In preparing these financial statements, the Company evaluated the events and transactions that occurred from April 1, 2011 through May 15, 2011, the date these financial statements were issued. The Company has made the required additional disclosures in reporting periods in which subsequent events occur.
The Company is dependent on a single vendor, Samsung, to supply the majority of its inventories. This vendor accounted for the majority of the Company’s purchases for 2010. The Company’s non-exclusive distributorship agreement with this vendor has a one-year term. This agreement has been renewed more than ten times, most recently on March 1, 2010 and expired on February 28, 2011. As of March 1, 2011, this vendor has confirmed the annual renewal of such agreement for one year. The Company has already signed the renewal agreement and is waiting to receive the fully executed agreement from Samsung. Termination of such distributorship agreement by this vendor would have a material adverse effect on the operations of the Company.
PART I – FINANCIAL INFORMATION
ACL SEMICONDUCTORS INC. AND SUBSIDIARIES
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion highlights the principal factors that have affected our financial condition and results of operations as well as our liquidity and capital resources for the periods described.
The information contained in this Form 10-Q is intended to update the information contained in our annual report on Form 10-K for the year ended December 31, 2010, (the “Form 10-K”), filed with the Securities and Exchange Commission, and presumes that readers have access to, and will have read, the “Management’s Discussion and Analysis of Financial Condition and Results of Operation,” our consolidated financial statements and the notes thereto, and other information contained in the Form 10-K. The following discussion and analysis also should be read together with our condensed consolidated financial statements and the notes to the condensed consolidated financial statements and the notes thereto included elsewhere in this Form 10-Q.
Forward-Looking Statements
Information included in this Form 10-Q may contain forward-looking statements. Except for the historical information contained in this discussion of the business and the discussion and analysis of financial condition and results of operations, the matters discussed herein are forward looking statements. These forward looking statements include but are not limited to the Company’s plans for sales growth and expectations of gross margin, expenses, new product introduction, and the Company’s liquidity and capital needs. This information may involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by any forward-looking statements. Forward-looking statements, which involve assumptions and describe our future plans, strategies and expectations, are generally identifiable by use of the words “may,” “will,” “should,” “expect,” “anticipate,” “estimate,” “believe,” “intend” or “project” or the negative of these words or other variations on these words or comparable terminology. In addition to the risks and uncertainties described in “Risk Factors” contained in the Form 10-K, these risks and uncertainties may include consumer trends, business cycles, scientific developments, changes in governmental policy and regulation, currency fluctuations, economic trends in the United States and inflation. Forward-looking statements are based on assumptions that may be incorrect, and there can be no assurance that any projections or other expectations included in any forward-looking statements will come to pass. Our actual results could differ materially from those expressed or implied by the forward-looking statements as a result of various factors. Except as required by applicable laws, we undertake no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.
Company Overview and Background
The Company, through its wholly-owned subsidiary Atlantic Components Limited, a Hong Kong corporation (“Atlantic”), is engaged primarily in the business of distribution of memory products under “Samsung” brand name which principally comprise DRAM, Graphic RAM and Flash for the Hong Kong and Southern China markets. Our wholly-owned subsidiary, Alpha Perform Technology Limited (“Alpha”), which previously engaged in this business, ceased activities as of January 1, 2004, and all its operations were consolidated with those of Atlantic.
On March 23, 2010, the Company concluded that Aristo is a variable interest entity under FASB ASC 810-10-25 and is therefore subject to consolidation with the Company beginning fiscal year 2007 under the guidance applicable to variable interest entities.
Aristo is engaged in the marketing, selling and servicing of computer products and accessories including semiconductors, LCD products, mass storage devices, consumer electronics, computer peripherals and electronic components for different generations of computer related products. In addition to Samsung-branded products, Aristo sells Hynix, Micron, Elpida, Qimonda, Lexar, Dane-Elec, Elixir, SanDisk and Winbond branded products. Aristo will provide value-added services to its products and resell it to its customers.
On December 14, 2010, the Company set up a wholly-owned subsidiary, ACL International Holdings Limited (“ACL Holdings”) in Hong Kong. On December 17, 2010 the Company restructured the group; the Company’s wholly owned subsidiary, Atlantic, was transferred to become a wholly owned subsidiary of ACL Holdings, therefore Atlantic became an indirect wholly-owned subsidiary of the Company. This restructuring has no effect on the Company’s financial statements.
26
PART I – FINANCIAL INFORMATION
ACL SEMICONDUCTORS INC. AND SUBSIDIARIES
As of March 31, 2011, ACL had more than 150 customers in Hong Kong and Southern China.
ACL is in the mature stage of operations. As a result, the relationships between sales, cost of sales, and operating expenses reflected in the financial information included in this document to a large extent represent future expected financial relationships. Many of the cost of sales and operating expenses reflected in our financial statements are recurring in nature.
Overview
Net sales
Net sales for the three months ended March 31, 2011 (“first quarter of 2011”) were $120,991,594, up $21,980,532 or 22.2% from the three months ended March 31, 2010 (“first quarter of 2010”). This compares favorably to the global semiconductor market where sales in the first quarter of 2011 were up only 8.6% compared to the first quarter of 2010. Growth in net sales provides higher rebate income from Samsung. This increase in net sales was largely due to renewed demand from consumers and businesses for electronics, and an associated increase in the average semiconductor content within those products. The company expects this demand growth to continue.
The Company’s gross profit for the first quarter of 2011 was $2,940,131, representing an increase of $113,527 or 4.0% over $2,826,604 in the same period of 2010. First quarter gross profit margin for 2011 eased to 2.43% from 2.85% in 2010. These results are due to increasing costs of sale associated with the Company’s continued focus on the promotion of Samsung’s high density NAND Flash (4GB and above), which has greatly increased our sales volume but lowered our profit margin. Additionally, semiconductor average selling prices, particularly DRAM, had been low in the first quarter of 2011, preceding the Japan earthquake, following robust inventories in 2010 and seasonality effects.
