SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES AND EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED MARCH 31, 2011
Commission File Number 119698
COSMO COMMUNICATIONS
CORPORATON
(Exact name of Registrant as Specified in Its Charter)
FLORIDA (State or Other Jurisdiction of Incorporation or Organization) | | 59-2268025 (IRS Employer Identification No.) |
Unit 2 – 55 Travail Road
Markham, Ontario, Canada
(905) 209-0488
(Address and Telephone Number of Principal Executive Offices)
Securities Registered Pursuant to Section 12(b) of the Act:
Common Stock, $.05 Par Value Per Share
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant of Section 13 or 15(d) of the Act. Yes o No þ
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. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes £ No £
Indicate by check mark if the disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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 10-K or any amendment to this Form 10-K. £
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company,” in Rule 12b-2 of the Exchange Act):
Large accelerated filler o Accelerated filer o Non-accelerated filer o Smaller reporting company þ
Indicate by check mark whether the Registrant is a shell company (as defined in Exchange Act Rule 12b-2) Yes o No þ
The aggregate market value of the Registrant's voting stock held by non-affiliates was undetermined as there have been no quotes on the bid and ask price of the registrant’s common stock. There were 40,467,636 shares of Common Stock issued and outstanding as of June 28, 2011.
COSMO COMMUNICATIONS CORPORATION ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED MARCH 31, 2011
TABLE OF CONTENTS
| | | Page | |
| | | | |
| PART I |
| Item 1. | | Business | | 4 | |
| Item 1A | | Risk Factors | | 13 | |
| Item 1B | | Unresolved Staff Comments | | 17 | |
| Item 2. | | Properties | | 17 | |
| Item 3. | | Legal Proceedings | | 18 | |
| Item 4. | | Submission of Matters to a Vote of Security Holders | | 18 | |
| |
| PART II |
| Item 5. | | Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities | | 18 | |
| Item 6. | | Selected Financial Data | | 19 | |
| Item 7. | | Management’s Discussion and Analysis of Financial Condition and Results of Continuing Operations | | 20 | |
| Item 7A | | Quantitative and Qualitative Disclosures About Market Risk | | 28 | |
| Item 8. | | Financial Statements and Supplementary Data | | 30 | |
| Item 9. | | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure | | 46 | |
| Item 9A. | | Controls and Procedures | | 46 | |
| Item 9B. | | Other Information | | 47 | |
| |
| PART III |
| Item 10. | | Directors, Executive Officers and Corporate Governance | | 47 | |
| Item 11. | | Executive Compensation | | 49 | |
| Item 12. | | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters | | 51 | |
| Item 13. | | Certain Relationships and Related Transactions, and Director Independence | | 51 | |
| Item 14. | | Principal Accountant Fees and Services | | 52 | |
| |
| PART IV |
| Item 15. | | Exhibits, Financial Statement Schedules and Reports on Form 8-K | | 53 | |
| Signatures | | 55 | |
Forward-Looking Statements and Risk Factors
We make forward-looking statements in this report including, without limitation, statements concerning the future of our industry, product development, business strategy, continued acceptance and growth of our products, dependence on significant customers and suppliers, and the adequacy of our available cash resources. Statements may contain projections of results of operations or of financial condition. These statements may be identified by the use of forward-looking terminology such as “may,” “will,” “believe,” “expect,” “anticipate,” “estimate,” “continue” or other similar words.
Forward-looking statements are subject to many risks and uncertainties. We caution you not to place undue reliance on these forward-looking statements, which speak only as at the date on which they are made. Actual results may differ materially from those described in these forward-looking statements. We disclaim any obligation or undertaking to update these forward-looking statements to reflect changes in our expectations or changes in events, conditions, or circumstances on which our expectations are based.
When considering our forward-looking statements, you should keep in mind the risk factors and other cautionary statements identified in this report. The risk factors noted throughout this Annual Report, particularly in the discussion in Item 1A, and other risk factors that Cosmo has not anticipated or discussed, could cause our actual results to differ significantly from those anticipated in our forward-looking statements.
Item 1. Business
Cosmo Communications Corporation (the “Company”, "Cosmo" "we," "us" or "our") was incorporated in the state of Florida in 1983.
The Company is engaged in the development, production, distribution, marketing and sale of consumer electronic audio and video equipment, accessories and clocks. We contract for the manufacture of all electronic equipment products with factories located in China. We market certain lines of our products under labels that we have distribution agreements with. We also sell products under private labels for a major customer.
During our early years of operations, the products we sold were principally that of quartz and digital clocks, and radio cassette players. In the 90’s, we began marketing Compact Disc (“CD”) equipment, cordless telephones and small screen televisions.
In April 2000, we entered into a Stock Purchase Agreement pursuant to which we offered shares of common stock representing 84.89% of the outstanding common stock to Master Light Enterprise Limited. (“Master Light”), a subsidiary of Starlight International Limited (“Starlight”), a publicly held company traded on the Hong Kong Stock Exchange, for $1 million. Pursuant to an amendment to the Stock Purchase Agreement, in January 2001, the transactions contemplated by the Stock Purchase Agreement, as amended, were consummated and, after rescinding the purchase of 1,347,420 shares, Master Light acquired 26,585,008 of our common stock shares, representing 93.8% of our currently issued and outstanding common stock. In September, 2001, additional financing from Starlight allowed us to discharge all our obligations to our financial institution lenders. Starlight owns and operates a number of subsidiaries globally. Its principal activity is in the manufacture, sale and distribution of consumer electronic products.
Our principal executive office is located in Ontario, Canada with warehouse facilities located in Ontario, Canada and California, USA.
Since 2001, our common stock shares have not traded on the OTC Bulletin Board. As used herein, the “Company”, "Cosmo," "we," us" and similar terms include Cosmo Communications Corporation, and its subsidiaries, Cosmo Communications Corporation Canada Inc., Cosmo Communications Corporation (HK) Limited and Cosmo Communication USA Corp. unless the context indicates otherwise.
All figures are presented in United States dollars, unless otherwise indicated.
We market and distribute an assortment of video products including DVD/TV combination units in both CRT’s and LCD’s with retails ranging from $99 – $299. In addition to the TV line up we also market a variety of DVD players both portable with TFT screens and stand alone players, retail pricing ranging from $25-$99.
We market and distribute a variety of MP3 and MP4 players with a memory size of 1GB – 4GB capacity. Retail prices have ranged from $30 - $89.
Cosmo’s Brands
Cosmo marketing and product development efforts are designed to enhance its brand images and generate increased loyalty among its consumers in each market segment and among the retailers who sell Cosmo products. Cosmo markets its products under the following primary brands:
| | l | Cosmo. Initially, we established Cosmo brand name for clocks and digital alarm clocks. We will keep this brand name for this product category to capitalize on brand recognition. This category represents 8% of our total sales. |
| | l | Audiologic. The Audiologic brand offers a range of radios, CD players, telephones, clock radios, portable boom boxes and multiple CD music systems. These items represent 4% of total sales. |
| | l | Digital Lab: Digital Lab is an upgraded line up from the audio category including clock radios, MP3 players and audio products with IPod connectivity. Digital Lab accounted for 12% of total sales. |
| | l | Diamond Brand. Cosmo introduced Diamond Vision and Diamond Sound as a new brand at the end of the 2005 fiscal year for DVD players. We have since added to this line Televisions, portable DVD players and MP3 Players. These items represent 2% of the total sales of the group. |
| | l | Disney. This is a licensed brand name of Disney Enterprises, Inc. The licensed electronics products include television, DVD players, CD players, and radio alarm clocks. These items represent 14% of the total sales of the group. |
| | l | Digitec. We offered Digitec brand for our LCD TV and DVD players. This brand represents 8% of the group sales. |
| | l | Llyods. We offered Llyods brand for our LCD TV and DVD players, portable DVD players and some audio clock radio products. This brand represents 11% of the group sales. |
| | l | Polaroid. This is a licensed brand name of PLR IP Holdings, LLC. The licensed electronics products include television, DVD players, CD players and digital cameras. This brand represents 15% of the group sales. |
| | l | Singing Machine Company (SMC). This brand name belongs to an associate company in the United States. We are the distributor of their karaoke products in Canada. This brand represents 17% of the group sales. |
We also build products under the private label of our customers. The category represents 7% of the Company’s sales.
Strategy for Cosmo’s Brands
Cosmo’s goal is to develop, distribute, market and sell consumer electronic audio and video equipment, accessories and clocks of well recognized and respected brands to customers around the world. Cosmo’s strategy is intended to enhance and reinforce Cosmo’s global brand images among consumers and retailers. Key elements of Cosmo’s strategy are to:
| | • | Continue to introduce new and technologically innovative products that embody distinctive Cosmo qualities; style and new features; |
| | • | Expand the current product lines by adding new features to LCD and Plasma TV’s, MP4 player and IPOD docking units and a new line of digital cameras; |
| | • | Expand Cosmo’s distribution with new and existing customers; |
| | • | Expand focus in the brand name products. As part of the Starlight Group, we have access to the Polaroid brand through our parent company and we will be focusing on building this brand name for our camera, LCD TV and DVD players in the future. |
Cosmo Products
Percent of Sales by Product Class
Cosmo sales since 2007 were divided among Cosmo’s principal product classes as shown in the following table:
| | | Year Ended March 31, | |
| | | 2011 | | | 2010 | | | 2009 | | | 2008 | | | 2007 | |
| Product Class: | | % | | | % | | | % | | | % | | | % | |
| MP3 Players | | | - | | | | - | | | | 5 | | | | 7 | | | | 12 | |
| Other Audio (1) | | | 40 | | | | 30 | | | | 28 | | | | 36 | | | | 27 | |
| Video (2) | | | 49 | | | | 61 | | | | 59 | | | | 48 | | | | 58 | |
| Clocks | | | 11 | | | | 8 | | | | 7 | | | | 8 | | | | 2 | |
| Tools | | | - | | | | 1 | | | | 1 | | | | 1 | | | | 1 | |
| Total | | | 100.0 | % | | | 100.0 | % | | | 100 | % | | | 100 | % | | | 100 | % |
(1) Includes boom boxes, CD players, IPOD docking system
(2) Includes digital photo frames, DVD players, LCD TV, portable DVD and TV/DVD combo
See below for financial information on geographic segments.
New Products
Cosmo introduces new products and enhances its existing products on a regular basis. In the first quarter of fiscal 2011 we brought in a limited quantity of large size LCD TV’s to gauge consumer interest, however the large size LCD TV project did not materialize due to severe price competition.
In fiscal 2012, we will be introducing a line of digital camera products to our major customers in Canada.
Sales, Marketing and Distribution
Cosmo endeavors to have its brands project images that appeal to consumers who appreciate quality and value. Cosmo products are promoted with advertisements in the various flyers of the companies that sell its products including Wal-Mart, Home Hardware, Shoppers Drug Mart, Loblaws, Canadian Tire, Hart Department Stores, Bargain Shop, etc.
We also market our products at various trade shows each year. We regularly attend the following trade shows and conventions: the Consumer Electronics Show each January in Las Vegas; the Hardware Shop in Los Angeles and the Hong Kong Electronics Show each October in Hong Kong.
