SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal quarter ended March 31, 2006
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________________ to __________________
Commission File Number 333-42036
SOYO GROUP, INC.
--------------------------------------------------------------------------------
(Exact Name of Registrant as specified in its Charter)
Nevada 95-4502724
---------------------------------------- ------------------------------------
(State or other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification Number)
1420 South Vintage Avenue, Ontario, California 91761-3646
--------------------------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
(909) 292-2500
--------------------------------------------------------------------------------
(Issuer's Telephone Number, Including Area Code)
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act: None
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Exchange Act 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 Act). Yes [ ] No [X]
1
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). [ ] Yes [X] No
Indicate the number of shares outstanding of each of the Registrant's
classes of Common Stock as of the latest practicable date.
As of May 15, 2006, there were 48,720,511 shares Outstanding.
Documents Incorporated by Reference: None
2
SOYO GROUP, INC. AND SUBSIDIARY
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets - March 31, 2006
(Unaudited) and December 31, 2005 4
Condensed Consolidated Statements of Operations (Unaudited) -
Three Months Ended March 31, 2006 and 2005 6
Condensed Consolidated Statements of Cash Flows (Unaudited) -
Three Months Ended March 31, 2006 and 2005 8
Notes to Condensed Consolidated Financial Statements
(Unaudited) - Three Months Ended March 31, 2006 and 2005 10
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 15
Item 3. Quantitative and Qualitative Disclosures about Market Risk 23
Item 4. Controls and Procedures 24
PART II. OTHER INFORMATION
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases
of Equity Securities 26
Item 3. Defaults upon Senior Securities 26
Item 4. Submission of Matters to a vote of security holders 26
Item 5. Other information 27
Item 6. Exhibits and Reports on Form 8-K 27
SIGNATURES 28
3
SOYO Group, Inc. and Subsidiary
Condensed Consolidated Balance Sheets
SOYO Group, Inc. and Subsidiary
Consolidated Balance Sheets
March 31, December 31,
------------------------------------------------- ---------------- ----------------
2006 (unaudited) 2005
------------------------------------------------- ---------------- ----------------
ASSETS
------------------------------------------------- ---------------- ----------------
CURRENT
------------------------------------------------- ---------------- ----------------
Cash and cash equivalents $ 54,411 $ 828,294
------------------------------------------------- ---------------- ----------------
Accounts receivable, net of allowance for doubtful 6,821,483 7,278,520
accounts of $639,224 at March 31, 2006 and
December 31, 2005 respectively
------------------------------------------------- ---------------- ----------------
Inventories 11,255,016 7,991,030
------------------------------------------------- ---------------- ----------------
Prepaid Expenses 2,105 20,984
------------------------------------------------- ---------------- ----------------
Income tax refund receivable 0 0
------------------------------------------------- ---------------- ----------------
------------------------------------------------- ---------------- ----------------
Total Current Assets 18,133,015 16,118,828
------------------------------------------------- ---------------- ----------------
------------------------------------------------- ---------------- ----------------
Property and Equipment 917,304 867,122
------------------------------------------------- ---------------- ----------------
Less: accumulated depreciation and amortization (141,296) (115,480)
------------------------------------------------- ---------------- ----------------
776,008 751,642
------------------------------------------------- ---------------- ----------------
------------------------------------------------- ---------------- ----------------
Deposits 42,445 36,920
------------------------------------------------- ---------------- ----------------
------------------------------------------------- ---------------- ----------------
Total Assets 18,951,468 16,907,390
------------------------------------------------- ---------------- ----------------
(continued)
4
SOYO Group, Inc. and Subsidiary
Condensed Consolidated Balance Sheets
SOYO Group, Inc. and Subsidiary
Consolidated Balance Sheets (continued)
March 31, December 31,
------------------------------------------------- ---------------- ----------------
2006 2005
------------------------------------------------- ---------------- ----------------
LIABILITIES
------------------------------------------------- ---------------- ----------------
CURRENT
------------------------------------------------- ---------------- ----------------
Accounts payable 16,930,908 13,977,579
------------------------------------------------- ---------------- ----------------
Total Accounts Payable 16,930,908 13,977,579
------------------------------------------------- ---------------- ----------------
------------------------------------------------- ---------------- ----------------
Accrued liabilities 347,509 1,287,108
------------------------------------------------- ---------------- ----------------
Advances from officers, directors and major 0 0
shareholder
------------------------------------------------- ---------------- ----------------
Business Loan 0 0
------------------------------------------------- ---------------- ----------------
Short Term Loan 100,000 165,000
------------------------------------------------- ---------------- ----------------
------------------------------------------------- ---------------- ----------------
Current Liabilities 17,378,417 15,429,687
------------------------------------------------- ---------------- ----------------
------------------------------------------------- ---------------- ----------------
Total Liabilities 17,378,417 15,429,687
------------------------------------------------- ---------------- ----------------
------------------------------------------------- ---------------- ----------------
EQUITY
------------------------------------------------- ---------------- ----------------
Class A Preferred stock, $0.001 par value 0 0
------------------------------------------------- ---------------- ----------------
Class B Preferred stock, $0.001 par value 1,752,342 1,702,486
------------------------------------------------- ---------------- ----------------
Preferred Stock Backup Withholding (99,956) (84,999)
------------------------------------------------- ---------------- ----------------
Common stock, $0.001 par value Authorized - 48,721 48,682
75,000,000 shares
------------------------------------------------- ---------------- ----------------
Additional paid-in capital 17,610,140 17,225,738
------------------------------------------------- ---------------- ----------------
------------------------------------------------- ---------------- ----------------
Accumulated deficit (17,738,196) (17,414,204)
------------------------------------------------- ---------------- ----------------
Total Shareholder's Equity (Deficiency) 1,573,051 1,477,703
------------------------------------------------- ---------------- ----------------
Total Liabilities plus Shareholders' Equity $ 18,951,468 $ 16,907,390
------------------------------------------------- ---------------- ----------------
See accompanying notes to condensed consolidated financial statements.
