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The following discussion and analysis should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in the Annual Report. The Company prepares its financial statements in accordance with U.S. GAAP. Year ended March 31, 1999 Compared to Year Ended March 31, 1998Year ended March 31, 1998 Compared to Year Ended March 31, 1997 Liquidity and Capital Resources Impact of Inflation Exchange Rates Year 2000 Issue Management Discussion and Analysis Year ended March 31, 1999 Compared to Year Ended March 31, 1998 The Company's net sales for the year ended March 31, 1998 were $66,169,000, an increase of $21,629,000 or 48.6% as compared to year ended March 31, 1997. Sales to Mita, Inter-Tel, Behringer and Namtai Shenzhen, the Company's four largest customers during the year ended March 31, 1998, represented approximately 79.7% of net sales for the year. The decrease in sales was due mainly to decreased sales in all product lines, consisting of decreases in sales of injection-molded plastic, electronic and metallic products of $2,669,000, $7,846,000 and $2,215,000, respectively, or decreases of 7.8%, 26.5% and 54.9% respectively as compared with the net sales in the prior year. The decrease in sales in the electronic division was mainly attributed to the substantial reduction in orders from subcontracted PCB assembly customers and the reduction in selling prices in both OEM and subcontracted sales as compared to the prior year. As regards to the plastics division, the reduction in orders from Mita and other customers were off set by the increase in demand from different customers. Net sales to customers by geographic area are determined by reference to shipping destinations as directed by the Company's customers. During the year ended March 31, 1999, sales to China, Hong Kong, the United States and Europe decreased by $2,747,000, $2,001,000, $772,000 and $7,367,000, respectively, and sales to Japan increased by $157,000, over 1998 levels. The overall gross profit for the year ended March 31, 1999 was $21,260,000, representing a gross profit margin of 39.8%. This compares with the overall gross profit and gross profit margin of $29,923,000 or 45.2% for the year ended March 31, 1998. The decrease in gross margin of 5.4% was mainly attributable to the reduction in selling prices on both OEM and subcontracted sales and the substantial reduction in orders of relatively higher margin subcontracted products from the Company's contract manufacturing operations in the year ended March 31, 1999. Selling, general and administrative expenses for the year ended March 31, 1999 were $10,364,000, amounting to 19.4% of total net sales, as compared to $14,067,000 or 21.2% of total net sales for the year ended March 31, 1998. The decrease in selling, general and administrative expenses of $3,703,000 over the prior year was largely due to the stricter control in these expenses and the internal takeover of quality control and research and development support work during the year ended March 31, 1999. As a result of the decrease in net sales, operating income was $10,896,000 for the year ended March 31, 1999, a decrease of $4,960,000 or 31.3% as compared with the prior year. The operating margin for the year ended March 31, 1999 was 20.4%, as compared to 24.0% in the previous year. Minority interests represent the 49% and 66.9% minority interests in the Company's electronic and metallic manufacturing subsidiaries respectively. The decrease in minority interest to $1,575,000 for the year ended March 31, 1999 from $3,289,000 for the year ended March 31, 1998 reflects the reduction in profits generated by the contract electronic manufacturing business during the year ended March 31, 1999 as compared to the prior year. This offset the effect of a reduced loss generated by the Company's metallic manufacturing operations during the year ended March 31, 1999 as compared to the prior year. As a result of the above factors, net income was $9,492,000 for the year ended March 31, 1999, a decrease of $3,479,000 or 26.8%, as compared to the year ended March 31, 1998 and net income as a percentage of net sales decreased slightly to 17.8% from 19.6% for both years. Year ended March 31, 1998 Compared to Year Ended March 31, 1997 The Company's net sales for the year ended March 31, 1998 were $66,169,000, an increase of $21,629,000 or 48.6% as compared to year ended March 31, 1997. Sales to Mita, Inter-Tel, Behringer and Namtai Shenzhen, the Company's four largest customers during the year ended March 31, 1998, represented approximately 79.7% of net sales for the year. The increase in net sales was mainly related to additional sales of injection-molded plastic, electronic and metallic products of $7,782,000, $11,008,000 and $2,839,000, respectively, or increases of 31.4%, 59.2% and 237.6%, respectively, as compared with the net sales of $24,764,000, $18,581,000 and $1,195,000, respectively in these categories of activity in the year ended March 31, 1997. Sales of plastic parts and components, electronic products and