Our products are sold in United States, Canada and to selective customers in other parts of the world, primarily through mass merchandisers, department stores, electronic stores, chains, and specialty stores. Our products are currently sold in such stores as Wal-Mart (Canada), Super-Stores, Home Hardware, Bargain Shop and Toys “R” Us (Canada). In fiscal 2011, approximately 94% of our sales were to the customers within Canada and 6% of sales were to the customers in USA. Sales are handled by our in-house sales team and our independent sales representatives. Our independent sales representatives are paid a commission based upon sales in their respective territories. The sales representative agreements are generally one year agreements, which automatically renew on an annual basis, unless terminated by either party on 30 days' notice. During fiscal year 2011, we did not appoint independent sales representatives in Canada or US.
As a percentage of total revenues, our net sales in the aggregate to our five largest customers during the fiscal years ended March 31, 2011, and 2010 were approximately 81% and 87%, respectively.
Although we have long-established relationships with all of our customers, we do not have contractual arrangements with any of them. A decrease in business from any of our major customers could have a material adverse effect on our results of operations and financial condition.
Geographic Distribution of Sales
Cosmo’s sales to external customers by geographic region were as follows:
| | | Years Ended March 31, | |
| Region | | 2007 | | | 2008 | | | 2009 | | | 2010 | | | 2011 | | | 2011 | |
| | | | | | | | | | | | % | |
| | | (In thousands) | | | | | | | | | | |
| USA | | | 13,350 | | | | 16,568 | | | | 13,721 | | | | 1,580 | | | | 915 | | | | 6 | % |
| Canada | | $ | 42,384 | | | | 17,891 | | | | 14,293 | | | | 14,785 | | | | 14,840 | | | | 94 | % |
| Europe | | | 113 | | | | - | | | | - | | | | - | | | | - | | | | - | |
| Others | | 440 | | | 362 | | | | 1,449 | | | | - | | | | - | | | | - | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | $ | 56,287 | | | | 34,821 | | | | 29,463 | | | | 16,365 | | | | 15,755 | | | | 100 | % |
Returns
Returns of electronic products by our customers are generally not permitted except in approved situations involving quality defects, damaged goods, or goods shipped in error. Our policy is to give credit to our customers for their returns, in these approved situations only. Our total returns represented 4% and 9% of our net sales in fiscal 2011 and 2010, respectively. Due to the length of time given to return defective products, a provision is made to acknowledge the obligations to provide credits to our customers on defective returns which have not been recorded in the current fiscal period. This provision is estimated based on the historical defective rate of the product category and their respective sales volume, adjusted by defective credits and allowances that have been issued.
We have an ongoing arrangement with Starlight, the Company’s parent, to refurbish defective products manufactured by Starlight. Defective returns originated from direct import sales are returned to Starlight for full refund and no refurbishment costs are charged. Defective returns which originated from domestic sales are written down to 30% of the original cost and then returned to Starlight with no refurbishment charge.
We do not have return privileges with the other ten factories we work with. Outside factories will generally charge 25% to 30% of the original cost to refurbish our products. We assess each defective return manufactured by the outside factories before we make the decision to repair or to sell as is. Our policy is to mark down the book value of defective returns produced by the outside factories as they are received back in our warehouse. Management periodically reviews the value of returned and refurbished goods on hand and adjusts the cost of such inventory after analyzing factors such as economic circumstances, product technology obsolescence and declines in retail sales prices. Provisions are recognized against returned and refurbished goods to reflect these adjusted values.
Distribution
We distribute our products to retailers and wholesale distributors through two methods: shipment of products from inventory held at our warehouse facility in Canada and USA (domestic sales), and shipments directly through our Hong Kong subsidiary (direct sales). Domestic sales are made to customers located throughout USA and Canada from inventories maintained at our warehouse facilities. In the fiscal year ended March 31, 2011, approximately 93% of our sales were sales from our domestic warehouses ("Domestic Sales") and 7% were sales shipped directly from China ("Direct Sales").
Domestic Sales. Our strategy of selling products from a domestic warehouse enables us to provide timely delivery and serve as a domestic supplier of imported goods. We purchase products overseas from certain factories in China for our own account, and warehouse the products in leased facilities in USA and in Canada. We are responsible for the costs of shipping, insurance, customs clearance, duties, storage and distribution related to such products and, therefore, domestic sales command higher sales prices than direct sales. We generally sell from our own inventory in less than container-sized lots.
Direct Sales. We ship some of our products directly to customers from China through our subsidiary in Hong Kong. Sales made through our subsidiary are completed by either delivering products to the customers' common carriers at the shipping point or by shipping the products to the customers' distribution centers, warehouses, or stores. Direct sales are made in larger quantities (generally container sized lots), who pay our subsidiary pursuant to irrevocable, transferable letters of credit or on open account.
Manufacturing and Production
Our products are manufactured and assembled by third parties pursuant to design specifications provided by us. Currently, substantially all of our video and CD products are manufactured by Starlight’s factory located in Guangdong Province in the People’s Republic of China (PRC). We also have ongoing relationships with ten factories, located in the southern provinces of the PRC. For fiscal 2012, we anticipate that majority of our products will be produced by Starlight’s factory. We believe that the manufacturing capacity of our factories is adequate to meet our purchase demands for our products in fiscal year 2012. However, if Starlight’s primary factory in China was prevented from manufacturing and delivering our products, our operation would be severely disrupted (see Item 1A – Risk Factors).
Our products are manufactured using molds and certain other tooling owned by Starlight and our other factories. Our products contain electronic components manufactured by other companies such as Sanyo, Toshiba, Hitachi and National Semiconductor. Our manufacturers purchase and install these electronic components in our products under our specifications.
While our equipment manufacturers purchase our supplies from a small number of large suppliers, all of the electronic components and raw materials used by us are available from several sources of supply, and we do not anticipate that the loss of any single supplier would have a material long-term adverse effect on our business, operations, or financial condition. To ensure that high standards of product quality and on-time shipping schedules, we utilize independent contractors as our representatives. These contractors include product inspectors who are knowledgeable about product specifications and work closely with the factories to verify that such specifications are met. Additionally, our key personnel frequently visit our factories for quality assurance and to maintain good working relationships.
All of the electronic equipment sold by us is warranted to the end user against manufacturing defects for a period of ninety (90) days for labor and parts. During the fiscal years ended March 31, 2011 and 2010, warranty claims have not been material to our results of operations.
Cosmo believes that its sources and supplies of finished goods, components and other materials are adequate for its needs. Cosmo has not experienced a significant inability to obtain necessary finished goods, components or other materials.
Reverse Logistic Operations
We have an arrangement with certain manufacturers that distribute television sets and DVD players in Canada to handle customer returns for them. Our warehouse facility in Canada has the capacity to handle a high volume of defective products. We charge the manufacturers a fee on a per piece basis or a percentage based on the retail sales value of the merchandise and reported this as commission and other income. Our agreement with these manufacturers to handle their returns is on an on-going and mutually agreed basis with no expiration date.
Commission
Revenues received from the reverse logistic operations are treated as commission income. Besides handling the defective returns, we also sell the returns on behalf of our logistic customers and charge a commission for this service.
License Agreements
The license agreement with Disney Enterprises, Inc. is between Starlight and Disney. The license agreement with PLR IP Holdings LLC is between Starlight and Polaroid. We are not obligated to pay license fees to Disney or Polaroid.
Competition
Our business is highly competitive since we compete mainly in the basic entry level category of our audio and video products. We believe that competition for our products is based primarily on price, product features, reputation, delivery times, and customer support. We believe that our brand names are recognized in the industry and help us to compete in these categories. Our financial position depends, among other things, on our ability to keep pace with changes and developments in the household entertainment industry and to respond to the requirements of our customers. Many of our competitors have significantly greater financial, marketing, and operating resources and broader product lines than we do.
Intellectual Property
We have registered “Audiologic” as our trademark in the United States and Canada and “Diamond Vision” and “Diamond Sound” as our trade marks in Canada.
We believe our intellectual property is adequately protected, but there are no assurances that these rights can be successfully asserted in the future or will not be invalidated or challenged.
Government Regulation
Our products must meet the safety standards imposed in various national, state, local and provincial jurisdictions. Our products sold in Canada are designed, manufactured and tested to meet the safety standards of Underwriters Laboratories, Inc. ("ULE") or Electronic Testing Laboratories ("ETL"). In Europe and other foreign countries, our products are manufactured to meet the CE marking requirements. CE marking is a mandatory European product marking and certification system for certain designated products. When affixed to a product and product packaging, CE marking indicates that a particular product complies with all applicable European product safety, health and environmental requirements within the CE marking system. Products complying with CE marking are now accepted to be safe in 28 European countries.
The manufacturing operations of our foreign suppliers in China are subject to foreign regulation. China has permanent "normal trade relations" ("NTR") status under Canadian tariff laws, which provides a favorable category of Canadian import duties. China's NTR status became permanent on January 1, 2002. This substantially reduces the possibility of China losing its NTR status, which would result in increasing costs for us.
Seasonality and Seasonal Financing
Our business is highly seasonal, with consumers making a large percentage of purchases of our products around the traditional holiday season in our second and third quarter. These seasonal purchasing patterns and requisite production lead times cause risk to our business associated with the underproduction or overproduction of products that do not match consumer demand. Retailers also attempt to manage their inventories more tightly, requiring that we ship products closer to the time that retailers expect to sell the products to consumers. These factors increase the risk that we may not be able to meet demand for certain products at peak demand times, or that our own inventory levels may be adversely impacted by the need to pre-build products before orders are placed. As of March 31, 2011, we had inventory of $4.7 million (net of reserves totaling $752,822) compared to inventory of $6.7 million as of March 31, 2010 (net of reserves totaling $1,103,360).
Our financing of seasonal working capital during fiscal 2011 was mainly from sales of inventory carried over from the prior year. We rely on credit terms from our manufacturers to finance the purchase of new inventory. We also have an understanding from Starlight to provide short term working funds to purchase inventory should we require them.
For fiscal 2012, we plan on minimum financing our inventory purchases by liquidating our inventory and if necessary with short term working funds provided by Starlight.
Information Systems
Cosmo’s information systems are designed to respond quickly to inquiries from managers, employees, suppliers and customers. Cosmo has implemented internet-based systems to provide accurate and timely information and allow Cosmo’s representatives, dealers and distributors to check the status of their orders at a secure Internet site. Cosmo has also implemented internet systems to provide accurate and timely information to its suppliers in support of just-in-time delivery of components to Cosmo’s manufacturing facilities. These systems help Cosmo reduce costs by reducing inventory requirements and for a more timely and accurate exchange of information with our suppliers.
Backlog
We ship our products in accordance with delivery schedules specified by our customers, which usually request delivery within three months of the date of the order. In the consumer electronics industry, orders are subject to cancellation or change at any time prior to shipment. In recent years, a trend toward just-in-time inventory practices in the consumer electronics industry has resulted in fewer advance orders and therefore less backlog of orders for us. We believe that backlog orders at any given time may not accurately indicate future sales. As of March 31, 2011 we had no backlog of orders and none in the same period in fiscal 2010. Backlog orders do not take into account of any sales ordered by customers directly from our domestic inventory with order turnaround time of one to two weeks. We normally have to keep the minimum inventory in our domestic warehouses for these type of sales.
