ITEM 1. DESCRIPTION OF BUSINESS.
Overview
The Company specializes in the design, production and distribution of Light Emitting Diode, “LED”, and Cold Cathode Fluorescent Lamp, “CCFL”, backlights for various Thin Film Transistor Liquid Crystal Displays, “TFT-LCD”, and Super-Twisted Nematic Liquid Crystal Display, “STN-LCD”, Twisted Nematic Liquid Crystal Display, “TN-LCD”, and Mono LCDs as well as the LED lighting, LED displays and LED TV sets, which are widely developed in production, taking together, these applications are referred to as “LCD” and “LED” applications. Those applications not only include color displays for cell phones, car televisions and navigation systems, digital cameras, televisions, computer displays, camcorders, PDAs and DVDs, CD and MP3/MP4 players, appliance display and the like, but also include indoor and outdoor lighting, home and office use with energy saving and environmental protections.
The Company conducts that business principally through the operations of Shenzhen Diguang Electronics Co., Ltd., based in Shenzhen, “Diguang Electronics”, along with its main backlight manufacturing operation in Dongguan, Guangdong Province of China, Dihao (Yangzhou) Co., Ltd., based in Yangzhou, “Dihao”, and Wuhan Diguang Electronics Co., Ltd, based in Wuhan, “Wuhan Diguang”. As of December 31, 2010, Diguang Electronics has approximately 1,139 full-time employees, which changes from time to time as needed; Diguang Electronics is headquartered in Shenzhen, China, with its backlight manufacturing operations in Dongguan, China. As of December 31, 2010, Dihao has approximately 147 full-time employees, which changes from time to time as needed. Dihao is a subsidiary of North Diamond, 65% of which was acquired by the Company on January 3, 2007. Wuhan Diguang was established as in-house facilities mainly for a Taiwan-based customer with the capacity to provide large inches TFT-LCD and it has approximately 406 employees as of December 31, 2010.
Dongguan Diguang Electronics Science and Technology Co., Ltd., “ Dongguan Diguang S&T”, was established under the laws of the People’s Republic of China in 2004 as the production base of Diguang Electronics. Dongguan Diguang completed its construction of Plant No. 1 and Dormitory Nos. 1 and 2 in 2005, which were subsequently rented to Diguang Electronics in 2005. The construction of Plant No. 3 and Dormitory No. 3 was completed in 2007 and the total acreage of the property is 67,176 m 2 . Dongguan Diguang has become a new manufacturing base for backlight, LED lighting R&D and production after it was acquired on December 30, 2007 and the expended space of the plant provides a vast opportunity to enlarge the production capacity for business expansion. Dongguan Diguang S&T started its own manufacturing activities since the second half year of 2008. As of December 31 2010, Dongguan Diguang has approximately 215 full-time employees.
Well Planner is involved in the import of raw materials into China and export of finished products from China. Well Planner currently has no fixed assets.
Diguang Technology is directly involved with the international buying of raw materials and selling of backlight products for Diguang Electronics. Diguang Technology purchases raw materials from international suppliers and acts as an international sales group for both Diguang Electronics and Well Planner. Diguang Technology has no fixed assets.
In 2010, the Company generated revenues of $64.9 million, net loss of $4.2 million and cash flow used by operation of $1.3 million. The Company has been profitable and cash flow positive each year since 1999 to 2006, and 2007 to 2010 are the years it has recorded a loss.
The Company’s Industry
The backlight industry is closely associated with the consumer electronics industry. LCDs are used to present data and images in a wide variety of applications, ranging from cell phones to car navigation and entertainment systems to the larger displays used in flat panel televisions and computer monitors, including laptop computer screens.
LCD technology allows for a higher level of light output than other types of panel displays. It has become the mainstream technology in today’s display market with demand for such technology increasing by 10 to 15 percent per year. According to Displaybank, a reputable Korean based research firm, the global LCD display market is expected to grow to approximately $94 billion by 2010. This significant growth projection is being driven by an increase in the breadth of applications utilizing LCDs to take advantage of their increased brightness and clarity, the development of new LCD-related technologies and the growing use of LCDs in larger screen applications, e.g. television sets.
Generally, companies that manufacture backlights supply them as a component to other parties, which incorporate them into a finished display unit, which consists of a film, such as a thin film transistor, that bears the image and the case or shell that is used to hold the backlight and film in place. As a result, the Company’s customers are typically the assemblers of the LCD modules, although the Company has some customers who are the final assemblers of the products that are sold to consumers.
Until recently, the backlight industry was centered in Japan and Korea, where the majority of modules used in the production of LCD displays, such as Samsung and Toshiba, are located. Based on certain cost advantages, Taiwan has become a leading producer of backlights as well.
More recently, a large number of backlight manufacturers, both independent ones and operations associated with Japanese and Korean companies have begun production in the PRC, including Diguang. This shift of backlight production to the PRC is based in large measure on the comparability of its technical workforce and facilities to those of the traditional Asian producers, together with significant labor cost advantages. Those factors have, to some extent, pulled the assembly of display units into the PRC as well, even though a relatively small amount of the modules used to make LCD displays are currently produced in the PRC.
The Company considers its industry to be one that is expanding, as electronics are incorporated into a growing number of products and devices that benefit from the display of information and images. The Company has benefited from certain cost and strategic advantages relative to its competitors and those advantages have enabled it to maintain certain margins on the Company’s products up to this point. However, as a growing percentage of backlight production shifts to the PRC from higher-cost countries, price competition will increase, and the Company’s ability to preserve margins will depend on its continuing to improve its product quality, production efficiency and customer services relative to its competitors.
Online was organized under the laws of Nevada in 2000 as Online Processing, Inc.
On January 10, 2006, Online entered into a share exchange agreement to acquire all of the issued and outstanding shares of the stock of Diguang Holdings in exchange for 18,250,000 shares of Online common stock. In connection with the Share Exchange, Online’s name was changed to Diguang. The total outstanding shares of common stock immediately prior to the Share Exchange were 1,943,000. Taking into account the shares issued in the Share Exchange and the private placement of $12 million described below, the “Offering”, the Company now has 22,593,000 shares of common stock issued and 22,072,000 shares outstanding.
On March 17, 2006, Online issued 2.4 million shares of its common stock in exchange for the gross proceeds of $12 million and issued another 18,250,000 shares of its common stock in exchange for 100% equity interest in Diguang Holdings, making Diguang Holdings a wholly-owned subsidiary of Online.
The Share Exchange is regarded as a reverse merger, since Diguang Holdings’ former shareholders obtained control of the Company. As a result, Diguang Holdings is considered to be the acquirer for accounting purposes. Also as a result of the Share Exchange, the Company ceased being a shell company.
The Company now owns 100% of the issued and outstanding stock of Diguang Holdings. The Company owns its subsidiaries through Diguang Holdings which was established under the law of the British Virgin Islands on July 27, 2004 and holds equity interests in the following entities:
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Shenzhen Diguang Electronics Co., Ltd., a China based entity, “Diguang Electronics”;
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Well Planner Limited, a Hong Kong based entity, “Well Planner”;
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Diguang Science and Technology (HK) Limited, a British Virgin Islands based entity, “Diguang Technology”;
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North Diamond;
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Wuhan Diguang Electronics Co., Ltd. “Wuhan Diguang”;
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Dongguan Diguang Electronics Science and Technology Co. Ltd., “Dongguan Diguang S&T”; and
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Shenzhen Optimum Electronics Co., Ltd., “Shenzhen Optimum”
The address of the Company’s executive and administrative offices is 23rd Floor, Building A, Galaxy Century, No. 3069, Caitian Road, Futian District, Shenzhen, the PRC. The Company’s telephone number is 86-755-2655-3152.
As of March 17, 2006, Diguang Holdings was 100% owned by Sino Olympics, a British Virgin Island company owned by Yi Song and Hong Song, two of the Company’s directors and officers. On March 17, 2006, in a private transaction completed just prior to the Share Exchange, five accredited investors acquired a total of 876,941, 6.85%, of Diguang Holding’s shares from Sino Olympics for $5,000,000, approximately $5.70 per share. Those five shareholders and Sino Olympics were the only shareholders of Diguang Holdings at the date of the Share Exchange.
Diguang Electronics is the principal operating subsidiary of Diguang. Diguang Electronics was established as an equity joint venture in Shenzhen under the laws of the People’s Republic of China on January 9, 1996 with an operating life of 20 years starting on that date. As of December 31, 2006, its registered capital was RMB 85 million, equivalent to approximately $10,573,615. Diguang Electronics designs, develops and manufactures LED and CCFL backlight units. These backlight units are essential components used in illuminating display panels such as TFT-LCD and color STN-LCD panels. These display panels are used in products such as mobile phones, PDAs, digital cameras, liquid crystal computer or television displays and other household and industrial electronic devices. Diguang Electronics’ customers are located in both China and overseas. Diguang Electronics’ address is 23rd Floor, Building A, Galaxy Century, No. 3069, Caitian Road, Futian District, Shenzhen, the PRC.
Well Planner was established under the laws of Hong Kong, Special Administrative Region on April 20, 2001. Originally owned by Yi Song and Hong Song, it is now a wholly-owned subsidiary of Diguang. Well Planner’s principal business is custom forwarding related to export and import activities conducted by Diguang Electronics for a service fee based on a service agreement, pursuant to which service fees should not be less than 2% of the goods Well Planner has sold. Well Planner mainly sells to Diguang Technology and has minimal sales to third-party customers. Well Planner mainly sells to Diguang Technology and has smaller sales to third-party customers since 2008. Well Planner’s address is 10/F, 579 Nathan Road, Mongkok, Kowloon, Hong Kong SAR.
Diguang Technology was established under the laws of British Virgin Islands on August 28, 2003. Originally owned by Yi Song and Hong Song, it is now a wholly-owned subsidiary of Diguang. The predecessor of Diguang Technology was an unlimited liability Hong Kong company named Diguang Electronics (Hong Kong) Co., which was established on October 12, 1998, also owned by Yi Song and Hong Song. Diguang Electronics (HK) handles all sales to international customers and procurements of electronic components and materials for Diguang Electronics. On October 31, 2003, all of the substantial business operations of Diguang Electronics (HK) were transferred to Cheer Top Capital Limited, a British Virgin Islands company owned by the Songs to base those operations in the British Virgin Islands. In June 2004 the name was changed to Diguang Science and Technology (HK) Limited. Diguang Technology’s address is Commonwealth Trust Limited, Drake Chambers, Tortola, British Virgin Islands.
Under a reorganization agreement entered on June 15, 2005, the owners of Diguang’s subsidiaries transferred their 100% equity interest in the above three entities to Diguang Holdings in exchange for a 100% equity interest in Diguang Holdings. Being a receiving entity under common control, Diguang Holdings recorded all the assets and liabilities transferred at their carrying amounts in the accounts of the three respective entities at the date of transfer under the guidance of SFAS No. 141, Appendix D. The effective date for this reorganization was June 30, 2005. As a result of the reorganization, Diguang Holdings became the 100% owner of Diguang’s subsidiaries, and the consolidated financial statements of Diguang Holdings and Diguang Holdings’ subsidiaries became Diguang Holdings’ historical financial statements.
Diguang Holdings acquired 65% interest of North Diamond since January 3, 2007. North Diamond is a holding company of Dihao (Yangzhou) Co ., Ltd., “ Dihao” , an operating entity, which is registered in the Yangzhou City Development Zone, Jiangsu Province, China. Dihao conducts business activities of developing, manufacturing and marketing backlight products for large size electronic display devices and provides relevant technical services in China.
Diguang Electronics and Diguang Holdings jointly set up Wuhan Diguang in Wuhan, Hubei Province, China, with a registered capital of $1 million, of which 70% was infused by Diguang Electronics and the remaining 30% by Diguang Holdings. Wuhan Diguang was established on March 13, 2007 and its business license issued by Wuhan Municipal Administrative Bureau for Industry and Commerce is valid for 20 years expiring on March 12, 2027. Wuhan Diguang manufactures and sells LED and CCFL backlight units in Central South region of China. Wuhan Diguang started operation on July 1, 2007.
On December 29, 2007, Diguang Holdings acquired 100% interest in Dongguan Diguang S&T. On January 1, 2008, Diguang Holdings assigned 70% of interest in Dongguan Diguang S&T to Diguang Electronics. Dongguan Diguang S&T was established under the laws of the People’s Republic of China on February 16, 2004 and has been used by Diguang Electronics as the production base since its inception. Dongguan Diguang S&T started its own manufacturing activities since 2008.
On April 30, 2009, Well Planner established a wholly owned entity named Shenzhen Optimum Electronics Co., Ltd., “Shenzhen Optimum” a China based entity. Shenzhen Optimum concentrates in sales of large size LED TV sets manufactured by Diguang Electronics to domestic customers throughout China.
The Company has been conducting operations in only one business segment; hence, there is only a segment disclosure which is based on geographical locations of the customers.
Historically, the capital expenditures have included the purchase of production equipment, office equipment and leasehold improvements, all within the PRC. In connection with the expansion and ramp-up of the Company’s PRC production capability and capacity, Diguang paid capital expenditures in cash of $2.61 million, $0.16 million and $4.8 million in 2008, 2009 and 2010, respectively. The Company depreciates its production equipment and office equipment on a straight-line basis over an estimated useful life of five to ten years, and land usage right and plant and buildings over 20 to 50 years.
The Company is constructing a manufacturing facility for production of large size LED products with a total capital commitment of $10.5 million. Please refer to Note 5 ─ Construction in process to Financial Statements.
Description of the Amended and Restated Share Exchange Agreement
The transactions contemplated by the Amended and Restated Share Exchange Agreement dated as of March 17, 2006 to acquire Diguang Holdings closed on March 17, 2006. As a result, Diguang Holdings became the Company’s wholly-owned subsidiary. The Company had previously changed its name from Online Processing, Inc. to Diguang International Development Co., Ltd., “Diguang” or the “Company” or “we” or “our”. Pursuant to the name change, the Company has a new OTCBB trading symbol, DGNG, which it disclosed in a Form 8-KA filed on March 6, 2006.
On March 17, 2006, the Company accepted subscriptions from 94 accredited investors to acquire 2,400,000 shares of its common stock through a private offering at a per share price of $5.00, generating gross proceeds of $12,000,000. This private equity financing was made pursuant to the exemption from the registration provisions of the Securities Act provided by Section 4(2) of the Securities Act of 1933, as amended for issuances not involving a public offering and Rule 506 of Regulation D promulgated thereunder.
The parties modified the Share Exchange Agreement to provide for the assumption of an option plan adopted by Diguang Holdings prior to the closing of the Share Exchange. No option issued by the Company has been exercised and total outstanding options amounted to 1,131,917 shares as of December 31, 2010. As the limit on the total options to be issued remains at 1,500,000 shares, under the assumed plan approximately 368,083 shares remain available for future issuances.
In the Share Exchange, the Company acquired all of Diguang Holdings’ issued and outstanding shares of common stock in exchange for 18,250,000 shares of its common stock. As a result of a 3 for 5 reverse stock split and cancellation of 4,967,940 shares and the issuance of 2,400,000 shares in the Offering, the Company now has 22,593,000 shares of common stock issued.
In accordance with the Share Exchange Agreement, the Company’s shareholders will be granted certain incentive shares if the Company meets certain financial performance criteria. The incentive shares and financial performance criteria are as follows:
(1) After-tax profit targets would be the income from operation, less taxes paid or payable with regard to such income, excluding the effect on income from operations, if any, resulting from issuance of incentive shares in any year.
The Company accounts for the transactions of issuing these incentive shares based on the fair value of grant date in accordance with SFAS 123R. Under SFAS 123R, the grant date was effective March 17, 2006. Accordingly, the compensation expense has been calculated, but will be recorded over the period, in which the shareholders of Diguang can earn any of the amounts each year, only if meeting the prescribed target in the Share Exchange Agreement is probable.
The Company did not meet the 2006, 2007, 2008 and 2009 after-tax profit target. No incentive shares have been issued to date.
Financial Information about Geographic Areas
Total revenues by category of activity and geographic market
The Company currently operates mainly in backlight production with portions of new products of LED monitor, LED general lighting, and LED TV sets assembly. Since the Company’s major production base is in China, and since export revenue and net income in overseas entities accounted for a significant portion of total consolidated revenue and net income, management believes that the following table presents useful information for measuring business performance, financing needs, and preparing the Company’s corporate budget, among other things.
Financial Information about Geographic Areas
During 2008, 2009 and 2010 the Company derived $15,002,027, $17,785,350 and $26,124,418 respectively, of its revenues from customers in China, excluding Hong Kong and Taiwan, the domicile of the Company’s four principal operating subsidiaries, Diguang Electronics, Dihao, Wuhan Diguang and Dongguan Diguang.
Revenues from customers outside of China for 2008, 2009 and 2010 totaled $40,428,654, $26,289,899 and $38,802,668 respectively. The Company attributes sales to individual foreign countries based on the destination to which it ships the products.
There are certain risks associated with the concentration of the Company’s operations in China. These include currency risks and political risks. See Risk Factors below. Until recently, the Chinese government pegged its currency, the renminbi (RMB) to the United States dollar, adjusting the relative value only slightly and on infrequent occasion. Many people viewed this practice as leading to a substantial undervaluation of the RMB relative to the dollar and other major currencies, providing China with a competitive advantage in international trade. China now allows the RMB to float to a limited degree against a basket of major international currencies, including the dollar, the Euro and the Japanese yen. This change in policy produced a cumulative revaluation of the RMB of about 17.7% so far.
This 17.7% increase in the value of the RMB has produced certain effect on the Company’s business or its financial performance. If the Chinese government allows significant further revaluations of the RMB in the near future, it could have adverse consequences on the Company’s ability to compete internationally. In particular, such a revaluation would make the Company’s products relatively more expensive in markets outside of China than before the revaluation, representing about 60% of the Company’s product revenues, including those from Hong Kong, which could slow or eliminate the Company’s anticipated growth.
Offsetting this risk to some degree is the fact that if further revaluation of the RMB does occur, it will result in an increase to the Company’s profits when stated in dollar terms for a given level of profit in RMB. It is difficult to tell which of these effects, if either will be more significant, and therefore the Company cannot know whether the revaluation of the RMB would have an overall negative or positive effect on the value of its business.
From a political standpoint, only recently has China moved away from a centrally planned economy toward a market driven economy. It is not possible to predict how rapidly the move to a market economy will continue, or if it will continue at all or even reverse. Similarly, the government has recently been encouraging the development and growth of privately owned enterprises. Both of those political trends have benefited the Company’s expansion. Should the government modify or reverse those policies, it could prove detrimental to us.
Additionally, China has historically been indifferent to the enforcement of intellectual property rights, on which the Company currently depends and expects to continue to depend to a significant degree. As a condition to its admission to the World Trade Organization, China committed to improve the enforcement of intellectual property rights, and there is evidence to show that it has done so, including increased prosecutions of intellectual property pirates. Should China reverse that policy, it could be detrimental to the Company’s business prospects due to its Chinese competitors’ infringement on the Company’s intellectual property.
It is not clear to the Company whether its three-year geographic financial information is indicative of its current or future operations, particularly with regard to the Company’s sources of revenues. Several factors make it difficult to tell whether the Company will derive more or less of its revenues from countries other than China going forward. This includes the Company’s growth, the anticipated rapid rate of growth of businesses in China that make products incorporating the Company’s backlight products and its development of larger backlights. However, the Company does not anticipate a material effect on its business if a shift in the geographic distribution of its sales occurs.
Narrative Description of Business
Prior to acquiring Diguang Holdings, the Company had not had any operations since March 2003. As a result of the Share Exchange, the operations of Diguang Holdings’ subsidiaries became the Company’s principal operations, and therefore all of the information provided below relates to the operations of Diguang Holdings’ subsidiaries.
The Company specializes in the design, production and distribution of small to medium-sized Light Emitting Diode and Cold Cathode Fluorescent Lamp backlights for various Thin Film Transistor Liquid Crystal Displays, “TFT-LCD”, and Super-Twisted Nematic Liquid Crystal Display, “STN-LCD”, Twisted Nematic Liquid Crystal Display, “TN-LCD”, and Mono LCDs as well as the LED lighting, LED displays and Notebook, which are widely developing in the production, taken together, these applications are referred to as “LCD” applications. Those applications not only include color displays for cell phones, car televisions and navigation systems, digital cameras, televisions, computer displays, camcorders, PDAs and DVDs, CD and MP3/MP4 players, appliance displays and the like, but also include the indoor and outdoor lighting, the home and office use with the energy saving and environmental protections. The Company conducts that business principally through the operations of facilities in Dongguan, Wuhan and Yangzhou.
LCDs consist of a top layer that uses electronic impulses, filters and liquid crystal molecules to create an image, often in color. However, the LCD component itself generates relatively little in the way of luminance or light output, making the image on the screen impractical to use on its own under most conditions. A second component to these displays is backlights, which provide the luminance that enables viewers to see a distinct image on the screen in a wide variety of lighting conditions. In that sense, they operate much in the same way the bulb in a film projector or a slide projector does, converting the dark image on the film to a bright image that can be readily viewed.
The Company achieved some success in expanding its customer base and its geographic markets during 2010. Sales to the Company’s largest customer generated 17.28% of its revenues for 2010 compared with 11.18% in 2009. Sales to the Company’s three largest customers accounted to 17.28%, 11.19%, and 9.84% of total revenue in 2010 and 11.18%, 7.86% and 6.62% in 2009. The Company is continuing its efforts to diversify and broaden its customer base to become less reliant on these customers, including the development of new products, such as backlights for flat panel televisions.
Diguang Electronics is one of the first companies in China to use patented light guide panel technology by mould injection method to produce backlight units. The Company has received various awards and accolades, including the Shenzhen Science and Technology Progress Award in 2003. Additionally, Diguang’s products, namely CCFL backlights and white LED backlights, were included in the National Important New Products Project, and the Company received the “Important New Products” certificate in 2003.
Diguang Electronics caters to the global demand for backlight products on the basis of quality, cost and order fulfillment time. Diguang Electronics’ focus on product quality includes the use of quality materials obtained from selected international suppliers, and thorough quality control inspection of raw materials in production and finished products. Diguang Electronics also strives to offer its products at a lower cost than most competitors. This is made possible through Diguang Electronics’ skilled labor force with a relative lower labor cost level after the enactment and effectiveness of the new labor law in China on April 1, 2008. Existing economies of scale also contribute to keeping costs low. Diguang Electronics also has the ability to deliver its initial run of products within 15 to 30 days from the time an order is placed, while many of its competitors may require more time. This rapid fulfillment capability is possible because of Diguang Electronics’ large and skilled product development team, and it provides an important advantage to Diguang Electronics in this competitive market.
Diguang Electronics’ commitment to quality is evidenced by its receipt in 1999 of ISO9002 certification from Shenzhen Quality Certification Centre; its receipt in 2002 of QS9000 certification from Moody International Certification, ISO9001 certification from the TUVCERT Certification Body in 2005, and the certification of ISO/TS16949 in 2006. These certifications signify that Diguang Electronics has established and adheres to high quality standards in the conduct of its product design and manufacturing operations.
As a full-service manufacturer of CCFL, LED backlights for LCDs, Diguang Electronics works with its customers to design the proper backlight to meet the customers’ specifications for a particular product and application. Nearly all of Diguang Electronics’ products are customized in terms of customers’ specific applications. Diguang Electronics currently co-develops 30-50 new products with customers each month. Diguang Electronics has developed or co-developed more than 2,600 different products and over 2300 sets of molds for LED/CCFL backlights meeting different customer specifications to date and has put more than 2,000 LED/CCFL products meeting unique customer specifications into mass production. Diguang Electronics typically does not receive direct payments from customers to develop products, but includes such costs of developing products to meet customers’ specification in current period expenses and takes consideration of the costs in its pricing with the customers.
The Company’s sales are obtained either through its internal workforce, its subsidiaries of Well Planner and Diguang Technology, or through commissioned sales agents that represent the Company in locations outside of China.
Historically, the majority of the world’s backlight production was located in Japan and Korea, although due to low cost advantages and recent improvements in product quality, Taiwan and Mainland China have emerged as significant areas of backlight production. By conducting the Company’s business related to the design, production and distribution of backlights in China, principally through the operations of Diguang Electronics, the Company is able to take advantage of the low labor and other costs in China relative to other countries.
The Company’s business is subject to slight seasonal fluctuation. Many products that incorporate its backlights are popular household electronic consumer goods such as home entertainment equipment and cellular phones, which enjoy a higher rate of retail sales in the fourth calendar quarter compared with other times of the year. However, the varying lead times associated with those products and the inclusion of many product lines that are not seasonal in nature, such as home appliances and office equipment, limit the seasonal nature of the Company’s business. Overall, the Company does not consider its business to vary from quarter to quarter that would justify it as a seasonal business.
There are no practices in the Company’s industry that have a significant effect on working capital requirements. Most of the Company’s business is done on a relatively short cycle time, on average, less than a month from customer order to initial fulfillment and between 1 to 3 months for payment. The capital costs associated with product development are relatively small on an individual product basis, although the aggregate of such costs is meaningful given the large number of products that the Company develops on an ongoing basis. Molds meeting customers’ size specifications are needed to form the housings for the backlights, but these molds are not costly, and the Company has accumulated approximately 2,300 of them during its years of operation, many of which can be reused to make a new product with little or no adjustment. A significant aspect of the Company’s business model is providing a rapid response to customer orders, which helps to minimize the amount of inventory the Company must carry. The Company also does not need to carry large amounts of raw material inventories because raw materials have been readily available from a number of suppliers.
