock options under our stock option plans to the named executive officers. OPTION/SAR GRANTS IN LAST FISCAL YEAR ================================================================================ INDIVIDUAL GRANTS ================================================================================
OPTION/SAR GRANTS IN LAST FISCAL YEAR ================================================================================ INDIVIDUAL GRANTS POTENTIAL ======================================================== REALIZABLE VALUE AT ASSUMED ANNUAL RATES OF STOCK ALTERNATIVE PERCENT OF PRICE TO (F) AND NUMBER OF TOTAL EXERCISE APPRECIATION (G): SECURITIES OPTIONS/SARS OF BASE FOR OPTION GRANT DATE UNDERLYING GRANTED TO BASE TERM VALUE NAME OPTION/SARS EMPLOYEES PRICE EXPIRATION GRANT DATE GRANTED IN FISCAL ($/SH) DATE 5% 10% PRESENT (#) YEAR ($) ($) VALUE $ $ $ (A) (B) (C) (D) (E) (F) (G) (H) ================================================================================ Dr. Kit Tsui 0 0 0 0 0 0 0 ================================================================================
The following table provides information as to the number and value of unexercised options to purchase the Company common stock held by the named executive officers at December 31, 2003. ___ of the named executive officers exercised any options during the fiscal year ended December 31, 2003. AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES ================================================================================ NUMBER OF SECURITIES VALUE OF UNDERLYING UNEXERCISED UNEXERCISED IN-THE-MONEY SHARES VALUE OPTIONS/SARS OPTIONS/SARS NAME ACQUIRED ON REALIZED AT FY-END (#) AT FY-END ($) EXERCISE (#) ($) EXERCISABLE/ EXERCISABLE/ UNEXERCISABLE UNEXERCISABLE (A) (B) (C) (D) (E) ================================================================================ Dr. Kit Tsui 0 0 0 0 ================================================================================ 48 LONG-TERM INCENTIVE PLAN AWARDS ("LTIP") TABLE The Company does not currently have any LTIP Awards, and did not have any LTIP awards for any of the periods covered. PENSION PLAN TABLE The Company does not currently have any defined benefit, pension, or actuarial plans. OPTION/SAR REPRICINGS No option or SAR repricings were conducted during the periods covered. Employment Agreements, Termination of Employment and Change-in-Control Arrangements The Company does not have any formal employment agreements, termination of employment agreements, or change-in-control arrangement. Compensation Committee Interlocks and Insider Participation The board of directors does not have a compensation committee. The salary committee consists of Dr. Kit Tsui, Mr. Weijiang Yu and Ms. Hongyan Sun. They participate in the decision process of executive compensations. Dr. Kit Tsui has served as Chairman of Shenzhen Wonderland Communication Science and Technology Company Limited ("Wonderland"), a subsidiary of Kexuntong, from 1993 until September 2003. He also served as Chairman and Chief Executive Officer of Broad Faith Limited from February, 2003 to Present. None of these entities had independent compensation committees or committees performing separate functions, and matters of executive compensation were determined by the Board of Directors as a whole Mr. Weijiang Yu has served as an executive officer of Wonderland from January 1999 to 2002, and served as member of the salary committee until his retirement in January 2004. He has also served as an executive officer of Shenzhen Yixiang Chemical Engineering Company in Hubei, China, and unaffiliated company, from 1997 to 1999. None of these entities had independent compensation committees or committees performing separate functions, and matters of executive compensation were determined by the Board of Directors as a whole. Ms. Hongyan Sun has served as executive officer to Resident Mission in China, an unaffiliated company, from May 2003 to December 2003. This entity did not have an independent compensation committees or committee performing separate functions, and matters of executive compensation were determined by the Board of Directors as a whole. 49 Mr. Zhiyong Xu has served as an executive officer to Wonderland, an affiliated company, since December 2003. This entity did not have an independent compensation committees or committee performing separate functions, and matters of executive compensation were determined by the Board of Directors as a whole. Ms. Guoqiong Yu has served as an executive officer to Wonderland since February 2003. This entity did not have an independent compensation committees or committee performing separate functions, and matters of executive compensation were determined by the Board of Directors as a whole. Mr. Bin Xu has served as an executive officer of Lixing Power from February 1993 to present. Mr. Xu has served as Chairman and Chief Executive Officer to Huhan Cable Company since May 1993. None of these entities had independent compensation committees or committees performing separate functions, and matters of executive compensation were determined by the Board of Directors as a whole. Performance Graph [RELATIVE PERFORMANCE GRAPH APPEARS HERE] The Company completed the reverse merger with the operating entity in China in February 2003. Prior to the merger, the previous operating entity was a private company, and the Company was a publicly-traded shell. As a result, the Company does not believe that the stock performance or private company book value prior to the merger presents a useful comparison. Accordingly, the date range selected for analysis was March 1, 2003 to December 31, 2003. 50 The Company used the AMEX Composite Index and the AMEX Computer Technology Index as a comparison for the relative performance with our stock relative performance. The Company's peer comparison for relative stock performance is its competitor, Qiao Xing Universal Telephone Inc., also a communication equipment manufacture based in China. The Company has also selected Abraxas Petroleum Corporation for peer comparison, based on its comparable market capitalization ($88.5 million as of March 29, 2004, compared to the Company's market capitalization of $63.9 million at even date). ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth, as of March 25, 2004, certain information regarding the ownership of Industries International's capital stock by each director and executive officer of Industries International, each person who is known to Industries International to be a beneficial owner of more than 5% of any class of Industries International's voting stock, and by all officers and directors of Industries International as a group. Unless otherwise Indicated below, to Industries International's knowledge, all persons listed below have sole voting and investing power with respect to their shares of capital stock, except to the extent authority is shared by spouses under applicable community property laws. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and generally includes voting or investment power with respect to securities. Shares of common stock subject to options, warrants or convertible securities exercisable or convertible within 60 days of March 25, 2004 are deemed outstanding for computing the percentage of the person or entity holding such options, warrants or convertible securities but are not deemed outstanding for computing the percentage of any other person, and is based on 31,199,466 shares issued and outstanding on a fully diluted basis, as of March 25, 2004.
- ------------------------------------------------------------------------------------------------------------- Name and Address Amount and Nature Percent Title of Of Of Beneficial Ownership Of Class Beneficial Owners (1) Class (2) - ------------------------------------------------------------------------------------------------------------- Common Stock Kit Tsui (3) 10,259,929 32.88% - ------------------------------------------------------------------------------------------------------------- Common Stock & Options Weijiang Yu (4) 350,000 1.12% - ------------------------------------------------------------------------------------------------------------- Common Stock Guoqiong Yu (5) 13,000 * - ------------------------------------------------------------------------------------------------------------- Common Stock & Options Zhiyong Xu (6) 162,500 * - ------------------------------------------------------------------------------------------------------------- Common Stock Xiaochen Li (7) 117,974 * - ------------------------------------------------------------------------------------------------------------- Common Stock Hongyan Sun (8) 12,500 * - ------------------------------------------------------------------------------------------------------------- Common Stock Bing Xu (9) 138,116 * - ------------------------------------------------------------------------------------------------------------- All officers and directors as a group (5 persons) 10,915,903 34.99% - ------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------
* - Indicates less than 1% beneficially owned. 51 (1) Unless otherwise noted, the address for each of the named beneficial owners is Industries International, Inc. 4/F. Wondial Building, Keji South 6 Road Shenzhen High-Tech Ind. Park, Shennan Road Shenzhen, China. (2) The number of outstanding shares of common stock of the Company on a fully diluted basis is based upon 31,199,466 as of March 25, 2004 (29,992,944 shares of common stock of the Company, and options and warrants to purchase 1,206,522 shares of common stock of the Company). (3) Kit Tsui is the Chief Executive Officer and Chairman of the Board of the Company. (4) Weijian Yu is the former President, Chief Operating Officer and Director of the Company. Includes options to purchase 300,000 shares of common stock of the Company at an exercise price of $5.6, expiring on 2013. (5) Guoqiong Yu is the Chief Financial Officer of the Company. (6) Zhiyong Xu is a director of the Company. Includes options to purchase 125,000 shares of common stock of the Company at an exercise price of $5.60, expiring on 2013. (7) Xiaochen Li is an independent director of the Company. (8) Hongyan Sun is the current President of the Company and a Director of the Board (9) Bing Xu is the Chairman and General Manager of Lixing Power, an affiliate of the Company. Change in Control To the knowledge of management, there are no present arrangements or pledges of securities of the Company which may result in a change in control of the Company. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Our Board of Directors has approved an Agreement for the Sale and Purchase of Shares in Li Sun Power International Limited ("Li Sun"), by and among the Company, Dr. Kit Tsui, who is the sole shareholder of Li Sun, Li Sun , Wuhan Hanhai High Technology Limited ("Hanhai"), Wuhan City Puhong Trading Limited ("Puhong Trading"), Shenzhen City Xing Zhicheng Industrial Limited ("Xing Zhicheng"), and Shenzhen Kexuntong Industrial Co. Ltd. ("Kexuntong"). Pursuant to the Agreement, we acquired all issued and outstanding shares of Li Sun from Dr. Tsui, who is our majority shareholder as well as our Chief Executive Officer and a director, in exchange for an amount of cash and restricted common stock in the Company determined based on the audited net income after tax of Li Sun. Hanhai, Puhong Trading, Xing Zhicheng, and Kexuntong (which is a subsidiary of the Company and which Indirectly owns 95% of 52 Kexuntong's capital stock), together, own approximately 72.83% of the capital stock of Lixing Power Sources Co., Ltd. of Wuhan ("Lixing Power Sources") as trustees for the benefit of Li Sun. By acquiring the capital stock of Li Sun, we will become the beneficial owner of approximately 72.83% of Lixing Power Sources. Of the remaining approximately 27.17% of Lixing Power Sources' equity, approximately 16.89% is owned by Chinese state-owned entities, and employees and former employees of Lixing Power Sources own the approximately 10.28% of Lixing Power Sources' remaining equity. Lixing Power Sources is a leading lithium and lithium-ion battery manufacturer in China. Established in 1993, Lixing Power Sources markets its OEM products to companies including ASUS, Legend, and MITAC, and also markets its products under the brand names "LixingTM" and "Lisun.TM" Its products are widely used in various types of electronic products including calculators, PDAs, laptop computers, cell phones and hybrid electric vehicles. This transaction is expected to close in May 2003. The Company's acquisition of Li Sun was completed on May 14, 2003, and consisted of the Company's purchase of 100% of the capital stock of Li Sun in exchange for 15,765,432 shares of the Company's common stock valued at $7,567,407.36 as well as an unwritten promissory note in the amount of $7,662,000, without expiration or maturity date, and bearing no interest rate, and is payable in cash or the Company's common stock based on mutual agreement. As a result of this acquisition, the Company now holds a 72.84% interest in Lixing Power. ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES Audit Fees The Company paid Moores Rowland Mazars for the last two years to audit our financials information according to the US GAAP. The aggregate amount paid for audit service in the last two years is $228,000. Audit-Related Fees Moores Rowland Mazars assisted the IDUL in the recapitalization process and received a fee of $100,000. The auditor also received 32,000 fees for reviewing Broad Faith Limited's financials. Tax Fees The Company did not pay any tax fees to its auditors in either of the last two fiscal years. All Other Fees The Company did not pay any other fees to its auditor in either of the last two fiscal years. Audit Committee Pre-Approval Policies The Company is in the process of establishing a formal audit committee, and will formalize its pre-approval policies and procedures once the audit committee has been formally established. The Board of Directors has approved all of the fees paid and identified herein. PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS OF FORM 8-K (a) The following exhibits, as required by Regulation S-X and Rules 301, 302 and 601 of Regulation S-K, are attached hereto, are incorporated herein by this reference. All management agreements and compensatory plans and arrangements required to be filed are specifically identified in paragraph (c) herein as Exhibit 10.5. (b) The Company did not file any Current Reports on Form 8-K during the fourth quarter of the fiscal year ended December 31, 2003. (c) List of Exhibits* 2.1 Amended and Restated Agreement and Plan of Share Exchange by and among Broad Faith Limited, a British Virgin Islands Corporation, and the Sole Stockholder of Broad Faith Limited on the one hand, and Industries International, Inc., a Nevada corporation and Certain Stockholders of Industries International, Inc., on the other hand dated February 10, 2003. (1) 2.2 Agreement for the Sale and Purchase of Shares in Li Sun Power International Ltd. Completion Agreement by and between Industries International, Inc., Kit Tsui, Li Sun Power International Ltd., Wuhan Hanhai High Technology Ltd., Wuhan City Puhong Trading Ltd., Shenzhen City Zing Zhicheng Industrial Ltd. and Shenzhen Kexuntong Industrial Co. Ltd., dated March 10, 2003. (3) 2.3 Completion Agreement by and between Industries International, Inc., Kit Tsui, Li Sun Power International Ltd., Wuhan Hanhai High Technology Ltd., Wuhan City Puhong Trading Ltd., Shenzhen City Zing Zhicheng Industrial Ltd. and Shenzhen Kexuntong Industrial Co. Ltd., dated May 14, 2003. (4) 3.1 Articles of Incorporation of Industries International, Incorporated. (5) 3.2 Amended and Restated Articles of Incorporation, as amended. (2) 3.3 By-laws of Industries International, Incorporated. (5) 3.4 Amended and Restated By-laws of Industries International, Incorporated. (2) 4.1 Form of Common Stock share certificate. 10.1 Stock Buyback Agreement by and between the Company and Zhu Zhuan Xu, dated December 10, 2003. 10.2 Regional Sales Agreement by and between Shenzhen Wondial Commununication Technology Incorporation and the Company, dated January 1, 2003. 10.3 Form of Purchase Agreement for Financing conducted February 25, 2004 10.4 Form of Warrant Agreement for Financing conducted February 25, 2004 53 10.5 Industries International 2003 Equity Incentive Plan (2) 10.6 Agreement by and between Broad Faith Ltd. and Unical Enterprises, Inc. (Northwestern Bell). 10.7 Purchase Agreement by and between WuHan Lixing Power Supply Ltd. Company and Li Gao International Company 10.8 Shenzhen City Real Estate Leasing Agreement by and between the Company and Shanghai Sheng Bang Inspection, dated September 16, 2003. 10.9 Rental Contract by and between the Company and Shenzhen HuaQiao City Real Estate Limited, dated September 21, 2003. 14.1 Code of Ethics Code of Business Ethics and Conduct 16.1 Letter regarding change in certifying accountant from Randy Simpson, CPA, PC to Moores Rowland, Chartered Accountants, Certified Public Accountants effective May 6, 2003. (6) 17.1 Letter from Mr. Weijiang Yu resigning from position as President and Director to the Company, dated January 2, 2003 and effective February 5, 2004. 21.1 List of subsidiaries 31.1 Certification of Chief Executive Officer pursuant to Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934. 31.2 Certification of Chief Financial Officer pursuant to Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934. 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (7) 32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (7) - ----------------------- * - A number of these agreements are directly translated from agreements originally drafted in Chinese, and conform to Chinese industry standards. (1) Incorporated by reference from the Company's Current Report on Form 8-K, as filed on February 12, 2003. (2) Incorporated by reference from the Company's Annual Report on Form 10-KSB for the year ended December 31, 2002, as filed on April 14, 2003. (3) Incorporated by reference from the Company's Current Report on Form 8-K, as filed March 25, 2003. (4) Incorporated by reference from the Company's Current Report on Form 8-K, as filed May 19, 2003. (5) Incorporated by reference from the Company's registration statement on Form 10-SB, as filed on December 04, 2000. (6) Incorporated by reference from the Company's Current Report on Form 8-K, as filed May 7, 2003. (7) The exhibit furnished shall not be deemed "filed" for the purposes of Section 18 of the Securities Exchange Act of 1934, as amended (15 U.S.C. 78r), or otherwise subject to the liability of that section. 54 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. INDUSTRIES INTERNATIONAL, INC. /s/ Kit Tsai --------------------------------- By: Dr. Kit Tsai Title: Chief Executive Officer and Chairman Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and the capacities and on the dates Indicated. Name Title Date Chief Executive Officer, /s/ Kit Tsai Chairman of the Board - ---------------------------- (principal executive officer) Kit Tsui April 20, 2004 President and Director /s/ Hongyan Sun - ---------------------------- Hongyan Sun April 20, 2004 Secretary and Director /s/ Zhiyong Xu - ---------------------------- Zhiyong Xu April 20, 2004 Chief Financial Officer and /s/ Guoqiong Yu Treasurer (principal - ---------------------------- accounting officer and Guoqiong Yu principal financial officer) April 20, 2004 54 EX-10.3 3 v02407_ex10-3.txt SECURITIES PURCHASE AGREEMENT This Securities Purchase Agreement (this "Agreement") is dated as of February 25, 2004, among Industries International, Incorporated, a Nevada corporation (the "Company"), and each purchaser identified on the signature pages hereto (each, including its successors and assigns, a "Purchaser" and collectively the "Purchasers"); and WHEREAS, subject to the terms and conditions set forth in this Agreement and pursuant to Section 4(2) of the Securities Act (as defined below), and Rule 506 promulgated thereunder, the Company desires to issue and sell to each Purchaser, and each Purchaser, severally and not jointly, desires to purchase from the Company in the aggregate, up to $5,800,000 of shares of Common Stock and Warrants on the Closing Date. NOW, THEREFORE, IN CONSIDERATION of the mutual covenants contained in this Agreement, and for other good and valuable consideration the receipt and adequacy of which are hereby acknowledged, the Company and each Purchaser agrees as follows: ARTICLE I. DEFINITIONS 1.1 Definitions. In addition to the terms defined elsewhere in this Agreement, for all purposes of this Agreement, the following terms have the meanings indicated in this Section 1.1: "Action" shall have the meaning ascribed to such term in Section 3.1(j). "Affiliate" means any Person that, directly or indirectly through one or more intermediaries, controls or is controlled by or is under common control with a Person as such terms are used in and construed under Rule 144. With respect to a Purchaser, any investment fund or managed account that is managed on a discretionary basis by the same investment manager as such Purchaser will be deemed to be an Affiliate of such Purchaser. "Closing" means the closing of the purchase and sale of the Common Stock and the Warrants pursuant to Section 2.1. "Closing Date" means the Trading Day when all of the Transaction Documents have been executed and delivered by the applicable parties thereto, and all conditions precedent to (i) the Purchasers' obligations to pay the Subscription Amount and (ii) the Company's obligations to deliver the Securities have been satisfied or waived. "Commission" means the Securities and Exchange Commission. 1 "Common Stock" means the common stock of the Company, $0.01 par value per share, and any securities into which such common stock may hereafter be reclassified. "Common Stock Equivalents" means any securities of the Company or the Subsidiaries which would entitle the holder thereof to acquire at any time Common Stock, including without limitation, any debt, preferred stock, rights, options, warrants or other instrument that is at any time convertible into or exchangeable for, or otherwise entitles the holder thereof to receive, Common Stock. "Company Counsel" means Richardson & Patel LLP. "Disclosure Schedules" means the disclosure schedules of the Company delivered concurrently herewith. "Effective Date" means the date that the Registration Statement is first declared effective by the Commission. "Escrow Agent" shall have the meaning set forth in the Escrow Agreement. "Escrow Agreement" shall mean the Escrow Agreement in substantially the form of Exhibit D hereto executed and delivered contemporaneously with this Agreement. "Exchange Act" means the Securities Exchange Act of 1934, as amended. "FW" means Feldman Weinstein LLP with offices located at 420 Lexington Avenue, Suite 2620, New York, New York 10170-0002. "Intellectual Property Rights" shall have the meaning ascribed to such term in Section 3.1(o). "Liens" means a lien, charge, security interest, encumbrance, right of first refusal, preemptive right or other restriction. "Material Adverse Effect" shall have the meaning ascribed to such term in Section 3.1(b). "Material Permits" shall have the meaning ascribed to such term in Section 3.1(m). "Per Share Purchase Price" equals $2.30, subject to adjustment for reverse and forward stock splits, stock dividends, stock combinations and other similar transactions of the Common Stock that occur after the date of this Agreement. 