Item 5. Operating and Financial Review and Prospects.
A. Operating results.
Fiscal Year Ended March 31,
2002 2003 2004
Net sales 100.0 % 100.0 % 100.0 %
Cost of goods sold 76.4 72.7 79.1
Gross profit 23.6 27.3 20.9
Selling, general administrative expenses 16.8 20.3 24.9
Operating income (loss) 6.8 7.0 (4.0 )
Interest expense 0.1 0.1 0.0
Interest income 2.3 1.6 1.3
Other income 0.1 0.3 0.6
Income (loss) from continuing operations before income taxes 9.1 8.8 (2.1 )
Provision for income taxes 1.7 0.8 0.2
Income (loss) from continuing operations 7.4 8.0 (2.3 )
Discontinued operations:
Loss from operation of the discontinued thin-film
electroluminescent ("TFEL") display business 12.9 1.1 0.0
Gain on disposal of TFEL display business 0.0 0.0 0.0
Income (loss) before minority interests (5.5 ) 6.9 (2.3 )
Minority interests 1.8 0.0 0.0
Net income (loss) (3.7 ) 6.9 (2.3 )
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
Net Sales. Our net sales include sales of finished goods, parts and accessories,
and tooling income from procuring, designing and manufacturing molds for certain
products that our customers choose to own. Tooling income is not a primary
source of our sales revenue and immaterial to overall sales. Net sales consist
of gross amounts invoiced less discounts and returns. Revenues from product
sales are recognized at the time of shipment when title passes. Under the
Company's standard terms and conditions of sale, which are mainly FOB shipping
point, title and risk of loss transfer to customers at the time product is
delivered to the customer's freight forwarder, and revenue is recognized
accordingly unless customer acceptance is uncertain or significant obligations
remain. It is rare to have any contingency concerning title passing when
explicit shipping terms are stated. We do not recognize sales for those products
where the customer has any right of return. Returns historically have been
immaterial.
Net sales in fiscal 2004 decreased approximately 11.4% to $66.9 million from
$75.5 million in fiscal 2003. The decrease was primarily due to declining sales
in kitchen appliances, and garment care and travel products that were not offset
by the increase in sales of floor care products.
Net sales are comprised primarily of sales in our three product categories:
kitchen appliances; garment care and travel products and floor care products.
Sales in each major category for fiscal 2004 as compared to fiscal 2003 were as
follows:
floor care product sales increased to $49.7 million, or 74.3% of
net sales, from $42.1 million, or 55.8% of net sales, primarily due
to new floor care product models contracted for by new customers.
We anticipate that the sales of floor care products will continue
to be a significant revenue source for us in the near term.
kitchen appliance sales decreased to $12.0 million, or 18.0% of net
sales, from $26.3 million, or 34.8% of net sales, primarily due to
decreases in sales of coffeemakers, breadmakers, and food steamers
32
Table of Contents
partially offset by increased sales of deep fryers. In fiscal 2004, our
last remaining significant customer for coffeemakers chose to source from
a lower cost competitor at prices we chose not to match. We anticipate
that the sales of kitchen appliances will continue to decrease in the
near future. We do not believe the decrease in sales of kitchen
appliances will have a significant impact on our results of operations.
sales of garment care and travel products decreased to $1.6
million, or 2.4% of net sales, from $2.8 million, or 3.7% of net
sales, primarily due to the decrease in sales of steam clothes
brushes and steam irons to our only major customer for these
based in Europe.
In fiscal 2004, sales to North America accounted for $56.1 million or 83.9 % of
net sales as compared to $64.8 million, or 85.8% of net sales in fiscal 2003. We
anticipate that North America will continue to be our dominated market in fiscal
2005. In fiscal 2004, sales to Asian countries increased by approximately $3.5
million to $5.7 million, or 8.6% of net sales in fiscal 2004 from $2.3 million,
or 3.0% in fiscal 2003. The increased Asian sales were primarily due to the
increased sales of a deep fryer model which accounted for 6.2% of net sales in
fiscal 2004. However, there is no assurance that the customer will continue to
buy this deep fryer model from us or that sales to Asia will continue to
increase in fiscal 2005.
Gross profit. Gross profit consists of net sales less cost of goods sold, which
includes the costs of raw materials, production materials, labor, in-bound
freight, depreciation and factory overhead. Gross profit in fiscal 2004 was
$13.9 million, or 20.9% of net sales, as compared to $20.6 million, or 27.3% of
net sales, in fiscal 2003. The decrease in gross profit as a percentage of net
sales was primarily due to lower selling prices, higher material costs and lower
production levels to absorb overhead. We reduced our selling prices on some of
our products particularly to our largest floor care customers to assist them in
retaining shelf space at the mass merchants. As we anticipate that sales of
floor care products will continue to be a significant sales revenue source for
us in the future, we believe we may have to lower the price of certain of our
floor care products to retain and attract new floor care customers. In fiscal
2004, our raw material costs as a percentage of net sales was approximately
63.6% as compared to 59.1% in fiscal 2003. In addition, the increase in material
costs including plastic resin, metal and motor components that were mostly used
in the manufacturing of floor care products currently cannot be shifted to our
customers. In particular, we are required to use higher-grade plastic resins,
which are more expensive, for our manufacture of floor care products.
Labor and overhead expenses as a percentage of net sales were 15.5% in fiscal
2004 as compared to 13.6% in fiscal 2003. There was a shortage of labor in
Guangdong Province and as a result, wage rates and benefits increased. In
addition, we had higher depreciation charges due to the change in useful lives
of some of our fixed assets as well as increases in overhead expenses including
consumable goods, loose tooling and staff benefits. Overhead is primarily a
fixed cost so production activity levels directly impact gross profit. We are
continuing to deploy automation in an effort to control our production costs.
