Item 1. Business.
Overview
SinoHub, Inc. and subsidiaries (collectively the “Company”) is an electronics company based in Shenzhen, People’s Republic of China (“PRC” or “China”) which services clients worldwide. The Company is currently engaged in two business segments: electronics product manufacturing and sales (Integrated Contract Manufacturing or “ICM”), and electronic component sales and services (“ECSS”) which is comprised of electronic component sales (“ECP”) and electronic component supply chain management services (“SCM”). We now report on each of ICM and ECSS as separate business segments.
SinoHub’s business operations are organized to take full advantage of the power of information exchange between its two business segments: ICM and ECSS. In this sense, SinoHub has become a market maker for our ECSS mobile phone design house customers by using them as suppliers in our ICM business.
In 2011, our business mix was 46% ICM and 54% ECSS as compared to 31% ICM and 69% ECSS in 2010. By 2012, we expect the significant majority of our revenue will come from our ICM segment. For further information on our performance by reportable segment, see Note 19 of the Notes to the Consolidated Financial Statements.
ICM
The ICM segment is currently focused on providing custom, private label mobile phones (also known as “white-box” mobile phones) and tablets to developing countries. This fast growing segment of our business is capitalizing on a trend by carriers and distributors to offer their own brands with features and functionality targeted at their local markets. SinoHub has implemented a new online reference design selection system which enables our customers to select a reference design as a starting point for our joint design process. Having a turnkey solution for the entire joint design process is making it significantly easier and more efficient for customers to work with SinoHub to create handsets and tablets with features and functionality targeted at their local markets. SinoHub reorganized its assembly lines into six long lines that include packaging. Each new assembly line is capable of producing 80,000 phones per month on average, giving SinoHub the capacity to manufacture 480,000 phones per month. The Company was able to increase SMT (surface mount technology to produce mother boards) capacity with its existing eight SMT lines by implementing a carrier tray system to increase the number of motherboards that can be built at the same time. Our SMT lines are now capable of producing approximately 1,200,000 motherboards per month.
The Company leverages its relationships with over twenty top tier mobile phone design houses in China to get insight into new features and functionality, and to get reference designs that it puts online for its customers to use as a starting point for the joint design effort with SinoHub to field new mobile phones and tablets.
ECSS
SinoHub’s ECSS segment includes procurement-fulfillment and spot electronic component sales to manufacturers and design houses, and warehousing, delivery and import/export. Roughly eighty percent (80%) of our ECSS business with design house and manufacturer customers is related to mobile phones. The components we source in this vertical market change rapidly in line with the rapid change of technology in this industry.
With the use of our proprietary, Web-based software platform, our ECSS division is also an electronic component supply chain management service provider, managing all aspects of the purchase and movement of electronic components from their receipt from suppliers in our Hong Kong warehouse to their delivery in Hong Kong or import into the PRC and delivery to a manufacturer there. We also handle the export of finished goods when that is required. We use these same capabilities for the benefit of our ICM business.
Business Operations
SinoHub uses its Hong Kong warehouse as a staging point for ECSS procurement-fulfillment programs in which the Company purchases components associated with a bill of materials. SinoHub also supports customers by providing a sourcing channel for electronic components that are not part of a specific procurement-fulfillment program. In these cases, SinoHub utilizes its industry knowledge and relationships with components suppliers to source products at competitive prices and within time constraints. SinoHub responds to these “spot” orders from customers, sources the product, confirms pricing, and executes delivery as required.
SinoHub carries inventory for its ICM business. We also carry electronic components that we are staging for ECSS procurement-fulfillment projects. Generally, we only buy components in our ECSS business with corresponding orders to purchase the components.
Development of SinoHub’s Business
SinoHub’s original business was the provision of supply chain management services to assist suppliers of electronic components with their supply chains into the PRC. We refer to these customers as our “supplier” customers and they are both franchised and independent distributors of electronic components. SinoHub developed an integrated service offering, including warehousing, delivery and import/export to assist suppliers with delivery of electronic components to Chinese manufacturers. From the outset, the majority of our business has been in the mobile phone vertical. As our component customers and the market became more aware of and confident in our service offerings, the opportunity arose for us to generate integrated sales of components and supply chain management services in a streamlined approach to inventory management and order procurement-fulfillment and the ECSS business segment was born.
As our ECSS business grew we strengthened our relationships with mobile phone design house customers. In late 2009 we realized that we had the opportunity to implement a powerful business model that rested on turning these design houses into suppliers and our ability to utilize the Internet to make it easy for customers to work with us through a joint design process that could create mobile phones and tablets with competitive advantages in their local markets. As we demonstrated our ability to provide strategic support to the distributor and operator customers we recruited, we won more business from them.
Market Overview
ICM - White-box Mobile Phones in Developing Countries
In comparison to developed countries where consumers typically think of mobile phones as being provided by a small number of very large vendors, the market in developing countries is markedly different. Most importantly, a large majority of mobile phones sold in these countries are classified as "white-box", or private-label phones, indicating that they are either unbranded or carry a regional, local brand name. In an article entitled “White-box, China brand electronics captivate emerging markets” published on November 11, 2011 Global Sources stated that white-box phones had 35.8% of the global hand set market in the second quarter of 2011, an increase of 7.7 percentage points from the 2010 figure. Annualizing the second quarter 2011 number of 153.6 million units sold worldwide lines up very closely with the projection made by JP Morgan in 2010 of 640 million units for 2011 or roughly 20% growth over 2010.
Following the loss of our largest ICM customer in early 2011, SinoHub struggled to regain momentum in ICM in the second and third quarters of 2011. An all out effort was made to find new customers with smaller volumes so that the loss of any one customer would not severely affect our business. This initiative paid off in the fourth quarter of 2011 as the Company almost tripled its ICM revenue from the third quarter number. At the same time the Company also began a new program to recruit new large customers recognizing that this would take longer to complete. Two such initiatives are in progress, one in the Philippines and one in Brazil where we entered into a joint venture agreement in February 2012.
The Electronic Component Industry in China
The world has witnessed the enormous growth of the Chinese electronic manufacturing industry over the past decade. As a result, China is currently a leading consumer of electronic components. We expect that this growth will continue to increase with the rapid development of new technologies and in turn to lead to growth in consumption of electronics products in China and China’s continuing growth as the world’s key electronics factory.
The rapid growth of electronic component distributors in China and the growth of Web-based Internet procurement have created a very fragmented electronic components market, with no distributor capturing significant market share. To date even the biggest electronic component distributors in China (WPG, Arrow, Avnet and Yosun) do not provide complete SCM services to their customers, unlike in the US and Europe where large component manufacturers and franchise distributors provide complete SCM services to their customers. The fragmented market for electronics components in China and the lack of an end-to-end SCM service offering created an opportunity for SinoHub to combine the sale of electronic components with efficient SCM services in its ECSS business segment to garner a share of the growing market for electronic components and services in China. However, unlike the 2G white-box market where the dominance of Mediatek created plentiful arbitrage opportunities, no such vendor has emerged in the 3G market making it more difficult to make money in ECP. Also, tightening of credit by Chinese banks on small and medium sized enterprises has put a lot of pressure on the Company to provide longer credit terms and has made it more difficult to collect receivables reducing the attractiveness of this business segment.
Company Strengths
We believe the strengths outlined below have contributed to our growth so far:
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a robust business model underlying our ICM business that allows SinoHub to provide strategic support to our distributor and operator customers through our online joint design process;
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the ability of our ICM business to fill the niche market for private label, custom mobile phones and tablets in developing markets with high quality, price competitive mobile communication devices;
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close relationships with over twenty of China’s top tier design houses;
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a supply chain management platform that connects customers, suppliers and SinoHub in real time to provide our customers and SinoHub with total transparency into their supply chains;
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continuous innovation of our proprietary online platforms to expand functionality and make it easier for our customers to do business with SinoHub;
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specialized knowledge about component sourcing and pricing which we obtain from our ECSS and ICM businesses;
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our ability to provide one-stop-shopping for our customers who wish to purchase components from us for delivery to the factory without the need to handle sourcing, import/export, or any other aspect of logistics or fulfillment;
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SinoHub SCM Shenzhen’s Client Coordinator Enterprise Coordinator status with the Huanggang Customs authority and our China-wide AA Customs High Credit Enterprise status, which facilitate our ability to clear shipments through Customs and enables us to permit our customers to defer payment of Value Added Tax; and
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a strong and seasoned management team with many years of experience in the electronic components industry.
SinoHub’s Strategy
SinoHub is an electronics company that has had its base of operations in China and has been successful because of the business models and platforms we have built in each of our two business segments: ICM and ECSS. Our long term goal is to make SinoHub a leading multi-national supplier of private label, custom design mobile phones and tablets. It is also our long term strategy to establish SinoHub as an electronics powerhouse that facilitates the mobile revolution with fully integrated contract manufacturing, component purchasing and supply chain management services for mobile communication devices. To accomplish this strategy, we plan to:
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increase awareness of SinoHub as a leading supplier of private label, custom design mobile phones that provides strategic support to our customers;
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acquire or build distribution channels and manufacturing plants in attractive markets;
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continue to enhance our online platforms and improve process efficiency; and
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expand our integrated contract manufacturing business worldwide.