2 "Person" means an individual or corporation, partnership, trust, incorporated or unincorporated association, joint venture, limited liability company, joint stock company, government (or an agency or subdivision thereof) or other entity of any kind. "Proceeding" means an action, claim, suit, investigation or proceeding (including, without limitation, an investigation or partial proceeding, such as a deposition), whether commenced or threatened. "Registration Rights Agreement" means the Registration Rights Agreement, dated as of the date of this Agreement, among the Company and each Purchaser, in the form of Exhibit A hereto. "Registration Statement" means a registration statement meeting the requirements set forth in the Registration Rights Agreement and covering the resale by the Purchasers of the Shares and the Warrant Shares. "Required Approvals" shall have the meaning ascribed to such term in Section 3.1(e). "Rule 144" means Rule 144 promulgated by the Commission pursuant to the Securities Act, as such Rule may be amended from time to time, or any similar rule or regulation hereafter adopted by the Commission having substantially the same effect as such Rule. "SEC Reports" shall have the meaning ascribed to such term in Section 3.1(h). "Securities" means the Shares, the Warrants and the Warrant Shares. "Securities Act" means the Securities Act of 1933, as amended. "Shares" means the shares of Common Stock issued or issuable to each Purchaser pursuant to this Agreement. "Subscription Amount" means, as to each Purchaser, the amounts set forth below such Purchaser's signature block on the signature page hereto, in United States dollars and in immediately available funds. "Subsidiary" shall mean the subsidiaries of the Company, if any, set forth on Schedule 3.1(a). "Trading Day" means a day on which the Common Stock is traded on a Trading Market. "Trading Market" means the following markets or exchanges on which the Common Stock is listed or quoted for trading on the date in question: OTC Bulletin Board, the American Stock Exchange, the New York Stock Exchange, the Nasdaq National Market or the Nasdaq SmallCap Market. 3 "Transaction Documents" means this Agreement, the Warrants, the Escrow Agreement and the Registration Rights Agreement and any other documents or agreements executed in connection with the transactions contemplated hereunder. "VWAP" means, for any date, the price determined by the first of the following clauses that applies: (a) if the Common Stock is then listed or quoted on a Trading Market, the daily volume weighted average price of the Common Stock for such date (or the nearest preceding date) on the Trading Market on which the Common Stock is then listed or quoted as reported by Bloomberg Financial L.P. (based on a trading day from 9:30 a.m. Eastern Time to 4:02 p.m. Eastern Time); (b) if the Common Stock is not then listed or quoted on a Trading Market and if prices for the Common Stock are then reported in the "Pink Sheets" published by the National Quotation Bureau Incorporated (or a similar organization or agency succeeding to its functions of reporting prices), the most recent bid price per share of the Common Stock so reported; or (c) in all other cases, the fair market value of a share of Common Stock as determined by an independent appraiser selected in good faith by the Purchasers and reasonably acceptable to the Company. "Warrants" means the Common Stock Purchase Warrants, in the form of Exhibit B, issuable to the Purchasers at the Closing, which warrants shall be exercisable immediately upon issuance for a term of 3 years and have an exercise price equal to $2.7601 per share. "Warrant Shares" means the shares of Common Stock issuable upon exercise of the Warrants. ARTICLE II. PURCHASE AND SALE 2.1 Closing. On the Closing Date, each Purchaser shall purchase from the Company, severally and not jointly with the other Purchasers, and the Company shall issue and sell to each Purchaser, (a) a number of Shares equal to such Purchaser's Subscription Amount divided by the Per Share Purchase Price and (b) the Warrants as determined pursuant to Section 2.2(a)(iii). The aggregate Subscription Amounts for Shares sold hereunder shall be up to $5,800,000. Upon satisfaction of the conditions set forth in Section 2.2, the Closing shall occur at the offices of the Escrow Agent or such other location as the parties shall mutually agree. 2.2 Closing Conditions; Deliveries. The Closing shall be subject to the following conditions and deliveries being met on the Closing Date: (a) On the Closing Date, the Company shall deliver or cause to be delivered to the Escrow Agent with respect to each Purchaser the following: 4 (i) this Agreement duly executed by the Company; (ii) a copy of the irrevocable instructions to the Company's transfer agent instructing the transfer agent to deliver, on an expedited basis, a certificate evidencing a number of Shares equal to such Purchaser's Subscription Amount divided by the Per Share Purchase Price, registered in the name of such Purchaser; (iii) with 3 Trading Days of the Closing Date, a Warrant, registered in the name of such Purchaser, pursuant to which such Purchaser shall have the right to acquire up to the number of shares of Common Stock equal to 30% of the Shares to be issued to such Purchaser at the Closing; (iv) the Registration Rights Agreement duly executed by the Company; (v) the Escrow Agreement duly executed by the Company; and (vi) a legal opinion of Company Counsel, in the form of Exhibit C attached hereto. (b) On the Closing Date, each Purchaser shall deliver or cause to be delivered to the Escrow Agent the following: (i) this Agreement duly executed by such Purchaser; (ii) such Purchaser's Subscription Amount by wire transfer to the account of the Escrow Agent; (iii) the Escrow Agreement duly executed by such Purchaser; and (iv) the Registration Rights Agreement duly executed by such Purchaser. (c) All representations and warranties of the respective parties contained herein shall remain true and correct as of the Closing Date and all covenants of the other party shall have been performed if due prior to such date. (d) From the date hereof to the Closing Date, trading in the Common Stock shall not have been suspended by the Commission (except for any suspension of trading of limited duration agreed to by the Company, which suspension shall be terminated prior to the Closing), and, at any time prior to the Closing Date, trading in securities generally as reported by Bloomberg Financial Markets shall not have been suspended or limited, or minimum prices shall not have been established on securities whose trades are reported by such service, or on any Trading Market, nor shall a banking moratorium have been declared either by the United States or New York State authorities nor shall there have occurred any material outbreak or escalation of hostilities or other national or international calamity of such magnitude in its effect on, or any material adverse change in, any financial market which, in each case, in the reasonable judgment of each Purchaser, makes it impracticable or inadvisable to purchase the Shares at the Closing. 5 ARTICLE III. REPRESENTATIONS AND WARRANTIES 3.1 Representations and Warranties of the Company. Except as set forth in the SEC Reports, and/or under the corresponding section of the Disclosure Schedules which Disclosure Schedules shall be deemed a part hereof, the Company hereby makes the representations and warranties set forth below to each Purchaser: (a) Subsidiaries. All of the direct and indirect subsidiaries of the Company are set forth on Schedule 3.1(a). The Company owns, directly or indirectly, all of the capital stock or other equity interests of each Subsidiary free and clear of any Liens, and all the issued and outstanding shares of capital stock of each Subsidiary are validly issued and are fully paid, non-assessable and free of preemptive and similar rights to subscribe for or purchase securities. If the Company has no subsidiaries, then references in the Transaction Documents to the Subsidiaries will be disregarded. (b) Organization and Qualification. Each of the Company and the Subsidiaries is an entity duly incorporated or otherwise organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation or organization (as applicable), with the requisite power and authority to own and use its properties and assets and to carry on its business as currently conducted. Neither the Company nor any Subsidiary is in violation or default of any of the provisions of its respective certificate or articles of incorporation, bylaws or other organizational or charter documents. Each of the Company and the Subsidiaries is duly qualified to conduct business and is in good standing as a foreign corporation or other entity in each jurisdiction in which the nature of the business conducted or property owned by it makes such qualification necessary, except where the failure to be so qualified or in good standing, as the case may be, could not have or reasonably be expected to result in (i) a material adverse effect on the legality, validity or enforceability of any Transaction Document, (ii) a material adverse effect on the results of operations, assets, business or financial condition of the Company and the Subsidiaries, taken as a whole, or (iii) a material adverse effect on the Company's ability to perform in any material respect on a timely basis its obligations under any Transaction Document (any of (i), (ii) or (iii), a "Material Adverse Effect") and no Proceeding has been instituted in any such jurisdiction revoking, limiting or curtailing or seeking to revoke, limit or curtail such power and authority or qualification. 6 (c) Authorization; Enforcement. The Company has the requisite corporate power and authority to enter into and to consummate the transactions contemplated by each of the Transaction Documents and otherwise to carry out its obligations thereunder. The execution and delivery of each of the Transaction Documents by the Company and the consummation by it of the transactions contemplated thereby have been duly authorized by all necessary action on the part of the Company and no further action is required by the Company in connection therewith other than in connection with the Required Approvals. Each Transaction Document has been (or upon delivery will have been) duly executed by the Company and, when delivered in accordance with the terms hereof, will constitute the valid and binding obligation of the Company enforceable against the Company in accordance with its terms except (i) as limited by applicable bankruptcy, insolvency, reorganization, moratorium and other laws of general application affecting enforcement of creditors' rights generally and (ii) as limited by laws relating to the availability of specific performance, injunctive relief or other equitable remedies. (d) No Conflicts. The execution, delivery and performance of the Transaction Documents by the Company, the issuance and sale of the Shares and the consummation by the Company of the other transactions contemplated thereby do not and will not (i) conflict with or violate any provision of the Company's or any Subsidiary's certificate or articles of incorporation, bylaws or other organizational or charter documents, or (ii) conflict with, or constitute a default (or an event that with notice or lapse of time or both would become a default) under, result in the creation of any Lien upon any of the properties or assets of the Company or any Subsidiary, or give to others any rights of termination, amendment, acceleration or cancellation (with or without notice, lapse of time or both) of, any agreement, credit facility, debt or other instrument (evidencing a Company or Subsidiary debt or otherwise) or other understanding to which the Company or any Subsidiary is a party or by which any property or asset of the Company or any Subsidiary is bound or affected, or (iii) subject to the Required Approvals, conflict with or result in a violation of any law, rule, regulation, order, judgment, injunction, decree or other restriction of any court or governmental authority to which the Company or a Subsidiary is subject (including federal and state securities laws and regulations), or by which any property or asset of the Company or a Subsidiary is bound or affected, or (iv) conflict with or violate the terms of any agreement by which the Company or any Subsidiary is bound or to which any property or asset of the Company or any Subsidiary is bound or affected; except in the case of each of clauses (ii) and (iii), such as could not have or reasonably be expected to result in a Material Adverse Effect. (e) Filings, Consents and Approvals. The Company is not required to obtain any consent, waiver, authorization or order of, give any notice to, or make any filing or registration with, any court or other federal, state, local or other governmental authority or other Person in connection with the execution, delivery and performance by the Company of the Transaction Documents, other than (i) filings required pursuant to Section 4.4 of this Agreement, (ii) the filing with the Commission of the Registration Statement, (iii) application(s) to each applicable Trading Market for the listing of the Shares and Warrant Shares for trading thereon in the time and manner required thereby, and (iv) the filing of Form D with the Commission and such filings as are required to be made under applicable state securities laws (collectively, the "Required Approvals"). 7 (f) Issuance of the Securities. The Shares and Warrants are duly authorized and, when issued and paid for in accordance with the Transaction Documents, will be duly and validly issued, fully paid and nonassessable, free and clear of all Liens imposed by the Company other than restrictions on transfer provided for in the Transaction Documents. The Warrant Shares, when issued in accordance with the terms of the Transaction Documents, will be validly issued, fully paid and nonassessable, free and clear of all Liens imposed by the Company. The Company has reserved from its duly authorized capital stock the maximum number of shares of Common Stock issuable pursuant to this Agreement and the Warrants. (g) Capitalization. The capitalization of the Company is as described in the Company's most recent periodic report filed with the Commission. The Company has not issued any capital stock since such filing other than pursuant to the exercise of stock options under the Company's equity incentive plan, the issuance of shares of Common Stock pursuant to the Company's equity incentive plan and pursuant to the conversion or exercise of outstanding Common Stock Equivalents outstanding. No Person has any right of first refusal, preemptive right, right of participation, or any similar right to participate in the transactions contemplated by the Transaction Documents. Except as a result of the purchase and sale of the Securities, there are no outstanding options, warrants, script rights to subscribe to, calls or commitments of any character whatsoever relating to, or securities, rights or obligations convertible into or exchangeable for, or giving any Person any right to subscribe for or acquire, any shares of Common Stock, or contracts, commitments, understandings or arrangements by which the Company or any Subsidiary is or may become bound to issue additional shares of Common Stock, or securities or rights convertible or exchangeable into shares of Common Stock. The issue and sale of the Securities will not obligate the Company to issue shares of Common Stock or other securities to any Person (other than the Purchasers) and will not result in a right of any holder of Company securities to adjust the exercise, conversion, exchange or reset price under such securities. All of the outstanding shares of capital stock of the Company are validly issued, fully paid and nonassessable, have been issued in compliance with all federal and state securities laws, and none of such outstanding shares was issued in violation of any preemptive rights or similar rights to subscribe for or purchase securities. No further approval or authorization of any stockholder, the Board of Directors of the Company or others is required for the issuance and sale of the Shares. Except as disclosed in the SEC Reports, there are no stockholders agreements, voting agreements or other similar agreements with respect to the Company's capital stock to which the Company is a party or, to the knowledge of the Company, between or among any of the Company's stockholders. 8 (h) SEC Reports; Financial Statements. The Company has filed all reports required to be filed by it under the Securities Act and the Exchange Act, including pursuant to Section 13(a) or 15(d) thereof, for the two years preceding the date hereof (or such shorter period as the Company was required by law to file such material) (the foregoing materials, including the exhibits thereto, being collectively referred to herein as the "SEC Reports") on a timely basis or has received a valid extension of such time of filing and has filed any such SEC Reports prior to the expiration of any such extension. As of their respective dates, the SEC Reports complied in all material respects with the requirements of the Securities Act and the Exchange Act and the rules and regulations of the Commission promulgated thereunder, and none of the SEC Reports, when filed, contained any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. The financial statements of the Company included in the SEC Reports comply in all material respects with applicable accounting requirements and the rules and regulations of the Commission with respect thereto as in effect at the time of filing. Such financial statements have been prepared in accordance with United States generally accepted accounting principles applied on a consistent basis during the periods involved ("GAAP"), except as may be otherwise specified in such financial statements or the notes ---- thereto and except that unaudited financial statements may not contain all footnotes required by GAAP, and fairly present in all material respects the financial position of the Company and its consolidated subsidiaries as of and for the dates thereof and the results of operations and cash flows for the periods then ended, subject, in the case of unaudited statements, to normal, immaterial, year-end audit adjustments. (i) Material Changes. Since the date of the latest audited financial statements included within the SEC Reports, except as specifically disclosed in the SEC Reports, (i) there has been no event, occurrence or development that has had or that could reasonably be expected to result in a Material Adverse Effect, (ii) the Company has not incurred any liabilities (contingent or otherwise) other than (A) trade payables and accrued expenses incurred in the ordinary course of business consistent with past practice and (B) liabilities not required to be reflected in the Company's financial statements pursuant to GAAP or required to be disclosed in filings made with the Commission, (iii) the Company has not altered its method of accounting, (iv) the Company has not declared or made any dividend or distribution of cash or other property to its stockholders or purchased, redeemed or made any agreements to purchase or redeem any shares of its capital stock and (v) the Company has not issued any equity securities to any officer, director or Affiliate, except pursuant to the Company's existing equity incentive plan. The Company does not have pending before the Commission any request for confidential treatment of information. (j) Litigation. There is no action, suit, inquiry, notice of violation, proceeding or investigation pending or, to the knowledge of the Company, threatened against or affecting the Company, any Subsidiary or any of their respective properties before or by any court, arbitrator, governmental or administrative agency or regulatory authority (federal, state, county, local or foreign) (collectively, an "Action") which (i) 10 adversely affects or challenges the legality, validity or enforceability of any of the Transaction Documents or the Securities or (ii) could, if there were an unfavorable decision, have or reasonably be expected to result in a Material Adverse Effect. Neither the Company nor any Subsidiary, nor any director or officer thereof, is or has been the subject of any Action involving a claim of violation of or liability under federal or state securities laws or a claim of breach of fiduciary duty. There has not been, and to the knowledge of the Company, there is not pending or contemplated, any investigation by the Commission involving the Company or any current or former director or officer of the Company. The Commission has not issued any stop order or other order suspending the effectiveness of any registration statement filed by the Company or any Subsidiary under the Exchange Act or the Securities Act. (k) Labor Relations. No material labor dispute exists or, to the knowledge of the Company, is imminent with respect to any of the employees of the Company which could reasonably be expected to result in a Material Adverse Effect. (l) Compliance. Neither the Company nor any Subsidiary (i) is in default under or in violation of (and no event has occurred that has not been waived that, with notice or lapse of time or both, would result in a default by the Company or any Subsidiary under), nor has the Company or any Subsidiary received notice of a claim that it is in default under or that it is in violation of, any indenture, loan or credit agreement or any other agreement or instrument to which it is a party or by which it or any of its properties is bound (whether or not such default or violation has been waived), (ii) is in violation of any order of any court, arbitrator or governmental body, or (iii) is or has been in violation of any statute, rule or regulation of any governmental authority, including without limitation all foreign, federal, state and local laws applicable to its business except