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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the Quarterly Period Ended December 31, 2004

OR

For the transition period from             to            

Commission File Number 0-29332

PEAK INTERNATIONAL LIMITED

(Exact Name of Registrant as Specified in its Charter)

(510) 449-0100

(Registrant’s telephone number)

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  x    No  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of March 21, 2005

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements

Condensed Consolidated Statements of Operations

(in thousands of United States Dollars, except share and per share data)

(See accompanying notes to Unaudited Condensed Consolidated Financial Statements)

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Condensed Consolidated Statements of Operations

(in thousands of United States Dollars, except share and per share data)

(See accompanying notes to Unaudited Condensed Consolidated Financial Statements)

2

Condensed Consolidated Balance Sheets

(in thousands of United States Dollars, except share and per share data)

(See accompanying notes to Unaudited Condensed Consolidated Financial Statements)

3

Condensed Consolidated Statements of Cash Flows

(in thousands of United States Dollars)

(See accompanying notes to Unaudited Condensed Consolidated Financial Statements)

4

Notes to Condensed Consolidated Financial Statements

(in thousands of United States Dollars, except share and per share data, unaudited)

(1) Organization and basis of presentation

Peak International Limited (the “Company”) was incorporated as an exempted company with limited liability in Bermuda under the Companies Act 1981 of Bermuda (as amended) on January 3, 1997. The subsidiaries of the Company are principally engaged in the manufacture and sale of precision engineered packaging products, such as matrix and disk drive trays, shipping tubes, reels and carrier tapes, leadframe boxes and interleaves used in the storage and transportation of semiconductor devices and other electronic components. The Company’s principal production facilities are located in the People’s Republic of China (the “PRC”) and the Company maintains offices in Hong Kong, Malaysia, Singapore, Taiwan, China, Italy, the Philippines and the United States of America.

The unaudited condensed consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intra-group balances and transactions have been eliminated on consolidation.

The accompanying condensed consolidated financial information has been prepared by the Company without being audited, in accordance with the instructions to Form 10-Q and therefore does not include all information and footnotes necessary for a fair presentation of financial position, results of operations and cash flows in accordance with accounting principles generally accepted in the United States of America.

The preparation of financial statements in conformity with generally accepted accounting principles requires the use of estimates and assumptions that affect reported amounts of certain assets, liabilities, revenues and expenses as of and for the reporting periods. Actual results could differ from those estimates. Differences from those estimates are reported in the period they become known.

The unaudited condensed consolidated financial statements reflect all adjustments (including normal recurring adjustments) which in the opinion of management are required for a fair presentation of the Company’s interim results. The results for interim periods are not necessarily indicative of the results that may be achieved in the entire year. These condensed consolidated financial statements and notes thereto should be read together with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended March 31, 2004.

New Accounting Standards

In December 2004, the FASB issued its final standard on accounting for employee stock options, SFAS No. 123(R), “Share-Based Payment”, which replaces SFAS Nos. 123 and supersedes Accounting Principles Board Opinion 25, “Accounting for Stock Issued to Employees.” SFAS No. 123(R) requires all companies to measure compensation costs for all share-based payments, including stock options, at fair value and expense such payments to the statement of operations over the service period. SFAS No. 123(R) is effective beginning for interim or annual periods beginning after June 15, 2005, which would be our first quarter of fiscal 2006.

In November 2004, the FASB issued its standard on inventory costs, SFAS No. 151, “Inventory Costs”. SFAS No. 151 requires all companies to recognize items, such as idle facility expense, excessive spoilage, double freight, and rehandling costs as current period charges. In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 is effective beginning for interim or annual periods beginning after June 15, 2005, which would be our first quarter of fiscal 2006.

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Notes to Condensed Consolidated Financial Statements—(continued)

(in thousands of United States Dollars, except share and per share data, unaudited

(2) Cost of goods sold

Included therein was $58 (unaudited) and $166 (unaudited) respectively (2003-$31 and $520, unaudited) write-off of machinery and molds due to technological obsolescence and capacity under-utilization for the quarter and for the nine months ended December 31, 2004.

The Company discovered errors in the computation and withholding of both taxes and social insurance contributions for workers at the Company’s main production facilities, which are located in Shenzhen, the PRC and operated pursuant to a processing agreement with an unaffiliated PRC company that obligates it to provide all of the personnel for the operation of the Company’s facilities and to render assistance in dealing with matters relating to the import of raw materials and the export of the Company’s products (the “Factory”). The error was discovered as a result of a claim by an employee regarding the computation of wages and withholding. Upon discovery of these errors, the Company conducted an internal review of the Factory’s practices and engaged third party advisors to assist the Company in assessing the Factory’s and the Company’s obligations with respect to these errors. Based on this review, management has concluded that the Factory has a duty to correct certain of these errors that amounted to a total of $1,332. While the Company believes it is not contractually obligated under the terms of its agreement with its processing partner to pay these amounts and while no claim has been made by any government agency, in the event the Factory was required to pay all or any portion of these liabilities, it is likely that the Company would make such payment in order to avoid the seizure of the Factory’s assets in order to keep it operational. Therefore, the Company has accrued $1,332 as additional manufacturing costs for the three months ended December 31, 2004.