5
SOYO Group, Inc. and Subsidiary
Condensed Consolidated Statements of Operations (unaudited)
Three months ended March 31,
----------------------------
----------------------------------------- ------------ ------------
2006 2005
----------------------------------------- ------------ ------------
Net revenues $ 11,548,187 $ 3,962,520
----------------------------------------- ------------ ------------
Cost of revenues 9,897,099 3,440,485
----------------------------------------- ------------ ------------
Prior Years Purchase Discounts 0 1,089,172
----------------------------------------- ------------ ------------
Gross margin 1,651,088 1,611,207
----------------------------------------- ------------ ------------
Costs and expenses:
----------------------------------------- ------------ ------------
Sales and marketing 74,886 239,465
----------------------------------------- ------------ ------------
General and administrative 1,484,994 933,973
----------------------------------------- ------------ ------------
Provision for doubtful accounts 50,000 31,124
----------------------------------------- ------------ ------------
Depreciation and amortization:
----------------------------------------- ------------ ------------
Property and equipment 25,815 8,749
----------------------------------------- ------------ ------------
Total costs and expenses 1,635,695 1,213,311
----------------------------------------- ------------ ------------
Income (Loss) from operations 15,393 397,896
----------------------------------------- ------------ ------------
Other income (expense):
----------------------------------------- ------------ ------------
Interest income 3,247 0
----------------------------------------- ------------ ------------
Interest expense (72,387) (11,221)
----------------------------------------- ------------ ------------
Other income (expense) 4,531 0
----------------------------------------- ------------ ------------
Other income (expense), net (64,609) (11,221)
----------------------------------------- ------------ ------------
Income (Loss) before cumulative effect of (49,216) 386,675
change in accounting principle
----------------------------------------- ------------ ------------
Cumulative Effect on Prior Years of (224,919) 0
Changing to Fair Value
Method of Accounting for Stock Based
Compensation
----------------------------------------- ------------ ------------
Net Income (loss) (274,135) 386,675
----------------------------------------- ------------ ------------
----------------------------------------- ------------ ------------
Less: Dividends on Convertible Preferred 49,856 39,213
Stock
----------------------------------------- ------------ ------------
Net income (loss) attributable to common (323,991) $ 347,462
shareholders
----------------------------------------- ------------ ------------
Net loss per common share - Basic and (.01) .01
diluted (.01) .01
----------------------------------------- ------------ ------------
Weighted average number of shares of 48,540,681 40,530,000
common stock outstanding - Basic and 53,296,071 44,748,149
diluted
----------------------------------------- ------------ ------------
(continued)
6
SOYO Group, Inc. and Subsidiary
Condensed Consolidated Statements of Operations (unaudited) (continued)
----------------------------------------- ------------ ------------
Earnings per common share
----------------------------------------- ------------ ------------
Income (loss) before cumulative effect of .00 .01
a change in accounting principle and
preferred stock dividends
----------------------------------------- ------------ ------------
Cumulative effect on prior years of (.01) 0
changing to fair value method of
accounting for stock-based compensation
----------------------------------------- ------------ ------------
Preferred stock dividends .00 .00
----------------------------------------- ------------ ------------
Net income (loss) (.01) .01
----------------------------------------- ------------ ------------
Earnings per common share assuming
dilution-
----------------------------------------- ------------ ------------
Income (loss) before cumulative effect of .00 .01
a change in accounting principle and
preferred stock dividends
----------------------------------------- ------------ ------------
Cumulative effect on prior years of (.01) 0
changing to fair value method of
accounting for stock-based compensation
----------------------------------------- ------------ ------------
Preferred stock dividends .00 .00
----------------------------------------- ------------ ------------
Net income (loss) (.01) .01
----------------------------------------- ------------ ------------
See accompanying notes to condensed consolidated financial statements.
7
SOYO Group, Inc. and Subsidiary
Condensed Consolidated Statements of Cash Flows (Unaudited)
Three Months Ended March 31,
----------------------------------------------- ------------ ------------
2006 2005
----------------------------------------------- ------------ ------------
OPERATING ACTIVITIES
----------------------------------------------- ------------ ------------
Net income $ (274,135) $ 386,675
----------------------------------------------- ------------ ------------
Adjustments to reconcile net
income to net cash used in
operating activities:
----------------------------------------------- ------------ ------------
Depreciation and Amortization 25,815 8,749
----------------------------------------------- ------------ ------------
Non cash payments for Director's Compensation 24,570 --
----------------------------------------------- ------------ ------------
Stock based Compensation 359,871 --
----------------------------------------------- ------------ ------------
Provision for doubtful Accounts 50,000 31,124
----------------------------------------------- ------------ ------------
Changes in operating assets and
liabilities:
----------------------------------------------- ------------ ------------
(Increase) decrease in:
----------------------------------------------- ------------ ------------
Accounts receivable 407,037 (593,089)
----------------------------------------------- ------------ ------------
Inventories (3,263,986) 1,043,196
----------------------------------------------- ------------ ------------
Prepaid expenses 18,879 (3,503)
----------------------------------------------- ------------ ------------
Deposits (5,525) 15,840
----------------------------------------------- ------------ ------------
Increase (decrease) in:
----------------------------------------------- ------------ ------------
Accounts payable - 2,953,329 (1,906,334)
----------------------------------------------- ------------ ------------
Accrued liabilities (939,599) (254,332)
----------------------------------------------- ------------ ------------
Net cash used in operating activities (643,744) (1,271,674)
----------------------------------------------- ------------ ------------
----------------------------------------------- ------------ ------------
INVESTING ACTIVITIES
----------------------------------------------- ------------ ------------
Purchase of property and equipment (50,182) --
----------------------------------------------- ------------ ------------
Proceeds from sale of equipment -- 56,662
----------------------------------------------- ------------ ------------
----------------------------------------------- ------------ ------------
Net cash used in investing activities (50,182) 56,662
----------------------------------------------- ------------ ------------
(continued)
8
SOYO Group, Inc. and Subsidiary
Condensed Consolidated Statements of Cash Flows (Unaudited) (continued)
----------------------------------------------- ------------ ------------
FINANCING ACTIVITIES
----------------------------------------------- ------------ ------------
Advances from officer, director and (65,000) (60,000)
major shareholder
----------------------------------------------- ------------ ------------
Proceeds from issuance of -- 500,000
Common Stock
----------------------------------------------- ------------ ------------
Payment of backup withholding tax on (14,957) --
accreted dividends on preferred stock
----------------------------------------------- ------------ ------------
Net cash provided by financing activities (79,957) 440,000
----------------------------------------------- ------------ ------------
----------------------------------------------- ------------ ------------
CASH AND CASH EQUIVALENTS
----------------------------------------------- ------------ ------------
Net decrease (773,883) (775,012)
----------------------------------------------- ------------ ------------
At beginning of period 828,294 1,288,351
----------------------------------------------- ------------ ------------
At end of period 54,411 $ 513,339
----------------------------------------------- ------------ ------------
----------------------------------------------- ------------ ------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
----------------------------------------------- ------------ ------------
----------------------------------------------- ------------ ------------
Cash paid for Interest 72,387 0
----------------------------------------------- ------------ ------------
----------------------------------------------- ------------ ------------
NON-CASH INVESTING AND FINANCING ACTIVITIES
----------------------------------------------- ------------ ------------
----------------------------------------------- ------------ ------------
Accretion of discount on preferred stock 49,856 39,213
----------------------------------------------- ------------ ------------
----------------------------------------------- ------------ ------------
Directors' compensation 24,570 --
----------------------------------------------- ------------ ------------
----------------------------------------------- ------------ ------------
Stock option compensation 359,871 --
----------------------------------------------- ------------ ------------
----------------------------------------------- ------------ ------------
See accompanying notes to condensed consolidated financial statements.
9
SOYO Group, Inc. and Subsidiary
Notes to Condensed Consolidated Financial Statements (Unaudited)
Three Months Ended March 31, 2006 and 2005
1. Organization and Basis of Presentation
Organization - Effective October 24, 2002, Vermont Witch Hazel Company, Inc., a
Nevada corporation ("VWHC"), acquired SOYO, Inc., a Nevada corporation ("SOYO
Nevada"), from SOYO Computer, Inc., a Taiwan corporation ("SOYO Taiwan), in
exchange for the issuance of 1,000,000 shares of convertible preferred stock and
28,182,750 shares of common stock, and changed its name to SOYO Group, Inc.
("SOYO"). The 1,000,000 shares of preferred stock were issued to SOYO Taiwan and
the 28,182,750 shares of common stock were issued to certain members of SOYO
Nevada management.
Subsequent to this transaction, SOYO Taiwan maintained an equity interest in
SOYO, continued to be the primary supplier of inventory to SOYO, and was a major
creditor. In addition, there was no change in the management of SOYO and no new
capital invested, and there was a continuing family relationship between certain
members of the management of SOYO and SOYO Taiwan. As a result, this transaction
was accounted for as a recapitalization of SOYO Nevada, pursuant to which the
accounting basis of SOYO Nevada continued unchanged subsequent to the
transaction date. Accordingly, the pre-transaction financial statements of SOYO
Nevada are now the historical financial statements of the Company.