We previously reported that SinoHub had begun the process of shifting the electronic component procurement (ECP) portion of our ECSS segment, which constitutes most of this segment, to a brokerage model from our current model where we take ownership of components and that this would result in much lower revenue (the Company will only be able to record commissions as revenue instead of the full value of the components), but much higher gross margins. We have not been successful in implementing the new brokerage model and have reduced our investment on ECP in favor of increased focus on ICM. We expect that by 2012 a significant majority of our revenues will be derived from our ICM business. SinoHub offers an ICM solution to our mobile phone distributor and operator customers that begins with a database of reference designs derived from motherboard designs provided by top tier design house suppliers with whom we collaborate and a query interface that allows these customers to select a reference design that meets their criteria as a starting point for our joint design process.
Customers
SinoHub’s ICM Customers
SinoHub continues to focus on distributor and operator customers in developing markets. Our primary target customers are “local kings” (a term coined by MediaTek and Spreadtrum), distributors who sell 100,000 phones per month or more and have their own brand which has an established national identity in their home country, although we have increased our efforts to recruit new operator customers and we have started a new initiative to add large retail store chains in developing markets.
SinoHub’s ECSS Customers
SinoHub’s manufacturer customers are Chinese companies that are in the business of contract manufacturing or are design houses (currently limited to mobile phone and tablet design) in China. These customers purchase components from us and ancillary to these purchases we also provide them procurement-fulfillment, electronic component purchasing and SCM services including warehousing, logistics and import/export.
SinoHub has reduced the number of our supplier customers from approximately 80 to approximately 30 as we have shifted our SCM capacity to service our rapidly growing ICM business. Our supplier customers are mainly companies incorporated outside of China which have representative offices in China and supply electronic components to Chinese manufacturers. The services we provide to our supplier customers are SCM services comprised of warehousing, delivery and import/export.
Competition
SinoHub’s ICM Competitors
Prior to SinoHub’s joint design ICM offering of white-box phones, distributors and operators in developing countries had two choices to procure private label, custom design mobile phones for resale:
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They could buy from the larger white-box manufacturers like Tianyu or TCL who, even though they have their own brands, would be willing to create a custom design and put the customer’s local brand on it, but in this case they would have to order a minimum of approximately 200,000 phones. This led to inventory problems if the phones they procured were not big sellers. SinoHub’s ICM business is still very small relative to these manufacturers, but the fact that we have a fully integrated offering and can handle lower volume orders really sets us apart from them.
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They could buy from smaller white-box manufacturers in Shenzhen like M2T Technologies and HonTech Communication Group who are much more flexible with initial order quantity, but then they could face quality problems and these suppliers do not have the financial resources to handle larger orders if the phone model becomes successful. Since competitors like M2T and HonTech have been in the white-box market longer than SinoHub, they have more volume than we do right now. We compete with these companies primarily based on quality, the flexibility afforded by having our own manufacturing facility and our financial position.
SinoHub’s ECSS competitors
We compete with a number of companies in China that sell or distribute electronic component parts and which may also offer import/export, logistics and other SCM services. We also compete with “in house” purchasing departments of large electronic component vendors, EMS providers and OEMs. We believe that many of the distributors against which we compete provide some but not all of the SCM services that we provide. We do not believe that any other company distributing electronic components in China currently provides a complete SCM solution, although some electronic component vendors and distributors provide logistic services to their customers and we expect that our competitors will eventually seek to offer, directly or indirectly, a greater number of SCM services. We also face competition from local import/export companies, which offer logistics services, although none of these companies focuses exclusively on the electronic components market. Professional freight forwarders provide express delivery to customers, however, they do not provide electronic component inventory management, currency exchange, VAT invoicing, and Customs and excise tax services, and they are not focused on the electronics field. We believe that SinoHub’s primary advantage over in-house purchasing departments is that the up-to-date sourcing and pricing knowledge which we gain from the large volume of components we handle as part of our ECSS business for suppliers and the knowledge we gain from the purchase transactions for our own component resale allows us to obtain better pricing and availability than these in-house departments in product categories such as mobile phones where the technology, pricing and availability of parts changes rapidly. Our advantage over many electronic component distributors is that we have very detailed knowledge of what manufacturers are buying and that we have a broader knowledge of electronic component pricing from our database of parts that we import.
Seasonality
The ECSS business segment is seasonal. Roughly 80% of the products made by the manufacturers to which we sell electronic components are sold in China. Sales are weaker in the first half and stronger in the second half because that is when products are manufactured for sale in the fourth quarter and the first quarter of the following year, which are the biggest quarters for sales of electronic products in China.
Bank Facilities
The Company has secured financing facilities with certain PRC banks to support our business operations. The facilities generally run for one year terms and are replaced by new facilities upon expiration. We expect that we will be able to obtain replacement facilities for the facilities listed below upon their expiration. The bank facilities include:
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Lines of credit facility with China Construction Bank in the amount of $13,505,000 to support our component sales business. Restricted cash balances are required as security for draws against the facility. The facility renews each year and is available through January 2013.
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Lines of credit facility with Industrial Bank in the amount of $7,477,000 to support our business. Restricted cash balances are required as security for draws against the facility. In addition, the bank requires third party guarantees from a third party, two subsidiaries, SinoHub Electronics Shenzhen, Ltd. and Topology Communication Technology (Shenzhen) Ltd. and an executive officer. The facility is available through December, 2012.
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Lines of credit facility with Bank of Ningbo in the amount of $7,000,000 to support our electronics product manufacturing and sales business. Restricted cash balances are required as security for draws against the facility. The facility renews each year and is available through July 2012. This facility had not been used as of December 31, 2011 and therefore there was no restricted cash associated with it at that date.
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Bank’s Acceptance Bill facility with Bank of Shanghai in the amount of $4,767,000 to support purchasing of raw material for our electronics product manufacturing and sales business. Restricted cash balances are required as security for draws against the facility. In addition, the bank requires third party guarantees from a subsidiary, SinoHub Electronics Shenzhen, Ltd. and the unlimited personal guaranty of an executive officer and his spouse. The facility renews each year and is available through October 2012.
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Lines of credit facility with Bank of Jiangsu in the amount of $15,534,000 to support our electronics product manufacturing and sales business. Restricted cash balances are required as security for draws against the facility. In addition, the bank requires third party guarantees from two subsidiaries, SinoHub Electronics Shenzhen, Ltd. and Topology Communication Technology (Shenzhen) Ltd. and an executive officer. The facility renews each year and is available through July 2012.
Our Corporate Structure
The diagram below illustrates the current corporate structure of SinoHub, Inc. and its subsidiaries:
The current operations of the Company include the following subsidiaries:
SinoHub International, Inc. was incorporated in March 1999 as a Delaware C corporation in the United States of America. This company is the holding company for the Chinese and Hong Kong subsidiaries listed below. SinoHub International, Inc. is wholly owned by SinoHub, Inc.
SinoHub Electronics Shenzhen, Ltd. was incorporated in September 2000 in the People’s Republic of China to provide one-stop SCM services for electronic manufacturers and distributors in southern China. SinoHub Electronics Shenzhen, Ltd. is wholly owned by SinoHub International, Inc.
SinoHub SCM Shenzhen, Ltd. was incorporated in December 2001 in the PRC to hold an import and export license in the PRC. SinoHub SCM Shenzhen, Ltd. purchases and sells electronic component parts and also provides customs clearance services to our customers. 100% of the equity interest in SinoHub SCM Shenzhen, Ltd. was held on behalf of SinoHub by SinoHub Electronics Shenzhen, Ltd. through a Declaration of Trust with SinoHub Electronics Shenzhen, Ltd. dated January 30, 2008. On August 21, 2009 our wholly-owned subsidiary SinoHub Electronics Shenzhen, Ltd. exercised its rights under a declaration of trust with the spouse of a director who is a citizen of the PRC and a shareholder of the Company, as trustee (the "Trustee") to cause the shares of SinoHub SCM Shenzhen, Ltd. previously registered in the name of the Trustee to be registered in the name of SinoHub Electronics Shenzhen, Ltd. SinoHub SCM Shenzhen, Ltd. is now directly and solely owned by SinoHub Electronics Shenzhen, Ltd.
SinoHub SCM Shanghai, Ltd. was incorporated in March 2005 in the PRC to provide one-stop SCM services for electronic manufacturers and distributors in northern China. SinoHub SCM Shanghai, Ltd. is wholly owned by SinoHub Electronics Shenzhen, Ltd.
SinoHub Electronics Shanghai, Ltd. was incorporated in July 2005 in the PRC to provide one-stop SCM services for electronic manufacturers and distributors in the PRC. SinoHub Electronics Shanghai, Ltd. is wholly owned by SinoHub International, Inc.
B2B Chips, Limited was incorporated in June 2006 in Hong Kong to purchase and sell electronic components. In 2010 the business conducted through B2B Chips, Limited was expanded to include the electronics product manufacturing and sales business. B2B Chips, Limited is wholly owned by SinoHub Electronics Shenzhen, Ltd.
