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1. Basis of presentation:

The accompanying financial statements have been prepared on a going concern basis which contemplates continuity of operations, realization of assets and liquidation of liabilities in the ordinary course of business and do not reflect adjustments that might result if the Company cannot continue as a going concern. The Company has incurred operating losses in the last several years and again in the nine months ended September 30, 2002.

In 2001, the Company secured a line of credit to finance its inventory and accounts receivable and also realized net proceeds from the sale of capital stock and warrants. In 2002, the Company increased its borrowing capacity under the credit line, however this financing and the net proceeds from the sale of the Company's common stock and warrants are not sufficient to fully implement the Company's business plan.

The above matters raise substantial doubt about the Company's ability to continue as a going concern. The Company's ability to continue as a going concern will depend on its obtaining additional financing and its return to profitable operations.

2. Principles of consolidation:

These consolidated financial statements, presented in US dollars and in accordance with accounting principles generally accepted in the United States, include the accounts of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated.

3. Revenue recognition:

Sales are recognized at the time of shipment of products. The Company estimates liabilities and records provisions for customer allowances as a reduction of revenue, when such revenue is recognized.

4. Inventory:

Inventory is valued at the lower of cost, determined by the first in, first out method, and net realizable value. The only significant class of inventory is finished goods.

5. Prepaid expenses:

Prepaid expenses primarily include insurance, advances on inventory purchases and current portion of royalties and product development costs.

6. Other assets:

Prepaid royalties are capitalized and written off over the term of the related agreements.

Product development costs for proprietary product lines are capitalized and written off over a period of twenty-four months.

7. Equipment and leasehold improvements:

Equipment and leasehold improvements are stated at cost less accumulated depreciation. Depreciation methods and annual rates adopted by the Company are as follows:

Asset	Method	Rate
Computer equipment	Declining balance	30%
Machinery and equipment	Declining balance	20%
Furniture and fixtures	Declining balance	20%
Trucks and automobiles	Declining balance	30%
Telephone equipment	Declining balance	30%
Leasehold improvements	Straight-line	Term of
		lease plus one
		renewal term

 

8. Impairment of long-lived assets and long-lived assets to be disposed of:

Management reviews long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows, undiscounted and without interest charges, expected to be generated by the asset. 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.

9. Foreign currency translation:

1. Grand Toys Ltd. and Grand Concepts Inc., which ceased operations on January 29, 2002, wholly-owned Canadian subsidiaries, use the Canadian dollar as their functional currency and translate their assets and liabilities into US dollars at the exchange rates prevailing at the balance sheet date and sales, expenses and cash flows are translated at the average exchange rate for the year. The resulting currency translation adjustments are accumulated and reported in other comprehensive income.
2. Other monetary assets and liabilities denominated in foreign currencies are translated at the exchange rates prevailing at the balance sheet date. Revenues and expenses denominated in foreign currencies are translated at the rates of exchange prevailing at the transaction dates. All exchange gains and losses are included in income.

10. Earnings per share:

1. On September 4, 2001, the Company completed a one-for-four reverse stock split. For purposes of earnings per share calculations and all share amounts, the comparative numbers of shares have been restated to reflect the reverse split.
2. Basic earnings per share are determined by dividing the weighted average number of common shares outstanding during the period into net earnings (loss).
3. Diluted earnings per share give effect to all potentially dilutive common shares that existed at September 30, 2002.

 

11. Advertising and promotion:

All costs associated with advertising and promoting products are expensed in the period incurred. Total expense for the period ended September 30, 2002 and 2001 amounted to approximately $386,539 and $ 213,428. These expenses include media and cooperative advertising and are shown as part of selling, general and administrative expenses in the financial statements.

12. Employee stock option plan:

The Company accounts for its employee stock option plan in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees. As such, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeds the exercise price. Financial Accounting Standards Board ("FASB") Statement No. 123, Accounting for Stock-Based Compensation, allows entities to continue to apply the provisions of APB Opinion No. 25 and requires pro-forma net earnings and pro-forma earnings per share disclosures for employee stock option grants as if the fair-value-based method defined in FASB Statement No. 123 had been applied.

13. Comprehensive income:

Comprehensive income consists of net income and cumulative currency translation adjustments and is presented in the consolidated statements of stockholders' equity and comprehensive income. The statement requires only additional disclosures in the consolidated financial statements; it does not affect the Company's financial position or results of operations.

14. Use of estimates:

	September 30, 2002	December 31, 2001
Amount due repayable in monthly payments of principal and
interest of $21,124 per month	$ 598,991	$ 743,215
Less current portion	208,024	194,494
	$ 390,967	$ 548,721

3. Other assets:

	September 30, 2002	December 31, 2001
Prepaid royalties	$ 278,071	$ 326,262
Product development costs	42,765	74,982
	320,836	401,244
Less current portion, included in prepaid expenses	276,150	267,418
	$ 44,686	$ 133,826

4. Equipment and leasehold improvements:

	September 30, 2002		December 31, 2001
	Cost	Accumulated depreciation	Cost	Accumulated depreciation
Computer equipment	$ 1,220,499	$ 1,038,066	$ 1,203,915	$ 983,266
Machinery and equipment	447,292	414,145	445,821	406,881
Furniture and fixtures	459,806	434,887	458,222	428,986
Trucks and automobiles	76,993	76,413	76,722	75,977
Telephone equipment	48,336	39,355	42,486	37,499
Leasehold improvements	322,614	286,898	321,479	282,613
	$ 2,575,540	$ 2,289,764	$ 2,548,645	$ 2,215,222
Discontinued operation (note 15)		-	26,852
Net book value	$ 285,776		$ 360,275