Income before income taxes for the three months ended March 31, 2011 was down $131,928 or 7.8% to $1,565,114 from $1,697,042 for three months ended March 31, 2010. This was largely due to an increase in general and administrative expenses to $1,308,539 in the three months ended March 31, 2011 from $1,057,869 in the three months ended March 31, 2010. This increase in general and administrative expense was mainly due to directors’ remuneration and entertainment expenses. The Company recorded a net income of $1,372,806 for the three months ended March 31, 2011, down $68,170 or 4.7% from $1,440,976 in the three months ended March 31, 2010.
The Company anticipates increased revenue from NAND Flash in 2011, due particularly to the rapidly expanding smartphone and tablet markets. However, we suspect this revenue increase may be offset by slightly reduced revenue from DRAM, as despite also benefiting from growth throughout the consumer electronics markets, average selling prices of DRAM were in steady decline preceding the March 11, 2011 Japan earthquake.
The biggest impact of the March 11, 2011 Japan earthquake on the global semiconductor market has been the increasing average selling prices of DRAM. Supply chain disruption in parts of Japan has created a threat of semiconductor supply shortages; Japan is the world’s leading producer of the silicon wafers required to produce semiconductors. Wafer output has been significantly reduced and if this persists, a supply shortage of DRAM may occur potentially by October, further increasing DRAM prices. The Japan earthquake is estimated to have caused a 1.1% reduction in global DRAM shipments in April and the second half of March.
The Company’s supply of semiconductors from Samsung has not been affected by the March 11, 2011 Japan earthquake. Neither has the Company experienced a reduction in demand for its products from its customers located in southern China and Hong Kong. Stabilization of infrastructure and continued recovery efforts in Japan have mitigated some of the impact that the March 11, 2011 Japan earthquake could have had on the global semiconductor market.
27
PART I – FINANCIAL INFORMATION
ACL SEMICONDUCTORS INC. AND SUBSIDIARIES
Cost of sales
Cost of sales consists of costs of goods purchased from Samsung, and purchases from other Samsung authorized distributors. Many factors affect our gross margin, including, but not limited to, the volume of production orders placed on behalf of its customers, the competitiveness of the memory products industry and the availability of cheaper Samsung memory products from overseas Samsung distributors due to regional demand and supply situations. Nevertheless, our procurement operations are supported by Samsung pursuant to a distributorship agreement between the Company and Samsung. Our cost of goods, as a percentage of total revenues, amounted to approximately 97.5% for the three months March 31, 2011 and approximately 97.1% for the three months ended March 31, 2010. This 2.3% reduction was due to the promotion of high density NAND flash memory which provided a very low profit margin with high turnover value.
Operating expenses
Our operating expenses for the three months ended March 31, 2011 and 2010 were comprised of sales and marketing and general and administrative expenses only.
Sales and marketing expenses consisted primarily of costs associated with advertising and marketing activities.
General and administrative expenses include all corporate and administrative functions that serve to support our current and future operations and provide an infrastructure to support future growth. Major items in this category include management and staff salaries, rent/leases, professional services, and travel and entertainment. We expect these expenses to increase as a result of increasing legal and accounting fees anticipated in connection with our compliance with ongoing reporting and accounting requirements of the Securities and Exchange Commission and as a result of anticipated expansion by the Company of its business operations. Sales and marketing expenses are expected to fluctuate as a percentage of sales due to the addition of sales personnel and various marketing activities planned throughout the year.
Interest expense, including finance charges, relates primarily to the Company’s short-term and long-term bank borrowings.
Results of Operations
| | | | | | | |
| | Three Months Ended | |
| | March 31, 2011 | | March 31, 2010 | |
| | | | | | | |
Net sales | | $ | 120,991,594 | | $ | 99,011,062 | |
| | | | | | | |
Cost of sales | | | 118,051,463 | | | 96,184,458 | |
| |
|
| |
|
| |
| | | | | | | |
Gross profit | | | 2,940,131 | | | 2,826,604 | |
| | | | | | | |
Operating expenses | | | | | | | |
Selling | | | 22,330 | | | 24,802 | |
General and administrative | | | 1,308,539 | | | 1,057,869 | |
| |
|
| |
|
| |
| | | | | | | |
Income from operations | | | 1,609,262 | | | 1,743,933 | |
| | | | | | | |
Other income (expenses) | | | (44,148 | ) | | (46,891 | ) |
| |
|
| |
|
| |
| | | | | | | |
Income before income taxes provision | | | 1,565,114 | | | 1,697,042 | |
| | | | | | | |
Income taxes provision | | | (192,308 | ) | | (256,066 | ) |
| |
|
| |
|
| |
| | | | | | | |
Net income | | | 1,372,806 | | $ | 1,440,976 | |
| |
|
| |
|
| |
| | | | | | | |
Earnings per share – basic and diluted | | | 0.05 | | $ | 0.05 | |
| |
|
| |
|
| |
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PART I – FINANCIAL INFORMATION
ACL SEMICONDUCTORS INC. AND SUBSIDIARIES
Unaudited Comparisons for Three Months ended March 31, 2011, to the Three Months Ended March 31, 2010
Net Sales
The following table presents our net sales for the three months ended March 31, 2011 and 2010, respectively:
| | | | | | | | |
Three Months Ended March 2011, | | | |
2011 | | 2010 | | % Change | |
| |
| |
| |
| | | | | | | | |
$ | 120,991,594 | | $ | 99,011,062 | | | 22.2 | % |
Net sales increased by $21,980,532 or 22.2%, from $99,011,062 for the three months ended March 31, 2010 to $120,991,594 in the three months ended March 31, 2011. This increase in net sales was largely due to renewed demand from consumers and businesses for electronics, and an associated increase in the average semiconductor content within those products.