Employees
As of March 31, 2011, we employed 18 people, 17 of whom are full-time employees, including two executive officers. Two of our employees are located at our subsidiary in Hong Kong and 16 in Canada. Of the employees, six are engaged in warehousing and technical support, and eight in accounting, marketing, sales and administrative functions. We have never had a work stoppage and none of our employees are unionized. We believe we have good employee relations.
Item 1A. Risk Factors
RISK FACTORS THAT MAY AFFECT COSMO’S OPERATING RESULTS, BUSINESS PROSPECTS AND STOCK PRICE
Before you buy or sell Cosmo stock, you should be aware that there are risks, including those described below and others Cosmo has not anticipated or discussed. You should consider carefully these and other risk factors, together with all of the other information included in Cosmo’s periodic filings and current reports filed with the SEC, before you decide to buy or sell shares of Cosmo’s common stock.
As you consider these risk factors, Cosmo also calls your attention to Cosmo’s statements about Forward Looking Statements and Risk Factors in Part I of this Annual Report.
We have significant working capital needs and if we are unable to obtain additional financing when needed, we may not have sufficient cash flow to continue operations.
As of March 31, 2011, our cash on hand is limited. We will finance our working capital needs from the collection of accounts receivable and sales of existing inventory. See "Liquidity and Capital Resources" beginning on page 22. As of March 31, 2011, our inventory was valued at approximately $4.7 million. If these sources do not provide us with adequate financing, we will be seeking financing from our factories. If we are not able to obtain adequate financing from our factories when needed, it will have a material adverse effect on our cash flow and our ability to continue operations.
A small number of our customers account for a substantial portion of our revenues, and the loss of one or more of these key customers could significantly reduce our revenues and cash flow.
As a percentage of total revenues, our net sales to our five largest customers during the fiscal period ended March 31, 2011 and 2010 were approximately 83% and 87%, respectively. We do not have long-term contractual arrangements with any of our customers and they can cancel their orders at any time prior to delivery. A substantial reduction in or termination of orders from our largest customers would decrease our revenues and cash flow significantly.
We rely on Starlight to manufacture and produce the majority of our CD players, DVD players and television sets and if Starlight does not support our delivery schedule, it would affect our revenues and profitability.
We believe that because Starlight has a substantial investment in our operation they will support us unconditionally. In the event of disruption in its factory, Starlight will source outside factories to manufacture our products but we risk losing sales and goodwill to our customers.
We are subject to pressure from our customers relating to price reduction and financial incentive and if we are pressured to make these concessions to our customers, it will reduce our revenues and profitability.
Because there is intense competition in the consumer electronic market, we are subject to pricing pressure from our customers. Many of our customers have demanded that we lower our prices or they will purchase from our competitor's products. If we do not meet our customer's demands for lower prices, we will not sell as many products. We are also subject to pressure from our customers regarding certain financial incentives, such as return credits or advertising allowances, which effectively reduce our profit. We gave advertising allowances in the amount of $682,017 during fiscal 2011 and $278,534 during fiscal 2010. We have historically offered advertising allowances to our customers because it is standard practice in the retail industry.
We experience difficulty forecasting the demand for our products and if we do not accurately forecast demand, our revenues, net income and cash flow may be affected.
Because of our reliance on manufacturers in China for our products, our production lead times range from one to four months. Therefore, we must commit to production in advance of customers orders. It is difficult to forecast customer demand because we do not have any scientific or quantitative method to predict this demand. Our forecasting is based on management's general expectations about customer demand, the general strength of the retail market and management's historical experiences. In the past, our experienced management team has been able to plan our production and inventory requirements without building excessively high inventory.
Our gross profit margins have not improved over the past years and we expect a continued competitive market in the future.
Over the past years our gross profit margins have not improved to our expectation due to price competition. For fiscal 2011, we continued to improve our profit margin due to the strong gain in the Canadian currency against the US dollar. We expect that our gross profit margin might decrease under downward pressure in fiscal 2012 due to the rise in material and labor costs in China. Based on past experience, we expect that we can pass on some of the price pressure to our manufacturers.
Our business is seasonal and therefore our annual operating results will depend, in large part, on our sales during the relatively brief holiday season.
Sales of consumer electronics in the retail channel are highly seasonal, with a majority of retail sales occurring during the period from September through December in anticipation of the holiday season, which includes Christmas. A substantial majority of our sales occur during the second quarter ended September 30 and the third quarter ended December 31. Sales in our second and third quarter, combined, accounted for approximately 66% and 62% of total sales in fiscal 2011 and 2010 respectively.
If Cosmo does not continue to develop, introduce and achieve market acceptance of new and enhanced products, sales may decrease.
The consumer electronic industry is characterized by rapid technological change, frequent new product introductions and enhancements and ongoing customer demands for greater performance. In addition, the average selling price of an electronic product has historically decreased over its life cycle, and we expect that trend to continue. As a result, our products may not be competitive if we fail to introduce new products or product enhancements that meet evolving customer demands. The development of new products is complex, and we may not be able to complete development in a timely manner. To introduce products on a timely basis, we must:
| | · | accurately define and design new products to meet market needs; |
| | · | design features that continue to differentiate our products from those of our competitors; |
| | · | update our manufacturing process technologies; |
| | · | identify emerging technological trends in our target markets; |
| | · | anticipate changes in end-user preferences with respect to our customers' products; |
| | · | introduce products to market on a timely basis at competitive prices; and |
| | · | respond effectively to technological changes or product announcements by our competitors. |
We believe that we will need to continue to enhance our products and develop new merchandise to keep pace with competition, technological developments, and to achieve market acceptance for our products. At the same time, we are identifying other products which may be different from audio and video equipment.
Our products are shipped from China and any disruption of shipping could prevent or delay our customers’ receipt of inventory.
We rely principally on independent ocean carriers to ship virtually all of the products that we import to our warehouse facilities in Los Angeles, USA and in Toronto, Canada. Retailers that take delivery of our products in China rely on a variety of carriers to import those products. Any disruptions in shipping, whether in Los Angeles, Toronto or China, caused by labor strikes, other labor disputes, terrorism, and international incidents may prevent or delay our customers' receipt of inventory. If our customers do not receive their inventory on a timely basis, they may cancel their orders or return products to us. Consequently, our revenues and net income would be affected.
Our manufacturing operations are located in the People’s Republic of China, subjecting us to risks common in international operations. If there is any problem with the manufacturing process, our revenues and net profitability may be affected.
We are using ten factories in the People's Republic of China to manufacture the majority of our products. These factories will be producing all of our products in fiscal 2012. Our arrangements with these factories are subject to the risks of running business abroad, such as import duties, trade restrictions, work stoppages, and foreign currency fluctuations, limitations on the repatriation of earnings and political instability, which could have an adverse impact on our business. Furthermore, we have limited control over the manufacturing processes themselves. As a result, any difficulties encountered by our third-party manufacturers that result in product defects, production delays, cost overruns or the inability to fulfill orders on a timely basis could adversely affect our revenues, profitability and cash flow. Also, since we do not have written agreements with any of these factories, we are subject to additional uncertainty if the factories do not deliver products to us on a timely basis.
We depend on third party suppliers for parts for our products, and if we cannot obtain supplies as needed, our operations will be severely damaged.
Our growth and ability to meet customer demand depends in part on our ability to obtain timely deliveries of our electronic products. We rely on third party suppliers to produce the parts and materials we use to manufacture and produce these products. If our suppliers are unable to provide our factories with the parts and supplies, we will be unable to produce our products. We cannot guarantee that we will be able to purchase the parts we need at reasonable prices or in a timely fashion. In the last several years, there have been shortages of certain components that we use in our DVD players and portable DVD products. If we are unable to anticipate any shortages of parts and materials in the future, we may experience severe production problems, which would impact our sales.
We are exposed to the credit risk of our customers who are experiencing financial difficulties, and if these customers are unable to pay us, our revenues and profitability will be reduced.
We sell products to retailers, including department stores, hardware stores and specialty stores. In the past, we have been diligent to screen credit worthiness of our customers and experience of bad debts has been insignificant. Deterioration in the financial condition of our customers could have a material adverse effect on our revenues and future profitability.
Our common stock currently is not actively traded.
Our common stock is inactive and has no bid and ask price. We believe that if we can establish a pattern of profitability in the near future, our common stock may be more actively traded.
The loss of its largest customer or significant reductions in the purchases of Cosmo’s products would reduce sales.
Cosmo’s largest customer accounts for 29%, 54% and 70% of Cosmo’s sales in 2011, 2010 and 2009 respectively. We will continue to reduce the concentration and dependence on one single customer in the future to reduce the significant risk of loss in our revenues and cash flows.
If Cosmo fails to manage its inventory effectively, Cosmo could incur additional costs or lose sales.
Cosmo customers have many brands to choose from when they decide to order products. If Cosmo cannot deliver products quickly and reliably, customers will order from a competitor. Cosmo must stock enough inventories to fill orders promptly, which increases Cosmo’s financing requirements and the risk of inventory obsolescence. Because competition has forced Cosmo to shorten its product life cycles and more rapidly introduce new and enhanced products, while simultaneously sourcing more products overseas and carrying larger inventories, there is a significant risk that Cosmo’s inventory could become obsolete.
Currency fluctuations may reduce the profitability of Cosmo’s foreign sales.
Cosmo currently makes sales to Canadian and certain European dealers and distributors in their respective currencies. As such Cosmo is exposed to gains and losses on foreign currency, in particular the Canadian dollar. Cosmo does not trade in derivatives or other financial instruments to reduce currency risks. In some instances this will subject Cosmo’s earnings to fluctuations because Cosmo is not protected against substantial currency fluctuations.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
Our corporate headquarters are located in Markham, Ontario, Canada in a 35,000 sq. ft. office and warehouse facility. We have a lease agreement in place until September of 2013.
Our subsidiary in Hong Kong shares office space with Starlight in Hong Kong from which we oversee China based manufacturing operations. There is no lease agreement with Starlight and we do not pay rent to Starlight for the facility.
We believe that our facility is well maintained, in substantial compliance with environmental laws and regulations, and adequately covered by insurance. We also believe that our leased facility is not unique and could be replaced, if necessary, at the end of the term of the existing lease.
Item 3. Legal Proceedings
We are from time to time involved in routine litigation incidental to our business, most of which is adequately covered by insurance and none of which is expected to have a material adverse affect on our business, financial condition or results of operation.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth quarter of our 2011 fiscal year.
| Item 5. | Market for Registrant’s Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities |
Since 2001, our common stock shares have not been traded on the OTC Bulletin Board. There were no quotes of high and low during fiscal 2011. We have 396 recorded holders of our common stock on June 28, 2011.