in each case as could not have a Material Adverse Effect. (m) Regulatory Permits. The Company and the Subsidiaries possess all certificates, authorizations and permits issued by the appropriate federal, state, local or foreign regulatory authorities necessary to conduct their respective businesses as described in the SEC Reports, except where the failure to possess such permits could not have or reasonably be expected to result in a Material Adverse Effect ("Material Permits"), and neither the Company nor any Subsidiary has received any notice of proceedings relating to the revocation or modification of any Material Permit. (n) Title to Assets. The Company and the Subsidiaries have good and marketable title in fee simple to all real property owned by them that is material to the business of the Company and the Subsidiaries and good and marketable title in all personal property owned by them that is material to the business of the Company and the Subsidiaries, in each case free and clear of all Liens, except for 11 Liens as do not materially affect the value of such property and do not materially interfere with the use made and proposed to be made of such property by the Company and the Subsidiaries and Liens for the payment of federal, state or other taxes, the payment of which is neither delinquent nor subject to penalties. Any real property and facilities held under lease by the Company and the Subsidiaries are held by them under valid, subsisting and enforceable leases of which the Company and the Subsidiaries are in compliance. (o) Patents and Trademarks. The Company and the Subsidiaries have, or have rights to use, all patents, patent applications, trademarks, trademark applications, service marks, trade names, copyrights, licenses and other similar rights necessary or material for use in connection with their respective businesses as described in the SEC Reports and which the failure to so have could have a Material Adverse Effect (collectively, the "Intellectual Property Rights"). Neither the Company nor any Subsidiary has received a written notice that the Intellectual Property Rights used by the Company or any Subsidiary violates or infringes upon the rights of any Person. To the knowledge of the Company, all such Intellectual Property Rights are enforceable and there is no existing infringement by another Person of any of the Intellectual Property Rights of others. (p) Insurance. The Company and the Subsidiaries are insured by insurers of recognized financial responsibility against such losses and risks and in such amounts as are prudent and customary in the businesses in which the Company and the Subsidiaries are engaged. To the best of Company's knowledge, such insurance contracts and policies are accurate and complete. Neither the Company nor any Subsidiary has any reason to believe that it will not be able to renew its existing insurance coverage as and when such coverage expires or to obtain similar coverage from similar insurers as may be necessary to continue its business without a significant increase in cost. (q) Transactions With Affiliates and Employees. Except as set forth in the SEC Reports, none of the officers or directors of the Company and, to the knowledge of the Company, none of the employees of the Company is presently a party to any transaction with the Company or any Subsidiary (other than for services as employees, officers and directors), including any contract, agreement or other arrangement providing for the furnishing of services to or by, providing for rental of real or personal property to or from, or otherwise requiring payments to or from any officer, director or such employee or, to the knowledge of the Company, any entity in which any officer, director, or any such employee has a substantial interest or is an officer, director, trustee or partner, in each case in excess of $60,000 other than (i) for payment of salary or consulting fees for services rendered, (ii) reimbursement for expenses incurred on behalf of the Company and (iii) for other employee benefits, including stock option agreements under any stock option plan of the Company. 12 (r) Sarbanes-Oxley; Internal Accounting Controls. The Company is in material compliance with all provisions of the Sarbanes-Oxley Act of 2002 which are applicable to it as of the Closing Date. The Company and the Subsidiaries maintain a system of internal accounting controls sufficient to provide reasonable assurance that (i) transactions are executed in accordance with management's general or specific authorizations, (ii) transactions are recorded as necessary to permit preparation of financial statements in conformity with GAAP and to maintain asset accountability, (iii) access to assets is permitted only in accordance with management's general or specific authorization, and (iv) the recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences. The Company has established disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the Company and designed such disclosure controls and procedures to ensure that material information relating to the Company, including its subsidiaries, is made known to the certifying officers by others within those entities, particularly during the period in which the Company's most recently filed periodic report under the Exchange Act, as the case may be, is being prepared. The Company's certifying officers have evaluated the effectiveness of the Company's controls and procedures as of the date prior to the filing date of the most recently filed periodic report under the Exchange Act (such date, the "Evaluation Date"). The Company presented in its most recently filed periodic report under the Exchange Act the conclusions of the certifying officers about the effectiveness of the disclosure controls and procedures based on their evaluations as of the Evaluation Date. Since the Evaluation Date, there have been no significant changes in the Company's internal controls (as such term is defined in Item 307(b) of Regulation S-K under the Exchange Act) or, to the Company's knowledge, in other factors that could significantly affect the Company's internal controls. (s) Certain Fees. No brokerage or finder's fees or commissions are or will be payable by the Company to any broker, financial advisor or consultant, finder, placement agent, investment banker, bank or other Person with respect to the transactions contemplated by this Agreement. The Purchasers shall have no obligation with respect to any fees or with respect to any claims made by or on behalf of other Persons for fees of a type contemplated in this Section that may be due in connection with the transactions contemplated by this Agreement. (t) Private Placement. Assuming the accuracy of the Purchasers representations and warranties set forth in Section 3.2, no registration under the Securities Act is required for the offer and sale of the Securities by the Company to the Purchasers as contemplated hereby. The issuance and sale of the Securities hereunder does not contravene the rules and regulations of the Trading Market. 13 (u) Investment Company. The Company is not, and is not an Affiliate of, and immediately after receipt of payment for the Shares, will not be or be an Affiliate of, an "investment company" within the meaning of the Investment Company Act of 1940, as amended. The Company shall conduct its business in a manner so that it will not become subject to the Investment Company Act. (v) Registration Rights. No Person has any right to cause the Company to effect the registration under the Securities Act of any securities of the Company. (w) Listing and Maintenance Requirements. The Company's Common Stock is registered pursuant to Section 12(g) of the Exchange Act, and the Company has taken no action designed to, or which to its knowledge is likely to have the effect of, terminating the registration of the Common Stock under the Exchange Act nor has the Company received any notification that the Commission is contemplating terminating such registration. The Company has not, in the 12 months preceding the date hereof, received notice from any Trading Market on which the Common Stock is or has been listed or quoted to the effect that the Company is not in compliance with the listing or maintenance requirements of such Trading Market. The Company is, and has no reason to believe that it will not in the foreseeable future continue to be, in compliance with all such listing and maintenance requirements. (x) Application of Takeover Protections. The Company and its Board of Directors have taken all necessary action, if any, in order to render inapplicable any control share acquisition, business combination, poison pill (including any distribution under a rights agreement) or other similar anti-takeover provision under the Company's Certificate of Incorporation (or similar charter documents) or the laws of its state of incorporation that is or could become applicable to the Purchasers as a result of the Purchasers and the Company fulfilling their obligations or exercising their rights under the Transaction Documents, including without limitation the Company's issuance of the Securities and the Purchasers' ownership of the Securities. (y) Disclosure. The Company confirms that, neither the Company nor any other Person acting on its behalf has provided any of the Purchasers or their agents or counsel with any information that constitutes or might constitute material, non-public information. The Company understands and confirms that the Purchasers will rely on the foregoing representations and covenants in effecting transactions in securities of the Company. All disclosure provided to the Purchasers regarding the Company, its business and the transactions contemplated hereby, including the Schedules to this Agreement, furnished by or on behalf of the Company with respect to the representations and warranties made herein are true and correct with respect to such representations and warranties and do not contain any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements made therein, in light of the circumstances under which they were made, not misleading. The Company acknowledges and agrees that no Purchaser makes or has made any representations or warranties with respect to the transactions contemplated hereby other than those specifically set forth in Section 3.2 hereof. 14 (z) No Integrated Offering. Assuming the accuracy of the Purchasers' representations and warranties set forth in Section 3.2, neither the Company, nor any of its affiliates, nor any Person acting on its or their behalf has, directly or indirectly, made any offers or sales of any security or solicited any offers to buy any security, under circumstances that would cause this offering of the Securities to be integrated with prior offerings by the Company for purposes of the Securities Act or any applicable shareholder approval provisions, including, without limitation, under the rules and regulations of any exchange or automated quotation system on which any of the securities of the Company are listed or designated. - (aa) Solvency. Based on the financial condition of the Company as of the Closing Date after giving effect to the receipt by the Company of the proceeds from the sale of the Securities hereunder, (i) the Company's fair saleable value of its assets exceeds the amount that will be required to be paid on or in respect of the Company's existing debts and other liabilities (including known contingent liabilities) as they mature; (ii) the Company's assets do not constitute unreasonably small capital to carry on its business for the current fiscal year as now conducted and as proposed to be conducted including its capital needs taking into account the particular capital requirements of the business conducted by the Company, and projected capital requirements and capital availability thereof; and (iii) the current cash flow of the Company, together with the proceeds the Company would receive, were it to liquidate all of its assets, after taking into account all anticipated uses of the cash, would be sufficient to pay all amounts on or in respect of its debt when such amounts are required to be paid. The Company does not intend to incur debts beyond its ability to pay such debts as they mature (taking into account the timing and amounts of cash to be payable on or in respect of its debt). (bb) Intentionally Omitted. (cc) Taxes. Except for matters that would not, individually or in the aggregate, have or reasonably be expected to result in a Material Adverse Effect, the Company and each Subsidiary has filed all necessary federal, state and foreign income and franchise tax returns and has paid or accrued all taxes shown as due thereon, and the Company has no knowledge of a tax deficiency which has been asserted or threatened against the Company or any Subsidiary. (dd) General Solicitation. Neither the Company nor any person acting on behalf of the Company has offered or sold any of the Shares by any form of general solicitation or general advertising. The Company has offered the Shares for sale only to the Purchasers and certain other "accredited investors" within the meaning of Rule 501 under the Securities Act. (ee) Foreign Corrupt Practices. Neither the Company, nor to the knowledge of the Company, any agent or other person acting on behalf of the Company, has (i) directly or indirectly, used any corrupt funds for unlawful contributions, gifts, entertainment or other 15 unlawful expenses related to foreign or domestic political activity, (ii) made any unlawful payment to foreign or domestic government officials or employees or to any foreign or domestic political parties or campaigns from corporate funds, (iii) failed to disclose fully any contribution made by the Company (or made by any person acting on its behalf of which the Company is aware) which is in violation of law, or (iv) violated in any material respect any provision of the Foreign Corrupt Practices Act of 1977, as amended. (ff) Accountants. The Company's accountants are set forth on Schedule 3.1(ff) of the Disclosure Schedule. To the Company's knowledge, such accountants, who the Company expects will express their opinion with respect to the financial statements to be included in the Company's Annual Report on Form 10-K for the year ended December 31, 2003, are independent accountants as required by the Securities Act. (gg) Acknowledgment Regarding Purchasers' Purchase of Shares. The Company acknowledges and agrees that each of the Purchasers is acting solely in the capacity of an arm's length purchaser with respect to the Transaction Documents and the transactions contemplated hereby. The Company further acknowledges that no Purchaser is acting as a financial advisor or fiduciary of the Company (or in any similar capacity) with respect to this Agreement and the transactions contemplated hereby and any advice given by any Purchaser or any of their respective representatives or agents in connection with this Agreement and the transactions contemplated hereby is merely incidental to the Purchasers' purchase of the Shares. The Company further represents to each Purchaser that the Company's decision to enter into this Agreement has been based solely on the independent evaluation of the transactions contemplated hereby by the Company and its representatives. 3.2 Representations and Warranties of the Purchasers. Each Purchaser hereby, for itself and for no other Purchaser, represents and warrants as of the date hereof and as of the Closing Date to the Company as follows: (a) Organization; Authority. Such Purchaser is an entity duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization with full right, corporate or partnership power and authority to enter into and to consummate the transactions contemplated by the Transaction Documents and otherwise to carry out its obligations thereunder. The execution, delivery and performance by such Purchaser of the transactions contemplated by this Agreement have been duly authorized by all necessary corporate or similar action on the part of such Purchaser. Each Transaction Document to which it is party a has been duly executed by such Purchaser, and when delivered by such Purchaser in accordance with the terms hereof, will constitute the valid and legally binding obligation of such Purchaser, enforceable against it in accordance with its terms, except (i) as limited by general equitable principles and applicable bankruptcy, insolvency, reorganization, moratorium and other laws of general application affecting enforcement of creditors' rights generally, (ii) as limited by laws relating to the availability of specific performance, injunctive relief or other equitable remedies and (iii) insofar as indemnification and contribution provisions may be limited by applicable law. 16 (b) Investment Intent. Such Purchaser understands that the Securities are "restricted securities" and have not been registered under the Securities Act or any applicable state securities law and is acquiring the Securities as principal for its own account for investment purposes only and not with a view to or for distributing or reselling such Securities or any part thereof, has no present intention of distributing any of such Securities and has no arrangement or understanding with any other persons regarding the distribution of such Securities (this representation and warranty not limiting such Purchaser's right to sell the Securities pursuant to the Registration Statement or otherwise in compliance with applicable federal and state securities laws). Such Purchaser is acquiring the Securities hereunder in the ordinary course of its business. Such Purchaser does not have any agreement or understanding, directly or indirectly, with any Person to distribute any of the Securities. (c) Purchaser Status. At the time such Purchaser was offered the Securities, it was, and at the date hereof it is, and on each date on which it exercises any Warrants, it will be either: (i) an "accredited investor" as defined in Rule 501(a)(1), (a)(2), (a)(3), (a)(7) or (a)(8) under the Securities Act or (ii) a "qualified institutional buyer" as defined in Rule 144A(a) under the Securities Act. Such Purchaser is not required to be registered as a broker-dealer under Section 15 of the Exchange Act. (d) Experience of Such Purchaser. Such Purchaser, either alone or together with its representatives, has such knowledge, sophistication and experience in business and financial matters so as to be capable of evaluating the merits and risks of the prospective investment in the Securities, and has so evaluated the merits and risks of such investment. Such Purchaser is able to bear the economic risk of an investment in the Securities and, at the present time, is able to afford a complete loss of such investment. (e) General Solicitation. Such Purchaser is not purchasing the Securities as a result of any advertisement, article, notice or other communication regarding the Securities published in any newspaper, magazine or similar media or broadcast over television or radio or presented at any seminar or any other general solicitation or general advertisement. (f) Registration Required. Such Purchaser hereby covenants with the Company not to make any sale of the Shares and Warrant Shares without complying with the provisions hereof and of the Registration Rights Agreement, and without effectively causing the prospectus delivery requirement under the Securities Act to be satisfied (unless such Purchaser is selling such Shares and Warrant Shares in a transaction not subject to the prospectus delivery requirement), and such Purchaser acknowledges that the certificates evidencing the Shares and Warrant Shares will be imprinted with a legend that prohibits their transfer except in accordance therewith. 17 (g) No Tax or Legal Advice. Such Purchaser understands that nothing in this Agreement, any other Transaction Document or any other materials presented to such Purchaser in connection with the purchase and sale of the Securities constitutes legal, tax or investment advice. Such Purchaser has consulted such legal, tax and investment advisors as it, in its sole discretion, has deemed necessary or appropriate in connection with its purchase of Securities. (h) Disclosure of Information. Such Purchaser believes it has received all the information it considers necessary or appropriate for deciding whether to purchase the Shares and Warrants. Such Purchaser further represents that it has had an opportunity to ask questions and receive answers from the Company regarding the terms and conditions of the offering of the Shares and Warrants and the business, properties, prospects and financial condition of the Company. Such Purchaser has reviewed the Company's Annual Report on Form 10K-SB for the fiscal year ended December 31, 2002 (the "10K-SB"), including, without limitation, all of the Factors Affecting Business, Operating Results and Financial Condition set forth therein (the "Risk Factors"). Each such Purchaser understands and accepts all of the Risk Factors in connection with such Purchaser's investment in the Securities. In addition, each Purchaser has reviewed and is aware of the information set forth in all SEC Reports filed with the SEC since the filing of the 10K-SB. (i) Open Short Position. As of the date hereof, each Purchaser, for itself only, represents and warrants that neither it, nor any person or entity acting at the direction of such Purchaser, holds an open short position in the Company's Common Stock. The Company acknowledges and agrees that each Purchaser does not make or has not made any representations or warranties with respect to the transactions contemplated hereby other than those specifically set forth in this Section 3.2. ARTICLE IV. OTHER AGREEMENTS OF THE PARTIES 4.1 Transfer Restrictions. (a) The Securities may only be disposed of in compliance with state and federal securities laws. In connection with any transfer of Securities other than pursuant to an effective registration statement or Rule 144, to the Company or to an Affiliate of a Purchaser or in connection with a pledge as contemplated in Section 4.1(b), the Company may require the transferor thereof to provide to the Company an opinion of counsel selected by the transferor and reasonably acceptable to the Company, the form and substance of which opinion and shall be reasonably satisfactory to the Company, to the effect that such transfer does not require registration of such transferred Securities under the Securities Act. As a condition of transfer, any such transferee shall agree in writing to be bound by the terms of this Agreement and shall have the rights of a Purchaser under this Agreement and the Registration Rights Agreement. (b) The Purchasers agree to the imprinting, so long as is required by this Section 4.1(b), of a legend on any of the Securities in the following form: THESE SECURITIES HAVE NOT BEEN REGISTERED WITH THE SECURITIES AND EXCHANGE COMMISSION OR THE SECURITIES COMMISSION OF ANY STATE IN RELIANCE UPON AN EXEMPTION FROM REGISTRATION UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND, ACCORDINGLY, MAY NOT BE OFFERED OR SOLD EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OR PURSUANT TO AN AVAILABLE EXEMPTION FROM, OR IN A TRANSACTION NOT SUBJECT TO, THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND IN ACCORDANCE WITH APPLICABLE STATE SECURITIES LAWS AS EVIDENCED BY A LEGAL OPINION OF COUNSEL TO THE TRANSFEROR TO SUCH EFFECT, THE SUBSTANCE OF WHICH SHALL BE REASONABLY ACCEPTABLE TO THE COMPANY. THESE SECURITIES MAY BE PLEDGED IN CONNECTION WITH A BONA FIDE MARGIN ACCOUNT WITH A REGISTERED BROKER-DEALER OR OTHER LOAN WITH A FINANCIAL INSTITUTION THAT IS AN "ACCREDITED INVESTOR" AS DEFINED IN RULE 501(a) UNDER THE SECURITIES ACT. The Company acknowledges and agrees that a Purchaser may from time to time pledge pursuant to a bona fide margin agreement with a registered broker-dealer or grant a security interest in some or all of the Securities to a financial institution that is an "accredited investor" as defined in Rule 501(a) under the Securities Act and who agrees to be bound by the provisions of this Agreement and the Registration Rights Agreement and, if required under the terms of such arrangement, such Purchaser may transfer pledged or secured Securities to the pledgees or secured parties. Such a pledge or transfer would not be subject to approval of the Company and no legal opinion of legal counsel of the pledgee, secured party or pledgor shall be required in connection therewith. Further, no notice shall be required of such pledge. At the appropriate Purchaser's expense, the Company will execute and deliver such reasonable documentation as a pledgee or secured party of Securities may reasonably request in connection with a pledge or transfer of the Securities, including, if the Securities are subject to registration pursuant to the Registration Rights Agreement, the preparation and filing of any required prospectus supplement under Rule 424(b)(3) under the Securities Act or other applicable provision of the Securities Act to appropriately amend the list of Selling Stockholders thereunder. 