Cost of sales
The following table presents our cost of sales for the three months ended March 31, 2011 and 2010, respectively:
| | | | | | | | |
Three Months Ended March 2011, | | | |
2011 | | 2010 | | % Change | |
| |
| |
| |
| | | | | | | | |
$ | 118,051,463 | | $ | 96,184,458 | | | 22.7 | % |
Cost of sales increased by $21,867,005, or 22.7%, from $96,184,458 for the three months ended March 31, 2010 to $118,051,463 for the three months ended March 31, 2011. The increase was mainly due to increase of sales volume and higher cost of sales.
Gross Profit
The following table presents our gross profit for the three months ended March 31, 2011 and 2010, respectively:
| | | | | | | | |
Three Months Ended March 2011, | | | |
2011 | | 2010 | | % Change | |
| |
| |
| |
| | | | | | | | |
$ | 2,940,131 | | $ | 2,826,604 | | | 4.0 | % |
Gross profit increased by $113,527, or 4%, from $2,826,604 for the three months ended March 31, 2010 to $2,940,131 for the three months ended March 31, 2011. Although we experienced a significant increase in net sales during the first quarter of 2011 when compared to the same period in 2010, this did not result in a corresponding increase in gross profit. This result is due to increasing costs of sale associated with the Company’s continued focus on the promotion of Samsung’s high density NAND Flash (4GB and above), which has greatly increased our sales volume but lowered our profit margin.
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PART I – FINANCIAL INFORMATION
ACL SEMICONDUCTORS INC. AND SUBSIDIARIES
Sales and MarketingExpenses
The following table presents the sales and marketing expenses for the three months ended March 31, 2011 and 2010, respectively:
| | | | | | | | |
Three Months Ended March 2011, | | | |
2011 | | 2010 | | % Change | |
| |
| |
| |
| | | | | | | | |
$ | 22,330 | | $ | 24,802 | | | -10.0 | % |
For the three months ended March 31, 2011, sales and marketing expenses decreased $2,472, or 10%, as compared to the three months ended March 31, 2010. The decrease was directly attributable to effective controlling of transportation expenses during the first quarter 2011.
General and AdministrativeExpenses
The following table presents the general and administrative expenses for the three months ended March 31, 2011 and 2010, respectively:
| | | | | | | | |
Three Months Ended March 2011, | | | |
2011 | | 2010 | | % Change | |
| |
| |
| |
| | | | | | | | |
$ | 1,308,539 | | $ | 1,057,869 | | | 23.7 | % |
For the three months ended March 31, 2011, general and administrative expenses increased $250,670, or 23.7%, as compared to the three months ended March 31, 2010. This increase was principally attributable to an increase in directors’ remuneration and entertainment expenses.
Income from Operations
The following table presents the income from operations for the three months ended March 31, 2011 and 2010, respectively:
| | | | | | | | |
Three Months Ended March 2011, | | | | |
2011 | | 2010 | | % Change | |
| |
| |
| |
| | | | | | | | |
$ | 1,609,262 | | $ | 1,743,933 | | | -7.7 | % |
Income from operations for the three months ended March 31, 2011 decreased by $134,671, or 7.7%, from $1,743,933for the three months ended March 31, 2010 to $1,614,819 in the three months ended March 31, 2011. Such decrease was mainly due to an increase of general and administrative expenses which decreased our gross margin.
Interest Income
The following table presents the interest income for the three months ended March 31, 2011 and 2010, respectively:
| | | | | | | | |
Three Months Ended March 2011, | | | |
2011 | | 2010 | | % Change | |
| |
| |
| |
| | | | | | | | |
$ | 451 | | $ | 93 | | | 384.9 | % |
For the three months ended March 31, 2011, interest income increased $358 or 384.9%, as compared to the three months ended March 31, 2010. This increase was due to increase of average bank balance when compared to the same period in 2010.
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PART I – FINANCIAL INFORMATION
ACL SEMICONDUCTORS INC. AND SUBSIDIARIES
Interest Expense
The following table presents the interest expense for the three months ended March 31, 2011 and 2010, respectively:
| | | | | | | | |
Three Months Ended March 2011, | | | |
2011 | | 2010 | | % Change | |
| |
| |
| |
| | | | | | | | |
$ | 108,781 | | $ | 95,164 | | | 14.3 | % |
For the three months ended March 31, 2011, interest expense increased by $13,617 or 14.3%, from $95,164 in the three months ended March 31, 2010 to $108,781 in the three months ended March 31, 2011. These increases were mainly due to an increase in the use of letters of credit to obtain goods from suppliers.
Net Income on Cash Flow Hedge
The following table presents the net income on cash flow hedge for the three months ended March 31, 2011 and 2010, respectively:
| | | | | | | | |
Three Months Ended March 2011, | | | |
2011 | | 2010 | | % Change | |
| |
| |
| |
| | | | | | | | |
$ | — | | $ | 15,410 | | | -100.0 | % |
For the three months ended March 31, 2011, income on cash flow hedge decreased by $15,410, or 100%, as compared to the three months ended March 31, 2010. The decreases were due to all currency hedging contracts had matured in the first quarter of 2010.