In conjunction with this transaction, SOYO Nevada transferred $12,000,000 of
accounts payable to SOYO Taiwan to long-term payable, without interest, due
December 31, 2005. During the three months ended March 31, 2004, the Company
agreed with a third party to convert the long-term payable into convertible
preferred stock.
On December 9, 2002, SOYO's Board of Directors elected to change SOYO's fiscal
year end from July 31 to December 31 to conform to SOYO Nevada's fiscal year
end.
On October 24, 2002, the primary members of SOYO Nevada management were Ming
Tung Chok, the Company's President, Chief Executive Officer and Director, and
Nancy Chu, the Company's Chief Financial Officer. Ming Tung Chok and Nancy Chu
are husband and wife. Andy Chu, the President and major shareholder of SOYO
Taiwan, is the brother of Nancy Chu.
Unless the context indicates otherwise, SOYO and its wholly-owned subsidiary,
SOYO Nevada, are referred to herein as the "Company".
Basis of Presentation - The accompanying condensed consolidated financial
statements include the accounts of SOYO and SOYO Nevada. All significant
intercompany accounts and transactions have been eliminated in consolidation.
The condensed consolidated financial statements have been prepared in accordance
with United States generally accepted accounting principles.
Interim Financial Statements - The accompanying interim condensed consolidated
financial statements are unaudited, but in the opinion of management of the
Company, contain all adjustments, which include normal recurring adjustments,
necessary to present fairly the financial position at March 31, 2006, the
results of operations for the three months ended March 31, 2006 and 2005, and
cash flows for the three months ended March 31, 2006 and 2005. The condensed
consolidated balance sheet as of December 31, 2005 is derived from the Company's
audited consolidated financial statements.
10
Certain information and footnote disclosures normally included in financial
statements that have been prepared in accordance with accounting principles
generally accepted in the United States have been condensed or omitted pursuant
to the rules and regulations of the Securities and Exchange Commission, although
management of the Company believes that the disclosures contained in these
condensed consolidated financial statements are adequate to make the information
presented therein not misleading. For further information, refer to the
consolidated financial statements and the notes thereto included in the
Company's Annual Report on Form 10-K for the fiscal year ended December 31,
2005, as filed with the Securities and Exchange Commission.
The preparation of financial statements in conformity with United States general
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
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. Significant estimates primarily relate to the realizable value
of accounts receivable, vendor programs and inventories. Actual results could
differ from those estimates.
The results of operations for the three months ended March 31, 2006 is not
necessarily indicative of the results of operations to be expected for the full
fiscal year ending December 31, 2006.
Business - The Company sells products under three different product lines: 1)
Computer Components and Peripherals 2) Consumer Electronics and 3)
Communications Equipment and Services. The products are sold to distributors and
retailers primarily in North, Central and South America.
Earnings Per Share - Statement of Financial Accounting Standards No. 128,
"Earnings Per Share", requires presentation of basic earnings per share ("Basic
EPS") and diluted earnings per share ("Diluted EPS"). Basic income per share is
computed by dividing net income available to common shareholders by the weighted
average number of common shares outstanding during the period. Diluted income
per share gives effect to all dilutive potential common shares outstanding
during the period. Potentially dilutive securities consist of the outstanding
shares of preferred stock.
As of March 31, 2006, potentially dilutive securities consisted of 2,948,342
shares of Class B Convertible Preferred Stock with a stated liquidation value of
$1.00 per share that are convertible into common stock at fair market value, but
not less than $0.25 per share.
As of March 31, 2006, 4,755,390 shares of common stock were issuable upon
conversion of the Class B Convertible Preferred Stock based on the $0.62 per
share conversion price.
As of March 31, 2005, potentially dilutive securities consisted of 1,000,000
shares of Class A Convertible Preferred Stock with a stated liquidation value of
$1.00 per share that are convertible into common stock at fair market value, and
2,653,408 shares of Class B Convertible Preferred Stock with a stated
liquidation value of $1.00 per share that are convertible into common stock at
fair market value, but not less than $0.25 per share.
As of March 31, 2005, 4,248,149 shares of common stock were issuable upon
conversion of the Class A Convertible Preferred Stock and the Class B
Convertible Preferred Stock, consisting of 1,162,791 shares of common stock
issuable upon conversion of the Class A Convertible Preferred Stock, based on
the closing price of $0.86 per common share at March 31, 2005, and 3,085,358
11
shares of common stock issuable upon conversion of the Class B Convertible
Preferred Stock, based on the $0.86 per share conversion price.
Comprehensive Income (Loss) - The Company displays comprehensive income or loss,
its components and accumulated balances in its consolidated financial
statements. Comprehensive income or loss includes all changes in equity except
those resulting from investments by owners and distributions to owners. The
Company did not have any items of comprehensive income (loss) during the three
months ended March 31, 2006 and 2005.
Significant Risks and Uncertainties - The Company operates in a highly
competitive industry subject to aggressive pricing practices, pressures on gross
margins, frequent introductions of new products, rapid technological advances,
continual improvement in product price/performance characteristics, and changing
consumer demand.
As a result of the dynamic nature of the business, it is possible that the
Company's estimates with respect to the realizability of inventories and
accounts receivable may be materially different from actual amounts. These
differences could result in higher than expected allowance for bad debts or
inventory reserve costs, which could have a materially adverse effect on the
Company's financial position and results of operations.
Stock-Based Compensation - Prior to January 1, 2006, the Company accounted for
employee stock-based compensation using the intrinsic value method supplemented
by pro forma disclosures in accordance with APB 25 and SFAS 123 "Accounting for
Stock-Based Compensation" ("SFAS 123"), as amended by SFAS No.148 "Accounting
for Stock-Based Compensation--Transition and Disclosures." Under the intrinsic
value method, compensation cost is measured as the excess of, if any, of the
market price of the Company's common stock at the date of grant, or at any
subsequent measurement date, over the amount an employee must pay to acquire the
stock. Such amounts are amortized as compensation expense over the vesting
period of the related stock options. Under the intrinsic value method, the
Company was not required to recognize stock-based compensation.
Effective January 1, 2006 the Company adopted SFAS 123R using the modified
prospective approach and accordingly prior periods have not been restated to
reflect the impact of SFAS 123R. Under SFAS 123R, stock-based awards granted
prior to its adoption will be expensed over the remaining portion of their
vesting period. These awards will be expensed under the accelerated amortization
method using the same fair value measurements which were used in calculating pro
forma stock-based compensation expense under SFAS 123. For stock-based awards
granted on or after January 1, 2006, the Company will amortize stock-based
compensation expense on a straight-line basis over the requisite service period,
which is generally a three-four year vesting period.
On March 7, 2005, the Company registered its 2005 Stock Compensation Plan on
Form S-8 with the Securities and Exchange Commission, registering on behalf of
our employees, officers, directors and advisors up to 5,000,000 shares of our
common stock purchasable by them pursuant to common stock options granted under
our 2005 Stock Compensation Plan. The plan was approved by shareholder vote
during a special meeting of shareholders on February 17, 2006.
On July 22, 2005, the Company issued 2,889,000 option grants to employees at a
strike price of $.75. One third of those options will vest and be available for
purchase on July 22, 2006, one third on July 22, 2007, and one third on July 22,
2008. As a result, the fair value of the options will be expensed between now
and July 22, 2008. The grants will expire if unused on July 22, 2010.
The Company has calculated the fair value of each option granted to employees as
sixty three cents (.63) based on the Black Scholes option pricing model.
