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 September 30, 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.
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(Exact Name of Registrant as specified in its Charter)
Nevada 95-4502724
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(State or other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification Number)
1420 South Vintage Avenue, Ontario, California 91761-3646
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(Address of Principal Executive Offices) (Zip Code)
(909) 292-2500
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(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 November 14, 2006, there were 49,025,511 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 - September 30, 2006
(Unaudited) and December 31, 2005
Condensed Consolidated Statements of Operations (Unaudited) -
Three Months and Nine Months Ended September 30, 2006 and 2005
Condensed Consolidated Statements of Cash Flows (Unaudited) -
Nine Months Ended September 30, 2006 and 2005
Notes to Condensed Consolidated Financial Statements
(Unaudited) - Three Months and Nine Months Ended September 30,
2006 and 2005
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Item 4. Controls and Procedures
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of
Equity Securities
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
3
SOYO Group, Inc. and Subsidiary
Condensed Consolidated Balance Sheets
September 30, December 31,
2006 2005
------------- -------------
(Unaudited)
ASSETS
CURRENT
Cash and cash equivalents $ 1,355,869 $ 828,294
Accounts receivable, net of
allowance for doubtful accounts
of $256,203 and $589,224 at
September 30, 2006 and December 31,
2005, respectively 7,003,019 7,278,520
Inventories 5,151,859 7,991,030
Prepaid expenses 0 20,984
------------- -------------
13,510,747 16,118,828
------------- -------------
Property and equipment 976,570 867,122
Less: accumulated depreciation
and amortization (194,976) (115,480)
------------- -------------
781,594 751,642
------------- -------------
Deposits 414,726 36,920
------------- -------------
$ 14,707,067 $ 16,907,390
============= =============
(continued)
4
SOYO Group, Inc. and Subsidiary
Condensed Consolidated Balance Sheets (continued)
September 30, December 31,
2006 2005
------------- -------------
(Unaudited)
LIABILITIES
CURRENT
Accounts payable 11,544,635 13,977,579
Accrued liabilities 282,182 1,287,108
Note payable 100,000 165,000
------------- -------------
11,926,817 15,429,687
------------- -------------
SHAREHOLDERS' DEFICIENCY
Preferred stock, $0.001 par value
Authorized - 10,000,000 shares
Issued and outstanding -
3,000,940 shares of Class B
Convertible Preferred Stock,
(2,788,948 shares in 2005)
$1.00 per share stated
liquidation value
($2,500,000 aggregate
liquidation value) 1,860,431 1,702,486
Preferred Stock Backup Withholding (132,383) (84,999)
Common stock, $0.001 par value
Authorized - 75,000,000 shares
Issued and outstanding -
49,025,511 shares,
(48,681,511 in 2005) 49,026 48,682
Additional paid-in capital 17,743,758 17,225,738
Accumulated deficit (16,740,582) (17,414,204)
------------- -------------
2,780,520 1,477,703
------------- -------------
$ 14,707,067 $ 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 September 30,
--------------------------------
2006 2005
-------------- --------------
Net revenues $ 10,005,084 $ 9,233,430
Cost of revenues 7,771,723 9,026,659
-------------- --------------
Gross margin 2,233,361 206,771
-------------- --------------
Costs and expenses:
Sales and marketing 231,272 256,259
General and administrative 1,427,441 886,500
Provision for doubtful accounts 20,635 0
Depreciation and amortization 27,107 8,653
-------------- --------------
Total costs and expenses 1,706,455 1,151,412
-------------- --------------
Income (loss) from operations 526,906 (944,641)
-------------- --------------
Other income (expense):
Interest income 0 1,202
Interest expense (200,939) (36,353)
Miscellaneous revenue (6,399) 600,000
State Tax Refund 0 17,600
-------------- --------------
Other income (expense), net (207,338) 582,449
-------------- --------------
Income before provision for
Income taxes 319,568 (362,192)
Provision for income taxes -- --
-------------- --------------
Net income (loss) $ 319,568 $ (362,192)
============== ==============
Less: Dividends on Class B
Convertible Preferred Stock (55,491) (42,935)
Net Income attributable to
Common Shareholders $ 264,077 $ (405,127)
Net income per common share -
Basic $ 0.01 $ (0.01)
Diluted $ 0.01 $ (0.01)
Weighted average number of
common shares outstanding -
Basic 49,006,511 47,461,999
Diluted 58,591,295 47,461,999
See accompanying notes to condensed consolidated financial statements.