The principal raw materials used in a LED backlight consist of LED chips, SMD, reflectors, brightness enhancing films, silica gels and plastics, PMMA or PC etc. Those materials are available from numerous suppliers, most of them based in Asia, such as Nanjing Longguang Electronics Co. Ltd., HI SPEED Company, Toryota, Nicha, Kimoto, Hong Kong Panac Company, Global Trading Company and Advanced OPTO Company, etc. The Company purchased its raw materials from over 20 suppliers in Asia and from two United States based companies, 3M and Cree. The Company follows a practice of obtaining each of its raw materials from multiple suppliers as a means of ensuring supply, protecting against fluctuations in price, whether producer or currency related, and making certain that the Company’s quality standards are consistently met.
Significant Recent Events
Credit facilities provided by banks
1. Short term bank loans
Diguang Electronics has acquired bank loan facilities of RMB30 million, equivalent to $4.6 million as of December 31, 2010, from Shenzhen Ping’an Bank. The RMB30 million bank loan facility was pledged by buildings in Dongguan Diguang S&T with a net book value of $3.7 million.
As of December 31, 2010, the Company fully used the RMB30 million bank facilities and borrowed RMB30 million, equivalent to $4,545,455, from Shenzhen Ping’an Bank with a prevailing annual rate of 5.47%. All of these bank loans will fall due in the first half year of 2011, among which, $1.5 million, $1.1 million, and $2.0 million will fall due on June 6, May 30, and May 13, 2011, respectively.
2. Fully guaranteed import financing loans
In addition to the abovementioned RMB30 million bank loan facilities, Diguang Electronics also received pledged import financing loans from Shenzhen Ping’an Bank. The import financing loans were nominated in US Dollars and were fully guaranteed by equivalent deposit of cash in RMB. The Company entered into such loan agreements to earn some interest income since there were different interest rates for US Dollars and RMB.
As of December 31, 2010, the Company pledged RMB20.5 million, equivalent to $3.1 million, for $2,996,989 loans from Shenzhen Ping’an Bank under the import financing agreements. As of January 12, 2011, the Company repaid the loans and received pledged deposit of cash at the maturity of loans.
3. Long term loan received by Diguang Electronics
On November 10, 2009, Diguang Electronics entered into a 5 year, long-term loan agreement with China Development Bank Co., Ltd. to borrow RMB100 million for the construction of the new facility located in the Guangming District of Shenzhen City. On December 30, 2009, Diguang Electronics paid RMB3 million to China Development Bank as 5 year guarantee expense for the RMB100 million bank facilities, upon which the bank facilities formally became effective.
The RMB100 million banking facilities are secured by the followings: (1) two joint and several personal guarantees from Mr. Yi Song and Mr. Hong Song, both are directors of the Company; (2) collateral placed on the office space owned by Diguang Electronics with a carrying amount of $2.3 million; and (3) collateral placed on the land use rights of the land on which the new manufacturing facility was located, which has a carrying amount of $2.4 million.
Research and Development
In addition to the Company’s product development work, taking existing, available technology and adapting it to the specific needs of a customer for a particular product, the Company engages in research and development, which involves developing new, proprietary techniques or products. The Company’s growth rate is attributable to a number of patents, especially in the area of light guides and other innovations that improve the quality, a combination of brightness, evenness, color of the light generated, and durability, of its products relative to other backlight manufacturers.
The Company is engaged in efforts to develop some technologies that reduce energy consumption and other environmental impacts of its devices. The innovations can be used for a variety of applications in screens of almost all sizes. Management believes that many of the Company’s new technologies will be patentable, and the Company expects to file for and maintain both Chinese and/or international patents where the value of the invention warrants the expense and effort of doing so.
The Company has spent $1.6 million, $3.1 million and $1.4 million for the years ended 2008, 2009 and 2010 respectively on research and development efforts to improve existing products and processes and to develop new products, not including the expenses to develop particular backlight products utilizing existing technology to meet customer specifications for products.
The Company’s major manufacturing processes are “dry,” meaning that they do not involve significant quantities of solvents, plating solutions or other types of materials that lead to the generation of large amounts of hazardous wastes, process wastewater discharges or air pollutant emissions. The Company has moved into its state-of-the-art manufacturing facility in Dongguan in 2005, and is now constructing a new manufacturing facility in Guangming District of Shenzhen City. But environment-related costs are not expected to be a material portion of the costs of constructing that facility, given the nature of the Company’s processes.
Customers
The Company’s customer base consists of many large and medium sized companies. Sales to the Company’s largest customer generated 17.28% of its revenues for 2010 compared with 11.18% in 2009. Sales to the Company’s three largest customers accounted to 17.28%, 11.19%, and 9.84% of total revenue in 2010 and 11.18%, 7.86% and 6.62% in 2009. As a result, the loss of one or more of the Company’s top customers or a significant decrease in the volume of business that the Company does with those customers would have a material adverse effect on its business. To help protect against that risk, the Company continually seeks to diversify its customer base, in particular by expanding its international sales efforts. The Company also expects to introduce new backlight technologies for a variety of applications that will help expand and diversify its customer base.
Due to the Company’s current modest utilization of its production capacity and its practice of rapid turnaround of customer orders, the Company does not maintain a large backlog of orders relative to its annual revenue figures. Also, because nearly all of the Company’s products are custom made to customer specifications, experience has shown that nearly the Company’s entire order backlog is firm; virtually all orders that are placed are completed and delivered.
The Company does not do any business directly with governments, although many of its customers may make products for sale to governments around the world.
Competition
The display backlight market is highly competitive. It has traditionally been centered in Japan and Korea, where the majority of LCDs and related components continue to be made. Due to cost advantages and an increase in product quality, Taiwan has recently emerged as a significant producer of backlights, and China is growing in importance as a source of backlights.
To management’s knowledge, there are no independently published industry statistics that can be used to measure the Company’s market share among China-based companies accurately. However, based on its general knowledge of the Chinese backlight industry, management believes that the Company is one of the largest and fastest growing manufacturers of backlight units in China.
Taking into consideration factors such as geographic market, product mix and customer base, the Company believes the following companies are its main competitors: Shian Yih Electronics Ind. Co. Ltd. (Taiwan), Wai Chi Electronics Ltd. (Hong Kong), Radiant Opto-Electronics Corporation (Taiwan) and K-Bridge Electronics Co. Ltd. (Taiwan) etc. Even though these competitors are based outside China, each has significant manufacturing operations in China. Due to the advancements that Taiwanese and Chinese producers have made within this industry, the Company’s main competitors are no longer Japanese or Korean producers.
As with most other products, competitive advantages in backlights derive from a favorable combination of price, quality and customer service. The Company believes that it is well-positioned to compete effectively in all three of those areas. The Company has an output capacity of 200,000-300,000 small and medium units per day depending on size of products. In addition, China’s well-known labor cost advantages relative to Japan, Korea and Taiwan have enabled the Company to put price pressure on its foreign rivals, thereby helping the Company to gain market share while maintaining certain margins. The Company currently expects that growth to continue. However, as more of the world’s backlight productions shift to China, the Company’s comparative advantage of lower costs comparing to other Asian countries will diminish.
The Company’s quality enhancements include innovations in light guide technology with a corresponding increase in backlight life. The improved overall performance resulting from these enhancements is one of the reasons the Company has enjoyed a history of rapid growth. The Company believes, based on its familiarity with other products in the market, that it has a technological advantage relative to other producers. The Company expects that this existing technological advantage, combined with its anticipated development of additional patented technology, will continue to give it a competitive advantage.
Another important factor in the Company’s ability to compete is its relative short cycle time from the receipt of a customer’s order to the initial delivery of products to the customer. On average, this is a 15- to 30- day process for us, while many of the Company’s competitors take longer to reach the same result. The Company’s short cycle time is due to, among other things, its modern facilities and equipment, along with its large and skilled product development staff.
Intellectual Property
Diguang Electronics owns 49 current patents. The patent transfer agreement for seven unexpired Chinese is in the process of being drafted as the Company is discussing with Mr. Yi Song, the owner of the patents and Diguang’s Chairman and CEO, whether or not any consideration, either cash or stock or both, would be paid for the contemplated patents transfer. However, prior to the completed patent transfer, Yi Song by way of a written license allowed Diguang Electronics to use his backlight patents free of charge until the relevant patents have been transferred to Diguang Electronics. Although two of these patents expired in March 2008 and October 2009 and three expired in May 2010, January 2011 and March 2011, respectively, the Company strengthened its intellectual property development and the number of patents have increased due to this patent transfer.
These patents include:
Patent Name
Patent Number
Holder
Effective
date of
Patents
Expiry
date of
Patents
Efficiency Fluorescent Lamp of New Model
ZL 200320130305.1
Diguang Electronics
23/12/2003
22/12/2013
Efficiency Photosensitive Sensor for Graphic Consent
LED Grouping with Parallel Connected Backlight Modules for Big Sized TFT-LCD TV
ZL200620120892.X
Diguang Electronics
11/07/2006
11/07/2016
Backlight Modules with LED Reflect Concave
ZL200620120893.4
Diguang Electronics
11/07/2006
11/07/2016
arrayed LED backlight modules with direct type
ZL200620120894.9
Diguang Electronics
11/07/2006
11/07/2016
Inserted CCFL Backlight Module
ZL200620139418.1
Diguang Electronics
30/12/2006
30/12/2016
LED backlight module with adiabatic euphotic material radiator system
ZL200720005429.5
Diguang Electronics
23/04/2007
23/04/2017
Backlight Module with Wedge-docking LGP
ZL200710102016.3
Diguang Electronics
30/04/2007
30/04/2017
Side Lighting Backlight with Integrated Light Guide Plate and Braced Frame
ZL200720156070.1
Diguang Electronics
26/07/2007
26/07/2017
LED Lightings (Streetlight)
ZL200720126525.5
Diguang Electronics
08/08/2007
08/08/2017
Lightings and Lamps
ZL200720001219.9
Diguang Electronics
09/01/2007
09/01/2017
Lightings and Lamps
ZL200720177852.3
Diguang Electronics
12/10/2007
12/10/2017
LED Light with Function of Landscape Lighting
ZL200820131088.0
Diguang Electronics
02/09/2008
02/09/2018
PCB Structure of Downward-Type LED Backlight Module
ZL200820117364.8
Diguang Electronics
23/06/2008
23/06/2018
Slim Type Integrated TFT-LCD Display
ZL200820124984.4
Diguang Electronics
31/07/2008
31/07/2018
Strip Shape LED PCB and LED Light Source Structure
ZL200820133517.8
Diguang Electronics
29/08/2008
29/08/2018
Edge-lit Uniform and High-brightness Backlight
ZL200920260958.9
Diguang Electronics
01/12/2009
01/12/2019
Rainbow Display Device and LCD Display
ZL200920129593.6
Diguang Electronics
20/01/2009
20/01/2019
Ultra-thin Display(A1903)
ZL200930204799.6
Diguang Electronics
02/09/2009
02/09/2019
Ultra-thin Display(A1901)
ZL200930204800.5
Diguang Electronics
02/09/2009
02/09/2019
Ultra-thin Display(A1902)
ZL200930209322.7
Diguang Electronics
02/09/2009
02/09/2019
Double Screen Display
ZL200920135540.5
Diguang Electronics
13/03/2009
13/03/2019
Double Screen Notebook
ZL200920135543.9
Diguang Electronics
13/03/2009
13/03/2019
LED Sensor Light (Type A)
200930001801.X
Diguang Electronics
07/01/2009
07/01/2019
LED Sensor Light (Type C )
200930001802.4
Diguang Electronics
07/01/2009
07/01/2019
LED Sensor Light (Type B )
ZL200930001803.9
Diguang Electronics
07/01/2009
07/01/2019
Video-controlled Dynamic LED Backlight Components
ZL200920149307.2
Diguang Electronics
08/04/2009
08/04/2019
Thin Liquid Crystal Display Device with Double-layer Panel
ZL200920204504.X
Diguang Electronics
27/08/2009
27/08/2019
High-brightness and Uniform LED Light
ZL200920260173.1
Diguang Electronics
09/11/2009
09/11/2019
High-brightness LED Light
ZL200920205989.4
Diguang Electronics
19/10/2009
19/10/2019
Ultra-thin LED Panel light
ZL200920260338.5
Diguang Electronics
11/11/2009
11/11/2019
Ultra Slim LCD Device Which Dissipates Heat Efficiently
ZL200920132753.2
Diguang Electronics
12/06/2009
12/06/2019
LED Light
ZL200930331026.4
Diguang Electronics
25/12/2009
25/12/2019
Down-straight High-brightness Ultra-thin Liquid Crystal Display Device
ZL200920262199.X
Diguang Electronics
28/12/2009
28/12/2019
Down-straight Ultra-thin Liquid Crystal Display Device
ZL201020056545.1
Diguang Electronics
14/01/2010
14/01/2020
Liquid Crystal Display Device
ZL201030046150.9
Diguang Electronics
15/01/2010
15/01/2020
the front panel of liquid crystal display and liquid crystal display device
ZL201020208266.2
Diguang Electronics
28/05/2010
28/05/2020
LED Backlight Device, Liquid Crystal Displays and DisplayTerminal
ZL201020283893.2
Diguang Electronics
06/08/2010
06/08/2020
Backlight modules, LCD Modules and LCD Display Devices
ZL201020242053.1
Diguang Electronics
28/06/2010
28/06/2020
Separated-Show Thin Liquid Crystal Display Device
ZL201020263283.6
Diguang Electronics
19/07/2010
19/07/2020
LED light
ZL201020125762.1
Diguang Electronics
08/03/2010
08/03/2020
Down-straight Ultra-thin LED Backlight Module
ZL201020117402.7
Diguang Electronics
10/02/2010
10/02/2020
Backlight Module and Liquid Crystal Display Device
ZL201020524903.7
Diguang Electronics
10/09/2010
10/09/2020
Direct Type Backlight
ZL200510090917.6
Diguang Electronics
19/08/2005
19/08/2025
LED Light Source Product
ZL200510103516.X
Diguang Electronics
19/09/2005
19/09/2025
Video Controlled LED Backlight and Its Controlling Calculation
ZL200610090989.5
Diguang Electronics
06/07/2006
06/07/2026
TFT-LCD Use LED Backlight Module
ZL200610127036.1
Diguang Electronics
21/09/2006
21/09/2026
LED Dynamic Backlight Control Circuit
ZL200610150425.6
Diguang Electronics
27/10/2006
27/10/2026
LED Dynamic Backlight Control Calculation Method
ZL200610170237.X
Diguang Electronics
21/12/2006
21/12/2026
LED Light Source System with Heat Conduction and Heat Dissipation System
ZL200810084833.5
Diguang Electronics
27/03/2008
27/03/2028
Efficiency Uniform Backlight of Front Backlight and White Backlight radiation
ZL 01 2 71009.1
Yi Song
19/11/2001
18/11/2011
Improved Uniform and Luminous Side Backlight Device with High Efficiency
ZL 090220868
Yi Song
30/11/2001
29/11/2011
Advanced Efficiency Backlight of Side radiation
ZL 01 2 19472.7
Yi Song
13/04/2001
12/04/2011
Efficiency Uniform Illuminance Equipment
ZL 02 2 05116.3
Yi Song
10/02/2002
9/02/2012
High Efficiency of Light Source for Planar Fluorescent Lamp
ZL 200420006645.8
Yi Song
11/03/2004
10/03/2014
High-Efficient Flat Fluorescent Light Source
ZL200420006645.8
Yi Song
11/3/2004
11/3/2014
LED Optic Display
ZL200410074672.3
Yi Song
13/09/2004
13/09/2024
Almost all of the Company’s products incorporate technology from one or more of the above patents. As these patents expire, the technology that they represent will become available to other backlight manufacturers. The expiration of eight patents in 2008, 2009, 2010 and 2011 did not have a material adverse impact on the Company’s operation results. However, the pace of change in this field will generally mean that the technology represented by the expired patents is out-of-date. The Company’s efforts will remain directed toward the development of new patents for leading-edge technologies that will help the Company to maintain its technological advantage. The Company also intends to patent its new inventions both in China and internationally, and it continues to work closely with leading Chinese universities and research institutions in the development of such technology.
Management is not aware of any current or previous infringement of the existing patents. If any infringement occurs, management will vigorously prosecute actions to halt the infringement and recover damages if the value of the patent is judged at the time to be sufficient to justify that effort.
DOING BUSINESS IN CHINA
CHINESE LEGAL SYSTEM
The practical effect of the Chinese legal system on the Company’s business operations in China can be viewed from two separate considerations. First, as a matter of substantive law, the Foreign Invested Enterprise Laws provide significant protection from government interference. In addition, these laws guarantee the full enjoyment of the benefits of corporate articles and contracts to Foreign Invested Enterprise participants. These laws, however, do impose standards concerning corporate formation and governance, which are not different from the general corporation laws of the several provinces. Similarly, the Chinese accounting laws mandate accounting practices, which are not consistent with US Generally Accepted Accounting Principles. The Chinese accounting laws require that an annual “statutory audit” be performed in accordance with Chinese accounting standards and that the books of account of Foreign Invested Enterprises be maintained in accordance with Chinese accounting laws. Article 14 of the People’s Republic of China Wholly Foreign-Owned Enterprise Law requires a Wholly Foreign-Owned Enterprise to submit certain periodic fiscal reports and statements to designated financial and tax authorities. Otherwise there is risk that its business license will be revoked.
Second, while the enforcement of substantive rights may appear less clear than those in the United States, the Foreign Invested Enterprises and Wholly Foreign-Owned Enterprises are Chinese registered companies which enjoy the same status as other Chinese registered companies in business dispute resolution. Because the terms of the Company’s various Articles of Association provide that all business disputes pertaining to Foreign Invested Enterprises will be resolved by the Arbitration Institute of the Stockholm Chamber of Commerce in Stockholm, Sweden applying Chinese substantive law, the Chinese minority partner in the Company’s joint venture companies will not assume any advantageous position regarding such disputes. Any award rendered by this arbitration tribunal is, by the terms of the various Articles of Association, enforceable in accordance with the “United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (1958).” Therefore, although no assurances can be given, the Chinese legal infrastructure, while different from its United States counterpart, should not present any significant impediment to the operation of Foreign Invested Enterprises.
ECONOMIC REFORM ISSUES
Although the Chinese Government owns the majority of productive assets in China, in the past several years the Government has implemented economic reform measures that emphasize decentralization and encourage private economic activity. Because these economic reform measures may be inconsistent or ineffectual, there is no assurance that:
·
The Company will be able to capitalize on economic reforms;
·
The Chinese Government will continue its pursuit of economic reform policies;
·
The economic policies, even if pursued, will be successful;
·
Economic policies will not be significantly altered from time to time; and
·
Business operations in China will not become subject to the risk of nationalization.
Negative impact on economic reform policies or nationalization could result in a total investment loss in the Company’s common stock.
Since 1979, the Chinese Government has reformed its economic systems. Because many reforms are unprecedented or experimental, they are expected to be refined and readjusted. Other political, economic and social factors, such as political changes, changes in the rates of economic growth, unemployment or inflation, or in the disparities in per capita wealth between regions within China, could lead to further readjustment of the reform measures. This refining and readjustment process may negatively affect the Company’s operations.
Over the last few years, China’s economy has registered a high growth rate. Recently, there have been indications that the rate of inflation has increased. In response, the Chinese Government recently has taken measures to curb the excessively expansive economy. These measures included implementation of a unitary and well-managed floating exchange rate system based on market supply and demand for the exchange rates of Renminbi, restrictions on the availability of domestic credit, reduction of the purchasing capability of certain of its citizens, and centralization of the approval process for purchases of certain limited foreign products. These austerity measures alone may not succeed in slowing down the economy’s excessive expansion or control inflation, and may result in severe dislocations in the Chinese economy. The Chinese Government may adopt additional measures to further combat inflation, including the establishment of freezes or restraints on certain projects or markets.
To date reforms to China’s economic system have not adversely affected the Company’s operations and are not expected to adversely affect the Company’s operations in the foreseeable future; however, there can be no assurance that reforms to China’s economic system will continue or that the Company will not be adversely affected by changes in China’s political, economic, and social conditions and by changes in policies of the Chinese Government, such as changes in laws and regulations, measures which may be introduced to control inflation, changes in the rate or method of taxation, imposition of additional restrictions on currency conversion and remittance abroad, reduction in tariff protection and other import restrictions.
ITEM 1A.
ITEM 1A. RISK FACTORS.
The Company’s business, financial conditions and results of operations could be materially and adversely affected by many risk factors. Because of these risk factors, actual results might differ significantly from those projected in the forward-looking statements. Factors that might cause such differences include, among others, the following:
Risks Related to the Company’s Business
The Company expects to continue to incur operating losses that may endanger its viability as a going concern.
The Company has incurred consecutive losses for four years since 2007. Currently, the Company’s operations are funded by debt financing. And, as of December 31, 2010 the available working capital dropped to negative $1.8 million, which means there may not be adequate working capital to meet the Company’s operating needs in 2011. Consequently, the Company may need to apply for new loans as soon as possible. However, as the PRC government is tightening the bank lending policy in China, the Company may not be able to secure future loans in order to finance its operations. The Company’s continuing losses, among other things, have caused its independent registered public accounting firm to add an explanatory paragraph in its audit report on the 2010 financial statements indicating that there is substantial doubt about the Company’s ability to continue as a going concern. Although the Company is focused on returning to profit, there can be no reasonable assurance that such efforts will result in predictable and scalable sources of revenue.
Adverse trends in the electronics industry, such as an overall decline in price or a shift away from products that incorporate the Company’s backlights, may reduce the Company’s revenues and profitability.
The Company’s business depends on the continued vitality of the electronics industry, which is subject to rapid technological change, short product life cycles and profit margin pressures. In addition, the electronics industry historically has been cyclical and subject to significant downturns characterized by diminished product demand, accelerated erosion of average selling prices and production over-capacity. It is also characterized by sudden upswings in the cycle, which can lead to shortages of key components needed for the Company’s business, for which there is not always an alternative source. Economic conditions affecting the electronics industry in general or the Company’s major customers may adversely affect the Company’s operating results by reducing the level of business that they furnish to the Company or the price they are willing to pay for the Company’s products. If the Company’s customers’ products fail to gain widespread commercial acceptance, become obsolete or otherwise suffer from low sales volume, its revenues and profitability may stagnate or decline.
If Organic Light Emitting Diode technology matures, it may lessen the demand for LCDs and LED/CCFL Backlights, which could reduce the Company’s revenues and profits.
Organic Light Emitting Diode technology is an alternative to traditional LED technology that is still in the development phase, with companies attempting to create an OLED solution for cell phones and other small size applications. This technology has the potential to supplant traditional LEDs in many applications, but it still faces many performance issues related to the life span, processing technology, restrictions of sizes, etc. and for many applications it is still cost prohibitive. If development of this technology overcomes those drawbacks, it will compete with existing LCD display technologies and may reduce the demand for LCDs and the backlights that the Company supplies to the makers of LCDs. The Company’s client base is currently diverse and involved with manufacturing products in a variety of different sizes and for many different applications. Due to the current diverse product base of the Company’s customers, a currently perceived growing demand for the Company’s backlights in medium and large size applications and enhancements in LCD technology, the Company believes that OLED technology will have little or no short term or medium-term effect on its levels of LCD backlight sales. However, if the OLED technology matures or the Company’s current beliefs or understandings materially change, it may lessen the demand for LCDs and related components, leading to a reduction of the Company’s revenues or profits or both.
A few customers and applications account for a significant portion of the Company’s sales, and the loss of any one of these customers may reduce the Company’s revenues and profits.
A significant portion of the Company’s revenue is generated from a small number of customers. 38.30% of the total revenue was generated from top three customers in the year ended December 31, 2010. Roughly 17.28% of the total revenue comes from one largest customer. Under present conditions, the loss of any of these customers, or a significant reduction in the Company’s level of sales to any or all of them, could have a material adverse effect on the Company’s business and operating results.
The Company does not have long-term purchase commitments from its customers and may have to rely on customer forecasts in making production decisions, and any cancellation of purchase commitments or orders may result in the waste of raw materials or work in process associated with those orders, reducing both its revenues and profitability.
As a backlight manufacturer, the Company must provide increasingly rapid product turnaround. A variety of conditions, both specific to individual customers and generally affecting the demand for these products, may cause customers to cancel, reduce or delay orders. Cancellations, reductions or delays by a significant customer or by a group of customers would result in a material reduction in revenue. Those customer decisions could also result in excess and obsolete inventory and/or unabsorbed manufacturing capacity, which could reduce the Company’s profits or impair the Company’s cash flow. On occasion, customers require rapid increases in production, which can strain the Company’s resources, leading to a reduction in the Company’s margins as a result of the additional costs necessary to meet those demands.
The Company’s customers generally do not provide the Company with firm, long-term volume purchase commitments. In addition, industry trends over the past five years have led to dramatically shortened lead time on purchase orders, as rapid product cycles have become the norm. Although the Company sometimes enters into manufacturing contracts with its customers, these contracts principally clarify order lead time, inventory risk allocation and similar matters, rather than providing for firm, long-term commitments to purchase a specified volume of products at a fixed price. As a result, customers can generally cancel purchase commitments or reduce or delay orders at any time. The large percentage of the Company’s sales to customers in the electronics industry, which is subject to severe competitive pressure, rapid technological change and product obsolescence, increases the Company’s inventory and overhead risks, among others, as the Company must maintain inventories of raw materials, work in process and finished goods to meet customer delivery requirements, and those inventories may become obsolete if the anticipated customer demand does not materialize.