Dividends
Our policy is to retain earnings and we have not declared any dividends in the past. Any payment of cash dividends in the future will be dependent upon the financial condition, capital requirements, earnings, contractual restrictions and other factors considered relevant by our Board of Directors.
Equity Compensation Plan Information
The Company does not have any stock option plan or 401K plan as long-term compensation.
Recent Sales of Unregistered Securities
Item 6. Selected Financial Data
The following selected consolidated financial data should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Continuing Operations” and Item 8, “Financial Statements and Supplementary Data” Included elsewhere in this Annual Report. The statements of operations data for the years ended March 31, 2011, 2010, 2009 and the balance sheet data at March 31, 2011, and 2010, are derived from our audited financial statements which are included elsewhere in this Annual Report. The statement of operations data for the year ended March 31, 2008 and 2007 and the balance sheet data at March 31, 2009, 2008 and 2007 are derived from our audited financial statements which are not included in this Form 10-K. The historical results are not necessarily indicative of results to be expected for future periods.
| | | Years Ended March 31, | |
| | | 2011 | | | 2010 | | | 2009 | | | 2008 | | | 2007 | |
| | | (In thousands, except per share data) | |
| Consolidated Statements of Operations: | |
| Net sales | | $ | 15,755 | | | $ | 16,365 | | | $ | 29,463 | | | $ | 34,821 | | | $ | 56,287 | |
| Cost of products sold | | | 13,868 | | | | 14,806 | | | | 27,458 | | | | 32,915 | | | | 53,034 | |
| | | | | | | | | | | | | | | | | | | | | |
| Gross profit | | | 1,887 | | | | 1,559 | | | | 2,005 | | | | 1,906 | | | | 3,253 | |
| Other income | | | 34 | | | | 96 | | | | 431 | | | | 852 | | | | 1,566 | |
| Operating expenses: | | | | | | | | | | | | | | | | | | | | |
| Selling and delivery | | | 1,632 | | | | 1,468 | | | | 2,012 | | | | 1,089 | | | | 1,677 | |
| General and administrative | | | 1,700 | | | | 1,795 | | | | 2,375 | | | | 3,040 | | | | 2,901 | |
| Depreciation and amortization | | | 15 | | | | 15 | | | | 15 | | | | 14 | | | | 19 | |
| | | | | | | | | | | | | | | | | | | | | |
| Total operating expenses | | | 3,347 | | | | 3,278 | | | | 4,402 | | | | 4,143 | | | | 4,597 | |
| | | | | | | | | | | | | | | | | | | | | |
| Operating income (loss) | | | (1,426 | ) | | | (1,623 | ) | | | (1,966 | ) | | | (1,385 | ) | | | 223 | |
| Interest and other expense | | | (41 | ) | | | (343 | ) | | | 930 | | | | 126 | | | | 238 | |
| Taxes – current and deferred | | | (1 | ) | | | (9 | ) | | | (183 | ) | | | 329 | | | | (164 | ) |
| Net income (loss) | | $ | (1,468 | ) | | $ | (1,271 | ) | | $ | (2,714 | ) | | $ | (1,840 | ) | | $ | 148 | |
| | | | | | | | | | | | | | | | | | | | | |
| Income (loss) per share: | | | | | | | | | | | | | | | | | | | | |
| Basic and diluted | | $ | (0.04 | ) | | $ | (0.03 | ) | | $ | (0.07 | ) | | $ | (0.05 | ) | | $ | 0.01 | |
| Weighted average shares: | | | | | | | | | | | | | | | | | | | | |
| Basic and diluted | | | 40,467 | | | | 40,467 | | | | 40,467 | | | | 29,104 | | | | 29,104 | |
| | | | | | As of March 31 (in thousands) | | | | |
| | | 2011 | | | 2010 | | | 2009 | | | 2008 | | | 2007 | |
Balance Sheet Data: | | | | | | | | | | | | | | | |
| Cash | | | 375 | | | $ | 636 | | | $ | 444 | | | $ | 512 | | | $ | 1,112 | |
| Total assets | | | 7,077 | | | | 9,613 | | | | 13,237 | | | | 15,486 | | | | 20,133 | |
| Total current liabilities | | | 9,302 | | | | 10,417 | | | | 13,448 | | | | 12,287 | | | | 15,826 | |
| Total long-term liabilities | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | |
| Stockholders’ equity (deficit) | | | -2,224 | | | | -804 | | | | -211 | | | | 3,199 | | | | 4,307 | |
| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
The following discussion should be read in conjunction with the Financial Statements and Notes filed herewith. Our fiscal year ends March 31. This document contains certain forward-looking statements including, among others, regarding anticipated trends in our financial condition and results of operations and our business strategy. (See Part I, Item 1A, "Risk Factors"). These forward-looking statements are based largely on our current expectations and are subject to a number of risks and uncertainties. Actual results could differ materially from these forward-looking statements. Important factors to consider in evaluating such forward-looking statements include (i) changes in external factors or in our internal budgeting process which might impact trends in our results of operations; (ii) unanticipated working capital or other cash requirements; (iii) changes in our business strategy or an inability to execute our strategy due to unanticipated changes in the industries in which we operate; and (iv) various competitive market factors that may prevent us from competing successfully in the marketplace.
Overview
Our operations were adversely affected by the slow recovery of the US and Canadian economies. Many retailers are cautious in planning their buying programs. Our sales dropped by 4% but gross profit margin increased from 9.5% in fiscal 2010 to 12% in the fiscal 2011.
Our operating costs increased by 6% mainly due to higher exchange rate of the Canadian dollar, which is the functional currency for our operation in Canada. The net increase in operating expenses was approximately $182,000. Selling expenses increased by approximately $165,000. Salaries and wages increased by $25,000 with $8,000 decrease in general and administration.
We reported a currency gain of $112,000 due to the strong Canadian dollar against the US dollar.
Fiscal Year Ended March 31, 2011 Compared with Fiscal Year Ended March 31, 2010
Sales
Net sales decreased by $609,000 or 4% compared to prior year. Geographically, sale revenues in the US decreased by 42% or $665000. Our US distribution is scaled down to on-line stores only. As competition in US is always severe, we are waiting for the opportunity to regain the loss of revenue in this region.
Sales in Canada increased slightly by 2% or $292,000. At the beginning of the fiscal year, we were expecting an increase in sales of LCD TV’s. We launched our 22” LCD TV in April 2010 but the project was terminated quickly due to severe price competition. We made up the loss in sales by selling refurbished LCD TVs for a few brand name manufacturers.
The mix between direct import sales and domestic warehouse sales in fiscal 2011 was 7% to 93% compared with 8% to 92% in fiscal 2010. During weak economic times, our retail customers were cautious not to purchase container loads of goods with a long lead time. Despite the fact we have to sell more goods out of our domestic warehouse, we continued to reduce our inventory levels on hand due to careful planning and monitoring of inventory.
Gross Profit
Gross profit for fiscal 2011 was $1.87 million or 12% of revenues compared with $1.56 million or 9.5% in fiscal 2010. The increase in gross profit was mainly attributable to a strong Canadian dollar against the US dollar throughout the fiscal year. For sales in Canada, we purchased our products from our suppliers in US dollars but booked the sales revenue in Canadian dollars. The Canadian dollar appreciated about 6% against the US dollar during the fiscal year and our purchase cost decreased relatively resulting in a higher gross profit.
Commission Income
Our commission and other income consist of commissions earned on brokering sales and handling return products for Starlight and another manufacturer. Commission income decreased from approximately $96,000 in fiscal 2010 to $34,000 in this fiscal year. The weak economy caused a general reduction in demands for goods and services, and thus we handled less returns for our customers in our reverse logistics operations. Rather, we have negotiated to buy the defective returns from the manufacturers, refurbish the goods in house and sell the refurbished goods to our customers. The revenue from the sale of refurbished goods for the current fiscal year was $1.2 million and is included with sales revenues.
Operating Expenses
Operating expenses for the current fiscal year increased from approximately $3.28 million in fiscal 2010 to $3.46 million in this fiscal year. Selling and warehousing contributed the largest increase of approximately $165,000. We offered more advertising allowances to our customers as incentives to carry our products. In administrative expenses we reduced our expenses from $734,398 to $726,717. Although the decrease was very moderate, it represented management effort to reduce operating costs. Salaries and wages increased by approximately $25,000 due mainly to a stronger average Canadian conversion rate to US dollars for the fiscal year. In Canadian currency, the level of salaries and wages were comparable.
Financial expenses and exchange gain
The Canadian dollar appreciated steadily from 0.98 to one US dollar at the beginning of this fiscal year to 1.029 at the end of the fiscal year resulting in a gain of $112,000 for the fiscal year. In fiscal 2010, we recorded an exchange gain of $354,000. We did not purchase any forward currency contracts to hedge against the volatility of the Canadian dollar.
Interest expense was comparable between fiscal 2010 and 2011.
Interest expense increased by $30,000 in the current fiscal year compared to the prior. We repaid our income tax liability in Canada, which we owed from a tax audit reassessment for the fiscal years 2003 and 2004. Included with the final payment was approximately $29,000 in accrued interest.
Income Tax Expenses
For the fiscal year ended March 31, 2011, we did not record any provision for income tax as the Company and its subsidiaries incurred taxable losses for the year. The Company does not anticipate future changes in rates and as such does not anticipate such variances in its current or deferred taxes in subsequent years.
We operate within multiple taxing jurisdictions and we are subject to audit in each jurisdiction. Because of the complex issues involved, any claims can require an extended period of time to resolve. In management's opinion, adequate provisions for income taxes have been made.
Fiscal Year Ended March 31, 2010 Compared with Fiscal Year Ended March 31, 2009
Sales
Net sales decreased by $13 million or 45% compared to prior year. The large decrease was due to the loss of a major account in our US subsidiary. We were successful selling to this account with our Disney and youth products in prior years. The decrease in Disney product demands coincided with a sharp decline in the overall toys segment in the US, resulting in this major account withdrawing our products in fiscal 2010. Although we have tried to renew their interest recently, it is unlikely this will happen in fiscal 2011.
We experienced decreases in sales of MP3 players and clocks but increase in sales of LCD TV’s and DVD players. The clocks segment was affected by a sharp increase in the costs of the products. The retail price of clocks increased and the cost was passed on to our customers. The decrease in clock sales was a reflection of the resistance by consumers to pay the higher prices. We are expecting an increase in sales of LCD TV’s in fiscal 2011. We launched our 22” LCD TV in April 2010 and will continue to launch larger size TV’s up to 32”.
The mix between direct import sales and domestic warehouse sales in fiscal 2010 was 8% to 92% compared with 16% to 84% in fiscal 2009. During weak economic times, our retail customers were cautious not to purchase container loads of goods with a long lead time. Despite the fact we have to sell more goods out of our domestic warehouse, we managed to reduce our inventory levels on hand due to careful planning and monitoring of inventory.
Gross Profit
Gross profit for fiscal 2010 was $1.6 million or 9.5% of revenues compared with 6.8% in fiscal 2009. The increase in gross profit margin was mainly attributable to a strong Canadian dollar against the US dollar throughout the fiscal year. For sales in Canada, we purchased our products from our suppliers in US dollars but booked the sales revenue in Canadian dollars. When the Canadian dollar appreciated against the US dollar, our purchase cost decreased relatively resulting in a higher profit margin.