6
SOYO Group, Inc. and Subsidiary
Condensed Consolidated Statements of Operations (Unaudited)
Nine Months Ended September 30,
-------------------------------
2006 2005
------------- -------------
Net revenues $ 32,340,785 $ 21,690,260
Cost of revenues 26,149,583 20,206,584
------------- -------------
Gross margin 6,191,202 1,483,676
------------- -------------
Costs and expenses:
Sales and marketing 628,286 619,753
General and administrative 4,182,118 2,701,828
Provision for doubtful accounts 123,819 34,513
Depreciation and amortization 79,496 26,740
------------- -------------
Total costs and expenses 5,013,719 3,382,834
------------- -------------
Income from operations 1,177,483 (1,899,158)
------------- -------------
Other income (expense):
Interest income 6,607 1,202
Interest expense (351,408) (59,731)
Miscellaneous revenue (1,115) 2,066,688
State Tax Refund -- 17,600
------------- -------------
Other income (expense), net (345,916) 2,025,759
------------- -------------
Income before provision for
income taxes 831,567 126,601
Provision for income taxes -- --
------------- -------------
Net income $ 831,567 $ 126,601
============= =============
Less: Dividends on Class B
Convertible Preferred Stock (157,945) (119,648)
Net Income attributable to
Common Shareholders $ 673,622 $ 6,953
Net income per common share -
Basic $ 0.01 $ 0.00
Diluted $ 0.01 $ 0.00
Weighted average number of
common shares outstanding -
Basic 49,006,511 47,461,999
Diluted 58,591,295 51,785,230
See accompanying notes to condensed consolidated financial statements.
7
SOYO Group, Inc. and Subsidiary
Condensed Consolidated Statements of Cash Flows (Unaudited)
Nine Months Ended September 30,
-------------------------------
2006 2005
------------- -------------
OPERATING ACTIVITIES
Net income $ 831,567 $ 126,601
Adjustments to reconcile net
income to net cash used in
operating activities:
Depreciation and
amortization 79,496 26,740
Provision for doubtful
accounts 123,819 (623,092)
Stock Based Compensation 398,484 --
Non cash payments for
Director's compensation 37,110 --
Non cash payments for public
Relations and promotion 82,770 --
Changes in operating
assets and liabilities:
(Increase) decrease in:
Accounts receivable 151,682 (3,126,009)
Inventories 2,839,171 (503,567)
Prepaid expenses 20,984 5,958
Deposits (377,806) 1,670
Increase (decrease) in:
Accounts Payable- SOYO
Computer Inc. -- (1,314,910)
Accounts payable-other (2,432,944) 1,324,672
Accrued liabilities (1,004,926) (323,402)
Income taxes payable -- --
------------- -------------
Net cash provided by (used in)
Operating activities 749,407 (4,405,339)
------------- -------------
INVESTING ACTIVITIES
Purchase of property and
equipment (109,448) 35,935
Proceeds from sale of equipment --
------------- -------------
Net cash provided by (used in)
Investing activities (109,448) 35,935
------------- -------------
(continued)
8
SOYO Group, Inc. and Subsidiary
Condensed Consolidated Statements of Cash Flows (Unaudited) (continued)
Nine Months Ended September 30,
-------------------------------
2006 2005
------------- -------------
FINANCING ACTIVITIES
Advances from officer,
director and major
shareholder -- $ (215,000)
Proceeds from issuance of
Note payable -- 200,000
Payment of note payable (65,000) --
Payment of backup withholding tax
on accreted dividends on
preferred stock (47,384) --
Proceeds from issuance of
Common Stock -- 3,559,246
------------- -------------
Net cash provided by (used in)
Financing activities (112,384) 3,544,246
------------- -------------
CASH AND CASH EQUIVALENTS
Net decrease 527,575 (825,158)
At beginning of period 828,294 1,288,351
------------- -------------
At end of period $ 1,355,869 $ 463,193
============= =============
NON-CASH INVESTING AND
FINANCING ACTIVITIES
Conversion of Business Loan of
$913,750 and accrued interest of
$51,552 to common stock $ -- $ 965,302
Conversion of accounts payable
Of $554,871 to common stock -- 554,871
Accretion of discount
on preferred stock $ 157,945 $ 119,648
See accompanying notes to condensed consolidated financial statements.
9
SOYO Group, Inc. and Subsidiary
Notes to Condensed Consolidated Financial Statements (Unaudited)
Three Months and Nine Months Ended September 30, 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
10
Company, contain all adjustments, which include normal recurring adjustments,
necessary to present fairly the financial position at September 30, 2006, the
results of operations for the three and nine months ended September 30, 2006 and
2005, and cash flows for the nine months ended September 30, 2006 and 2005. The
condensed consolidated balance sheet as of December 31, 2005 is derived from the
Company's audited consolidated financial statements.