The Company also makes significant decisions, including determining the levels of business that it will seek and accept, production schedules, component procurement commitments, facility requirements, personnel need, and other resource requirements, based upon its estimates of customer requirements. The short-term nature of the Company’s customers’ commitments and the possibility of rapid changes in demand for these products reduce the Company’s ability to estimate accurately the future requirements of those customers. Because many of the Company’s costs and operating expenses are fixed, a reduction in customer demand can reduce the Company’s gross margins and operating results. In order to transact business, the Company assesses the integrity and creditworthiness of its customers and suppliers and it may, based on this assessment, incur design and development costs that it expects to recoup over a number of orders produced for the customer. Such assessments are not always accurate and expose the Company to potential costs, including the write off of costs incurred and inventory obsolescence if the orders anticipated do not materialize. The Company may also occasionally place orders with suppliers based on a customer’s forecast or in anticipation of an order that is not realized. Additionally, from time to time, the Company may purchase quantities of supplies and materials greater than required by customer orders to secure more favorable pricing, delivery or credit terms. These purchases can expose the Company to losses from cancellation costs, inventory carrying costs or inventory obsolescence, and hence adversely affect the Company’s business and operating results.
Failure to optimize the Company’s manufacturing potential and cost structure could materially increase the Company’s overhead, causing a decline in the Company’s margins and profitability.
The Company strives to utilize the manufacturing capacity of its facilities fully but may not do so on a consistent basis. The Company’s factory utilization is dependent on its success in accurately forecasting demand, predicting volatility, timing volume sales to its customers, balancing its productive resources with product mix, and planning manufacturing services for new or other products that it intends to produce. Demand for contract manufacturing of these products may not be as high as the Company expects, and it may fail to realize the expected benefit from its investment in its manufacturing facilities. The Company’s profitability and operating results are also dependent upon a variety of other factors, including: utilization rates of manufacturing lines, downtime due to product changeover, impurities in raw materials causing shutdowns, and maintenance of contaminant-free operations. Failure to optimize the Company’s manufacturing potential and cost structure could materially and adversely affect its business and operating results.
Moreover, the Company’s cost structure is subject to fluctuations from inflationary pressures in China and other geographic regions where the Company conducts business. China's economy is currently growing. This growth may lead to continued pressure on wages and salaries that may exceed increases in productivity. In addition, these may not be compensated for and may be exacerbated by currency movements.
The Company faces intense competition, and many of its competitors have substantially greater resources than the Company has. Increased competition from these competitors may reduce the Company’s revenues or decrease its margins, either or both of which would reduce its profitability and could impair cash flow.
The Company operates in a competitive environment that is characterized by price deflation and technological change. The Company competes with major international and domestic companies. The Company’s major competitors include Shian Yih Electronics Ind. Co. Ltd., Wai Chi Electronics Ltd., Radiant Opto-Electronics Corporation, K-Bridge Electronics Co. Ltd., etc. and other similar companies primarily located in Japan, Taiwan, Korea, Hong Kong and China Mainland. The Company’s competitors may have greater market recognition and substantially greater financial, technical, marketing, distribution, purchasing, manufacturing, personnel and other resources than the Company does. Furthermore, some of the Company’s competitors have manufacturing and sales forces that are geographically diversified, allowing them to reduce transportation expenses, tariff costs and currency fluctuations for certain customers in markets where their facilities are located. Many competitors have production lines that allow them to produce more sophisticated and complex devices than the Company currently does and to offer a broader range of display devices to the Company’s target customers. Other emerging companies or companies in related industries may also increase their participation in the display and display module markets, which would intensify competition in the Company’s markets. The Company might lose some of its current or future business to these competitors or be forced to reduce its margins to retain or acquire that business, which could decrease its revenues or slow its future revenue growth and lead to a decline in profitability.
The Company depends on the market acceptance of its customers’ products, and significant slowdown in demand for those products would reduce its revenues and the Company’s profits.
Currently, the Company does not sell products to end users. Instead, the Company designs and manufactures various display product solutions that its customers incorporate into their products. As a result, the Company’s success depends almost entirely upon the widespread market acceptance of its customers’ products. Any significant slowdown in the demand for the Company’s products would likely reduce the Company’s revenues and profits. Therefore, the Company must identify industries that have significant growth potential and establish strong, long-term relationships with manufacturers in those industries. The Company’s failure to identify potential growth opportunities or establish these relationships would limit the Company’s revenue growth and profitability.
The Company extends credit to its customers and may not be able to collect all receivables due to it, and its inability to collect such receivables may have an adverse effect on its immediate and long-term liquidity.
The Company extends credit to its customers based on assessments of their financial circumstances, generally without requiring collateral. As of December 31, 2010, the Company’s accounts receivable, after deducting an allowance for bad debts, was $14.1 million. The Company’s overseas customers may be subject to economic cycles and conditions different from those of its domestic customers. The Company may also be unable to obtain satisfactory credit information or adequately secure the credit risk for some of these overseas customers. The extension of credit presents an exposure to risk of uncollected receivables. Additionally, the Company may not realize from receivables denominated in a foreign currency the anticipated amounts in United States dollar terms due to fluctuations in currency values. The Company’s inability to collect on these accounts may reduce on the Company’s immediate and long term liquidity.
The growth of the Company’s business depends on its ability to finance new products and services and these increased costs may reduce its cash flows and, if the products and services in which the Company has invested do not succeed, it would reduce the Company’s profitability.
The Company operates in the consumer electronics industry, which is characterized by rapid change. New technologies are appearing with increasing frequency to supplant existing technologies. In order to capture increased market share, manufacturers are adopting a shorter product life cycle from a cosmetic, if not functional, standpoint, but those cosmetic changes generally have a direct effect on the backlight products that the new designs incorporate. Technological advances, the introduction of new products, new designs and new manufacturing techniques could render the Company’s inventory obsolete, or it could shift demand into areas where the Company is not currently engaged. If the Company fails to adapt to those changing conditions in a timely and efficient manner, its revenues and profits would likely decline. To remain competitive, the Company must continue to incur significant costs in product development, equipment and facilities and to make capital investment. These costs may increase, resulting in greater fixed costs and operating expenses. As a result, the Company could be required to expend substantial funds for and commit significant resources to the following:
¨
research and development activities on existing and potential product solutions;
¨
additional engineering and other technical personnel;
¨
advanced design, production and test equipment;
¨
manufacturing services that meet changing customer needs;
¨
technological changes in manufacturing processes; and
¨
expansion of manufacturing capacity.
The Company’s future operating results will depend to a significant extent on the Company’s ability to continue to provide new product solutions and electronic manufacturing services that compare favorably on the basis of time to market, cost and performance with the design and manufacturing capabilities and competing third-party suppliers and technologies. The Company’s failure to increase its net sales sufficiently to offset these increased costs would reduce the Company’s profitability.
The Company is subject to lengthy sales cycles, and it could take longer than the Company anticipates before its sales and marketing efforts result in revenue.
The Company’s focus on developing a customer base that requires custom displays and devices means that it may take longer to develop strong customer relationships. Moreover, factors specific to certain industries have an impact on the Company’s sales cycles. In particular, those customers who operate in or supply to the medical and automotive industries require longer sales cycles, as qualification processes are longer and more rigorous, often requiring extensive field audits. These lengthy and challenging sales cycles may mean that it could take longer before the Company’s sales and marketing efforts result in revenue to us, if at all. As a result, the return on the time and effort invested in developing these opportunities may be deferred, or may not be realized at all, reducing the Company’s profitability.
Products the Company manufactures may contain design or manufacturing defects, which could result in reduced demand for its services and customer claims, causing it to sustain additional costs, loss of business reputation and legal liability.
The Company manufactures products to its customers’ requirements, which can be highly complex and may at times contain design or manufacturing errors or failures. Any defects in the products manufacture, whether caused by a design, manufacturing or component failure or error, may result in returns, claims, delayed shipments to customers or reduced or cancelled customer orders. If these defects occur, the Company will incur additional costs, and if in they occur in large quantity or frequently, it may sustain additional costs, loss of business reputation and legal liability.
The Company could become involved in intellectual property disputes, resulting in substantial costs and diversion of its management resources. Such disputes could materially and adversely affect the Company’s business by increasing its expenses and limiting the resources that the Company can devote to expansion of its business, even if the Company ultimately prevail.
Diguang Electronics currently possesses 38 Chinese patents, and the Company utilizes the additional patented technologies that are material to its business, which are in the process of being transferred to Diguang Electronics from Yi Song, referred to in its prior filings as Song Yi to conform to Chinese convention of last name first, its Chairman, CEO and the current owner of the patents. If the patents are not successfully transferred, the Company will not be able to use the same patents, which would hamper the Company’s production and this would have a material and adverse effect on its business and revenues. If a patent is infringed upon by a third party, the Company may need to devote significant time and financial resources to attempt to halt the infringement. The Company may not be successful in defending the patents involved in such a dispute. Similarly, while the Company does not knowingly infringe on patents, copyrights or other intellectual property rights owned by other parties; it may be required to spend a significant amount of time and financial resources to resolve any infringement claims against it. The Company may not be successful in defending its position or negotiating an alternative remedy. Any litigation could result in substantial costs and diversion of the Company’s management resources and could reduce the Company’s revenues and profits.
The Company’s customers may decide to design and/or manufacture the products that they currently purchase from the Company, which may reduce its revenues and profits, as it may not be able to compete successfully with these in-house developments.
The Company’s competitive position could also be adversely affected if one or more of its customers decide to design and/or manufacture their own backlights and display modules. The Company may not be able to compete successfully with these in-house developments by its customers, which would tend to favor their in-house supply over the Company, even in cases where price and quality may not be comparable.
The Company may develop new products that may not gain market acceptance, and its significant costs in designing and manufacturing services for new product solutions may not result in sufficient revenue to offset those costs or to produce profits.
The Company operates in an industry characterized by frequent and rapid technological advances, the introduction of new products and new design and manufacturing technologies. As a result, the Company may be required to expend funds and commit resources to research and development activities, possibly requiring additional engineering and other technical personnel; purchasing new design, production, and test equipment; and continually enhancing design and manufacturing processes and techniques. The Company may invest in equipment employing new production techniques for existing products and new equipment in support of new technologies that fail to generate adequate returns on the investment due to insufficient productivity, functionality or market acceptance of the products for which the equipment may be used. could, therefore, incur significant sums in design and manufacturing services for new product solutions that do not result in sufficient revenue to make those investments profitable. Furthermore, customers may change or delay product introductions or terminate existing products without notice for any number of reasons unrelated to the Company, including lack of market acceptance for a product. The Company’s future operating results will depend significantly on its ability to provide timely design and manufacturing services for new products that compete favorably with design and manufacturing capabilities and third party suppliers.
The Company’s component and materials suppliers may fail to meet its needs, causing it to experience manufacturing delays, which may harm its relationships with current or prospective customers and reduce sales.
The Company does not have long term supply contracts with the majority of its suppliers or for specific components. This generally serves to reduce its commitment risk but does expose it to supply risk and to price increases that the Company may not be able to pass on to its customers. In the Company’s industry, at times, there are shortages of some of the materials and components that it uses. If the Company is unable to obtain sufficient components on a timely basis, the Company may experience manufacturing delays, which could harm its relationships with current or prospective customers and reduce sales. Moreover, some suppliers may offer preferential terms to the Company’s competitors, who may have greater buying power or leverage in negotiations. That would place the Company at a competitive disadvantage.
The Company may be affected by power shortages, causing delays in delivery of products to its customers, resulting in possible loss of business or claims against it and cause it to lose future business from those or other customers.
The Company’s Dongguan factory consumes a significant amount of electricity, and there are a significant number of industrial facilities in the area where this factory is located. Therefore, power shortages may occur and the facility may be deprived of electricity for undetermined periods of time. This may result in longer production timeframes and delays in delivery of product to the Company’s customers. Failure to meet delivery deadlines may result in the loss of business or claims against the Company, which may have a material and adverse effect on its business, profitability and reputation.
The Company’s financial performance could be harmed if compliance with new environmental regulations becomes too burdensome.
Although the Company believes that it is operating in compliance with applicable Chinese government environmental laws, there is no assurance that the Company will be in compliance consistently, as such laws and regulations or their interpretation and implementation change. Failure to comply with environmental regulation could result in the imposition of fines, suspension or halting of production or closure of manufacturing operations.
The Company may not be able to secure financing needed for future operating needs on acceptable terms, or on any terms at all.
From time to time, the Company may seek additional equity or debt financing to provide the capital required to maintain or expand its design and production facilities and equipment and/or working capital, as well as to repay outstanding loans if cash flow from operations is insufficient to do so. The Company cannot predict with certainty the timing or amount of any such capital requirements. If such financing is not available on satisfactory terms, the Company may be unable to expand its business or to develop new business at the rate desired.
Failure to manage growth effectively could result in inefficiencies that could increase the Company’s costs, reducing the Company’s profitability.
The Company has increased the number of its manufacturing and design programs and intends to expand further the number and diversity of its programs. The number of locations where the Company manufactures may also increase. The Company’s ability to manage its planned growth effectively will require the Company to:
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enhance quality, operational, financial and management systems;
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expand facilities and equipment; and
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successfully hire, train and motivate additional employees, including the technical personnel necessary to operate the Company’s production facilities.
An expansion and diversification of the Company’s product range, manufacturing and sales will result in increases in its overhead and selling expenses. The Company may also be required to increase staffing and other expenses as well as expenditures on plant, equipment and property in order to meet the anticipated demand of its customers. Customers, however, generally do not commit to firm production schedules for more than a short time in advance. Any increase in expenditures in anticipation of future orders that do not materialize would adversely affect the Company’s profitability. Customers also may require rapid increases in design and production services that place an excessive short-term burden on the Company’s resources and reduce its profitability.
Potential strategic alliances may not achieve their objectives, which could lead to wasted effort or involvement in ventures that are not profitable and could harm the Company’s reputation.
The Company is currently exploring strategic alliances designed to enhance or complement its technology or to work in conjunction with its technology, increase its manufacturing capacity, provide additional know-how, components or supplies, and develop, introduce and distribute products and services utilizing its technology and know-how. Any strategic alliances entered into may not achieve their strategic objectives, and parties to the Company’s strategic alliances may not perform as contemplated. As a result, the alliances themselves may run at a loss, which would reduce the Company’s profitability, and if the products or customer service provided by such alliances were of inferior quality, its reputation in the marketplace could be harmed, affecting its existing and future customer relationships.
The Company may not be able to retain, recruit and train adequate management and production personnel. The Company relies heavily on those personnel to help develop and execute its business plans and strategies, and if the Company loses such personnel, it would reduce its ability to operate effectively.
The Company’s success is dependent, to a large extent, on its ability to retain the services of its executive management, who have contributed to its growth and expansion to date. The executive directors play an important role in the Company’s operations and the development of its new products. Accordingly, the loss of their services, in particular Mr. Yi Song without suitable replacements, will have an adverse affect on the Company’s business generally, operating results and future prospects.
In addition, the Company’s continued operations are dependent upon its ability to identify and recruit adequate management and production personnel in China. The Company requires trained graduates of varying levels and experience and a flexible work force of semi-skilled operators. Many of the Company’s current employees come from the more remote regions of China as they are attracted by the wage differential and prospects afforded by Shenzhen and the Company’s operations. With the economic growth currently being experienced in China, competition for qualified personnel will be substantial, and there can be no guarantee that a favorable employment climate will continue and that wage rates the Company must offer to attract qualified personnel will enable it to remain competitive internationally. Inability to attract such personnel may or the increased cost of doing so could reduce the Company’s competitive advantage relative to other backlight producers, reducing or eliminating the Company’s growth in revenues and profits.
Mr. Yi Song, the Company’s Chief Executive Officer, and Mr. Song Hong, Vice President, control approximately 69 % of the Company’s outstanding common shares and may have conflict of interest with the Company’s minority shareholders.
Mr. Yi Song, the Company’s Chief Executive Officer, and Mr. Song Hong, Vice President, beneficially own approximately 69% of the outstanding shares of the Company’s common stock. As a result of being the majority shareholder, for transactions that require shareholders approval, he has control over decisions to enter into any of them, which could result in the approval of transactions that might not maximize shareholders’ value, and has the ability to prevent entry into any of them. In addition, he can control the election of members of the Company’s board, have the ability to appoint new members to the Company’s management team and control the outcome of matters submitted to a vote of the holders of the Company’s common stock. The interests of Mr. Yi Song may at times conflict with the interests of the Company’s other shareholders.
The Company may be subject to fines and legal sanctions imposed by State Administration of Foreign Exchange(SAFE) or other Chinese government authorities if it or its Chinese directors or employees fail to comply with recent Chinese regulations relating to employee share options or shares granted by offshore listed companies to Chinese domestic individuals.
On December 25, 2006, the People’s Bank of China, or PBOC, issued the Administration Measures on Individual Foreign Exchange Control, and the corresponding Implementation Rules were issued by SAFE on January 5, 2007. Both of these regulations became effective on February 1, 2007. According to these regulations, all foreign exchange matters relating to employee stock holding plans, share option plans or similar plans with Chinese domestic individuals’ participation require approval from the SAFE or its authorized branch. On March 28, 2007, the SAFE issued the Application Procedure of Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Holding Plan or Stock Option Plan of Overseas-Listed Company, or the Stock Option Rule. Under the Stock Option Rule, Chinese domestic individuals who are granted share options or shares by an offshore listed company are required, through a Chinese agent or Chinese subsidiary of the offshore listed company, to register with the SAFE and complete certain other procedures. As the Company is an offshore listed company, its Chinese domestic directors and employees who may be granted share options or shares shall become subject to the Stock Option Rule. Under the Stock Option Rule, employees stock holding plans, share option plans or similar plans of offshore listed companies with Chinese domestic individuals’ participation must be filed with the SAFE. After the Chinese domestic directors or employees exercise their options, they must apply for the amendment to the registration with the SAFE. The Company is reviewing the procedures for such SAFE registration. If the Company or its Chinese domestic directors or employees fail to comply with these regulations, the Company or its Chinese domestic directors or employees may be subject to fines or other legal sanctions imposed by the SAFE or other Chinese government authorities.
Risks Related to International Operations
If China does not continue its policy of economic reforms, it could, among other things, result in an increase in tariffs and trade restrictions on products the Company produces or sells following a business combination, making its products less attractive and potentially reducing its revenues and profits.
China’s government has been reforming its economic system since the late 1970s. The economy of China has historically been a nationalistic, “planned economy,” meaning it has functioned and produced according to governmental plans and pre-set targets or quotas.
However, in recent years, the Chinese government has implemented measures emphasizing the utilization of market forces for economic reform and the reduction of state ownership in business enterprises. Although the Company believes that the changes adopted by the government of China have had a positive effect on the economic development of China, additional changes still need to be made. For example, a substantial portion of productive assets in China are still owned by the Chinese government. Additionally, the government continues to play a significant role in regulating industrial development. The Company cannot predict the timing or extent of any future economic reforms that may be proposed, but should they occur, they could reduce the Company’s operating flexibility or require it to divert its efforts to products or ventures that are less profitable than those it would elect to pursue on its own.
A recent positive economic change has been China’s entry into the World Trade Organization, the global international organization dealing with the rules of trade between nations. It is believed that China’s entry will ultimately result in a reduction of tariffs for industrial products, a reduction in trade restrictions and an increase in trading with the United States. However, China has not fully complied with all of its WTO obligations to date, including fully opening its markets to American goods and easing the current trade imbalance between the two countries. If actions are not taken to rectify these problems, trade relations between the United States and China may be strained, and this may have a negative impact on China's economy and the Company’s business by leading to the imposition of trade barriers on items that incorporate the Company’s products, which would reduce the Company’s revenues and profits.
The Company is dependent on its Chinese manufacturing operations to generate the majority of its income and profits, and the deterioration of any current favorable local conditions may make it difficult or prohibitive to continue to operate or expand the manufacturing facilities in China.
The Company’s current manufacturing operations are located in China, its administrative offices are in the United States and the Company has additional establishments in Hong Kong and the British Virgin Islands. The geographical distances between these facilities create a number of logistical and communications challenges, including time differences and differences in the cultures in each location, which makes communication and effective cooperation more difficult. In addition, because of the location of the manufacturing facilities in China, the Company could be affected by economic and political instability there, including problems related to labor unrest, lack of developed infrastructure, variances in payment cycles, currency fluctuations, overlapping taxes and multiple taxation issues, employment and severance taxes, compliance with local laws and regulatory requirements, greater difficulty in collecting accounts receivable, and the burdens of cost and compliance with a variety of foreign laws. Moreover, inadequate development or maintenance of infrastructure in China, including adequate power and water supplies, transportation, raw materials availability or the deterioration in the general political, economic or social environment could make it difficult, more expensive and possibly prohibitive to continue to operate or expand the manufacturing facilities in China.
The Chinese government could change its policies toward, or even nationalize, private enterprise, which could leave the Company unable to use the assets the Company has accumulated for the purpose of generating profits for the benefit of its shareholders.
Over the past several years, the Chinese government has pursued economic reform policies, including the encouragement of private economic activities and decentralization of economic regulation. The Chinese government may not continue to pursue these policies or may significantly alter them to the Company’s detriment from time to time without notice. Changes in policies by the Chinese government that result in a change of laws, regulations, their interpretation, or the imposition of confiscatory taxation, restrictions on currency conversion or imports and sources of supply could materially reduce the value of the Company’s business by making it uncompetitive or, for example, by reducing the Company’s after-tax profits. The nationalization or other expropriation of private enterprises by the Chinese government could result in the total loss of the Company’s investment in China, where a significant portion of the Company’s profits are generated.
The Chinese legal system may have inherent uncertainties that could materially and adversely impact the Company’s ability to enforce the agreements governing its operations.
The performance of the agreements and the operations of the Company’s factories are dependent on its relationship with the local government. The Company’s operations and prospects would be materially and adversely affected by the failure of the local government to honor the Company’s agreements or an adverse change in the laws governing them. In the event of a dispute, enforcement of these agreements could be difficult in China. China tends to issue legislation, which is followed by implementing regulations, interpretations and guidelines that can render immediate compliance difficult. Similarly, on occasion, conflicts arise between national legislation and implementation by the provinces that take time to reconcile. These factors can present difficulties in the Company’s ability to achieve compliance. Unlike the United States, China has a civil law system based on written statutes in which judicial decisions have limited precedential value. The Chinese government has enacted laws and regulations to deal with economic matters such as corporate organization and governance, foreign investment, commerce, taxation and trade. However, the Company’s experience in implementing, interpreting and enforcing these laws and regulations is limited, and its ability to enforce commercial claims or to resolve commercial disputes in China is therefore unpredictable. These matters may be subject to the exercise of considerable discretion by agencies of the Chinese government, and forces and factors unrelated to the legal merits of a particular matter or dispute may influence their determination.
Because the Company’s operations are international, it is subject to significant worldwide political, economic, legal and other uncertainties that may make collection of amounts owed to it difficult or costly, or conducting operations more difficult should materials needed from certain places be unavailable for an indefinite or extended period of time.
The Company has subsidiaries in the British Virgin Islands, China and Hong Kong. Because the Company manufactures all of its products in China, substantially all of the net book value of its total fixed assets is located there. However, the Company sells its products to customers worldwide, with concentrations of customers in Taiwan, Hong Kong, North America, Europe, Japan, Southeast Asia and China Mainland. As a result, the Company will have receivables from and goods in transit to those locations. Protectionist trade legislation in the United States or foreign countries, such as a change in export or import legislation, tariff or duty structures, or other trade policies, could adversely affect the Company’s ability to sell products in these markets, or even to purchase raw materials or equipment from foreign suppliers. Moreover, the Company is subject to a variety of United States laws and regulations, changes to which may affect its ability to transact business with certain customers or in certain product categories.
The Company is also subject to numerous national, state and local governmental regulations, including environmental, labor, waste management, health and safety matters and product specifications. The Company is subject to laws and regulations governing its relationship with its employees, including: wage and hour requirements, working and safety conditions, citizenship requirements, work permits and travel restrictions. These include local labor laws and regulations, which may require substantial resources for compliance. The Company is subject to significant government regulation with regard to property ownership and use in connection with its leased facilities in China, import restrictions, currency restrictions and restrictions on the volume of domestic sales and other areas of regulation, all of which can limit the Company’s ability to react to market pressures in a timely or effective way, thus causing it to lose business or miss opportunities to expand its business.
Fluctuation of the Renminbi could make the Company’s pricing less attractive, causing it to lose sales, or could reduce the Company’s profitability when stated in terms of another currency, such as the U.S. dollar.
The value of the Renminbi, the main currency used in China, fluctuates and is affected by, among other things, changes in China’s political and economic conditions. The conversion of Renminbi into foreign currencies such as the dollar has been generally based on rates set by the People’s Bank of China, which are set daily based on the previous day's interbank foreign exchange market rates and current exchange rates on the world financial markets. The official exchange rate had remained stable over the past several years. However, Chinese Government recently adopted a floating rate with respect to the value of Renminbi against foreign currencies, with a 0.3% fluctuation. As a result, the exchange rate was increased to RMB6.62 against the dollar at December 31, 2010, accounting for a 3% increase of Renminbi within one year. This floating exchange rate, and any appreciation of the Renminbi that may result from such rate, could have various effects on the Company’s business, which include making its products more expensive relative to those of its competitors than has been true in the past, or increasing the Company’s profitability when stated in dollar terms. It is not possible to predict if the net effects of the appreciation of the Renminbi, if it occurred, would be positive or negative for the Company’s business.
Changes in foreign exchange regulations in China may affect the Company’s ability to pay dividends in foreign currency or conduct other business for which the Company would need access to foreign currency exchange.
Renminbi, or RMB, is not currently a freely convertible currency, and the restrictions on currency exchanges may limit the Company’s ability to use revenues generated in RMB to fund business activities outside China or to make dividends or other payments in United States dollars. The Chinese government strictly regulates conversion of RMB into foreign currencies. For example, RMB cannot be converted into foreign currencies for the purpose of expatriating the foreign currency, except for purposes such as payment of debts lawfully owed to parties outside of China. Over the years, foreign exchange regulations in China have significantly reduced the government’s control over routine foreign exchange transactions under current accounts.