18 (c) Certificates evidencing the Shares and Warrant Shares shall not contain any legend (including the legend set forth in Section 4.1(b)), (i) while a registration statement (including the Registration Statement) covering the resale of such security is effective under the Securities Act, or (ii) following any sale of such Shares or Warrant Shares pursuant to Rule 144, or (iii) if such Shares or Warrant Shares are eligible for sale under Rule 144(k), or (iv) if such legend is not required under applicable requirements of the Securities Act (including judicial interpretations and pronouncements issued by the Staff of the Commission). The Company shall cause its counsel to issue a legal opinion to the Company's transfer agent promptly after the Effective Date if required by the Company's transfer agent to effect the removal of the legend hereunder. If all or any portion of a Warrant is exercised at a time when there is an effective registration statement to cover the resale of the Warrant Shares, such Warrant Shares shall be issued free of all legends. The Company agrees that following the Effective Date or at such time as such legend is no longer required under this Section 4.1(c), it will, no later than three Trading Days following the delivery by a Purchaser to the Company or the Company's transfer agent of a certificate representing Shares or Warrant Shares, as the case may be, issued with a restrictive legend (such date, the "Legend Removal Date"), deliver or cause to be delivered to such Purchaser a certificate representing such Securities that is free from all restrictive and other legends. The Company may not make any notation on its records or give instructions to any transfer agent of the Company that enlarge the restrictions on transfer set forth in this Section. (d) In addition to such Purchaser's other available remedies, the Company shall pay to a Purchaser, in cash, as partial liquidated damages and not as a penalty, for each $1,000 of Shares or Warrant Shares (based on the VWAP of the Common Stock on the date such Securities are submitted to the Company's transfer agent) subject to Section 4.1(c), $10 per Trading Day (increasing to $20 per Trading Day five (5) Trading Days after such damages have begun to accrue) for each Trading Day after the Legend Removal Date until such certificate is delivered. Nothing herein shall limit such Purchaser's right to pursue actual damages for the Company's failure to deliver certificates representing any Securities as required by the Transaction Documents, and such Purchaser shall have the right to pursue all remedies available to it at law or in equity including, without limitation, a decree of specific performance and/or injunctive relief. (e) Each Purchaser, severally and not jointly with the other Purchasers, agrees that the removal of the restrictive legend from certificates representing Securities as set forth in this Section 4.1 is predicated upon the Company's reliance that the Purchaser will sell any Securities pursuant to either the registration requirements of the Securities Act, including any applicable prospectus delivery requirements, or an exemption therefrom. (f) Until the date that each Purchaser holds less than 20% of the Shares initially purchased hereunder by such Purchaser, the Company shall not undertake a reverse or forward stock split or reclassification of the Common Stock without the prior written consent of the Purchasers holding a majority in interest of the Shares. 19 4.2 Furnishing of Information. As long as any Purchaser owns Securities, the Company covenants to timely file (or obtain extensions in respect thereof and file within the applicable grace period) all reports required to be filed by the Company after the date hereof pursuant to the Exchange Act. As long as any Purchaser owns Securities, if the Company is not required to file reports pursuant to the Exchange Act, it will prepare and furnish to the Purchasers and make publicly available in accordance with Rule 144(c) such information as is required for the Purchasers to sell the Securities under Rule 144. The Company further covenants that it will take such further action as any holder of Securities may reasonably request, all to the extent required from time to time to enable such Person to sell such Securities without registration under the Securities Act within the limitation of the exemptions provided by Rule 144. 4.3 Integration. The Company shall not sell, offer for sale or solicit offers to buy or otherwise negotiate in respect of any security (as defined in Section 2 of the Securities Act) that would be integrated with the offer or sale of the Securities in a manner that would require the registration under the Securities Act of the sale of the Securities to the Purchasers or that would be integrated with the offer or sale of the Securities for purposes of the rules and regulations of any Trading Market such that it would require shareholder approval prior to the closing of such other transaction unless shareholder approval is obtained before the closing of such subsequent transaction. 4.4 Securities Laws Disclosure; Publicity. The Company shall, by 8:30 a.m. Eastern time on the Trading Day following the date hereof, issue a press release or file a Current Report on Form 8-K, in each case reasonably acceptable to each Purchaser disclosing the material terms of the transactions contemplated hereby. The Company and each Purchaser shall consult with each other in issuing any other press releases with respect to the transactions contemplated hereby, and neither the Company nor any Purchaser shall issue any such press release or otherwise make any such public statement without the prior consent of the Company, with respect to any press release of any Purchaser, or without the prior consent of each Purchaser, with respect to any press release of the Company, which consent shall not unreasonably be withheld, except if such disclosure is required by law, in which case the disclosing party shall promptly provide the other party with prior notice of such public statement or communication. Notwithstanding the foregoing, the Company shall not publicly disclose the name of any Purchaser, or include the name of any Purchaser in any filing with the Commission or any regulatory agency or Trading Market, without the prior written consent of such Purchaser, except (i) as required by federal securities law in connection with the registration statement contemplated by the Registration Rights Agreement and (ii) to the extent such disclosure is required by law or Trading Market regulations, in which case the Company shall provide the Purchasers with prior notice of such disclosure permitted under subclause (i) or (ii). 20 4.5 Shareholders Rights Plan. No claim will be made or enforced by the Company or, to the knowledge of the Company, any other Person that any Purchaser is an "Acquiring Person" under any shareholders rights plan or similar plan or arrangement in effect or hereafter adopted by the Company, or that any Purchaser could be deemed to trigger the provisions of any such plan or arrangement, by virtue of receiving Securities under the Transaction Documents or under any other agreement between the Company and the Purchasers. The Company shall conduct its business in a manner so that it will not become subject to the Investment Company Act. 4.6 Non-Public Information. The Company covenants and agrees that neither it nor any other Person acting on its behalf will provide any Purchaser or its agents or counsel with any information that the Company believes constitutes material non-public information, unless prior thereto such Purchaser shall have executed a written agreement regarding the confidentiality and use of such information. The Company understands and confirms that each Purchaser shall be relying on the foregoing representations in effecting transactions in securities of the Company. 4.7 Use of Proceeds. Except as set forth on Schedule 4.7 attached hereto, the Company shall use the net proceeds from the sale of the Securities hereunder for working capital purposes and not for the satisfaction of any portion of the Company's debt (other than payment of trade payables in the ordinary course of the Company's business and prior practices), to redeem any Company equity or equity-equivalent securities or to settle any outstanding litigation. 4.8 Reimbursement. If any Purchaser becomes involved in any capacity in any Proceeding by or against any Person who is a stockholder of the Company (except as a result of sales, pledges, margin sales and similar transactions by such Purchaser to or with any current stockholder, or a breach of such Purchaser's representation, warranties or covenants under the Transaction Documents, or any agreements or understandings such Purchaser may have with any such stockholder, or any violations by the Purchaser of state or federal securities laws, or any conduct by such Purchaser which constitutes fraud, gross negligence, willful misconduct or malfeasance), solely as a result of such Purchaser's acquisition of the Securities under this Agreement, the Company will reimburse such Purchaser for its reasonable legal and other expenses (including the cost of any investigation preparation and travel in connection therewith) incurred in connection therewith, as such expenses are incurred. The reimbursement obligations of the Company under this paragraph shall be in addition to any liability which the Company may otherwise have, shall extend upon the same terms and conditions to any Affiliates of the Purchasers who are actually named in such action, proceeding or investigation, and partners, directors, agents, employees and controlling persons (if any), as the case may be, of the Purchasers and any such Affiliate, and shall be binding upon and inure to the benefit of any successors, assigns, heirs and personal representatives of the Company, the Purchasers and any such Affiliate and any such Person. The Company also agrees that neither the Purchasers nor any such Affiliates, partners, directors, agents, employees or controlling persons shall have any liability to the Company or any Person asserting claims on behalf of or in right of the Company solely as a result of acquiring the Securities under this Agreement. 21 4.9 Indemnification of Purchasers. Subject to the provisions of this Section 4.9, the Company will indemnify and hold the Purchasers and their directors, officers, shareholders, partners, employees and agents (each, a "Purchaser Party") harmless from any and all losses, liabilities, obligations, claims, contingencies, damages, costs and expenses, including all judgments, amounts paid in settlements, court costs and reasonable attorneys' fees and costs of investigation that any such Purchaser Party may suffer or incur as a result of or relating to (a) any breach of any of the representations, warranties, covenants or agreements made by the Company in this Agreement or in the other Transaction Documents or (b) any action instituted against a Purchaser, or any of them or their respective Affiliates, by any stockholder of the Company who is not an Affiliate of such Purchaser, with respect to any of the transactions contemplated by the Transaction Documents (unless such action is based upon a breach of such Purchaser's representation, warranties or covenants under the Transaction Documents or any agreements or understandings such Purchaser may have with any such stockholder or any violations by the Purchaser of state or federal securities laws or any conduct by such Purchaser which constitutes fraud, gross negligence, willful misconduct or malfeasance). If any action shall be brought against any Purchaser Party in respect of which indemnity may be sought pursuant to this Agreement, such Purchaser Party shall promptly notify the Company in writing, and the Company shall have the right to assume the defense thereof with counsel of its own choosing. Any Purchaser Party shall have the right to employ separate counsel in any such action and participate in the defense thereof, but the fees and expenses of such counsel shall be at the expense of such Purchaser Party except to the extent that (i) the employment thereof has been specifically authorized by the Company in writing, (ii) the Company has failed after a reasonable period of time to assume such defense and to employ counsel or (iii) in such action there is, in the reasonable opinion of such separate counsel, a material conflict on any material issue between the position of the Company and the position of such Purchaser Party. The Company will not be liable to any Purchaser Party under this Agreement (i) for any settlement by an Purchaser Party effected without the Company's prior written consent, which shall not be unreasonably withheld or delayed; or (ii) to the extent, but only to the extent that a loss, claim, damage or liability is attributable to any Purchaser Party's breach of any of the representations, warranties, covenants or agreements made by the Purchasers in this Agreement or in the other Transaction Documents. 4.10 Reservation of Common Stock. As of the date hereof, the Company has reserved and the Company shall continue to reserve and keep available at all times, free of preemptive rights, a sufficient number of shares of Common Stock for the purpose of enabling the Company to issue Shares pursuant to this Agreement and Warrant Shares pursuant to any exercise of the Warrants. 4.11 Listing of Common Stock. The Company hereby agrees to use best efforts to maintain the listing of the Common Stock on a Trading Market, and as soon as reasonably practicable following the Closing (but not later than the earlier of the Effective Date and the first anniversary of the Closing Date) to list all of the Shares and Warrant Shares on such Trading Market. The Company further agrees, if the Company applies to have the Common Stock traded on any other Trading Market, it will include in such application all of the Shares and Warrant Shares, and will take such other action as is necessary to cause all of the Shares and Warrant Shares to be listed on such other Trading Market as promptly as possible. The Company will take all action reasonably necessary to continue the listing and trading of its Common Stock on a Trading Market and will comply in all respects with the Company's reporting, filing and other obligations under the bylaws or rules of the Trading Market. 22 4.12 Equal Treatment of Purchasers. No consideration shall be offered or paid to any person to amend or consent to a waiver or modification of any provision of any of the Transaction Documents unless the same consideration is also offered to all of the parties to the Transaction Documents. For clarification purposes, this provision constitutes a separate right granted to each Purchaser by the Company and negotiated separately by each Purchaser, and is intended to treat for the Company the Purchasers as a class and shall not in any way be construed as the Purchasers acting in concert or as a group with respect to the purchase, disposition or voting of Securities or otherwise. 4.13 Participation in Future Financing. From the date hereof until 12 months after the Effective Date, upon any financing by the Company of its Capital Shares or Capital Shares Equivalents (a "Subsequent Financing"), each Purchaser shall have the right to participate in up to 100% of such Subsequent Financing (the "Participation Maximum"). At least 5 Trading Days prior to the closing of the Subsequent Financing, the Company shall deliver to each Purchaser a written notice of its intention to effect a Subsequent Financing ("Pre-Notice"), which Pre-Notice shall ask such Purchaser if it wants to review the details of such financing (such additional notice, a "Subsequent Financing Notice"). Upon the request of a Purchaser, and only upon a request by such Purchaser, for a Subsequent Financing Notice, the Company shall promptly, but no later than 1 Trading Day after such request, deliver a Subsequent Financing Notice to such Purchaser. The Subsequent Financing Notice shall describe in reasonable detail the proposed terms of such Subsequent Financing, the amount of proceeds intended to be raised thereunder, the Person with whom such Subsequent Financing is proposed to be effected, and attached to which shall be a term sheet or similar document relating thereto. If by 6:30 p.m. (New York City time) on the fifth Trading Day after all of the Purchasers have received the Pre-Notice, notifications by the Purchasers of their willingness to participate in the Subsequent Financing (or to cause their designees to participate) is, in the aggregate, less than the total amount of the Subsequent Financing, then the Company may effect the remaining portion of such Subsequent Financing on the terms and to the Persons set forth in the Subsequent Financing Notice. If the Company receives no notice from a Purchaser as of such 5th Trading Day, such Purchaser shall be deemed to have notified the Company that it does not elect to participate. The Company must provide the Purchasers with a second Subsequent Financing Notice, and the Purchasers will again have the right of participation set forth above in this Section 4.13, if the Subsequent Financing subject to the initial Subsequent Financing Notice is not consummated for any reason on the terms set forth in such Subsequent Financing Notice within 60 Trading Days after the date of the initial Subsequent Financing Notice. In the event the Company receives responses to Subsequent Financing Notices from Purchasers seeking to purchase more than the aggregate amount of the Subsequent Financing, each such Purchaser shall have the right to purchase their Pro Rata Portion (as defined below) of the Participation Maximum. "Pro Rata Portion" is the ratio of (x) the Subscription Amount of Securities purchased by a participating Purchaser and (y) the sum of the aggregate Subscription Amount of all participating Purchasers. Notwithstanding the foregoing, this Section 4.13 shall not apply in respect of the issuance of (a) shares of Common Stock or options to employees, officers or directors of the Company pursuant to any stock or option plan duly adopted by a majority of the non-employee members of the Board of Directors of the Company or a majority of the members of a committee of non-employee directors established for such purpose or (b) securities upon the exercise of or conversion of any convertible securities, options or warrants issued and outstanding on the date of this Agreement, provided that such securities have not been amended since the date of this Agreement. 23 4.14 Subsequent Equity Sales. Except as contemplated in Section 4.17, from the date hereof until 90 days after the Effective Date, neither the Company nor any Subsidiary shall issue shares of Common Stock or Common Stock Equivalents; provided, however, the 90 day period set forth in this Section 4.14 shall be extended for the number of Trading Days during such period in which (y) trading in the Common Stock is suspended by any Trading Market, or (z) following the Effective Date, the Registration Statement is not effective or the prospectus included in the Registration Statement may not be used by the Purchasers for the resale of the Shares and Warrant Shares. Notwithstanding the foregoing, this Section 4.14 shall not apply in respect of the issuance of (a) shares of Common Stock or options to key consultants, employees, officers or directors of the Company pursuant to any stock or option plan duly adopted the Board of Directors of the Company or a majority of the members of a committee of directors established for such purpose or (b) securities upon the exercise of or conversion of any convertible securities, options or warrants (including securities issuable pursuant to this Agreement) issued and outstanding on the date of this Agreement, provided that such securities have not been amended since the date of this Agreement. 4.15 Deliver of Securities After Closing. The Company shall deliver, or cause to be delivered, the respective Shares and Warrants purchased by each Purchaser to such Purchaser within 3 Trading Days of the Closing Date. 4.16 Intentionally Omitted. 