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
generally 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 and nine months ended September 30, 2006
are not necessarily indicative of the results of operations to be expected for
the full fiscal year ending December 31, 2006. The largest part of the Company's
business, the importing and resale of consumer electronic products, is a
seasonal business. The busiest time of the year is the holiday season, which
occurs at the end of the year. Accordingly, sales for the year should improve as
the year passes, culminating in strongest sales in the fourth quarter.
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 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 and options.
As of September 30, 2006, potentially dilutive securities consisted of 3,061,051
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 September 30, 2006, 9,565,784 shares of common stock were issuable upon
conversion of the Class B Convertible Preferred Stock, based on the closing
price of $0.32 per common share at September 30, 2006.
11
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
or nine months ended September 30, 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 - The Company has adopted Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS
No. 123"), which establishes a fair value method of accounting for stock-based
compensation plans, as amended by Statement of Financial Accounting Standard No.
148, "Accounting for Stock-Based Compensation - Transition and Disclosure"
("SFAS No. 148").
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 $126,924 for the three months ended September 30,
2006. For further information, refer to note 4, Stock based Compensation on page
14.
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. However, since
Mr. Chok and Ms. Chu, husband and wife, are directors who own more than 50% of
the Company, shareholder approval is essentially a formality, hence the grant
date of the stock options is July 22, 2005.
12
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. The grants will expire if unused on July 22, 2010.
As of September 30, 2006, 10 employees who had been granted stock options had
left the Company, and grants totaling 462,000 options were returned to the
Company. As of September 30, 2006, the Company has not issued any option grants
to employees other than the 2,889,000 option grants issued on July 22, 2005.
2. Short Term Loan
In October 2005, the Company borrowed $165,000 from an individual for working
capital purposes. As of September 30, 2006, $65,000 of the loan had been repaid,
and $100,000 is 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
without regard to the conversion limitation. The Class B preferred stock has
unlimited piggy-back registration rights, and is non-transferrable.
13
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.
4. 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"). Under the intrinsic value based method, compensation
cost is the excess, if any, of the quoted market price of the stock at grant
date or other measurement date over the amount an employee must pay to acquire
the stock.
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 straight line
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-year vesting period.
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 has been recorded net of estimated
forfeitures for the period ended September 30, 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.
If the fair value based method under FAS123 had been applied in measuring
stock-based compensation expense for the nine-month period ended September 30,
2005, the pro forma net income and net income per share would have been as
follows:
Nine-month
Period ended
September 30, 2005
Net income, as reported $ 126,601
Add: Stock-based employee compensation expense
included in reported net income, net of
related tax effect --
Deduct: Total stock-based employee compensation
expense determined under fair-value based
method for all awards not included in net
income (89,968)
------------------
Pro forma net income $ 36,633
==================
Income (loss) per share:
Basic/diluted - as reported $ 0.00 / $0.00
------------------
Basic/diluted - pro forma $ 0.00 / $0.00
------------------
14
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 Sept. 30, Nine Months Ended Sept. 30,
---------------------------- ----------------------------
2006 2005 2006 2005
------------ ------------ ------------ ------------
Revenues
Distributors $ 7,570,129 $ 1,113,584 $ 23,113,748 $ 4,701,601
Retailers 2,068,429 8,094,398 8,264,126 17,216,232
Others 366,526 25,448 962,911 (227,573)
------------ ------------ ------------ ------------
$ 10,005,084 $ 9,233,430 $ 32,340,785 $ 21,690,260
============ ============ ============ ============
During the three months ended September 30, 2006 and 2005, the Company offered
price protection to certain customers under specific programs aggregating
$95,752 and $7,142, 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 September 30, 2006, the Company had one customer
that accounted for revenues of $1,319,350, equivalent to 13.2% of net revenues.
The customer was D & H Distributing, Inc. The customer is a distributor who
sells the Company's products to retailers in the United States.
b. Geographic Segments
Financial information by geographic segments is summarized as follows:
Three Months Ended Sept. 30, Nine Months Ended Sept. 30,
---------------------------- ---------------------------
2006 2005 2006 2005
------------ ------------ ------------ ------------
Revenues
United States $ 5,292,158 $ 4,868,531 $ 22,751,676 $ 10,162,922
Canada 1,660,253 2,500,052
Central and
South America 3,046,713 365,239 6,790,067 893,791
Other locations 5,960 3,999,660 298,990 10,633,547
------------ ------------ ------------ ------------
$ 10,005,084 $ 9,233,430 $ 32,340,785 $ 21,690,260
============ ============ ============ ============
NOTE: Prior to 2006, the Company reported all United States and Canadian revenue
as a single line item under the caption North America. As such, the breakout
between US and Canadian revenue is not available. The 2005 revenue reported as
US revenue includes sales to Canada.