For example, we recently shipped equipment to our manufacturing facility that
when installed will automate our system of surface mount assembly on printed
circuit boards. We believe this automation process will enhance our product
quality and reduce overhead expenses.
Selling, general and administrative expenses. The primary components of our
selling, general and administrative, or SG&A expenses are related to advertising
and promotion, product design and development, transportation of finished goods,
salaries for marketing and administrative personnel, professional fees and
utilities. SG&A expenses in fiscal 2004 were $16.7 million, or 24.9% of net
sales, as compared to $15.3 million, or 20.3% of net sales, in fiscal 2003.
Shipping, handling or other costs that are incurred for the sale of products are
classified as a selling expense. The primary shipping expense relates to inland
freight from the factory to the port, where title is passed to the customer.
During the fiscal years ended March 31, 2004 and 2003, shipping and handling
costs charged to selling expenses were $1.4 million and $1.8 million,
respectively.
Out of the total SG&A expenses in fiscal 2004, $2.0 million and $2.2 million
respectively were attributable to our new display and OLED programs compared to
$1.3 million for our OLED program in fiscal 2003. The aggregate increase of $2.9
million was the main contributor to our total SG&A expenses increasing $1.4
million. Shipping savings due to lower volume and a reduction in engineering and
administrative staff in our core business offset some of the increase in our
display and OLED programs and legal and professional fees. We do not believe
33
Table of Contents
the reduction in engineering and administrative staff will have a significant
impact on our results of operations of the core business.
Approximately 20% of the SG&A expenses for our display program was for marketing
and business development and the balance for actual product development. In both
fiscal 2004 and 2003, SG&A included license amortization of $0.7 million.
Excluding this, our OLED development program costs increased to $1.5 million in
fiscal 2004 from $0.6 million in the prior year.
We expect that SG&A expenses will increase for both the Global Display and OLED
programs in fiscal 2005 as a result of an accelerated effort to market and
produce display products. However, we plan to continue to tighten our control on
other discretionary costs particularly those related to our small appliance
business. For fiscal 2005, we plan to spend approximately $6 million to further
support and expand research and development for our display programs. In
addition, we plan to incur approximately $1.0 million and $1.5 million for our
core business and OLED program, respectively.
The primary components of design and development expense included in SG&A
include design and prototyping costs, patent fees, testing charges, inspection
fees and salaries for engineers and designers. In fiscal 2004, total product
development expenses were $2.3 million as compared to $1.8 million (after
netting out the effect of discontinued operations in fiscal 2003) in fiscal
2003. Of the $2.3 million in fiscal 2004, $0.7 million and $0.3 million were
incurred in the display and OLED programs, respectively.
Operating income (loss). In fiscal 2004, we incurred an operating loss of $2.7
million, as compared to an operating income of $5.3 million in fiscal 2003. The
decrease was mainly due to lower gross profit due to decreased sales and
production in our core business and an increase in investment in our new display
program and our OLED development.
Interest expense, interest income and other income, net.Interest expense
consists of interest on our short and long-term bank loans. Interest expense was
approximately $18,000 in fiscal 2004 as compared to $57,000 in fiscal 2003. The
decrease in interest expense was due to lower outstanding bank loans and a lower
effective rate on our loan borrowings. Interest income in fiscal 2004 was
approximately $851,000 as compared to $1.2 million in fiscal 2003. The decrease
was due to a decline in interest rate on the funds invested by the Company as we
primarily invest cash in low risk financial instruments. In fiscal 2004, we had
an average invested fund balance which includes cash and cash equivalents and
short-term investment of approximately $63.5 million with an average rate of
return of approximately 1.3% as compared to an average invested fund balance of
approximately $59.7 million with an average rate of return of approximately 2.1%
in fiscal 2003. Other income, net includes sundry and non-recurring income.
Other income, net, in fiscal 2004 was approximately $428,000, as compared to
$228,000 in fiscal 2003, and consisted primarily of exchange gains in both
years.
Income tax. We are not subject to taxation in the British Virgin Islands in
accordance with British Virgin Islands tax regulations. We are subject to income
tax in each jurisdiction in which our subsidiaries do business. Certain of our
income accrues in China where the effective tax rate is 27.0% and in Hong Kong,
where the corporate tax rate is 17.5% on income from operations but excluding
interest, dividend income and capital gains. In Hong Kong, estimated taxes for
each fiscal year are paid during the year based on the prior year's taxable
earnings from operations. An adjustment in the form of additional taxes paid or
refunds to us is then made in the following fiscal year based on actual taxable
earnings. Therefore, in each fiscal year, our statement of income reflects a
provision for estimated taxes for the current fiscal year and adjustments for
over-or under-provision with respect to the prior fiscal year.