SinoHub Technology (Hong Kong) Limited was incorporated in May 2007 in Hong Kong and has not yet commenced business. SinoHub Technology (Hong Kong) Limited is wholly owned by B2B Chips, Limited.
Topology Communication Technology (Shenzhen), Ltd. was incorporated in April 2010 in Shenzhen to manufacture mobile phones and other electronic devices. Topology Communication Technology (Shenzhen), Ltd. is wholly owned by B2B Chips, Limited.
CiaoHub, SA was incorporated in March 2012 in Vila Velha, Espirito Santo, Brazil. SinoHub, Inc. owns 46.5% of CiaoHub, SA. Mr. Cochran, CEO of SinoHub, owns 1% of CiaoHub as is required under Brazilian law for directors of a Brazilian corporation.
History
Our predecessor, Liberty Alliance, Inc. was a corporation organized in Utah in 1986. In 1991, Liberty Alliance, Inc. completed its domestication as a Delaware corporation. Liberty Alliance, Inc. filed for bankruptcy in 1994 and the bankruptcy proceedings were completed in 1995. From 1995 to 2006, Liberty Alliance, Inc. had no or nominal assets and was not conducting any business operations. In August 2006, Liberty Alliance, Inc. changed its name to Vestige, Inc., and in September 2006 it changed its name back to Liberty Alliance, Inc. On August 1, 2007, Liberty Alliance, Inc. became a voluntary reporting company under the Exchange Act when it filed a Form 10 registration statement with respect to its shares of common stock. Shares of Liberty Alliance, Inc. common stock began to be reported on the over-the-counter bulletin board under the symbol “LBTI” on November 14, 2007.
In May 2008, Liberty Alliance, Inc., its wholly-owned subsidiary SinoHub Acquisition Corp., SinoHub, Inc., and Steven L. White, the principal stockholder of Liberty Alliance, Inc., entered into an Agreement and Plan of Merger pursuant to which SinoHub Acquisition Corp. merged with and into SinoHub, Inc. and SinoHub, Inc. became a wholly-owned subsidiary of Liberty Alliance, Inc. Pursuant to the Agreement and Plan of Merger, the holders of 5,203,907 shares of Liberty Alliance, Inc. common stock tendered their shares to the Company for cancellation, Liberty Alliance, Inc. issued to the former stockholders of SinoHub, Inc. 18,290,000 shares of Liberty Alliance, Inc. common stock in exchange for all the outstanding shares of SinoHub, Inc.’s preferred and common stock, and Liberty Alliance, Inc. assumed options to purchase shares of SinoHub, Inc. common stock which became exercisable for 489,451 shares of Liberty Alliance common stock. In addition, Liberty Alliance, Inc. also issued 510,000 shares of its common stock to certain consultants for services rendered in connection with the merger, including 500,000 shares issued to JC Global Capital Partners LLC. These consulting services included investment banking advice and strategic advisory services relating to the structure and consummation of the reverse merger between SinoHub and Liberty Alliance, Inc. that was eventually consummated. Immediately following the merger, Liberty Alliance, Inc. had 20,000,000 shares of common stock outstanding and options exercisable for an additional 489,451 shares of common stock. The merger was accounted for as a reverse acquisition with SinoHub, Inc. as the acquirer for accounting purposes. After completion of the merger, the original stockholders of Liberty Alliance, Inc. held approximately 6% of the issued and outstanding shares of Liberty Alliance, Inc. common stock on a fully diluted basis and the former stockholders of SinoHub, Inc., including the shares issued to consultants for services rendered in connection with the merger, held approximately 94% of Liberty Alliance, Inc. issued and outstanding shares of common stock.
Subsequent to the completion of the merger, on July 18, 2008:
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SinoHub, Inc. amended its certificate of incorporation to change its name to SinoHub International, Inc.;
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Liberty Alliance, Inc. amended its certificate of incorporation to change its name to SinoHub, Inc. and effect a 3.5-to-1 reverse stock split of all issued and outstanding shares of its common stock; and
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shares of SinoHub, Inc. (formerly Liberty Alliance, Inc.) common stock began to be reported on the over-the-counter bulletin board under the new symbol “SIHI” on a post-merger, post-split basis.
For financial reporting purposes, the reverse takeover of the Company has been accounted for as a recapitalization of the Company with SinoHub International as the accounting acquirer whereby the historical financial statements and operations of SinoHub International, Inc. became the historical financial statements of the Company, with no adjustment of the carrying value of the assets and liabilities. When we refer in this Form 10-K to business and financial information for periods prior to the consummation of the reverse acquisition, we are referring to the business and financial information of SinoHub International, Inc. on a consolidated basis unless the context suggests otherwise.
Employees
At December 31, 2011, there were 1,042 full-time employees of SinoHub and its subsidiaries, compared to 801 full-time employees of SinoHub and its subsidiaries at December 31, 2010.
Available Information
The Company’s mailing address and principal executive offices are located at 6/F, Building 51, Road 5, Qiongyu Blvd., Technology Park, Nanshan District, Shenzhen 518057, People’s Republic of China. The Company’s telephone number, including the International Code and Area Code is +86-755-2661-2106 and its corporate website is www.sinohub.com. The information contained on our website is not part of this Report. The reports that the Company files with the Securities and Exchange Commission pursuant to the Exchange Act are available on the Securities and Exchange Commission website at www.sec.gov. The public may read and copy any materials filed by the Company with the Securities and Exchange Commission at the Public Reference Room at 100 F Street, N.E., Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the Securities and Exchange Commission at 1-800-SEC-0330. The Securities and Exchange Commission maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the Securities and Exchange Commission at www.sec.gov. The contents of these websites are not incorporated into this filing.
The Company has a written code of conduct and ethics (the “Code of Conduct and Ethics”) that applies to all of our personnel and a code of ethics for senior financial officers (the “Senior Financial Officer Code of Ethics”) that applies to the Company’s Chief Executive Officer and senior financial officers, including the Company’s Chief Financial Officer, Controller and persons performing similar functions (collectively, the “Senior Financial Officers”). Printable copies of the Code of Conduct and Ethics and the Senior Financial Officer Code of Ethics are available at www.sinohub.com under the heading Investors (Corporate Governance). Any amendments to or waivers from the Code of Conduct and Ethics or the Senior Financial Officer Code of Ethics shall be posted to our website within four business days in accordance with paragraph (c) of Item 5.05 of Form 8-K. In addition, the Company’s internet website includes other items related to corporate governance matters, including, among other things, charters of various committees of the Board of Directors. The Company also intends to disclose on its Internet website any amendments to the charters of various committees of the Board of Directors.
Item 1A.
Item 1A. Risk Factors.
Risks Related To Our Business
The industry in which we have chosen to concentrate our sales efforts is fast moving and our customers may not be successful in growing in pace with the industry.
We have chosen to concentrate our business efforts and resources in the fast-moving mobile phone business, where the life cycles of new products can be relatively short, and our available capital limits the number of new customers we can handle at any given time. We face the risk of our customers’ growth not keeping pace with this dynamic market, whether as a result of manufacturing products for which there is lesser demand, lack of capitalization or otherwise. In addition, given our limited resources to evaluate new customers, if we ultimately select new customers who are less successful, it will provide a smaller return on our efforts than if we select more successful customers. Despite our requirement of non-cancelable purchase orders from our customers and our efforts to investigate the credit histories of our customers, there is no guarantee that all our customers will be able to pay for all of the goods they order.
Our continued expansion into mobile phone sales will depend on the continued growth of the mobile communications industry, and if the mobile communications industry does not grow as we expect, our sales and profitability may be adversely affected.
In the past two years we have made significant investments to enter into the business of making and selling private-label mobile communication devices, which we expect to account for the majority of our revenues in 2012. Sales of our mobile phone and tablet products depend on continued growth in mobile communications and continued growth in the private-label segment of the industry in the geographic markets we serve in terms of the number of existing mobile subscribers who upgrade or simply replace their existing mobile devices, the number of new subscribers and increased usage. As well, our sales and profitability are affected by the extent to which there is increasing demand for, and development of, value-added services, leading to opportunities for us to successfully market mobile devices that feature these services. These developments are outside of our control.
Allegations of health risks from the electromagnetic fields generated by mobile devices, and lawsuits and publicity relating to them, regardless of merit, could affect our operations negatively by leading consumers to reduce their use of mobile devices or by causing us to allocate monetary and personnel resources to these issues.
There has been public speculation about possible health risks to individuals from exposure to electromagnetic fields from the use of mobile devices such as mobile phones, which we manufacture and sell in our ICM business and to which our ECSS business is dedicated. While a substantial amount of scientific research conducted to date by various independent research bodies has indicated that these radio signals, at levels within the limits prescribed by public health authority safety standards and recommendations, present no adverse effect to human health, we cannot be certain that future studies, irrespective of their scientific basis, will not suggest a link between electromagnetic fields and adverse health effects that would adversely affect our sales and share price. Research into these issues is ongoing by government agencies, international health organizations and other scientific bodies in order to develop a better scientific and public understanding of these issues.