15
c. During the quarter ended June 30, 2006, the Company began calculating net
revenue by product line for financial reporting purposes. 2006 sales by product
line are as follows:
Three Months Ended Sept. 30, Nine Months Ended Sept. 30,
---------------------------- -----------------------------
2006 2005 2006 2005
---------- ---------- ---------- ----------
Revenues
Consumer
Electronics $ 7,803,431 NOT $27,093,098 NOT
Computer
Products 1,760,853 AVAILABLE 4,862,719 AVAILABLE
VOIP 440,800 384,968
----------- -----------
$10,005,084 $32,340,785
=========== ===========
d. 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 25% of any products sold in 2006 will be produced by
one vendor.
6. Income Taxes
The Company has calculated federal and state income taxes due for the nine-month
period ended September 30, 2006. The Company believes that federal income tax
due for this period is offset by federal net operating loss carryforward which
had a balance of $4,500,000 as of December 31, 2005, expiring in various years
through 2024. The Company believes that any state income taxes due for the nine
month period ending September 30, 2006 would be offset by state net operating
loss carryforwards, and that if any balance were due, the amount would be
immaterial to this report. For the nine-month period ended September 30, 2005,
the Company believes that all income taxes due are offset by federal and state
net operating loss carryforwards. The state net operating loss carryforward of
$157,000 has been reduced to $0 as of September 30, 2006. No deferred tax
benefit for the remaining federal operating losses has been recognized in the
consolidated financial statements due to the uncertainty as to their
realizability in future periods.
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 September 30,
2006 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 September 30, 2006 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.
16
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. 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 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".
In 2004, the Company decided to make a significant change in the core offerings
for sale. The emphasis switched from motherboards and hardware to peripherals,
leading to a more diverse product offering. Also in 2004, the Company introduced
its VoIP products. In 2005, SOYO Group, Inc. entered the LCD display market with
the introduction of 17- and 19-inch LCD monitors, and 32 and 37 inch LCD
televisions. Both products were introduced in the second quarter of 2005.
Currently, 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.
Financial Outlook:
On August 29, 2006, the Company issued a press release announcing a
multi-million dollar agreement with GE Capital Solutions to provide both
manufacturing and retailer finance options. The agreement is the first major
financing commitment the Company has secured. The Company continues to negotiate
with outside parties to secure additional financing and product commitments.
Since October 24, 2002, the date that SOYO Nevada became a wholly-owned
subsidiary of VWHC, SOYO has attempted to implement various measures designed to
improve its operating results, cash flows and financial position, including the
following:
- The Company has changed its product mix substantially in the past two
years, and has changed its sales plan to focus on higher margin products.
17
- The Company has expanded the number and credit quality of its customer
accounts.
- The Company is negotiating with additional suppliers, but the ability to
buy goods from those suppliers is reliant on cash flows.
- The Company moved its office and warehouse operations into a larger, more
efficient facility in September 2003.
- The Company is attempting to increase its operating liquidity by exploring
the availability of outside debt and equity financing; to the extent such
funding is available under reasonable terms and conditions.
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:
Firm agreements with 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
18
incentive is offered. The Company records the corresponding effect in cost or
expense at the time it has a firm agreement with a vendor.
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. The Company records
the corresponding effect on receivable and revenue when the Company offers the
incentive to customers. All accruals estimating sales incentives, warranties,
rebates and returns are based on historical experience and the Company
management's collective experience in anticipating customers actions. These
amounts are reviewed and updated each month when financial statements are
generated.
Complicating these estimates is the Company's different return policies. The
Company does not accept returns from customers for refunds, but does repair
merchandise as needed. The cost of the shipping and repairs may be borne by the
customer or the Company, depending on the amount of time that has passed since
the sale and the product warranty.
The Company has different return policies with different customers. While the
Company does not participate in "guaranteed sales" programs, the Company has
begun to sell products to several national retail chains. Some of these chains
have standard contracts which require the Company to accept returns for credit
within standard return periods, usually sixty days. While these return policies
are more generous than the Company usually offers, management has made the
decision to accept the policies and sell the products to these national chains
for both the business volume and exposure such sales generate. These sales have
been taking place since late 2005, and returns have consistently been below
management's expectations. Therefore, no adjustments to the financial statements
have been necessary.