Our Chinese subsidiaries are subject to income tax based upon the taxable income
as reported in the statutory financial statements prepared under Chinese
accounting regulations. Our subsidiary in China was exempt from income tax for
two years starting from its first profitable year (after utilizing accumulated
tax loss carry forwards or a lapse of five years) followed by a 50% exemption
for the next three years. In September 2002, our subsidiary in China filed
amended tax returns with the tax authorities for the tax periods of 1995 to
2002. The PRC tax authorities confirmed our amended tax returns as submitted,
establishing the first profitable year as 1999. Our Chinese subsidiary was not
therefore subject to income tax from 1999 and 2000 and received a 50% exemption
for the years from 2001 to 2003. Commencing January 1, 2004, our subsidiary in
China is subject to the full tax rate of
34
Table of Contents
27.0%. This Chinese subsidiary is our manufacturing facility that incurs a
significant portion of our manufacturing overhead. This subsidiary makes sales
of finished goods to our other subsidiaries. For these reasons, we do not
believe the full tax rate will have a significant impact on our financial
condition or results of operations. In fiscal 2004, we established a new
subsidiary, Dongguan Lite Array Company Limited, which is also exempt from
income tax for a two year period effective from its first profitable year and
followed by a 50% exemption for the next three years. We do not believe the full
implementation of the PRC income taxes will have a significant impact on our
financial condition and results of operations. To the extent that we have income
effectively connected with the conduct of a U.S. trade or business in any fiscal
year, we would be subject to U.S. taxes at an effective rate up to 55%. We do
not believe that our current method of operations subjects us to U.S. taxes. We
have established a subsidiary in Macau, China where we conduct sales, marketing,
administration and other activities. Similar to our subsidiaries established in
the British Virgin Islands, we are not subject to taxation in Macau in
accordance with Macau tax regulations.
We had taxable income in Hong Kong in both fiscal 2004 and 2003. The financial
statements include provisions for profits tax of approximately $108,000 and
$624,000 in fiscal 2004 and 2003, respectively.
Discontinued operations. In the third quarter of fiscal 2003, we sold the TFEL
business to the former management of Lite Array, Inc. The loss from operations
of the discontinued TFEL business was $835,000 (excluding $29,000 gain on
disposal of TFEL business) in fiscal 2003.
Net income (loss). In fiscal 2004, net loss was approximately $1.5 million, or
$0.13 per share as compared to a net income of $5.3 million, or $0.43 per share
in fiscal 2003.
Fiscal Year Ended March 31, 2003 Compared with Fiscal Year Ended March 31, 2002
Net Sales. Our sales includes sales of finished goods, parts and accessories,
and tooling income from procuring, designing and manufacturing molds for certain
products pursuant to customer purchase orders. Tooling income is not our primary
source of sales revenue and immaterial as related to sales. Our net sales
consist of gross amounts invoiced less discounts and returns. Revenues from
products are recognized at the time of shipment when title passes. Under the
Company's standard terms and conditions of sale, which are FOB shipping point,
title and risk of loss transfer to customers at the time the product is
delivered to the customer's freight forwarder, and revenue is recognized
accordingly unless customer acceptance is uncertain or significant obligations
remain. It is rare to have any contingency concerning the passage of title when
explicit shipping terms are stated. We do not recognize sales for those products
where the customer has any right of return. Returns historically have been
immaterial.
Net sales in fiscal 2003 decreased approximately 11.5% to $75.5 million from
$85.3 million in fiscal 2002. Decreases in sales of kitchen appliances, garment
care and travel products were partially offset by the increase in sales of floor
care products. Our floor care products sales to one major customer, Royal
Appliance ("Royal") decreased from $36.2 million in fiscal 2002 to $33.4 million
in fiscal 2003. However, the reduction in sales to Royal was more than offset by
sales of floor care products to new customers. Despite being acquired by TTI,
our competitor in Hong Kong, Royal continued to place purchase orders on the
existing floor care products manufactured by us. Our sales of personal care and
kitchen appliance products were also negatively impacted by the bankruptcy of
Moulinex.
Net sales are comprised primarily of sales in our three major product
categories: kitchen appliances; garment care and travel products and floor care
products. Sales in each major category for fiscal 2003 as compared to fiscal
2002 were as follows:
sales of kitchen appliances decreased to $26.3 million, or 34.8% of
net sales, from $36.1 million, or 42.3% of net sales, primarily due
to the decrease in sales of coffeemakers, breadmakers, and food
steamers, deep fryers and food processors to two major European
customers.
sales of garment care products decreased to $2.2 million, or 2.9%
of net sales, from $6.5 million, or 7.7% of net sales, primarily
due to the decrease in sales of steam irons to our only major
customer for these products based in Europe. That customer was
able to secure a lower cost source of supply in
35
Table of Contents
China and we chose not to match that lower price because of the impact
it would have on our profit margins.
floor care products sales increased to $42.1 million, or 55.8% of
net sales, from $37.3 million, or 43.8% of net sales, primarily due
to new floor care product models contracted for by new customers.
We anticipate that sales of floor care products should continue to
be a significant source of revenue for us in the near term and will
generate profit sufficient to offset the impact of the anticipated
sales decrease in the garment care and kitchen appliance product
categories.
Gross profit. Gross profit consists of net sales less cost of goods sold, which
includes the costs of raw materials, production materials, labor, freight in,
depreciation and factory overhead. It has historically been our goal to attempt
to make product development decisions and work with particular partners based on
the opportunity for consistently profitable sales. Since fiscal 2001, sales of
certain personal care and kitchen appliance products have consistently resulted
in lower gross margins. In recent years, we have concentrated on manufacturing
more profitable floor-care products to offset the price pressure being exerted
by mass merchandisers on garment and kitchen appliance products. Consequently,
we have experienced decreased sales on lower margin products such as
coffeemakers, breadmakers, food-steamers and steam irons because of our business
decision to concentrate on the manufacture of products with higher profit
margins.
Gross profit in fiscal 2003 was $20.5 million, or 27.3% of net sales, as
compared to $20.2 million, or 23.6% of net sales, in fiscal 2002. The increase
in gross profit as a percentage of net sales was primarily due to lower material
costs. In fiscal 2003, our raw material costs as a percentage of net sales were
approximately 59.1% as compared to 62.5% in fiscal 2002. This decrease resulted
primarily from better supply chain management in raw materials and product
components. Labor and other overhead expenses as a percentage of net sales were
13.6% in fiscal 2003 as compared to 13.8% in fiscal 2002. Excluding similar
depreciation charges for both fiscal 2002 and 2003, labor and overhead expenses
as a percentage of net sales were approximately 8.9% in fiscal 2003 as compared
to 9.3% in fiscal 2002.