As of March 31, 2006, employees have left the Company and forfeited 330,000
options. Therefore, the charge against earnings was calculated on the remaining
2,559,000 options.
12
For the three months ended March 31, 2006, the Company recorded stock-based
compensation expense of $134,952 which reduced income from operations and net
income. The cumulative effect of the change from intrinsic value to fair value
method of accounting for stock-based compensation in the amount of $224,919 was
also recognized and reduced net income. The impact on basic and diluted net
income per share for the three months ended March 31, 2006 was $(0.01). SFAS
123R requires forfeitures to be estimated at the time of grant and revised, if
necessary, in subsequent periods if actual forfeitures differ from initial
estimates. Stock-based compensation expense was recorded net of estimated
forfeitures for the three months ended March 31, 2006 such that expense was
recorded only for those stock-based awards that are expected to vest. Previously
under APB 25 to the extent awards were forfeited prior to vesting, the
corresponding previously recognized expense was reversed in the period of
forfeiture.
For the three month period ended March 31, 2006, the fair value of option grants
is estimated on the date of grant utilizing the Black-Scholes option-pricing
model with the weighted average assumption for options granted during 2005-2006,
expected life of the option is 5 years, expected volatility of 146%, risk free
interest rate of 4.04% and a 0% dividend yield on common stock. The weighted
average fair value at the grant date for such option is $0.63 per option.
2. Short Term Loan
In October 2005, the Company borrowed $165,000 from an individual for working
capital purposes. As of March 31, 2006, $65,000 of the loan had been repaid, and
$100,000 was still outstanding.
3. Equity-Based Transactions
Effective December 30, 2003, SOYO Taiwan entered into an agreement with an
unrelated third party to sell the $12,000,000 long-term payable due it by the
Company. As part of the agreement, SOYO Taiwan required that the purchaser would
be limited to collecting a maximum of $1,630,000 of the $12,000,000 from the
Company without the prior consent of SOYO Taiwan. In substance, SOYO Taiwan
forgave debt in an amount equal to the difference between the $12,000,000 and
the value of the preferred stock issued in settlement of this debt. This
forgiveness of debt was treated as a capital transaction. Payment from the third
party was received by SOYO Taiwan in February and March 2004. An agreement was
reached during the three months ended March 31, 2004 whereby 2,500,000 shares of
Class B preferred stock would be issued by the Company to the unrelated third
party in exchange for the long-term payable.
The Class B preferred stock has a stated liquidation value of $1.00 per share
and a 6% dividend, payable quarterly in arrears, in the form of cash, additional
shares of preferred stock, or common stock, at the option of the Company. The
Class B preferred stock has no voting rights. The shares of Class B preferred
stock are convertible, in increments of 100,000 shares, into shares of common
stock based on the $1.00 stated value, at any time through December 31, 2008,
based on the fair market value of the common stock, subject, however, to a
minimum conversion price of $0.25 per share. No more than 500,000 shares of
Class B preferred stock may be converted into common stock in any one year. On
December 31, 2008, any unconverted shares of Class B preferred stock
automatically convert into shares of common stock based on the fair market value
of the common stock, subject, however, to a minimum conversion price of $0.25
per share. Beginning one year after issuance, upon ten days written notice, the
Company or its designee will have the right to repurchase for cash any portion
or all of the outstanding shares of Class B preferred stock at 80% of the
liquidation value ($0.80 per share). During such notice period, the holder of
the preferred stock will have the continuing right to convert any such preferred
shares pursuant to which written notice has been received into common stock
13
without regard to the conversion limitation. The Class B preferred stock has
unlimited piggy-back registration rights, and is non-transferrable.
The Company recorded the issuance of the Class B preferred stock at its fair
market value on March 31, 2004 of $1,304,000, which was determined by an
independent investment banking firm. The $10,696,000 difference between the
$12,000,000 long-term payable and the $1,304,000 fair market value of the Class
B preferred stock was credited to additional paid-in capital. The difference
between the fair market value and the liquidation value of the Class B preferred
stock is being recognized as an additional dividend to the Class B preferred
stockholder, and as a reduction to earnings available to common stockholders,
and will be accreted from April 1, 2004 through December 31, 2008.
5. Significant Concentrations
a. Customers
The Company sells to both distributors and retailers. Revenues through such
distribution channels are summarized as follows:
Three Months Ended March 31,
--------------------------------
2006 2005
----------- -----------
Revenues
Distributors $ 4,479,959 38.8% $ 2,821,181 71.2%
Retailers 7,068,228 61.2% 1,141,339 28.8%
----------- -----------
$11,548,187 100.0% $ 3,962,520 100.0%
=========== ===========
During the three months ended March 31, 2006 and 2005, the Company offered price
protection to certain customers under specific programs aggregating $0 and
$99,272, respectively, which reduced net revenues and accounts receivable
accordingly.
Information with respect to customers that accounted for 10% or more of the
Company's revenues is presented below.
During the three months ended March 31, 2006 and 2005, the Company had two
customers that accounted for revenues of $4,213,370 and $1,673,160, equivalent
to 36.5% and 42.2% of net revenues, respectively. The two customers were Shop at
Home Network, LLC and E23 Inc.
b. Geographic Segments
Financial information by geographic segments is summarized as follows:
Three Months Ended March 31,
--------------------------------
2006 2005
----------- -----------
Revenues
North America $ 9,114,585 78.9% $ 1,560,833 39.4%
Central and South America 2,205,222 19.1% 280,623 7.1%
Hong Kong 0 1,945,308 49.1%
Other locations 228,380 2.0% 175,756 4.4%
----------- -----------
$11,548,187 100.0% $ 3,962,520 100.0%
=========== ===========
14
c. Suppliers
Of the products the Company sold in 2005, no more than 39% of the products were
produced by any one vendor. The Company is working to reduce that dependency and
expects that no more than 20% of any products sold in 2006 will be produced by
one vendor.
Through October 24, 2002, SOYO Nevada was a wholly-owned subsidiary of SOYO
Taiwan (see Note 1). Subsequent to that date, SOYO Taiwan agreed to provide
inventory to SOYO on an open account basis through December 31, 2005. Despite
that commitment, SOYO Group purchased no products from SOYO Taiwan in 2006 or
2005.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Cautionary Statement Pursuant to Safe Harbor Provisions of the Private
Securities Litigation Reform Act of 1995:
This Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2005
contains "forward-looking statements" within the meaning of Section 27A of the
Securities Act of 1933, as amended, including statements that include the words
"believes", "expects", "anticipates", or similar expressions. These
forward-looking statements include, but are not limited to, statements
concerning the Company's expectations regarding its working capital
requirements, financing requirements, business prospects, and other statements
of expectations, beliefs, future plans and strategies, anticipated events or
trends, and similar expressions concerning matters that are not historical
facts. The forward-looking statements in this Quarterly Report on Form 10-Q for
the quarterly period ended March 31, 2005 involve known and unknown risks,
uncertainties and other factors that could cause the actual results, performance
or achievements of the Company to differ materially from those expressed in or
implied by the forward-looking statements contained herein.
Background and Overview:
Historically, the Company has sold computer components and peripherals to
distributors and retailers primarily in North, Central and South America. The
Company operated in one business segment. A substantial majority of the
Company's products were purchased from SOYO Taiwan pursuant to an exclusive
distribution agreement effective through December 31, 2005, and were sold under
the "SOYO" brand.