subassemblies and metallic products represented 49.2%, 44.7% and 6.1%, respectively, of the Company's total sales during the year ended March 31, 1998 as compared to 55.6%, 41.7% and 2.7%, respectively, of the Company's total sales during the year ended March 31, 1997. The increase in sales of plastic parts and components in absolute dollars during fiscal 1998 compared to fiscal 1997 resulted from the increase in sales to existing and new customers, with sales to Mita, Inter-Tel, Namtai Shenzhen and VTech Communications Ltd. increasing by an aggregate of $7,387,000. Management attributes the increase in orders from these customers mainly to the customers' recognition of the efficiency in the manufacture and high quality of the Company's products. The substantial increase in sales of electronic products during fiscal 1998 compared to fiscal 1997 was mainly attributed to the increase in both OEM and subcontract sales to the Company's existing customers, with sales to Behringer and Inter-Tel in fiscal 1998 increasing by $11,470,000 from fiscal 1997. Revenues from the metallic operation were generated from a subsidiary acquired in October 1996 and accordingly fiscal 1998 sales increases in these operations resulted from including them for a full year rather than only about six months as was the case in fiscal 1997. Net sales to customers by geographic area are determined by reference to shipping destinations as directed by the Company's customers. During the year ended March 31,1998, sales to China, Hong Kong, the United States, Europe and Japan increased by $8,402,000, $2,358,000, $2,241,000, $8,098,000 and $530,000, respectively, over 1997 levels. The overall gross profit for the year ended March 31, 1998 was $29,923,000, representing a gross profit margin of 45.2%. This compares with the overall gross profit of $19,075,000 or 42.8% for the year ended March 31, 1997. The slight increase in gross margin of 2.4% was mainly attributable to higher margins generated from the plastic assembly work during fiscal 1998, from the plastic tooling modification requests from an existing customer and from the higher margins generated from the increase in electronic subcontracting orders. The gross margins on the sale of plastic parts and assembly increased slightly to 45.6% in the year ended March 31, 1998 as compared to 42.4% in the previous year. The gross margins on sales of electronic products and subassemblies increased to 50.9% in fiscal 1998 from 45.8% in fiscal 1997. The increases of 3.2% and 5.1% on the gross profit margins in plastic and electronic operations were primarily attributable to the Company's concentrated and continuing efforts to secure orders with higher margins and the higher margins generated from the increase in electronic subcontracting sales. Selling, general and administrative expenses for the year ended March 31, 1998 were $14,067,000, amounting to 21.2% of total net sales, as compared to $7,943,000 or 17.8% of total net sales for the year ended March 31, 1997. The increase in selling, general and administrative expenses of $6,124,000 over fiscal 1997 was largely due to the growth in the Company's operations. The increase in selling, general and administrative expenses as a percentage of total sales during fiscal 1998 over fiscal 1997 levels primarily resulted from the increase in expenses for providing research and development, quality control and engineering support to the Company. As a result of the increase in net sales, operating income was $15,856,000 for the year ended March 31, 1998, an increase of $4,724,000 or 42.4%, as compared with the prior year. There was no material fluctuation in the overall operating margins between the two years. The operation margin for the year ended March 31, 1998 was 24.0%, as compared to 25.0% in the previous year. <Minority interests represent the 49% and 66.9% minority interest in the electronics and metallic subsidiaries, respectively. The increase in minority interest to $3,289,000 for the year ended March 31, 1998 from $2,165,000 for the year ended March 31, 1997 reflects the fact that the electronic business generated greater profits in fiscal 1998 than in fiscal 1997. As the operations of metallic subsidiary are in the preliminary stage, its operating results and minority interest effects have not been material to the Company since these operations were acquired in October 1996. As a result of the above factors, net income was $12,971,000 for the year ended March 31, 1998, an increase of $4,226,000 or 48.3%, as compared to the year ended March 31, 1997 and net income as a percentage of net sales remained at 19.6% for both years. Liquidity and Capital Resources For the year ended March 31,1999, net cash generated from operated totaled $15,303,000, including net income of $9,492,000 and depreciation and amortization of $4,223,000. Accounts receivable and inventories decreased by $2,283,000 and $513,000, respectively, over levels at March 31,1998, primarily as a result of decreases in sales and the general decrease in business activities. Accounts payable