Commission Income
Our commission and other income consist of commissions earned on brokering sales and handling return products for Starlight and another manufacturer. Commission income decreased from approximately $431,000 in fiscal 2009 to $96,000 in this fiscal year. The weak economy caused a general reduction in demands for goods and services, and thus we handled less returns for our customers in our reverse logistics operations.
Operating Expenses
Operating expenses for the current fiscal year decreased from approximately $4.4 million in fiscal 2009 to $3.3 million in this fiscal year. Selling and warehousing contributed the largest decrease of approximately $544,000. Our warehousing expense in US was significantly decreased due to the decrease of sales and activities in this region. Similarly, in administrative expenses we reduced travel, phone allowances, and office rent and office expenses in our US subsidiary which accounted for the majority of the $330,000 decreases. Salaries and wages decreased by approximately $250,000 and the majority of this decrease came from payroll cuts in the Canadian operation.
Financial expenses and exchange gain
The Canadian dollar appreciated steadily from 0.8 to one US dollar at the beginning of this fiscal year to 0.98 at the end of the fiscal year resulting in a gain of $354,000 for the fiscal year. In fiscal 2009, we incurred exchange loss of $739,000. We did not purchase any forward currency contracts to hedge against the volatility of the Canadian dollar. However, our parent company Starlight, as our major supplier of goods, purchased forward contracts on our behalf to allow us to repay Starlight in Canadian dollars.
Interest expense decreased by approximately $180,000 compared with the prior fiscal year. The decrease was due to a one time interest charge levied by the Canadian tax authority in fiscal 2009 and a reduction in direct import sales activities compared with the prior fiscal year.
Income Tax Expenses
Significant management judgment is required in developing our provisions for income taxes, including the determination of foreign tax liabilities, deferred tax assets and liabilities and any valuation allowances that might be required against deferred tax assets. Management evaluates its ability to realize its deferred tax assets on a quarterly basis and adjusts its valuation allowance when it believes that it is not likely to be realized.
For the fiscal year ended March 31, 2010, we recovered income tax expense in the amount of $9,047. In the prior years a tax audit on the Canadian subsidiary was conducted on years 2004 and 2005 and additional taxes were reassessed. Taxes related to these audits amounted to $714,638 in fiscal 2008. The current year tax recovery was a result of carryback of losses in the current year to prior years. The Company does not anticipate future changes in rates and as such does not anticipate such variances in its current or deferred taxes in subsequent years.
We operate within multiple taxing jurisdictions and we are subject to audit in each jurisdiction. Because of the complex issues involved, any claims can require an extended period of time to resolve. In management's opinion, adequate provisions for income taxes have been made.
Liquidity and Capital Resources
On March 31, 2011, we had cash on hand of $375,365 compared to cash on hand of $635,516 on March 31, 2010. The decrease of cash on hand was primarily used in operating activities to reduce our trade payable with outside parties and with our parent company. We have liquidated close to $2 million of inventory to fund our operating activities in the current fiscal year.
There have been no cash flows from investing and financing activities for the fiscal years ended March 31, 2011 and 2010.
As of March 31, 2011 we had a working capital deficit of approximately $2.2 million. Our current liabilities of $9.3 million include:
| | · | amount due to Starlight resulting from normal course of the business for $7.8 million; |
| | · | current liabilities resulting from normal course of the business with other factories and suppliers for $0.9 million; |
| | · | advance from Starlight for $0.6 million |
We expect our factories will continue to provide credits to us and that Starlight will not demand immediate repayment of current liabilities and will provide financing to us if we require additional short term working capital.
We do not plan to acquire any significant capital items within the next twelve months.
Off Balance Sheet Arrangements
Cosmo does not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities referred to as structured finance or variable interest entities (VIE’s), which would be established for the purpose of facilitating off-balance sheet arrangements. As of March 31, 2011, Cosmo did not have any unconsolidated VIE’s.
Contractual Obligations as of March 31, 2011
Cosmo had contractual obligations at March 31, 2011 as follows:
| | | Payments Due by Period | |
| | | | | Less Than | | | | | More Than | |
| Contractual Obligations | | Total | | | 1 Year | | | 1-3 Years | | | 3-5 Years | | | 5 Years | |
| | | | | | | | | | | | | | | | |
| Interest payable to related party | | $ | 604,627 | | | $ | 604,627 | | | $ | — | | | | — | | | | — | |
| Operating leases | | $ | 894,367 | | | $ | 355,466 | | | $ | 538, 901 | | | | — | | | | — | |
Working Capital Requirements for the Short and Long Term
During the next twelve month period, we plan on financing our working capital needs from:
| | · | The collection of accounts receivable; |
| | · | Sales of existing inventory; and |
| | · | The continued support of factories in China that finance our purchases of goods for fiscal 2012. |
Our sources of cash for working capital in the long term are the same as our sources for the short term. If we need additional financing for the long term use, one of the options that we may explore in the near future is by private offerings. However, we cannot guarantee that our financing plan will succeed. If we need to obtain additional financing and fail to do so, it may have a material adverse effect on our ability to meet our financial obligations and continue our operations.
During fiscal 2012, we will continue to control our operating costs. We expect domestic sales will continue to expand which will improve our working capital to finance inventory and accounts receivable.
Except for the foregoing, we do not have any present commitment that is likely to cause our liquidity to increase or decrease in any material way. In addition, except for the Company's need for additional capital to finance inventory purchases, the Company is not aware of any trend, additional demand, event or uncertainty that will result in, or that is reasonably likely to result in, the Company's liquidity increasing or decreasing in any material way.
Exchange Rates
For direct sales, we sell our products in U.S. dollars and pay for all of our manufacturing costs in either U.S. or Hong Kong dollars. Operating expenses of the Hong Kong office are paid in Hong Kong dollars. 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 U.S. $1.00 and, accordingly, has not represented a currency exchange risk to the U.S. dollar. Operating expenses of our Canada office is paid in Canadian dollars, and domestic sales are received in Canadian dollars. The exchange rate between the Canadian dollar and US dollar can represent an exchange risk to us. Therefore any adverse fluctuation in this exchange rate may have a material effect on our business, financial condition or results of operation. The overall percentage of domestic sales in Canadian dollars is at approximately 90% of total sales. Due to the upward trend of the Canadian dollar throughout the fiscal year, we did not take any action to hedge against the Canadian dollar.
Seasonal and Quarterly Results
Historically, our operations have been seasonal, with the highest net sales occurring in the second and third quarters (reflecting increased orders for electronic audio and video equipment during the Christmas selling months) and to a lesser extent the first and fourth quarters of the fiscal year. Sales in our fiscal second and third quarter, combined, accounted for approximately 66% and 62% of net sales in fiscal 2011, and 2010, respectively.
Our results of operations may also fluctuate from quarter to quarter as a result of the amount and timing of orders placed and shipped to customers, as well as other factors. The fulfillment of orders can therefore significantly affect results of operations on a quarter-to-quarter basis.
Inflation
Inflation has not had a significant impact on the Company's operations. The Company has historically passed on any price increases to customers since prices charged by the Company are generally not fixed by long-term contracts.
Critical Accounting Policies and Estimates
The methods, estimates and judgments Cosmo uses in applying its accounting policies have a significant impact on the results reported in its consolidated financial statements. Cosmo evaluates its estimates and judgments on an on-going basis. Cosmo bases its estimates on historical experience and assumptions that Cosmo believes to be reasonable under the circumstances. Cosmo’s experience and assumptions form the basis for its judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may vary from what Cosmo anticipates and different assumptions or estimates about the future could change its reported results.
Cosmo believes the following accounting policies are the most critical to Cosmo, in that they are important to the portrayal of Cosmo’s consolidated financial statements and they require Cosmo’s most difficult, subjective or complex judgments in the preparation of its consolidated financial statements:
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. These estimates are reviewed periodically, and, as adjustments become necessary, they are reported in earnings in the period in which they become known.
For fiscal 2011, the Company had significant estimates for allowances for doubtful accounts in the amount of $175,206, allowance for obsolete inventory reserve of $725,822 and sales return and allowance reserve of $252,977.
Revenue Recognition
Sales, net of estimated sales returns, are recognized upon passage of title to the customer. This occurs upon shipment or upon receipt by the customer depending on the country of the sale and the agreement with the customer. Revenue is recognized if persuasive evidence of an agreement exists, the sales price is fixed or determinable, and collectability is reasonably assured.
Commission income is derived from reverse logistic services that consist of handling other distributor companies returned goods. In providing these services, the Company acts as an agent or broker without assuming the risks and rewards of ownership of the goods and therefore reports the commissions on a net basis. Revenue is recognized based on the completion of the contracted services.
Inventories
Inventories are valued at the lower of cost or net realizable value. Cost is determined on a first-in, first-out basis. Inventory is comprised of finished products that the Company intends to sell to its customers. The Company periodically makes judgments and estimates regarding the future utility and carrying value of its inventory. The carrying value of inventory is periodically reviewed and impairments, if any, are recognized when the expected future benefit from the inventory is less than its carrying value. The Company has inventory reserves for estimated obsolescence or unmarketable inventory which is equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions.
Foreign Translation Adjustment
The accounts of the foreign subsidiaries were translated into U.S. dollars in accordance with the Accounting Standards Codification (“ASC”) 830, subtopic 30 - Foreign Currency Translation. Management has determined that the Hong Kong dollar is the functional currency of the Hong Kong subsidiaries and the Canadian dollar is the functional currency of the Canadian subsidiary. Certain current assets and liabilities of these foreign entities are denominated in U.S. dollars. In accordance with ASC 830, transaction gains and losses on these assets and liabilities are included in the determination of income for the relevant periods. Adjustments resulting from the translation of the financial statements from their functional currencies to United States dollars are accumulated as a separate component of accumulated other comprehensive income and have not been included in the determination of income for the relevant periods.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market risk represents the risk of loss that may impact our financial position, results of operations or cash flows due to adverse changes in financial and commodity market prices and interest rates. We are exposed to market risk in the areas of changes in Canada and International borrowing rates and changes in foreign currency exchange rates. In addition, we are exposed to market risk in certain geographic areas that have experienced or remain vulnerable to an economic downturn, such as China. We purchase substantially all our inventory from companies in China and, therefore, we are subject to the risk that such manufacturers will be unable to provide inventory at competitive prices.
While we believe that if such an event were to occur we would be able to find alternative sources of inventory at competitive prices, we cannot assure you that we would be able to do so. These exposures are directly related to our normal operating and funding activities. Historically and as of March 31, 2011, we have not used derivative instruments or engaged in hedging activities to minimize market risk.
Interest Rate Risk
As of March 31, 2011, we have borrowed from Starlight and discounted our trade bills to obtain cash advance on our direct sales. An increase in prime rate will increase our costs of borrowing accordingly.