Each month, management reviews the accounts receivable aging report and adjusts
the allowance for bad debts based on that review. The adjustment is made based
on historical experience and management's evaluation of the collectibility of
outstanding accounts receivable over 90 days. At all times, the allowance for
bad debts is large enough to cover all receivables that management is not
certain it will collect, plus another one percent of the net accounts
receivable. At September 30, 2006, the allowance was $256,203. Since the net A/R
balance was approximately $7.0 million, the amount the Company considered
uncollectible was under $180,000.
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.
19
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.
Prior Year's Purchases and Discounts
Soyo negotiated with its suppliers for discounts and allowances related to
purchases made in 2004. Soyo and its suppliers settled their differences in
2005. Soyo accounted in 2005 for the settlement as a gain contingency, in
accordance with FAS 5, Accounting for Contingencies.
Soyo also accounted in 2005 for its settlement with suppliers of discounts and
allowances as a reduction of cost of goods sold because purchase discounts and
allowances are of a "character typical of the customary business activities of
the entity" in accordance with APB 9, as amended by APB 30, Reporting the
Results of Operations--Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions.
Results of Operations:
Three Months Ended September 30, 2006 and 2005:
Net Revenues. Net revenues increased by $771,654 or 8.4%, to $10,005,084 in the
three months ended September 30, 2006, as compared to $9,233,430 in 2005. The
increase in the net revenues was due to the Company's strong sales of consumer
electronics. The Company began to sell the LCD products during the second
quarter of 2005, and in the past year has greatly expanded its distribution
channel. The Company continues to sell products to new customers. Customers who
bought products from the Company in the three months ended September 30, 2006
that had not previously purchased our products included 4Sure.com, Shop NBC,
Time Import Corporation, Boston Inc. and DBL Distributing, Inc.
Gross Margin. Gross margin was $2,233,361 or 22.3% in 2006, as compared to
$206,771 or 2.2% in 2005. The increase in the gross margin as a percentage of
sales can be attributed entirely to the consumer electronics products, which
were sold at a high margin. The Company believes that gross margins will
stabilize around 16% in the future.
Sales and Marketing Expenses. Selling and marketing expenses decreased by
$24,987 to $231,272 in 2006, as compared to $256,259 in 2005. The decrease is
entirely due to the Company sponsoring fewer sales programs in 2006. The market
demand is strong enough that large rebate programs and other sales incentives
are not needed to generate sales.
General and Administrative Expenses. General and administrative expenses
increased by $540,941 to $1,427,441 in 2006, as compared to $886,500 in 2005.
The increase can be explained by three distinct factors.
The first factor in the increased G&A costs was the Company's mandatory
implementation of SFAS No. 123(R). In December 2004, the FASB issued Statement
of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment
20
("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) was effective for public
companies at the beginning of the first fiscal year that begins after June 15,
2005.
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 $126,924 for the three months ended September 30,
2006.
The second factor leading to increased costs during the quarter were legal fees.
The Company's fees for legal expenses rose by $141,000 during the quarter. The
fees were due to work performed on the Normandan case (see legal proceedings)
and additional work done for state regulators regarding the Company's rebate
programs.
The 3rd factor that led to increased costs during the quarter is increased use
of consultants and contractors. The Company's business is growing rapidly, and
the Company is actively searching for additional financing opportunities. The
Company has also begun to set up quality control checkpoints in Asia to ensure
that all goods purchased meet Company quality requirements. Lastly, the Company
has hired a consultant to review and evaluate the Company's sales efforts and
efficiency. Taken together, the Company spent over $100,000 during the quarter
on these projects, but management believes the efforts are required to manage
the Company's growth.
These three items accounted for over $400,000 additional expenses over the
comparable quarter in 2005.
Provision for Doubtful Accounts. The Company recorded a provision for doubtful
accounts of $20,635 in the three months ended September 30, 2006. The Company
did not record a provision for doubtful accounts for the three months ended
September 30, 2005. As of September 30, 2006, the Company believes its provision
for doubtful accounts is adequate.
Depreciation and Amortization. Depreciation and amortization of property and
equipment was $27,107 for the three months ended September 30, 2006, as compared
to $8,653 in 2005. The increase is a result of the use of leasehold improvements
provided by the landlord after the move from Fremont to Ontario, CA, and
depreciable assets purchased in December 2005 in China for the VoIP business.
Income from Operations. The income from operations was $526,906 for the three
months ended September 30, 2006, as compared to a loss from operations of
$944,641 for the three months ended September 30, 2005. This is a result of the
improved sales volume and strong operating margins described above.