Selling, general and administrative expenses. The primary components of our
selling, general and administrative, or SG&A, expenses are related to
advertising and promotion, product design and development, transportation of
finished goods, salaries for marketing and administrative personnel,
professional fees and utilities. SG&A expenses in fiscal 2003 were $15.3
million, or 20.3% of net sales, as compared to $14.3 million, or 16.8% of net
sales, in fiscal 2002. We incurred more design and prototyping costs in fiscal
2003 due to initiating a number of programs for our display business. We were
not able to achieve our goal of maintaining SG&A expenses at 15% of net sales as
we incurred higher depreciation and amortization charges for transportation
equipment and our OLED license and higher rent due to relocation of our
executive office in September 2002, which was only partially offset by a
reduction in selling and transportation expenses and legal and professional
fees. It is anticipated that the Global Display and OLED programs will not
generate sufficient revenue in fiscal 2004 to absorb the SG&A expenses incurred
in respect of these programs. Therefore, we expect SG&A expenses will continue
to increase in the near future and we anticipate that our target of 15% of net
sales will be exceeded in the next few years by a significant factor until sales
of display oriented products materialize. Over the next two fiscal years, we
expect design and development expenses to increase to approximately $4.0 million
per fiscal year, including approximately $1.5 million for Lite Array and
approximately $1.5 million for Global Display and the balance in our core
business. It is anticipated that these increased development costs included in
SG&A expenses will have a material impact on our results of operations for
fiscal 2004 and into the following year.
In fiscal 2002, we recognized approximately $0.3 million for the impairment of
property, plant and equipment; $5.2 million representing our share of a loss in
a joint venture and $3.6 million for the write-off of goodwill arising from the
acquisition of the TFEL business, which are all reflected separately in
discontinued operations on our financial statements.
The primary components of design and development included in SG&A expenses
include expenses related to sample design, patent fees, testing charges,
inspection fees and salaries for engineers and designers. Development expenses
were approximately $2.2 million and $2.0 million in fiscal 2002 and 2003,
respectively. After netting out the effect of discontinued operations,
development expenses were $2.0 million and $1.8 million in fiscal 2002 and 2003.
R&D expenses incurred in our Global Display business were immaterial in fiscal
2003. In fiscal 2003, we
36
Table of Contents
also incurred approximately $140,000 in R&D expenditures for OLED. The expense
was mainly attributable to the wages for the dedicated OLED R&D staff.
Operating income (loss). In fiscal 2003, operating income was $5.3 million as
compared to $5.9 million in fiscal 2002. The decrease was primarily due to SG&A
not decreasing in the same proportion as sales.
Interest expense, interest income and other income, net. Interest expense
consists of interest on our short and long-term banking facilities. Interest
expense was approximately $57,000 in fiscal 2003 as compared to $126,000 in
fiscal 2002. The decrease in interest expense was due to a lower effective rate
of interest on our loan borrowings. Interest income in fiscal 2003 was $1.2
million as compared to $2.0 million in fiscal 2002. The decrease was due to a
decline in interest rates on the funds invested by the Company as we primarily
invest our cash in short-term U.S. Government paper. In fiscal 2003, we had an
average invested fund balance which includes cash and cash equivalents and
short-term investments of approximately $59.7 million with an average return on
investments of approximately 1.58% as compared to an average invested fund
balance of approximately of $55.9 million with an average rate of return of
approximately of 2.3% in fiscal 2002. Other income, net, in fiscal 2003 was
approximately $228,000, as compared to $85,000 in fiscal 2002. The decrease in
fiscal 2003 was due to lower sundry income.
Income tax. We are not subject to taxation in the British Virgin Islands in
accordance with British Virgin Islands tax regulations. We are subject to income
tax in each jurisdiction in which our subsidiaries do business. Certain of our
income accrues in China where the effective tax rate is 27.0% and in Hong Kong,
where the corporate tax rate is 17.5% on income from operations but excluding
interest, dividend income and capital gains. In Hong Kong, estimated taxes for
each fiscal year are paid during the year based on the prior year's taxable
earnings from operations. An adjustment in the form of additional taxes paid or
refunds to us is then made in the following fiscal year based on actual taxable
earnings. Therefore, in each fiscal year, our statement of income reflects a
provision for estimated taxes for the current fiscal year and adjustments for
over-or under-provision with respect to the prior fiscal year.
Our Chinese subsidiaries are subject to income tax based upon the taxable income
as reported in the statutory financial statements prepared under Chinese
accounting regulations. Our subsidiary in China was exempt from income tax for
two years starting from its first profitable year (after utilizing accumulated
tax loss carry forwards or a lapse of five years) followed by a 50% exemption
for the next three years. In September 2002, our subsidiary in China filed
amended tax returns with the tax authorities for the tax periods of 1995 to
2002. The PRC tax authorities confirmed our amended tax returns as submitted,
establishing the first profitable year as 1999. Our Chinese subsidiary was not
therefore subject to income tax from 1999 and 2000 and received a 50% exemption
for the years from 2001 to 2003. Commencing January 1, 2004, our subsidiary in
China is subject to the full tax rate of 27.0%.
To the extent that we have income effectively connected with the conduct of a
U.S. trade or business in any fiscal year, we would be subject to U.S. taxes at
an effective rate up to 55%. We do not believe that our current method of
operations subjects us to U.S. taxes. We have established a subsidiary in Macau,
China where we conduct sales, marketing, administration and other activities.