Foreign Currency Risk
We have a wholly-owned subsidiary in USA, a wholly-owned subsidiary in Canada and a wholly-owned subsidiary in Hong Kong. Sales by the Canadian operations made in Canada are denominated in Canadian dollar; purchases of inventory are denominated in US or Hong Kong dollar, and operating expenses in Canadian dollar. The Hong Kong operating expenses are denominated in Hong Kong dollar, sales are denominated in U.S. dollar, and purchases of inventory are denominated in U.S. or Hong Kong dollar. These transactions create exposures to changes in exchange rates. Changes in the Hong Kong dollar exchange rate and Canadian dollar exchange rate with the U.S. dollar may positively or negatively affect our gross margins, operating income and retained earnings. We do not believe that near-term changes in the exchange rates, if any, will result in a material effect on our future earnings, fair values or cash flows, and therefore, we have chosen not to enter into foreign currency hedging transactions. We cannot assure you that this approach will be successful, especially in the event of a significant and sudden change in the value of the Canadian and Hong Kong dollar. The Canadian dollar has been rising during fiscal 2011. We have not taken steps to hedge against this currency in fiscal 2011.
Item 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
| | | Page # | |
| | | | |
| Report of Independent Registered Public Accounting Firm | | 31 | |
| Consolidated Balance Sheets as of March 31, 2011 and 2010 | | 32 | |
| Consolidated Statements of Operations and Comprehensive Loss for the years ended March 31, 2011, 2010, and 2009 | | 33 | |
Consolidated Statements of Stockholders’ Deficit for the years ended March 31, 2011 and 2010 | | 34 | |
| Consolidated Statements of Cash Flows for the years ended March 31, 2011, 2010, and 2009 | | 35 | |
| Notes to the Consolidated Financial Statements | | 36 | |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Cosmo Communications Corporation and Subsidiaries
We have audited the accompanying consolidated balance sheets of Cosmo Communications Corporation and Subsidiaries as of 31 March 2011 and 2010 and the related consolidated statements of operations and comprehensive loss, stockholders' deficit and cash flows for each of the three years in the period then ended 31 March 2011. 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 audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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 consolidated financial position of Cosmo Communications Corporation and Subsidiaries as of 31 March 2011 and 2010 and the consolidated results of its operations and cash flows for each of the three years in the period then ended 31 March 2011, in conformity with accounting principles generally accepted in the United States of America.
/s/ DNTW Chartered Accountants, LLP
Licensed Public Accountants
Markham, Ontario, Canada
COSMO COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF 31 MARCH
(Expressed in United States Dollars)
| | | Note | | | 2011 | | | 2010 | |
| ASSETS | | | | | | | | | |
| Current Assets | | | | | | | | | |
| Cash | | | | | $ | 375,365 | | | $ | 635,516 | |
| Accounts receivable, less allowance of $175,206 and $187,321 at 31 March 2011 and 2010, respectively | | 3 | | | | 1,971,806 | | | | 2,259,969 | |
| Inventories less allowance of $752,822 and $1,103,360 at 31 March 2011 and 2010, respectively | | | | | | 4,712,192 | | | | 6,682,679 | |
| Prepaid expenses and other | | | | | | 9,702 | | | | 11,259 | |
| | | | | | | | | | | | |
| Total Current Assets | | | | | | 7,069,065 | | | | 9,589,423 | |
| | | | | | | | | | | | |
| Equipment and Other Assets | | | | | | | | | | | |
| Equipment, net | | 4 | | | | - | | | | 15,367 | |
| Deferred taxes | | 5 | | | | 8,317 | | | | 8,317 | |
| | | | | | | | | | | | |
| Total Equipment and Other Assets | | | | | | 8,317 | | | | 23,684 | |
| | | | | | | | | | | | |
| Total Assets | | | | | $ | 7,077,382 | | | $ | 9,613,107 | |
| | | | | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS' DEFICIT | | | | | | | | | | | |
| Current Liabilities | | | | | | | | | | | |
| Accounts payable and accrued liabilities | | 7 | | | $ | 887,642 | | | $ | 597,557 | |
| Accounts payable to parent company | | 6 | | | | 7,809,241 | | | | 9,132,241 | |
| Taxes payable | | 5 | | | | - | | | | 82,905 | |
| Interest payable to parent company | | 6 | | | | 604,627 | | | | 604,627 | |
| | | | | | | | | | | | |
| Total Liabilities | | | | | | 9,301,510 | | | | 10,417,330 | |
| | | | | | | | | | | | |
| Commitments | | 8 | | | | | | | | | |
| | | | | | | | | | | | |
| Stockholders' Deficit | | | | | | | | | | | |
| Preferred stock, $0.01 par value, cumulative and convertible, 30,000 shares authorized | | | | | | - | | | | - | |
| Preferred stock, $0.01 par value, 9,970,000 shares authorized | | | | | | - | | | | - | |
| Capital stock, $0.05 par value, 50,000,000 shares authorized, 40,467,636 shares issued and outstanding | | | | | | 2,023,382 | | | | 2,023,382 | |
| Additional paid-in capital | | | | | | 27,704,592 | | | | 27,704,592 | |
| Accumulated other comprehensive income | | | | | | 355,598 | | | | 306,205 | |
| Accumulated deficit | | | | | | (32,307,700 | ) | | | (30,838,402 | ) |
| Total Stockholders' Deficit | | | | | | (2,224,128 | ) | | | (804,223 | ) |
| Total Liabilities and Stockholders' Deficit | | | | | $ | 7,077,382 | | | $ | 9,613,107 | |
The accompanying notes are an integral part of these consolidated financial statements.
COSMO COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
FOR THE YEARS ENDED 31 MARCH
(Expressed in United States Dollars)
| | | 2011 | | | 2010 | | | 2009 | |
| | | | | | | | | | |
| SALES | | $ | 15,755,443 | | | $ | 16,364,733 | | | $ | 29,463,154 | |
| | | | | | | | | | | | | |
| COST OF PRODUCTS SOLD | | | 13,868,625 | | | | 14,806,460 | | | | 27,458,287 | |
| | | | | | | | | | | | | |
| GROSS PROFIT | | | 1,886,818 | | | | 1,558,273 | | | | 2,004,867 | |
| | | | | | | | | | | | | |
| COMMISSION INCOME | | | 34,248 | | | | 96,497 | | | | 430,982 | |
| | | | | | | | | | | | | |
| OPERATING EXPENSES | | | | | | | | | | | | |
| Salaries and wages | | | 1,085,416 | | | | 1,060,735 | | | | 1,310,628 | |
| General and administrative | | | 726,717 | | | | 734,398 | | | | 1,064,791 | |
| Selling and delivery | | | 1,632,478 | | | | 1,467,694 | | | | 2,012,088 | |
| Depreciation | | | 15,367 | | | | 14,874 | | | | 14,874 | |
| | | | | | | | | | | | | |
| TOTAL OPERATING EXPENSES | | | 3,459,978 | | | | 3,277,701 | | | | 4,402,381 | |
| | | | | | | | | | | | | |
| LOSS FROM OPERATIONS | | | (1,538,912 | ) | | | (1,622,931 | ) | | | (1,966,532 | ) |
| | | | | | | | | | | | | |
| Financial | | | 41,407 | | | | 11,800 | | | | 191,578 | |
| (Gain) loss on foreign exchange | | | (111,833 | ) | | | (354,340 | ) | | | 739,437 | |
| | | | | | | | | | | | | |
| LOSS BEFORE INCOME TAXES | | | (1,468,486 | ) | | | (1,280,391 | ) | | | (2,897,547 | ) |
| | | | | | | | | | | | | |
| INCOME TAX EXPESE (RECOVERY) | | | 812 | | | | (9,047 | ) | | | (183,067 | ) |
| | | | | | | | | | | | | |
| NET LOSS | | $ | (1,469,298 | ) | | $ | (1,271,344 | ) | | $ | (2,714,480 | ) |
| | | | | | | | | | | | | |
| FOREIGN CURRENCY TRANSLATION ADJUSTMENT | | | 49,393 | | | | 677,987 | | | | (695,458 | ) |
| | | | | | | | | | | | | |
| COMPREHENSIVE LOSS | | $ | (1,419,905 | ) | | $ | (593,357 | ) | | $ | (3,409,938 | ) |
| | | | | | | | | | | | | |
| LOSS PER WEIGHTED NUMBER OF SHARES OUTSTANDING - BASIC AND DILUTED | | $ | (0.04 | ) | | $ | (0.03 | ) | | $ | (0.07 | ) |
| | | | | | | | | | | | | |
| WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING - BASIC AND DILUTED | | | 40,467,636 | | | | 40,467,636 | | | | 40,467,636 | |
The accompanying notes are an integral part of these consolidated financial statements.
COSMO COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
FOR THE YEARS ENDED 31 MARCH 2011 AND 2010
(Expressed in United States Dollars)
| | | Shares | | | Capital Stock | | | Additional Paid-In Capital | | | Accumulated Other Comprehensive Income (Loss) | | | Accumulated Deficit | | | Total Stockholders' Deficit | |
| Balance, 1 April 2009 | | | 40,467,636 | | | $ | 2,023,382 | | | $ | 27,704,592 | | | $ | (371,782 | ) | | $ | (29,567,058 | ) | | $ | (210,866 | ) |
| Foreign currency translation | | | - | | | | - | | | | - | | | | 677,987 | | | | - | | | | 677,987 | |
| Net loss for the year | | | - | | | | - | | | | - | | | | - | | | | (1,271,344 | ) | | | (1,271,344 | ) |
| Balance, 31 March 2010 | | | 40,467,636 | | | | 2,023,382 | | | | 27,704,592 | | | | 306,205 | | | | (30,838,402 | ) | | | (804,223 | ) |
| Foreign currency translation | | | - | | | | - | | | | - | | | | 49,393 | | | | - | | | | 49,393 | |
| Net loss for the year | | | - | | | | - | | | | - | | | | - | | | | (1,469,298 | ) | | | (1,469,298 | ) |
| Balance, 31 March 2011 | | | 40,467,636 | | | $ | 2,023,382 | | | $ | 27,704,592 | | | $ | 355,598 | | | $ | (32,307,700 | ) | | $ | (2,224,128 | ) |
The accompanying notes are an integral part of these consolidated financial statements.