In and around August 2004, approximately 86 employees in the Factory, filed various lawsuits against the Factory based on an assortment of violations of the labor laws in the PRC. These lawsuits were instigated by changes in the way the Factory workers were paid that resulted in reductions in worker’s take-home pay. The lawsuits allege breach of employment contracts due to violations of various labor laws by the Factory including, among others, the minimum wage laws, failure to properly compute and pay overtime wages, failure to pay social insurance payments, and other matters. Most of these claimants seek compensation not only for the unpaid amounts, but also for statutory severance pay based on the breach of the employment contract. The total amount sought by these claimants is approximately $300.

These cases were consolidated into three proceedings and are in various stages of litigation. Typically, labor cases in the PRC are first arbitrated and then may be appealed to the courts. The Factory has acknowledged its obligation to properly compute and pay overtime and social insurance and similar payments but seeks to avoid liability for severance payments. While the Factory prevailed during the arbitration on the issue of liability for severance payments, these cases are set for trial and further appeals. The Factory has offered to settle all of these lawsuits for the amount of the underpayments and costs incurred in a total amount of approximately $30.

While the Company believes it is not contractually obligated under the terms of its agreement with its processing partner to pay these amounts, in the event a judgment for damages shall be entered against the Factory and the Factory shall have insufficient assets to satisfy the judgment, then it is likely that the Company will pay the amount of such insufficiency to protect the Factory against the seizure of its assets.

Accordingly, the Company has accrued for $300 as additional manufacturing costs for the three months ended December 31, 2004.

(3) Delivery and freight expenses

For the quarter and for the nine months ended December 31, 2004, the Company incurred delivery and freight expenses of approximately $893 (unaudited) and $2,656 (unaudited) (2003—$836 and $2,281, unaudited) respectively, which have been included as part of selling and marketing expenses.

(4) Income tax benefit /(expense)

Income is subject to taxation in the various countries in which the Company and its subsidiaries operate. A net gain of $340 was recognized in the quarter ended September 30, 2004 as a result of a settlement with the Inland Revenue Department of Hong Kong for prior years’ tax disputes when Peak was allowed a significant relief on related interest charges.

(5) Inventories

(6) Income Taxes Receivable

As at March 31, 2004, this represents approximately $5,061 of tax reserve certificates purchased from the Inland Revenue Department of Hong Kong (“IRD”) in respect of prior year taxes that were under examination by the IRD. These tax reserve certificates have been utilized in the quarter ended September 30, 2004 to pay for those prior year taxes as a result of a settlement reached with the IRD.

(7) Other Deposit

This represents the security bond placed at a Taiwanese court in order to obtain an anti-injunction order in respect of a potential patent dispute in Taiwan. See Note 13(a) “Litigation”. Management of the Company does not expect the case to be settled within 12 months and therefore the amount was classified as a non-current asset.

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Notes to Condensed Consolidated Financial Statements—(continued)

(in thousands of United States Dollars, except share and per share data, unaudited

(8) Stock Options

Option activity relating to the Company’s stock option plan is summarized as follows (unaudited):

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Notes to Condensed Consolidated Financial Statements—(continued)

(in thousands of United States Dollars, except share and per share data, unaudited)

(9) (Losses) Earnings Per Share

The following is a reconciliation of the numerator and the denominator of the basic (losses) earnings per share:

For the quarter ended and nine months ended December 31, 2004, exercise of all outstanding stock options would have been anti-dilutive and such stock options were therefore not included in the computation of diluted losses per share.

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Notes to Condensed Consolidated Financial Statements—(continued)

(in thousands of United States Dollars, except share and per share data, unaudited)

(10) Comprehensive (Loss) Income

The Company’s comprehensive (loss) income consists of the following:

(11) Employee Stock Purchase and Option Plans

During the quarter ended December 31, 2004, under the 1998 Stock Option Plan the Company issued options to purchase 50,000 shares to directors of the Company at a price of $3.975 per share. Pursuant to the Company’s 2000 Employee Stock Purchase Plan, the Company issued to officers and employees of the Company 9,800 shares at a price of $4.2075 for contributions made during the quarter ended September 30, 2004, and authorized the issuance of 11,622 shares at a price of $3.4383 to officers and employees for contributions made during the quarter ended December 31, 2004.