Similar to our subsidiaries established in the British Virgin Islands, we are
not subject to taxation in Macau in accordance with Macau tax regulations.
We had taxable income in Hong Kong in both fiscal 2003 and 2002. The financial
statements include provisions for profit tax of approximately $0.6 million and
$1.4 million in fiscal 2003 and 2002, respectively. The provision for fiscal
2002 includes $0.8 million in penalties, interest and taxes imposed on an
insurance settlement we had received six years ago as a result of a flood at our
former factory. Our tax position was disputed by the Inland Revenue Department
of Hong Kong in their audit of certain subsidiaries for the period 1993-2001.
Accordingly, we determined that a settlement was appropriate and paid a total of
$1.2 million to settle outstanding issues with the Inland Revenue Department in
May 2002.
Discontinued operations. In the third quarter of fiscal 2003, we sold the TFEL
business to the former management of Lite Array, Inc. The loss from operations
of the discontinued TFEL business was $11.0 million and $835,000 (excluding
$29,000 gain on disposal of TFEL business) in fiscal 2002 and 2003,
respectively.
37
Table of Contents
Minority interests. Lite Array's minority shareholder's share of the loss in
Lite Array has been credited to the income statement up to the total minority
interest. All further losses incurred at Lite Array will accrue to us since the
minority interest was exhausted in fiscal 2002.
Net income (loss). In fiscal 2003, net income was approximately $5.3 million or
$0.43 per share, as compared to a net loss of $3.0 million, or $0.25 per share,
in fiscal 2002.
B. Liquidity and Capital Resources.
Our primary source of financing has been cash generated from operating
activities. During fiscal 2004 and 2003, we generated approximately $4.1 million
and $10.4 million, respectively, in cash provided by operating activities. The
decrease in fiscal 2004 is due primarily to the net loss incurred compared to
net income in the prior year offset by a reduction in operating assets and
liabilities of $0.4 million and increased depreciation and amortization of $0.7
million. At March 31, 2004, inventories were $8.8 million, compared to $7.5
million as of March 31, 2003. The increase in inventories was primarily due to
an increase in work-in-progress, mainly components and subassemblies awaiting
customer release of pending orders.
Accounts receivable were $10.0 million in fiscal 2004, compared to $10.2 million
in fiscal 2003. Receivables at March 31, 2004 represented 55 days of sales
compared to 50 days of sales at March 31, 2003. The change in number of days of
sales was essentially due to timing as there were no material changes to the
credit terms granted to customers. Sales to one of our largest customers, Royal
Appliance Manufacturing Co. ("Royal") represented 48.4% of total net sales
during fiscal 2004. We extended the payment terms for Royal in this and prior
years and we expect this practice to continue in fiscal 2005.
In our manufacturing facility in Dongguan, China, we paid value-added tax on raw
materials and consumable goods that were procured in China. However, we are
eligible for refunds when these materials and consumable goods are transformed
into finished goods and exported out of China. During fiscal 2004, we received
substantially all of the outstanding VAT refund due. As of March 31, 2004, we
had an outstanding balance of $0.7 million due from the Chinese government.
Since the Chinese Government is historically slow in processing refunds, we
believe that we will eventually receive the monies owed to us in due course. At
March 31, 2004, accounts payable were approximately $5.1 million as compared to
$5.2 million at March 31, 2003.
Working capital increased by $1.3 million from $72.4 million at March 31, 2003
to $73.7 million at March 31, 2004. Excluding cash, short-term investments and
loans of $64.1 million and $63.2 million as of March 31, 2004 and 2003
respectively, working capital increased $0.4 million.
In October 1998, we made a loan to a start-up U.S. corporation wholly owned by
the spouse of an executive of ours in the original principal amount of $1.0
million, bearing interest at a fixed annual rate of 7.0% and payable in
quarterly installments of approximately $81,000 commencing October 28, 2003,
with any remaining balance due in full on October 28, 2008. As of March 31,
2004, accrued interest on the loan was approximately $700,000. We have reserved
fully against the interest due. Effective April 30, 2004, we acquired all of the
outstanding shares of this company for $1,000. There was no gain or loss
recorded by us as a result of this acquisition since the only assets acquired
were cash and intangible assets that had no value and we have continued to carry
this loan at the same amount as the underlying cash value. See "Item 7.B-Related
Party Transactions."
In October 1999, we made a loan to an officer for the purchase of a residence
and office. The loan is in the principal amount of $460,000, bearing interest at
a fixed annual rate of 6.02%, and is secured by a mortgage on the property. The
loan is payable in six years with annual installments of approximately $77,000
of principal together with interest on the unpaid principal balance, commencing
October 21, 2000. Payments on the loan will be forgiven in arrears, however, on
each payment due date in consideration for the director's continued service to
us. All transactions with our executive officers and directors must be approved
by a majority of our independent directors. Furthermore, in order to comply with
the Sarbanes-Oxley Act of 2002 enacted by the United States Congress, we will
not enter into any loan agreements with any director or executive officer or
their respective affiliates or renew
38
Table of Contents
or modify any existing loan agreements with directors or executive officers or
their respective affiliates. See "Item 7.B-Related Party Transactions."
Our aggregate capital expenditures during fiscal 2004 and 2003 were $3.2 million
and $3.5 million, respectively. Capital expenditures in fiscal 2004 primarily
included acquisition of moulds and tools, furniture and equipment and machinery,
most of which was devoted to our display and OLED programs. During fiscal 2003,
we wrote off some transportation equipment and furniture and fixtures and also
disposed of fixed assets as part of the sale of the TFEL business, thus the net
increase in our fixed assets was approximately $2.2 million. We have incurred an
aggregate of approximately $2.3 million in capital expenses to date for a clean
room and equipment in our Dongguan facility to support our OLED display
development program. Currently, no OLED products are ready for commercial sale.