Miscellaneous Income. Miscellaneous income was a loss of $6,399 for the three
months ended September 30, 2006. Miscellaneous income was $600,000 in the three
months ended September 30, 2005.
Interest Income. The Company earned no interest income in the three months ended
September 30, 2006. Interest income in 2005 was $1,202.
21
Interest Expense. Interest expense was $200,939 for the three months ended
September 30, 2006. Interest expense was $36,353 for the three months ended
September 30, 2005. The increase was due to several factors. The Company is
factoring all receivables to improve cash flow and has also entered into a new
financing arrangement with GE Capital. Both of these programs are extremely
expensive, but were necessary to guarantee the uninterrupted flow of goods from
our suppliers overseas.
Provision for Income Taxes. There was no provision for income taxes in 2006 or
in 2005.
Net Income. Net income was $319,568 for the three months ended September 30,
2006, as compared to a loss of $362,192 for the three months ended September 30,
2005.
Nine Months Ended September 30, 2006 and 2005:
Net Revenues. Net revenues increased by $10,650,525 or 49.1%, to $32,340,785 in
2006, as compared to $21,690,260 in 2005. The large increase in the net revenues
was due entirely to the Company's consumer electronics business. Sales of LCD
televisions exceeded $5,000,000 during the quarter, and sales of LCD monitors
exceeded $2,600,000 during the quarter.
Gross Margin. Gross margin was $6,191,202 or 19.1% for the nine months ended
September 30, 2006, as compared to $1,483,676 or 6.8% in 2005. The 2005 gross
margin was negatively affected by the settlement of a dispute with a vendor,
resulting in large returns during the period that depressed the gross margin.
The Company believes that as the LCD market becomes more mature, gross margin is
likely to stabilize in the 15-16% range.
Sales and Marketing Expenses. Selling and marketing expenses increased by $8,533
to $628,286 in 2006, as compared to $619,753 in 2005. The increase of
approximately 1% is insignificant. The Company has added sales representatives
and spent additional funds on travel to customers and road shows, but those
costs have been offset by reduced costs of direct sales incentive plans.
General and Administrative Expenses. General and administrative expenses
increased by $1,480,290 to $4,182,118 in 2006, as compared to $2,701,828 in
2005. The increase is primarily due to five factors.
First, the cost of the annual audit increased by approximately $75,000 over the
prior year. The increase was primarily due to the Company's untimely loss of
accounting personnel as described in Item 9A of report 10K dated December 31,
2005. The Company believes the problem has been solved, and expects that the
cost of future audits will be in line with prior years.
Second, 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
alleged 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 sought
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
sought to recover all costs and attorney fees. The case arose from a consultant
who worked for the Company in 2004 and whose contract was not renewed. During
22
the second quarter, the Company settled the case for $70,000, which it believed
to be less than the cost of the upcoming trial. As a result, the entire
settlement amount was accrued and expensed during the quarter, and the legal
fees spent preparing for the case were paid and expensed during the period as
well.
The third factor leading to increased costs during the nine months were a large
increase in other legal fees. The Company's fees for legal expenses rose by
$141,000 during the 3rd quarter alone. The fees were due to work performed on
the Normandan case (see legal proceedings) and additional work done for state
regulators regarding the Company's rebate programs.
The 4th factor that led to increased costs during the year is increased use of
consultants and contractors. The Company's business is growing rapidly, and the
Company is actively searching for additional financing opportunities. The
Company has also begun to set up quality control checkpoints in Asia to ensure
that all goods purchased meet Company quality requirements. Lastly, the Company
has hired a consultant to review and evaluate the Company's sales efforts and
efficiency. Taken together, the Company spent over $100,000 during the 3rd
quarter on these projects, and has spent almost $200,000 in the first three
quarters of the fiscal year. Management believes the efforts are required to
manage the Company's growth.
The biggest factor in the increased G&A costs was the Company's mandatory
implementation of SFAS No. 123(R). 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) was effective for public
companies at the beginning of the first fiscal year that begins after June 15,
2005.
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,
$121,573 for the three months ended June 30, 2006, and $126,924 for the three
months ended September 30,2006. The complete effect of the adoption was a non
cash charge against earnings of approximately $380,000 over the nine month
period.
Provision for Doubtful Accounts. The Company recorded a provision for doubtful
accounts of $123,819 for the nine months ended September 30, 2006. The Company
recorded a provision for doubtful accounts of $34,513 for the nine months ended
September 30, 2005.The increase in the provision is directly attributable to the
large sales increase, and the Company's conservative approach. The Company
believes that the provision for doubtful accounts is sufficient as of September
30, 2006.