Effective October 24, 2002, Vermont Witch Hazel Company, Inc., a Nevada
corporation ("VWHC"), acquired SOYO, Inc., a Nevada corporation ("SOYO Nevada"),
from SOYO Computer, Inc., a Taiwan corporation ("SOYO Taiwan), in exchange for
the issuance of 1,000,000 shares of convertible preferred stock and 28,182,750
shares of common stock, and changed its name to SOYO Group, Inc. ("SOYO"). The
1,000,000 shares of preferred stock were issued to SOYO Taiwan and the
28,182,750 shares of common stock were issued to certain members of SOYO Nevada
15
management. During October 2002, certain members of the management of SOYO
Nevada also separately purchased 6,026,798 shares of the 11,817,250 shares of
common stock of VWHC outstanding prior to VWHC's acquisition of SOYO Nevada, for
$300,000 in personal funds. The 6,026,798 shares represented 51% of the
outstanding shares of VWHC common stock. Accordingly, SOYO Taiwan and SOYO
Nevada management currently own 34,209,548 shares of the 40,000,000 shares of
the Company's common stock outstanding.
Subsequent to this transaction, SOYO Taiwan maintained an equity interest in
SOYO, continued to be the primary supplier of inventory to SOYO, and was a major
creditor. In addition, there was no change in the management of SOYO and no new
capital invested, and there was a continuing family relationship between certain
members of the management of SOYO and SOYO Taiwan. As a result, for financial
reporting purposes, this transaction was accounted for as a recapitalization of
SOYO Nevada, pursuant to which the accounting basis of SOYO Nevada continued
unchanged subsequent to the transaction date. Accordingly, the pre-transaction
financial statements of SOYO Nevada are now the historical financial statements
of the Company.
Unless the context indicates otherwise, SOYO and its wholly-owned subsidiary,
SOYO Nevada, are referred to herein as the "Company".
The Company's is a distributor of Computer Peripherals, Communications
Equipment, and Consumer Electronics. SOYO Group's products have always been sold
through an extensive network of authorized distributors to resellers, system
integrators, and value-added resellers (VARs). These products are also sold
through major retailers, mail-order catalogs and e-tailers to the consumers
throughout North America, Latin America and around the world.
Through 2004, the Company was a distributor of computer products, a substantial
portion of which were manufactured in Taiwan and China. Through SOYO Inc. the
Company offered a full line of designer motherboards and related peripherals for
intensive multimedia applications, corporate alliances, telecommunications and
specialty market requirements. The product line also included basic bare bones
PC motherboard systems, flash memory as well as small hard disk drives for
corporate and mobile users, internal multimedia reader/writer and wireless
networking solutions products for home and office (SOHO) users.
In 2004, the Company expanded its product offerings into new and higher margin
segments. The offerings were divided into three areas: Computer, Peripherals,
Communications Equipment, and Consumer Electronics. Throughout 2005 and the
first quarter of 2006, these were the areas that produced revenues for the
Company.
Financial Outlook:
As of March 31, 2006, the Company is reliant upon the cash flows from its
operations. The Company does not have any external sources of capital, and no
established credit facilities. In the past two years, the Company has borrowed
funds from an officer, director, major shareholder and a private lender.
The Company is currently attempting to improve its financial condition and
liquidity by exploring the availability of outside debt and equity financing; to
the extent such funding is available under reasonable terms and conditions.
Additionally, the Company is attempting to secure credit facilities that will
16
reduce the cost of purchasing inventory, provide better and cheaper terms on
purchases and improve cash flow.
On March 28, 2005 the Company announced that an accredited investor, Ever-Green
Technology (Hong Kong) Co., Ltd., purchased 500,000 unregistered shares of its
common stock, $0.001 par value per share (the "Shares") and common stock
purchase warrants to purchase 100,000 shares of its common stock exercisable at
$1.50 per share at any time until March 22, 2008 (the "Warrants"). The total
offering price was $500,000, which was paid in cash.
There can be no assurances that these measures will result in an improvement in
the Company's operations or liquidity. To the extent that the Company's
operations and liquidity do not improve, the Company may be forced to reduce
operations to a level consistent with its available working capital resources.
The Company may also have to consider a formal or informal restructuring or
reorganization.
Critical Accounting Policies:
The Company prepared its condensed consolidated financial statements in
accordance with accounting principles generally accepted in the United States of
America. The preparation of these financial statements requires the use of
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 amount of revenues and expenses
during the reporting period. Management periodically evaluates the estimates and
judgments made. Management bases its estimates and judgments on historical
experience and on various factors that are believed to be reasonable under the
circumstances. Actual results may differ from these estimates as a result of
different assumptions or conditions.
The Company operates in a highly competitive industry subject to aggressive
pricing practices, pressures on gross margins, frequent introductions of new
products, rapid technological advances, continual improvement in product
price/performance characteristics, and changing consumer demand.
As a result of the dynamic nature of the business, it is possible that the
Company's estimates with respect to the realizability of inventories and
accounts receivable may be materially different from actual amounts. These
differences could result in higher than expected allowance for bad debts or
inventory reserve costs, which could have a materially adverse effect on the
Company's financial position and results of operations.
The following critical accounting policies affect the more significant judgments
and estimates used in the preparation of the Company's condensed consolidated
financial statements.
Vendor Programs:
Funds received from vendors for price protection, product rebates, marketing and
training, product returns and promotion programs are generally recorded as
adjustments to product costs, revenue or sales and marketing expenses according
to the nature of the program. The Company records estimated reductions to
revenues for incentive offerings and promotions. Depending on market conditions,
the Company may implement actions to increase customer incentive offerings,
which may result in an incremental reduction of revenue at the time the
incentive is offered.
17
Accounts Receivable:
The Company recognizes revenue when persuasive evidence of an arrangement
exists, delivery has occurred, the sales price is fixed or determinable, and
collectibility is probable.
The Company records estimated reductions to revenue for incentive offerings and
promotions. Depending on market conditions, the Company may implement actions to
increase customer incentive offerings, which may result in an incremental
reduction of revenue at the time the incentive is offered.
In order to determine the value of the Company's accounts receivable, the
Company records a provision for doubtful accounts to cover probable credit
losses. Management reviews and adjusts this allowance periodically based on
historical experience and its evaluation of the collectibility of outstanding
accounts receivable.
Inventories:
Inventories are stated at the lower of cost or market. Cost is determined by
using the average cost method. The Company maintains a perpetual inventory
system which provides for continuous updating of average costs. The Company
evaluates the market value of its inventory components on a regular basis and
reduces the computed average cost if it exceeds the component's market value.
Inventories consist primarily of computer parts and components purchased from
SOYO Taiwan.
Income Taxes:
The Company records a valuation allowance to reduce its deferred tax assets to
the amount that is more likely than not to be realized. In the event the Company
was to determine that it would be able to realize its deferred tax assets in the
future in excess of its recorded amount, an adjustment to the deferred tax
assets would be credited to operations in the period such determination was
made. Likewise, should the Company determine that it would not be able to
realize all or part of its deferred tax assets in the future, an adjustment to
the deferred tax assets would be charged to operations in the period such
determination was made.
Results of Operations:
Three Months Ended March 31, 2006 and 2005:
Net Revenues. Net revenues increased by $7,585,667 or 191%, to $11,548,187 in
2006, as compared to $3,962,520 in 2005. The increase in net revenues in 2006 as
compared to 2005 was simple. During the first quarter of 2005 the Company had
not yet begun selling the LCD televisions and monitors. The products had been
ordered, but had not yet arrived. With very little inventory to sell, sales were
scarce.
Gross Margin. Gross margin was $1,651,088 or 14.3% in 2006, as compared to
$1,611,207 or 40.7% in 2005. Comparing the gross margin between the quarters is
impractical, as the sales were generated from different products. In 2005, the
Company was still selling computer parts only, with a smattering of VOIP sales.