4.17 Additional Investment. From the date hereof until 12 months after the Closing Date, each Purchaser may, in its sole determination and severally and not jointly with the other Purchasers, elect to purchase, in the ratio of such Purchaser's Subscription Amount on the Closing Date to the aggregate Subscription Amounts of all Purchasers on the Closing Date, additional shares of Common Stock and Warrants for an aggregate purchase price among all Purchasers of up to $3,000,000. Any additional investment will be on terms and prices identical those set forth in the Transaction Documents, mutatis mutandis. In order to effectuate a purchase and sale of the additional shares of Common Stock and Warrants, the Company and the Purchasers shall enter into the following agreements: (x) a securities purchase agreement identical to this Agreement, mutatis mutandis and shall include updated disclosure schedules and (y) a registration rights agreement identical to the Registration Rights Agreement, mutatis mutandis and shall include updated disclosure schedules. Any such additional Investment shall, subject to the closing conditions set forth in the securities purchase agreement, close within 10 Trading Days of notice to the Company by a Purchaser that such Purchaser elects to exercise its rights hereunder. The parties hereby agree and acknowledge that the rights granted hereunder to a Purchaser are independent and separate of the rights granted to any other Purchaser and a Purchasers election to exercise its right to an additional investment hereunder does not obligate any other Purchaser to also elect at such time nor does it waive any Purchaser's right to elect to exercise at a later date. 24 ARTICLE V. MISCELLANEOUS 5.1 Fees and Expenses. Except as otherwise set forth in this Agreement, each party shall pay the fees and expenses of its advisers, counsel, accountants and other experts, if any, and all other expenses incurred by such party incident to the negotiation, preparation, execution, delivery and performance of this Agreement. The Company shall pay all stamp and other taxes and duties levied in connection with the sale of the Securities. 5.2 Entire Agreement. The Transaction Documents, together with the exhibits and schedules thereto, contain the entire understanding of the parties with respect to the subject matter hereof and supersede all prior agreements and understandings, oral or written, with respect to such matters, which the parties acknowledge have been merged into such documents, exhibits and schedules. 5.3 Notices. Any and all notices or other communications or deliveries required or permitted to be provided hereunder shall be in writing and shall be deemed given and effective on the earliest of (a) the date of transmission, if such notice or communication is delivered via facsimile at the facsimile number set forth on the signature pages attached hereto prior to 6:30 p.m. (New York City time) on a Trading Day, (b) the next Trading Day after the date of transmission, if such notice or communication is delivered via facsimile at the facsimile number set forth on the signature pages attached hereto on a day that is not a Trading Day or later than 6:30 p.m. (New York City time) on any Trading Day, (c) the second Trading Day following the date of mailing, if sent by U.S. nationally recognized overnight courier service, or (d) upon actual receipt by the party to whom such notice is required to be given. The address for such notices and communications shall be as set forth on the signature pages attached hereto. 5.4 Amendments; Waivers. No provision of this Agreement may be waived or amended except in a written instrument signed, in the case of an amendment, by the Company and each Purchaser or, in the case of a waiver, by the party against whom enforcement of any such waiver is sought. No waiver of any default with respect to any provision, condition or requirement of this Agreement shall be deemed to be a continuing waiver in the future or a waiver of any subsequent default or a waiver of any other provision, condition or requirement hereof, nor shall any delay or omission of either party to exercise any right hereunder in any manner impair the exercise of any such right. 25 5.5 Construction. The headings herein are for convenience only, do not constitute a part of this Agreement and shall not be deemed to limit or affect any of the provisions hereof. The language used in this Agreement will be deemed to be the language chosen by the parties to express their mutual intent, and no rules of strict construction will be applied against any party. 5.6 Successors and Assigns. This Agreement shall be binding upon and inure to the benefit of the parties and their successors and permitted assigns. The Company may not assign this Agreement or any rights or obligations hereunder without the prior written consent of each Purchaser. Any Purchaser may assign any or all of its rights under this Agreement to any Person to whom such Purchaser assigns or transfers any Securities, provided such transferee agrees in writing to be bound, with respect to the transferred Securities, by the provisions hereof that apply to the "Purchasers". 5.7 No Third-Party Beneficiaries. This Agreement is intended for the benefit of the parties hereto and their respective successors and permitted assigns and is not for the benefit of, nor may any provision hereof be enforced by, any other Person, except as otherwise set forth in Section 4.9. 5.8 Governing Law. All questions concerning the construction, validity, enforcement and interpretation of the Transaction Documents shall be governed by and construed and enforced in accordance with the internal laws of the State of New York, without regard to the principles of conflicts of law thereof. Each party hereby irrevocably submits to the exclusive jurisdiction of the state and federal courts sitting in the City of New York, borough of Manhattan for the adjudication of any dispute hereunder or in connection herewith or with any transaction contemplated hereby or discussed herein (including with respect to the enforcement of any of the Transaction Documents), and hereby irrevocably waives, and agrees not to assert in any suit, action or proceeding, any claim that it is not personally subject to the jurisdiction of any such court, that such suit, action or proceeding is improper or inconvenient venue for such proceeding. Each party hereby irrevocably waives personal service of process and consents to process being served in any such suit, action or proceeding by mailing a copy thereof via registered or certified mail or overnight delivery (with evidence of delivery) to such party at the address in effect for notices to it under this Agreement and agrees that such service shall constitute good and sufficient service of process and notice thereof. Nothing contained herein shall be deemed to limit in any way any right to serve process in any manner permitted by law. The parties hereby waive all rights to a trial by jury. If either party shall commence an action or proceeding to enforce any provisions of the Transaction Documents, then the prevailing party in such action or proceeding shall be reimbursed by the other party for its attorneys' fees and other costs and expenses incurred with the investigation, preparation and prosecution of such action or proceeding. 5.9 Survival. The representations and warranties herein shall survive the Closing and delivery of the Shares and Warrant Shares. 26 5.10 Execution. This Agreement may be executed in two or more counterparts, all of which when taken together shall be considered one and the same agreement and shall become effective when counterparts have been signed by each party and delivered to the other party, it being understood that both parties need not sign the same counterpart. In the event that any signature is delivered by facsimile transmission, such signature shall create a valid and binding obligation of the party executing (or on whose behalf such signature is executed) with the same force and effect as if such facsimile signature page were an original thereof. 5.11 Severability. If any provision of this Agreement is held to be invalid or unenforceable in any respect, the validity and enforceability of the remaining terms and provisions of this Agreement shall not in any way be affected or impaired thereby and the parties will attempt to agree upon a valid and enforceable provision that is a reasonable substitute therefor, and upon so agreeing, shall incorporate such substitute provision in this Agreement. 5.12 Rescission and Withdrawal Right. Notwithstanding anything to the contrary contained in (and without limiting any similar provisions of) the Transaction Documents, whenever any Purchaser exercises a right, election, demand or option under a Transaction Document and the Company does not timely perform its related obligations within the periods therein provided, then such Purchaser may rescind or withdraw, in its sole discretion from time to time upon written notice to the Company, any relevant notice, demand or election in whole or in part without prejudice to its future actions and rights. 5.13 Replacement of Securities. If any certificate or instrument evidencing any Securities is mutilated, lost, stolen or destroyed, the Company shall issue or cause to be issued in exchange and substitution for and upon cancellation thereof, or in lieu of and substitution therefor, a new certificate or instrument, but only upon receipt of evidence reasonably satisfactory to the Company of such loss, theft or destruction and customary and reasonable indemnity, if requested. The applicants for a new certificate or instrument under such circumstances shall also pay any reasonable third-party costs associated with the issuance of such replacement Securities. 5.14 Remedies. In addition to being entitled to exercise all rights provided herein or granted by law, including recovery of damages, each of the Purchasers and the Company will be entitled to specific performance under the Transaction Documents. The parties agree that monetary damages may not be adequate compensation for any loss incurred by reason of any breach of obligations described in the foregoing sentence and hereby agrees to waive in any action for specific performance of any such obligation the defense that a remedy at law would be adequate. 5.15 Payment Set Aside. To the extent that the Company makes a payment or payments to any Purchaser pursuant to any Transaction Document or a Purchaser enforces or exercises its rights thereunder, and such payment or payments or the proceeds of such enforcement or exercise or any part thereof are subsequently invalidated, declared to be fraudulent or preferential, set aside, recovered from, disgorged by or are required to be refunded, repaid or otherwise restored to the Company, a trustee, receiver or any other person under any law (including, without limitation, any bankruptcy law, state or federal law, common law or equitable cause of action), then to the extent of any such restoration the obligation or part thereof originally intended to be satisfied shall be revived and continued in full force and effect as if such payment had not been made or such enforcement or setoff had not occurred. 27 5.16 Independent Nature of Purchasers' Obligations and Rights. The obligations of each Purchaser under any Transaction Document are several and not joint with the obligations of any other Purchaser, and no Purchaser shall be responsible in any way for the performance of the obligations of any other Purchaser under any Transaction Document. Nothing contained herein or in any Transaction Document, and no action taken by any Purchaser pursuant thereto, shall be deemed to constitute the Purchasers as a partnership, an association, a joint venture or any other kind of entity, or create a presumption that the Purchasers are in any way acting in concert or as a group with respect to such obligations or the transactions contemplated by the Transaction Document. Each Purchaser shall be entitled to independently protect and enforce its rights, including without limitation, the rights arising out of this Agreement or out of the other Transaction Documents, and it shall not be necessary for any other Purchaser to be joined as an additional party in any proceeding for such purpose. Each Purchaser has been represented by its own separate legal counsel in their review and negotiation of the Transaction Documents. For reasons of administrative convenience only, Purchasers and their respective counsel have chosen to communicate with the Company through FW. FW does not represent all of the Purchasers but only HPC Capital Management, who has acted as placement agent to the transaction. The Company has elected to provide all Purchasers with the same terms and Transaction Documents for the convenience of the Company and not because it was required or requested to do so by the Purchasers. 5.17 Liquidated Damages. The Company's obligations to pay any partial liquidated damages or other amounts owing under the Transaction Documents is a continuing obligation of the Company and shall not terminate until all unpaid partial liquidated damages and other amounts have been paid notwithstanding the fact that the instrument or security pursuant to which such partial liquidated damages or other amounts are due and payable shall have been canceled. (Signature Page Follows) 28 IN WITNESS WHEREOF, the parties hereto have caused this Securities Purchase Agreement to be duly executed by their respective authorized signatories as of the date first indicated above. INDUSTRIES INTERNATIONAL, INCORPORATED Address for Notice: ------------------- By: ---------------------------------------------- Name: Tsui Kit Title: Chief Executive Officer With a copy to (which shall not constitute notice): [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK SIGNATURE PAGES FOR PURCHASERS FOLLOW] 29 [PURCHASER SIGNATURE PAGES TO IDUL SECURITIES PURCHASE AGREEMENT] IN WITNESS WHEREOF, the undersigned have caused this Securities Purchase Agreement to be duly executed by their respective authorized signatories as of the date first indicated above. Name of Investing Entity: ______________________________________________________ Signature of Authorized Signatory of Investing Entity: _________________________ Name of Authorized Signatory: __________________________________________________ Title of Authorized Signatory: _________________________________________________ Email Address of Authorized Entity:_____________________________________________ Address for Notice of Investing Entity: Address for Delivery of Securities for Investing Entity (if not same as above): Subscription Amount: Shares: Warrant Shares: EIN Number: [PROVIDE THIS UNDER SEPARATE COVER] [SIGNATURE PAGES CONTINUE] 30 EX-10.4 4 v02407_ex10-4.txt NEITHER THIS SECURITY NOR THE SECURITIES INTO WHICH THIS SECURITY IS EXERCISABLE HAVE BEEN REGISTERED WITH THE SECURITIES AND EXCHANGE COMMISSION OR THE SECURITIES COMMISSION OF ANY STATE IN RELIANCE UPON AN EXEMPTION FROM REGISTRATION UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND, ACCORDINGLY, MAY NOT BE OFFERED OR SOLD EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OR PURSUANT TO AN AVAILABLE EXEMPTION FROM, OR IN A TRANSACTION NOT SUBJECT TO, THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND IN ACCORDANCE WITH APPLICABLE STATE SECURITIES LAWS AS EVIDENCED BY A LEGAL OPINION OF COUNSEL TO THE TRANSFEROR REASONABLY ACCEPTABLE TO THE COMPANY TO SUCH EFFECT, THE SUBSTANCE OF WHICH SHALL BE REASONABLY ACCEPTABLE TO THE COMPANY. THIS SECURITY MAY BE PLEDGED IN CONNECTION WITH A BONA FIDE MARGIN ACCOUNT WITH A REGISTERED BROKER-DEALER OR OTHER LOAN WITH A FINANCIAL INSTITUTION THAT IS AN "ACCREDITED INVESTOR" AS DEFINED IN RULE 501(a) UNDER THE SECURITIES ACT. COMMON STOCK PURCHASE WARRANT To Purchase __________ Shares of Common Stock of Industries International, Incorporated THIS COMMON STOCK PURCHASE WARRANT (the "Warrant") CERTIFIES that, for value received, _____________ (the "Holder"), is entitled, upon the terms and subject to the limitations on exercise and the conditions hereinafter set forth, at any time on or after the date of issuance of this Warrant (the "Initial Exercise Date") and on or prior to the third anniversary of the Initial Exercise Date (the "Termination Date") but not thereafter, to subscribe for and purchase from Industries International, Incorporated, a Nevada corporation (the "Company"), up to ____________ shares (the "Warrant Shares") of Common Stock, par value $0.01 per share, of the Company (the "Common Stock"). The purchase price of one share of Common Stock (the "Exercise Price") under this Warrant shall be $2.7601 subject to adjustment hereunder. The Exercise Price and the number of Warrant Shares for which the Warrant is exercisable shall be subject to adjustment as provided herein. Capitalized terms used and not otherwise defined herein shall have the meanings set forth in that certain Securities Purchase Agreement (the "Purchase Agreement"), dated February 25, 2004, among the Company and the purchasers signatory thereto. 1 1. Title to Warrant. Prior to the Termination Date and subject to compliance with applicable laws and Section 7 of this Warrant, this Warrant and all rights hereunder are transferable, in whole or in part, at the office or agency of the Company by the Holder in person or by duly authorized attorney, upon surrender of this Warrant together with the Assignment Form annexed hereto properly endorsed. The transferee shall sign an investment letter in form and substance reasonably satisfactory to the Company. 2. Authorization of Shares. The Company covenants that all Warrant Shares which may be issued upon the exercise of the purchase rights represented by this Warrant will, upon exercise of the purchase rights represented by this Warrant, be duly authorized, validly issued, fully paid and nonassessable and free from all taxes, liens and charges in respect of the issue thereof (other than taxes in respect of any transfer occurring contemporaneously with such issue). 3. Exercise of Warrant. (a) Exercise of the purchase rights represented by this Warrant may be made at any time or times on or after the Initial Exercise Date and on or before the Termination Date by delivery to the Company of a duly executed facsimile copy of the Notice of Exercise Form annexed hereto (or such other office or agency of the Company as it may designate by notice in writing to the registered Holder at the address of such Holder appearing on the books of the Company); provided, however, within 5 Trading Days of the date said Notice of Exercise is delivered to the Company, the Holder shall have surrendered this Warrant to the Company and the Company shall have received payment of the aggregate Exercise Price of the shares thereby purchased by wire transfer or cashier's check drawn on a United States bank. Certificates for shares purchased hereunder shall be delivered to the Holder within the earlier of (i) 5 Trading Days after the date on which the Notice of Exercise shall have been delivered by facsimile copy or (ii) 3 Trading Days from the delivery to the Company of the Notice of Exercise Form by facsimile copy, surrender of this Warrant and payment of the aggregate Exercise Price as set forth above ("Warrant Share Delivery Date"); provided, however, in the event the Warrant is not surrendered or the aggregate Exercise Price is not received by the Company within 5 Trading Days after the date on which the Notice of Exercise shall be delivered by facsimile copy, the Warrant Share Delivery Date shall be extended to the extent such 5 Trading Day period is exceeded. This Warrant shall be deemed to have been exercised on the later of the date the Notice of Exercise is delivered to the Company by facsimile copy and the date the Exercise Price is received by the Company. The Warrant Shares shall be deemed to have been issued, and Holder or any other person so designated to be named therein shall be deemed to have become a holder of record of such shares for all purposes, as of the date the Warrant has been exercised by payment to the Company of the Exercise Price and all taxes required to be paid by the Holder, if any, pursuant to Section 5 prior to the issuance of such shares, have been paid. If 2 the Company fails to deliver to the Holder a certificate or certificates representing the Warrant Shares pursuant to this Section 3(a) by the third Trading Day following the Warrant Share Delivery Date, then the Holder will have the right to rescind such exercise. In addition to any other rights available to the Holder, if the Company fails to deliver to the Holder a certificate or certificates representing the Warrant Shares pursuant to an exercise by the third Trading Day after the Warrant Share Delivery Date, and if after such day the Holder is required by its broker to purchase (in an open market transaction or otherwise) shares of Common Stock to deliver in satisfaction of a sale by the Holder of the Warrant Shares which the Holder anticipated receiving upon such exercise (a "Buy-In"), then the Company shall (1) pay in cash to the Holder the amount by which (x) the Holder's total purchase price (including brokerage commissions, if any) for the shares of Common Stock so purchased exceeds (y) the amount obtained by multiplying (A) the number of Warrant Shares that the Company was required to deliver to the Holder in connection with the exercise at issue times (B) the price at which the sell order giving rise to such purchase obligation was executed, and (2) at the option of the Holder, either reinstate the portion of the Warrant and equivalent number of Warrant Shares for which such exercise was not honored or deliver to the Holder the number of shares of Common Stock that would have been issued had the Company timely complied with its exercise and delivery obligations hereunder. For example, if the Holder purchases Common Stock having a total purchase price of $11,000 to cover a Buy-In with respect to an attempted exercise of shares of Common Stock with an aggregate sale price giving rise to such purchase obligation of $10,000, under clause (1) of the immediately preceding sentence the Company shall be required to pay the Holder $1,000. The Holder shall provide the Company written notice indicating the amounts payable to the Holder in respect of the Buy-In, together with applicable confirmations and other evidence reasonably requested by the Company. Nothing herein shall limit a Holder's right to pursue any other remedies available to it hereunder, at law or in equity including, without limitation, a decree of specific performance and/or injunctive relief with respect to the Company's failure to timely deliver certificates representing shares of Common Stock upon exercise of the Warrant as required pursuant to the terms hereof. (b) If this Warrant shall have been exercised in part, the Company shall, at the time of delivery of the certificate or certificates representing Warrant Shares, deliver to Holder a new Warrant evidencing the rights of Holder