Depreciation and Amortization. Depreciation and amortization of property and
equipment was $79,496 for the nine months ended September 30, 2006, as compared
to $26,740 in 2005. The increase is a result of the purchase of depreciable
equipment in December 2005 in China for the VoIP business.
23
Income from Operations. The income from operations was $1,177,483 for the nine
months ended September 30, 2006, as compared to a loss from operations of
$1,899,158 for the nine months ended September 30, 2005. This is a direct result
of the increased sales volumes and strong margins.
Miscellaneous Income. Miscellaneous income was a loss of $1,115 for the nine
months ended September 30, 2006.
Interest Income. Interest income was $6,607 for the nine months ended September
30, 2006, as opposed to $1,202 in 2005.
Interest Expense. Interest expense was $351,408 for the nine months ended
September 30, 2006. Interest expense was $59,731 for the nine months ended
September 30, 2005. The increase was due to several factors. The Company has
been aggressively borrowing funds on a short term basis as needed to support its
growth. The Company is factoring all receivables to improve cash flow and has
entered into a long term financing arrangement with GE Capital. Both of these
programs were necessary to guarantee the uninterrupted flow of goods from our
suppliers overseas. The sale of all invoices is done with recourse, which means
that if the factor is not paid, they can charge back the Company for the unpaid
invoice plus interest.
Provision for Income Taxes. There was no provision for income taxes in 2006 or
in 2005.
Net Income. Net income was $831,567 for the nine months ended September 30,
2006, as compared to $126,601 for the nine months ended September 30, 2005. The
2006 numbers include the charges for the adoption of SFAS 123R. Looking at the
numbers on a comparable basis, the 2006 numbers are significantly better, which
is a result of strong sales volume and strong operating margins.
Financial Condition - September 30, 2006:
Liquidity and Capital Resources:
On August 29, 2006, the Company issued a press release announcing a
multi-million dollar agreement with GE Capital Solutions to provide both
manufacturing and retailer finance options. The agreement is the first major
financing commitment the Company has secured. The Company continues to negotiate
with outside parties to secure financing and product commitments.
Operating Activities. The Company generated cash of $749,407 in operating
activities during the nine months ended September 30, 2006, as compared to
utilizing cash of $4,405,339 in operating activities during the nine months
ended September 30, 2005.
At September 30, 2006, the Company had cash and cash equivalents of $1,355,869,
as compared to $828,294 at December 31, 2005.
The Company had working capital of $1,583,930 at September 30, 2006, as compared
to working capital of $689,141 at December 31, 2005, resulting in current ratios
of 1.13:1 and 1.04:1 at September 30, 2006 and December 31, 2005, respectively.
Accounts receivable decreased to $7,003,019 at September 30, 2006, as compared
to $7,278,520 at December 31, 2005, a decrease of $275,501. The Company's
provision for doubtful accounts stood at $256,203 as of September 30, 2006, as
compared to $589,224 at December 31, 2005.
Inventories decreased to $5,151,859 at September 30, 2006, as compared to
$7,991,030 at December 31, 2005, a decrease of $2,839,171 or 35.5%. As detailed
24
in this report, the Company signed a financing agreement during the quarter with
GE Capital Solutions for the financing of inventory. The Company continues to
negotiate with outside parties to establish credit lines for inventory
purchasing.
Accounts payable decreased to $11,544,635 at September 30, 2006, as compared to
$13,977,579 at December 31, 2005, a decrease of $2,432,944, as a direct result
of reduced inventory purchases. The decrease in payables is comparable to the
decrease in inventory levels as older purchases were paid for and newer purchase
volumes declined.
Accrued liabilities decreased to $282,182 at September 30, 2006, as compared to
$1,287,108 at December 31, 2005, a decrease of $1,004,926 or 78%. The main
reason for the decrease is reduced accruals for RMA returns. Now that the
Company has been selling the LCD products for a full year, the Company has a
track record at estimating returns and repairs. The Company believes its current
accruals are sufficient to handle all expected returns and reserves.
Financing Activities. In October 2005, the Company borrowed $165,000 from an
individual for working capital purposes. As of September 30, 2006, $100,000 is
owed to that individual.
Principal Commitments:
A summary of the Company's contractual cash obligations as of September 30, 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 $ 456,748 $ 212,692 $ 244,056 $ -- $ --
Note payable 100,000 100,000 -- -- --
Purchase Commitments 2,682,012 2,682,012 -- -- --
Total contractual cash
obligations $3,238,760 $2,994,704 $ 244,056 $ -- $ --
---------- ---------- ---------- --------- --------
Purchase Commitments:
At September 30, 2006, the Company had purchased inventory costing $2,682,012
that had not yet arrived in the warehouse. The Company had no other long-term or
short-term purchase commitments.