Our capital commitments as of March 31, 2004 were approximately $0.6 million for
the acquisition of tooling and purchase of equipment.
We maintain adequate cash to support our new business development. Our quick
assets, which include cash, callable deposits and short-term investments,
increased from $62.9 million in fiscal 2003 to $64.1 million in fiscal 2004.
Excluding the expenditures for our new display and OLED programs, we generated
approximately $8.0 million in cash from the operating activities of our core
business in fiscal 2004. In fiscal 2005, we expect to begin selling and shipping
display products and we have sufficient funds available to support the display
and OLED programs. For fiscal 2005, we plan to spend about $6 million to further
support and expand research and development for our display programs. We intend
to fund the program with the cash generated from our operating activities of
core business and our cash on hand. However, there is no assurance that it will
be feasible to continue funding these projects.
During fiscal 2004, we made a $5.0 million multi callable deposit that will
mature on August 11, 2008. The deposit carried variable interest rates of not
more than 2.5% per annum. The bank had the right to terminate the deposit in
full and repay our money on the 11th day of February, May, August and November,
commencing November 11, 2003. If the bank exercises its right to prematurely
repay the deposit, we may incur a lower rate of return when reinvesting the
funds. If for any reason we require access to these funds prior to maturity, we
are required to fully reimburse the bank for its losses and indemnify it for the
costs incurred as a result of its terminating, liquidating, obtaining or
re-establishing any hedge or related trading position. There was no change in
the market value of this deposit as of March 31, 2004.
Our long-term debt consists of two term loans with an aggregate outstanding
amount of $374,000 as of March 31, 2004 (including the current portion of
long-term debt), provided by Standard Chartered Bank to finance the purchase of
machinery and equipment. These loans bear interest at rates per annum currently
ranging from 1.14% to 3.25% and mature in April 2004 and February 2005,
respectively. The loans are payable in monthly and quarterly installments which
were approximately $36,000 as of March 31, 2004. The Hong Kong dollar is pegged
to the U.S. dollar. As of March 31, 2004, we had an outstanding loan of $338,000
(or EURO 277,000) denominated in EURO. This loan will mature in May 2005. During
fiscal 2004, the exchange rate for the U.S. dollar against the EURO had
depreciated from $1.0863 per EURO to $1.2682 per EURO. Consequently, we have to
pay more Hong Kong dollars for each quarterly installment. However, due to the
immaterial amount of the loan, we do not expect a continued increase in the
value of the EURO to have a material impact on our financial position.
We are in compliance with all of the covenants entered into with our banks in
connection with the outstanding debt and have been in compliance during all
periods presented. In addition, we have not entered into any cross-default
provision in our debt agreements with our banks. However, since the debt
agreements are subject to periodic review by our banks, which may result in
changes of their terms and conditions, there can be no assurance that our debt
agreements will not be subject to cross-default provisions in the future.
Our revolving credit facilities are with Standard Chartered Bank, Citibank, N.A.
and Hongkong Bank with an aggregate facilities limit of approximately $30.5
million as of March 31, 2004, bearing interest at floating commercial bank
lending rates in Hong Kong ranging from 6.63% to 13.99% per annum. The amounts
payable each month on the revolving credit facilities varies depending upon the
amounts drawn at the time. Our outstanding borrowings vary according to our
seasonal working capital requirements. As of March 31, 2004, we had an aggregate
outstanding amount of $48,000 and the amount utilized under our bank facilities
was $1.3 million, including letters of credit amounting to $0.7 million for the
purchase of materials and the balance in guarantees.
39
Table of Contents
We anticipate that cash from operating activities should be adequate to satisfy
our capital requirements for at least the next two years. We have over prior
years considered potential acquisitions of complimentary businesses. Although we
have not reached an agreement for such an acquisition, we plan to continue to
pursue selected acquisitions of complementary businesses. In the event that we
should consummate such an acquisition, our capital requirements could increase.
Our acquisition of Lite Array, Inc. was completed in May 2001. Total
consideration for our investment in Lite Array was approximately $9.6 million,
of which approximately $3.8 million was settled in cash and we took
responsibility for paying the balance due on a license of $1.8 million. The
remaining portion of the consideration was satisfied in exchange of convertible
notes issued by Lite Array in fiscal 2001. Sometime after making our investment
decision, as part of our analysis of the potential for Lite Array's TFEL display
business and its joint venture operation, we determined that the long-term
prospects were limited. We decided to discontinue the production of TFEL
displays and cease funding the joint venture in China as of September 30, 2002.
We decided to write off the value of Lite Array's investment in the joint
venture, the goodwill associated with the TFEL display business and certain TFEL
production equipment owned by us. In fiscal 2003, we sold the TFEL business to
the former management of Lite Array.
Pursuant to the small molecule OLED license we assumed as a result of our
acquisition of Lite Array, we were required to pay royalties of a fixed
percentage of the net sales of OLED display products that are produced by using
the licensed know-how and sold by Lite Array and its subsidiaries before January
1, 2004. Lite Array also must pay royalties of the greater of a fixed amount or
a fixed percentage of the net sales of OLED display products that are produced
by using the licensed know-how and sold by Lite Array and its subsidiaries after
January 1, 2004. The license expires in 2023 and may be terminated at any time
by us after January 1, 2004. Presently, Lite Array is still in the research and
development stage; however, we have paid a portion of a fixed amount of the
royalties and sought approval from the licensor to defer the remaining balance
to October 2004. We are also working with other strategic partners to expedite
the manufacturing of OLED display products.