decreased by $890,000 over March 31, 1998. For the year ended March 31, 1998, net cash generated from operations totaled $14,933,000, including net income of $12,971,000 and depreciation and amortization of $3,356,000. Accounts receivable and inventories increased by $3,757,000 and $854,000, respectively, over levels at March 31,1997, primarily as a result in increase in sales and the general increase in business activities. Accounts payable decreased by $913,000 over March 31, 1997. Net cash used in investing activities amounted to $3,713,000 and $7,428,000 for the years ended March 31,1999 and 1998, respectively. Capital expenditures during these periods totaled $4,282,000 and $7,420,000, respectively, and were financed by cash generated from operations for the year ended March 31,1999 and from net proceeds from the sale of the Company's securities and internally generated funds for the year ended March 31,1998. The capital expenditure primarily related to the acquisition of plant and machinery for the Company's production facilities in China and office equipment for the Company's administrative operations in China. Cash of $551,000 in the year ended March 31,1999 was released as security for a decreased short-term borrowing facilities whereas additional cash of $16,000 in the year ended March 31,1998 was pledged as security for increased short-term borrowing facilities. Net cash used in financing activities for the year ended March 31,1999 was $5,936,000 as compared to net cash provided financing activities of $2,394,000 for the year ended March 31,1998. Net cash used in financing activities during the year ended March 31,1999 was primarily to fund the Company's dividend payments to its shareholders. Integrated paid a dividend totaling $774,000 to its shareholders during the year ended March 31,1998. The Company received $395,000 as its share of the dividend and Messrs. S.K. Lee and M.C. Tam, minority shareholders of Integrated, received $379,000, as their share of the dividend. During the year ended March 31,1998 and other years since fiscal 1995, the major sources of financing that have been the net proceeds from the issuance of the Company's equity securities. The Company generates sufficient funds from its operating activities to finance its operations and there is little need for external financing. The Company had no outstanding short-term borrowings or long-term debt at March 31,1999 or 1998. Dividends paid under Hong Kong law are tax free to the recipient. While the Company had paid dividends to its shareholders prior to its IPO, it discontinued payment of dividends after the IPO until its new dividend policy was announced in July 1996. At that time, Company announcing that it planned to pay cash dividends semi-annually in the form of an interim and final dividend based on the Company's growth during the preceding year limited, however, by the net cash flow available for future development. The interim dividend would be based upon the Company's first six months operating results and would be paid between November and December and the final dividend would be based upon the Company's second six months of operations and would be declared and paid between July and August. Under this dividend policy, the Company declared and paid dividends during the year ended March 31:
The Company currently plans to continue its dividend policy as announced, but such plans and policy for future dividends consist of forward-looking statements within the meaning of Section 27A of the Securities Act 1933 and Section 21E of the Securities Exchange Act of 1934. Whether future dividends will be declared will be depend upon the Company's future growth and earnings, of which there can be no assurance, and the Company's cash flow needs for future development. Accordingly, there can be no assurance that future cash dividends on the Company's Common Shares will be declared, what the amounts of such dividends, once declared for a specific period will continue for any future or at all. As a consequence of the fixed exchange rate between the Hong Kong dollar, interest rates on Hong Kong dollar borrowing are similar to U.S. dollar, interest rates on Hong Kong dollar borrowings are similar to U.S. interest rates. The Hong Kong Prime Rate increased during the year ended March 31,1999, decreasing from 10.0% at the beginning of the year to 8.25% at March 31,1999. At March 31,1999, the Company had cash and cash equivalents of $27,556,000 and committed bank lines of credit of $11,499,000, none of which had been used. The Company also had restricted cash of $2,376,000 and leasehold land and buildings of $1,439,000, which were pledged as collateral for those credit facilities. The Company expects that working capital requirements and capital additions will continue to be funded through cash on hand and internally generated funds. The Company's working capital requirements are expected to increase in line with the growth in the Company's business. The Company had capital commitments for plant and machinery of $356,000 as of March 31,1999. The