Off-Balance Sheet Arrangements:
At September 30, 2006, the Company did not have any transactions, obligations or
relationships that could be considered off-balance sheet arrangements.
Commitments and Contingencies:
At September 30, 2006, the Company did not have any material commitments for
capital expenditures.
25
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
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.
26
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 $383,449 for the nine months ended September 30,
2006.
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 September 30, 2006 are primarily short-term
in nature and non-interest bearing, the Company does not have any risk from an
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
Evaluation of Disclosure and Control Procedures
-----------------------------------------------
Based on a current evaluation under the supervision and with the participation
of the Company's management, the Company's principal executive officer and
principal financial officer have concluded that the Company's disclosure
27
controls and procedures as defined in rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended (Exchange Act) were not effective as
of September 30, 2006 and did not ensure that information required to be
disclosed by the Company in reports that it files or submits under the Exchange
Act is (i) recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission rules and forms and (ii)
accumulated and communicated to the Company's management, including its
principal executive officer and principal financial officer, as appropriate to
allow timely decisions regarding required disclosure. Based on that evaluation,
that as of such date, 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 the fact that the
Company's system of internal control requires considerable manual intervention
to do the following: (1) to properly record accounts payable to vendors for
purchases of inventory, (2) to properly record adjustments to inventory per the
general ledger to physical inventory balances, (3) to properly record inventory
adjustments to the lower of cost or market using the average inventory method,
(4)to have adequate controls over interim physical inventory procedures, and 5)
to 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
relevant contemporaneous documentation for ongoing business transactions, and
significant turnover in the Company's financial staff. 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
period ended September 30, 2006.
A significant deficiency should be classified as a material weakness if, by
itself or in combination with other control deficiencies, it results in more
than a remote likelihood that a material misstatement in the company's annual or
interim financial statements will not be prevented or detected.
To address these significant deficiencies and material 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 September 30, 2006, the Company is operating without an Accounting
Manager or Controller. While the Company is searching for a
replacement, the Company has 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. The Company needs and is
seeking to immediately hire an Accounting Manager and additional
personnel to focus on financial accounting and reporting issues.
>> Each month, the Company's Accounting Manager supervises the
reconciliation of the accounts payable subsidiary ledgers with the
general ledger, and approves adjustments to inventory based on
reconciliation of the general ledger to physical inventory counts.
Each quarter, the Accounting Manager records inventory adjustments to
28
the lower of cost or market. These tasks will be supervised by the
financial consultant until the new Accounting Manager is hired.
>> Every month, the Accounting Manager reconciles the bank accounts and
compares the bank reconciliation with the balance per general ledger
and the daily cash report, reviews the recording of accounts payable
to vendors for purchases of inventory, and prepares financial
statements with a complete set of adjustments. These tasks will be
supervised by the financial consultant until the new Accounting
Manager is hired.
>> A complete inventory is physically counted and reconciled at the end
of every month.
Changes in Internal Control over Financial Reporting
----------------------------------------------------
We made changes during our most recently completed fiscal quarter in our
internal control over financial reporting that have materially affected , or are
reasonably likely to materially affect, our internal control over financial
reporting.
In light of the foregoing, in 2006, management took the following actions to
rectify the significant deficiencies and material weaknesses 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 Company has been
testing and customizing the software for the last few months, and
expects that the software will be installed and operational during the
first quarter of 2007.
In conjunction with the audit review of the Company's financial statements for
the quarter ended September 30, 2006, 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 September 30, 2006, the Company is working quickly to hire 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, all significant
deficiencies will have been addressed and corrected.
29
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
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.
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 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
None
30
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: November 14, 2006 By: /s/ Ming Tung Chok
-----------------------
Ming Tung Chok
President and Chief
Executive Officer
DATE: November 14, 2006 By: /s/ Nancy Chu
-----------------------
Nancy Chu
Chief Financial Officer
DATE: November 14, 2006 By /s/ Paul F. Risberg
--------------------------
Name: Paul F. Risberg
Title: Director
DATE: November 14, 2006 By /s/ Chung Chin Keung
--------------------------
Name: Chung Chin Keung
Title: Director
DATE: November 14, 2006 By /s/ Zhi Yang Wu
--------------------------
Name: Zhi Yang Wu
Title: Director
31
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
32