Although we believe our products and solutions are designed to meet all relevant safety standards and recommendations globally, even a perceived risk of adverse health effects of mobile communications devices could adversely affect us through a reduction in sales of mobile devices or increased difficulty in obtaining sites for base stations, and could have a negative effect on our reputation and brand value as well as harm our share price.
Our management and a certain significant shareholder owning more than 10% of our common stock collectively own a high percentage of our common stock.
Collectively, our officers, directors and a certain significant shareholder (the sole shareholder outside of management to own 10% or more of our common stock) own or exercise voting and investment control over approximately 26% of our outstanding common stock. As a result, investors may be prevented from affecting matters involving the company, including:
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the composition of our board of directors and, through it, any determination with respect to our business direction and policies, including the appointment and removal of officers;
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any determinations with respect to mergers or other business combinations;
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our acquisition or disposition of assets; and
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our corporate financing activities.
Furthermore, this concentration of voting power could have the effect of delaying, deterring or preventing a change of control or other business combination that might otherwise be beneficial to our stockholders. This significant concentration of share ownership may also adversely affect the trading price for our common stock because investors may perceive disadvantages in owning stock in a company that is controlled by a small number of stockholders.
Changes in governmental regulations affecting the export of electronics from China may hurt our business.
While we believe that our manufacturer customers sell approximately 90% of their products in the Chinese market, the sales of mobile phones in our ICM business unit to date have almost all been overseas and to the extent the Company or its manufacturer customers sell overseas, factors which adversely affect export of electronic products from China may materially and adversely affect our business, financial condition, results of operations and business prospects, including regulatory restrictions, trade disputes, industry-specific quotas, copyright levies, tariffs, non-tariff barriers and taxes that may result in limiting exports from China.
Our business is sensitive to general economic conditions.
As the vast majority of our sales in our procurement-fulfillment business are to manufacturers and design houses in China which in turn causes the end products to be distributed to consumers in China. Our procurement-fulfillment business could be adversely affected if there were to be a slowdown in the consumer demand in China for products incorporating the components we sell or we process for our supplier customers. Our mobile phone sales, which have become an increasingly significant portion of our business, are primarily made outside of China to other countries in Asia such as Indonesia and India. Accordingly, our mobile phone business could be adversely affected if there were to be a slowdown in the consumer demand for mobile phones in those countries. Our business may also be negatively affected by rising labor and material costs in China and, to the extent the Company or its manufacturer customers sell overseas, by a downturn in general economic condition in importing countries and regions.
Negative perception or publicity of Chinese products may hurt our business.
Any negative perception or publicity of Chinese electronic products may cause a decline in demand for Chinese electronic products and in turn negatively affect our sales and revenue outside China.
SinoHub envisions a continued emphasis on growth that may impose a significant burden on its administrative and operational resources which if not effectively managed, could impair its growth.
SinoHub’s strategy envisions a continued emphasis on growth that may impose a significant burden on its administrative and operational resources. The growth of SinoHub’s business will require significant investments of capital, expansion of facilities and management’s close attention. SinoHub’s ability to effectively manage its growth will require it to substantially expand the capabilities of its administrative and operational resources and to attract, train, manage and retain qualified management, technicians and other personnel. If SinoHub is unable to successfully manage its growth, SinoHub may be unable to achieve its goals.
In order to grow at the pace expected by management, we will require additional capital to support our long-term business plan. If we are unable to obtain additional capital in future years, we may be unable to proceed with our long-term business plan and we may be forced to curtail or cease our operations or further business expansion.
We will require additional working capital to support our long-term business plan. A large proportion of the Company’s business is procurement-fulfillment which requires the Company to have available capital to purchase components for inventory prior to reselling those components to customers. In addition, our ICM business, which is currently a significant portion of our business and which we expect to generate the majority of our revenue in the future, will also require working capital to purchase components required to fill orders for products. Our ICM business also requires capital to build inventory and for equipment and facilities used to manufacture and/or assemble products. A lack of sufficient capital beyond cash on hand and funds available under the Company’s credit facilities can be expected to significantly impair the Company’s ability to take on new customers and the size of the orders the Company can take from existing customers. Our working capital requirements and the cash flow provided by future operating activities, if any, will vary greatly from quarter to quarter, depending on the volume of business during the period and payment terms with our customers and suppliers. We may also underestimate our capital requirements and other expenditures or overestimate our future cash flows. In such event, additional capital, debt or other forms of financing may be required for our working capital. We may not be able to obtain adequate levels of additional financing, whether through equity financing, debt financing or other sources, especially in light of the current economic environment. If we are unable to raise additional financing, we may be unable to implement our long-term business plan, develop or enhance our products and services, take advantage of future opportunities or respond to competitive pressures on a timely basis. In addition, a lack of additional financing could force us to substantially curtail or cease operations. As a result, our business, operating results, liquidity and financial position would be adversely affected.
We may issue additional shares of our capital stock, which would reduce the equity interest of our shareholders.
To raise funds, we may need to issue new equity securities which could result in additional dilution to our existing investors. Additional financings could also result in significant dilution to our earnings per share or the issuance of securities with rights superior to our current outstanding securities or containing covenants that would restrict our operations and strategy. In addition, we may grant registration rights to investors purchasing our equity securities in the future which could increase the number of shares available to the public or restrict our ability to use registration statements to sell our securities.
We face risks associated with debt financing (including exposure to increases in interest rates and lacking sufficient funds to repay debt).
Our total outstanding indebtedness for bank borrowings as of December 31, 2011 was $69 million. The interest rates on these bank loans are fixed on an annual basis. Our obligations under our existing loans have been mainly met through the cash flow from our operations and our financing activities. We are subject to risks normally associated with debt financing, including the risk of significant increase in interest rates as borrowings increase or are rolled over for additional periods, typically on an annual basis and the risk that our cash flow will be insufficient to meet required payment of principal and interest. In the past, cash flow from operations had been sufficient to meet payment obligations and/or we have been able to roll over our borrowings. There is however no assurance that we will be able to do so in the future. Failure to pay loans or any portion thereof when due could result in the acceleration of any obligations due under the loans and hinder our ability to obtain additional financing, if necessary, to the extent any loans contain covenants restricting our ability to obtain additional financing while such loans are outstanding, or to the extent our existing leverage discourages other potential investors.
The competitive pressures we face could have a material adverse affect on our business.
The market for our products and services is very competitive and subject to rapid technological change. We compete with many other suppliers in our ICM business, with other distributors and in-house service teams in the electronic component sales aspect of our ECSS business and with other third-party logistics providers in the supply chain management aspect of our ECSS business. Our failure to maintain and enhance its competitive position could adversely affect its business and prospects. Furthermore, our efforts to compete in the marketplace could cause deterioration of gross profit margins and, thus, overall profitability. The sizes of our competitors vary across business segments, as do the resources we have allocated to the segments in which it does business. Therefore, some of the competitors may have a more extensive customer base than we have in all, or some, of our business segments or greater resources and funding to capture clients in such segments.
Unexpected order cancellations by our customers could materially adversely affect our business, results of operations, financial condition or liquidity.
Our sales are typically made pursuant to individual purchase orders, and we generally do not have long-term contracts with our customers. We try to limit the risk of non-payment by providing that customer orders for mobile phones are backed by deposits or letters of credit and that procurement-fulfillment projects and purchase orders for component purchases are non-cancelable. However, we do provide our customers with payment terms on component sales that occur in connection with procurement-fulfillment projects and spot purchases. While we generally collect a deposit of 15-20% on each procurement-fulfillment project, deal only in standard components, and limit the size of each order, we cannot be certain that every invoice for a completed order will be paid on time and that collection issues will not materially adversely affect our business, results of operations, financial condition or liquidity.
SinoHub generally does not have long-term contracts with its significant customers.
We generally do not have long-term contracts with our customers. In 2011, SinoHub had three customers, who accounted for 21%, 8% and 6% of our revenue, respectively. While we expect this concentration to go down as our business expands, if the concentration remains and we are not able to secure further business from these customers or are unable to replace the business provided by these customers, it may have a material adverse affect on our business, results of operations, financial condition or liquidity.
The consumer electronics industry is subject to significant fluctuations in the availability of raw materials and components. If we do not properly anticipate the need for critical raw materials and components, we may be unable to meet the demands of our customers and end-users, which could reduce our competitiveness, cause a decline in our market share and have a material adverse effect on our results of operations.
If the availability of raw materials and components decreases, the cost of acquiring those raw materials and components ordinarily increases. If we fail to procure adequate supplies of raw materials and components in anticipation of our customers' orders or end-users’ demand, our gross margins may be negatively impacted due to higher prices that we are required to pay for raw materials and components in short supply. High growth product categories have experienced chronic shortages of raw materials and components during periods of exceptionally high demand. If we do not properly anticipate the need for critical raw materials and components, we may pay higher prices for the raw materials and components, and we may be unable to meet the demands of our customers and end-users, which could reduce our competitiveness, cause a decline in our market share and have a material adverse effect on our results of operations.
Unanticipated disruptions in our operations or slowdowns by our suppliers or shipping companies could adversely affect our ability to deliver our products and service our customers which could materially and adversely affect our revenues and our relationships with our customers.