The Company accounts for stock-based compensation awarded to employees using the intrinsic value method prescribed in Accounting Principles Board Opinions (“APB”) No. 25 “Accounting for Stock Issued to Employees” and related interpretations. No stock-based employee compensation cost is reflected in net (loss) income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant.

9

Notes to Condensed Consolidated Financial Statements—(continued)

(in thousands of United States Dollars, except share and per share data, unaudited)

(11) Employee Stock Purchase and Option Plans (con’t)

If the Company had accounted for its stock option plans and the stock purchase plan by recording compensation based on the fair value at grant date for such awards consistent with the method of Statement of Financial Accounting Standards (“SFAS”) No. 123 “Accounting for Stock-Based Compensation”, the Company’s net (loss) income and (losses) earnings per share would have been increased/decreased as follows:

(12) Share Repurchase

In September 2000, the Board of Directors of the Company authorized the repurchase by the Company of up to $10,000 of its common stock at prices not to exceed 150% of the Company’s net asset value per share. Common stock repurchased will be cancelled immediately. The excess of purchase price over par value is charged to additional paid-in capital.

The Company purchased 656,186 shares from Mr. T. L. Li for $2,400 on May 5, 2003. The shares repurchased from Mr. T. L. Li were immediately retired. The shares were purchased from Mr. T. L. Li at a per share price of $3.66 per share, which represented a 5% discount from the $3.85 closing price of the shares on the NASDAQ National Market on that date. The excess of purchase price over par value was recorded as a reduction to additional paid-in capital.

In addition, the Company repurchased 4,000 shares at an average price of $3.94 in the first quarter of fiscal 2004. There was no repurchase of shares for the quarter ended and nine months ended December 31 2004.

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Notes to Condensed Consolidated Financial Statements—(continued)

(in thousands of United States Dollars, except share and per share data, unaudited)

(13) Commitments and Contingencies

(a) Litigation

R.H. Murphy Co., Inc. (“Murphy”) is the owner of U.S. Reexamined Patent 5,400,904 C1 and certain corresponding foreign patents, which patents are directed to specific features in trays used to carry integrated circuits. Murphy has notified the Company and certain of its customers that it believes these patents are infringed by certain integrated circuit trays that the Company provided to its customers, and indicated that licenses to these patents are available. The Company does not believe that any valid claim of these patents is infringed, and is proceeding consistent with that belief.

On July 8, 2002, the Company placed a security bond of approximately $301 at a Taiwanese district court in connection with a preliminary injunction order so that the Company can continue to sell trays in Taiwan without being interrupted by Murphy and its three distributors in Taiwan. The Taiwanese district court granted the order in June 2002, after which Murphy’s three local distributors filed an appeal with the Taiwanese high court against the grant of the order by the district court. In December 2002, the high court ruled that the anti-injunction order should be revoked. In February 2003, the Company filed an appeal to the Taiwanese Supreme Court which was granted and resulted in the dismissal of Murphy’s local distributors’ appeals. The grant of the preliminary injunction order has now become final and, accordingly, it is unlikely that Murphy or its local distributors will be able to obtain preliminary injunctive relief against the Company or its Taiwan customers during the pendency of the underlying litigation. In addition, in October 2002, the Company filed a civil suit against Murphy with the Taiwanese district court seeking permanent relief in connection with the preliminary injunction order. An additional security bond of approximately $13 was placed with the Taiwanese court in connection with the underlying civil suit, which was later increased by approximately $24. If the Company’s effort to receive permanent relief is not successful, the Company may be required to forfeit the bonds and Murphy and its distributors in Taiwan may assert patent infringement claims against the Company which, if successful, could prevent the Company from selling certain of its products in Taiwan and could result in monetary damages. In December 2001, the Company also filed an action with the Taiwanese Intellectual Property Office to invalidate Murphy’s patent. Murphy subsequently amended its patent and in February 2005 the Company’s invalidation proceeding was dismissed by the Taiwanese Intellectual Property Office. In February 2002, the Company also filed a complaint for unfair competition with the Taiwanese Fair Trade Commission against Murphy. The Fair Trade Commission dismissed the action and the Company has filed an appeal. That appeal was dismissed by the Executive Yuan and the Company has filed an administrative suit contesting the dismissal. At present, the outcome of this potential patent dispute cannot be predicted with reasonable particularity and no impact to the financial statements has been reflected in this respect.