Income Tax Provision
The following table presents the income tax provision for the three months ended March 31, 2011 and 2010, respectively:
| | | | | | | | |
Three Months Ended March 2011, | | | | |
2011 | | 2010 | | % Change | |
| |
| |
| |
| | | | | | | | |
$ | 192,308 | | $ | 256,066 | | | -24.9 | % |
Income tax provision decreased by $63,758 or 24.9% from $256,066 for the three months ended March 31, 2010 to $192,308 for the three months ended March 31, 2011. The decrease was due to a decrease in the estimated Hong Kong taxes payable by Atlantic.
Liquidity and Capital Resources
Our principal sources of liquidity have been cash from operations, bank lines of credit and credit terms from suppliers. Our principal uses of cash have been for operations and working capital. We anticipate these uses will continue to be our principal uses of cash in the future.
As of March 31, 2011, we had revolving lines of credit and loan facilities in the aggregate amount of $20,794,541, of which $5,195,736 was available for drawdown as short-term loans repayable within 90 days. Detailed disclosures on credit facilities are made in Note 8 and Note 9 of Notes to the Condensed Consolidated Financial Statements (Unaudited) for the quarter ended March 31, 2011, including the amounts of facilities, outstanding balances, maturity date, and pledges of assets.
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PART I – FINANCIAL INFORMATION
ACL SEMICONDUCTORS INC. AND SUBSIDIARIES
Our ability to draw down under our various credit and loan facilities is, in each case, subject to the prior consent of the relevant lending institution to make advances at the time of the requested advance and each facility (other than with respect to certain long term mortgage loans) is payable within 90 days of drawdown. As a result of the general tightening of credit markets in Hong Kong and Asia, many lenders have revised the terms of their revolving credit lines to levels we did not deem commercially reasonable. Accordingly, on a case by case basis, we may elect to terminate or not renew several of our credit facilities resulting in significant reduction in our available short term borrowings.
To address the reduction in available credit facilities, we are relying on our own cash reserves and cash flows from operations to fund our ongoing operations and have tightened the credit terms we extend to our customers. As a result, the Company does not expect that the reduction in available credit facilities is going to have a materially adverse impact upon our operations for the foreseeable future.
We will continue to seek additional sources of available financing on acceptable terms; however, there can be no assurance that we will be able to obtain the necessary additional capital on a timely basis or on acceptable terms, if at all. In addition, if the results are negatively impacted and delayed as a result of political and economic factors beyond management’s control, our capital requirements may increase.
The short-term borrowings from banks to finance the cash flow required to finance the purchase of Samsung memory products from Samsung must be made a day in advance of the release of goods from Samsung’s warehouse before receiving payments from customers upon physical delivery of such goods in Hong Kong which, in most instances, take approximately two days from the date of such delivery.
The following factors, among others, could have negative impacts on our results of operations and financial position: the termination or change in terms of the Distributorship Agreement; pricing pressures in the industry; a continued downturn in the economy in general or in the memory products sector; an unexpected decrease in demand for Samsung’s memory products; our ability to attract new customers; an increase in competition in the memory products market; and the ability of some of our customers to obtain financing.
Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We are under no duty to update any of the forward-looking statements after the date of this report to conform them to actual results or to make changes in our expectations.
Net Cash provided by Operating Activities
In the three months ended March 31, 2011, net cash provided by operating activities was $3,134,805 while in the three months ended March 31, 2010, net cash used for operating activities was $436,143, an increase of $3,570,948. This increase was primarily due to decrease of accounts receivable and increase of accounts payable net of increase of inventories as of March 31, 2011.
Net Cash Used for Investing Activities
For the three months ended March 31, 2011, net cash used for investing activities was $881,481 while in the three months ended March 31, 2010, net cash provided by investing activities was $757,263, an increase in cash used of $1,638,744. This increase was primarily due to the increase of amounts due from Aristo / Mr. Yang as of March 31, 2011.
Net Cash Provided by Financing Activities
In the three months ended March 31, 2011, net cash provided by financing activities was $11,942 while in the three months ended March 31, 2010, net cash provided by financing activities was $1,007,350, a decrease of $995,408. This decrease was due to decrease in the balance of bank lines of credit and notes payable as of March 31, 2011.
32
PART I – FINANCIAL INFORMATION
ACL SEMICONDUCTORS INC. AND SUBSIDIARIES
Principles of Consolidation
The consolidated financial statements of ACL Semiconductors Inc. include the accounts of Atlantic Components Ltd., a Hong Kong subsidiary, ACL Holdings International Ltd., a Hong Kong subsidiary, Alpha Perform Technology Limited, a BVI subsidiary, and Aristo Technologies Ltd., a Hong Kong company, a variable interest entity deemed to be a subsidiary. All significant inter-company transactions and balances are eliminated in consolidation.
Critical Accounting Policies
The U.S. Securities and Exchange Commission (“SEC”) recently issued Financial Reporting Release No. 60, “Cautionary Advice Regarding Disclosure About Critical Accounting Policies” (“FRR 60”), suggesting companies provide additional disclosure and commentary on their most critical accounting policies. In FRR 60, the SEC defined the most critical accounting policies as the ones that are most important to the portrayal of a company’s financial condition and operating results, and require management to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, our most critical accounting policies include: inventory valuation, which affects cost of sales and gross margin; policies for revenue recognition, allowance for doubtful accounts, and stock-based compensation. The methods, estimates and judgments we use in applying these most critical accounting policies have a significant impact on the results we report in our consolidated financial statements.
Revenue Recognition
The Company derives revenues from resale of computer memory products. The Company recognizes revenue in accordance with the ASC 605 “Revenue Recognition”. Under ASC 605, revenue is recognized when there is persuasive evidence of an arrangement, delivery has occurred or services are rendered, the sales price is determinable, and collectability is reasonably assured. Revenue typically is recognized at time of shipment. Sales are recorded net of discounts, rebates, and returns, which historically were not material.