On November 1, 2002, we announced that our subsidiary, Global Lite Array (BVI)
Limited, entered into an agreement to sell Lite Array's TFEL display business,
including the interest that Lite Array owns in a joint venture manufacturing
facility in Jiangmen, China, to ViewPoint Flat Panel Display, Inc. a corporation
in California, owned by the former management of Lite Array. During the
transaction, the former management of Lite Array assigned a loan due to Global
Lite Array outstanding as of the closing date. The loan amount was approximately
$2.8 million. We have provided adequate provision for the loan due to Global
Lite Array. There is no assurance that we can collect the loan if the former
management of Lite Array cannot successfully derive profits from the TFEL
business. After the sale of the TFEL business, we recorded its losses as losses
from discontinued operations of approximately $11.0 million and $0.8 million for
the fiscal years 2002 and 2003, respectively.
On January 7, 2003, we entered into an asset purchase and lease agreement with
Opsys US Corporation (Opsys), a Delaware Corporation. We purchased their R&D
experimental production equipment for small molecule OLED displays for $1.0
million. Concurrent with the purchase of the equipment, we leased it back to
Opsys through February 28, 2003 for a rental payment of $1,000 per month. Upon
the execution of the Purchase Agreement, we were granted a warrant to purchase
securities of Opsys (and of any of its affiliates that raised capital) having an
aggregate valuation of $2.0 million, with such warrants having an exercise price
of $0.0001 per share. At the time of the execution of the Purchase Agreement, we
believed that the purchase of the equipment and the opportunity to acquire such
securities would accelerate our progress in OLED product development. An
involuntary proceeding under Chapter 7 of the United States Bankruptcy Code was
commenced against Opsys on May 3, 2003. On September 4, 2003, the Bankruptcy
Court for the Northern District of California issued an order to allow us to
proceed with removal of the equipment located in Opsys' business location. We
removed and shipped the equipment to our facility in Dongguan, China for
re-installation and plan to operate the prototype line there in a new clean room
currently under construction.
Inflation. From 2000 through May 2004, the rate of inflation in Hong Kong has
ranged from approximately -8.1% to 6.6% per year (approximately -2.6% during
2003 and -1.6% for the first five months during 2004) and the average rate of
inflation in China ranged from approximately -2.2% to 9.8% per year
(approximately 1.2% during 2003). As a general matter, the effect of this
inflation on us is primarily limited to labor costs, which
40
Table of Contents
represent a small component of our total expenses. As we purchase most of our
raw materials from outside China, inflation in China does not have a significant
effect on our overall costs.
Currency and exchange rates. The functional currency of our Company is the Hong
Kong dollar. The functional currencies of our subsidiaries in the locations
outside Hong Kong are the respective local currencies. Nearly all of our sales
are denominated in U.S. dollars. The majority of our expenses, including wages
and other production and administrative costs are denominated in Hong Kong
dollars and Chinese Renminbi. Certain raw materials and capital equipment are
purchased using a variety of currencies including the U.S. dollar, Chinese
Renminbi, Japanese yen and EURO but the majority are purchased using Hong Kong
dollars which is pegged to the U.S. dollar. Currently, we have a long-term loan
denominated in EUROs. During fiscal 2004, the value of the U.S. dollar
depreciated from $1.0863 per EURO to $1.2682 per EURO. However, in aggregate we
have not been significantly affected by exchange rate fluctuations and therefore
have not needed to hedge our positions. See Note 3(l) of Notes to Consolidated
Financial Statements.
Application of Critical Accounting Policies.
The Company believes the following critical accounting policies and estimates
used in the preparation of its consolidated financial statements can affect its
results of operations. The policies set forth below require management's most
subjective or complex judgments, often as a result of the need to estimate the
effect of matters that are inherently uncertain.
Valuation of property, plant and equipment. We assess impairment
periodically for property, plant and equipment when events indicate
that future operations will not produce sufficient revenue to cover
the related future costs. Impairment losses are recognized when the
sum of expected future net cash flow (undiscounted and without
interest charges) are less than the carrying amount of the assets.
Measurement of the impairment loss is based on the fair value of the
assets. Effective April 1, 2002, we changed to the straight-line
method of depreciation for machinery. We believe the straight-line
depreciation method more accurately reflects financial results over
the useful lives of these assets. The effect of the change was not
material to the results of operations for fiscal 2003 and 2004.
Impairment of intangible assets. An appraisal of the fair market
value of the license for small molecule PM-OLED technology was
performed by an independent appraisal company and this amount was
used in our purchase accounting. Based upon the license value and
our evaluation of the life of the technology before it is
superseded, we determined that the license would be amortized over
eight years. Each year we evaluate whether there is any impairment
in the carrying value based on an analysis of the financial plan
for the OLED display business, a discounted cash flow analysis and
an update from the appraisal company.
Deferred tax valuation allowance. We account for income taxes under
the provisions of SFAS No. 109. Deferred tax assets are recognized
for losses carried forward but we provide a valuation allowance if we
believe that these losses are more likely than not to be utilized. We
consider future taxable income and ongoing prudent and feasible tax
planning strategies in assessing the need for such a valuation
allowance. In the event we were to determine that we would not be
able to realize any deferred tax assets in the future, an adjustment
to the deferred tax assets would be charged to earnings in the period
such determination was made. Likewise, if we later determined that it
is more likely than not that the net deferred tax assets would be
realized, the previously provided valuation allowance would be
reversed.