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Notes to Condensed Consolidated Financial Statements—(continued)

(in thousands of United States Dollars, except share and per share data, unaudited)

(b) Contingent Liabilities

With respect to errors in the computation and withholding of social insurance contributions in the Factory as described in note (2), management has been advised by the Company’s legal counsel that the Chinese tax authorities generally do not impose penalties in certain situations where the taxpayer voluntarily corrects past errors without formal demand from the tax authorities. However, the government has discretion to impose on the Factory and /or individuals responsible for such errors an interest penalty computed at an annual rate of approximately 72 percent on unpaid social insurance contributions. While the Company anticipates that minimal penalty interest will be imposed on the Factory, the maximum amount of penalty interest authorized by law is approximately $384. As with the underlying social insurance contributions, while the Company believes it is not contractually obligated under the terms of its agreement with its processing partner to pay these amounts and no claim has been made by any government agency, in the event penalty interest are imposed on the Factory, it is likely that the Company would pay such penalties in order to avoid the seizure of the Factory’s assets in order to keep it operational.

(c) Commitments

At December 31, 2004, the Company had commitments for capital expenditures of approximately $52.

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Notes to Condensed Consolidated Financial Statements—(continued)

(in thousands of United States Dollars, except share and per share data, unaudited)

(14) Segment Information

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Notes to Condensed Consolidated Financial Statements—(continued)

(in thousands of United States Dollars, except share and per share data, unaudited)

(15) Asset to be disposed of by sale/asset impairment charge

A subsidiary of the Company owns an industrial building under construction in the PRC. In view of its production needs and the market conditions, the completion of the building under construction was delayed. During the fourth quarter of the year ended March 31, 2001, management reassessed the fair value of the building given the downturn in the industrial property market in which the building is located and a provision of $759 was recorded to adjust the carrying value of the building.

During the quarter ended June 30, 2002, the industrial building under construction and the related land use right in the PRC, which has an assigned period for 50 years commencing May 1993, were reclassified as “asset to be disposed of by sale” following management’s decision to dispose of the property as a general purpose industrial building. As a result, the property has been written down to its fair market value less costs to sell pursuant to SFAS No. 144 “Accounting for the Impairment of Disposal of Long-Lived Assets,” resulting in an asset impairment charge of $13,378 during the year ended March 31, 2003. The net book value of the property and the land use right were $4,071 and $1,159 respectively as of December 31, 2004, March 31, 2004 and 2003. The Company entered into a contract for the sale of the subsidiary of the Company that holds title to this building and the associated land use rights in the PRC. Management anticipates that the sale will be completed after this fiscal year end.

(16) Concentration of Major Customers

One of our customers accounted for 11.85% of the Company’s net sales during the nine months ended December 31, 2004. No other customer accounted for more than 10% of the Company’s net sales during the period.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

The following management’s discussion and analysis of financial condition and results of operations is based upon and should be read together with the consolidated financial statements of the Company and notes thereto included in this Report and the Registrant’s Annual Report on Form 10-K for the year ended March 31, 2004.

Forward-Looking Statements

Management’s discussion and analysis of financial condition and results of operations and other sections of this Report contain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. We intend for the forward-looking statements to be covered by the safe harbor provisions for forward-looking statements in these sections. These statements, which include statements regarding the Company’s belief that it is not contractually obligated to pay amounts owed by a factory at which the Company’s products are manufactured and its expectations regarding the assessment of any penalties on such amounts, the Company’s expected financial position, business and financing plans, the Company’s expectations regarding the amount of inventory charges and severance costs related to the exit of the tube business, our beliefs that our existing cash and cash equivalents and anticipated cash flow from operations will be sufficient to meet our anticipated cash needs in the ordinary course of business for at least the next 12 months, statements regarding possible shortages in PVC Resin and price increases in PVC Resin, our beliefs regarding foreign currency fluctuations and the potential impact of currency fluctuations on the Company, our expectation that we will be able to renegotiate the terms and conditions of our processing agreement, our beliefs that our operations in the PRC are now in compliance with the applicable PRC legal and regulatory requirements, statements regarding intellectual property rights of third parties, statements regarding the disposal of assets located in the PRC, statements regarding our critical accounting policies, and statements regarding the validity of lawsuits against the Company are forward-looking statements. Such forward-looking statements are identified by use of forward-looking words such as “anticipates,” “believes,” “plans,” “estimates,” “expects,” and “intends” or words or phrases of similar expression. These forward-looking statements are subject to various assumptions, risks and uncertainties, including but not limited to, changes in political and economic conditions in general and the unrest in the Middle East, the current war on terrorism and the impact of terrorist activities in the United States and abroad, economic conditions in the semiconductor and disk drive industries, any future economic downturn, demand for the Company’s products, acceptance of new products, technology developments affecting the Company’s products, the Company’s ability to raise additional capital if necessary, the price and availability of raw materials, fluctuations in currency markets, the outcome of lawsuits by and against the Company, difficulties related to working in the PRC, including regional government and processing partner relations and contracts, foreign currency exchange laws, taxation and health issues, increased charges for under-absorbed production overhead costs, the Company’s ability to continue to be listed on the Nasdaq Stock Market, and those discussed in the Company’s filings with the Securities and Exchange Commission. Actual results could differ materially from those contemplated by the forward-looking statements as a result of these factors and those set forth under “Factors Which May Affect Operating Results” below. These forward-looking statements speak only as of the date hereof. The Company expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in the Company’s expectations with regard hereto or any change in events, conditions or circumstances on which any such statement is based.