to purchase the unpurchased Warrant Shares called for by this Warrant, which new Warrant shall in all other respects be identical with this Warrant. (c) The Holder shall not have the right to exercise any portion of this Warrant, pursuant to Section 3(a) or otherwise, to the extent that after giving effect to such issuance after exercise, the Holder (together with the Holder's affiliates), as set forth on the applicable Notice of Exercise, would beneficially own in excess of 4.99% of the number of shares of the Common Stock outstanding immediately after giving effect to such issuance. For purposes of the foregoing sentence, the number of shares of Common Stock beneficially owned by the Holder and its affiliates shall include the number of shares of Common Stock issuable upon exercise of this Warrant with respect to which the determination of such sentence is being made, but shall exclude the number of shares of Common Stock which would be issuable upon (A) exercise of the remaining, nonexercised portion of this Warrant beneficially owned by the Holder or any of its affiliates and (B) exercise or conversion of the unexercised or nonconverted portion of any other securities of the Company (including, without limitation, any other Warrants) subject to a limitation on conversion or exercise analogous to the limitation contained herein beneficially 3 owned by the Holder or any of its affiliates. Except as set forth in the preceding sentence, for purposes of this Section 3(c), beneficial ownership shall be calculated in accordance with Section 13(d) of the Exchange Act, it being acknowledged by Holder that the Company is not representing to Holder that such calculation is in compliance with Section 13(d) of the Exchange Act and Holder is solely responsible for any schedules required to be filed in accordance therewith. To the extent that the limitation contained in this Section 3(c) applies, the determination of whether this Warrant is exercisable (in relation to other securities owned by the Holder) and of which a portion of this Warrant is exercisable shall be in the sole discretion of such Holder, and the submission of a Notice of Exercise shall be deemed to be such Holder's determination of whether this Warrant is exercisable (in relation to other securities owned by such Holder) and of which portion of this Warrant is exercisable, in each case subject to such aggregate percentage limitation, and the Company shall have no obligation to verify or confirm the accuracy of such determination. For purposes of this Section 3(c), in determining the number of outstanding shares of Common Stock, the Holder may rely on the number of outstanding shares of Common Stock as reflected in (x) the Company's most recent Form 10-Q or Form 10-K, as the case may be, (y) a more recent public announcement by the Company or (z) any other notice by the Company or the Company's Transfer Agent setting forth the number of shares of Common Stock outstanding. Upon the written or oral request of the Holder, the Company shall within two Trading Days confirm orally and in writing to the Holder the number of shares of Common Stock then outstanding. In any case, the number of outstanding shares of Common Stock shall be determined after giving effect to the conversion or exercise of securities of the Company, including this Warrant, by the Holder or its affiliates since the date as of which such number of outstanding shares of Common Stock was reported. (d) If at any time after one year from the date of issuance of this Warrant there is no effective Registration Statement registering the resale of the Warrant Shares by the Holder, this Warrant may also be exercised at such time by means of a "cashless exercise" in which the Holder shall be entitled to receive a certificate for the number of Warrant Shares equal to the quotient obtained by dividing [(A-B) (X)] by (A), where: (A) = the VWAP on the Trading Day immediately preceding the date of such election; (B) = the Exercise Price of this Warrant, as adjusted; and (X) = the number of Warrant Shares issuable upon exercise of this Warrant in accordance with the terms of this Warrant by means of a cash exercise rather than a cashless exercise. (e) Subject to the provisions of this Section 3, if after the Effective Date the VWAP for each of ten consecutive Trading Days (the "Measurement Price", which period shall not have commenced until after the Effective Date) exceeds the then Exercise Price (subject to adjustment as set forth herein) (the "Threshold Price") by 200%, then the Company may, within two Trading Days of such period, call for cancellation of all or any portion of this Warrant for which a Notice of Exercise has not yet been delivered (such right, a "Call"). To exercise this right, the Company must deliver to the Holder an 4 irrevocable written notice (a "Call Notice"), indicating therein the portion of unexercised portion of this Warrant to which such notice applies. If the conditions set forth below for such Call are satisfied from the period from the date of the Call Notice through and including the Call Date (as defined below), then any portion of this Warrant subject to such Call Notice for which a Notice of Exercise shall not have been received from and after the date of the Call Notice will be cancelled at 6:30 p.m. (New York City time) on the tenth Trading Day after the date the Call Notice is received by the Holder (such date, the "Call Date"). Any unexercised portion of this Warrant to which the Call Notice does not pertain will be unaffected by such Call Notice. In furtherance thereof, the Company covenants and agrees that it will honor all Notices of Exercise with respect to Warrant Shares subject to a Call Notice that are tendered from the time of delivery of the Call Notice through 6:30 p.m. (New York City time) on the Call Date. The parties agree that any Notice of Exercise delivered following a Call Notice shall first reduce to zero the number of Warrant Shares subject to such Call Notice prior to reducing the remaining Warrant Shares available for purchase under this Warrant. For example, if (x) this Warrant then permits the Holder to acquire 100 Warrant Shares, (y) a Call Notice pertains to 75 Warrant Shares, and (z) prior to 6:30 p.m. (New York City time) on the Call Date the Holder tenders a Notice of Exercise in respect of 50 Warrant Shares, then (1) on the Call Date the right under this Warrant to acquire 25 Warrant Shares will be automatically cancelled, (2) the Company, in the time and manner required under this Warrant, will have issued and delivered to the Holder 50 Warrant Shares in respect of the exercises following receipt of the Call Notice, and (3) the Holder may, until the Termination Date, exercise this Warrant for 25 Warrant Shares (subject to adjustment as herein provided and subject to subsequent Call Notices). Subject again to the provisions of this Section 3(e), the Company may deliver subsequent Call Notices for any portion of this Warrant for which the Holder shall not have delivered a Notice of Exercise. Notwithstanding anything to the contrary set forth in this Warrant, the Company may not deliver a Call Notice or require the cancellation of this Warrant (and any Call Notice will be void), unless, from the beginning of the 10th consecutive Trading Days used to determine whether the Common Stock has achieved the Threshold Price through the Call Date, (i) the Company shall have honored in accordance with the terms of this Warrant all Notices of Exercise delivered by 6:30 p.m. (New York City time) on the Call Date, (ii) the Registration Statement shall be effective as to all Warrant Shares and the prospectus thereunder available for use by the Holder for the resale of all such Warrant Shares and (iii) the Common Stock shall be listed or quoted for trading on the Trading Market. The Company's right to Call the Warrant shall be exercised ratably among the Purchasers based on each Purchaser's initial purchase of Common Stock pursuant to the Purchase Agreement. 4. No Fractional Shares or Scrip. No fractional shares or scrip representing fractional shares shall be issued upon the exercise of this Warrant. As to any fraction of a share which Holder would otherwise be entitled to purchase upon such exercise, the Company shall pay a cash adjustment in respect of such final fraction in an amount equal to such fraction multiplied by the Exercise Price. 5 5. Charges, Taxes and Expenses. Issuance of certificates for Warrant Shares shall be made without charge to the Holder for any issue or transfer tax or other incidental expense in respect of the issuance of such certificate, all of which taxes and expenses shall be paid by the Company, and such certificates shall be issued in the name of the Holder or in such name or names as may be directed by the Holder; provided, however, that in the event certificates for Warrant Shares are to be issued in a name other than the name of the Holder, this Warrant when surrendered for exercise shall be accompanied by the Assignment Form attached hereto duly executed by the Holder; and the Company may require, as a condition thereto, the payment of a sum sufficient to reimburse it for any transfer tax incidental thereto. 6. Closing of Books. The Company will not close its stockholder books or records in any manner which prevents the timely exercise of this Warrant, pursuant to the terms hereof. 7. Transfer, Division and Combination. (a) Subject to compliance with any applicable securities laws and the conditions set forth in Sections 1 and 7(e) hereof and to the provisions of Section 4.1 of the Purchase Agreement, this Warrant and all rights hereunder are transferable, in whole or in part, upon surrender of this Warrant at the principal office of the Company, together with a written assignment of this Warrant substantially in the form attached hereto duly executed by the Holder or its agent or attorney and funds sufficient to pay any transfer taxes payable upon the making of such transfer. Upon such surrender and, if required, such payment, the Company shall execute and deliver a new Warrant or Warrants in the name of the assignee or assignees and in the denomination or denominations specified in such instrument of assignment, and shall issue to the assignor a new Warrant evidencing the portion of this Warrant not so assigned, and this Warrant shall promptly be cancelled. A Warrant, if properly assigned, may be exercised by a new holder for the purchase of Warrant Shares without having a new Warrant issued. (b) This Warrant may be divided or combined with other Warrants upon presentation hereof at the aforesaid office of the Company, together with a written notice specifying the names and denominations in which new Warrants are to be issued, signed by the Holder or its agent or attorney. Subject to compliance with Section 7(a), as to any transfer which may be involved in such division or combination, the Company shall execute and deliver a new Warrant or Warrants in exchange for the Warrant or Warrants to be divided or combined in accordance with such notice. (c) The Company shall prepare, issue and deliver at its own expense (other than transfer taxes) the new Warrant or Warrants under this Section 7. (d) The Company agrees to maintain, at its aforesaid office, books for the registration and the registration of transfer of the Warrants. 6 (e) If, at the time of the surrender of this Warrant in connection with any transfer of this Warrant, the transfer of this Warrant shall not be registered pursuant to an effective registration statement under the Securities Act and under applicable state securities or blue sky laws, the Company may require, as a condition of allowing such transfer (i) that the Holder or transferee of this Warrant, as the case may be, furnish to the Company a written opinion of counsel (which opinion shall be in form, substance and scope customary for opinions of counsel in comparable transactions) to the effect that such transfer may be made without registration under the Securities Act and under applicable state securities or blue sky laws, (ii) that the holder or transferee execute and deliver to the Company an investment letter in form and substance acceptable to the Company and (iii) that the transferee be an "accredited investor" as defined in Rule 501(a)(1), (a)(2), (a)(3), (a)(7), or (a)(8) promulgated under the Securities Act or a qualified institutional buyer as defined in Rule 144A(a) under the Securities Act. 8. No Rights as Shareholder until Exercise. This Warrant does not entitle the Holder to any voting rights or other rights as a shareholder of the Company prior to the exercise hereof. Upon the surrender of this Warrant and the payment of the aggregate Exercise Price (or by means of a cashless exercise), the Warrant Shares so purchased shall be and be deemed to be issued to such Holder as the record owner of such shares as of the close of business on the later of the date of such surrender or payment. 9. Loss, Theft, Destruction or Mutilation of Warrant. The Company covenants that upon receipt by the Company of evidence reasonably satisfactory to it of the loss, theft, destruction or mutilation of this Warrant or any stock certificate relating to the Warrant Shares, and in case of loss, theft or destruction, of indemnity or security reasonably satisfactory to it (which, in the case of the Warrant, shall not include the posting of any bond), and upon surrender and cancellation of such Warrant or stock certificate, if mutilated, the Company will make and deliver a new Warrant or stock certificate of like tenor and dated as of such cancellation, in lieu of such Warrant or stock certificate. 10. Saturdays, Sundays, Holidays, etc. If the last or appointed day for the taking of any action or the expiration of any right required or granted herein shall be a Saturday, Sunday or a legal holiday, then such action may be taken or such right may be exercised on the next succeeding day not a Saturday, Sunday or legal holiday. 11. Adjustments of Exercise Price and Number of Warrant Shares. (a) Stock Splits, etc. The number and kind of securities purchasable upon the exercise of this Warrant and the Exercise Price shall be subject to adjustment from time to time upon the happening of any of the following. In case the Company shall (i) pay a dividend in shares of Common Stock or make a distribution in shares of Common Stock to holders of its outstanding Common Stock, (ii) subdivide its outstanding shares of Common Stock into a greater number of shares, (iii) combine its outstanding shares of Common Stock into a smaller number of shares of Common Stock, or (iv) issue any shares of its capital stock in a reclassification of the Common Stock, then the 7 number of Warrant Shares purchasable upon exercise of this Warrant immediately prior thereto shall be adjusted so that the Holder shall be entitled to receive the kind and number of Warrant Shares or other securities of the Company which it would have owned or have been entitled to receive had such Warrant been exercised in advance thereof. Upon each such adjustment of the kind and number of Warrant Shares or other securities of the Company which are purchasable hereunder, the Holder shall thereafter be entitled to purchase the number of Warrant Shares or other securities resulting from such adjustment at an Exercise Price per Warrant Share or other security obtained by multiplying the Exercise Price in effect immediately prior to such adjustment by the number of Warrant Shares purchasable pursuant hereto immediately prior to such adjustment and dividing by the number of Warrant Shares or other securities of the Company that are purchasable pursuant hereto immediately after such adjustment. An adjustment made pursuant to this paragraph shall become effective immediately after the effective date of such event retroactive to the record date, if any, for such event. (b) Anti-Dilution Provisions. During the Exercise Period, the Exercise Price shall be subject to adjustment from time to time as provided in this Section 11(b). In the event that any adjustment of the Exercise Price as required herein results in a fraction of a cent, such Exercise Price shall be rounded up or down to the nearest cent. (i) Adjustment of Exercise Price. If and whenever the Company issues or sells, or in accordance with Section 11(b)(ii) hereof is deemed to have issued or sold, any shares of Common Stock for an effective consideration per share of less than the then Exercise Price or for no consideration (such lower price, the "Base Share Price" and such issuances collectively, a "Dilutive Issuance"), then, the Exercise Price shall be multiplied by a fraction of which the numerator shall be the number of shares of Common Stock Outstanding immediately prior to the Dilutive Issuance plus the number of shares of Common Stock which the aggregate offering price for such Dilutive Issuance (assuming receipt by the Corporation in full of all consideration payable upon exercise of such rights, options or warrants) would purchase at the Exercise Price, and the denominator of which shall be the sum of the number of shares of Common Stock Outstanding immediately prior to the Dilutive Issuance plus the number of shares of Common Stock so issued or issuable in connection with the Dilutive Issuance. Such adjustment shall be made whenever such shares of Common Stock or Capital Share Equivalents are issued. For purposes of this Section 11(b), "Common Stock Outstanding" as of a given date shall be the number of shares of Common Stock (excluding treasury shares, if any) issued and outstanding. (ii) Effect on Exercise Price of Certain Events. For purposes of determining the adjusted Exercise Price under Section 11(b) hereof, the following will be applicable: (A) Issuance of Rights or Options. If the Company in any manner issues or grants any warrants, rights or options, whether or not immediately exercisable, to subscribe for or to purchase Common Stock or Common Stock Equivalents (such warrants, rights and options to purchase Common Stock or Common Stock Equivalents are hereinafter referred to as "Options") and the effective price per share for 8 which Common Stock is issuable upon the exercise of such Options is less than the Exercise Price ("Below Base Price Options"), then the maximum total number of shares of Common Stock issuable upon the exercise of all such Below Base Price Options (assuming full exercise, conversion or exchange of Common Stock Equivalents, if applicable) will, as of the date of the issuance or grant of such Below Base Price Options, be deemed to be outstanding and to have been issued and sold by the Company for such price per share and the maximum consideration payable to the Company upon such exercise (assuming full exercise, conversion or exchange of Common Stock Equivalents, if applicable) will be deemed to have been received by the Company. For purposes of the preceding sentence, the "effective price per share for which Common Stock is issuable upon the exercise of such Below Base Price Options" is determined by dividing (i) the total amount, if any, received or receivable by the Company as consideration for the issuance or granting of all such Below Base Price Options, plus the minimum aggregate amount of additional consideration, if any, payable to the Company upon the exercise of all such Below Base Price Options, plus, in the case of Common Stock Equivalents issuable upon the exercise of such Below Base Price Options, the minimum aggregate amount of additional consideration payable upon the exercise, conversion or exchange thereof at the time such Common Stock Equivalents first become exercisable, convertible or exchangeable, by (ii) the maximum total number of shares of Common Stock issuable upon the exercise of all such Below Base Price Options (assuming full conversion of Common Stock Equivalents, if applicable). No further adjustment to the Exercise Price will be made upon the actual issuance of such Common Stock upon the exercise of such Below Base Price Options or upon the exercise, conversion or exchange of Common Stock Equivalents issuable upon exercise of such Below Base Price Options. (B) Issuance of Common Stock Equivalents. If the Company in any manner issues or sells any Common Stock Equivalents, whether or not immediately convertible (other than where the same are issuable upon the exercise of Options) and the effective price per share for which Common Stock is issuable upon such exercise, conversion or exchange is less than the Exercise Price, then the maximum total number of shares of Common Stock issuable upon the exercise, conversion or exchange of all such Common Stock Equivalents will, as of the date of the issuance of such Common Stock Equivalents, be deemed to be outstanding and to have been issued and sold by the Company for such price per share and the maximum consideration payable to the Company upon such exercise (assuming full exercise, conversion or exchange of Common Stock Equivalents, if applicable) will be deemed to have been received by the Company. For the purposes of the preceding sentence, the "effective price per share for which Common Stock is issuable upon such exercise, conversion or exchange" is determined by dividing (i) the total amount, if 9 any, received or receivable by the Company as consideration for the issuance or sale of all such Common Stock Equivalents, plus the minimum aggregate amount of additional consideration, if any, payable to the Company upon the exercise, conversion or exchange thereof at the time such Common Stock Equivalents first become exercisable, convertible or exchangeable, by (ii) the maximum total number of shares of Common Stock issuable upon the exercise, conversion or exchange of all such Common Stock Equivalents. No further adjustment to the Exercise Price will be made upon the actual issuance of such Common Stock upon exercise, conversion or exchange of such Common Stock Equivalents. (C) Change in Option Price or Conversion Rate. If there is a change at any time in (i) the amount of additional consideration payable to the Company upon the exercise of any Options; (ii) the amount of additional consideration, if any, payable to the Company upon the exercise, conversion or exchange of any Common Stock Equivalents; or (iii) the rate at which any Common Stock Equivalents are convertible into or exchangeable for Common Stock (in each such case, other than under or by reason of provisions designed to protect against dilution), the Exercise Price in effect at the time of such change will be readjusted to the Exercise Price which would have been in effect at such time had such Options or Common Stock Equivalents still outstanding provided for such changed additional consideration or changed conversion rate, as the case may be, at the time initially granted, issued or sold. (D) Calculation of Consideration Received. If any Common Stock, Options or Common Stock Equivalents are issued, granted or sold for cash, the consideration received therefor for purposes of this Warrant will be the amount received by the Company therefor, before deduction of reasonable commissions, underwriting discounts or allowances or other reasonable expenses paid or incurred by the Company in connection with such issuance, grant or sale. In case any Common Stock, Options or Common Stock Equivalents are issued or sold for a consideration part or all of which shall be other than cash, the amount of the consideration other than cash received by the Company will be the fair market value of such consideration, except where such consideration consists of securities, in which case the amount of consideration received by the Company will be the fair market value (closing bid price, if traded on any market) thereof as of the date of receipt. In case any Common Stock, Options or Common Stock Equivalents are issued in connection with any merger or consolidation in which the Company is the surviving corporation, the amount of consideration therefor will be deemed to be the fair market value 10 of such portion of the net assets and business of the non-surviving corporation as is attributable to such Common Stock, Options or Common Stock Equivalents, as the case may be. The fair market value of any consideration other than cash or securities will be determined in good faith by an investment banker or other appropriate expert of national reputation selected by the Company and reasonably acceptable to the holder hereof, with the costs of such appraisal to be borne by the Company. (E) Exceptions to Adjustment of Exercise Price. Notwithstanding the foregoing, no adjustment will be made under this Section 11(b) in respect of (1) the granting of stock or options to employees, officers, directors or key consultants pursuant to any equity incentive plan duly adopted by the Board of Directors of the Company or a majority of the members of a committee of directors established for such purpose or (2) upon the exercise of or conversion of any Common Stock Equivalents or Options issued and outstanding on the Original Issue Date, provided that the securities have not been amended since the date of the Purchase Agreement except as a result of the Purchase Agreement. (iii) Minimum Adjustment of Exercise Price. No adjustment of the Exercise Price shall be made in an amount of less than 1% of the Exercise Price in effect at the time such adjustment is otherwise required to be made, but any such lesser adjustment shall be carried forward and shall be made at the time and together with the next subsequent adjustment which, together with any adjustments so carried forward, shall amount to not less than 1% of such Exercise Price. 