The State Administration for Foreign Exchange, or “SAFE”, regulates the conversion of the RMB into foreign currencies. Currently, Foreign Invested Enterprises, or “FIE”, are required to apply for “Foreign Exchange Registration Certificates,” which permit the conversion of RMB into foreign exchange for the purpose of expatriating profits earned in China to a foreign country. The Company’s China subsidiary, Diguang Electronics, is a FIE that has obtained the registration certifications, and with such registration certifications, which need to be renewed annually, Diguang Electronics is allowed to open foreign currency accounts including a “current account” and “capital account.” Currently, conversion within the scope of the “current account”, e.g. remittance of foreign currencies for payment of dividends, etc., can be effected without requiring the approval of SAFE. However, conversion of currency in the “capital account”, e.g. for capital items such as direct investments, loans, securities, etc., still requires the approval of SAFE. In accordance with the existing foreign exchange regulations in China, Diguang Electronics is able to pay dividends in foreign currencies, without prior approval from the SAFE, by complying with certain procedural requirements.
Although the Company has not experienced any difficulties in the repatriation of its profits out of China or in meeting its foreign exchange needs to date, there can be no assurance that the current foreign exchange measures will not be changed in a way that will make payment of dividends and other distributions outside of China more difficult or unlawful. As a result, if the Company intends to distribute profits outside of China, there can be no assurance that the Company will be able to obtain sufficient foreign exchange to do so.
In addition, on October 21, 2005, SAFE promulgated Notice 75, Notice on Issues concerning Foreign Exchange Management in People’s Republic of China Residents’ Financing and Return investments through Overseas Special Intention Company. Notice 75 provides that Chinese residents shall apply for Foreign Exchange Investment Registration before establishing or controlling an OSIC, which is defined by Notice 75 as a foreign enterprise directly established or indirectly controlled by Chinese residents for foreign equity capital financing with their domestic enterprise assets and interests.
Notice 75 further requires that Chinese residents shall process the modification of foreign investment exchange registration for the interests of net assets held by Chinese residents in an OSIC and its alteration condition, if Chinese residents contributed their domestic assets or shares into the OSIC, or processed foreign equity capital financing after contributing their domestic assets or shares into the OSIC.
Pursuant to Notice 75, Chinese residents are prohibited, among other things, from distributing profits or proceeds from a liquidation, paying bonuses, or transferring shares of the OSIC outside of China if Chinese residents have not completed or do not maintain the Foreign Investment Exchange Registration.
Yi Song and Hong Song, the Company’s principals, have filed the requisite application for foreign investment exchange registration under the relevant laws of China and the regulations of Notice 75, and their registration application has been approved by SAFE. Their foreign investment exchange registration is valid, legal and effective for the purpose of Notice 75.
However, the Company cannot provide any assurance that Chinese regulatory authorities will not impose further restrictions on the convertibility of the RMB. Since the Company’s subsidiary in China generates a significant proportion of its revenue and these revenues are denominated mainly in RMB, any future restrictions on currency exchanges may limit the Company’s ability to repatriate such revenues for the distribution of dividends to its shareholders or for funding the Company’s other business activities outside China.
The Company is subject to various tax regimes, which may adversely affect its profitability and tax liabilities in the future.
Diguang Development has subsidiaries and/or operations or other presence in the U.S., China, Hong Kong and the British Virgin Islands, and it will be subject to the tax regimes of these countries. Although virtually all of Diguang Development’s profits will be earned outside of the U.S., under U.S. tax laws it is possible that some or much of Diguang Development’s earnings will be subject to U.S. taxation. That may be true even if Diguang Development does not repatriate any of its foreign earnings to the U.S. If that occurs, Diguang Development’s after-tax profits could decrease significantly. Diguang Development will attempt to structure its operations in a manner that minimizes its overall corporate tax costs, but there is no assurance that it will be able to avoid having to pay significantly higher taxes than the Company have paid historically.
As the Company was established under the laws of the state of Nevada, the Company is subject only to federal income tax and state income tax. Because the Company’s main operating activities are located outside the U.S., the taxable income outside the U.S. may not be able to offset the taxable loss generated in the U.S. The Company may have accumulated certain net operation loss carry forwards; however, due to the changes in ownership, the use of these net operation loss carry forward may be limited in accordance with the U.S. tax laws.
In addition, any change in tax laws and regulations or the interpretation or application thereof, either internally in one of those jurisdictions or as between those jurisdictions, may adversely affect Diguang Development’s profitability and tax liabilities in the future.
Cessation of the income tax exemption for Diguang Electronics may have an adverse impact on the Company’s net profits.
Diguang Electronics is registered in Shenzhen and was subject to a favorable income tax rate of 15% compared to a statutory income tax rate of 33%, 30% for the central government and 3% for the local government. Diguang Electronics has been deemed a high-tech company by Shenzhen Bureau of Science, Technology & Information. Diguang Electronics was subject to an income tax rate of 15% since January 1, 2007 according to the old tax law. A newly enacted enterprise income tax law, “EIT Law”, was effective January 1, 2008. The EIT Law imposes a unified EIT of 25% on all domestic-invested enterprises and foreign invested enterprises unless these foreign investment enterprises qualify under certain grand-father rules. For enterprises like Diguang Electronics which were taxed under the privileged preferential income tax rate of 15% under the old tax law, the applicable income tax rate should transit to 25% in 5 years, that is, 18% in the year ended December 31, 2008, 20%, 22%, 24% and 25% in the following four years ending December 31, 2009, 2010, 2011 and 2012, and 25% thereafter. So the applicable income tax rate for Diguang Electronics is 22% for the year ended December 31, 2010.
Cessation of value added tax refund for Diguang Electronics may have an adverse impact on the Company’s net profits.
Normally, Diguang Electronics would be required to pay a value added tax, or the difference between the VAT it pays and collects. Based on the fact that two of Diguang Electronics’ products, its color CCFL backlight for TFT-LCD TV and its white LED backlight, are included in the National (and/or Provincial) Important New Products Project, Diguang Electronics is entitled to receive financial support according to the Rules for the Implementation of Financial Preferential Treatment on Shenzhen Important New Products. In accordance with the detailed explanation provided by relevant government agencies, Diguang Electronics applied to receive government subsidy based on a 50% of the local portion of the VAT, which represents 25% of the total VAT, or VAT paid x 25% x 50%, in relation to these two products approved by Shenzhen Treasury Department financial fund assistance. This application should be effective for three years from the date a product receives approval to be included in the National (and/or Provincial) Important New Products Project. Pursuant to the relevant approvals, Diguang Electronics received the subsidies for the income tax imposed on the profit generated by these two products from the local government. Diguang Electronics has been noticed through governmental circular that it is entitled to receive subsidy for 2006 because one product named New Type High Efficiency CCFL/LED Backlight (TFT-LCD Backlight) was listed on the National (and/or Provincial) Important New Products Project by the relevant local government. Diguang Electronics intends to apply for continued inclusion of this one product within the National (and/or Provincial) Important New Products Project in October 2006 for the 2006 subsidy; if the application is approved, Diguang Electronics will be entitled to the VAT refund until at least October 2007. However, there is no assurance that Diguang Electronics’ application will be approved. If Diguang Electronics’ application is not successful, the subsidy of VAT tax refund, may be reduced and its after tax profits may be adversely affected.
Because Chinese law will govern almost all of the Company’s material agreements after the Share Exchange, the Company may not be able to enforce its legal rights within China or elsewhere, which could result in a significant loss of business, business opportunities, or capital.
Chinese law will govern almost all of the Company’s material agreements after the Share Exchange. The Company cannot assure you that the Company will be able to enforce any of its material agreements or that remedies will be available outside of China. The system of laws and the enforcement of existing laws in China may not be as certain in implementation and interpretation as in the United States. The Chinese judiciary is relatively inexperienced in enforcing corporate and commercial law, leading to a higher than usual degree of uncertainty as to the outcome of any litigation. The inability to enforce or obtain a remedy under any of the Company’s future agreements could result in a significant loss of business, business opportunities or capital.
Additionally, substantially all of the Company’s assets will be located outside of the United States and most of its officers and directors will reside outside of the United States. As a result, it may not be possible for United States investors to enforce their legal rights, to effect service of process upon the Company’s directors or officers or to enforce judgments of United States courts predicated upon civil liabilities and criminal penalties of the Company’s directors and officers under Federal securities laws. Moreover, the Company has been advised that China does not have treaties providing for the reciprocal recognition and enforcement of judgments of courts with the United States. Further, it is unclear if extradition treaties now in effect between the United States and China would permit effective enforcement of criminal penalties of the Federal securities laws.
It will be extremely difficult to acquire jurisdiction and enforce liabilities against the Company’s officers, directors and assets based in China.
Because most of the Company’s officers and directors reside outside of the United States, it may be difficult, if not impossible, to acquire jurisdiction over those persons if a lawsuit is initiated against the Company and/or its officers and directors by a shareholder or group of shareholders in the United States. Also, because the Company’s officers will likely be residing in China at the time such a suit is initiated, achieving service of process against such persons would be extremely difficult. Furthermore, because the majority of the Company’s assets are located in China it would also be extremely difficult to access those assets to satisfy an award entered against the Company in United States court. Moreover, shave been advised that China does not have treaties with the United States providing for the reciprocal recognition and enforcement of judgments of courts.
The Company may have difficulty establishing adequate management, legal and financial controls in China, which could impair its planning processes and make it difficult to provide accurate reports of its operating results.
China historically has not followed Western style management and financial reporting concepts and practices, and its access to modern banking, computer and other control systems has been limited. The Company may have difficulty in hiring and retaining a sufficient number of qualified employees to work in China in these areas. As a result of these factors, the Company may experience difficulty in establishing management, legal and financial controls, collecting financial data and preparing financial statements, books of account and corporate records and instituting business practices that meet Western standards, making it difficult for management to forecast its needs and to present the results of the Company’s operations accurately at all times.
Imposition of trade barriers and taxes may reduce the Company’s ability to do business internationally, and the resulting loss of revenue could harm the Company’s profitability.
The Company may experience barriers to conducting business and trade in its targeted emerging markets in the form of delayed customs clearances, customs duties and tariffs. In addition, the Company may be subject to repatriation taxes levied upon the exchange of income from local currency into foreign currency, substantial taxes of profits, revenues, assets and payroll, as well as value-added tax. The markets in which the Company plans to operate may impose onerous and unpredictable duties, tariffs and taxes on its business and products, and there can be no assurance that this will not reduce the level of sales that the Company achieves in such markets, which would reduce the Company’s revenues and profits.
There can be no guarantee that China will comply with the membership requirements of the World Trade Organization, which could leave the Company subject to retaliatory actions by other governments and reduce the Company’s ability to sell its products internationally.
China has agreed that foreign companies will be allowed to import most products into any part of China. In the sensitive area of intellectual property rights, China has agreed to implement the trade-related intellectual property agreement of the Uruguay Round. There can be no assurances that China will implement any or all of the requirements of its membership in the World Trade Organization in a timely manner, if at all. If China does not fulfill its obligations to the World Trade Organization, the Company may be subject to retaliatory actions by the governments of the countries into which the Company sells its products, which could render its products less attractive, thus reducing its revenues and profits.
There can be no guarantee that the Company’s management will continuously meet its obligations under Chinese law to enable distribution of profits earned in China to entities outside of China.
A circular recently promulgated by the State Administration of Foreign Exchange, “SAFE”, has increased the ability of foreign holding companies to receive distributions of profits earned by Chinese operating subsidiaries. The Company qualifies for this treatment, but remaining qualified for it will require the Chinese principals involved, Yi Song and Hong Song to meet annual filing obligations. While they have agreed to meet those annual requirements, it is possible that they will fail to do so, which could limit the Company’s ability to gain access to the profits earned by Diguang Electronics. The result could be the inability to pay dividends to the Company’s stockholders or to deploy capital outside of China in a manner that would be beneficial to the Company’s business as a whole.
Risks Related to the Company’s Securities.
The market price of the Company’s shares is subject to significant price and volume fluctuations.
The markets for equity securities have been volatile. The price of the Company’s common shares may be subject to wide fluctuations in response to variations in operating results, news announcements, trading volume, general market trends both domestically and internationally, currency movements and interest rate fluctuations or sales of common shares by its officers, directors and its principal shareholders, customers, suppliers or other publicly traded companies. Certain events, such as the issuance of common shares upon the exercise of the Company’s outstanding stock options, could also materially and adversely affect the prevailing market price of the Company’s common shares. Further, the stock markets in general have recently experienced extreme price and volume fluctuations that have affected the market prices of equity securities of many companies and that have been unrelated or disproportionate to the operating performance of such companies. These fluctuations may materially and adversely affect the market price of the Company’s common shares and the ability to resell shares at or above the price paid, or at any price.
There may not be an active, liquid trading market for the Company’s common stock.
The Company’s common stock is currently traded on the Over the Counter Bulletin Board. If the Company does not succeed in securing a listing on the NASDAQ Market, it could limit the ability to trade the Company’s common stock and result in a reduction of the price that can be obtained for shares being sold.
Compliance with all of the provisions of the Sarbanes-Oxley Act may be a further condition of continued listing or trading. There is no assurance that if the Company is granted a listing on the NASDAQ Market it will always be able to meet the NASDAQ Market listing requirements, or that there will be an active, liquid trading market for the Company’s common stock in the future. Failure to meet the NASDAQ Market listing requirements could result in the delisting of the Company’s common stock from the NASDAQ Market, which may adversely affect the liquidity of its shares, the price that can be obtained for them or both.
The Company may not pay dividends.
The Company may not pay dividends in the future. Instead, the Company expects to apply earnings toward the further expansion and development of its business. The likelihood of the Company’s paying dividends is further reduced by the fact that, in order to pay dividends, the Company would need to repatriate profits earned outside of the U.S., and in doing so those profits would become subject to U.S. taxation. Thus, the liquidity of your investment is dependent upon your ability to sell stock at an acceptable price, rather than receiving an income stream from it. The price of the Company’s stock can go down as well as up, and fluctuations in market price may limit the Company’s ability to realize any value from your investment, including recovering the initial purchase price.
The Company may not raise funds in the equity market for future expansion.
The stock price of the Company may plunge to its bottom price during times of economic recession and may not recover for a long time. This will affect its ability to raise fund in the stock market as the stock price cannot rebound from the prospective investors' perspective.
Though a company's nominal share price by itself may not provide much assistance in judging its business prospects, however, stocks at low levels can negatively impact investors' psychology and therefore it will limit such company ’ s ability to raise new equity capital or make acquisitions using stock as currency, and it limits institutional ownership and brokerage research coverage. In addition, some brokerages discourage customers from buying lowly priced stocks.
With a fundamental recovery in the underlying business, of course, not all stocks can snap back to their reasonable levels. Moreover, history shows that certain stocks can languish in low single digits for years once they fall to that range and it will trade at low price-earnings multiple for years which will adversely affect its expansion.
The Company may face severe operating environment during times of global economic recession.
The sales volume of the Company’s core products is largely influenced by the demand for its end products which are mostly sold in US and European markets. The global economic crisis in 2008, triggered by the US subprime problem, led to a drastic drop in demand for electronic consumer goods. The Company’s direct customers had excessive inventory which hindered its production capacity. Moreover, the uncertain customers’ requirement and the changes in supply-demand balance would affect the Company’s capital expenditure and innovation pace. They may lower the Company’s new product development which can adversely impact the Company’s financial performance and operating efficiencies when these occurred during the times of soft economy.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not Applicable.
ITEM 2.
ITEM 2. PROPERTY
Neither the Company, Diguang Holdings, Well Planner, nor Diguang Technology owns or leases any property. The Company’s indirect subsidiary, Diguang Electronics, was headquartered in Shenzhen, China. Diguang Electronics acquired an office space of 1,220 square meters which has a net book value of RMB 15,166,276, or approximately equivalent to $2.3 million. Diguang Electronics also acquired a land with land usage right of 34,930 square meters in Shenzhen, which has a net book value of RMB 16,043,201, or approximately equivalent to $2.4 million; Diguang Electronics is now constructing a new manufacturing facility on the land, the total budgeted capital investment for this facility is estimated to be $10.5 million and cost already incurred was $8.1 million as of December 31, 2010.
Dongguan Diguang S&T owned property with a net book value of RMB 47,326,262, or approximately equivalent to $7.2 million, which was used as a production base both for Diguang Electronics and Dongguan Diguang S&T.
On September 10, 2008, Wuhan Diguang entered into a lease agreement with Hannstar-TPV Display (Wuhan) Corp. to rent machinery from Hannstar-TPV Display (Wuhan) Corp; according to the lease agreement, the annual rental was RMB800,000, or approximately $117,259, for the period from October 2008 to December 2013.
Wuhan Diguang also entered into a lease agreement with Wuhan Jabao Composite materials Co., Ltd. to rent warehouse at RMB41,666, or approximately $6,313, per month from March of 2010 to the month of 2012. Wuhan Diguang also entered into a lease agreement with Wuhan Jinchen Industrial CO., LTD. to rent warehouse at RMB22,404, or approximately $3,395, per month from March of 2010 to the month of 2012.
Future minimum payments required under the lease agreement with Hannstar-TPV Display (Wuhan) Corp. ,Wuhan TPV , and Jinchen that has an initial or a remaining lease term in excess of one year at December 31, 2010 are as follows:
Dihao entered into a lease agreement with Transcend Optronics (Yangzhou) Co, Ltd. to rent the factory at a rental of RMB 120,882, or approximately $18,316 per month started from October 2009.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
Neither the Company nor any of its direct or indirect subsidiaries is a party to, nor is any of its property the subject of, any legal proceedings other than ordinary routine litigation incidental to their respective businesses. There are no proceedings pending in which any of the Company’s officers, directors, promoters or control persons are adverse to it or any of the Company’s subsidiaries or in which they are taking a position or have a material interest that is adverse to it or any of its subsidiaries.
Neither the Company nor any of its subsidiaries is a party to any administrative or judicial proceeding arising under federal, state or local environmental laws or their Chinese counterparts.
ITEM 4.
ITEM 4. RESERVED
PART II
ITEM 5.
ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
(a) MARKET PRICES OF COMMON STOCK
The Company’s common stock currently trades in the over-the-counter market on the OTC Bulletin Board under the symbol “DGNG. The following table shows for the periods indicated the high and low bid quotations for Diguang’s common stock, as reported by financial reporting services. These quotations are believed to represent inter-dealer quotations without adjustment for retail mark-up, mark-down or commissions, and may not represent actual transactions.
(b) STOCKHOLDERS
The Company’s common shares are issued in registered form. Signature Stock Transfer, Inc. in Plano, Texas is the registrar and transfer agent for the Company’s common stock. As of December 31, 2010 there were 22,593,000 shares of the Company’s common stock issued and 22,072,000 shares outstanding and the Company had approximately 88 active stockholders of record as of December 31, 2010.
(c) DIVIDENDS
The Company has never declared or paid any cash dividends on its common stock and it does not anticipate paying any cash dividends in the foreseeable future. The Company currently intends to retain future earnings, if any, to finance operations and the expansion of its business. Any future determination to pay cash dividends will be at the discretion of the Company's board of directors (the "Board of Directors") and will be based upon the Company’s financial condition, operating results, capital requirements, plans for expansion, restrictions imposed by any financing arrangements and any other factors that the Board of Directors deems relevant.
(d) SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLAN
The securities authorized for issuance under equity compensation plan are as follows:
As of December 31, 2010, 1,131,917 shares of the Company’s common stock are subject to outstanding options. This is because approximately 540,000, 26,000, 888,000 and 50,000 shares of option of the Company’s common stock were granted in 2006, 2007, 2008, and 2009 respectively, under the Diguang 2006 Option Plan. None of these options has been exercised. But 372,083 shares subject to the option were forfeited due to staff resignation. Pursuant to the terms of the Amended and Restated Share Exchange Agreement, the Company assumed Diguang’s outstanding 2006 stock incentive plan covering options totaling the equivalent of 1,500,000 shares of the Company’s common stock. The exercise price for each of these options is $5 per share for 566,000 shares, $1.19 per share for 40,000 shares, $0.12 per share for 548,000 shares, $0.10 per share for 300,000 shares and $0.51 for 50,000 shares. Awards generally vest over four years in equal installments on the next four succeeding anniversaries of the grant date, but options granted to independent directors vest monthly at the end of each month, options granted to chief operating officer vest quarterly at the beginning of each quarter over three years, and 50,000 shares of options granted in 2009 vested immediately. The options that have been issued expire ten years from their grant date.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Not required for smaller reporting companies.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Report contains forward-looking statements, including statements that include the words "believes," "expects," "estimates," "anticipates" or similar expressions. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the Company’s actual results, performance or achievements to differ materially from those expressed or implied by such forward-looking statements. Risk factors include, but are not limited to, costs associated with financing new products; the Company’s ability to cost-effectively manufacture its products on a commercial scale; the concentration of the Company’s current customer base; competition; the Company’s ability to comply with applicable regulatory requirements; potential need for expansion of the Company’s production facility; the potential loss of a strategic relationship; inability to attract and retain key personnel; management's ability to effectively manage the Company’s growth; difficulties and resource constraints in developing new products; protection and enforcement of the Company’s intellectual property and intellectual property disputes; compliance with environmental laws; climate uncertainty; currency fluctuations; control of the Company’s management and affairs by principal shareholders
The reader should carefully consider, together with the other matters referred to herein, the information contained under the caption "Risk Factors" in the Company’s current Report on Form 8-k filed with the commission on March 21, 2006 for a more detailed description of these significant risks and uncertainties. The Company cautions the reader, however, not to unduly rely on these forward-looking statements.
RISK FACTORS
Investment in the Company’s common stock involves risk. You should carefully consider the investing risks before deciding to invest. The market price of the Company’s common stock could decline due to any of these risks, in which case you could lose all or part of your investment. In assessing these risks, you should also refer to the other information included in this report, including the Company’s consolidated financial statements and the accompanying notes. You should pay particular attention to the fact that the Company is a holding company with substantial operations in China and is subject to legal and regulatory environments that in many respects differ from that of the United States. The Company’s business, financial condition or results of operations could be affected materially and adversely by any of the risks discussed in this report and any others not foreseen. This discussion contains forward-looking statements.
Business Overview
The Company specializes in the design, production and distribution of small to medium-size LED, CCFL, TFT-LCD, STN-LCD, TN-LCD, and Mono LCDs. Taken together, these applications are referred to as “LCD” applications and include color displays for cell phones, car televisions and navigation systems, digital cameras, televisions, computer displays, camcorders, PDAs, DVD, CD, MP3/MP4 players, and appliance displays, etc.
The Company’s headquarters is located in Shenzhen, China. The Company conducts its business principally through the operations of Diguang Electronics, which is based in Shenzhen along with its main backlight manufacturing operation in Dongguan, Guangdong Province, China. Diguang Electronics had approximately 1,139 full-time employees as of December 31, 2010.
Dihao, which is based in Yangzhou, is a 100% wholly-owned subsidiary of North Diamond. The Company gained controlling interest of Dihao by acquiring 65% of North Diamond on January 3, 2007. As of December 31, 2010, Dihao had approximately 147 full-time employees.
Wuhan Diguang, which is based in Wuhan, was established on March 13, 2007 and commenced its operation on July 1, 2007. Wuhan Diguang was established with the capacity to provide large-size TFT-LCD, which are mainly sold to its customers in Taiwan. Wuhan Diguang had approximately 406 employees as of December 31, 2010.
Dongguan Diguang S&T was established as the production base of Diguang Electronics. It became a wholly-owned subsidiary of Diguang Holdings in December 30, 2007. As of December 31, 2010, Dongguan Diguang S&T had approximately 215 full-time employees.
Shenzhen Optimum was established to sell large-size LED TV sets manufactured by Diguang Electronics to domestic customers throughout China. As of December 31, 2010, Shenzhen Optimum had approximately 22 full-time employees.
Well Planner is involved in the importation of raw materials into China and the exportation of finished products from China.
Diguang S&T, which is based in Hong Kong, is directly involved in the international procurement of raw materials and the sales of backlight products for Shenzhen Diguang Electronics. Diguang S&T purchases raw materials from international suppliers and acts as an international sales group for Shenzhen Diguang Electronics, Dongguan Diguang S&T and Well Planner.
Critical Accounting Policies and Estimates
The discussion and analysis of the Company’s financial condition presented in this section are based on the Company’s financial statements, which have been prepared in accordance with the generally accepted accounting principles in the United States. During the preparation of the Company’s financial statements the Company is required to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, the Company evaluates its estimates and judgments, including those related to sales, returns, pricing concessions, bad debts, inventories, investments, fixed assets, intangible assets, income taxes and other contingencies. The Company bases its estimates on historical experience and on various other assumptions that the Company believes are reasonable under current conditions. Actual results may differ from these estimates under different assumptions or conditions.
In response to the SEC’s Release No. 33-8040, “Cautionary Advice Regarding Disclosure about Critical Accounting Policy,” the Company identified the most critical accounting principles upon which the Company’s financial status depends. The Company determined that those critical accounting principles are related to the use of estimates, inventory valuation, revenue recognition, income tax and impairment of intangibles and other long-lived assets. The Company presents these accounting policies in the relevant sections in this management’s discussion and analysis, including the Recently Issued Accounting Pronouncements discussed below.
Revenue Recognition
Revenue generated from sales of backlight units to customers is recognized when persuasive evidence of an arrangement exists, delivery of the products has occurred, the significant risks and rewards of the ownership have been transferred to the customer, the price is fixed or determinable and collectability is reasonably assured. The Company will sign sales order (or purchase order prepared by customers) with customers for each sales transaction. A sales order signed by both parties is deemed to be persuasive evidence for revenue recognition. Sales terms of products are usually “FOB destination” and delivery is deemed to occur when the products have been delivered to the sites prescribed by customers. Revenue is recognized when the Company receives customers’ confirmation of transaction statements. Due to the nature of backlight products, when the products have quality issue, the Company will replace these products and the products with quality issue are brought back. Accordingly, no provision has been made for returnable goods. Revenue presented on the Company’s income statements is net of sales taxes.