All references to the “Company,” “Peak,” “we,” “us” or “our” herein are references to Peak International Limited, a company incorporated under Bermuda law on January 3, 1997, and, unless the context otherwise requires, its subsidiaries and predecessors. All references to “Peak (HK)” herein are to Peak Plastic & Metal Products (International) Limited, a company incorporated in Hong Kong and a wholly-owned subsidiary of the Company and, unless the context otherwise requires, its subsidiaries and predecessors. References in this Quarterly Report on Form 10-Q (“Quarterly Report”) to our historical business and operations assume that the corporate reorganization in 1997 (the “Restructuring”) by which, among other things, Peak (HK) became a wholly-owned subsidiary of the Company and the Company acquired its other subsidiaries, had already occurred as of the times to which the references relate. Any discrepancies in the tables included in this Quarterly Report between the amounts indicated and the totals thereof are due to rounding. All references to “US Dollars,” “US$” or “$” herein are to United States dollars, references to “HK Dollars” or “HK$” are to Hong Kong dollars.

Results of Operations

Net Sales. Net sales decreased by approximately 1% to $16.8 million in the third quarter of fiscal 2005 from $17.0 million in the same quarter of fiscal 2004. The slight decrease was primarily due to an offset of an increase in sales of our tubes with a decrease in sales of disk drive trays. Net sales of semiconductor trays increased by 1.8% over the same period last year reflecting a 4.5% increase in sales volume, and a 2.6% drop in average realized sales prices. For the third quarter of fiscal 2005, net sales of tapes and reels decreased by 2.5% compared to the third quarter of fiscal 2004, primarily due to a 16.1% increase in sales volume combined with a 16.0% drop in average realized sales prices. Net sales for tubes increased by 18.6% compared to the same period last year, primarily due to a 16.4% increase in sales volume for tubes and an increase of 1.8% in the average realized sales price of tubes. Net sales for disk drive trays decreased by 20.3% compared to the same period last year, driven by a volume increase of

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0.9% and the drop in average realized sales prices by 21.0%. Our disk drive tray sales have generally been to one major customer or to subcontractors supporting that customer. These sales are largely dependent on the introduction of new products by that customer. New product introductions are difficult to forecast both with respect to timing as well as demand. We have been producing new custom molds for that customer in anticipation of several new products, but this activity has not yet led to significant production orders. Mature products, while requiring some replacement trays, do not generally generate a sustainable high level of revenue. As a result, revenue from sales of our disk drive trays has, and will in the future, fluctuate dramatically with the corresponding fluctuations in the introduction of new products.

Net sales increased by approximately 8.6% to $51.4 million for the nine months ended December 31, 2004 from $47.3 million for the nine months ended December 31, 2003. Net sales of semiconductor trays increased by 19.0% comparing the nine months ended December 31, 2004 to the nine months ended December 31 2003, primarily due to an increase in sales volume by 25.3% and a 5.1% drop in average realized sales prices. Net sales of tapes and reels increased by 16.3% comparing the nine months ended December 31, 2004 to the nine months ended December 31, 2003, primarily due to a 36.1% increase in sales volume and a 14.5% drop in average realized sales price. Net sales of tubes increased by 36.4% comparing the nine months ended December 31, 2004 to the nine months ended December 31, 2003, reflecting a 40.5% increase in sales volume and a 2.9% drop in average realized sales price. Net sales of disk drive trays decreased by 49.8% comparing the nine months ended December 31, 2004 to the nine months ended December 31, 2003, primarily due to a 32.7% decrease in sales volume combined with a 25.5% drop in average realized sales price. As discussed above, our disk drive tray sales have generally been to one major customer or to subcontractors supporting that customer and revenue from sales of our disk drive trays has, and will in the future, fluctuate dramatically with the corresponding fluctuations in the introduction of new products.

During the quarter ended December 31, 2004, we announced to our customers our intention to discontinue the production and sale of tubes and exit the tube business. We have given our customers until the end of March to place orders for “last time buys.” We have accelerated depreciation on the dedicated equipment used in the manufacturing of tubes and expect that as a result all such assets will have a zero book value at the time of disposal. We anticipate that existing orders and last time buy orders will consume our current inventories. Thus we currently do not expect to have any inventory charges related to the exit of the tube business. We may incur some small severance costs as we readjust our workforce upon discontinuance of these products. Those severance costs are not expected to be material and will be recognized in the accounting period when severance takes place.