Company expects that internally generated funds will be sufficient to satisfy its cash needs for at least the next 12 months. Impact of Inflation The Company believes that inflation has not had a material effect on its business. Although the Company has found it difficult to increase the prices of its products in order to keep pace with inflation, particularly in its plastics operations, the Company believes that the location of its manufacturing operations in Southern China has resulted in a lower cost base which it still provides it with a competitive advantage. Accordingly, the Company is reliant upon increasing its transaction volume in order to compensate for the effects of inflation. Exchange Rates The Company sells most of its products and pays for most components in either Hong Kong dollars or U.S. dollars. Exchange rate fluctuations have not had a significant impact on the Company's operating results. Labor cost and overhead expenses of the Company's Hong Kong operationss and China factories are paid in Hong Kong dollars and renminbi, respectively. The exchange rate of the Hong Kong dollar to the U.S. dollar has been fixed by the Hong Kong government since 1983 at approximately HK$7.80 to US$1.00 and accordingly has not represented a currency exchange risk to the U.S. dollars. The Chinese government has announced its intention to maintain this fixed exchange rate, but despite such assurances there has been uncertainty reported in this regard. There can be no assurance that the Chinese government will continue to maintain the present currency exchange mechanism and the Company could face increased currency risks if the current exchange rate mechanism is changed. If the currency exchange mechanism between the Hong Kong dollar and the U.S. dollar is changed, the Company's results of operations and financial condition could be materially adversely affected. Labor and overhead expenses of the Company's China operations amounted to approximately 23%, 21% and 24% of the Company's total expenses during the years ended March 31, 1997, 1998 and 1999, respectively. In 1994, China adopted a floating currency system whereby the official exchange rate is equal to the market rate. Since the market and official yuan rates were unified, the value of the yuan against the dollar has been essentially stable, with an average rate of 8.28 yuan per $1.00 during calendar years 1998, 1997, and 1996. The Company believes, because its Chinese operations presently are confined to manufacturing products for export or for customers in China that are controlled by foreign investors and which pay the Company in Hong Kong dollars, that the current economic climate in China should not have a direct adverse impact on the Company's business. Year 2000 Issue Many existing computer programs, including some programs used by the Company in its computer systems and equipment, use only two digits to identify a year in the date field. These programs were designed without considering the impact of the upcoming change in the century. If not corrected, these computer applications and systems could fail or create erroneous results before, during, or after the year 2000. The Company's investigations and efforts to date have included studies, investigations, inquiries to software and equipment suppliers, testing by internal management and outside consultants, and the purchase of certain replacement software and rewriting certain sections of existing programs. Based on these efforts, the cost of which has not been material to date, management does not anticipate that the Company will incur any material operating expenses or be required to incur material costs as a result of the year 2000 issue. Management believes that as a result of its efforts to date, the Company is year 2000 compliant. Despite management's effort to take reasonable precautions to be year 2000 ready, and its belief that it is currently year 2000 compliant, to the extent the Company's systems are not fully year 2000 compliant, there can be no assurance that potential systems interruptions or the cost necessary to update software would not have a material adverse effect on the Company's business, financial condition, results or operations and business prospects. In addition to the internal preparations discussed above, the Company has had discussions with its key suppliers and key customers to ensure that they do not expect any year 2000 problems to impact their business dealings with the Company. In the event that the Company's significant customers and suppliers do not successfully and timely achieve year 2000 compliance, the Company's business or operations could be adversely affected. There is also a risk that year 2000 problems may cause regional or global problems for utility companies, transportation systems, banking systems, or the global economy. To the extent that these problems materialize, The Company expects that its business will be adversely impacted and to date the Company has not completed a year 2000 contingency plan.
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