Certain sales are subject to the ultimate usage of the products by the Company’s customers. Revenue is not recognized on these transactions until the period in which the Company is able to determine that the products shipped have been used by its customers.
Accounts Receivable and Concentration of Credit Risk
During the normal course of business, the Company extends unsecured credit to its customers. Typically credit terms require payment to be made within 90 days of the invoice date. The Company does not require collateral from its customers. The Company maintains its cash accounts at credit worthy financial institutions and closely monitors the movements of its cash positions.
The Company regularly evaluates and monitors the creditworthiness of each customer on a case-by-case basis. The Company includes any accounts balances that are determined to be uncollectible in the allowance for doubtful accounts. After all attempts to collect a receivable have failed, the receivable is written off against the allowance. Based on the information available to management, the Company believes that its allowance for doubtful accounts as of December 31, 2009 and 2010 were adequate, respectively. However, actual write-off might exceed the recorded allowance.
Inventories
Inventories are composed of raw materials and components, work in progress, finished goods and consignment goods, most of which are related to backlight products. The consignment goods are owned by the Company as inventory and are stored at a customer’s place.
Inventories are valued at the lower of cost (based on weighted average method) and the market. Full amount provisions were made for obsolete inventories where it is difficult to estimate future utilization. Once the inventory cost is written down, the written-down costs are treated as a new cost basis for the inventory, and are not adjusted back up to the previous cost basis in future periods. For inventories which will be used in the ordinary course of production or sales, the net realizable value of the inventories is compared with their carrying value, if the net realizable value is lower than the carrying value, a provision for the difference between the net realizable value and the carrying value of the inventories was recognized. Net realizable value is determined based on the most recent selling price of these inventories less the estimated cost to sell.
Income Taxes
The Company recognizes deferred tax liabilities and assets when it accounts for income taxes. Deferred tax assets and liabilities are recognized for the future tax consequence attributable to the difference between the tax bases of assets and liabilities and their reported amounts in the financial statements. Deferred tax assets and liabilities are measured using the enacted tax rate expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that included the enactment date.
Diguang Electronics is registered in Shenzhen and is subject to the new enterprise income tax law (“EIT Law”) which was effective January 1, 2008. The EIT Law imposes a unified EIT of 25% on all domestic-invested enterprises and foreign invested enterprises unless these foreign investment enterprises qualify under certain grand-father rules. For enterprises like Diguang Electronics which were privileged preferential income tax rate of 15% under the old tax law, the applicable income tax rate should transit to 25% in 5 years, that is, 18% in the year ended December 31, 2008, 20%, 22%, 24% and 25% in the following four years ended December 31, 2009, 2010, 2011 and 2012, and 25% thereafter. Based on that regulation, the applicable income tax rate for Diguang Electronics is 22% for the year ended December 31, 2010.
Well Planner is subject to an income tax rate at 17.5% under Hong Kong Inland Revenue jurisdiction. However, Well Planner does not have Hong Kong sourced income. In accordance with Hong Kong tax regulation, Well Planner has not been taxed since its inception.
Diguang Technology is a BVI registered company. There is no income tax for the company domiciled in the BVI. Accordingly, the Company’s financial statements do not present any income tax provision related to the British Virgin Islands tax jurisdiction.
Dihao is registered in Yangzhou and has been recognized as a high-tech company by Yangzhou Bureau of Science, Technology and Information. Under this category, Dihao is entitled to enjoy a 100% exemption of corporate income tax for the two years from January 1, 2006 to December 31, 2007 and a 50% exemption of corporate income tax for the following three years from January 1, 2008 to December 31, 2010 in accordance with the preferential rules established by Yangzhou local tax authority on August 2, 1999. Under the new EIT Law, the income tax rate for Dihao is 25%; the applicable income tax rate for Dihao is 12.5% for the three years ended December 31, 2010.
Wuhan Diguang is registered in Wuhan. As a manufacturing company with foreign investment set up before March 16, 2007, Wuhan Diguang is entitled to enjoy a 100% exemption of corporate income tax for the first two years of operations with a profit position and a 50% exemption of corporate income tax for the following three years. After the five-year exemption period, Wuhan Diguang will be subject to the unified income tax rate of 25% in accordance with the new EIT Law. It was the first year for Wuhan Diguang to enjoy a 50% exemption of income tax in 2010.
Dongguan Diguang S&T is registered in Dongguan of Guangdong Province is entitled to enjoy a 100% exemption of corporate income tax for the first two years of operation with a profit position and a 50% exemption of corporate income tax for the following three years and will be subject to the unified income tax rate of 25% after the five-year exemption period. Dongguan Diguang S&T has used up its two years’ 100% exemption in the years 2008 and 2007, even though it suffered losses in these two years. It is the second year for Dongguan Diguang S&T to enjoy 50% exemption of income tax in 2010.
Diguang International Development Co., Ltd. was established under the laws of the State of Nevada and is subject to U.S. federal income tax and one state income tax. For U.S. income tax purposes no provision has been made for U.S. taxes on undistributed earnings of overseas subsidiaries with which the Company intends to continue to reinvest. It is not practicable to estimate the amount of additional tax that might be payable on the foreign earnings if they were remitted as dividends, or lent to the Company, or if the Company should sell its stock in the subsidiary. The predecessor company accumulated certain net operation loss carry forwards; however, due to changes in ownership, the use of these net operation loss carry forwards may be limited in accordance with the U.S. tax laws.
Because the consolidated financial statements were based on the respective entities’ historical financial statements, the respective effective income tax rate for the periods reported represents the effect of actual income tax provisions incurred to Diguang Electronics, Dihao, Wuhan Diguang, Dongguan Diguang S&T and Diguang International Development Co., Ltd. Since the Company cannot file a consolidated return, the losses in one entity do not offset income in another.
Impairment of Long-Lived Assets
The Company reviewed long-lived assets for impairment since it suffered consecutive losses in recent years. The estimated undiscounted cash flows expected to result from the use and eventual disposition of the assets were compared with carrying amount of long-lived assets. Whenever any such impairment exists, an impairment loss will be recognized for the amount by which the carrying value exceeds the fair value.
Impairment of Financial Investments
The Company accounts for its investments in common stocks using the cost method. Other than temporary impairment loss is recognize when a series of operating losses of an investee or other factors indicate a decrease in value of investments.
Recently Issued Accounting Pronouncements Adopted
FASB ASU 2010-09
In February 2010, FASB issued ASU No. 2010-9, “Amendments to Certain Recognition and Disclosure Requirements”. This update addresses certain implementation issues related to an entity’s requirement to perform and disclose subsequent-events procedures, removes the requirement that public companies disclose the date of their financial statements in both issued and revised financial statements. According to the FASB, the revised statements include those that have been changed to correct an error or conform to a retrospective application of U.S. GAAP. The amendment is effective immediately. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.
FSAB ASU 2010-06
In January 2010, FASB issued ASU No. 2010-06, “Improving Disclosures about Fair Value Measurements.” This update provides amendments to Subtopic 820-10 that requires new disclosure as follows: 1) Transfers in and out of Levels 1 and 2. A reporting entity should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers. 2) Activity in Level 3 fair value measurements. In the reconciliation for fair value measurements using significant unobservable inputs (Level 3), a reporting entity should present separately information about purchases, sales, issuances, and settlements (that is, on a gross basis rather than as one net number). This update provides amendments to Subtopic 820-10 that clarifies existing disclosures as follows: 1) Level of disaggregation. A reporting entity should provide fair value measurement disclosures for each class of assets and liabilities. A class is often a subset of assets or liabilities within a line item in the statement of financial position. A reporting entity needs to use judgment in determining the appropriate classes of assets and liabilities. 2) Disclosures about inputs and valuation techniques. A reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. Those disclosures are required for fair value measurements that fall in either Level 2 or Level 3. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. These disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.
FASB ASU 2010-29
The FASB has issued ASU No. 2010-29, “Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations.” This ASU reflects the decision reached in EITF Issue No. 10-G. The amendments in this ASU affect any public entity as defined by Topic 805, Business Combinations, that enters into business combinations that are material on an individual or aggregate basis. The amendments in this ASU specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings.
The amendments are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.
Recently Issued Accounting Pronouncements Not Adopted Yet
FASB ASU 2010-13
In April 2010, the FASB issued Accounting Standards Update ("ASU") No. 2010-13, “Compensation - Stock Compensation (Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades,” which addresses the classification of a share-based payment award with an exercise price denominated in the currency of a market in which the underlying equity security trades. Topic 718 is amended to clarify that a share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity securities trades shall not be considered to contain a market, performance, or service condition. Therefore, such an award is not to be classified as a liability if it otherwise qualifies as equity classification. The amendments in this Update should be applied by recording a cumulative-effect adjustment to the opening balance of retained earnings. The cumulative-effect adjustment should be calculated for all awards outstanding as of the beginning of the fiscal year in which the amendments are initially applied, as if the amendments had been applied consistently since the inception of the award. ASU 2010-13 is effective for interim and annual periods beginning on or after December 15, 2010 and is not expected to have a material impact on the Company’s consolidated financial position or results of operations.
FASB ASU 2010-17
The FASB issued ASU No. 2010-17, “Revenue Recognition-Milestone Method (Topic 605): Milestone Method of Revenue Recognition.” This ASU codifies the consensus reached in EITF Issue No. 08-9, “Milestone Method of Revenue Recognition.” The amendments to the Codification provide guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions. Consideration that is contingent on achievement of a milestone in its entirety may be recognized as revenue in the period in which the milestone is achieved only if the milestone is judged to meet certain criteria to be considered substantive. Milestones should be considered substantive in their entirety and may not be bifurcated. An arrangement may contain both substantive and nonsubstantive milestones, and each milestone should be evaluated individually to determine if it is substantive. ASU 2010-17 is effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010. The Company is currently evaluating the impact of this ASU; however, the Company does not expect the adoption of this ASU to have a material impact on its consolidated financial statements.
Results of Operations
Comparison of Years Ended December 31, 2010 and 2009
Revenue
Net revenue was approximately $64.9 million for the year ended December 31, 2010, an increase of $20.8 million, or 47%, compared with $44.1 million for the prior year. The Company’s manufacturing facilities in Dongguan and Wuhan contributed to the increase in sales revenue by $7.7 million and $13.4 million respectively; while the Yangzhou facility suffered a minor decrease of $0.3 million in the year of 2010. The increase in sales revenue was primarily due to management’s effort to develop new customers.
Total net revenue can be divided into international sales and domestic sales as follows:
Sales to domestic customers were $26.1 million for the year ended December 31, 2010, an increase of $8.3 million, or 47%, compared with $17.8 million for the prior year. The increase in domestic sales reflected management’s strategy in developing the domestic market.
Sales to international customers totaled $38.8 million for the year ended December 31, 2010, an increase of $12.5 million, or 48%, compared with $26.3 million for the prior year. The increase in international sales was attributable to the global demand growth in the digital display products such as automobile TV, portable DVD, MP3, MP4 and LCD products resulting from the worldwide economic recovery in 2010 from prior year’s financial crisis.
The Company currently has three manufacturing facilities which are located in the eastern China region (Yangzhou), central China region (Wuhan), and southern China region (Dongguan). There are different capacities in the principal manufacturing facility of Dongguan, such as LCD TV and monitor manufacturers and LCD assembly enterprises, to meet requirements of customers. The Company launched large-size LED backlights and LCDs at the Dongguan facility in 2009. The Yangzhou factory used to focus on producing small and mid-size CCFL and LED backlight products but began to provide large sized LCM products since the fourth quarter of 2009. The Wuhan facility solely manufactures large-size CCFL backlight products. The construction of the new facility in Shenzhen of Southern China was suspended due to lack of capital. This new facility was supposed to be used to manufacture large-size LED backlight products and LED TV sets.
The Company has thousands of categories of products and the products mixtures are constantly changing in order to adapt to market demands during the years of 2010 and 2009. In addition, as the sale prices are different for different categories of products, it is almost impossible to discuss the impact of changes in volume and changes in product price here. From the product mix aspect, the sales can be divided into five main categories as follows.
Sales of LED backlight products totaled $28.9 million for the year ended December 31, 2010, an increase of $7.5 million, or 35%, compared with $21.4 million for the prior year. Sales of mid and large size of LED products contributed a $11.9 million increase in sales revenue, while a decrease in sales of small size LED products offset the increase by $4.4 million.
Sales of CCFL backlights products totaled $23.8 million for the year ended December 31, 2010, an increase of $12.7 million, or 114%, compared with $11.1 million for 2009. The significant increase of CCFL products was mainly contributed by increased sales of large size CCFL products in Wuhan facility.
Sales of LCMs totaled $9.0 million in 2010, a decrease of $1.1 million, or 11%, compared with $10.1 million in 2009. The decrease in sales of LCMs was due to the stressed upstream supply of crystal glass, the main materials in manufacturing LCMs, in the year of 2010.
Sales of Liquid Crystal Displays (LCD) were $2.2 million in 2010, representing an increase of $1.7 million, compared with $500,000 in the year of 2009. LCD products were launched in 2009, and the Company began mass production of LCDs in the second quarter of 2010.
Cost of Sales
Since the basic materials for all backlight products are similar, the Company discusses cost of sales in aggregate for all products. Cost of sales was $60.0 million for 2010, an increase of $19.5 million, or 48%, compared with $40.5 million for 2009. The increase in cost of sales is primarily due to the growth in sales revenue.
Raw material cost was $52.2 million for the year of 2010, representing an increase of $18.3 million, or 54%, compared with $33.9 million for the prior year. The increase in raw material cost was mainly attributable to the increase of sales revenue. The percentage of raw material cost to total cost of sales was 87% for 2010, compared with 84% for 2009; the increase of this percentage was the result of changes in product mix. As the Company increased production for new products such as the large-size LED backlights, LCMs and LCDs, these new products required more expensive raw materials than traditional products. Raw materials cost accounted for 80% and 77% of total sales revenue in 2010 and 2009, respectively.
Labor cost was $4.0 million for 2010, representing an increase of $0.7 million, or 21%, compared with $3.3 million for 2009. The percentage of labor cost to total cost of sales was 7% for 2010, compared with 8% for 2009. The Company strengthened management controls on labor cost; therefore the increase of labor cost was lower than the increase of cost of sales. Labor cost accounted for 6% and 8% of total sales revenue in 2010 and 2009 respectively.
Production overhead was $3.8 million for 2010, an increase of $0.5 million, or 15%, compared with $3.3 million for 2009. Production overhead includes depreciation charges for fixed assets and amortization for building improvement, water and electricity expenses, repair expenses, and rentals, etc. The increase of production overhead was mainly due to the increase of the cost of sales, but because of the semi-variable nature of production overhead, the increase of production overhead is not directly associated with the increase of cost of sales. The production overhead accounted for 6% and 7% of total revenue for the years of 2010 and 2009, respectively.
Gross Margin
The overall gross margin for 2010 was 8%, which was flat with 2009. The management discusses the change in gross margin in the three major product categories of CCFL products, LED products and LCM below.
The gross margin of LED backlight products increased from 8% in 2009 to 11% in 2010. The increase was contributed by sales of mid size LED products, which have a gross margin of 12% in 2010, higher than 10% in 2009.
Gross margin of CCFL backlight products fell to 4% in 2010 from 7% in 2009. The Wuhan facility contributed most of the CCFL sales in 2010; but as an OEM factory, the gross margin in the Wuhan facility was very low, and the low margin in the Wuhan facility led to a decrease in the overall CCFL gross margin.
The gross margin for LCM had decreased from 14% in 2009 to 4% in 2010. The decrease was mainly caused by sales of LED LCM which had much lower selling prices in 2010 than in 2009.
Selling Expenses
Selling expenses were $2.8 million for 2010, an increase of approximate $512,000, or 22%, compared with $2.3 million for 2009. Selling expenses consisted mainly of salaries, commission, transportation expenses, and office expenses. The increase of selling expenses was primarily due to higher commission, transportation expenses, and salaries commensurate with an increase of sales volume.
As a percentage of total revenue, selling expenses were approximately 4.4% for 2010 and 5.3% for 2009, respectively.
Research and Development Expenses
Net research and development expenses for 2010 were $1.4 million, a decrease of $1.6 million, or 53%, compared with $3.0 million for 2009. The decrease of net research and development costs was attributed to two reasons. First, the Company reduced research and development activities when new developed products were put into production. Second, the research and development costs were offset by a government subsidy of $520,000 for the TFT-LCD project in 2010 when this project was successfully completed.
The percentage of research and development expenses to total sales revenue was approximately 2.2% and 6.9% for 2010 and 2009, respectively.
General and Administrative Expenses
General and administrative expenses were $4.3 million for 2010, a slight decrease of $0.1 million, or 2%, compared with $4.4 million for 2009. General and administrative expenses mainly included payroll, provision for bad debts, professional service fee, rentals, share-based compensation and depreciation, etc.
The percentages of general and administrative expenses to total sales revenue were approximately 6.6% and 10% for 2010 and 2009.
Interest Expense
Net interest expenses were $810,000 for 2010, representing an increase of $443,000, or 121%, compared with $367,000 for 2009. With continuous losses through its operating activities, the Company had to seek more funds from bank loans to support its working capital demands. As of December 31, 2009, the loan from bank balance was $10.2 million; while as of December 2010, the Company had overall a bank loan of $16.8 million outstanding, and the increased loan brought increased interest expense.
Net interest expenses for the year of 2010 and 2009 represented 1.2% and 0.8% of total sales revenue, respectively.
Other Income
Other income was $212,000 for 2010, representing an increase of $52,000, compared with $160,000 for 2009. The increase in other income derived primarily from an increase of sales revenue from scrap materials.
As a percentage to total sales revenue, other income represented 0.3% and 0.4% in 2010 and 2009 respectively.
Income Tax Provision
Income tax provision for 2010 was approximately $41,000, a slight decrease compared with $42,000 for 2009. Income tax provision for 2010 was accrued by the Dongguan facility, Yangzhou Dihao and Wuhan facility. Income tax provision for 2009 was accrued in Yangzhou Dihao and included reversal of deferred tax assets recognized in the prior year and minor adjustment to current income tax of the prior year.
As a percentage to total sales revenue, income tax provision represented 0.09% and 0.08% in 2010 and 2009 respectively.
Net Loss
Net loss was $4.2 million for 2010, compared with net loss of $7.2 million for 2009, representing a decrease of $3.0 million, or 42%, in net loss. The net loss decreased mainly due to increased gross profit brought by increased sales revenue.
As a percentage of total revenue, net loss for 2010 and 2009 accounted for 6.5% and 16.4% respectively.
Losses per Share
The basic loss per share was $0.18 for 2010, compared with $0.33 for 2009. A decrease in basic losses per share in 2010 was due to a decrease in net loss. The number of weighted average common shares outstanding was 22,072,000 for the years of 2010 and 2009.
Liquidity and Capital Resources
Comparison of Years Ended December 31, 2010 and 2009
As of December 31, 2010 and 2009, the Company had cash and cash equivalents of $6.6 million and $6.2 million, and working capital of approximately negative $1.8 million and $7.7 million, respectively. Working capital dropped sharply from $7.7 million to negative $1.8 million, representing a decrease of 123%.
Currently, the Company’s operations are financed by debt financing, which included short-term and long-term bank loans and accounts payable. The Company believes that it should be able to get additional loans as needed by pledging as collateral its property and facility at Dongguan which has a market value of about $6.0 million. Since the Chinese government is tightening its bank credit policy, the Company may not be able to obtain more funds from bank loans; furthermore, the Company may not be able to renew short-term bank loans at their maturity. Cash on hand as of December 31, 2010 may not be adequate to meet working capital demands from the Company’s operating activities in 2011. Consequently, the Company may need to apply for new loans as soon as possible.
The Company started to construct a new manufacturing facility in the Guangming District of Shenzhen at the beginning of 2010. Total budget investment for the new facility was $11 million. As of December 31, 2010, total construction cost invested in the new facility amounted to $8.1 million, among which, $4.2 million was actually paid and $3.9 million was outstanding. The interior decoration of the facility was on hold as the Company did not have adequate cash for further proceeding. This construction was financed by a long-term bank facility of RMB100 million, approximately $15.2 million, from China Development Bank. As of December 31, 2010, the Company drew down RMB53 million, equivalent to about $8.7 million, from this facility and there was still RMB43 million, equivalent to $6.5 million, available for future use. The Company needs to apply for further draw-downs from this facility with China Development Bank. There is no assurance that the Company can succeed in its application with China Development Bank.
For the year ended December 31, 2010, net cash used in operating activities was $1.3 million, representing a decrease of $7.8 million compared to $9.1 million of net cash used in operating activities in the prior year. The decrease in cash used by operating activities was mainly contributed by a substantial increase in accounts payable, for example, the balance of accounts payable increased from $15.4 million as of December 31, 2009 to $25.3 million as of December 31, 2010, representing an increase of 64%, or $9.9 million; among the $9.9 million increase of accounts payable, $6.0 million was related to purchase of raw materials and $3.9 million was related to construction of the new facility in Shenzhen. We had a hard time to pay our suppliers on a timely basis, for example, 20% of accounts payable as of December 31, 2010 was out of the credit terms provided by suppliers. To delay payment to suppliers may have an adverse impact on our ability to acquire enough raw materials in future operations. Decrease in net loss contributed $3.0 million of operating cash, which was totally offset by increased cash occupied by inventory.
Net cash flow used in investing activities was $4.8 million for the year ended December 31, 2010, which was mainly investment in construction of the new manufacturing facility whereas there were only minor investment activities in the year of 2009.
Net cash flow provided by financing activities was $7.0 million for the year ended December 31, 2010. Finance from long-term bank loans contributed $7.4 million of cash, while repayment to related parties used cash of $0.9 million.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not required for smaller reporting companies.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
(a) Financial Statements
The following financial statements are set forth at the end hereof.
1. Report of Independent Registered Public Accounting Firm
2. Consolidated Balance Sheets as of December 31, 2010 and 2009
3. Consolidated Statements of Income and Comprehensive Income (Loss) for the years ended December 31, 2010 and 2009
4. Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2010 and 2009
5. Consolidated Statements of Cash Flows for the years ended December 31, 2010 and 2009
6. Notes to Consolidated Financial Statements.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None .
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures:
The Company maintains disclosure controls and procedures designed to ensure that information required to be disclosed in the reports the Company files or submits 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's, the “SEC”, rules and forms, and that such information is accumulated and communicated to the Company's management, including its chief executive officer, the “CEO”, and controller, the “Controller”, as appropriate, to allow timely decisions regarding required financial disclosure.
In connection with the preparation of this annual report on Form 10-K, the “Form 10-K”, the Company carried out an evaluation as of December 31, 2010, under the supervision and with the participation of the Company's management, including the CEO and Controller, of the effectiveness of the design and operation of the Company's disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based upon this evaluation, the CEO and Controller concluded that as of December 31, 2010 the Company's disclosure controls and procedures were not effective because of the material weaknesses described below under “Management's Report on Internal Control over Financial Reporting.”
To address these material weaknesses, the Company performed additional analyses and other procedures, described below under the subheading “Interim Measures”, to ensure that the Company’s consolidated financial statements were prepared in accordance with generally accepted accounting principles in the United States, “GAAP”. Accordingly, management believes that the consolidated financial statements included in this Form 10-K fairly present in all material respects the Company’s financial condition, results of operations and cash flows for the periods presented and that this Form 10-K does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the periods covered by this report.
(b) Management’s report on internal control over financial reporting.
Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company, as such term is defined in Rules 13a -15(f) and 15d-15(f) under the Exchange Act. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with GAAP.
Management has conducted an assessment, including testing, of the effectiveness of the Company's internal control over financial reporting as of December 31, 2010. In making its assessment, management used the criteria in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO").
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company's annual or interim financial statements will not be prevented or detected on a timely basis. The following material weaknesses in internal control over financial reporting have been identified as of December 31, 2010. In light of the material weaknesses, management concluded that the Company’s internal control over financial reporting was not effective as of December 31, 2010.
1. Entity level material weaknesses-control environment
In the definitions under the Sarbanes-Oxley Act, “A key control is a control that, if it fails, means there is at least a reasonable likelihood that a material error in the financial statements would not be prevented or detected on a timely basis”.
The Company did not have an appropriate level of control consciousness as it relates to the establishment and maintenance of policies and procedures with respect to key internal controls. Effective controls were not designed and in place over the process related to identifying and accumulating all required information to ensure the completeness and accuracy of consolidated financial statements and disclosures as required by Regulation S-X:-
¨
Control over Information and Communication. The Company lacks effective communication of the importance of internal control over financial reporting across its structure, and management failed to set adequate tone to increase the awareness of control consciousness.
¨
Control environment. The Company lacks an effective anti-fraud program, including an effective whistle-blower program, designed to detect and prevent fraud. The Company fails to conduct consistent background checks of personnel in positions of responsibility and establish an ongoing program to manage identified fraud risks.
2. Insufficient resources for US GAAP compliance
The Company currently lacks finance and accounting personnel who possess sufficient skills and experience to ensure that all transactions are accounted for in accordance with US GAAP. In addition, the Company does not have sufficient internal financial policies and procedures to ensure that the existing personnel are capable of fulfilling the requirements of US GAAP reporting. Amongst those deficiencies, revenue and cost recognition were affected most as evidenced by their significant adjustments as compared to the Company’s preliminary consolidated financial statements.
3. Ineffective information technology general control
The Company currently does not have any formal documentation on the information technology general controls, including program development, program changes, computer operations and access to programs and data, which would have an impact on application-level controls and financial statements:-
(i) Impact on application-level controls
Many control procedures are programmed into an entity’s computer system. For example, the process of matching a vendor to a database of preapproved vendors may be completely computerized. A user may submit an invoice for payment, the computer performs the match, and, if the vendor is on the list, processing is allowed to continue. The user is informed only when the computer detects an error, namely, that the vendor has not been preapproved. It is then the user’s responsibility to take the appropriate follow-up action. Again, the follow-up of the identified errors is a critical component of the control.