Gross (Loss) Profit. Gross loss was $73,000 in the third quarter of fiscal 2005 whereas gross profit was $5.8 million in the third quarter of fiscal 2004. Gross margin decreased as a percentage of sales to (0.4)% in the third quarter of fiscal 2005 from 33.9% in the same quarter of fiscal 2004. The decrease in gross profit and gross margin as a percentage of sales were mainly attributable to continued high raw material costs which have been impacted by high petroleum prices, an increase in inventory reserves associated with approximately $0.9 million of recycled trays that could not be economically utilized and errors that we discovered in the computation and withholding of both taxes and social insurance contributions for workers at our main production facilities, which are located in Shenzhen, the PRC and operated pursuant to a processing agreement with an unaffiliated PRC company that obligates it to provide all of the personnel for the operation of our facilities and to render assistance in dealing with matters relating to the import of raw materials and the export of our products (the “Factory”). The error was discovered as a result of a claim by an employee regarding the computation of wages and withholding. Upon discovery of these errors, we conducted an internal review of the Factory’s practices and engaged third party advisors to assist us in assessing the Factory’s and our obligations with respect to these errors. Based on this review, management has concluded that the Factory has a duty to correct certain of these errors that amounted to a total of $1.3 million. While we believe we are not contractually obligated under the terms of our agreement with our processing partner to pay these amounts and while no claim has been made by any government agency, in the event the Factory was required to pay all or any portion of these liabilities, it is likely that we would make such payment in order to avoid the seizure of the Factory’s assets in order to keep it operational. Therefore, we have accrued $1.3 million as additional manufacturing costs for the three months ended December 31, 2004. With respect to these errors, management has been advised that the Chinese tax authorities generally do not impose penalties in certain situations where the taxpayer voluntarily corrects past errors without formal demand from the tax authorities. However, the government has discretion to impose on the Factory and/or individuals responsible for such errors an interest penalty computed at an annual rate of approximately 72 percent on unpaid social insurance contributions. While we anticipate that minimal penalty interest will be imposed on the Factory, the maximum amount of penalty interest authorized by law is approximately $384,000 and is considered a contingent liability. Therefore, penalty interest has not been accrued in the three months ended December 31, 2004. As with the underlying social insurance contributions, while we believe we are not contractually obligated under the terms of our agreement with our processing partner to pay these amounts and no claim has been made by any government agency, in the event penalty interest is imposed on the Factory, it is likely that we would pay such penalties in order to avoid the seizure of the Factory’s assets in order to keep it operational. An additional $0.3 million recorded as manufacturing costs also contributed to the decrease in gross margin for the three months ended December 31, 2004. In August 2004, approximately 86 employees at the Factory filed various employment related lawsuits against the Factory. These lawsuits allege breach of employment contracts due to violations of various labor laws by the Factory including, among others, the minimum wage laws, failure to properly compute and pay overtime wages, failure to pay social insurance payments, and other matters. The total amount sought by these claimants is approximately $0.3 million. The Factory has offered to settle all these lawsuits for the amount of the under payments and costs incurred in a total amount of approximately $30,000. While we believe we are not contractually obligated under the terms of our agreement with our processing partner to pay these amounts, in the event a judgment for damages shall be entered against the Factory and the Factory shall have insufficient assets to satisfy the judgment, then it is likely that we will pay the amount of such insufficiency to protect the Factory against the seizure of its assets.

Gross profit decreased to $8.0 million for the nine months ended December 31, 2004 from $14.1 million for nine months ended December 31, 2003. Gross margin as a percentage of sales dropped to 15.7% for the nine months ended December 31, 2004 from 29.8% for the nine months ended December 31, 2003. As described above, an accrual of $1.3 million has been

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made in the nine months ended December 31, 2004 in respect of certain errors in computation and withholding of both taxes and social insurance contributions for workers at the Factory. Potential penalty interest of up to $384,000 is considered contingent based on advice given to our management and is therefore not accrued for in the nine month period ended December 31, 2004. An additional $0.3 million recorded as manufacturing cost also contributed to the decrease in gross margin for the nine months ended December 31, 2004. As described above, such amounts were recorded as a result of certain claims from employees in the Factory. In addition, our gross profit and gross margin were impacted by higher raw material costs during the nine months ended December 31, 2004. Plastic resins, the basic raw material for most of our products have risen dramatically in price, as petroleum prices have increased. We have been unable to raise customers’ prices to offset this substantial increase in costs. Finally, during the nine months ended December 31, 2004, we accrued inventory reserves of approximately $1.3 million for certain slow moving or non usable inventories.