Our ability to provide high quality customer service, process and fulfill orders and manage inventory depends on:
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the efficient and uninterrupted operation of our procurement and distribution functions; and
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the timely and uninterrupted performance of third party suppliers, shipping companies, and dock workers.
Any material disruption or slowdown in the operation of our procurement and distribution functions, manufacturing facilities or management information systems, or comparable disruptions or slowdowns suffered by our principal manufacturers, suppliers and shippers could cause delays in our ability to receive, process and fulfill customer orders and may cause orders to be canceled, lost or delivered late, goods to be returned or receipt of goods to be refused. As a result, our revenues and operating results could be materially and adversely affected.
The components which we sell in our ECSS business or incorporate in the products sold in our ICM business are designed or manufactured by third parties and if third-party manufacturers lack sufficient quality control or if there are significant changes in the financial or business condition of such third-party manufacturers, it may have a material adverse effect on our business.
We rely on third-party suppliers for the components that we sell in our ECSS business and incorporate in the products we sell in our ICM business. If third parties lack sufficient quality control or if there are significant changes in the financial or business condition of such third parties, it could have a material adverse effect on our business. While we do not believe we have any warranty liability for the components we sell in our ECSS business, if the manufacturers do not stand by their warranties or other problems with such supply develops, it could affect our business.
We also have third-party arrangements for the design or manufacture of certain products, parts and components. If the parties we engage with lack the capabilities or capacities required by our business, or if these third parties fail to deliver quality products, parts and components on time and at reasonable prices, we could have difficulties fulfilling our orders and our sales and profits could decline.
If the quality of our products does not meet our customers’ expectations, then our sales and operating earnings, and ultimately our reputation, could be adversely affected.
Some of the products we sell may have quality issues resulting from the design or manufacture of the product, or from the components or software used in the product. Sometimes, these issues may be caused by components we purchase from other manufacturers or suppliers. These issues may be identified prior to the shipment of the products or after they have been shipped to our customers. Such pre-shipment and post-shipment quality issues can have legal and financial ramifications, including: delays in the recognition of revenue, loss of revenue or future orders, customer-imposed penalties on us for failure to meet contractual requirements, increased costs associated with repairing or replacing products, and a negative impact on our goodwill and brand name reputation.
In some cases, if the quality issue affects the product’s safety or regulatory compliance, then such a “defective” product may need to be recalled. In the case of our ICM business, depending on the nature of the defect and the number of products in the field, we might have an obligation to recall a product, which could cause us to incur substantial recall costs, in addition to the costs associated with the potential loss of future orders, and the damage to our goodwill. In addition, we may be required to pay damages for failed performance that might exceed the revenue that we receive from the contracts. Recalls involving regulatory agencies could also result in fines and additional costs. Finally, recalls could result in third-party litigation, including class action litigation by persons alleging common harm resulting from the purchase of the products.
SinoHub faces risks relating to intellectual property rights.
Our business will be harmed if: (i) we, our customers and/or our suppliers are found to have infringed intellectual property rights of third parties, (ii) if the intellectual property indemnities in our supplier agreements are inadequate to cover damages and losses due to infringement of third-party intellectual property rights by supplier products, (iii) if we are required to provide broad intellectual property indemnities to our customers, or (iv) if our intellectual property protection is inadequate to protect our proprietary rights.
Because our products are comprised of complex technology, substantially all of which we acquire from suppliers through the purchase of components, we may become involved in or impacted by litigation regarding patent and other intellectual property rights. Third parties may assert intellectual property infringement claims against us and against our customers and suppliers. Defending claims may be expensive and divert the time and efforts of our management and employees. If we do not succeed in any such litigation, we could be required to expend significant resources to pay damages, develop, license or purchase non-infringing intellectual property or to obtain licenses to the intellectual property that is the subject of such litigation. However, we cannot be certain that any such licenses, if available at all, will be available to us on commercially reasonable terms. In some cases, we might be forced to stop delivering certain products if we or our customer or supplier are subject to a final injunction.
SinoHub is dependent on our continued ability to hire and retain skilled technical and managerial personnel.
SinoHub’s continued success depends in large part on its continued ability to attract, train, motivate and retain qualified management and highly-skilled employees, particularly managerial, technical, sales, and marketing personnel, technicians, and other critical personnel. Any failure to attract and retain the required highly-trained managerial and technical personnel who are integral to production and development and technical support teams may have a negative impact on the operation of SinoHub’s plants, which would have a negative impact on revenues. There can be no assurance that SinoHub will be able to attract and retain skilled persons and the loss of skilled technical personnel would adversely affect its business.
SinoHub is dependent upon its key officers for management and direction and the loss of any of these persons could adversely affect its operations and results.
SinoHub is dependent upon its officers for implementation of its proposed expansion strategy and execution of its business plan. These key officers include Henry T. Cochran, our CEO, Lei Xia, our President, and De Hai Li, our chief financial officer. The loss of any of these officers could have a material adverse effect upon its results of operations and financial position and could delay or prevent the achievement of its business objectives. SinoHub does not maintain “key person” life insurance for any of its officers.
Future acquisitions may have an adverse effect on our ability to manage our business.
Selective acquisitions form part of our strategy to further expand our business. If we are presented with appropriate opportunities, we may acquire additional companies, products or technologies. Future acquisitions and the subsequent integration of new companies into ours would require significant attention from our management. Our company has little experience with integrating newly acquired businesses. Potential problems encountered by each organization during mergers and acquisitions would be unique, posing additional risks to the company. The diversion of our management's attention and any difficulties encountered in any integration process could have an adverse effect on our ability to manage our business. Future acquisitions would expose us to potential risks, including risks associated with the assimilation of new operations, technologies and personnel, unforeseen or hidden liabilities, the diversion of resources from our existing businesses, the inability to generate sufficient revenue to offset the costs and expenses of acquisitions, and potential loss of, or harm to, relationships with employees, customers and suppliers as a result of integration of new businesses.
We incur significant costs to ensure compliance with United States corporate governance and accounting requirements.
We incur significant costs associated with our public company reporting requirements, costs associated with applicable corporate governance requirements, including requirements under the Sarbanes-Oxley Act of 2002 and other rules implemented by the Securities and Exchange Commission, or the Commission. We expect all of these applicable rules and regulations to cause us to continue to incur substantial legal and financial compliance costs and to make some activities more time consuming and costly. We also expect that these applicable rules and regulations may make it more difficult and more expensive for us to maintain affordable director and officer liability insurance and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified individuals to serve on our board of directors or as executive officers.
If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud; as a result, current and potential stockholders could lose confidence in our financial reports, which could harm our business and the trading price of our common stock.
Effective internal controls are necessary for us to provide reliable financial reports and effectively prevent fraud. Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate and report on our internal controls over financial reporting. We cannot be certain that the measures we have undertaken to comply with Section 404 will ensure that we will maintain adequate controls over our financial processes and reporting in the future. Furthermore, if we are able to rapidly grow our business, the internal controls that we will need will become more complex, and significantly more resources will be required to ensure our internal controls remain effective. Failure to implement required controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations. We determined that there was a material weakness in our internal control over financial reporting at December 31, 2010 relating to the accounting for certain stock purchase warrants which resulted in the restatement of our financial statements for the year ended December 31, 2010 and each of the quarterly periods from March 31, 2010 through September 30, 2010 and, as a result that our disclosure controls and procedures and internal controls over financial reporting were not effective as of December 31, 2010. While the Company believes that it has taken appropriate steps to remediate the material weakness, we cannot be certain that such measures will be successful. If we or our auditors discover further material weaknesses in our internal controls, the disclosure of that fact, even if the weakness is quickly remedied, could diminish investors’ confidence in our financial statements and harm our stock price. In addition, non-compliance with Section 404 could subject us to a variety of administrative sanctions, including the suspension of trading, ineligibility for listing on one of the national securities exchanges and the inability of registered broker-dealers to make a market in our common stock, which could reduce our stock price.
Risks Related to Conducting Business in the People’s Republic of China
SinoHub’s Chinese operations subject it to certain risks inherent in conducting business operations in China, including political instability and foreign government regulation, which could significantly impact its ability to operate in such countries and impact its results of operations.
To date, SinoHub has conducted a majority of its business in China and all of its operations other than ICM sales and marketing are conducted in the PRC or Hong Kong. SinoHub’s Chinese operations are, and will be, subject to risks generally associated with conducting businesses in China and in other developing foreign countries, such as:
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any general economic downturn in China which affects consumer demand for the components we process and sell;
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changes in applicable laws and regulations - for example, Customs regulations in China are quite complicated and are subject to change;
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challenges to, or failure of, title - should the Company purchase facilities, it is more difficult in China to perfect clear title than it is in the United States and this represents a potential risk;
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changes in foreign economic and political conditions - to the extent SinoHub sells overseas and to the limited extent that the Company’s manufacturer customers sell overseas, economic downturns and political instability outside of China is bad for our business. Also, since China is an export driven economy, economic downturns overseas are bad for China generally and this will have some effects on our manufacturer customers which make products for the local Chinese market;
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export and import restrictions - as noted above, Customs regulations change frequently and such changes could have negative effects on our business;
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tariffs, Customs, duties and other trade barriers - VAT and Customs Duty make electronic components more expensive in China (roughly 85% are imported), which makes products such as mobile phones, components of which are core to the Company’s business, more expensive in China;
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difficulties in staffing and managing foreign operations - the number of qualified managers in China is much less than the need, therefore it is hard for the Company to hire highly qualified managers; and
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difficulties in enforcing agreements - China’s legal system is not as fully developed as the legal system in the United States, which means there is more risk that the Company could have difficulty enforcing agreements.