12. Reorganization, Reclassification, Merger, Consolidation or Disposition of Assets. In case the Company shall reorganize its capital, reclassify its capital stock, consolidate or merge with or into another corporation (where the Company is not the surviving corporation or where there is a change in or distribution with respect to the Common Stock of the Company), or sell, transfer or otherwise dispose of its property, assets or business to another corporation and, pursuant to the terms of such reorganization, reclassification, merger, consolidation or disposition of assets, shares of common stock of the successor or acquiring corporation, or any cash, shares of stock or other securities or property of any nature whatsoever (including warrants or other subscription or purchase rights) in addition to or in lieu of common stock of the successor or acquiring corporation ("Other Property"), are to be received by or distributed to the holders of Common Stock of the Company, then the Holder shall have the right thereafter to receive, at the option of the Holder, (a) upon exercise of this Warrant, the number of shares of Common Stock of the successor or acquiring corporation or of the Company, if it is the surviving corporation, and Other Property receivable upon or as a result of such reorganization, reclassification, merger, consolidation or disposition of assets by a Holder of the number of shares of Common Stock for which this Warrant is exercisable immediately prior to such event or (b) cash equal to the value of this Warrant as determined in accordance with the Black Scholes option pricing formula. In case of any such reorganization, reclassification, merger, consolidation or disposition of assets, the successor or acquiring corporation (if other than the Company) shall expressly assume the due and punctual observance and performance of each and every covenant and condition of this Warrant to be performed and observed by the Company and all the obligations and liabilities hereunder, subject to such modifications as may be deemed 1 appropriate (as determined in good faith by resolution of the Board of Directors of the Company) in order to provide for adjustments of Warrant Shares for which this Warrant is exercisable which shall be as nearly equivalent as practicable to the adjustments provided for in this Section 12. For purposes of this Section 12, "common stock of the successor or acquiring corporation" shall include stock of such corporation of any class which is not preferred as to dividends or assets over any other class of stock of such corporation and which is not subject to redemption and shall also include any evidences of indebtedness, shares of stock or other securities which are convertible into or exchangeable for any such stock, either immediately or upon the arrival of a specified date or the happening of a specified event and any warrants or other rights to subscribe for or purchase any such stock. The foregoing provisions of this Section 12 shall similarly apply to successive reorganizations, reclassifications, mergers, consolidations or disposition of assets. 13. Voluntary Adjustment by the Company. The Company may at any time during the term of this Warrant reduce the then current Exercise Price to any amount and for any period of time deemed appropriate by the Board of Directors of the Company. 14. Notice of Adjustment. Whenever the number of Warrant Shares or number or kind of securities or other property purchasable upon the exercise of this Warrant or the Exercise Price is adjusted, as herein provided, the Company shall give notice thereof to the Holder, which notice shall state the number of Warrant Shares (and other securities or property) purchasable upon the exercise of this Warrant and the Exercise Price of such Warrant Shares (and other securities or property) after such adjustment, setting forth a brief statement of the facts requiring such adjustment and setting forth the computation by which such adjustment was made. 15. Notice of Corporate Action. If at any time: (a) the Company shall take a record of the holders of its Common Stock for the purpose of entitling them to receive a dividend or other distribution, or any right to subscribe for or purchase any evidences of its indebtedness, any shares of stock of any class or any other securities or property, or to receive any other right, or (b) there shall be any capital reorganization of the Company, any reclassification or recapitalization of the capital stock of the Company or any consolidation or merger of the Company with, or any sale, transfer or other disposition of all or substantially all the property, assets or business of the Company to, another corporation or, (c) there shall be a voluntary or involuntary dissolution, liquidation or winding up of the Company; then, in any one or more of such cases, the Company shall give to Holder (i) at least 10 days' prior written notice of the date on which a record date shall be selected for such dividend, distribution or right or for determining rights to vote in respect of any such reorganization, reclassification, merger, consolidation, sale, transfer, disposition, liquidation or winding up, and (ii) in the case of any such reorganization, reclassification, merger, consolidation, sale, transfer, disposition, dissolution, liquidation or winding up, at least 10 12 days' prior written notice of the date when the same shall take place. Such notice in accordance with the foregoing clause also shall specify (i) the date on which any such record is to be taken for the purpose of such dividend, distribution or right, the date on which the holders of Common Stock shall be entitled to any such dividend, distribution or right, and the amount and character thereof, and (ii) the date on which any such reorganization, reclassification, merger, consolidation, sale, transfer, disposition, dissolution, liquidation or winding up is to take place and the time, if any such time is to be fixed, as of which the holders of Common Stock shall be entitled to exchange their Warrant Shares for securities or other property deliverable upon such disposition, dissolution, liquidation or winding up. Each such written notice shall be sufficiently given if addressed to Holder at the last address of Holder appearing on the books of the Company and delivered in accordance with Section 17(d). 16. Authorized Shares. The Company covenants that during the period the Warrant is outstanding, it will reserve from its authorized and unissued Common Stock a sufficient number of shares to provide for the issuance of the Warrant Shares upon the exercise of any purchase rights under this Warrant. The Company further covenants that its issuance of this Warrant shall constitute full authority to its officers who are charged with the duty of executing stock certificates to execute and issue the necessary certificates for the Warrant Shares upon the exercise of the purchase rights under this Warrant. The Company will take all such reasonable action as may be necessary to assure that such Warrant Shares may be issued as provided herein without violation of any applicable law or regulation, or of any requirements of the Trading Market upon which the Common Stock may be listed. Except and to the extent as waived or consented to by the Holder, the Company shall not by any action, including, without limitation, amending its certificate of incorporation or through any reorganization, transfer of assets, consolidation, merger, dissolution, issue or sale of securities or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms of this Warrant, but will at all times in good faith assist in the carrying out of all such terms and in the taking of all such actions as may be necessary or appropriate to protect the rights of Holder as set forth in this Warrant against impairment. Without limiting the generality of the foregoing, the Company will (a) not increase the par value of any Warrant Shares above the amount payable therefor upon such exercise immediately prior to such increase in par value, (b) take all such action as may be necessary or appropriate in order that the Company may validly and legally issue fully paid and nonassessable Warrant Shares upon the exercise of this Warrant, and (c) use commercially reasonable efforts to obtain all such authorizations, exemptions or consents from any public regulatory body having jurisdiction thereof as may be necessary to enable the Company to perform its obligations under this Warrant. Before taking any action which would result in an adjustment in the number of Warrant Shares for which this Warrant is exercisable or in the Exercise Price, the Company shall obtain all such authorizations or exemptions thereof, or consents thereto, as may be necessary from any public regulatory body or bodies having jurisdiction thereof. 13 17. Miscellaneous. (a) Jurisdiction. All questions concerning the construction, validity, enforcement and interpretation of this Warrant shall be determined in accordance with the provisions of the Purchase Agreement. (b) Restrictions. The Holder acknowledges that the Warrant Shares acquired upon the exercise of this Warrant, if not registered, will have restrictions upon resale imposed by state and federal securities laws. (c) Nonwaiver and Expenses. No course of dealing or any delay or failure to exercise any right hereunder on the part of Holder shall operate as a waiver of such right or otherwise prejudice Holder's rights, powers or remedies, notwithstanding all rights hereunder terminate on the Termination Date. If the Company willfully and knowingly fails to comply with any provision of this Warrant, which results in any material damages to the Holder, the Company shall pay to Holder such amounts as shall be sufficient to cover any costs and expenses including, but not limited to, reasonable attorneys' fees, including those of appellate proceedings, incurred by Holder in collecting any amounts due pursuant hereto or in otherwise enforcing any of its rights, powers or remedies hereunder. (d) Notices. Any notice, request or other document required or permitted to be given or delivered to the Holder by the Company shall be delivered in accordance with the notice provisions of the Purchase Agreement. (e) Limitation of Liability. No provision hereof, in the absence of any affirmative action by Holder to exercise this Warrant or purchase Warrant Shares, and no enumeration herein of the rights or privileges of Holder, shall give rise to any liability of Holder for the purchase price of any Common Stock or as a stockholder of the Company, whether such liability is asserted by the Company or by creditors of the Company. (f) Remedies. Holder, in addition to being entitled to exercise all rights granted by law, including recovery of damages, will be entitled to specific performance of its rights under this Warrant. The Company agrees that monetary damages would not be adequate compensation for any loss incurred by reason of a breach by it of the provisions of this Warrant and hereby agrees to waive the defense in any action for specific performance that a remedy at law would be adequate. (g) Successors and Assigns. Subject to applicable securities laws, this Warrant and the rights and obligations evidenced hereby shall inure to the benefit of and be binding upon the successors of the Company and the successors and permitted assigns of Holder. The provisions of this Warrant are intended to be for the benefit of all Holders from time to time of this Warrant and shall be enforceable by any such Holder or holder of Warrant Shares. (h) Amendment. This Warrant may be modified or amended or the provisions hereof waived with the written consent of the Company and the Holder. 14 (i) Severability. Wherever possible, each provision of this Warrant shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Warrant shall be prohibited by or invalid under applicable law, such provision shall be ineffective to the extent of such prohibition or invalidity, without invalidating the remainder of such provisions or the remaining provisions of this Warrant. (j) Headings. The headings used in this Warrant are for the convenience of reference only and shall not, for any purpose, be deemed a part of this Warrant. ******************** 15 IN WITNESS WHEREOF, the Company has caused this Warrant to be executed by its officer thereunto duly authorized. Dated: February____, 2004 INDUSTRIES INTERNATIONAL, INCORPORATED By: ________________________________ Name: Tsui Kit 16 Title: Chief Executive Officer NOTICE OF EXERCISE To: Industries International, Incorporated (1)____________The undersigned hereby elects to purchase ________ Warrant Shares of the Company pursuant to the terms of the attached Warrant (only if exercised in full), and tenders herewith payment of the exercise price in full, together with all applicable transfer taxes, if any. (2)____________Payment shall take the form of (check applicable box): [ ] in lawful money of the United States; or [ ] the cancellation of such number of Warrant Shares as is necessary, in accordance with the formula set forth in subsection 3(d), to exercise this Warrant with respect to the maximum number of Warrant Shares purchasable pursuant to the cashless exercise procedure set forth in subsection 3(d). (3)____________Please issue a certificate or certificates representing said Warrant Shares in the name of the undersigned or in such other name as is specified below: ___________________________________________ The Warrant Shares shall be delivered to the following: ___________________________________________ ___________________________________________ ___________________________________________ (4) Accredited Investor. The undersigned is an "accredited investor" as defined in Regulation D under the Securities Act of 1933, as amended. [PURCHASER] By: ______________________________ Name: Title: Dated: ________________________ ASSIGNMENT FORM (To assign the foregoing warrant, execute this form and supply required information. Do not use this form to exercise the warrant.) FOR VALUE RECEIVED, the foregoing Warrant and all rights evidenced thereby are hereby assigned to _______________________________________________ whose address is _______________________________________________________________. _______________________________________________________________ Dated: ______________, _______ Holder's Signature:_______________ Holder's Address: ________________ Signature Guaranteed: ___________________________________________ NOTE: The signature to this Assignment Form must correspond with the name as it appears on the face of the Warrant, without alteration or enlargement or any change whatsoever, and must be guaranteed by a bank or trust company. Officers of corporations and those acting in a fiduciary or other representative capacity should file proper evidence of authority to assign the foregoing Warrant. EX-10.8 5 v02407_ex10-8.txt SHENZHEN CITY REAL ESTATE LEASING AGREEMENT COPY RIGHT BY DEPARTMENT OF URBAN PLANNING AND LAND RESOURCE, SHENZHEN CITY REAL ESTATE LEASING AGREEMENT Leaser: Shenzhen Wondial communication Technology Ltd. Company Address: No. 29 Nan Shan Road Nan Shan High-tech Industrial Park, ShenZhen, China Zip: 518057 Agency: Address: Zip: Renter: Shanghai Sheng Bang Inspection Limited, ShenZhen Division Address: 2/F ShuTaik Building Ba Lin Hui Rd, FuTian District, ShenZhen, China Zip: 518029 ID Number: Agency: Address: Zip: According to the contract Law of People Republic of China, Real estate management Law of People Republic of China and Real Estate of ShenZhen economic Zoom, Leaser and Renter agreement to make this contract. Clause 1 Leaser will rent the No.29 Keji South Road, Unit 1 and Unit 2, NanShan District to Renter. The Square foot of total is 3895.35, total is 3 floors. Leaser: Shenzhen Wondial communication Technology Ltd. Company Real Estate Certificate or the ownership/ the other effective certificates, codes: ShenNan Chen Dang Yan Zi The useless of space: Office and Operation Clause 2 The rent fee for each unit, each square foot and each month will account by RMB 146679.5. Clause 3 The renter will pay the deposit before 09/15/2003, total amount will be RMB146679.5. Clause 4 The renter will pay the leasing fee by fifth of each Month, when the leaser get the pay check, he/she would give the effective receipt. Clause 5 The renter has the right to use the space from 09/16/2003 to 11/15/2006. The above contract can't beyond usage of the property, it is not become effective for the beyond part. If it causes any damage, both parties have contract, otherwise the leaser must take care of that. Clause 6 Leaser should rent this space through the legal perspective. The renter must use the space by legal usage, no right to change to another usage. If Renter wants to change the usage, it must be approved by Leaser. And also under some of regulations and rules, Renter should apply change the usage, after approval he can change the usage according his application file. Clause 7 The Leaser will rent the space to renter by 09/15/2003, at same time all law regulations will be done. If Leaser can't provide the space to renter according to the contract timing, renter can ask to extend this contract. And also both parties should report to registration department. Clause 8 When the leaser release the property, both parties should confirm the subsidiary facilities and current condition, it will explain at the attachment. Clause 9 When the leaser releases the property, leaser can get the rental fee no more than three months deposit, total is RMB293359. When the renter pays the deposit, the leaser will give the receipt. The condition for leaser to return the deposit to renter: 1. After discussion to cancel the contract 2. During the rent period, renter doesn't make the damage to the facility. 3. Renter pay the rent fee every month It includes all three items above. One of the situations happen, leaser can refuse to pay the deposit back to renter: 1. Renter doesn't pay the rent by monthly. 