Inventory Valuation
Our policy is to value inventories at the lower of cost or market on a part-by-part basis. In addition, we write down unproven, excess and obsolete inventories to net realizable value. This policy requires us to make a number of estimates and assumptions including market and economic conditions, product lifecycles and forecast demand for our product to value our inventory. To the extent actual results differ from these estimates and assumptions, the balances of reported inventory and cost of products sold will change accordingly. Since Aristo supplies different generations of computer related products, older generation products will sell more slowly owing to lower market demand. According to the management’s experience and estimation of the actual market situation, old generation products carrying on hand for ten years will have no re-sell value. Therefore, these inventories on hand over ten years will be written off by Aristo immediately.
Allowance for Doubtful Accounts.
We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. Our allowance for doubtful accounts is based on our assessment of the collectability of specific customer accounts, the aging of accounts receivable, our history of bad debts, and the general condition of the industry. If a major customer’s credit worthiness deteriorates, or our customers’ actual defaults exceed our historical experience, our estimates could change and impact our reported results.
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PART I – FINANCIAL INFORMATION
ACL SEMICONDUCTORS INC. AND SUBSIDIARIES
New Accounting Pronouncements
ASC 105, Generally Accepted Accounting Principles (“ASC 105”) (formerly Statement of Financial Accounting Standards No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles a replacement of FASB Statement No. 162) reorganized by topic existing accounting and reporting guidance issued by the Financial Accounting Standards Board (“FASB”) into a single source of authoritative generally accepted accounting principles (“GAAP”) to be applied by nongovernmental entities. All guidance contained in the Accounting Standards Codification (“ASC”) carries an equal level of authority. Rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. Accordingly, all other accounting literature will be deemed “non-authoritative”. ASC 105 is effective on a prospective basis for financial statements issued for interim and annual periods ending after September 15, 2009. The Company has implemented the guidance included in ASC 105 as of July 1, 2009. The implementation of this guidance changed the Company’s references to GAAP authoritative guidance but did not impact the Company’s financial position or results of operations.
ASC 855, Subsequent Events (“ASC 855”) (formerly Statement of Financial Accounting Standards No. 165, Subsequent Events) includes guidance that was issued by the FASB in May 2009, and is consistent with current auditing standards in defining a subsequent event. Additionally, the guidance provides for disclosure regarding the existence and timing of a company’s evaluation of its subsequent events. ASC 855 defines two types of subsequent events, “recognized” and “non-recognized”. Recognized subsequent events provide additional evidence about conditions that existed at the date of the balance sheet and are required to be reflected in the financial statements. Non-recognized subsequent events provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date and, therefore; are not required to be reflected in the financial statements. However, certain non-recognized subsequent events may require disclosure to prevent the financial statements from being misleading. This guidance was effective prospectively for interim or annual financial periods ending after June 15, 2009. The Company implemented the guidance included in ASC 855 as of April 1, 2009. The effect of implementing this guidance was not material to the Company’s financial position or results of operations.
ASC 944, Financial Services – Insurance (“ASC 944”) contains guidance that was previously issued by the FASB in May 2008 as Statement of Financial Accounting Standards No. 163, Accounting for Financial Guarantee Insurance Contracts—an interpretation of FASB Statement No. 60 that provides for changes to both the recognition and measurement of premium revenues and claim liabilities for financial guarantee insurance contracts that do not qualify as a derivative instrument in accordance with ASC 815, Derivatives and Hedging (formerly included under Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities). This financial guarantee insurance contract guidance also expands the disclosure requirements related to these contracts to include such items as a company’s method of tracking insured financial obligation with credit deterioration, financial information about insured financial obligations, and management’s policies for placing and monitoring the insured financial obligations. ASC 944, as it relates to financial guarantee insurance contracts, was effective for fiscal years beginning after December 15, 2008, except for certain disclosures related to the insured financial obligations, which were effective for the third quarter of 2008. The Company does not have financial guarantee products, and, accordingly, the implementation of this portion of ASC 944 did not have an effect on the Company’s results of operations or financial position.
34
PART I – FINANCIAL INFORMATION
ACL SEMICONDUCTORS INC. AND SUBSIDIARIES
ASC 805, Business Combinations (“ASC 805”) (formerly included under Statement of Financial Accounting Standards No. 141 (revised 2007), Business Combinations) contains guidance that was issued by the FASB in December 2007. It requires the acquiring entity in a business combination to recognize all assets acquired and liabilities assumed in a transaction at the acquisition-date fair value, with certain exceptions. Additionally, the guidance requires changes to the accounting treatment of acquisition related items, including, among other items, transaction costs, contingent consideration, restructuring costs, indemnification assets and tax benefits. ASC 805 also provides for a substantial number of new disclosure requirements. ASC 805 also contains guidance that was formerly issued as FSP FAS 141(R)-1, Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies which was intended to provide additional guidance clarifying application issues regarding initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination. ASC 805 was effective for business combinations initiated on or after the first annual reporting period beginning after December 15, 2008. The Company implemented this guidance effective January 1, 2009. Implementing this guidance did not have an effect on the Company’s financial position or results of operations; however it will likely have an impact on the Company’s accounting for future business combinations, but the effect is dependent upon acquisitions, if any, that are made in the future.
ASC 810, Consolidation (“ASC 810”) includes new guidance issued by the FASB in December 2007 governing the accounting for and reporting of noncontrolling interests (previously referred to as minority interests). This guidance established reporting requirements which include, among other things, that noncontrolling interests be reflected as a separate component of equity, not as a liability. It also requires that the interests of the parent and the noncontrolling interest be clearly identifiable. Additionally, increases and decreases in a parent’s ownership interest that leave control intact shall be reflected as equity transactions, rather than step acquisitions or dilution gains or losses. This guidance also requires changes to the presentation of information in the financial statements and provides for additional disclosure requirements. ASC 810 was effective for fiscal years beginning on or after December 15, 2008. The Company implemented this guidance as of January 1, 2010 and made necessary changes accordingly including but not limited to filing amendments for the prior periods to comply with all applicable requirements.