COSMO COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED 31 MARCH
(Expressed in United States Dollars)
| | | 2011 | | | 2010 | | | 2009 | |
| | | | | | | | | | |
| CASH FLOWS FROM OPERATING ACTIVITIES | | | | | | | | | |
| | | | | | | | | | |
| Net loss | | $ | (1,469,298 | ) | | $ | (1,271,344 | ) | | $ | (2,714,480 | ) |
| | | | | | | | | | | | | |
| Adjustment to reconcile net earnings to net cash (used in) provided by operating activities | | | | | | | | | | | | |
| Depreciation | | | 15,367 | | | | 14,874 | | | | 14,874 | |
| | | | (1,453,931 | ) | | | (1,256,470 | ) | | | (2,699,606 | ) |
| Changes in operating assets and liabilities: | | | | | | | | | | | | |
| Accounts receivable | | | 288,163 | | | | 291,465 | | | | 1,290,932 | |
| Inventories | | | 1,970,487 | | | | 3,505,255 | | | | 842,062 | |
| Prepaid expenses and other | | | 1,557 | | | | 3,886 | | | | 33,082 | |
| Accounts payable and accrued liabilities | | | 290,085 | | | | (96,026 | ) | | | 63,017 | |
| Taxes payable | | | (82,905 | ) | | | 31,245 | | | | (260,107 | ) |
| Accounts payable to parent company | | | (1,323,000 | ) | | | (2,966,236 | ) | | | 1,358,584 | |
| | | | | | | | | | | | | |
| CASH FLOWS (USED IN) PROVIDED BY OPERATING ACTIVITIES | | | (309,544 | ) | | | (486,881 | ) | | | 627,964 | |
| | | | | | | | | | | | | |
| CASH FLOWS FROM INVESTING ACTIVITIES | | | | | | | | | | | | |
| Acquisition of equipment | | | - | | | | - | | | | (268 | ) |
| | | | | | | | | | | | | |
| CASH FLOWS USED IN INVESTING ACTIVITIES | | | - | | | | - | | | | (268 | ) |
| | | | | | | | | | | | | |
| CASH FLOWS FROM FINANCING ACTIVITIES | | | - | | | | - | | | | - | |
| | | | | | | | | | | | | |
| EFFECT OF EXCHANGE RATE CHANGES ON CASH | | | 49,393 | | | | 677,987 | | | | (695,458 | ) |
| | | | | | | | | | | | | |
| NET (DECREASE) INCREASE IN CASH | | | (260,151 | ) | | | 191,106 | | | | (67,762 | ) |
| | | | | | | | | | | | | |
| CASH, BEGINNING OF YEAR | | | 635,516 | | | | 444,410 | | | | 512,172 | |
| | | | | | | | | | | | | |
| CASH, END OF YEAR | | $ | 375,365 | | | $ | 635,516 | | | $ | 444,410 | |
The accompanying notes are an integral part of these consolidated financial statements.
COSMO COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED 31 MARCH 2011 AND 2010
(Expressed in United States Dollars)
Cosmo Communications Corporation and Subsidiaries (the "Company" or "Cosmo") market and distribute consumer electronic products. The Company has operations in the United States, Hong Kong and Canada.
| 2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
The accounting policies of the Company are in accordance with accounting principles generally accepted in the United States of America. Presented below are those policies considered particularly significant:
Principles of Consolidation
The Company includes, in consolidation, its wholly owned subsidiaries, Cosmo Communications Canada Inc., Cosmo Communications (H.K.) Limited and Cosmo Communication USA Corp. All significant intercompany transactions and balances have been eliminated upon consolidation.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. These estimates are reviewed periodically, and, as adjustments become necessary, they are reported in earnings in the period in which they become known.
As of 31 March 2011, the Company had significant estimates for allowances for doubtful accounts in the amount of $175,206, allowance for obsolete inventory reserve of $725,822 and sales return and allowance reserve of $252,977.
Revenue Recognition
Sales, net of estimated sales returns, are recognized upon passage of title to the customer. This occurs upon shipment or upon receipt by the customer depending on the country of the sale and the agreement with the customer. Revenue is recognized if persuasive evidence of an agreement exists, the sales price is fixed or determinable, and collectability is reasonably assured.
Commission income is derived from reverse logistic services that consist of handling other distributor companies returned goods. In providing these services, the Company acts as an agent or broker without assuming the risks and rewards of ownership of the goods and therefore reports the commissions on a net basis. Revenue is recognized based on the completion of the contracted services.
Cost of Products Sold
Included in cost of sales are cost of purchases (FOB cost) and cost associated with the import of the products. Import cost components are customs entry fees levied by the country of import and the freight and handling cost to unload containers.
Advertising Allowances
The Company followed the guidance in Accounting Standards Codification (“ASC”) 605-50, Revenue Recognition- Customer Payments and Incentives. In accordance with ASC 605-50, the Company is required to classify certain payments to its customers as a reduction of sales. The Company grants advertising allowances to its major customers as contributions to promote the Company's products. Management has determined that the Company meets the requirements of ASC 605-50 in order to characterize these contributions as a cost as opposed to a reduction in revenue and accordingly these costs are included in selling and delivery expenses.
| 2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) |
Consolidated Statements of Income Classifications
The Company calculates its gross profit as the difference between its revenue and the associated cost of products sold. Cost of products sold includes direct product costs, inbound freight, excise taxes, casualty insurance, import duties and broker fees, vendor allowances, and increases or decreases to the Company’s FIFO reserve. The Company’s gross profit may not be comparable to other entities whose shipping and handling expenses are a component of cost of sales. Instead the Company includes these costs in selling and delivery expenses which amounted to $629,656 (2010 - $960,084).
The Company classifies the following expense categories separately on its statements of operations: salaries and wages; selling and delivery; and general and administrative. The Company’s labor costs of the warehouse and office staff are included in the salaries and wages expense category. The Company’s selling expenses primarily include shipping and handling costs, sales commissions, travel, entertainment, and product promotional costs. General and administrative expenses of the Company primarily include legal costs, insurance, rent, repairs, and general office expenses.
Cash and Cash Equivalents
Cash and cash equivalents consist of commercial accounts and interest-bearing bank deposits and are carried at cost, which approximates current value. Items are considered to be cash equivalents if the original maturity is three months or less.
Inventories
Inventories are valued at the lower of cost and net realizable value. Cost is determined on a first-in, first-out basis. Inventory is comprised of finished products that the Company intends to sell to its customers. The Company periodically makes judgments and estimates regarding the future utility and carrying value of its inventory. The carrying value of inventory is periodically reviewed and impairments, if any, are recognized when the expected future benefit from the inventory is less than its carrying value. The Company has inventory reserves for estimated obsolescence or unmarketable inventory which is equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. As of 31 March 2011, the Company’s inventory reserve was $725,822 ($1,103,360 in 2009).
Trade receivables
The Company's accounts receivable and related allowance for doubtful accounts are analyzed in detail on a quarterly basis and all significant customers with delinquent balances are reviewed to determine future collectability. Reserves are established in the quarter in which the Company makes the determination that the account is deemed uncollectible. The Company maintains additional reserves based on its historical bad debt experience. The provision for accounts receivables was assessed as of 31 March 2011 and 2010 as $175,206 and $187,321, respectively.
Equipment
Equipment is stated at historical cost less accumulated depreciation. Depreciation, based on the estimated useful lives of the assets, is provided using the under noted annual rates and methods:
| Furniture and fixtures | 20% declining balance |
| Equipment | 20% declining balance |
| Computer | 25% declining balance |
| Warehouse equipment | 20% declining balance |
| 2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) |
Foreign Translation Adjustment
The accounts of the foreign subsidiaries were translated into U.S. dollars in accordance with the provisions of ASC 830, Foreign Currency Matters. Management has determined that the Hong Kong dollar is the functional currency of the Hong Kong subsidiary, the US dollar is the functional currency of the US subsidiary and the Canadian dollar is the functional currency of the Canadian subsidiary. Certain current assets and liabilities of these foreign entities are denominated in U.S. dollars. In accordance with ASC 830, transaction gains and losses on these assets and liabilities are included in the determination of income for the relevant periods. Adjustments resulting from the translation of the financial statements from their functional currencies to United States dollars are accumulated as a separate component of accumulated other comprehensive income and have not been included in the determination of income for the relevant periods.
Income Taxes
The Company accounts for income taxes pursuant to ASC 740, Income Taxes. Deferred tax assets and liabilities are recorded for differences between the financial statement and tax basis of the assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is recorded for the amount of income tax payable or refundable for the period increased or decreased by the change in deferred tax assets and liabilities during the period.
Fair Value of Financial Instruments
The Company measures its financial assets and liabilities in accordance with the requirements of ASC 820, Fair Value Measurements and Disclosures. ASC 820 clarifies the definition of fair value, prescribes methods for measuring fair value, and establishes a fair value hierarchy to classify the inputs used in measuring fair value as follows:
Level 1 - Inputs are unadjusted quoted prices in active markets for identical assets or liabilities available at the measurement date.
Level 2 - Inputs are unadjusted quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, inputs other than quoted prices that are observable, and inputs derived from or corroborated by observable market data.
Level 3 - Inputs are unobservable inputs which reflect the reporting entity’s own assumptions on what assumptions the market participants would use in pricing the asset or liability based on the best available information.
The Company's financial instruments include cash and cash equivalents, receivables, payables, and advances from the parent company.
The estimated fair value of financial instruments has been determined by the Company using available market information and valuation methodologies. Considerable judgment is required in estimating fair value. Accordingly, the estimates may not be indicative of the amounts the Company could realize in a current market exchange. As of 31 March 2011and 2010, the carrying amounts of cash, accounts receivable, accounts payable and accrued liabilities, and loans payable approximate their fair values due to the short-term maturities of these instruments.
| 2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) |
Comprehensive Income
The Company adopted ASC 220, Comprehensive Income that establishes standards for reporting and presentation of comprehensive income and its components in a full set of financial statements. Comprehensive income is presented in the statements of changes in stockholders' equity and consists of foreign currency translation adjustments. ASC 220 requires only additional disclosures in the financial statements and does not affect the Company's financial position or results of operations.
Earnings or Loss Per Share
The Company accounts for earnings per share pursuant to ASC 260, Earnings per Share, which requires disclosure on the financial statements of "basic" and "diluted" earnings (loss) per share. Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding for the year. Diluted earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding plus common stock equivalents (if dilutive) related to stock options and warrants for each year.
There were no dilutive financial instruments for the years ended 31 March 2011 and 2010.
Valuation of Long-Lived Assets
In accordance with ASC 360 Property, Plant and Equipment, long-lived assets to be held and used are analyzed for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable. The Company evaluates at each balance sheet date whether events and circumstances have occurred that indicate possible impairment. If there are indications of impairment, the Company uses future undiscounted cash flows of the related asset or asset grouping over the remaining life in measuring whether the assets are recoverable. In the event such cash flows are not expected to be sufficient to recover the recorded asset values, the assets are written down to their estimated fair value. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value of the asset less cost to sell.
Concentration of Credit Risks
The Company is exposed to credit risk on accounts receivable from its customers. In order to reduce its credit risk, the Company has adopted credit policies which include the analysis of the financial position of its customers and the regular review of their credit terms. Our five largest customers during fiscal year 2011 made up approximately 81% o f our total revenues (2010 – 87%).
Cash includes cash on hand and demand deposits in accounts maintained with state-owned banks within Canada, United States and Hong Kong. Certain financial instruments, which subject the Company to concentration of credit risk, consist of cash. The Company maintains cash balances at financial institutions which, from time to time, may exceed Federal Deposit Insurance Corporation insured limits for the banks located in the United States and Canada. Balances at financial institutions or state-owned banks within Hong Kong are not covered by insurance. Total cash in state-owned banks and cash on hand at March 31, 2011 and 2010, amounted to $18,598 and $105,340, respectively, of which no deposits are covered by insurance. The Company has not experienced any losses in such accounts and believes it is not exposed to any risks on its cash in bank accounts.
The Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environments in China, and by the general state of the Chinese economy. The Company’s operations in China are subject to specific considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environments and foreign currency exchange. The Company’s results may be adversely affected 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.
Foreign Currency Risk
Foreign currency risk arises from fluctuations in foreign exchange rates and the degree of volatility of these rates relative to the Canadian dollar. Consequently, some assets, liabilities, revenues and purchases are exposed to foreign exchange fluctuations.
Management has determined that the Hong Kong dollar is the functional currency of the Hong Kong subsidiary, the US dollar is the functional currency of the US subsidiary and the Canadian dollar is the functional currency of the Canadian subsidiary. Certain current assets and liabilities of these foreign entities are denominated in U.S. dollars. The Company is therefore exposed to currency risks due to potential variation of the currencies in which it operates. The Company does not use derivative instruments to hedge its foreign exchange risk.
| 2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) |
Recent Accounting Pronouncements
In October 2009, the FASB issued amended revenue recognition guidance for arrangements with multiple deliverables. The new guidance eliminates the residual method of revenue recognition and allows the use of management’s best estimate of selling price for individual elements of an arrangement when vendor specific objective evidence (VSOE), vendor objective evidence (VOE) or third-party evidence (TPE) is unavailable. For the company, this guidance is effective for all new or materially modified arrangements entered into on or after July 1, 2011 with earlier application permitted as of the beginning of a fiscal year. Full retrospective application of the new guidance is optional. The Company is currently assessing its implementation of this new guidance, but does not expect a material impact on the consolidated financial statements.
Other recent accounting pronouncements issued by the FASB and the SEC did not or are not believed by management to have a material impact on the Company's present or future consolidated financial statements.
| 3. | VALUATION AND QUALIFYING ACCOUNTS AND RESERVES |
The carrying amounts of trade accounts receivable are reduced by an allowance that reflects management’s best estimate of the amounts that will not be collected. Management individually reviews all accounts receivable balances and creates an allowance for doubtful accounts based on the credit worthiness of specific accounts and an estimate of other uncollectible accounts based on historical performance and current economic conditions.
Allowances for estimated returns are recorded at the estimated gross profit based upon our historical return patterns. Sales return allowances are recorded in accounts payable and accrued liabilities in the consolidated balance sheets.
The following is the activity within the Company’s consolidated valuation and qualifying accounts and reserves as of 31 March 2011 and 2010:
| | | Balance at Beginning of Year | | | Additions (Reductions) Charged to Costs and Expenses | | | Deductions | | | Balance at End of Year | |
| | | | | | | | | | | | | |
| Year ended 31 March 2011 | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| Deducted from asset account: | | | | | | | | | | | | |
| Allowance for doubtful accounts | | $ | 187,321 | | | $ | - | | | $ | (12,115 | ) | | $ | 175,206 | |
| Sales return and allowance reserve | | | 257,569 | | | | 571,659 | | | | (576,251 | ) | | | 252,977 | |
| Total | | $ | 444,890 | | | $ | 571,659 | | | $ | (588,366 | ) | | $ | 428,183 | |
| | | | | | | | | | | | | | | | | |
| Year ended 31 March 2010 | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Deducted from asset account: | | | | | | | | | | | | | | | | |
| Allowance for doubtful accounts | | $ | 196,426 | | | $ | 34,973 | | | $ | (44,078 | ) | | $ | 187,321 | |
| Sales return and allowance reserve | | | 104,641 | | | | 1,653,881 | | | | (1,500,953 | ) | | | 257,569 | |
| Total | | $ | 301,067 | | | $ | 1,688,854 | | | $ | (1,545,031 | ) | | $ | 444,890 | |
The components of equipment are as follows:
| | | Cost | | | Accumulated Depreciation | | | Net 2011 | | | Net 2010 | |
| | | | | | | | | | | | | |
| Furniture and fixtures | | $ | 42,462 | | | $ | (42,462 | ) | | | - | | | $ | 927 | |
| Equipment | | | 31,858 | | | | (31,858 | ) | | | - | | | | 891 | |
| Computer | | | 53,295 | | | | (53,295 | ) | | | - | | | | 5,643 | |
| Warehouse equipment | | | 68,575 | | | | (68,575 | ) | | | - | | | | 7,906 | |
| | | $ | 196,190 | | | $ | (196,190 | ) | | | - | | | $ | 15,367 | |
The provision for income taxes reconciles to the amount obtained by applying the statutory income tax rates of 31% (2010 - 33%) in Canada, 16.5% (2010 - 16.5%) in Hong Kong and 15% (2010 – 15%) in US to income before provision for taxes as follows:
| | | 2011 | | | 2010 | |
| | | | | | | |
| Computed expected tax | | $ | (379,234 | ) | | $ | (168,545 | ) |
| Expenses not deductible for tax purposes | | | 15,417 | | | | 7,287 | |
| Equipment | | | 3,815 | | | | 2,976 | |
| Tax losses available for carryforward | | | 363,376 | | | | 267,837 | |
| Utilization of prior year tax losses | | | (3,374 | ) | | | (109,555 | ) |
| Other | | | 812 | | | | (9,047 | ) |
| | | | | | | | | |
| Provision for income taxes | | $ | 812 | | | $ | (9,047 | ) |
The Company has $5,910,259 of tax losses available to offset future taxable income which expire as follows:
| | | USA | | | Canada | | | Hong Kong | | | Total | |
| Do not expire | | $ | - | | | $ | - | | | $ | 1,758,284 | | | $ | 1,758,284 | |
| 2029 | | | 489,043 | | | | 1,324,155 | | | | - | | | | 1,813,198 | |
| 2030 | | | 380,147 | | | | 682,693 | | | | - | | | | 1,062,840 | |
| 2031 | | | 102,534 | | | | 1,173,403 | | | | - | | | | 1,275,937 | |
| | | | | | | | | | | | | | | | | |
| | | $ | 971,724 | | | $ | 3,180,251 | | | $ | 1,758,284 | | | $ | 5,910,259 | |
The components of deferred income taxes have been determined at the combined statutory rates as follows:
| | | 2011 | | | 2010 | |
| | | | | | | |
| Deferred income tax assets (liabilities): | | | | | | |
| Book over tax depreciation | | $ | 8,317 | | | $ | 8,317 | |
| Tax losses available for carryforward | | | 1,421,753 | | | | 1,056,754 | |
| Valuation allowance | | | (1,421,753 | ) | | | (1,054,754 | ) |
| | | | | | | | | |
| Deferred income taxes | | $ | 8,317 | | | $ | 8,317 | |
| 6. | AMOUNTS PAYABLE TO PARENT COMPANY |
As of 31 March 2011, the Company owed $8,413,869 (2010 - $9,763,868) to The Starlight Group of Companies, the principal corporate shareholder of the Company ("Starlight"). Of this amount $7,809,242 (2010 - $9,132,241) was owed in the form of trade payable and the remainder was in the form of advances and interest on advances. The advances from Starlight were paid for by the issuance of shares in the fiscal year ended 31 March 2007, leaving only the accrued interest as payable. These amounts are payable on demand and Starlight has agreed not to charge further interest on the accrued interest payable. Interest accrued as of 31 March 2011 was $604,627 (2010 - $604,627).
| 7. | ACCOUNTS PAYABLE AND ACCRUED LIBILITIES |
The balance is comprised of:
| | | 2011 | | | 2010 | |
| Trade payables | | | 496,179 | | | | 113,829 | |
| Accrued liabilities | | | 118,066 | | | | 226,159 | |
| Claims payable | | | 20,420 | | | | - | |
| Sales return and allowance reserve | | | 252,977 | | | | 257,569 | |
| | | | | | | | | |
| | | $ | 887,642 | | | $ | 597,557 | |
The Company leases premises under an operating lease with a five year term in Canada and shares the facilities for its Hong Kong operation. Minimum lease commitments under the leases at 31 March 2011 were:
| 2012 | | $ | 355,466 | |
| 2013 | | | 358,317 | |
| 2014 | | | 180,584 | |
| | | | | |
| | | $ | 894,367 | |
| 9. | RELATED PARTY TRANSACTIONS |
Apart from those as disclosed in note 6, the Company's transactions with related parties were, in the opinion of the directors, carried out on normal commercial terms and in the ordinary course of the Company's business.
During the year ended 31 March 2011, the Company purchased $7,299,267 (2010 - $10,800,354) of goods from Starlight. The Company purchased $1,936,077 of goods from an associate company, The Singing Machine Company (SMC) (2010 - $1,701,203) and sold goods of $233,904 to SMC.(2010 - $622,261).
The Company recorded as an accrued liability $100,000 payable to Starlight as fees to handle and repair defective returns in 2011 (none in 2010).
The Company is economically dependent on its parent company for the supply of inventory products to its customers. For the year ended 31 March 2011, the Company purchased 65% of its inventory needs from Starlight (2010 - 80%).
The Company has been traditionally dependent on one single large mass-market merchandiser and chain store located in Canada and the US which accounted for 54% of sales in 2010. During the year ended 31 March 2011, the Company has built up sales with a second account located in Canada. The two customers accounted for 55% of sales in fiscal 2011. Economic dependence exists with these two customers. Loss of both customers may have significant adverse results to the financial position of the Company.
As of 31 March 2011, the accounts receivable from these two customers amounted to approximately $948,601 (2010 - $1,252,960) and claims payable for inventory returns amounted to approximately $20,420 (2010 - $12,076).
| 11. | OPERATING SEGMENT INFORMATION |
The Company operated in one business segment and all of its sales are consumer electronic products. The Company's customers are principally in Canada and in the USA.
| | | Canada | | | Hong Kong | | | United States | | | Total | |
| | | | | | | | | | | | | |
| 2011 | | | | | | | | | | | | |
| Assets | | | 6,044,244 | | | | 136,493 | | | | 896,645 | | | | 7,077,382 | |
| Sales, net | | | 13,763,003 | | | | 1,077,458 | | | | 914,983 | | | | 15,775,444 | |
| | | | | | | | | | | | | | | | | |
| Gross margin | | | 1,752,635 | | | | 115,225 | | | | 18,958 | | | | 1,886,818 | |
| Net loss | | | (1,186,699 | ) | | | (180,065 | ) | | | (102,534 | ) | | | (1,469,298 | ) |
| | | | | | | | | | | | | | | | | |
| 2010 | | | | | | | | | | | | | | | | |
| Assets | | | 7,036,473 | | | | 606,215 | | | | 1,970,419 | | | | 9,613,107 | |
| Sales, net | | | 13,471,277 | | | | 1,313,933 | | | | 1,579,523 | | | | 16,364,733 | |
| Gross margin | | | 1,398,821 | | | | 115,537 | | | | 43,915 | | | | 1,558,273 | |
| Net loss | | | (829,432 | ) | | | (61,767 | ) | | | (380,145 | ) | | | (1,271,344 | ) |
| 12. | SUPPLEMENTAL CASH FLOW INFORMATION |
During the year ended 31 March 2011 the Company paid interest of $41,407 (2010 - $11,800) and paid income taxes of $53,777 (2010 - $33,000).