2. During the rent period, renter makes the huge damage to the facility, it might not fixable. Clause 10 during the leasing, leaser should pay the expenditure fee of property usage, and tax of the property usage, management fee of property usage, renter will on time to pay the utility fees, such as power, water, management fees. Clause 11 The Leaser must make sure that the rental agreement of the real estate and the subsidiary facilities must fulfill its usage objective, and guarantee its safety according to the law regulations. If the Renter suffered physical injury or property loss due to the carelessness of the Leaser, the Renter has the right to obtain compensation from the Leaser. Clause 12 The Renter must not involve any illegal activities within the property, and the Leaser cannot interrupt any legal activities that are carried out by the Renter. Clause 13 During the lease period, if there are damaged property or malfunction facilities that are not the Renter responsibility, the Renter must inform the Leaser immediately so that restoration or repair will be carried out and avoid bigger problem. The Leaser must restore or repair the report damaged property or malfunction facilities within 2 days, or ask the Renter to fix it. If the Renter cannot contact the Leaser, or the Leaser cannot fix the problems within 2 days, the Renter is authorized to fix the problems according to the contract. If the damaged property or malfunction facilities are considered emergency, the Renter must fix the problem for the Leaser right away, and inform the Leaser about the situation. The two restoration and repair expenses above (include the expenses spend on restoration and repair to avoid bigger problem) is paid by the Leaser. If there are damaged property or malfunction facilities and the Renter does not carry out the duties mentioned above, does not inform the Leaser immediately, or does not carry out an effective way to avoid the problems, the Renter has to bear the responsibility and pay the restoration or repair expenses. Clause 14 If there are damaged property or malfunction facilities due to the wrongful use of the Renter, the renter must inform the Leaser immediately and is responsible for the restoration and repair. If the Renter refuses to carry out the restoration or repair, the Leaser will have to do the fixing according to the memorandum in the contract, and the Renter has to pay all the expenses. Clause 15 During the lease period, any restoration, expansion, or redecoration of the property must be agreed and signed on a new agreement by both parties. All changes in the agreement must be approved by the authorities. Clause 16 ( ) During the lease period, the Renter can sublet partial or the whole property to third party, and finish the application procedures in the Leaser management department. The sub lease period must not be longer than the original lease period. ( ) The Renter cannot sub let partial or whole property to third party. During the lease period, if the Leaser approves, the Renter can sub let partial or whole property to third party by finishing the application procedures in the Leaser management department. However, the sub lease contract cannot be longer than the original leaser period. ( ) During the lease period, the Renter is not allowed to sub let partial or whole property to third party. (There are three selections above, put a "v" mark on the selected one, which is also agreed by both parties) Clause 17 During the lease period, if the Leaser wants to sell partial or whole property, the Leaser has to inform the Renter in a written form letter a month before. The Renter has the initiative right to buy the property. If the Leaser sold the property to third party, the Leaser is responsible to inform or guarantee the buyer to carry out this initial agreement lease. Clause 18 During the lease period, the contract can be changed or terminated if any of the following situations happen: (1) Any unsolved problems that cause break off of the contract; (2) The government wants to use, buy, recall, or tear down the property; (3) Both the Leaser and Renter reach an agreement. Clause 19 If happen any of the following situations, the Leaser can (V) Ask for compensation from the Renter (X) Refuse to return the deposits (X) The Renter agreed to pay --- amount. (There are three selections above, put a "v" mark on the selected one, which is also agreed by both parties) Situations: (1) the Renter owe the rental more than 15 days (half month); (2) the Renter owe the expenses that cause the loss of the Leaser of ____ amount; (3) the Renter carry out illegal activities in the property, damaged the facilities or cause the loss of other people; (4) the Renter changes the construction without approval by the Leaser or authorities; (5) The Renter violates the Clause 14 in this agreement, refuse to bear the responsibility of restoration/repair, or refuse to pay the expenses, and cause serious damaged property or malfunction facilities. (6) the Renter restore or redecorate the property without approval by the Leaser or authorities (7) the Renter sub let the property to third party without approval by the Leaser The Leaser can ask for compensation or change/terminate the contract agreement if any of the above situations happen. Clause 20 if any of the following situations happens, the Renter can (V) Request fine or penalty (X) Request fine or penalty that is doubling the deposits (X) Leaser pays fine or penalty for ____ amount (Yuen) (There are three selections above, put a "v" mark on the selected one, which is also agreed by both parties) (1) Leaser delay the property releasing for more than 15 days (half month); (2) Leaser break the Clause 11 (3) Leaser break the Clause 13 (4) Leaser restore, redecorate or expand the property without approval by the Renter and authorities The Renter can ask for compensation and change or terminate (the Renter must inform the Leaser in a written form after receiving the compensation and return the property to the Leaser) the contract agreement if any of the above situations happen. Clause 21 When the contract is ended, Renter shall move out the rental property within 10 days since the day the contract is ended. In addition, Renter shall insure that the rental property and its subsidiary facilities are as good as they were (except the depreciation parts). Furthermore, Renter shall pay all necessary closing or ending contract expenditures that are belong to Renter. If Renter cannot move out of rental property within days that specified in the paragraph one of Clause 1, Leaser has the legal right to collect the rental property back and request a fine which is doubling the original rent from Renter. Clause 22 If Renter will renew the contract after it is ended, Renter shall notify Leaser 1 month before this contract is ended; In addition, the current Renter in this contract has the priority to renew the contract. Both parties shall re-establish the contract if they want to renew this current contract, and they shall re-register the new contract to legal bureau. Clause 23 Both parties shall practice in faith carrying out this agreement. Each party shall have the obligation to insure fulfillment of each clause in this agreement, or they will be responsible for breaking any clause in this agreement. Clause 24 Any additional clause that is not in this agreement, both parties shall settle it and attach it in the attachment page of this agreement, and this attachment is also a legal part of this agreement once both parties sign and stamp on this attachment(s) and on this agreement. Clause 25 Any dispute that is resulted by this agreement shall be solved by negotiation between both parties. Any dispute that cannot be solved by negotiation, it shall transfer to legal bureau for settlement. If this still cannot be solved, then this dispute shall transfer to following bureau for arbitration: [_] Shenzhen Arbitration Committee [_] China International Economic Trade Arbitration Committee, [_] Shenzhen district. Courts Clause 26 This agreement will be effective as it is signed by both parties. Both parties shall register to related legal bureau within 10 days since the date this agreement is signed. Clause 27 The formal copy of this agreement is Chinese version. Clause 28 This agreement has 3 original copies, one copy for Leaser, one copy for Renter, and one copy for contract registration bureau. (Attachment one) 1. Leaser lease the following rental property to Renter: The portion of 1st floor, and 2nd, and 6th floor Shenzhen High-tech Industrial Park Shenzhen Blvd, Shenzhen, P.R. China Whereas the total rental size is 3895.35 square feet (1st floor has 748.45 square feet, 2nd floor has 1573.45 square feet, and 6th floor has 1573.45 square feet). The rent also includes property management expenditure, air-conditioning maintenance expenditure, and lifter expenditure. 2. By signing this agreement, Renter shall pay Leaser deposit which is equal to Renter's two-months rent. 3. The Leaser allows the Renter to have two months of restoration period (September 16, 2003 to November 15, 2003). The Renter does not have to pay the Rental during the restoration period. 4. The Leaser agrees not to reconstruct or remodel the current rental property. If for any reason the Leaser has to reconstruct the property and causing the Renter to be unable to work or work normally, the Leaser has to bear the responsibility. 5. If the Renter need to use another power supply, both parties have to agree and sign another agreement 6. All clauses within the appendix are as effective as the agreement. EX-10.9 6 v02407_ex10-9.txt RENTAL CONTRACT Leaser: ShenZhen HuaQiao City real estate Limited. Address: 21th and 22th floor HanTang Building HuaQiao City XingLong St. ShenZhen Tel: 26936000 26911826 Renter: ShenZhen City ChuangLi Power Company Address: Tel: 82995658 13312922960 ID Number/Business License Number: Whereas {{ShenZhen Economic Zone Rental Regulation}} and its detailed clauses, Whereas both parties'(leaser and renter) settlement, result this contract with clauses below. Clause 1 Leaser will lease its property to Renter. This rental property is located at: NorthEast A-3, Building 302 DongDu industrial zone YuShan Area, HuaQiaoCheng ShenZhen The total size of this rental property is 1165 square feet. Clause 2 Renter will rent this property from September 21th, 2003 to September 20th, 2006. The total duration is 24 months. Clause 3 Renter rents this property on factory premises purpose only and all activities at this property should also fulfill country's fire safety regulations. In addition, renter shall obtained some necessary legal documentations from Chinese legal authorities and Leaser's approving if renter use this property on any other purpose. Clause 4 Renter shall pay Leaser nineteen thousand seven hundred and 5 Yen each month for this rental property, and such transaction shall be done before 5th day of every month. Clause 5 By signing this contract, Renter shall pay for the deposit with the total of thirty nine thousand six hundred and ten Yen. Leaser shall give Renter a receipt for the deposit. After the ending date of this contract, Leaser shall return the deposit back to Renter. Clause 6 Within 10 days since the date Leaser receives the deposit from Renter, Leaser shall release the property to Renter. If Leaser cannot releaser the property on time, Renter can ask for extension for this contract, and it also shall stated on written notice and shall sign by both parties. At the time of property releasing both parties shall confirm property conditions (such as door, windows, ground, etc...). All the confirmations have to be in the written notice, as well as the date of property releasing. Clause 7 All Renter's activities at this rental property have to be as it is on clause 3. Clause 8 Any structure damage discovered during the use of rental property, Renter shall contact Leaser and prevent further damage. Leaser shall start repairing within 20 days since the date it receives Renter's notice of structure damage. If Leaser refuses the repairing, Renter can refer to legal rental regulation authorities and get the repairing done, and all those costs shall be paid by Leaser. During the mean time, Renter shall also obtain its obligation to pay the rent on time. Clause 9 During the leasing period, Leaser shall have obligation to pay all the necessary taxations and bank payment and interest for this rental property, and Renter shall pay for all other relative management expenditures (exclude utilities expense). Clause 10 At the time of property releasing, Leaser shall insure all the structure and equipment within this rental property shall fulfill requirements of certain related legal regulations. Renter also has the obligation to maintain the structure and equipments and prevent them from damage. When the contract is ended, Renter shall return property to Leaser and guarantee the property is as it was, Leaser shall also settle and end all the cost of rent and necessary expenditures for Renter. Clause 11 During the leasing period, Renter shall pay all the damages of this rental property if they are done by Renter. If Renter refuses to pay for the repairing, Leaser can refer to legal rental regulation authorities and get the repairing done, and all those costs shall be paid by Renter. Clause 12 During the leasing period, Renter shall not restructure or remodel the rental property, unless it is approved by Leaser and the plan of restructuring or remodeling shall also be approved by legal authority. Both parties may negotiate this clause in detail and sign otherwise. Clause 13 During the effective period, if the Renter has to do any restoration, he/she must get approval from the Leaser and the fire department. After the restoration, the site must be inspected by the Leaser and the fire department in order to be used. The Renter must understand that the Leaser is not responsible for all the restoration expenses or payment during the lease period. Clause 14 The Leaser has all the advertising right and the management right. If the Renter needs to install or put up any advertising signboard or notice board, he/she must get the approval from the Leaser, and follow the regulations while installing them. Clause 15 During the lease period, the Renter must follow all regulations by the government and fire department. If for any reasons the Renter is not able to proceed his/her business due to the violation of the regulations, the Renter bear all the responsibility and still need to pay the rental and related expenses. Clause 16 The Renter must get the approval from the Leaser if he/she wants to sublet the property. If the Leaser approves, the Renter has to complete the application process, and the sublease period must not be later than the original lease period. The Renter must also guarantee that the sub Renter will not again sub the lease to another party. Clause 17 During the lease period, if the Leaser wants to sell the whole or part of the property to another party, the Leaser must inform the Renter a month before. The Renter has the initiative right of buying the property. The Leaser has to guarantee that the buyer of the property must carry out the initial contract agreement. Clause 18 During the lease period, the lease will be terminated automatically if any of the following situations happens: (1) The contract agreements cannot be carried out due to any unsolved problems or accidents. (2) The property need to be tore down by the government for other purposes. Clause 19 The Leaser has the right to terminate the lease and be paid the loss by the Renter if the following situations happen: (1) The Renter owes the rental more than 2 months (2) The Renter owes the utilities for more than 2 months. (3) The Renter sublet the property to other party without the approval of the Leaser. If any of the above situations happen, the Leaser has the right to terminate the lease by informing the Renter in a written form letter to move out the property. The Renter must pay all the expenses owed before he/she move out. The Leaser has the right to keep the deposits as the compensation of breaking the contract. Clause 20 The Renter has the right to terminate the lease and be paid the loss by the Leaser if the following situations happen: (1) The Leaser delays the releasing of the property more than 30 days. (2) The Leaser violates the Clause 7 of this agreement contract, and the Renter is unable to start the usage of the property. (3) The Leaser violates the Clause 8 of this agreement contract, which the Leaser refuses to restore or pay the restoration expenses, and the Renter is unable to start the usage of the property. (4) The Leaser restores, redecorates, or expands the lease property without notifying and approval by the Renter. If any of the above situations happen, the Renter has the right to terminate the lease by informing the Leaser in a written form letter and move out of the property. The Renter has the right to ask for the deposits paid and other prepaid expenses. If the Renter terminate the lease due to other reasons not listed above, the Renter has to pay the Leaser the equal amount of deposits as compensation fees, and the Leaser has the right to keep the deposits as the compensation fees. Clause 21 If the Renter wants to renew the lease, he/she must request the lease renewal 2 months before the original lease is expired. The Renter has the initiative right to renew the current lease. A new lease should be signed for the renewal of the current lease. Clause 22 When the lease is expired, the Renter has to move out the property within 5 days, and the rental is accounted till the day when the Renter moves out. If the Renter refuses to move out or return the property, the Leaser has the right to cut off the utilities supply and sue the Renter through authorities. The Renter must move out on time and leave nothing in the property. If there are items left in the property, they are considered to be the property of the Leaser. Clause 23 If the Renter delays the rental payment, he/she has to pay a late fee to the Leaser. The late fee is accounted by the number of days delay times 0.05% of the rental. If the Renter delay the payment more than 30 days, the Leaser has the right to cut off the utilities supply, and do not have to bear the responsibility. Clause 24 The Renter has to go to Shenzhen HuaQiao City Real Estate Limited Company to pay the rental or process any bank payment application. The Renter has to ask for receipt of the rental payment within 3 months after the payment. If the Renter does not ask for the receipt or lost the receipt, he/she has to bear the responsibility. Clause 25 The Leaser is responsible for the electricity voltage supplies (everything before the power switch, not including the power switch) and maintenance. If the Renter need a voltage change or specific request, he/she must ask HuaQiao City Water and Electricity Utility Company to install the required equipments. All expenses including the maintenance fees, and application fees are paid by the Renter. Clause 26 (Clause 26 was skipped) Clause 27 Each party shall pay for the lost of counterparty for not carrying out the agreement. Clause 28 Any addition or deletion to this contract, both parties shall attach this to attachment page, such page also has the legal prospect as those in clauses above. Clause 29 Any conflict or dispute resulted between both parties by this contract, it shall be solve via negotiation. If any dispute that cannot be solved by negotiation, it shall bring up tot local court house for arbitration. Clause 30 This contract has 6 copies, two for each party, and two for local court house in case of any litigation. Clause 31 This contract is immediately effective since the date it's signed by both parties. EX-17.1 7 v02407_ex17-1.txt RESIGNATION LETTER Jan 3, 2004 Board of Directors Industries International Inc. For personal reasons, I am submitting to the Board of Directors of Industries International Inc my decision to resign as the company's president and director. It is an honor of mine to have had the opportunity to serve the company and I would like to thank you for your approval of my resignation. Regards /s/ Weijiang Yu Weijiang Yu EX-21.1 8 v02407_ex21-1.txt List of Subsidiaries Industries International Incorporated, incorporated in Nevada, the United States of America Broad Faith Limited, incorporated in the British Virgin Islands, 100% owned by Industries International Incorporated Shenzhen Kexuntong Industrial Limited, incorporated in Shenzhen China, 95% owned by Broad Faith Limited Sunbest Industries Limited, incorporated in Shanghai, China, 100% owned by Industries International Incorporated Shenzhen Wonderland Communication Science & Technology Company, Limited, incorporated in Shenzhen, China, 68.73% owned by Shenzhen Kexuntong Industrial Limited and 4.24% owned by Sunbest Industries Limited Li Sun Power International Limited, incorporated in British Virgin Islands, 100% owned by Industries International Incorporated Wuhan Lixing Power Sources Company Limited, incorporated in Wuhan, China, 72.84% owned by Li Sun Power International Limited Shenzhen Chuang Lixing Power Sources Company Limited, incorporated in Shenzhen China, 90% owned by Li Sun Power International Limited Wuhan Lixing (Torch) Power Sources Company, Limited, (Joint Venture with HSBC) incorporated in Wuhan China, 70.7% owned by Wuhan Lixing Power Sources Company Limited EX-31.1 9 v02407_ex31-1.txt EXHIBIT 31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14 or 15d-14, and pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 I, Kit Tsui, Chairman of the Board and Chief Executive Officer of Industries International, Inc., certify that: 1. I have reviewed this annual report on Form 10-K of Industries International, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the Audit Committee of the registrant's Board of Directors (or persons performing the equivalent function): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: April 20, 2004 /s/ Dr. Kit Tsui ----------------------------------- Dr. Kit Tsui Chairman of the Board and Chief Executive Officer Industries International, Inc. EX-31.2 10 v02407_ex31-2.txt EXHIBIT 31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14 or 15d-14, and pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 I, Guoqiong Yu, Chief Financial Officer and Treasurer Industries International, Inc., certify that: 1. I have reviewed this annual report on Form 10-K of Industries International, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the Audit Committee of the registrant's Board of Directors (or persons performing the equivalent function): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: April 20, 2004 /s/ Guoqiong Yu ----------------------------------- Guoqiong Yu Chief Financial Officer and Treasurer Industries International, Inc. EX-32.2 11 v02407_ex32-1.txt EXHIBIT 32.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(b) or 15d-14(b) and 18 U.S.C. 1350, and pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 I, Kit Tsui, Chairman of the Board and Chief Executive Officer of Industries International, Inc., certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge: (1) the annual report on Form 10-K for the period ended December 31, 2003 (the "Annual Report"), which this statement accompanies fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934 (15 U.S.C. 78m) and (2) information contained in the Annual Report fairly presents, in all material respects, the financial condition and results of operations of Industries International, Inc. This certificate is being furnished solely for purposes of Section 906. Date: April 20, 2004 /s/ Dr. Kit Tsui ----------------------------------- Dr. Kit Tsui Chairman of the Board and Chief Executive Officer Industries International, Inc. EX-32.2 12 v02407_ex32-2.txt EXHIBIT 32.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(b) or 15d-14(b) and 18 U.S.C. 1350, and pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 I, Guoqiong Yu, Chief Financial Officer and Treasurer of Industries International, Inc., certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge: (1) the annual report on Form 10-K for the period ended December 31, 2003 (the "Annual Report"), which this statement accompanies fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934 (15 U.S.C. 78m) and (2) information contained in the Annual Report fairly presents, in all material respects, the financial condition and results of operations of Industries International, Inc. This certificate is being furnished solely for purposes of Section 906. Date: April 20, 2004 /s/ Guoqiong Yu ----------------------------------- Guoqiong Yu Chief Financial Officer and Treasurer Industries International, Inc. -----END PRIVACY-ENHANCED MESSAGE-----