Inventory reserves. Inventories are stated at the lower of cost or
market value. Cost, calculated on the first-in first-out basis,
comprises materials and, where applicable, direct labor and an
appropriate proportion of production overhead. Obsolete and
unmarketable inventories are adjusted to the estimated market value
based upon assumptions of future demand and market conditions. If
the actual market conditions are less favorable than those projected
by management, additional inventory reserves might be necessary.
Allowance for doubtful accounts. We maintain allowances for
doubtful accounts for estimated losses resulting from the
inability of its customers to make required payments. If the
financial condition of our
41
Table of Contents
customers were to deteriorate, resulting in an impairment of their
ability to make payments, additional allowances would be required.
Recent changes in accounting standards
In January 2003, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 46 ("FIN 46"): "Consolidation of Variable Interest Entities,
an Interpretation of ARB No. 51." In December 2003, the FASB modified FIN 46 to
make certain technical corrections and address certain implementation issues
that had arisen. FIN 46 provides a new framework for identifying variable
interest entities ("VIEs") and determining when a company should include the
assets, liabilities, non-controlling interests and results of activities of a
VIE in its consolidated financial statements. In general, a VIE is a
corporation, partnership, limited liability corporation, trust, or any other
legal structure used to conduct activities or hold assets that either (i) has an
insufficient amount of equity to carry out its principal activities without
additional subordinated financial support, (ii) has a group of equity owners
that are unable to make significant decisions about its activities, or (iii) has
a group of equity owners that do not have the obligation to absorb losses or the
right to receive returns generated by its operations. FIN 46 requires a VIE to
be consolidated if a party with an ownership, contractual or other financial
interest in the VIE (a variable interest holder) is obligated to absorb a
majority of the risk of loss from the VIE's activities, is entitled to receive a
majority of the VIE's residual returns (if no party absorbs a majority of the
VIE's losses), or both.
A variable interest holder that consolidates the VIE is called the primary
beneficiary. Upon consolidation, the primary beneficiary generally must
initially record all of the VIE's assets, liabilities and non-controlling
interests at fair value and subsequently account for the VIE as if it were
consolidated based on majority voting interest. FIN 46 also requires disclosures
about VIEs that the variable interest holder is not required to consolidate but
in which it has a significant variable interest.
FIN 46 was effective immediately for VIEs created after January 31, 2003. The
provisions of FIN 46, as revised, were early adopted for the Company's interests
in all VIEs and there was no cumulative effect on the Company's results of
operations or financial position upon the adoption of the provisions of the
revised FIN 46.
C. Research and development, patents and licenses, etc.
We spent approximately $2.3 million, $1.8 million (excluding approximately $0.2
million incurred by the TFEL business that was discontinued in fiscal 2003) and
$2.0 million, respectively, on product design and development in each of fiscal
2004, 2003 and 2002. The expense was primarily attributable to the wages for the
technical staff and prototyping and design fees. For fiscal 2005, we plan to
spend approximately $6 million to further support and expand research and
development for our display programs. Additionally, we anticipate incurring $1.0
million and $1.5 million for our core business and OLED programs. For a more
complete description of our research and development, patents and licenses,
etc., see "Item 4.B-Business Overview-Product Design and Development
and-Intellectual Property Rights."
Our primary objective in the OLED business is to be a low-cost producer of
passive molecule organic light emitting diodes (PMOLED) as a component supplier
to the wireless equipment and consumer electronic industries for use in products
such as mobile phones and personal digital products. With the use of our OLED
license to attract business partners in displays and electronics in Asia, we
plan to develop a flexible process to manufacture small passive matrix OLEDs
with minimal capital investment and also develop a process that will allow for
simple ramp up to volume production at multi-sites if necessary.
D. Trend information.
See "Item 5.A-Operating and Financial Review and Prospects-Operating Results"
and "Item 5.B-Operating and Financial Review and Prospects-Liquidity and Capital
Resources" for discussion of the most significant recent trends in our business
since the last fiscal year.
42
Table of Contents
E. Off-balance sheet arrangements.
The Company has no off-balance-sheet arrangements such as guarantees, derivative
securities, retained interests or variable interests that will or could have a
material effect on the Company's financial condition, revenue and expenses,
results of operations, liquidity, capital expenditures and capital resources.
F. Tabular Disclosure of Contractual Obligations:
The following is a schedule reflecting our aggregate financial commitments as of
March 31, 2004:
Payment Due by Period
Less than 1
Contractual Obligations Total year 1-3 years 3-5 years After 5 years
Long-Term Bank Loans (1) $ 373,612 $ 373,612 - - -
Capital Commitments (2) $ 643,724 $ 643,724 - - -
Operating Lease Commitments (3) $ 987,762 $ 331,964 $ 396,773 $ 155,415 $ 103,610
Fee Payable for Land Use Rights $ 91,019 $ 91,019 - - -
Other Long-Term Liabilities (4) $ 250,000 $ 250,000 - - -
Total Contractual Obligations $ 2,096,117 $ 1,440,319 $ 396,773 $ 155,415 $ 103,610
(1) Our long-term debt consists of two term loans with an aggregate
outstanding amount of approximately $374,000 as of March 31, 2004
(including the current portion of long-term debt), provided by
one bank to finance the purchase of machinery, equipment and
motor vehicles. These loans bear interest at rates per annum
currently ranging from 1.14% to 3.25% and mature in fiscal 2004.
All of such loans are payable in monthly installments which were
approximately $36,000 as of March 31, 2004.
(2) Our capital commitments are for the purchase of property,
plant and equipment.
(3) We have various operating lease agreements for parking lots,
motor vehicles, equipment and real estate that extend through
2009.
(4) It includes minimum royalties payable.
43
Table of Contents
|