Additionally, the gross margin in 2005 contains $1,089,172 of income derived
from "Prior Year's Purchases Discounts and Allowances settled in 2005". The
gross margin in 2006 represents a mix of sales of all of the Company's product
lines, which is relevant for future periods.
Sales and Marketing Expenses. Selling and marketing expenses decreased by
$164,579 to $74,886 in 2006, as compared to $239,465 in 2005. The decrease is
18
due to the large decrease in marketing funds given to customers. In 2005, with
the only sales coming from the highly competitive computer peripherals
department, many co-op programs were necessary to fuel sales. In 2006, with the
more diverse product lines, the Company is not participating in the same types
of programs.
General and Administrative Expenses. General and administrative expenses
increased by $551,021 to $1,484,994 in 2006, as compared to $933,973 in 2005.
The increase is due to three factors: Increased attorney's fees dealing with the
two lawsuits the Company is involved in, the costs of purchasing and testing the
Company's new accounting software, and the SEC's requirement that the Company
change to the fair value method of Accounting for Stock Based Compensation.
Provision for Doubtful Accounts. The Company recorded a provision for doubtful
accounts of $50,000 in the three months ended March 31, 2006. The Company
recorded a provision for doubtful accounts of $31,124 the three months ended
March 31, 2005. The larger provision is due to the increased sales volume,
increased receivables, and slightly greater average age of the receivables.
Depreciation and Amortization. Depreciation and amortization of property and
equipment was $25,815 in 2006, as compared to $8,749 in 2005. The increase is
due to the telephone lines purchased in China in 2005 now being depreciated.
Income from Operations. The income from operations was $15,393 for the three
months ended March 31, 2006, as compared to income from operations of $397,896
for the three months ended March 31, 2005. The income from operations in 2006
equalled approximately two percent of gross sales, which the company believes is
in line with expectations. The 2005 results included several hundred thousand
dollars of prior years purchases and discounts, which inflated the number as
compared to sales. Additionally, the 2006 number contains a charge of
approximately $135,000 to comply with the requirements of SFAS 123R, Share-Based
Payment, that the Company change to the fair value method of Accounting for
Stock Based Compensation. Without this charge against earnings, income from
operations would have been approximately $150,000.
Miscellaneous Income. Miscellaneous income was $4,531 for the three months ended
March 31, 2006. There was no miscellaneous income in the three months ended
March 31, 2005.
Interest Income. Interest income was $3,247 for the three months ended March 31,
2006. There was no interest income in 2005.
Interest Expense. Interest expense was $72,387 for the three months ended March
31, 2006. Interest expense was $11,221 in 2005. The large increase is due to the
Company beginning to factor receivables to improve cash flow in the middle of
2005, and the switch of financing institutions. The Company paid $40,000 to the
old financier to pay off minimum requirements, and has now switched to another
financier with better coverage of the receivables.
Provision for Income Taxes. There was no provision for income taxes in 2006 or
in 2005.
Net Income (loss). Net loss was $274,135 for the three months ended March 31,
2006, as compared to net income of $386,675 for the three months ended March 31,
2005. The net loss included approximately $360,000 of non cash expenses to
comply with the requirements of SFAS 123R, Share-Based Payment, that the Company
change to the fair value method of Accounting for Stock Based Compensation. Of
19
this amount, $224,919 represents cumulative effect of the change in accounting
principle. Without this charge, net income would have been almost $90,000.
Financial Condition - March 31, 2006:
Liquidity and Capital Resources:
Effective December 30, 2003, SOYO Taiwan entered into an agreement with an
unrelated third party to sell the $12,000,000 long-term payable due it by the
Company. As part of the agreement, SOYO Taiwan required that the purchaser would
be limited to collecting a maximum of $1,630,000 of the $12,000,000 from the
Company without the prior consent of SOYO Taiwan. In substance, SOYO Taiwan
forgave debt in an amount equal to the difference between the $12,000,000 and
the value of the preferred stock issued in settlement of this debt. This
forgiveness of debt was treated as a capital transaction. Payment from the third
party was received by SOYO Taiwan in February and March 2004. An agreement was
reached during the three months ended March 31, 2004 whereby 2,500,000 shares of
Class B preferred stock would be issued by the Company to the unrelated third
party in exchange for the long-term payable.
The Class B preferred stock has a stated liquidation value of $1.00 per share
and a 6% dividend, payable quarterly in arrears, in the form of cash, additional
shares of preferred stock, or common stock, at the option of the Company. The
Class B preferred stock has no voting rights. The shares of Class B preferred
stock are convertible, in increments of 100,000 shares, into shares of common
stock based on the $1.00 stated value, at any time through December 31, 2008,
based on the fair market value of the common stock, subject, however, to a
minimum conversion price of $0.25 per share. No more than 500,000 shares of
Class B preferred stock may be converted into common stock in any one year. On
December 31, 2008, any unconverted shares of Class B preferred stock
automatically convert into shares of common stock based on the fair market value
of the common stock, subject, however, to a minimum conversion price of $0.25
per share. Beginning one year after issuance, upon ten days written notice, the
Company or its designee will have the right to repurchase for cash any portion
or all of the outstanding shares of Class B preferred stock at 80% of the
liquidation value ($0.80 per share). During such notice period, the holder of
the preferred stock will have the continuing right to convert any such preferred
shares pursuant to which written notice has been received into common stock
without regard to the conversion limitation. The Class B preferred stock has
unlimited piggy-back registration rights, and is non-transferable.
The Company recorded the issuance of the Class B preferred stock at its fair
market value on March 31, 2005 of $1,304,000, which was determined by an
independent investment banking firm. The $10,696,000 difference between the
$12,000,000 long-term payable and the $1,304,000 fair market value of the Class
B preferred stock was credited to additional paid-in capital. The difference
between the fair market value and the liquidation value of the Class B preferred
stock is being recognized as an additional dividend to the Class B preferred
stockholder, and as a reduction to earnings available to common stockholders,
and will be accreted from April 1, 2004 through December 31, 2008.
Operating Activities. The Company utilized cash of $643,744 in operating
activities during the three months ended March 31, 2006, as compared to
$1,271,674 in operating activities during the three months ended March 31, 2005.
20
At March 31, 2006, the Company had cash and cash equivalents of $54,411 as
compared to $828,294 at December 31, 2005. During the final few days of the
quarter, the Company was informed that two big shipments totaling approximately
$4,000,000 that were to be sent to customers were delayed. The customers needed
to delay the receipt of the goods for business reasons. As a result, the Company
was unable to sell the products before the end of the quarter, and unable to
factor the invoices. This resulted in a severe cash shortage at quarter end.
The Company had working capital of $754,598 at March 31, 2006, as compared to
working capital of $689,141 at December 31, 2005, resulting in current ratios of
1.04:1 and 1.04:1 at March 31, 2006 and December 31, 2005, respectively.
Accounts receivable decreased to $6,821,483 at March 31, 2006, as compared to
$7,278,520 at December 31, 2005, a decrease of $457,037 or 6.3%. The Company's
provision for doubtful accounts stood at $639,224 and $589,224 as of March 31,
2006 and December 31, 2005 respectively.
Inventories increased to $11,255,016 at March 31, 2005, as compared to
$7,991,030 at December 31, 2005, an increase of $3,263,986 or 40.8%. During the
final few days of the quarter, the Company was informed that two big shipments
totaling approximately $4,000,000 that were to be sent to customers were
delayed. The customers needed to delay the receipt of the goods for business
reasons. As a result, the Company was unable to sell the product before the end
of the quarter. The products were sold to customers during the second quarter.