ASC 825, Financial Instruments (“ASC 825”) includes guidance which was issued in February 2007 by the FASB and was previously included under Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities Including an amendment of FASB Statement No. 115. The related sections within ASC 825 permit a company to choose, at specified election dates, to measure at fair value certain eligible financial assets and liabilities that are not currently required to be measured at fair value. The specified election dates include, but are not limited to, the date when an entity first recognizes the item, when an entity enters into a firm commitment or when changes in the financial instrument causes it to no longer qualify for fair value accounting under a different accounting standard. An entity may elect the fair value option for eligible items that exist at the effective date. At that date, the difference between the carrying amounts and the fair values of eligible items for which the fair value option is elected should be recognized as a cumulative effect adjustment to the opening balance of retained earnings. The fair value option may be elected for each entire financial instrument, but need not be applied to all similar instruments. Once the fair value option has been elected, it is irrevocable. Unrealized gains and losses on items for which the fair value option has been elected will be reported in earnings. This guidance was effective as of the beginning of fiscal years that began after November 15, 2007. The Company does not have eligible financial assets and liabilities, and, accordingly, the implementation of ASC 825 did not have an effect on the Company’s results of operations or financial position.
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PART I – FINANCIAL INFORMATION
ACL SEMICONDUCTORS INC. AND SUBSIDIARIES
ASC 820, Fair Value Measurements and Disclosures (“ASC 820”) (formerly included under Statement of Financial Accounting Standards No. 157, Fair Value Measurements) includes guidance that was issued by the FASB in September 2006 that created a common definition of fair value to be used throughout generally accepted accounting principles. ASC 820 applies whenever other standards require or permit assets or liabilities to be measured at fair value, with certain exceptions. This guidance established a hierarchy for determining fair value which emphasizes the use of observable market data whenever available. It also required expanded disclosures which include the extent to which assets and liabilities are measured at fair value, the methods and assumptions used to measure fair value and the effect of fair value measures on earnings. ASC 820 also provides additional guidance for estimating fair value when the volume and level of activity for the asset or liability have significantly decreased. The emphasis of ASC 820 is that fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between willing market participants, under current market conditions. ASC 820 also further clarifies the guidance to be considered when determining whether or not a transaction is orderly and clarifies the valuation of securities in markets that are not active. This guidance includes information related to a company’s use of judgment, in addition to market information, in certain circumstances to value assets which have inactive markets.
Fair value guidance in ASC 820 was initially effective for fiscal years beginning after November 15, 2007 and for interim periods within those fiscal years for financial assets and liabilities. The effective date of ASC 820 for all non-recurring fair value measurements of nonfinancial assets and nonfinancial liabilities was fiscal years beginning after November 15, 2008. Guidance related to fair value measurements in an inactive market was effective in October 2008 and guidance related to orderly transactions under current market conditions was effective for interim and annual reporting periods ending after June 15, 2009.
The Company applied the provisions of ASC 820 to its financial assets and liabilities upon adoption at January 1, 2008 and adopted the remaining provisions relating to certain nonfinancial assets and liabilities on January 1, 2009. The difference between the carrying amounts and fair values of those financial instruments held upon initial adoption, on January 1, 2008, was recognized as a cumulative effect adjustment to the opening balance of retained earnings and was not material to the Company’s financial position or results of operations. The Company implemented the guidance related to orderly transactions under current market conditions as of April 1, 2009, which also was not material to the Company’s financial position or results of operations.
In August 2009, the FASB issued ASC Update No. 2009-05, Fair Value Measurements and Disclosures (Topic 820): Measuring Liabilities at Fair Value (“ASC Update No. 2009-05”). This update amends ASC 820, Fair Value Measurements and Disclosures and provides further guidance on measuring the fair value of a liability. The guidance establishes the types of valuation techniques to be used to value a liability when a quoted market price in an active market for the identical liability is not available, such as the use of an identical or similar liability when traded as an asset. The guidance also further clarifies that a quoted price in an active market for the identical liability at the measurement date and the quoted price for the identical liability when traded as an asset in an active market when no adjustments to the quoted price of the asset are required are both Level 1 fair value measurements. If adjustments are required to be applied to the quoted price, it results in a level 2 or 3 fair value measurement. The guidance provided in the update is effective for the first reporting period (including interim periods) beginning after issuance. The Company does not expect that the implementation of ASC Update No. 2009-05 will have a material effect on its financial position or results of operations.
In September 2009, the FASB issued ASC Update No. 2009-12, Fair Value Measurements and Disclosures (Topic 820): Investments in Certain Entities that Calculate Net Asset Value per Share (or Its Equivalent) (“ASC Update No. 2009-12”). This update sets forth guidance on using the net asset value per share provided by an investee to estimate the fair value of an alternative investment. Specifically, the update permits a reporting entity to measure the fair value of this type of investment on the basis of the net asset value per share of the investment (or its equivalent) if all or substantially all of the underlying investments used in the calculation of the net asset value is consistent with ASC 820. The update also requires additional disclosures by each major category of investment, including, but not limited to, fair value of underlying investments in the major category, significant investment strategies, redemption restrictions, and unfunded commitments related to investments in the major category. The amendments in this update are effective for interim and annual periods ending after December 15, 2009 with early application permitted. The Company does not expect that the implementation of ASC Update No. 2009-12 will have a material effect on its financial position or results of operations.