5. Bank indebtedness:

In 2001, the Company secured a line of credit to finance its inventory and accounts receivable providing for advances of up to $1,500,000 (Cdn$2,425,000). An additional amount of $47,000 (Cdn$75,000) was advanced to the Company based on the value of certain of its equipment. In May 2002, the Company increased its total credit facility to $2,308,000 (Cdn$3,500,000), representing an increase in borrowing capacity of $660,000 (Cdn$1,000,000). The receivable loan has a discount fee of 2% and both the inventory loan and the equipment loan bear interest at Canadian prime plus 7.5%. The latter is being repaid through monthly capital repayments of $1,100 (Cdn$1,875). The agreement was automatically renewed on the expiration date, August 16, 2002.

The loan is secured by a first lien on all present and future assets of the Company.

The Company had approximately $1,194,216 of credit available as at September 30, 2002.

6. Shortfall on share conversions:

8. Stock options and warrants:

The Company's amended and restated employee stock option plan (the "Option Plan") provides for the issuance of up to 300,000 options (150,000 as at December 31, 2001) to acquire common stock of the Company. Stock options granted under the Option Plan may be Incentive Stock Options under the requirements of the Internal Revenue Code, or may be Non-statutory Stock Options, which do not meet such requirements. Options may be granted under the Option Plan to, in the case of Incentive Stock Options, all employees (including officers) of the Company, or, in the case of Non-statutory Stock Options, all employees (including officers) or non-employee directors of the Company.

Under the option plan, the exercise price of each option granted has been equal to the market price of the Company's stock on the grant date, and an option's maximum term is ten years.

Changes in options and warrants are as follows:

	Option Plan	Other stock options	Warrants	Total	Weighted-average exercise price per share
January 1, 2002	134,093	236,875	412,143	783,111	$ 3.72
Granted	90,500	20,000	2,745,000	2,855,500
Expired	(93,783)	(60,875)	-	(154,658)
September 30, 2002	130,810	196,000	3,157,143	3,483,953	$ 0.47

 

 

9. Earnings per share:

	Income (numerator)	Shares (denominator)	Per Share Amount
Quarter ended September 30, 2002
Basic EPS
From continuing operations	$ 106,266	2,619,210	$ 0.04
Discontinued operation	-	2,619,210	-
Earnings available to common stockholders	106,266	2,619,210	0.04
Diluted EPS
From continuing operations	$ 106,266	3,475,804	$ 0.03
Discontinued operation	-	3,475,804	-
Earnings available to common stockholders
and assumed conversions	106,266	3,475,804	0.03
Period ended September 30 2002
Basic and diluted EPS
From continuing operations	$ (523,762)	1,851,422	$ (0.28)
Disontinued operation	83,300	1,851,422	0.04
Earnings available to common stockholders	(440,462)	1,851,422	(0.24)
Quarter ended September 30 2001
Basic and diluted EPS
From continuing operations	$ 96,606	1,284,619	$ 0.08
Discontinued operation	(38,837)	1,284,619	(0.03)
Before extraordinary item	57,769	1,284,619	0.05
Gain on debt extinguishment	-	1,284,619	-
Earnings available to common stockholders	57,769	1,284,619	0.05
Period ended September 30 2001
Basic and diluted EPS
From continuing operations	$ (920,498)	1,144,329	(0.80)
Discontinued operation	(348,193)	1,144,329	(0.30)
Before extraordinary item	(1,268,691)	1,144,329	(1.10)
Gain on debt extinguishment	695,538	1,144,329	0.61
Earnings available to common stockholders	(573,153)	1,144,329	(0.49)

 

For the quarter ended September 30, 2002, options and warrants to purchase 398,768 shares of the Company's common stock outstanding were not included in the diluted earnings per share calculation as their effect is anti-dilutive.

For the nine months ended September 30, 2002, options and warrants to purchase 3,483,953 shares of the Company's common stock outstanding (December 2001 - 783,111) were not included in the diluted earnings per share calculation as their effect is anti-dilutive.

 

10. Net change in operating working capital items:

	For the nine months ended September 30,
	2002	2001
Increase in accounts receivable	$ (805,630)	$ (155,296)
Decrease in due from employees and affiliated company	376	16,853
(Increase) decrease in inventory	(1,020,987)	42,438
Decrease in income taxes recoverable	145,692	551,702
Decrease in prepaid expenses	234,632	59,481
Increase in trade accounts payable	490,590	476,496
Increase (decrease) in other accounts payable and accrued liabilities	305,375	(684,146)
Increase/(decrease) in royalties payable	14,315	(10,103)
	$ (635,637)	$ 297,425

 

11. Commitments:

The Company has entered into long-term leases with minimum annual rental payments approximately as follows:

2002	$ 76,000
2003	305,000
2004	237,000
2005	8,000
2006	8,000
	$ 634,000

Rent expense for the period ended September 30, 2002, and 2001 amounted to approximately $118,564 and $171,023, respectively.

12. Contingencies:

1. Lawsuits for alleged breach of contract have been filed against the Company's Canadian subsidiary by two former sales representatives and an employee. In the opinion of management, these actions have no merit. At this point in time it is difficult to ascertain or estimate the value of a settlement, if any.