Accounts payable increased to $16,930,908 at March 31, 2006, as compared to
$13,977,579 at December 31, 2005, an increase of $2,953,329 or 21.1%, as a
result of large inventory purchases during the quarter.
Accrued liabilities decreased to $347,509 at March 31, 2006, as compared to
$1,287,108 at December 31, 2005, a decrease of $939,599. The large decrease is
due to reductions in accruals for marketing expenses, RMA expenses and other
accrued liabilities. The Company had large accruals over the year end, as the
Company had very little experience selling the new products, and was unsure of
the return or RMA rates. With the additional time that has passed and the
additional experience, the Company is satisfied that the current accruals are
sufficient.
Financing Activities. In October 2005, the Company borrowed $165,000 from an
individual for working capital purposes. As of March 31, 2006, $100,000 is owed
to that individual.
Principal Commitments:
A summary of the Company's contractual cash obligations as of March 31, 2006 is
as follows:
Payments Due By Period
----------------------
Contractual Less than Between Between After
Cash Obligations Total 1 year 1-2 years 3-5 years 5 years
---------------------- ---------- ---------- ---------- --------- --------
Operating leases $ 567,178 $ 212,692 $ 354,486 $ -- $ --
Short Term Loan 100,000 100,000 -- -- --
---------- ---------- ---------- --------- --------
Total contractual cash
obligations $ 667,178 $ 312,692 $ 354,486 $ -- $ --
========== ========== ========== ========= ========
21
Off-Balance Sheet Arrangements:
At March 31, 2006, the Company did not have any transactions, obligations or
relationships that could be considered off-balance sheet arrangements.
Commitments and Contingencies:
At March 31, 2006, the Company did not have any material commitments for capital
expenditures.
Recent Accounting Pronouncements:
In May 2005, FASB issued SFAS No. 154, Accounting Changes and Error Corrections,
a replacement of APB Opinion No. 20 and FASB Statement No. 3. SFAS 154 applies
to all voluntary accounting principle changes as well as the accounting for and
reporting of such changes. SFAS 154 is effective for accounting changes and
corrections of errors made in fiscal years beginning after December 15, 2005.
SFAS 154 requires voluntary changes in accounting principle be
retrospectively applied to financial statements from previous periods unless
such application is impracticable. Changes in depreciation, amortization, or
depletion for long-lived, non-financial assets are accounted for as a change in
accounting estimate that is affected by a change in accounting principle, under
the newly issued standard.
SFAS 154 replaces APB Opinion No. 20 and SFAS 3. SFAS 154 carries forward
many provisions of Opinion 20 and SFAS 3 without change including those
provisions related to reporting a change in accounting estimate, a change in
reporting entity, correction of an error and reporting accounting changes in
interim financial statements. The FASB decided to completely replace Opinion 20
and SFAS 3 rather than amending them in keeping to the goal of simplifying U.S.
GAAP. The provisions of SFAS No. 154 are not expected to have a material effect
on the Company's consolidated financial position or results of operation.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary
Assets, an amendment of APB Opinion No. 29". SFAS 153 addresses the measurement
of exchanges of nonmonetary assets. It eliminates the exception from fair value
measurement for nonmonetary exchanges of similar productive assets in paragraph
21(b) of APB Opinion No. 29, Accounting forNonmonetary Transactions, and
replaces it with an exception for exchanges that do not have commercial
substance. SFAS 153 specifies that a nonmonetary exchange has commercial
substance if the future cash flows of the entity are expected to change
significantly as a result of the exchange.
The exception under APB 29 required that some nonmonetary exchanges, although
commercially substantive, be recorded on a carryover basis. SFAS 153 eliminates
the exception to fair value for exchanges of similar productive assets and
replaces it with a general exception for exchange transactions that do not have
commercial substance--that is, transactions that are not expected to result in
significant changes in the cash flows of the reporting entity.
SFAS 153 is effective on January 1, 2006. The adoption of SFAS 153 is not
22
expected to have an impact on the Company's consolidated financial statements or
disclosures.
In December 2004, the FASB issued Statement of Financial Accounting Standards
No. 123 (revised 2004), Share-Based Payment ("SFAS No. 123(R)") which replaces
SFAS No. 123, Accounting for Stock-Based Compensation and supersedes APB Opinion
No. 25, Accounting for Stock Issued to Employees. SFAS No. 123(R) requires that
companies recognize all share-based payments to employees, including grants of
employee stock options, in the financial statements. The cost will be based on
the fair value of the equity or liability instruments issued and recognized over
the respective vesting period of the stock option. Pro forma disclosure of this
cost will no longer be an alternative under SFAS No. 123(R). SFAS 123(R) is
effective for public companies at the beginning of the first fiscal year that
begins after June 15, 2005.
Transition methods available to public companies include either the modified
prospective or modified retrospective adoption. The modified prospective
transition method requires that compensation cost be recognized beginning on the
effective date, or date of adoption if earlier, for all share-based payments
granted after the date of adoption and for all unvested awards existing on the
date of adoption. The modified retrospective transition method, which includes
the requirements of the modified prospective transition method, additionally
requires the restatement of prior period financial information based on amounts
previously recognized under SFAS No. 123 for purposes of pro-forma disclosures.
The Company adopted SFAS No. 123(R) effective January 1, 2006.The Company
adopted the modified prospective method. As a result, the Company recognized a
charge against earnings of $134,952 for the three months ended March 31, 2006,
and the cumulative effect on prior years of changing to the fair value method of
$224,919.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs, an amendment
of ARB No. 43, Chapter 4." SFAS 151 amends the guidance in ARB No. 43, Chapter
4, "Inventory Pricing," to clarify the accounting for abnormal amounts of idle
facility expense, freight, handling costs, and wasted material (spoilage).
Paragraph 5 of ARB 43, Chapter 4, previously stated that ". . . under some
circumstances, items such as idle facility expense, excessive spoilage, double
freight, and rehandling costs may be so abnormal as to require treatment as
current period charges. . . ." SFAS 151 requires that those items be recognized
as current-period charges regardless of whether they meet the criterion of "so
abnormal." In addition, SFAS 151 requires that allocation of fixed production
overheads to the costs of conversion be based on the normal capacity of the
production facilities.
SFAS 151 is effective on January 1, 2006. Earlier application is permitted for
inventory costs incurred beginning January 1, 2005. The provisions of SFAS 151
shall be applied prospectively. The adoption of SFAS 151 is not expected to have
an impact on the Company's consolidated financial statements or disclosures.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does not have any market risk with respect to such factors as
commodity prices, equity prices, and other market changes that affect market
risk sensitive investments.
As the Company's debt obligations at March 31, 2006 are primarily short-term in
nature and non-interest bearing, the Company does not have any risk from an
23
increase in interest rates. However, to the extent that the Company arranges new
interest-bearing borrowings in the future, an increase in current interest rates
would cause a commensurate increase in the interest expense related to such
borrowings.
The Company does not have any foreign currency risk, as its revenues and
expenses, as well as its debt obligations, are denominated and settled in United
States dollars.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures:
In conjunction with the audit of the Company's financial statements for the
years ended December 31, 2003 and 2004, the Company's Chief Executive Officer
and its Chief Financial Officer reviewed and evaluated the effectiveness of the
Company's disclosure controls and procedures (as defined in Exchange Act Rule
13a-15(e) and 15d-15(e)), which are designed to ensure that material information
the Company must disclose in its reports filed or submitted under the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), is recorded, processed,
summarized and reported on a timely basis, and have concluded, based on that
evaluation, that as of such dates, the Company's disclosure controls and
procedures were not adequate. In addition, the Company's automated financial
reporting systems are overly complex, poorly integrated and inconsistently
implemented.