Ultimately, the effectiveness of computer application controls will depend on the effectiveness of relevant computer general controls, including:-
· Systems development. The application was properly developed and tested to make sure that the control functions as designed.
· Access. Access to the program is monitored to ensure that unauthorized changes to the program cannot be made.
The control objectives for computer application controls are the same as the objectives for manual controls-information must remain complete and accurate at all phases, from initiation (data input) through processing.
(ii) Impact on financial statements
When designing the documentation of internal control, the Company is considering to include the following functional features in the future:-
· Maintainability. The documentation should facilitate easy updating and maintenance as business processes and controls change over time.
· Ease of review. The documentation of internal control should be designed in a user-friendly fashion. For compliance purposes, the project team is the primary user, and so the documentation should allow for these individuals to:-
- Easily assess the effectiveness of the design of internal control
- Facilitate the design of tests of controls
· Information gathering. To create new or update existing documentation will require people to gather information about the Company’s business processes and controls. The documentation methods should recognize this need and, to the extent possible, make it easy to gather and input the information required to create appropriate documentation.
· Scalability. The documentation techniques should be equally adept at handling processes with many control points and those with only a few.
PCAOB Auditing Standard No. 5 requires the following information to be included in the documentation of routine transactions:-
- The design of controls over all relevant assertions related to all significant accounts and disclosures in the financial statements. The documentation should include the five components of internal control over financial reporting.
- Information about how significant transactions are initiated, authorized, recorded, processed, and reported.
- Sufficient information about the flow of transactions to identify the points at which material misstatements due to error or fraud could occur.
- Controls designed to prevent or detect fraud, including who performs the controls and the related segregation of duties.
Remediation Measures of Material Weaknesses
To remediate the material weaknesses described above in “Management’s Report on Internal Control over Financial Reporting”, the Company has implemented or planned to implement the following measures, and will continue to evaluate and may in the future implement additional measures:-
1.
The Company planned remediation measures of hiring and training of personnel who will address these material weaknesses generally as it will have sufficient personnel with knowledge, experience and training in the application of U.S. GAAP commensurate with the Company’s financial reporting requirements;
2.
The Audit Committee and management will prioritize improvement of the Company’s internal control over financial reporting. The Company has a comprehensive training program in financial reporting on U.S. GAAP internally and the Company’s staff have enrolled in professional accounting seminars.
3.
The Company continues to retain the services of outside U.S. counselor to advise on SEC disclosure requirements and at the same time, the Company has the staff training plan on the disclosure requirement either internally or enrolment in professional courses.
4.
The Company is in the progress of implementing an ERP system which it considered would enable it to enhance its management capability on monitoring the Company's business operations. Besides, the Company is in the process of establishing a comprehensive IT short term development plan and long term strategic plan that are appropriately aligned with business objectives and include the following:
¨
IT short term development plan: Business departments will initialize the information technology requests in accordance with their business workflow, and senior management will develop implementation plans and procedures;
¨
IT long term strategic plan: IT long term strategic plan development is based on corporate strategic requirement, including the IT goal and mission, guidance, objectives and the Company’s actions. The IT mission and guidance drive how IT should implement and align with the Company’s strategic goals; and
¨
Senior management of the Company will review and approve the IT strategic plan.
The Company also planned to develop an appropriate IT Organization and Relationships program to regulate IT organizational structure that adequately supports critical systems and segregation of duties, including the following:
¨
IT managers to have adequate knowledge and experience to fulfill their responsibilities to deliver high quality IT services;
¨
Significant IT processes, controls and activities documented;
¨
Job roles and responsibilities within the IT organization clearly defined and documented;
¨
IT personnel to understand and accept their responsibilities regarding internal controls; and
¨
IT management to implement a division of roles and responsibilities, segregation of duties, that reasonably prevents a single individual from subverting a critical process.
The overall ERP implementation was performed on a continuous basis during 2010. To cope with the operation and control requirements, new modules of MRP and product cost control were implemented, together with the above mentioned policies and procedures, in September 2010.
Subsequent to year end, the Company has taken the following actions to remedy the material weaknesses:-
To compensate for the lack of effective communication across the departments, meetings were held regularly to review the progress of the internal control implementation and remedial actions were taken. For example, the essential workflows and information were circularized on the Office Automation System to all employees. Simultaneously, training courses were conducted regularly to enhance the importance of internal controls.
Preventive and detective controls on anti-fraud
An Anti-fraud program was designed to prevent and detect kick-backs on procurement. The prohibition on fraud was clearly defined in the Company’s staff handbook and the Company encourages the whistle-blowers plan and checks were imposed by internal audit departments to investigate any possible frauds and irregularities.
Effective from the end of 2007, the Company has implemented the ERP system which includes financial reporting module and supply chain management module. It is an integrated system which currently allows the Company to generate a great deal of financial and operational information in a timely fashion to facilitate strict monitor of business transactions. However, the Company did not possess high level of formal documentation on the information technology general controls (ITGC), including program development, program changes, computer operations, and access to programs and data. Consequently, it might lessen the reliability and timeliness of the application control, including input and output control, processing control and eventually it might affect the financial statements generated from the system.
Subsequent to December 31, 2010, the Company is taking steps to document the IT general control, including the systematic control system amendments and establishment of database defaults. All these were to ensure the application system ongoing effectiveness.
The Company believes that it is taking the steps necessary for remediation of the material weaknesses identified above, and it will continue to monitor the effectiveness of these steps and to make any changes that its management deems appropriate.
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. As a smaller reporting company, management’s report was not subject to attestation by the Company’s registered public accounting firm.
(c) Changes in internal controls over financial reporting:
For the fourth quarter ended December 31, 2010, there has been no change in the Company’s internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, its internal control over financial reporting.
(d) Inherent Limitations on Effectiveness of Controls
The Company’s management, including the CEO and Controller, does not expect that the Company’s disclosure controls or the Company’s internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on 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. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS, CORPORATE GOVERNANCE AND BOARD INDEPENDENCE
The following table and text set forth the names and ages of all directors and executive officers of the Company as of December 31, 2010. The Board of Directors is comprised of only one class. All of the directors will serve until the next annual meeting of stockholders and until their successors are elected and qualified, or until their earlier death, retirement, resignation or removal. Also provided herein are brief descriptions of the business experience of each director and executive officer during the past five years and an indication of directorships held by each director in other companies subject to the reporting requirements under the federal securities laws.
Name
Age
Position
Yi Song
Board Chairman and CEO
Hong Song
Director and Vice President
Keith Hor*
Chief Financial Officer (resigned as of June 30 2010)
Junjiang Li
Financial Controller (appointed as of June 30 2010)
Jerry Yu
Chief Operating Officer (appointed as of December 9, 2008)
Heung Sang Fong
Independent Director
Hai Cheng Guo
Independent Director
Tuen-Ping Yang
Independent Director
The following is a summary of the biographical information of our directors and officers.
Yi Song, Board Chairman, President and Chief Executive Officer , established Diguang Electronics in 1996 and has been its chairman since inception. Mr. Song started his career in 1976 when he joined Hubei Wei Te Engine Factory as a technician. He was subsequently promoted to the position of engineer and thereafter, director of technology. From 1978 to 1979, he conducted research in the detecting fuse tube system of mathematical control together with a team of researchers from Wuhan Wireless Research Institute. From 1990 to 1996, he worked in the field of the marketing and sales operation in Shenzhen Nanji Electromechanical Company Ltd. under Aidi (Group) Corporation of China. Mr. Song is one of the members of SID, or Society for Information Display, the Deputy Director (Commissioner) of Working Committee of Shenzhen Electronics Communication Experts, one of the members of China Flat Plate Display Association, and Deputy Director of Shenzhen Optoelectronic Industry Association. In 2003, he was awarded Excellent Entrepreneur by Shenzhen Government and in 2006 he was again awarded the same title. Mr. Song cooperated with Wuhan University to research and develop the computer detecting project of Motor Automation Control Engineering. Mr. Song has completed a CEO course from Tsinghua University that focused on International Enterprise Management and received his MBA for the University of Southern Queensland. Mr. Song is Hong Song's older brother and Tuen-Ping Yang's nephew.
Hong Song, Vice President and former Chief Operating Officer , joined Diguang Electronics in January 2001 and became Chief Operating Officer in 2006. Prior to joining Diguang Electronics, Mr. Song was an engineer involved in the design of mining engineering equipment at Beijing Engineering Design & Research Institute for Nonferrous Metals Industry (ENFI) from 1983 to 1990, where he was later promoted to project chief designer. Mr. Song has also held management positions at China National Non-Ferrous Metals Industry Corporation (CNNC) from 1990 to 1998. He obtained a degree in Mechanical Engineering from Xi’an Construction Technology University in 1983 and participated in post-graduate studies in Project Economic Analysis at Paris Mineral Industries University in Paris, France from 1998 to 1999. Mr. Song received his MBA from Peking University in 2001. Mr. Song is Yi Song’s younger brother and Tuen-Ping Yang’s nephew. Mr. Song ceased to be Chief Operating Officer after Mr. Jerry Yu was appointed to the said post.
Junjiang Li, Financial Controller, joined Diguang in March 2010. He graduated from Guangxi University of Finance and Economics in 1996 and with MBA degree from Hefei University of Technology in 2008. From 1996 to 2004, he served as accountant and cost in-charge in Harris Communications (Shenzhen) Co., Ltd. From 2004 to 2005, he served as deputy financial manager in DPBG, Foxconn Technology Group. From 2005 to 2007 he served as financial manager in Arnold Magnetic Technologies (Shenzhen) Co., Ltd. From 2007 to March 2010, he served as chief financial officer in Amphenol pcd Shenzhen Co., Ltd. From June 2010 to now, he serves as the Financial Controller of Diguang International Development Co., Ltd.
Jerry Yu, Chief Operating Officer and Vice President, graduated with Bachelor of Science degree majoring in Accounting from California State University, Chico and Master of Business Taxation degree from University of Southern California. He is a Certified Public Accountant and a member of AICPA. Since 2001, he has served as CEO & Director of Shenzhen Baotian Investment Development Co. Ltd., a holding company with investments in real estate development, property management and business acquisitions. From 2001 to 2003 he served as President & Director of Beijing Hai Hua Aquaculture, Ltd., an aqua-business specializing in high intensity indoor shrimp farming, and providing turn-key operation to customers, including feasibility study, company set-up, site selection, factory design and construction, equipment importation and engineering service, management and employees training and technology transfer. From 1992 to 2002, he served as CEO & Director of Fair Fund Industrial (Group), Ltd., a holding company with operations both in the mainland China and Hong Kong, including real estate development, construction, property and service apartment management, food and entertainment service, manufacturing and import/export trading. From 1989 to 1992 he served as Special Assistant to the Chairman of Da Shung Engineering Co. Ltd., a Taiwanese company with operations in construction, real estate development, manufacturing, and golf course management. From 1979 to 1989, he served as Audit Manager - Johnson & Grover Accountants, Century City, California, Audit Senior - Laventhal & Horwath, Los Angeles, California and Audit Staff - Ernst & Ernst, Los Angeles, California.
Heung Sang Fong, Independent Director, appointed as of August 8, 2007, is a US Certified Public Accountant, and since December 2006 has served as the Executive Vice President for Corporate Development of Fuqi International, Inc.(Nasdaq: FUQI) From January 2004 to November 2006, Mr. Fong served as the managing partner of Iceberg Financial Consultants, a financial advisory firm based in China that advises Chinese clients on raising capital in the United States. From March 2002 to March 2004, Mr. Fong served as Chief Financial Officer of Pacific Systems Control Technology, Inc. (NASDAQ: PFSY), a Chinese company listed on NASDAQ and later on OTCBB. From December 2001 to December 2003, Mr. Fong was the Chief Executive Officer of Holley Communications, a Chinese company that engaged in CDMA chip and cell phone design. Mr. Fong currently serves as an independent director and audit committee member of Universal Technology Holdings Limited (HK Stock Code 8091), a Hong Kong public company, and as an independent director and chairman of the audit committee of Kandi Technologies, Inc., a U.S. public company (Nasdaq: KNDI). Mr. Fong graduated from the Baptist University with a diploma in history in 1982. He has a MBA from the University of Nevada at Reno and a Masters in Accounting from the University of Illinois at Urbana-Champagne, and is a member of the American Institute of Certified Public Accountants (AICPA) appointed as of August 8, 2007, is a Certified Public Accountant, and since December 2006 has served as the Executive Vice President for Corporate Development of Fuqi International, Inc. From January 2004 to November 2006, Mr. Fong served as the managing partner of Iceberg Financial Consultants, a financial advisory firm based in China that advises Chinese clients on raising capital in the United States. From March 2002 to March 2004, Mr. Fong served as Chief Financial Officer of Pacific Systems Control Technology, Inc. (NASDAQ: PFSY), a Chinese company listed on NASDAQ and later on OTCBB. From December 2001 to December 2003, Mr. Fong was the Chief Executive Officer of Holley Communications, a Chinese company that engaged in CDMA chip and cell phone design. Mr. Fong currently serves as an independent director and audit committee member of Universal Technology Holdings Limited (HK Stock Code 8091), a Hong Kong public company, and as an independent director and chairman of the audit committee of Stone Mountain Resources, Inc., a U.S. public company (OTCBB: SMOU). Mr. Fong graduated from the Baptist University with a diploma in history in 1982. He has a MBA from the University of Nevada at Reno and a Masters in Accounting from the University of Illinois at Urbana-Champagne.
Hai Cheng Guo, Independent Director, appointed as of August 8, 2007, is the Dr. William Mong Endowed Chair Professor of Nanotechnology at the Hong Kong University of Science and Technology. He has served as a consultant to numerous companies, and currently for Bona Fide Instruments, Ltd (Hong Kong), Integrated Micro-displays Limited (Hong Kong), and Himax Displays (Taiwan). He has founded four companies, and most recently eLite Displays (Hong Kong) in 2004. He received his B.S. in Electrical Engineering from Northwestern University in 1973, and received his B.S. and Ph.D. in Applied Physics from Harvard University in 1974 and 1978, respectively
Tuen-Ping Yang, Independent Director, has been the President of Cinema Systems, Inc. located in California since 1992. Previously, from 1984 to 1986, Mr. Yang served as the President of World Television Network and a Director of the Los Angeles National Bank. He has also been an Assistant Professor at Chinese Culture University, and a Manager of CMPC Taipei, Taiwan. He received his first Golden House Award (Taiwan’s Oscar Award) as the Best Film Director in 1972, and has received that award an additional three times since that date. He received his bachelor's degree from the National Taiwan University of Arts in 1967 and his master’s degree of Fine Arts from the University of California, Los Angeles, U.S. in 1976. Mr. Yang is Yi Song’s and Hong Song’s uncle.
Significant Employees
The following are employees of Diguang Electronics who are not executive officers, but who are expected to make significant contributions to the Company’s business:
Huade Zuo, Manager, R&D , Diguang Electronics, joined Diguang Electronics in 1999 as an engineer, manager, deputy chief engineer and later as Technology Superintendent. He is responsible for the Company’s technology, especially for the new technology and products. From 1981 to 1999, he worked with Hubei Wei Te Engine Factory, where he was involved in product development. He has extensive experience in the design and production of moulds. Mr. Zou Huade graduated from Wuhan Wireless Industries College in 1981, specializing in the design and production of moulds.
Maoshan Ding, Manager, the Indoor Lighting R&D Department, Diguang Technology, joined Diguang Electronics in 2001 as R&D Engineer, R&D manager and later R & D Superintendent. He was also a director of Diguang Electronics at the beginning of 2005. He was engaged in working at Hu Bei Wei Te Engine Factory, as Technology Section Chief and Engineer from 1980 to 1988. He was engaged in working on R&D fields for engine products, Honghu Mechanical Electronic Research Institute from 1988 to 2001. He graduated from Hubei Electronic Industrial School with a major in Semi-conductors.
Chen Rongguo, Controller, Human Resources Administration, Diguang Electronics, joined Diguang Electronics in 2003 as deputy chief economist and production manager and later as budget & control superintendent. From 1980 to 1989, he worked with Hubei Wei Te Engine Factory where he held various positions in production, finance and corporate management functions. In 1989, he joined Wan Ma Company as an assistant to the general manager where he was involved in the day-to-day operations of the Company. In 1995, he was transferred to the holding company, Ji Li Group Company, as logistics control manager. Mr. Chen studied economic management by remote learning in Beijing Institute of Economic Management from 1983 to 1986.
Chao Guo, Manager, the fifth Marketing Department for Terminal Product, Diguang Technology , jointed Diguang Electronics in January 2003. From January 2003 up to now he worked as manager in Diguang Electronics for overseas sales in charge of Korea and Europe market development and because of his good achievements he was promoted as General Manager of Medium Sized backlight SBU on September 1, 2007. From July 2002 to December 2002 he worked for Dongguan Tailian Manufacture Co, LTD as PMC dept Assistant. Mr. Guo studied in Xi An Europe Asia Foreign Language University, China in July 2002 with Major as International Trade.
Audit Committee Financial Expert
The Company has separately designated a standing Audit Committee of the Board of Directors established in accordance with Section 3(a)(58)(A) of the Exchange Act, as amended. The Audit Committee consists of the following individuals, all of whom the Company considers to be independent, as defined under the SEC’s rules and regulations and the Nasdaq’s definition of independence: Heung Sang Fong, Hai Cheng Guo and Tuen-Ping Yang. Mr. Heung Sang Fong is the Chairman of the Audit Committee. The Board has determined that Mr. Heung Sang Fong is the Audit Committee financial expert, as defined in Item 407(d)(5)of Regulation S-K, serving on the Company’s audit committee.
Compensation Committee
The Company has separately designated a standing Compensation Committee of the Board of Directors. The Compensation Committee is responsible for determining compensation for the Company’s executive officers. The Company’s three independent directors, as defined under the SEC’s rules and regulations and Nasdaq’s definition of independence, are Heung Sang Fong, Hai Cheng Guo and Tuen-Ping Yang, all of which serve on the Compensation Committee. Mr. Hai Cheng Guo is the Chairman of the Compensation Committee.
Nominating Committee
The Company has separately designated a standing Nominating Committee of the Board of Directors. Director candidates are nominated by the Nominating Committee. The Nominating Committee will consider candidates based upon their business and financial experience, personal characteristics, expertise that is complementary to the background and experience of the other Board members, willingness to devote the required amount of time to carrying out the duties and responsibilities of Board membership, willingness to objectively appraise management performance, and any such other qualifications the Nominating Committee deems necessary to ascertain the candidates ability to serve on the Board. In general, in order to provide sufficient time to enable the Nominating Committee to evaluate candidates recommended by stockholders, the Corporate Secretary must receive the stockholder's recommendation no later than thirty (30) days after the end of the Company's fiscal year. The Company’s independent directors, as defined under the SEC’s rules and regulations and the Nasdaq’s definition of independence, Heung Sang Fong, Hai Cheng Guo and Tuen-Ping Yang serve on the Nominating Committee. Mr. Tuen Ping Yang is the Chairman of the Nominating Committee.
Stockholders Communication
Stockholders interested in communicating directly with the Board of Directors, or specified individual directors, may email the Company’s independent directors and they will review all such correspondence and will regularly forward to the Board copies of all such correspondence that deals with the functions of the Board or committees thereof or that he otherwise determines requires their attention. Directors may at any time review all of the correspondence received that is addressed to members of the Board of Directors and request copies of such correspondence. Concerns relating to accounting, internal controls or auditing matters will immediately be brought to the attention of the Audit Committee and handled in accordance with procedures established by the Audit Committee with respect to such matters.
Code of Ethics and Conduct
The Board of Directors has adopted a Code of Ethics and Conduct which is applicable to all officers, directors and employees. The Code of Ethics and Conduct filed herewith is incorporated by reference from the Code of Ethics filed as an exhibit to the Registration Statement on Amendment No. 1 to Form S-1 filed with the Commission on October 30, 2006.
Section 16(a) Beneficial Ownership Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the Company’s executive officers and directors and persons who own more than 10% of a registered class of the Company’s equity securities to file with the Securities and Exchange Commission initial statements of beneficial ownership, reports of changes in ownership and annual reports concerning their ownership of common stock and other of the Company’s equity securities, on Forms 3, 4 and 5 respectively. Executive officers, directors and greater than 10% stockholders are required by Commission regulations to furnish the Company with copies of all Section 16(a) reports they file. To the best of the Company’s knowledge (based solely upon a review of the Form 3, 4 and 5 filed), no officer, director or 10% beneficial shareholder failed to file on a timely basis any reports required by Section 16(a) of the Securities Exchange Act of 1934, as amended.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The Company’s Compensation Committee is empowered to review and approve the annual compensation and compensation procedures for the executive officers of the Company. The primary goals of the Compensation Committee of the Board of Directors with respect to executive compensation are to attract and retain the most talented and dedicated executives possible and to align executives’ incentives with stockholder value creation. The Compensation Committee evaluates individual executive performance with a goal of setting compensation at levels the committee believes are comparable with executives in other companies of similar size and stage of development operating in similar industry while taking into account the Company’s relative performance and its own strategic goals.
The Company has not retained a compensation consultant to review its policies and procedures with respect to executive compensation. The Company conducts an annual review of the aggregate level of its executive compensation, as well as the mix of elements used to compensate its executive officers. Based on the compensations committee general industry knowledge of various companies in the electronics industry, the Company believes the salaries and bonuses of the key officers and employees of Diguang are fair and reasonable.
Elements of Compensation
Executive compensation consists of following elements:
Base Salary. Base salaries for the Company’s executives are established based on the scope of their responsibilities, taking into account competitive market compensation paid by other companies for similar positions. Generally, the Company believes that executive base salaries should be targeted near the median of the range of salaries for executives in similar positions with similar responsibilities at comparable companies, in line with the Company’s compensation philosophy. Base salaries are reviewed annually, and adjusted from time to time to realign salaries with market levels after taking into account individual responsibilities, performance and experience. The Compensation Committee did not hold a separate meeting during the 2010 fiscal year, but members did attend to compensation issues informally both with other members of the Compensation Committe and during the meeting of the Board of Directors.
Discretionary Annual Bonus. The Compensation Committee has the authority to award discretionary annual bonuses to the Company’s executive officers under the Compensation Committee Charter. So far, no discretionary bonus has been awarded. Bonuses, if they are awarded, are intended to compensate officers for achieving financial and operational goals and for achieving individual annual performance objectives. These objectives vary depending on the individual executive, but relate generally to strategic factors such as the financial performance, results of operation and per share performance of the Company’s common stock.
The Company’s chief executive officer and chief operating officer are eligible for a discretionary annual bonus, the specific amount of which will be determined by the Compensation Committee. The actual amount of discretionary bonus is determined following a review of each executive’s individual performance and contribution to the Company’s strategic goals conducted during the first quarter of each fiscal year. The Compensation Committee has not fixed a maximum payout for any officers’ annual discretionary bonus.
Long-Term Incentive Program. The Company believes that long-term performance is achieved through an ownership culture that encourages such performance by its key employees through the use of stock options. The Company’s stock compensation plan has been established to provide certain of the Company’s employees with incentives to help align those employees’ interests with the interests of stockholders. The Compensation Committee believes that the use of stock options offers the best approach to achieving the Company’s compensation goals. The Company has not adopted stock ownership guidelines, and its stock compensation plan has provided the principal method for its key employees to acquire equity interests in the Company. The Company believes that the annual aggregate value of these awards should be set near competitive median levels for comparable companies.
Options . The Company’s 2006 Stock Incentive Plan authorizes the Company to grant options to purchase shares of common stock to the Company’s employees, directors and consultants. The Company’s Compensation Committee was the administrator of the stock option plan until the authority was delegated by the Board to the Company’s former Chief Operating Officer, Song Hong in 2007 and then to the Company’s Chief Executive Officer, Song Yi in 2008. Stock option grants were made on February 25, 2006 or at the commencement of employment. The Board of Directors reviewed and approved the stock option to the Company’s key employees, including the Company’s Chief Financial Officer, and the Company’s independent directors on February 25, 2006 and the granting of stock options subsequent to that was administered and approved by the Compensation Committee, based upon a review of the competitive compensation of key officers and key employees, its assessment of individual performance, a review of each executive’s existing long-term incentives, and retention considerations. In 2006, the Company’s former Chief Financial Officer, the only named executive officer at that time, was awarded stock options in the amounts indicated in the section entitled “Grants of Plan Based Awards”. These grants were made to encourage an ownership culture among the Company’s employees. The Chief Executive Officer has not been granted any stock options. In 2007, the Company’s two of three current independent directors were awarded stock options. The Company’s current Chief Financial Officer was granted with 20,000 shares of option on March 1, 2007, with an exercise price of $5 per share, which vest over four years in equal installments on the following four succeeding anniversaries of the grant date; the Chief Operating Officer was granted with 300,000 shares of option on December 17, 2008, with an exercise price of $0.10 per share, which vest quarterly at the beginning of each quarter over three years starting from January 1, 2009. Please refer to “Grants of Plan Based Awards”.
In order to motivate the Company’s employees to achieve the fixed operation targets in 2009, on December 9, 2008 the Board of Directors approved the granting of the Incentive Option Shares in 2009 to the employees of the Company, totaling up to 548,000 shares. The actual number of stock options to be granted to the employees is connected with his or her annual target achievements and responsible projections, and the person who can achieve all the annual achievements will be entitled to all the granted stock options, and the person who partially achieves the annual achievements will be entitled to the partial granted stock options. If the employee fails to achieve the target completely, no stock options would be granted. Based on the employee’s annual target achievements, the respective stock options shall be granted as to 25% of the individual’s total entitled stock options (shares) on each of the first four anniversaries of the vesting commencement date.