To the extent that the Chinese government may in the future require local ownership of companies to perform certain activities, the Company’s ownership structure may not permit it to accomplish all of its business objectives in China. Foreign governments also may impose additional taxes and/or royalties on our business, which would adversely affect SinoHub’s profitability. Internal unrest, acts of violence or strained relations between a foreign government and SinoHub or other governments may adversely affect its operations. These developments may, at times, significantly affect SinoHub’s results of operations, and must be carefully considered by its management when evaluating the level of current and future activity in such countries.
The PRC government exerts substantial influence over the manner in which we must conduct our business activities.
The PRC government has exercised and continues to exercise substantial control over virtually every aspect of the Chinese economy through regulation and state ownership. Our ability to operate in China may be harmed by changes in its laws and regulations, including those relating to taxation, import and export tariffs, environmental regulations, land use rights, property and other matters. We believe that our operations in China are in material compliance with all applicable legal and regulatory requirements. However, the central or local governments of the jurisdictions in which we operate may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations or interpretations.
Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof and could require us to divest ourselves of any interest we then hold in Chinese properties or joint ventures.
SinoHub SCM Shenzhen, Ltd. has certain favored customs statuses with Chinese authorities which provide it with competitive advantages. Should it lose such statuses or should the benefits of the statuses change it could materially adversely impact our operations.
Over 70% of the electronic components that we sell are imported into China by SinoHub SCM Shenzhen, Ltd. (“SinoHub SCM SZ”), a PRC corporation organized by our wholly-owned subsidiary SinoHub Electronics Shenzhen, Ltd., also a PRC corporation (“SinoHub Electronics SZ”). In September 2008, SinoHub SCM SZ attained Client Coordinator Enterprise Coordinator status with the Customs authorities at the Huanggang border crossing with Hong Kong. As a Client Coordinator Enterprise, SinoHub SCM SZ is able to achieve expedited Customs clearance of its goods that it is importing into China and may defer the payment of Value Added Tax and Customs Duty for two weeks. In April 2009, SinoHub SCM SZ was approved as an AA Customs High Credit Enterprise by the General Administration of Customs of the People's Republic of China. AA Customs High Credit Enterprise status is the highest status level that may be attained by importers. Recognized in all of China’s customs ports, AA Customs High Credit Enterprises are given priority, expedited customs clearance, including exemption from customs examinations and processing by dedicated customs personnel.
The success of our current import operations in China is based in part upon SinoHub SCM SZ’s statuses as a Client Coordinator Enterprise and as an AA Customs High Credit Enterprise. If SinoHub SCM SZ were to lose either status for any reason, such loss of status could result in disruption of our business, diversion of management attention and the incurrence of substantial costs, and could have a material adverse effect on our results of operations and financial condition. Among the reasons such statuses could be lost are failure to fully comply with applicable customs regulations. A future change in Chinese law, such as the elimination of Value Added Tax, that impacted the benefits of our Client Coordinator Enterprise or AA Customs High Credit Enterprise status by removing our competitive advantage of the deferral in the payment of the tax we receive from such Client Coordinator Enterprise status or the expedited processing permitted by our AA Customs High Credit Enterprise status, could have a similar material adverse effect on our results of operations and financial condition.
We believe that our operations in China through and by SinoHub Electronics SZ and SinoHub SCM SZ are valid under current PRC laws and regulations. However, many PRC import/export laws and regulations are relatively new and as the PRC legal system continues to rapidly evolve, the interpretations of many PRC laws, regulations and rules are not always uniform and enforcement of these laws, regulations and rules involves uncertainties. We cannot predict the effect of future developments in the PRC legal system, including the promulgation of new laws, changes to existing laws or the interpretation or enforcement thereof, the preemption of local regulations by national laws, or the overruling of local government’s decisions by the superior, national government. If we are required to restructure our operations to comply with new PRC laws or regulations, there can be no assurance that SinoHub SCM SZ would be able to preserve its status as a Client Coordinator Enterprise.
China’s economic policies could affect our business.
Substantially all of our assets are located in China and substantially all of our revenue is derived from our operations in China other than sales of ICM products which are generally made outside of China. Accordingly, our results of operations and prospects are subject, to a significant extent, to the economic, political and legal developments in China.
While China’s economy has experienced a significant growth in the past twenty years, growth has been irregular, both geographically and among various sectors of the economy. The Chinese government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures benefit the overall economy of China, but may also have a negative effect on us. For example, our operating results and financial condition may be adversely affected by the government control over capital investments, changes in tax regulations, changes in interest rates, or availability of credit.
The economy of China has been transitioning from a planned economy to a more market-oriented economy. In recent years the Chinese government has implemented measures emphasizing the utilization of market forces for economic reform and the reduction of state ownership of productive assets and the establishment of corporate governance in business enterprises; however, a substantial portion of productive assets in China are still owned by the Chinese government. In addition, the Chinese government continues to play a significant role in regulating industry development by imposing industrial policies. It also exercises significant control over China's economic growth through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies.
Fluctuations in currency exchange rates could adversely affect our business and the value of our securities.
The value of our common stock will be indirectly affected by the foreign exchange rate between U.S. dollars and Chinese Renminbi (RMB) and between those currencies and other currencies in which our sales may be denominated, because the majority of our ECSS earnings and of our cash assets are denominated in RMB. In addition, appreciation or depreciation in the value of the RMB relative to the U.S. dollar would affect our financial results reported in U.S. dollar terms without giving effect to any underlying change in our business or results of operations. Although we have no current intention to pay any dividends in the foreseeable future, fluctuations in the exchange rate would also affect the relative value of any dividend we issue that will be exchanged into U.S. dollars as well as earnings from, and the value of, any U.S. dollar-denominated investments we make in the future.
Since July 2005, the RMB has not longer been pegged to the U.S. dollar. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the RMB may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future PRC authorities may lift restrictions on fluctuations in the RMB exchange rate and lessen intervention in the foreign exchange market.
Very limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions. While we may enter into hedging transactions in the future, the availability and effectiveness of these transactions may be limited, and we may not be able to successfully hedge our exposure at all. In addition, our foreign currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert RMB into foreign currencies.
Currently, all of the components we sell to our Chinese customers are imported. In the event that the U.S. dollar appreciates against the RMB, our costs will increase. If we cannot pass the resulting cost increases on to our customers, our profitability and operating results will be adversely affected. In addition, as our sales to international customers grow, we will be increasingly subject to the risk of foreign currency depreciation.
We may be restricted from exchanging RMB to other currencies in a timely manner.
At the present time the RMB is not a freely exchangeable currency. The Company receives the majority of its revenue in RMB, a portion of which may need to be exchanged to other currencies, primarily U.S. dollars, and remitted outside of the PRC. Effective from July 1, 1996, foreign currency “current account” transactions by foreign investment enterprises, including Sino-foreign joint ventures, are no longer subject to the approval of State Administration of Foreign Exchange, or SAFE, but need only a ministerial review, according to the foreign exchange regulations. Current account items include international commercial transactions, which occur on a regular basis, such as those relating to trade and provision of services. Distributions to joint venture parties also are considered a current account transaction. Other non-current account items, known as capital account items, remain subject to SAFE approval. Under current regulations, the Company can obtain foreign currency in exchange for RMB from swap centers authorized by the government. The Company does not anticipate problems in obtaining foreign currency to satisfy its requirements; however, there is no assurance that foreign currency shortages or changes in currency exchange laws and regulations by the PRC government will not restrict the Company from exchanging RMB in a timely manner. If such shortages or changes in laws and regulations occur, the Company may accept RMB, which can be held or reinvested in other projects.
Restrictions under PRC law on our PRC subsidiaries' ability to make dividends and other distributions could materially and adversely affect our ability to grow, make investments or acquisitions that could benefit our business, pay dividends to you, and otherwise fund and conduct our businesses.
Currently, SinoHub’s operating subsidiaries in China generate substantially all of the company’s consolidated revenues. However, PRC regulations restrict the ability of our PRC subsidiaries to make dividends and other payments to their US-based parent. To repatriate the cash generated to the US-based parent, these subsidiaries would need to declare a dividend or make some other type of payment to the US-based parent. Current PRC regulations permit our subsidiaries to pay dividends to us only out of their accumulated after-tax profits, if any, determined in accordance with Chinese accounting standards and regulations. In addition, our subsidiaries in China are required to set aside at least 10% of our annual after-tax profits determined in accordance with PRC GAAP in a statutory general reserve fund until the amount in such fund reaches 50% of our registered capital. Allocations to these statutory reserve funds can only be used for specific purposes and are not transferable to us in the form of loans, advances or cash dividends. Further, if our subsidiaries and affiliated Chinese entities in China incur debt on their own behalf, the instruments governing the debt may restrict their ability to pay dividends or make other payments to us, which may restrict our ability to satisfy our liquidity requirements. Any limitations on the ability of our PRC subsidiaries to transfer funds to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends and otherwise fund and conduct our business.