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PART I – FINANCIAL INFORMATION
ACL SEMICONDUCTORS INC. AND SUBSIDIARIES
ASC 810-10-05 to 10-65 “Variable Interest Entity” codified No. 167, Amendments to FASB Interpretation No. 46(R) and FASB Interpretation No. 46R, Consolidation of Variable Interest Entities an interpretation of ARB No. 51 (“FIN 46R”) to require an analysis to determine whether a company has a controlling financial interest in a variable interest entity. This analysis identifies the primary beneficiary of a variable interest entity as the enterprise that has a) the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and b) the obligation to absorb losses of the entity that could potentially be significant to the variable interest entity or the right to receive benefits from the entity that could potentially be significant to the variable interest entity. The statement requires an ongoing assessment of whether a company is the primary beneficiary of a variable interest entity when the holders of the entity, as a group, lose power, through voting or similar rights, to direct the actions that most significantly affect the entity’s economic performance. The Company has adopted ASC 810-10-5 to 10-65 and filed all necessary amendments to comply with ASC 810-10-5 to 10-65.
In 2010, the FASB issued ASC Update (“ASU”) No.2010-21, Accounting for Technical Amendments to Various SEC Rules and Schedules. This update amends various SEC paragraphs in the FASB Accounting Standards Codification pursuant to SEC Final Rule, “Technical Amendments to Rules Forms, Schedules and Codification of Financial Reporting Policies”. The adoption of this update did not have any material impact on the Company’s financial statements.
In 2010, the FASB issued ASC Update (“ASU”) No.2010-22, Accounting for Various Topics. This update amends various SEC paragraphs in the FASB Accounting Standards Codification based on external comments received and the issuance of Staff Accounting Bulletin (SAB) No. 112 which amends or rescinds portion of certain SAB topics. SAB 112 was issued to existing SEC guidance into conformity with ASC 805 “Business Combination” and ASC 810 “Consolidation”. The adoption of this update did not have any material impact on the Company’s financial statements.
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Item 3. | Quantitative and Qualitative Disclosures about Market Risk |
We are a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and are not required to provide the information required under this item.
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Item 4T. | Controls and Procedures |
(a) Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission (SEC) rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), as appropriate, to allow timely decisions regarding required disclosure.
Limitations on the Effectiveness of Disclosure Controls. In designing and evaluating the Company’s disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, Company management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
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PART I – FINANCIAL INFORMATION
ACL SEMICONDUCTORS INC. AND SUBSIDIARIES
Evaluation of Disclosure Controls and Procedures. The Company’s CEO and CFO have evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) as of March 31, 2011, and based on this evaluation, the Company’s principal executive and financial officers have concluded that the Company’s disclosure controls and procedures were not effective to ensure that material information is recorded, processed, summarized and reported by management of the Company on a timely basis in order to comply with the Company’s disclosure obligations under the Exchange Act and the rules and regulations promulgated thereunder. The Company’s principal executive and financial officers conclusion regarding the Company’s disclosure controls and procedures is based on management’s conclusion that the Company’s internal control over financial reporting are ineffective, based on their evaluation as described in the Company’s annual report on Form 10-K for the fiscal year ended December 31, 2010 which discloses the following material weaknesses:
Company-level controls. We did not maintain effective company-level controls as defined in the Internal Control—Integrated Framework published by COSO. These deficiencies related to each of the five components of internal control as defined by COSO (control environment, risk assessment, control activities, information and communication, and monitoring). These deficiencies resulted in more than a remote likelihood that a material misstatement of our annual or interim financial statements would not be prevented or detected. Specifically,
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• | Our control environment did not sufficiently promote effective internal control over financial reporting throughout our organizational structure, and this material weakness was a contributing factor to the other material weaknesses described in this Item 4; |
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• | Our board of directors has not established adequate financial reporting monitoring activities to mitigate the risk of management override, specifically: |
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| – | no formally documented financial analysis was presented to our board of directors, specifically fluctuation, variance, trend analysis or business performance reviews; |
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| – | an effective whistleblower program had not been established; |
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| – | there was insufficient oversight of external audit specifically related to fees, scope of activities, executive sessions, and monitoring of results; |
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| – | there was insufficient oversight of accounting principle implementation; |
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| – | there was insufficient review of related party transactions; and |
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| – | there was insufficient review of recording of stock transactions. |
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• | We did not maintained sufficient competent evidence to support the effective operation of our internal controls over financial reporting, specifically related to our board of directors’ oversight of quarterly and annual SEC filings; and management’s review of SEC filings, journal entries, account analyses and reconciliations, and critical spreadsheet controls; |
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• | We had inadequate risk assessment controls, including inadequate mechanisms for anticipating and identifying financial reporting risks; and for reacting to changes in the operating environment that could have a material effect on financial reporting; |
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• | There was inadequate communication from management to employees regarding the general importance of controls and employees duties and control responsibilities; |
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• | We had inadequate monitoring controls, including inadequate staffing and procedures to ensure periodic evaluations of internal controls to ensure that appropriate personnel regularly obtain evidence that controls are functioning effectively and that identified control deficiencies are remediated timely; |
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• | We had an inadequate number of trained finance and accounting personnel with appropriate expertise in U.S. generally accepted accounting principles. Accordingly, in certain circumstances, an effective secondary review of technical accounting matters was not performed; |
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• | We had inadequate controls over our management information systems related to program changes, segregation of duties, and access controls; |
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PART I – FINANCIAL INFORMATION
ACL SEMICONDUCTORS INC. AND SUBSIDIARIES
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• | We had inadequate access and change controls over end-user computing spreadsheets. Specifically, our controls over the completeness, accuracy, validity and restricted access and review of certain spreadsheets used in the period-end financial statement preparation and reporting process were not designed appropriately or did not operate as designed; and |
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• | We were unable to assess effectiveness of our internal control over financial reporting in a timely matter. |
Financial statement preparation and review procedures. We had inadequate policies, procedures and personnel to ensure that accurate, reliable interim and annual consolidated financial statements were prepared and reviewed on a timely basis. Specifically, we had insufficient: a) levels of supporting documentation; b) review and supervision within the accounting and finance departments; c) preparation and review of footnote disclosures accompanying our financial statements; and d) technical accounting resources. These deficiencies resulted in errors in the financial statements and more than a remote likelihood that a material misstatement of our annual or interim financial statements would not be prevented or detected. In addition, as discussed in Note 2 of Notes to the Condensed Consolidated Financial Statements (Unaudited) of this Form 10-Q, we determined that Aristo Technologies Limited (“Aristo”), a related party, is a variable interest entity under FASB ASC 810-10-25. Consequently, we are consolidating the financial statements of Aristo with those of the Company for the period effective and are restating our previously filed annual and interim financial statements in amended Form 10-Ks for years ended 2007 and 2008 to reflect the disclosure in accordance with ASC 810-10-25.