On July 15, 2007, the Company entered into a two year Consultancy Agreement with Mr. Chen Min. On July 10, 2009, just before termination of the Consultancy Agreement, the Board of Directors of the Company granted 50,000 shares of stock option to Mr. Chen Min for the past consulting service rendered. The 50,000 shares of stock option vested on the grant date and the option may be exercised for sixty months after termination of the above mentioned Consultancy Agreement.
2006 Stock Incentive Plan. The Company’s 2006 Stock Incentive Plan authorizes the Company to grant incentive stock option, nonstatutory stock option, stock options, cash awards and stock awards to the Company’s employees, directors and consultants. Mr. Song Yi, the Company’s chief executive officer is the administrator of the plan. If and when stock option awards are granted, they will be made as per the approval of the board of directors, for which the vesting commencement date will be the first day of the month in the year and, occasionally, to meet other special retention or performance objectives. Mr. Song Yi will provide the stock option award plans to the Compensation Committee for review on the executive officers and other key employees, etc. based upon the competitive compensation of the key officers and the key employees, its assessment of individual performance, a review of each executive’s existing long-term incentives, and retention considerations. Periodic stock option award plan to eligible employees, etc. will be regularly prepared by Mr. Song Yi for the approval of the Board of Directors.
Stock Appreciation Rights. The Company currently does not have any Stock Appreciation Rights Plan that authorizes it to grant stock appreciation rights.
Other Compensation. The Company’s chief executive officer and chief operating officer who were parties to employment agreements prior to the filing of this annual report will continue to be parties to such employment agreements in their current form until such time as the Compensation Committee determines in its discretion that revisions to such employment agreements are advisable. There has been no employment agreement with the Company’s previous chief financial officer. Other than the annual salary stipulated in the employment agreements of the Company’s chief executive officer and chief operating officer and the bonus that may be awarded to them at the discretion of the Compensation Committee, and other than the annual salary and the stock options granted to the Company’s chief financial officer, chief operating officer and key employees, the Company does not have any other benefits and perquisites for its executive officers; however, the Compensation Committee in its discretion may provide benefits and perquisites to these executive officers if it deems it advisable. The Company currently has no plans to change the employment agreements (except as required by law or as required to clarify the benefits to which its executive officers are entitled as set forth herein) or to extend benefits and perquisites.
SUMMARY COMPENSATION TABLE
(1) Please refer to Note 8 to Financial Statements for determination of option awards.
On December 9, 2008, Mr. Hong Song resigned from his position as the Chief Operating Officer and was appointed as a Vice President of the Company on the same day.
Mr. Yi Song entered into an employment letter agreement with the Company as of April 19, 2006, to serve as the Company’s Chief Executive Officer from March 17, 2006 through March 17, 2009, the “Initial Term”, and has continued after that for an unspecified term. During the Initial Term, the employment relationship may be terminated by: (i) Yi Song for any reason upon 30 days notice, or (ii) the Company without cause, as defined in the employment agreement, upon 30 days notice or (iii) the Company for cause, as defined in the employment agreement, with immediate effect. Following the Initial Term, the employment relationship may be terminated by Yi Song or the Company according to the Company’s policies at the time of termination. Yi Song shall receive a monthly base salary of $20,833.33, which may be increased during the Initial Term on each anniversary of March 17, 2006.
Mr. Hong Song entered into an employment letter agreement with the Company as of April 19, 2006, to serve as the Company’s Chief Operating Officer from March 17, 2006 through March 17, 2009, the “Initial Term”, and has continued after that for an unspecified term. During the Initial Term, the employment relationship may be terminated by: (i) Hong Song for any reason upon at least 30 days written notice, or (ii) the Company without cause, as defined in the employment agreement, upon 30 days written notice, or (iii) the Company for cause, as defined in the employment agreement, with immediate effect. Following the Initial Term, the employment relationship may be terminated by Hong Song or the Company according to the Company’s policies at the time of termination. Hong Song shall receive a monthly base salary of $16,666.67, which may be increased during the Initial Term on each anniversary of March 17, 2006.
Mr. Keith Hor entered into an employment agreement, the "Employment Agreement", on March 7, 2007, to serve as the Company’s Chief Financial Officer with effect from March 8, 2007. Pursuant to the Employment Agreement, Mr. Hor shall receive a salary of $10,000 per month, payable pursuant to the Company’s normal payroll practices. In addition, Mr. Hor was granted options to purchase the equivalent of 20,000 of the Company’s shares under the Company’s 2006 Stock Incentive Plan. The vesting schedule of his options is as follows: 25% of the shares subject to the stock options shall vest on each of the first four anniversary of March 1, 2008. Mr. Hor resigned on June 30, 2010.
Mr. Jerry Yu was appointed as the Company’s Chief Operating Officer with effect from December 9, 2008. Prior to Mr. Yu’s appointment, Mr. Yu was an executive of the Company. On July 31, 2008, the Company entered into an employment agreement, the “Employment Agreement” , with Mr. Jerry Yu to serve as the Company’s executive with effect from September 1, 2008.
On December 17 2008, the board approved that in accordance with Jerry Yu’s Employment Agreement signed with the Company on July 31, 2008 and his subsequent appointment approved as the Chief Operation Officer of the Company on December 9, 2008, under the Company’s 2006 Stock Incentive Plan Jerry Yu was granted Three Hundred Thousand, 300,000, shares of Company common stock option, the "Stock Option Grant", by the Company for the first three years, 36 months, of service with the Company, this Stock Option Grant will vest over three (3) years in twelve (12) quarterly installments. After the initial first three (3) years of service with the Company, he shall be granted One Hundred Thousand, 100,000, shares of Company common stock option for each additional year of service with the Company, each annual Stock Option Grant will vest over one (1) year in four (4) quarterly installments, provided that he has continuously provided active services to the Company throughout each relevant quarter. The Stock Option Grant is evidenced by the Company's form of respective Notice of Stock Option Grant and the Stock Option Agreement under the 2006 Stock Incentive Plan. He will be eligible for future additional stock grants and stock option grants at the discretion of the Board of Directors.
The Company shall also pay Messrs. Yi Song, Hong Song and Jerry Yu such bonuses as may be determined from time to time by its Compensation Committee. The amount of annual bonus payable to them may vary at the discretion of the Compensation Committee. In determining the annual bonus to be paid to them, the Compensation Committee may, consider all factors they deem to be relevant and appropriate.
Grants of Plan-Based Awards
*Mr. Hor resigned on June 30, 2010.
Outstanding Equity Awards at Fiscal Year-End of 2010
Pursuant to the terms of the Amended and Restated Share Exchange Agreement, the Company assumed Diguang’s outstanding 2006 stock incentive plan covering options totaling the equivalent of 1,500,000 shares of its common stock. Options equivalent to approximately 566,000 shares of the Company’s common stock were issued under the Diguang 2006 Option Plan before the Share Exchange closed as follows: the equivalent of 20,000 and 80,000 shares were granted to Diguang’s current and former chief financial officer in 2007 Agreement, as of March 7, 2007, the date the former chief financial officer resigned, 20,000 of her options have been vested and are exercisable but none of them has been exercised as of March 7, 2007. Under the Stock Option Agreement, the remaining of the 60,000 shares subject to the option that were unvested and hence unexercisable shall terminate and expire effective immediately on March 7, 2007, the date of her resignation. Under the Stock Option Agreement, 16,795 of her options have been vested and are exercisable but none of them has been exercised as March 1, 2008. On December 17, 2008, the Board of Directors approved to grant 300,000 shares of stock options to the Company’s current Chief Operation Officer. The vesting commencement date of the option is January 1, 2009. The Chief Executive Officer is not granted any options.
Director Compensation
(1) Please refer to Note 8 to Financial Statements for determination of option awards.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
As used in this section, the term beneficial ownership with respect to a security is defined by Rule 13d-3 under the Securities Exchange Act of 1934, as amended, as consisting of sole or shared voting power, including the power to vote or direct the vote, and/or sole or shared investment power, including the power to dispose of or direct the disposition of, with respect to the security through any contract, arrangement, understanding, relationship or otherwise, subject to community property laws where applicable.
As of December 31, 2006, the Company had a total of 22,593,000 shares of common stock outstanding, which are its only issued and outstanding voting equity securities. As of December 2010, the Company had repurchased a total of 521,000 shares and had 22,072,000 shares of common stock outstanding.
The following table sets forth, as of February 28, 2010: (a) the names and addresses of each beneficial owner of more than five percent (5%) of the Company’s common stock known to us, the number of shares of common stock beneficially owned by each such person, and the percent of the Company’s common stock so owned; and (b) the names and addresses of each director and executive officer, the number of shares the Company’s common stock beneficially owned, and the percentage of the Company’s common stock so owned, by each such person, and by all of the Company’s directors and executive officers as a group. Each person has sole voting and investment power with respect to the shares of the Company’s common stock, except as otherwise indicated. Beneficial ownership consists of a direct interest in the shares of common stock, except as otherwise indicated.
(1) All percentages have been rounded up to the nearest one hundredth of one percent.
(2) Mr. Yi Song is the majority stockholder of Sino Olympics, as such he may be viewed as having beneficial ownership over all 15,590,000 shares owned by Sino Olympics.
* Individual owns less than 1% of the Company’s securities.
Pursuant to the terms of the Share Exchange, and as described above, the Company assumed Diguang’s 2006 Option Plan, which includes a total of 1,500,000 shares. Employees, as well as officers and directors, will be eligible to receive shares under Diguang’s 2006 Option Plan.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Transaction with management and others
During the normal course of business, transactions involving the movement of funds among certain related parties have occurred from time to time. The details of amounts due from and due to related parties are summarized as follows:
Related Party Relationships
Name of Related Parties
Relationship with the Company
Mr. Yi Song
One of the shareholders of the Company
Mr. Hong Song
One of the shareholders of the Company
Shenzhen Diguang Engine & Equipment Co., Ltd., a China based entity
80% owned by Mr. Yi Song and 20% owned by Mr. Hong Song
Sino Olympics Industrial Limited
The representative of Song’s brothers
The roll forward details of amount due to related parties were summarized as follows:
As of December 31, 2010, amounts due to stock holders was $130,655, which was the consideration to be paid to Shenzhen Diguang Engine & Equipment Co., Ltd. and Sino Olympics Industrial Limited for purchase of 100% interest in Dongguan Diguang S&T in 2007. The amount fell due on June 30, 2009 and was still outstanding as of December 31, 2010.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
The following table sets forth the aggregate fees for professional audit services rendered by BDO China Li Xin Da Hua CPA Co., Ltd., BDO China Li Xin Da Hua CPA Co., Ltd. provided audit services for the fiscal years 2010 and 2009 respectively. The Audit Committee has approved all of the following fees.
Audit Committee’s Pre-Approval Policy
During fiscal year ended December 31, 2010, the Audit Committee of the Board of Directors adopted policies and procedures for the pre-approval of all audit and non-audit services to be provided by the Company’s independent auditor and for the prohibition of certain services from being provided by the independent auditor. The Company may not engage the Company’s independent auditor to render any audit or non-audit service unless the service is approved in advance by the Audit Committee or the engagement to render the service is entered into pursuant to the Audit Committee’s pre-approval policies and procedures. On an annual basis, the Audit Committee may pre-approve services that are expected to be provided to the Company by the independent auditor during the fiscal year. At the time such pre-approval is granted, the Audit Committee specifies the pre-approved services and establishes a monetary limit with respect to each particular pre-approved service, which limit may not be exceeded without obtaining further pre-approval under the policy. For any pre-approval, the Audit Committee considers whether such services are consistent with the rules of the Securities and Exchange Commission on auditor independence. There was no audit committee for the fiscal year ended 2005.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) List of Financial Statements/Schedules
Consolidated Financial Statements
Consolidated Balance Sheets
Consolidated Statements of Income and Comprehensive Income
Consolidated Statements of Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
(b) Exhibits
The following is a list of exhibits filed as part of this Annual Report on Form 10-K. Where so indicated by footnote, exhibits that were previously filed are incorporated by reference.
Exhibit No.
Description
3.1(i)
Amended and Restated Articles of Incorporation (incorporated by reference from Form S-1/A filed on October 30, 2006).
3.1(ii)
Amended and Restated By-laws (incorporated by reference from Form S-1/A filed on October 30, 2006).
10.1
Production Building Lease Contract with Dongguan Diguang Electronics Science & Technology Co., Ltd. and Shenzhen Diguang Electronics Co. dated March 30, 2005 (incorporated by reference from Form S-1 filed on June 16, 2006).
10.2
Employment Agreement of Yi Song (incorporated by reference from Form 8-K filed on April 21, 2006).
10.3
Employment Agreement of Hong Song (incorporated by reference from Form 8-K filed on April 21, 2006).
10.4
Employment Agreement of Keith Hor dated March 7 2007 (incorporated by reference from Form 8-K filed on March 13, 2007).
10.5
Lease Agreement between Dihao Electronics ( Yangzhou ) Co. Ltd and Transcend Optronics ( Yangzhou ) Co., Ltd dated October 1, 2007 (incorporated by reference from Form 10-K filed on April 14, 2008).
10.6
Lease Agreement between Wuhan Diguang Electronics Co. Ltd and Wuhan Hannstar Technology Co. Ltd dated October 29, 2007 (incorporated by reference from Form 10-K filed on April 14, 2008).
10.7
Sale and Purchase Agreement relating to 100% interest in Dongguan Diguang Science & Technology Limited dated December 29, 2007 (incorporated by reference from Form 8-K filed on January 4, 2008).
10.8
Translation of the Comprehensive Credit Line Agreement entered into between Shenzhen Diguang Electronics and Ping An Bank dated July 1, 2008 (incorporated by reference from Form 8-K filed on July 8, 2008).
10.9
Translation of the Pledge Contract entered into between Dongguan Diguang S&T and Ping An Bank dated July 1, 2008 (incorporated by reference from Form 8-K filed on July 8, 2008).
10.10
Employment Agreement of Jerry Yu dated July 31, 2008 (incorporated by reference from Form 8-K filed on December 15, 2008).
14.1
Code of Ethics (incorporated by reference from Form S-1/A filed on October 30, 2006).
21.1
Subsidiaries of the registrant (incorporated by reference from Form S-1 filed on June 16, 2006).
31.1
Rule 13a-14(a) Certification*
31.2
Rule 13a-14(a) Certification*
32.1
Section 1350 Certification*
32.2
Section 1350 Certification*
* Filed herewith
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the Company caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: March 31, 2011
Diguang International Development Co., Ltd.
(Registrant)
/s/ Yi Song
By: Yi Song
Title: Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)
/s/ Junjiang Li
By: Junjiang Li
Title: Controller
(Principal Financial Officer and Principal Accounting Officer)
Pursuant to the requirements of the Securities Act of 1933, this report has been signed by the following persons in the capacities and on the dates indicated.
FINANCIAL STATEMENTS
DIGUANG INTERNATIONAL DEVELOPMENT CO., LTD.
CONTENTS
Report of Independent Registered Public Accounting Firm
The Board of Directors
Diguang International Development Co., Ltd
We have audited the accompanying consolidated balance sheets of Diguang International Development Co., Ltd (the “Company”) as of December 31, 2009 and 2010, and the related statements of income and comprehensive income, stockholders’ equity and cash flows for each of the years in a two-year period ended December 31, 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and schedule are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Diguang International Development Co., Ltd, as of December 31, 2009 and 2010, the results of its operations and its cash flows for each of the years in a two-year period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 13 to the financial statements, the Company has suffered recurring losses from operations and has a net working capital deficiency that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 13. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/BDO China Li Xin Da Hua CPA Co., Ltd.
BDO China Li Xin Da Hua CPA Co., Ltd.
Shenzhen, PRC
March 28, 2011
DIGUANG INTERNATIONAL DEVELOPMENT CO., LTD.
CONSOLIDATED BALANCE SHEETS
(In US Dollars)
See accompanying notes to financial statements
DIGUANG INTERNATIONAL DEVELOPMENT CO., LTD.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2009 AND 2010
(In US Dollars)
See accompanying notes to financial statements.
DIGUANG INTERNATIONAL DEVELOPMENT CO., LTD.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2010 AND 2009
(In US Dollars)
See accompanying notes to financial statements
DIGUANG INTERNATIONAL DEVELOPMENT CO., LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase (Decrease) in Cash and Cash Equivalents
(In US Dollars)
See accompanying notes to financial statements
DIGUANG INTERNATIONAL DEVELOPMENT CO., LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 ─ ORGANIZATION AND OVERVIEW OF BUSINESS
Diguang International Development Co., Ltd., formerly known as Online Processing, Inc., “Online”, was organized under the laws of the State of Nevada in 2000. On January 10, 2006, Online entered into a stock exchange agreement with Diguang International Holdings Limited., “Diguang Holdings”. On March 17, 2006, Online issued 2.4 million shares of its common stock in exchange for the gross proceeds of $12 million and issued 18,250,000 shares of its common stock in exchange for 100% equity interest in Diguang Holdings, making Diguang Holdings a wholly owned subsidiary of Online. One of the conditions to closing the transaction was changing the name from Online Processing, Inc. to “Diguang International Development Co., Ltd.”, and the name was changed on February 28, 2006.
The Company specializes in the design, production and distribution of Light Emitting Diode, “LED”, and Cold Cathode Fluorescent Lamp, “CCFL”, backlights for various Thin Film Transistor Liquid Crystal Displays, “TFT-LCD”, and Super-Twisted Nematic Liquid Crystal Display, “STN-LCD”, Twisted Nematic Liquid Crystal Display, “TN-LCD”, and Mono LCDs, taking together, these applications are referred to as “LCD” applications. Those applications include color displays for cell phones, car televisions and navigation systems, digital cameras, televisions, computer displays, camcorders, PDAs and DVDs, CD and MP3/MP4 players, appliance displays and the like. In late 2009, the Company started its trial run of producing LED TV sets with two sizes.
The Company’s headquarter is located in Shenzhen, China. The Company owns its subsidiaries through Diguang Holdings. Diguang Holdings was established under the law of the British Virgin Islands on July 27, 2004 and holds equity interests in the following entities:
Well Planner Limited, a Hong Kong based entity;
Diguang Science and Technology (HK) Limited, a British Virgin Islands based entity;
Shenzhen Diguang Electronics Co., Ltd., a China based entity;
North Diamond;
Wuhan Diguang Electronics Co., Ltd.; and,
Dongguan Diguang Electronics Science and Technology Co., Ltd.
Shenzhen Optimum Electronics Co., Ltd.
Well Planner Limited, “Well Planner”, was established under the laws of Hong Kong Special Administrative Region on April 20, 2001 and has been doing major business in custom forwarding related to export and import activities conducted by Diguang Electronics for a service fee based on a service agreement, pursuant to which service fees should not be less than 2% of the goods Well Planner has sold. Well Planner mainly sells to Diguang Science and Technology (HK) Limited and has minimal sales to third-party customers.
Diguang Science and Technology (HK) Limited, “Diguang Technology”, was established under the laws of the British Virgin Islands on August 28, 2003 and has handled all sales to international customers and procurements of electronic components and materials for Diguang Electronics.
Both Well Planner and Diguang Technology do not have any office space leased in Hong Kong and British Virgin Islands.
NOTE 1 ─ORGANIZATION AND OVERVIEW OF BUSINESS (Continued)
Shenzhen Diguang Electronics Co. Ltd., “Diguang Electronics”, was established as an equity joint venture in Shenzhen under the laws of the People’s Republic of China, the “PRC”, on January 9, 1996 with an operating life of 20 years starting on that date. As of December 31, 2006, its registered capital was RMB 85 million, equivalent to approximately $10,573,615. Diguang Electronics designs, develops and manufactures LED and CCFL backlight units. These backlight units are essential components used in illuminating display panels such as TFT-LCD and color STN-LCD panels. These display panels are used in products such as mobile phones, PDAs, digital cameras, liquid crystal computer or television displays and other household and industrial electronic devices. Diguang Electronics’ customers are located in both China and overseas.
Diguang Holdings acquired 65% interest of North Diamond since January 3, 2007. North Diamond is a holding company of Dihao (Yangzhou) Co., Ltd., “Dihao”, an operating entity, which is registered in the Yangzhou City Development Zone, Jiangsu Province, China. Dihao conducts business activities of developing, manufacturing and marketing backlight products for large size electronic display devices and provides relevant technical services in China.
Diguang Electronics and Diguang Holdings jointly set up Wuhan Diguang Electronics Co., Ltd., “Wuhan Diguang”, in Wuhan, Hubei Province, China, with a registered capital of $1 million, of which 70% was infused by Diguang Electronics and the remaining 30% by Diguang Holdings. Wuhan Diguang was established on March 13, 2007 and its business license issued by Wuhan Municipal Administrative Bureau for Industry and Commerce is valid for 20 years expiring on March 12, 2027. Wuhan Diguang manufactures and sells LED and CCFL backlight units in Central South region of China. Wuhan Diguang started operation on July 1, 2007.
On December 29, 2007, Diguang Holdings acquired 100% interest in Dongguan Diguang Electronics Science and Technology Co. Ltd., “Dongguan Diguang S&T”. On January 1, 2008, Diguang Holdings assigned 70% of interest in Dongguan Diguang S&T to Diguang Electronics. Dongguan Diguang S&T was established under the laws of the People’s Republic of China on February 16, 2004 and has been used by Diguang Electronics as the production base since its inception. Dongguan Diguang S&T started its own manufacturing activities since 2008.
On April 30, 2009, Well Planner established wholly owned entity named Shenzhen Optimum Electronics Co., Ltd, “Shenzhen Optimum”, a China based entity. Shenzhen Optimum concentrates in sales of large size LED TV sets manufactured by Diguang Electronics to domestic customers throughout China.
NOTE 2 ─ SUMMARY OF ACCOUNTING POLICIES
Principles of Consolidation
The financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant inter-company accounts and transactions have been eliminated. All of the consolidated financial statements have been prepared based on generally accepted accounting principles in the United States.
Foreign Currency Translations and Transactions
The Renminbi (“RMB”), the national currency of PRC, is the primary currency of the economic environment in which the operations of five subsidiaries, Diguang Electronics, Dihao, Wuhan Diguang, Dongguan Diguang S&T, and Shenzhen Optimum, are conducted. Hong Kong dollar is the primary currency of the economic environment in which the operations of Well Planner are conducted. The Company uses the United States dollars (“U.S. dollars”) for financial reporting purposes.
The Company translates the above six subsidiaries’ assets and liabilities into U.S. dollars using the rate of exchange prevailing at the balance sheet date, and the statement of income is translated at average rate during the reporting period. Adjustments resulting from the translation of subsidiaries’ financial statements from the functional currency into U.S. dollars are recorded in shareholders’ equity as part of accumulated comprehensive income (loss) - translation adjustments. Gains or losses resulting from transactions in currencies other than the functional currency are reflected in the statements of income for the reporting periods.
Revenue Recognition
Revenue generated from sales of backlight units to customers is recognized when persuasive evidence of an arrangement exists, delivery of the products has occurred, the significant risks and rewards of the ownership have been transferred to the customer, the price is fixed or determinable and collectability is reasonably assured. The Company will sign sales order (or purchase order prepared by customers) with customers for each sales transaction. A sales order signed by both parties is deemed to be persuasive evidence for revenue recognition. Sales terms of products are usually “FOB destination” and the delivery is deemed to occur when the products have been delivered to the sites prescribed by customers. Revenue is recognized when the Company receives customers’ confirmation of transaction statements. Due to the nature of backlight products, when the products have quality issue, the Company will replace these products and the products with quality issue are brought back. Accordingly, no provision has been made for returnable goods. Revenue presented on the Company’s income statements is net of sales taxes.
Certain sales are subject to the ultimate usage of the products by the Company’s customers. Revenue is not recognized on these transactions until the period in which the Company is able to determine that the products shipped have been used by its customers.
Cash and Cash Equivalents
The Company considers all highly liquid investments with maturity of three months or less to be cash equivalents.
NOTE 2 ─ SUMMARY OF ACCOUNTING POLICIES (Continued)
Accounts Receivable and Concentration of Credit Risk
During the normal course of business, the Company extends unsecured credit to its customers. Typically credit terms require payment to be made within 90 days of the invoice date. The Company does not require collateral from its customers. The Company maintains its cash accounts at credit worthy financial institutions and closely monitors the movements of its cash positions.
The Company regularly evaluates and monitors the creditworthiness of each customer on a case-by-case basis. The Company includes any accounts balances that are determined to be uncollectible in the allowance for doubtful accounts. After all attempts to collect a receivable have failed, the receivable is written off against the allowance. Based on the information available to management, the Company believes that its allowance for doubtful accounts as of December 31, 2009 and 2010 were adequate, respectively. However, actual write-off might exceed the recorded allowance.
The following table presents allowance activities in accounts receivable.
Inventories
Inventories are composed of raw materials and components, work in progress, finished goods and consignment goods, most of which are related to backlight products. The consignment goods are owned by the Company as inventory and are stored at a customer’s place.
Inventories are valued at the lower of cost (based on weighted average method) and the market. Full amount provisions were made for obsolete inventories which are difficult to estimate future utilization. Once the inventory cost is written down, the written-down costs are treated as a new cost basis for the inventory, and are not adjusted back up to the previous cost basis in future periods. For inventories which will be used in ordinary course of production or sales, the net realizable value of the inventories is compared with their carrying value, if the net realizable value is lower than the carrying value, a provision for the difference between the net realizable value and the carrying value of the inventories was recognized. Net realizable value is determined based on the most recent selling price of these inventories less the estimated cost to sell.