The Company's Chief Executive Officer and Chief Financial Officer arrived
at this conclusion based on a number of factors, including that the Company's
system of internal control during 2003 and 2004 did not: (1) properly record
accounts payable to vendors for purchases of inventory, (2) did not properly
record adjustments to inventory per the general ledger to physical inventory
balances, (3) did not properly record inventory adjustments to the lower of cost
or market using the average inventory method, (4) did not periodically reconcile
the Company's main bank account between August 2003 and December 2003, (5) did
not have adequate controls over interim physical inventory procedures, and (6)
did not generate timely and accurate financial information to allow for the
preparation of timely and complete financial statements. The Company did not
have an adequate financial reporting process because of the aforementioned
material weaknesses, including the difficulty in identifying and assembling all
relevant contemporaneous documentation for ongoing business transactions, and
significant turnover in the Company's financial staff. In addition to the
foregoing, a former employee withheld information from the auditor during the
2003 audit. Accordingly, the Company's Chief Executive Officer and Chief
Financial Officer concluded that there were significant deficiencies, including
material weaknesses, in the Company's internal controls over its financial
reporting at the end of the fiscal period ended December 31, 2003.
In view of the fact that the financial information presented in the 2003
annual report was prepared in the absence of adequate internal controls over
financial reporting, the Company devoted a significant amount of time and
resources to the analysis of the financial information and documentation
underlying the financial statements contained in this annual report, including
the related interim financial statements, resulting in the restatement of
certain interim financial statements. In particular, the Company reviewed all
significant account balances and transactions underlying the financial
statements to verify the accuracy of the financial statements contained in the
2003 annual report.
24
When the Company's senior management realized that there were significant
deficiencies, including material weaknesses, in our 2003 internal control over
financial reporting, we retained outside advisors to assist the Company's
financial staff in preparing the Company's financial statements, including the
restated interim periods
To address these weaknesses, the Company took the following corrective actions:
>> The Company hired a new Accounting Manager, then replaced the Accounting
Manager with a more qualified candidate. That employee recently left the Company
to return overseas for a family emergency. The employee will not be returning to
the Company, which means that as of March 31, 2006, the Company was operating
without an Accounting Manager or Controller. While the Company searched for a
replacement, the Company retained a financial consultant and former CPA to
oversee the day to day management of the accounting department. The Company has
recently added additional personnel to complete the day to day accounting tasks.
In light of the foregoing, management took the following actions to rectify the
deficiencies as described above.
>> Management hired experts to assist with the financial reporting required, and
to train Company employees to perform such tasks in the future.
>> Management hired experts to assist in the evaluation and implementation of
new accounting software. The evaluation was completed, and the software has been
paid for. The software is currently being tested and will be installed and
operational during the second quarter of fiscal year 2006.
In conjunction with the audit of the Company's financial statements for the year
ended December 31, 2005, the Company's Chief Executive Officer and its Chief
Financial Officer reviewed and evaluated the corrective actions listed above.
The officers believed that such corrective actions minimize the risk of material
misstatement, but the corrective actions continued to have significant
deficiencies.
As of May 15, 2006, the Company has hired an Accounting Manager and additional
finance personnel. The Chief Executive Officer and the Chief Financial Officer
are satisfied that with the personnel in place, and with the additional efforts
of the Financial Consultant/ CPA, that the books and records portray a
completely accurate picture of the Company's financial position and that all
transactions are being captured and reported as required. The Company believes
that once the new software is installed and operational, and the new Accounting
Manager is trained, all significant deficiencies will have been addressed and
corrected.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On August 2, 2004, a lawsuit was filed in California Superior Court entitled
Gerry Normandan. et al, v. SOYO Inc. Case No. RCV 082128. The case seeks class
action status and alleges defects in motherboards which Soyo distributes, and
that the Company misrepresented and omitted material facts concerning the
motherboards. The plaintiff seeks restitution and disgorgement of all amounts
25
obtained by defendant as a result of alleged misconduct, plus interest, actual
damages, punitive damages and attorneys' fees. The Company is vigorously
defending the lawsuit and believes that it will be resolved with no material
adverse effect on the Company.
On April 14, 2005 a lawsuit was filed in Superior Court of the State of
California, County of San Bernardino, entitled Afshin Pourvajdi v. SOYO Group,
Inc., Nancy Chu and various Doe defendants. Case RCV 086992. The complaint
alleges causes of action for: 1) Double damages for violation of labor code
Section 970; 2) Misrepresentation; 3) Intentional Infliction of Emotional
Distress; 4) Breach of Contract. The prayer for relief in the Complaint seeks
damages of no less than $200,000 on the first and second causes of action, plus
an unspecified amount of punitive damages and an unspecified amount of general
and punitive damages on the third cause of action and an unspecified amount of
general and punitive damages on the fourth cause of action. Plaintiff also seeks
to recover all costs and attorney fees. The case arises from a consultant who
worked briefly for the Company in 2004 and whose contract was not renewed. The
Company expects the case to be settled during the second quarter of 2006. The
Company will update shareholders as to the status of the case as soon as a
definitive outcome is reached.
There are no other legal proceedings that have been filed against the Company.
None of the Company's directors, officers or affiliates, or owner of record
of more than five percent (5%) of its securities, or any associate of any such
director, officer or security holder, is a party adverse to the Company or has a
material interest adverse to the Company in reference to pending litigation.
ITEM 1A: RISK FACTORS
In addition to the other information set forth in this report, you should
carefully consider the factors discussed in Part I, "Item 1A. Risk Factors" in
our Annual Report on Form 10-K for the year ended December 31, 2005, which could
materially affect our business, financial condition or future results. The risks
described in our Annual Report on Form 10-K are not the only risks facing our
Company. Additional risks and uncertainties not currently known to us or that we
currently deem to be immaterial also may materially adversely affect our
business, financial condition and/or operating results.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On March 7, 2005, the Company registered its 2005 Stock Compensation Plan on
Form S-8 with the Securities and Exchange Commission, registering on behalf of
our employees, officers, directors and advisors up to 5,000,000 shares of our
common stock purchasable by them pursuant to common stock options granted under
26
our 2005 Stock Compensation Plan. The plan was approved by shareholder vote
during a special meeting of shareholders on February 17, 2006.
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
A list of exhibits required to be filed as part of this report is set forth in
the Index to Exhibits, which immediately precedes such exhibits, and is
incorporated herein by reference.
(b) Reports on Form 8-K
Three Months Ended March 31, 2006:
None
27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
SOYO GROUP, INC.
--------------------
(Registrant)
DATE: May 15, 2006 By: /s/ Ming Tung Chok
-----------------------
Ming Tung Chok
President and Chief
Executive Officer
DATE: May 15, 2006 By: /s/ Nancy Chu
-----------------------
Nancy Chu
Chief Financial Officer
DATE: May 15, 2006 By /s/ Paul F. Risberg
--------------------------
Name: Paul F. Risberg
Title: Director
DATE: May 15, 2006 By /s/ Chung Chin Keung
--------------------------
Name: Chung Chin Keung
Title: Director
DATE: May 15, 2006 By /s/ Zhi Yang Wu
--------------------------
Name: Zhi Yang Wu
Title: Director
28
INDEX TO EXHIBITS
Exhibit
Number Description of Document
------ -----------------------
31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002 - Ming Tung Chok
31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002 - Nancy Chu
32 Certification pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 - Ming Tung Chok and Nancy Chu
29