Inadequate reviews of account reconciliations, analyses and journal entries. We had inadequate review procedures over account reconciliations, account and transaction analyses, and journal entries. Specifically, deficiencies were noted in the following areas: a) management review of supporting documentation, calculations and assumptions used to prepare the financial statements, including spreadsheets and account analyses; and b) management review of journal entries recorded during the financial statement preparation process. These deficiencies resulted in a more than a remote likelihood that a material misstatement of our annual or interim financial statements would not be prevented or detected.
Inadequate controls over purchases and disbursements. We had inadequate controls over the segregation of duties and authorization of purchases, and the disbursement of funds. These weaknesses increase the likelihood that misappropriation of assets and/or unauthorized purchases and disbursements could occur and not be detected in a timely manner. These deficiencies resulted in errors in the financial statements and in more than a remote likelihood that a material misstatement of our annual or interim financial statements would not be prevented or detected. Specifically,
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• | We had inadequate procedures and controls to ensure proper segregation of duties within our purchasing and disbursements processes and accounting systems; |
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• | We had inadequate procedures and controls to ensure proper authorization of purchase orders; and |
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• | We had inadequate approvals for payment of invoices and wire transfers. |
This quarterly report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the SEC that permit us to provide only management’s report in this quarterly report.
As of March 31, 2011, we had not completed the remediation of any of these material weaknesses.
We are addressing the outstanding material weaknesses described above, as well as our control environment. We also expect to undertake the following remediation efforts:
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• | We plan on formalizing quarterly financial statement variance analysis of actual versus budget with relevant explanations of variances for distribution to our board of directors. |
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• | We are in the process of developing, documenting, and communicating a formal whistleblower program to employees. We expect to post the policy on the Company web site in the governance section and in the common areas in the office. We plan on providing a toll free number for reporting complaints and will hire a specific third party whistleblower company to monitor the hotline and provide monthly reports of activity to our board of directors. |
39
PART I – FINANCIAL INFORMATION
ACL SEMICONDUCTORS INC. AND SUBSIDIARIES
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• | Management intends to continue to provide SEC and US GAAP training for employees and retain external consultants with appropriate SEC and US GAAP expertise to assist in financial statement review, account analysis review, review and filing of SEC reports, policy and procedure compilation assistance, and other related advisory services. |
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• | We intend on developing an internal control over financial reporting evidence policy and procedures which contemplates, among other items, a listing of all identified key internal controls over financial reporting, assignment of responsibility to process owners within the Company, communication of such listing to all applicable personnel, and specific policies and procedures around the nature and retention of evidence of the operation of controls. |
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• | We have restricted access to all financial modules. In order to mitigate the risks of management or other override, only authorized persons have edit access to each. We will remove or add authorized personnel as appropriate to mitigate the risks of management or other override; and |
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• | We have re-assign roles and responsibilities, and intend to continue improving segregation of duties. |
These specific actions are part of an overall program that we are currently developing in an effort to remediate the material weaknesses described above.
Attached as exhibits to this report are certifications of our CEO and CFO, which are required in accordance with Rule 13a-14 of Securities Exchange Act of 1934, as amended. The discussion above in this Item 4 includes information concerning the controls and controls evaluation referred to in the certifications and those certifications should be read in conjunction with this Item 4 for a more complete understanding of the topics presented.
We are committed to improving our internal control processes and will continue to diligently review our internal control over financial reporting and our disclosure controls and procedures. The failure to implement adequate controls may result in deficient and inaccurate reports under the Exchange Act.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended March 31, 2011, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
40
PART II – OTHER INFORMATION
ACL SEMICONDUCTORS INC. AND SUBSIDIARIES
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Item 1. | Legal Proceedings |
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None |
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Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
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None |
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Item 3. | Defaults Upon Senior Securities |
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None |
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Item 4. | (Removed and Reserved) |
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Item 5. | Other Information |
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None |
41
PART II – OTHER INFORMATION
ACL SEMICONDUCTORS INC. AND SUBSIDIARIES
Exhibits:
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| 31.1 | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
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| 31.2 | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
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| 32.1 | Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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| 32.2 | Certification by Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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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.
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| ACL SEMICONDUCTORS INC. |
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Date: May 16, 2011 | By: | /s/Chung-Lun Yang |
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| | Chung-Lun Yang |
| | Chief Executive Officer |
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Date: May 16, 2011 | By: | /s/ Kun Lin Lee |
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|
| | Kun Lin Lee |
| | Chief Financial Officer |
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