(Loss) Income from Operations. An operating loss of $4.8 million was recorded in the third quarter of fiscal 2005 compared to an operating profit of $1.0 million in the third quarter of fiscal 2004. An operating loss margin changed to 28.7% in the third quarter of fiscal 2005 from an operating profit margin of 6.0% in the third quarter of fiscal 2004. The increase in operating loss was due primarily to the decrease in gross margin.

An operating loss increased to $6.4 million for the nine months ended December 31, 2004 from an operating profit of $0.4 million for the nine months ended December 31, 2003. The increase in operating loss was primarily due to the decrease in gross margin.

Selling and Marketing. Selling and marketing expenses remained steady at approximately $3.0 million in both third quarters of fiscal 2005 and 2004.

Selling and marketing expenses increased by 6.8% to $9.2 million for the nine months ended December 31, 2004 from $8.6 million for the nine months ended December 2003, primarily due to an increase of $0.4 million in freight charges and delivery expenses resulting from increased sales volume.

General and Administrative. General and administrative expenses remained steady at approximately $1.6 to $1.7 million in both third quarters of fiscal 2005 and 2004.

General and administrative expenses increased by 4% to $5.1 million for the nine months ended December 31, 2004 from $4.9 million for the nine months ended December 31, 2003 primarily due to a refund in the amount of $81,000 from our employer funded pension plan in the first quarter of fiscal 2004. The refund was a result of the return of our contributions to the pension plan for employees who subsequently left us in fiscal 2004.

Other Income (Expense)—net. Other Income (Expenses) —net primarily represented differences in realized and unrealized exchange (losses) gains that we recorded arising from transactions in foreign currencies. During the third quarter of fiscal 2005, a net exchange gain of $212,000 was recorded compared to a net exchange loss of $39,000 that was recorded in the third quarter of fiscal 2004. The gain in the third quarter of fiscal 2005 was primarily due to favorable movements of New Taiwan Dollars and Singapore Dollars against the US Dollar during that period.

For the nine months ended December 31, 2004, a net exchange gain of $48,000 was recorded compared to a net exchange loss of $35,000 for the nine months ended December 31, 2003. The gain in the nine months ended December 31, 2004 was primarily due to favorable movements of New Taiwan Dollars and Singapore Dollars against the US Dollar during that period.

Interest Income. Interest income increased by 74.4% to $68,000 for the third quarter of fiscal 2005 from $39,000 for the third quarter of fiscal 2004 primarily due to higher bank deposit interest rates and increased average cash balances in the third quarter of fiscal 2005.

Interest income increased by 14.2% to $145,000 for the nine months ended December 31, 2004 from $127,000 for the nine months ended December 31, 2003, primarily due to the increase in bank deposit interest rates and average cash balances during that period.

Income Tax (Expense) Benefit. An income tax benefit of $378,000 was recorded for the third quarter of fiscal 2005, compared to a $120,000 expense recorded in the third quarter of fiscal year 2004.

A $817,000 tax benefit was recorded for the nine months ended December 2004, compared with a tax expense of $305,000 recorded for the same period last year, primarily due to a net gain of $340,000 that was recognized during the quarter ended December 31, 2004, as a result of a settlement of a tax dispute with the Inland Revenue Department of Hong Kong regarding computation of our prior years’ taxes.

Net (Loss) Income. We had a net loss of approximately $4.2 million for the third quarter of fiscal 2005, compared to a net income of $0.9 million for the same quarter of fiscal 2004, reflecting the effects of the previously discussed factors.

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We had a net loss of $5.3 million for the nine months ended December, 2004, compared to a net income of $ 0.2 million for the nine months ended December 31, 2003, as a result of the forgoing factors.

(Losses) Earnings Per Share. Diluted losses per share for the third quarter of fiscal 2005 was $0.34, compared to a diluted earnings per share of $0.07 for the same period last year, reflecting the effects of the foregoing factors.

Diluted losses per share for the nine months ended December 31, 2004 was $0.43, compared to a diluted earnings per share of $0.02 for the same period last year, reflecting the effects of the foregoing factors.

Liquidity and Capital Resources

Our net cash provided by operating activities was $7.2 million for the nine months ended December 31, 2004, compared to $3.9 million for the nine months ended December 31, 2003. This increase in net cash provided by operating activities was primarily due to improved collections . During the nine months ended December 31, 2004, the tax dispute with the Inland Revenue Department of Hong Kong (“HK IRD”) was settled, with tax reserve certificates and deposits in the amount of $300,000 previously paid to the HK IRD utilized on final settlement.

Net cash used in investing activities was $3.7 million for the nine months ended December 31, 2004, compared to $4.5 million for the nine months ended December 31, 2003. For both the nine months ended December 31, 2004 and December 31, 2003 $4.5 million was paid for the acquisition of property, plant and equipment.