We may have difficulty establishing adequate management, legal and financial controls in the People's Republic of China.
The People's Republic of China historically has been deficient in Western style management and financial reporting concepts and practices, as well as in modern banking, computer and other control systems. We may have difficulty in hiring and retaining a sufficient number of employees who are qualified to assist us in application of such concepts and practices to work in the People's Republic of China. As a result of these factors, we 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.
Because our assets and operations are located in China, you may have difficulty enforcing any civil liabilities against us under the securities and other laws of the United States or any state.
SinoHub, Inc. is a holding company, and substantially all of its assets are located in the People’s Republic of China. In addition, some of our directors and officers are non-residents of the United States and all or a substantial portion of the assets of these non-residents are located outside the United States. As a result, it may be difficult for investors to effect service of process within the United States upon these non-residents, or to enforce against them judgments obtained in United States courts, including judgments based upon the civil liability provisions of the securities laws of the United States or any state.
There is uncertainty as to whether courts of the People’s Republic of China would enforce:
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Judgments of United States courts obtained against us or these non-residents based on the civil liability provisions of the securities laws of the United States or any state; or
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In original actions brought in the Republic of China, liabilities against us or non-residents predicated upon the securities laws of the United States or any state. Enforcement of a foreign judgment in the Republic of China also may be limited or otherwise affected by applicable bankruptcy, insolvency, liquidation, arrangement, moratorium or similar laws relating to or affecting creditors' rights generally and will be subject to a statutory limitation of time within which proceedings may be brought.
Uncertainties with respect to the PRC legal system could limit the legal protections available to you and us.
We conduct substantially all of our business through our operating subsidiaries in the PRC. Our operating subsidiaries are generally subject to PRC laws and regulations including those applicable to foreign investments in China and, in particular, laws applicable to foreign-invested enterprises. The PRC legal system is a civil law system based on written statutes. Unlike common law systems, decided legal cases have little precedential value in the PRC. In 1979, the PRC government began to promulgate a comprehensive system of laws and regulations governing economic matters in general. The overall effect of legislation since 1979 has significantly enhanced the protections afforded to various forms of foreign investment in China. However, PRC laws and regulations change frequently and the interpretation of laws and regulations is not always uniform and enforcement thereof can involve uncertainties. For instance, we may have to resort to administrative and court proceedings to enforce the legal protection that we are entitled to by law or contract. However, since PRC administrative and court authorities have significant discretion in interpreting statutory and contractual terms, it may be difficult to evaluate the outcome of administrative court proceedings and the level of law enforcement that we would receive in more developed legal systems. Such uncertainties, including the potential inability to enforce our contracts, could limit legal protections available to you and us and could affect our business and operations. In addition, intellectual property rights and confidentiality protections in China may not be as effective as in the United States or other countries. Accordingly, we cannot predict the effect of future developments in the PRC legal system, particularly with regard to the industries in which we operate, including the promulgation of new laws. This may include changes to existing laws or the interpretation or enforcement thereof, or the preemption of local regulations by national laws. These uncertainties could limit the availability of law enforcement, including our ability to enforce our agreements with PRC government entities and other foreign investors.
Failure to comply with the United States Foreign Corrupt Practices Act could subject us to penalties and other adverse consequences.
We are required to comply with the United States Foreign Corrupt Practices Act, which prohibits U.S. companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. Non-U.S. companies, including some of our competitors, are not subject to these prohibitions. Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices occur from time to time in mainland China. If our competitors engage in these practices, they may receive preferential treatment either from personnel of companies to whom they may provide bribes or other inappropriate incentives, giving our competitors an advantage in securing business, or from government officials who might give our competitors priority in obtaining new licenses, which would put us at a disadvantage. Although we inform our personnel and other agents that such practices are illegal, we cannot assure you that our employees or other agents will not engage in such conduct for which we might be held responsible. If our employees or other agents are found to have engaged in such practices, we could suffer severe penalties and other consequences that may have a material adverse effect on our business, financial condition and results of operations.
Any recurrence of Severe Acute Respiratory Syndrome (SARS), Avian Flu, or another widespread public health problem, in the PRC could adversely affect our operations.
A renewed outbreak of SARS, Avian Flu, or another widespread public health problem in China, where all of our manufacturing facilities are located and where the substantial portion of our sales occur, could have a negative effect on our operations. Our business is dependent upon its ability to continue to manufacture products. Such an outbreak could have an impact on our operations as a result of:

quarantines or closures of some of our manufacturing facilities, which would severely disrupt our operations,

the sickness or death of our key officers and employees, and

a general slowdown in the Chinese economy.
Any of the foregoing events or other unforeseen consequences of public health problems could adversely affect our operations.
We face risks related to natural disasters, terrorist attacks or other events in China that may affect usage of public transportation, which could have a material adverse effect on our business and results of operations.
Our business could be materially and adversely affected by natural disasters, terrorist attacks or other events in China. For example, in early 2008, parts of China suffered a wave of strong snow storms that severely impacted public transportation systems. In May 2008, Sichuan Province in China suffered a strong earthquake measuring approximately 8.0 on the Richter scale that caused widespread damage and casualties. The May 2008 Sichuan earthquake has had a material adverse effect on the general economic conditions in the areas affected by the earthquake. Any future natural disasters, terrorist attacks or other events in China could cause a reduction in usage of or other severe disruptions to, public transportation systems and could have a material adverse effect on our business and results of operations.
PRC labor laws restrict our ability to reduce our workforce in the PRC in the event of an economic downturn and may increase our labor costs.
In June 2007, the National People’s Congress of the PRC enacted the Labor Contract Law, which became effective on January 1, 2008. To clarify certain details in connection with the implementation of the Labor Contract Law, the State Council promulgated the Implementing Rules for the Labor Contract Law, or the Implementing Rules, on September 18, 2008 which came into effect immediately. The Labor Contract Law provides various rules regarding employment contracts that will likely have a substantial impact on employment practices in China. The Labor Contract Law imposes severe penalties on employers that fail to timely enter into employment contracts with employees. The employer is required to pay a double salary to the employee if it does not enter into a written contract with the employee within one month of the employment, and a non-fixed-term contract is assumed if a written contract is not executed after one year of the employment. Additionally, the Labor Contract Law sets a limit of two fixed-term contracts regardless of the length of each term, after which the contract must be renewed on a non-fixed-term basis should the parties agree to a further renewal unless otherwise required by the respective employee. This requirement curtails the common practice of continuously renewing short-term employment contracts. The Implementing Rules appear to further tighten this rule by suggesting that an employee has the right to demand a non-fixed-term contract upon the completion of the second fixed term regardless of whether the employer agrees to a contract renewal. A non-fixed-term contract does not have a termination date and it is generally difficult to terminate such a contract because termination must be based on limited statutory grounds. The employer can no longer supplement such statutory grounds through an agreement with the employee. In addition, the Labor Contract Law requires the payment of statutory severance upon the termination of an employment contract in most circumstances, including the expiration of a fixed-term employment contract.
Under the Labor Contract Law, employers can only impose a post-termination non-competition provision on employees who have access to their confidential information for a maximum period of two years. If an employer intends to maintain the enforceability of a post-termination non-competition provision, the employer has to pay the employee compensation on a monthly basis post-termination of the employment. Under the Labor Contract Law, a “mass layoff” is defined as termination of more than 20 employees or more than 10% of the workforce. The Labor Contract Law expands the circumstances under which a mass layoff can be conducted, such as when a company undertakes a restructuring pursuant to the PRC Enterprise Bankruptcy Law, suffers serious difficulties in business operations, changes its line of business, performs significant technology improvements, changes operating methods, or where there has been a material change in the objective economic circumstances relied upon by the parties at the time of the conclusion of the employment contract, thereby making the performance of such employment contract impractical. The employer must follow specific procedures in conducting a mass layoff. There is little guidance on what penalties an employer will suffer if it fails to follow the procedural requirements in conducting the mass layoff. Finally, the Labor Contract Law requires that the employer discuss the company’s internal rules and regulations that directly affect the employees’ material interests (such as employees’ salary, work hours, leave, benefits, and training, etc.) with all employees or employee representative assemblies and consult with the trade union or employee representatives on such matters before making a final decision.
All of our employees based exclusively within the PRC are covered by the new laws. As there has been little guidance and precedents as to how the Labor Contract Law and its Implementing Rules shall be enforced by the relevant PRC authorities, there remains uncertainty as to their potential impact on our business and results of operations. The implementation of the Labor Contract Law and its Implementing Rules may increase our operating expenses, in particular our personnel expenses and labor service expenses. If we want to maintain the enforceability of any of our employees’ post-termination non-competition provisions, the compensation and procedures required under the Labor Contract Law may add substantial costs and cause logistical burdens to us. Prior to the new law such compensation was often structured as part of the employee’s salary during employment, and was not an additional compensation cost. In the event that we decide to terminate employees or otherwise change our employment or labor practices, the Labor Contract Law and its Implementing Rules may also limit our ability to effect these changes in a manner that we believe to be cost-effective or desirable, which could adversely affect our business and results of operations. In particular, our ability to adjust the size of our operations when necessary in periods of recession or less severe economic downturns such as the recent financial turmoil may be affected. In addition, during periods of economic decline when mass layoffs become more common, local regulations may tighten the procedures by, among other things, requiring the employer to obtain approval from the relevant local authority before conducting any mass layoff. Such regulations can be expected to exacerbate the adverse effect of the economic environment on our results of operations and financial condition.