NOTE 2 ─ SUMMARY OF ACCOUNTING POLICIES (Continued)
Plant, Property and Equipment
Properties and equipment are recorded at historical cost, net of accumulated depreciation. The Amount of depreciation is determined using the straight-line method over the shorter of the estimated useful lives and the remaining contractual life related to leasehold improvements, as follows:
Land usage right
48.5, 50 years
Plant and office building
20, 50 yeas
Machinery and equipment
5-10 years
Furniture and office equipment
5 years
Software
2-5 years
Vehicles
5-10 years
Leasehold improvement
5 years
Maintenance and repairs are charged directly to expense as incurred, whereas betterment and renewals are generally capitalized in their respective property accounts. When an item is retired or otherwise disposed of, the cost and applicable accumulated depreciation are removed and the resulting gain or loss is recognized and reflected as an item before operating income (loss).
The Chinese government owns all of the parcels of land on which the Company’s plants are built. In the PRC, land usage rights for commercial purposes are granted by the PRC government typically for a term of 40-50 years. The Company is required to pay a lump sum of money to the State Land and Resource Ministry of the applicable locality to acquire such rights. The Company capitalizes the lump sum of money paid and amortizes these land usage rights by using the straight line method over the term of the land use license granted by the applicable governmental authority.
Construction in progress is stated at cost. The cost accumulation process starts from time the construction project is set-up and ends at the time the project has been put into service and all regulatory permits and approvals have been received. The interest costs incurred for these construction projects have been determined to be insignificant by management. No interest has been capitalized during the reporting period.
Fair Value of Financial Instruments
The carrying amount of cash, accounts receivable, other receivables, advances to vendors, accounts payable and accrued liabilities are reasonable estimates of their fair value because of the short maturity of these items. The fair value of amounts due from or paid to related parties and stockholders are reasonable estimates of their fair value since the amounts will be collected and paid off in a period less than one year.
Impairment of Long-Lived Assets
The Company review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable through the estimated undiscounted cash flows expected to result from the use and eventual disposition of the assets. Whenever any such impairment exists, an impairment loss will be recognized for the amount by which the carrying value exceeds the fair value.
NOTE 2 ─ SUMMARY OF ACCOUNTING POLICIES (Continued)
Impairment of Financial Investments
The Company accounts for its investments in common stocks using the cost method. Other than temporary impairment loss is recognized when a series of operating losses of an investee or other factors indicate a decrease in value of investments.
Research and Development
Research and development costs are expensed as incurred. Research and development expenses are offset against government subsidiaries received for supporting research and development efforts and other revenue.
Value Added Tax
Diguang Electronics, Dihao, Wuhan Diguang, Dongguan Diguang S&T and Shenzhen Optimum are subject to value added tax (VAT) imposed by the PRC government on its domestic product sales. VAT rate for the Company is 17%. The input VAT can be offset against the output VAT. VAT payable or receivable balance presented on the Company’s balance sheets represents either the input VAT less than or larger than the output VAT. The debit balance represents a credit against future collection of output VAT instead of a receivable.
Share-Based Payments
The Company receives employee and certain non-employee services in exchange for (a) equity securities of the Company or (b) liabilities that are based on the fair value of the Company’s equity securities or that may be settled by the issuance of such equity securities. The Company uses a fair-value-based method to calculate and account for above mentioned transactions.
Income Taxes
The Company recognizes deferred tax liabilities and assets when accounts for income taxes. Deferred tax assets and liabilities are recognized for the future tax consequence attributable to the difference between the tax bases of assets and liabilities and their reported amounts in the financial statements. Deferred tax assets and liabilities are measured using the enacted tax rate expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that included the enactment date.
NOTE 2 ─ SUMMARY OF ACCOUNTING POLICIES (Continued)
Income Taxes (Continued)
Diguang Electronics is registered at Shenzhen and was subject to a favorable income tax rate at 15% compared with a statutory income tax rate of 33%, 30% for the central government and 3% for the local government. And Diguang Electronics has been deemed a high-tech company by Shenzhen Bureau of Science, Technology & Information. Under this category, Diguang Electronics has been entitled to enjoy a 50% exemption from enterprise income tax at the rate of 15% for the years from January 1, 2004 to December 31, 2006. Diguang Electronics was subject to an income tax rate of 15% since January 1, 2007 according to the old tax law. A newly enacted enterprise income tax law (“EIT Law”) was effective January 1, 2008. The EIT Law imposes a unified EIT of 25% on all domestic-invested enterprises and foreign invested enterprises unless these foreign investment enterprises qualify under certain grand-father rules. For enterprises like Diguang Electronics which enjoyed privileged preferential income tax rate of 15% under the old tax law, the applicable income tax rate should transit to 25% in 5 years, that is, 18% in the year ended December 31, 2008, 20%, 22%, 24% and 25% in the following four years ending December 31, 2009, 2010, 2011 and 2012, and 25% ever after. So the applicable income tax rate for Diguang Electronics is 22% for the year ended December 31, 2010.
Well Planner is subject to an income tax rate at 17.5% under Hong Kong Inland Revenue jurisdiction. However, Well Planner does not have Hong Kong sourced income. In accordance with Hong Kong tax regulation, Well Planner has not been taxed since its inception.
Diguang Technology is a BVI registered company. There is no income tax for the company domiciled in the BVI. Accordingly, the Company’s financial statements do not present any income tax provision related to the British Virgin Islands tax jurisdiction.
Dihao is registered at Yangzhou and has been deemed a high-tech company by Yangzhou Bureau of Science, Technology and Information. Under this category, Dihao was entitled to enjoy a 100% exemption of corporate income tax for the two years from January 1, 2006 to December 31, 2007 and a 50% exemption of corporate income tax for the following three years from January 1, 2008 to December 31, 2010 in accordance with the preferential rules established by Yangzhou local tax authority on August 2, 1999. Under the new EIT Law, the income tax rate for Dihao is 25%; the applicable income tax rate for Dihao is 12.5% for the three years ending December 31, 2010.
Wuhan Diguang is registered in Wuhan. As a manufacturing company with foreign investment set up before March 16, 2007, Wuhan Diguang entitled to enjoy a 100% exemption of corporate income tax for the first two years of operations with a profit position and a 50% exemption of corporate income tax for the following three years. After the five-year exemption period, Wuhan Diguang will subject to the unified income tax rate of 25% in accordance with new EIT Law. It is the first year for Wuhan Diguang to enjoy 50% exemption, which is 12.5% of income tax in 2010.
Dongguan Diguang S&T is registered at Dongguan of Guangdong Province and is entitled to enjoy a 100% exemption of corporate income tax for the first two years of operation and a 50% exemption of corporate income tax for the following three years and will subject to the unified income tax rate of 25% after the five-year exemption period. Dongguan Diguang S&T has used up its two years’ 100% exemption in the years 2008 and 2007, even though it suffered losses in these two years. It is the second year for Dongguan Diguang S&T to enjoy 50% exemption of income tax in 2010.
NOTE 2 ─ SUMMARY OF ACCOUNTING POLICIES (Continued)
Income Taxes (Continued)
Shenzhen Optimum is registered at Shenzhen of Guangdong Province. No exemption was granted to Shenzhen Optimum and it is subject to the unified income tax rate of 25%.
Diguang International Development Co., Ltd. was established under the laws of the State of Nevada and is subject to U.S. federal income tax and one state income tax. For U.S. income tax purposes no provision has been made for U.S. taxes on undistributed earnings of overseas subsidiaries with which the Company intends to continue to reinvest. It is not practicable to estimate the amount of additional tax that might be payable on the foreign earnings if they were remitted as dividends, or lent to the Company, or if the Company should sell its stock in the subsidiary. The predecessor company accumulated certain net operation loss carry forwards; however, due to the changes in ownership, the use of these net operation loss carry forwards may be limited in accordance with the U.S. tax laws.
Because the consolidated financial statements were based on the respective entities’ historical financial statements, the respective effective income tax rate for the periods reported represents the effect of actual income tax provisions incurred to Diguang Electronics, Dihao, Wuhan Diguang, Dongguan Diguang S&T, Shenzhen Optimum and Diguang International Development Co., Ltd.
Comprehensive Income (Loss)
The Company adopted FASB Accounting Standards Codification 220, Comprehensive Income, which establishes standards for reporting and presentation of comprehensive income (loss) and its components in a full set of general-purpose financial statements. The Company has chosen to report comprehensive income (loss) in the statements of income and comprehensive income. Comprehensive income (loss) is comprised of net income and all changes to stockholders’ equity except those due to investments by owners and distributions to owners.
Earnings (Loss) Per Share
Basic earnings (loss) per share includes no dilution and is computed by dividing income (loss) available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share reflect the potential dilution of securities that could share in the earnings of an entity, similar to fully diluted earnings (loss) per share.
Retained Earnings
It is the intention of the Company to reinvest earnings generated from the operations of its foreign subsidiaries and retained in those foreign subsidiaries. Accordingly, no provision has been made for U.S. income and foreign withholding taxes since there was no earnings repatriated.
NOTE 2 ─ SUMMARY OF ACCOUNTING POLICIES (Continued)
Appropriations to Statutory Reserve
Under the corporate law and relevant regulations in China, each subsidiary of the Company located in the mainland China (Diguang Electronics, Dihao, Wuhan Diguang, Dongguan Diguang S&T, Shenzhen Optimum) is required to appropriate a portion of its retained earnings to statutory reserve. It is required to appropriate 10%(the proportion is 15% before 2006) of its annual after-tax income (under Chinese GAAP) each year to statutory reserve until the statutory reserve balance reaches 50% of the registered capital. Total registered capital of the five subsidiaries located in China is $24.6 million and in theory total statutory reserve to be appropriated is $12.3 million; as of December 31, 2010, the Company had statutory reserve of $0.8 million and there was further $11.5 million to be appropriated if all the five companies had enough after-tax income in future. In general, the statutory reserve shall not be used for dividend distribution purpose.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates.
Recently Issued Accounting Pronouncements Adopted
FASB ASU 2010-09
In February 2010, FASB issued ASU No. 2010-9, “Amendments to Certain Recognition and Disclosure Requirements”. This update addresses certain implementation issues related to an entity’s requirement to perform and disclose subsequent-events procedures, removes the requirement that public companies disclose the date of their financial statements in both issued and revised financial statements. According to the FASB, the revised statements include those that have been changed to correct an error or conform to a retrospective application of U.S. GAAP. The amendment is effective immediately. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.
FSAB ASU 2010-06
In January 2010, FASB issued ASU No. 2010-06, “Improving Disclosures about Fair Value Measurements.” This update provides amendments to Subtopic 820-10 that requires new disclosure as follows: 1) Transfers in and out of Levels 1 and 2. A reporting entity should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers. 2) Activity in Level 3 fair value measurements. In the reconciliation for fair value measurements using significant unobservable inputs (Level 3), a reporting entity should present separately information about purchases, sales, issuances, and settlements (that is, on a gross basis rather than as one net number). This update provides amendments to Subtopic 820-10 that clarifies existing disclosures as follows: 1) Level of disaggregation. A reporting entity should provide fair value measurement disclosures for each class of assets and liabilities. A class is often a subset of assets or liabilities within a line item in the statement of financial position. A reporting entity needs to use judgment in determining the appropriate classes of assets and liabilities. 2) Disclosures about inputs and valuation techniques. A reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. Those disclosures are required for fair value measurements that fall in either Level 2 or Level 3. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. These disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.
FASB ASU 2010-29
The FASB has issued ASU No. 2010-29, “Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations.” This ASU reflects the decision reached in EITF Issue No. 10-G. The amendments in this ASU affect any public entity as defined by Topic 805, Business Combinations, that enters into business combinations that are material on an individual or aggregate basis. The amendments in this ASU specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings.
The amendments are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.
NOTE 2 ─ SUMMARY OF ACCOUNTING POLICIES (Continued)
Recently Issued Accounting Pronouncements Not Adopted Yet
FASB ASU 2010-13
In April 2010, the FASB issued Accounting Standards Update ("ASU") No. 2010-13, “Compensation - Stock Compensation (Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades,” which addresses the classification of a share-based payment award with an exercise price denominated in the currency of a market in which the underlying equity security trades. Topic 718 is amended to clarify that a share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity securities trades shall not be considered to contain a market, performance, or service condition. Therefore, such an award is not to be classified as a liability if it otherwise qualifies as equity classification. The amendments in this Update should be applied by recording a cumulative-effect adjustment to the opening balance of retained earnings. The cumulative-effect adjustment should be calculated for all awards outstanding as of the beginning of the fiscal year in which the amendments are initially applied, as if the amendments had been applied consistently since the inception of the award. ASU 2010-13 is effective for interim and annual periods beginning on or after December 15, 2010 and is not expected to have a material impact on the Company’s consolidated financial position or results of operations.
Reclassification
Certain line items presented on the comparative financial information have been reclassified to conform to the presentation of current financial statements.
NOTE 3 ─ INVENTORIES
The inventories are as follows:
NOTE 4 ─ PLANT, PROPERTY AND EQUIPMENT
A summary of property, plant and equipment at cost is as follows:
The depreciation and amortization for the years ended December 31, 2009 and 2010 were $1.6 million and $1.5 million, respectively.
NOTE 5 ─ CONSTRUCTION IN PROCESS
The Company began to construct a manufacturing facility for production of large size LED products in the Guangming District of Shenzhen City at the beginning of 2010. Total budgeted capital investment for this facility is estimated to be $10.5 million excluding cost of land usage right, which was already acquired in the year of 2007. As of December 31, 2010, total construction cost occurred for the new facility was $8.1 million, among which, $3.9 million was still outstanding for further payments. The external portion of the facility has been completed and the interior decoration has not started on December 31, 2010 due to shortage of funds. The Company estimates that the interior decoration will cost additional $2.4 million in order to make this facility to be functional.
NOTE 6 ─ BANK LOANS
Bank loans from Shenzhen Ping’an Bank
Short term bank loans
Diguang Electronics has acquired bank loan facilities of RMB30 million, equivalent to $4.6 million as of December 31, 2010, from Shenzhen Ping’an Bank. The RMB30 million bank loan facility was pledged by buildings in Dongguan Diguang S&T with a net book value of $3.7 million.
As of December 31, 2010, the Company fully used the RMB30 million bank facilities and borrowed RMB30 million, equivalent to $4,545,455, from Shenzhen Ping’an Bank with a prevailing annual rate of 5.47%. All of these bank loans will fall due in the first half year of 2011, among which, $1.5 million, $1.1 million, and $2.0 million will fall due on June 6, May 30, and May 13, 2011, respectively.
Fully guaranteed import financing loans
In addition to the abovementioned RMB30 million bank loan facilities, Diguang Electronics also received import financing loans from Shenzhen Ping’an Bank. The import financing loans were nominated in US Dollars and were fully guaranteed by equivalent deposit of cash in RMB. The Company entered into such loan agreements to earn some interest income since there were different interest rates for US Dollars and RMB.
As of December 31, 2010, the Company pledged RMB20.5 million, equivalent to $3.1 million, for loans of $2,996,989 from Shenzhen Ping’an Bank under the import financing agreements. As of January 12, 2011, the Company paid out the loans and received pledged deposit of cash at the maturity of loans.
Loan agreements with China Development Bank Co., Ltd.
Long term loan received by Diguang Electronics
On November 10, 2009, Diguang Electronics entered into a 5 year long-term loan agreement with China Development Bank Co., Ltd. to borrow RMB100 million for the construction of the new facility located in the Guangming District of Shenzhen City. On December 30, 2009, Diguang Electronics paid RMB3 million to China Development Bank as 5 year guarantee expense for the RMB100 million bank facilities, upon which the bank facilities formally became effective.
The RMB100 million banking facilities are secured by the followings: (1) two joint and several personal guarantees from Mr. Yi Song and Mr. Hong Song (directors of the Company); (2) collateral placed on the office space owned by Diguang Electronics with a carrying amount of $2.3 million; and (3) collateral placed on the land use rights of the land on which the new manufacturing facility was located, which has a carrying amount of $2.4 million.
NOTE 6 ─ BANK LOANS (Continued)
Loan agreements with China Development Bank Co., Ltd. (Continued)
Long term loan received by Diguang Electronics (Continued)
As of December 31, 2010, Diguang Electronics had received RMB57.2 million, equivalent to $8,665,152, from China Development Bank Co., Ltd. The bank loans under the RMB100 million bank loan facility agreement should be repaid in four years ever since June 15, 2011. Accordingly, the $8,665,152 bank loans received should be paid in stages as below:
Long term loan received by Dongguan Diguang S&T
On May 25, 2010, Dongguan Diguang S&T entered into a loan agreement with China Development Bank Co., Ltd. for RMB30 million bank facilities. The bank facilities provided by the Bank aimed to replenish working capital for a specified customer’s purchase orders and the issuances of loan proceeds were tied up with purchase orders received from the specific customer.
The RMB30 million banking facilities are secured by the followings: (1) joint and several liabilities guarantee from Diguang Electronics; (2) all the interest and income related to the lease agreement between Dongguan Diguang S&T’s and Diguang Electronics, by which Dongguan Diguang S&T leased its plants to Diguang Electronics for an annual rental of RMB4.6 million, equivalent to $0.7 million as of December 31, 2010; (3) all the interest and income related to sales contract between Dongguan Diguang S&T and the specified customer.
On July 9, 2010, Dongguan Diguang S&T received RMB4.0 million, equivalent to $597,863, from China Development Bank Co., Ltd. According to loan agreement, $0.24 million of the loan should be repaid in 2011, and the other $0.24 million and $0.12 million should be repaid in 2012 and 2013, respectively.
Since Dongguan Diguang S&T had not received enough purchase orders as expected from the specific customer, the Company estimated that the rest bank facilities of RMB26 million was no longer available.
NOTE 7 ─ INCOME TAXES
The income before income taxes in 2009 and 2010 respectively, was as following:
NOTE 7 ─ INCOME TAXES (Continued)
The income tax provision was as follows:
Deferred tax assets and liabilities reflect the net tax effects of temporary differences between carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components that give rise to deferred tax assets as of December 31, 2009 and 2010 were as follows:
Management estimates that it is more likely than not that the potential economic benefits of the net operating loss will not be materialized in the near future. Accordingly, a full amount of valuation allowance was provided.
The difference between the effective income tax rate and the expected federal statutory rate was as follows:
NOTE 8 ─ STOCK OPTIONS
The Company recognized the share-based compensation cost based on the estimated grant-date fair value. There were no stock options issued before January 1, 2006.
From February 25, 2006 to December 31, 2009, the Company issued stock option to purchase 1,504,000 shares of its common stock with total fair value of $6,218,888. During the year ended December 31, 2009, the Company issued stock option to purchase 50,000 shares of it common stock at $0.51 per share with a fair value of $24,500.
The share-based compensation recognized for stock options granted was $281,175 and $44,874 for the years ended December 31, 2009 and 2010, respectively. No tax benefit was recognized for the share-based compensation due to the stock options granted. The total intrinsic value of options exercised during the years ended December 31, 2009 and 2010, was approximately $0, and $0, respectively, as no stock options were exercised in each respective year since they were granted.
Assumptions
The disclosure of the above fair value for these awards was estimated using the Black-Scholes option pricing model with the assumptions listed below:
The expected volatilities are essentially based on the historical volatility of the Company’s stock. The observation was made on a daily basis. The periods of observation covered were from March 17, 2006 through the grant day for all the options granted in 2009. The expected terms of stock options are based on the average vesting period and the contractual life of stock options granted.
The risk-free rates are consistent with the expected terms of stock option and based on the U.S. Treasury yield curve in effect at the time of grant. The Company estimated the forfeiture rate of its stock options was 6.13%.
Stock Option Plan
The Company’s 2006 Stock Incentive Plan (the “2006 Plan”), which is shareholder-approved, permits the grant of stock options to its employees up to 1,500,000 shares of common stock. The Company believes that such awards better align the interests of its employees with those of its shareholders. Option awards are generally granted with an exercise price per share equal to the five-day average share price before the Board of Directors’ approval. These options have up to ten-year contractual life term.
NOTE 8 ─ STOCK OPTIONS (Continued)
Awards generally vest over four years in equal installments on the next four succeeding anniversaries of the grant date. The share-based compensation will be recognized based on graded vesting method over the four years or over the three years regarding the options granted to directors in order to match their directorship terms. A summary of option activities under the 2006 Plan during the years ended December 31, 2009 and 2010 is presented as follows:
On July 15, 2007, the Company entered into a two years Consultancy Agreement with Mr. Chen Min. On July 10, 2009, just before termination of the Consultancy Agreement, the Board of Directors granted stock option to Mr. Chen Min to purchase 50,000 shares of its common stock for the past consulting service rendered. The stock option vested at the grant date and the option may be exercised for sixty months after termination of the above mentioned Consultancy Agreement. The share option has a fair value of $24,500 and was recognized as compensation cost immediately upon the granting.
The trading price of the Company stock at December 31, 2009 and 2010 was $0.26, and $0.44 per share, respectively. Intrinsic value for outstanding and exercisable options as of December 31, 2009 was $107,360 and $30,840, and intrinsic value for outstanding and exercisable options as of December 31, 2010 was $217,200 and $68,000, respectively.
As of December 31, 2010, the total unrecognized stock-based compensation based on fair value on the granting date related to non-vested stock options was $23,137. That cost is expected to be recognized over a period of two years.
NOTE 9 ─ EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted net earnings per share for the periods as indicated:
NOTE 10 ─ RESEARCH FUNDING ADVANCED
The Company’s subsidiaries, Diguang Electronics, Dihao, and Dongguan Diguang S&T, received research funding from local governments. Local governments usually provide research fund to companies to support development of specific products with a requirement for the developed products to meet certain standards. The Company recorded the research fund received as a liability and recognized the fund in income statement to offset research and development expenses when the development projects were successfully completed. The research fund recognized in income statement to offset research and development expenses were $0 million and $0.5 million, respectively, for the years ended December 31, 2009 and 2010.
NOTE 11 ─ SEGMENT REPORTING
The Company currently operates mainly in backlight production with portions of new products of LED monitors, LED general lighting and LED TV sets assembly. As the Company’s major production base is in China while export revenue and net income in overseas entities is accounted for a significant portion of total consolidated revenue and net income, management believes that the following tables present useful information to chief operation decision makers for measuring business performance, financing needs, and preparing corporate budget, etc.
NOTE 12 ─ QUARTERLY FINANCIAL DATA
Summarized quarterly financial data for 2009 and 2010 is as follows:
NOTE 13 ─ UNCERTAINTY ON GOING CONCERN
The Company has incurred consecutive losses for four years since 2007 and has a working capital deficit of $1.8 million as of December 31, 2010. The cash flows from operating activities for the past three years were all negative. Management is fully aware of the current situation and knows the demand for cash from its operating activities and completion of building up its manufacturing facility. Management is planning to do its best to secure more loans from commercial banks by collateralizing its properties located in Dongguan. Management believes that the Company should be able to obtain more loans from commercial banks based on the properties it owns and the fact that the market value of these properties has appreciated substantially under the trend of China property market. However, there is no assurance that management could succeed in its endeavor to obtain more loans from commercial banks.
NOTE 14 ─ SUBSEQUENT EVENTS
The Company evaluated all events or transactions that occurred after December 31, 2010 up through the date the Company issued these financial statements. During this period the Company did not have any material recognizable subsequent events.
Exhibit Index
Exhibit No.
Description
3.1(i)
Amended and Restated Articles of Incorporation (incorporated by reference from Form S-1/A filed on October 30, 2006).
3.1(ii)
Amended and Restated By-laws (incorporated by reference from Form S-1/A filed on October 30, 2006).
10.1
Production Building Lease Contract with Dongguan Diguang Electronics Science & Technology Co., Ltd. and Shenzhen Diguang Electronics Co. dated March 30, 2005 (incorporated by reference from Form S-1 filed on June 16, 2006).
10.2
Employment Agreement of Yi Song (incorporated by reference from Form 8-K filed on April 21, 2006).
10.3
Employment Agreement of Hong Song (incorporated by reference from Form 8-K filed on April 21, 2006).
10.4
Amended and Restated Purchase Option Agreement dated May 12, 2006 (incorporated by reference from Form 10-QSB filed on May 15, 2006).
10.5
Lease Agreement between Wuhan Diguang Electronics Co. Ltd. and TPV Technology ( Wuhan ) Co. Ltd dated November 18, 2006 (incorporated by reference from Form 10-K filed on April 14, 2008).
10.6
Employment Agreement of Keith Hor dated March 7 2007 (incorporated by reference from Form 8-K filed on March 13, 2007).
10.7
Lease Agreement between Dihao Electronics ( Yangzhou ) Co. Ltd and Transcend Optronics ( Yangzhou ) Co., Ltd dated October 1, 2007 (incorporated by reference from Form 10-K filed on April 14, 2008).
10.8
Lease Agreement between Wuhan Diguang Electronics Co. Ltd and Wuhan Hannstar Technology Co. Ltd dated October 29, 2007 (incorporated by reference from Form 10-K filed on April 14, 2008).
10.9
Sale and Purchase Agreement relating to 100% interest in Dongguan Diguang Science & Technology Limited dated December 29, 2007 (incorporated by reference from Form 8-K filed on January 4, 2008).
10.10
Translation of the Comprehensive Credit Line Agreement entered into between Shenzhen Diguang Electronics and Ping An Bank dated July 1, 2008 (incorporated by reference from Form 8-K filed on July 8, 2008).
10.11
Translation of the Pledge Contract entered into between Dongguan Diguang S&T and Ping An Bank dated July 1, 2008 (incorporated by reference from Form 8-K filed on July 8, 2008).
10.12
Employment Agreement of Jerry Yu dated July 31, 2008 (incorporated by reference from Form 8-K filed on December 15, 2008).
14.1
Code of Ethics (incorporated by reference from Form S-1/A filed on October 30, 2006).
21.1
Subsidiaries of the registrant (incorporated by reference from Form S-1 filed on June 16, 2006).
31.1
Rule 13a-14(a) Certification*
31.2
Rule 13a-14(a) Certification*
32.1
Section 1350 Certification*
32.2
Section 1350 Certification*
* Filed herewith