Net cash provided by financing activities was $0.4 million for the nine months ended December 31, 2004, compared to net cash used in financing activities of $1.5 million for the nine months ended December 31, 2003. The decrease in net cash used in financing activities was primarily due to the fact that we did not repurchase any shares of our common stock during the nine months ended December 31, 2004 as compared to the nine months ended December 31, 2003, during which we repurchased $2.4 million of our common stock.

As of December 2004, we had commitments for capital expenditures of $52,000 for the purchase of plant machinery and computer software and had no outstanding bank borrowings. Our cash and cash equivalents balance at December 31, 2004 was $24.1 million. We believe that our existing cash and cash equivalents and anticipated cash flow from operations will be sufficient to meet our anticipated cash needs in the ordinary course of business for at least the next 12 months. If our existing cash and cash equivalents and cash generated from operations is insufficient to satisfy our liquidity requirements, we may seek to sell additional public or private equity securities or obtain debt financing. There can be no assurance that additional funding will be available at all, or if available, will be obtained on terms favorable to us. Additional financing may also be dilutive to our existing shareholders.

Critical Accounting Policies

In preparing our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, we must make a variety of estimates that affect the reported amounts and related disclosures. The following accounting policies are currently considered most critical to the preparation of our financial statements. If actual results differ significantly from management’s estimates and projections, there could be a material effect on our financial statements.

Revenue Recognition. Our revenue is recognized when the product has been shipped and title to the product has transferred to the customer. Title to the product may transfer to the end customer or distributor when shipped or when received by the customer based on a specific agreement. We evaluate the provision for estimated returns monthly, based on historical sales and returns. To date we have not experienced significant returns. Any increase in the level of returns could have a material and adverse effect on our financial statements.

Allowance for Doubtful Accounts. Allowance for doubtful accounts is made against accounts receivable to the extent they are considered to be doubtful. Accounts receivable in the balance sheet are stated net of such provision. We evaluate the collectability of our accounts receivable based on a combination of factors. In circumstances where we are aware of a specific customer’s inability to meet its financial obligation to us, we record a specific reserve for bad debts against amounts due. A provision is also made based on the aging of the receivables. If circumstances change, such as the incurrence of higher than expected defaults or an unexpected material adverse change occurs regarding a major customer’s ability to meet its financial obligations to us, our estimates of the recoverability of amounts due to us could be reduced by a material amount.

Inventory Valuation. We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. At each balance sheet date, inventory on hand in excess of one year’s demand or usage or those that were produced more than twelve months ago, are written down to zero. If actual future demand or market conditions are less favorable than those projected by management, additional write-downs may be required.

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Valuation of Long-lived Assets. We assess the carrying value of long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important which could trigger an impairment review include the following:

Upon the existence of one or more of the above indicators of impairment, we test such assets for a potential impairment. The carrying value of a long-lived asset is considered impaired when the estimated future cash flows, undiscounted, are less than the asset’s carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair market value of the long-lived asset. Fair market value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved.

Asset to be Disposed of By Sale. Asset to be disposed of by sale represents the factory under construction in Shenzhen, the PRC, together with the land use right on which the building is built and is stated at fair value less cost to sell as of the balance sheet date in accordance with SFAS No. 144 “Accounting for the Impairment of Disposal of Long-Lived Assets.” Fair value was calculated on the basis of a professional valuation report on the property provided by an independent appraiser.

Deferred Taxes. As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes and tax bases of assets and liabilities in each of the jurisdictions in which we operate. This process involves us estimating our current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income, and, to the extent we believe that recovery is more unlikely than likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include an expense within the tax provision in the statement of operations. Any change in the future recoverability of the deferred tax assets could significantly affect the results of our operations or cash flows.

Property, plant and equipment, net Property, plant and equipment is stated at cost less accumulated depreciation. Gains or losses on disposals are reflected in current operations. Major expenditures for betterments and renewals are capitalized. All ordinary repairs and maintenance costs are expenses as incurred. Depreciation is provided using the straight-line method over the estimated useful lives.

The useful lives of property, plant and equipment adopted for depreciation purposes are as follows:

Factors Which May Affect Operating Results

The risks and uncertainties described below are not the only ones we face. If an adverse outcome of any of the following risks actually occurs, our business, financial condition or results of operations could be materially and adversely affected. In evaluating our business, shareholders should consider carefully the following factors in addition to the other information presented herein.

Our operating results are difficult to predict and are likely to fluctuate significantly based on several factors, which can cause our stock price to decline.

Our operating results are affected by a wide variety of factors that could materially affect net sales and profitability or lead to significant fluctuations in our quarterly or annual operating results. These factors include, among others:

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