Our failure to fully comply with PRC labor laws exposes us to potential liability.
Companies operating in China must comply with a variety of labor laws, including certain social insurance, housing fund and other staff welfare-oriented payment obligations. While we believe we have complied with such obligations, there exist uncertainties to the interpretation, implementation and enforcement of such obligations. If relevant governmental authorities determine that we have not complied fully with such obligations, we may be in violation of applicable PRC labor laws and we cannot assure you that PRC governmental authorities will not impose penalties on us for any failure to comply. In addition, in the event that any current or former employee files a complaint with relevant governmental authorities, we may be subject to making up such staff-welfare oriented obligations as well as paying administrative fines.
Because our funds are held in banks which do not provide insurance, the failure of any bank in which we deposit our funds could affect our ability to continue in business.
Banks and other financial institutions in the PRC do not provide insurance for funds held on deposit. A significant portion of our assets are in the form of cash deposited with banks in the PRC, and in the event of a bank failure, we may not have access to our funds on deposit. Depending upon the amount of money we maintain in a bank that fails, our inability to have access to our cash could impair our operations, and, if we are not able to access funds to pay our suppliers, employees and other creditors, we may be unable to continue in business.
Risks Related to Ownership of SinoHub Common Stock
There can be no assurance that a liquid public market for our common stock will exist in the future.
Although our common stock is listed on the NYSE Amex stock exchange, our average daily trading volume in the last three months of 2011 was about 50,600 shares and there may not be a highly liquid market in our common stock in the future. There can also be no assurance as to the strength of any market for our common stock or the prices at which holders may be able to sell their shares.
It is likely that there will be significant volatility in the trading price.
In recent years, the securities markets in the United States have experienced a high level of price and volume volatility, and the market price of securities of many companies has experienced wide fluctuations that have not necessarily been related to the operations, performance, underlying asset values or prospects of such companies. For these reasons, our shares of common stock can also be expected to be subject to volatility resulting from purely market forces over which we will have no control. If our business development plans are successful, we may require additional equity financing to continue our growth and our success in raising additional equity capital could be affected by such volatility. Market prices for our common stock will be influenced by many factors and can be expected to be subject to significant fluctuations in response to variations in our operating results and other factors. Our stock price will also be affected by the trading price of the stock of all US listed companies with operations in China, of all companies that went public through a reverse takeover and of our competitors, investor perceptions of SinoHub, interest rates, general economic conditions and those specific to our industry, developments with regard to SinoHub’s operations and activities, our future financial condition, and changes in our management.
If our common stock were delisted and determined to be a “penny stock,” a broker-dealer may find it more difficult to trade our common stock and an investor may find it more difficult to acquire or dispose of our common stock in the secondary market.
While we do not believe that there is a current basis for delisting our common stock, if our common stock were removed from listing with the NYSE Amex, it may be subject to the so-called “penny stock” rules. The SEC has adopted regulations that define a penny stock to be any equity security that has a market price per share of less than $5.00, subject to certain exceptions, such as any securities listed on a national securities exchange. For any transaction involving a penny stock, unless exempt, the rules impose additional sales practice requirements on broker-dealers, subject to certain exceptions. If our common stock were delisted and determined to be a penny stock, a broker-dealer may find it more difficult to trade our common stock and an investor may find it more difficult to acquire or dispose of our common stock on the secondary market. Investors in penny stocks should be prepared for the possibility that they may lose their whole investment.
We do not intend to pay dividends.
We have not paid any cash dividends on any of our securities since inception and we do not anticipate paying any cash dividends on any of our securities in the foreseeable future.
The ability of the Board of Directors of SinoHub to issue “blank check” preferred stock and any anti-takeover provisions we adopt may depress the value of our Common Stock.
The authorized capital of SinoHub includes shares of “blank check” preferred stock. The SinoHub Board has the power to issue any or all of the authorized but unissued shares of its preferred stock, including the authority to establish one or more series and to fix the powers, preferences, rights and limitations of such class or series, without seeking stockholder approval. The authority of the SinoHub Board of Directors to issue “blank check” preferred stock and any future anti-takeover measures it may adopt, in certain circumstances delay, deter or prevent takeover attempts and other changes in control of SinoHub not approved by its Board of Directors. As a result, SinoHub stockholders may lose opportunities to dispose of their shares at favorable prices generally available in takeover attempts or that may be available under a merger proposal and the market price of the Common Stock and the voting and other rights of its stockholders may also be affected.
Item 1B.
Item 1B. Unresolved Staff Comments.
Not applicable.
Item 2.
Item 2. Properties.
We do not currently own any real property. In China, only the PRC government and peasant collectives may own land. We lease the real properties described below.
Corporate Office. We lease 27,600 square feet of combined office and warehouse space located at 6/F, Building 51, Road 5, Qiongyu Blvd., Technology Park, Nanshan District,, Shenzhen 518053, People’s Republic of China. This location is our corporate headquarters. We occupy this facility under a lease that commenced on August 10, 2008 and ends on August 30, 2013. On August 30, 2011 the rent for this facility increased from $12,690 to $15,060 per month. We use the facility for both our ECSS and our ICM businesses.
Import/Export Department Office near Huanggang Customs. We lease 1,076 square feet of office space located at Unit 1904, Huang Cheng Guang Chang Da Sha, Rd. Huanggang, Futian District, Shenzhen, People’s Republic of China. We occupy this facility under a lease that commenced on June 6, 2010 and ends on June 6, 2012. Our monthly rental cost is about $805. We use the facility mainly for our ECSS business.
Hong Kong Facility. We lease approximately 53,000 square feet of warehouse space at Unit B, 22nd Floor, Tins Plaza, 3 San On Street, Tuen Mun, N.T. Kowloon, Hong Kong SAR for a monthly rental of about $28,500. We occupy this facility under a lease that commenced on December 10, 2009 and ends on January 31, 2013. We use the facility for both our ECSS and our ICM businesses.
Baoan Facility. We lease approximately 104,410 square feet of manufacturing space located at No. 49, Zhou Shi Rd, Shiyan, Baoan District, Shenzhen, People’s Republic of China. We occupy this facility under a lease that commenced on April 4, 2010 and ends on April 4, 2013. Our monthly rental cost is about $23,500. We use the facility for our ICM business.
Che Gong Miao Facility. We lease approximately 4,070 square feet of office space located at Unit 12B, Hong Song Building A, Tairan Six Rd., Futian District, Shenzhen, People’s Republic of China. We occupy this facility under a lease that commenced on March 18, 2010 and ends on March 31, 2015. Our monthly rental cost is about $4,600. We use the facility for our ICM business.
Item 3.
Item 3. Legal Proceedings.
There are no material pending legal proceedings to which we are a party or to which any of our property is subject.
Item 4.
Item 4. Mine Safety Disclosures.
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
SIHI common stock is quoted on the NYSE Amex under the symbol “SIHI”. Presented below are the per share high and low closing sales prices of our common stock, as reported by the NYSE Amex, for each quarterly period during the two most recent fiscal years.
Our common shares are issued in registered form. The registrar and transfer agent for our shares is:
Interwest Transfer Co. Inc.
1981 Murray Holladay Road, Suite 100
Salt Lake City, UT 84117
Telephone: 801-272-9294
Facsimile: 801-277-3147
Securities Authorized for Issuance Under Equity Compensation Plans
The following table includes the information as of the end of 2011 for our equity compensation plans:
(1)
Consists of our 2000 Stock Incentive Plan and Amended and Restated 2008 Stock Plan (the “2008 Plan”). See Note 15 - “Stock Options” of the Notes to the Consolidated Financial Statements included in this Annual Report on Form 10-K. The Company’s stockholders approved the 2008 Plan at the Company’s annual meeting of stockholders on June 19, 2009.
Holders
As of February 29, 2011, there were approximately 3,063 holders of record of our common stock. The number of record holders does not include persons who held our common stock in nominee or “street name” accounts through brokers.
Dividends
We have not declared any dividends since incorporation and do not anticipate that we will do so in the foreseeable future. Our intention is to retain future earnings for use in our operations and the expansion of our business.
Recent Sales of Unregistered Securities
None.
Repurchase of Equity Securities
None.
Item 6.
Item 6. Selected Financial Data.
Item 6 is not applicable to us because we are a smaller reporting company.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis is based on, and should be read in conjunction with our consolidated financial statements, which are included elsewhere in this Form 10-K. Management’s Discussion and Analysis of Financial Condition and Results of Operations contains statements that are forward-looking. These statements are based on current expectations and assumptions that are subject to risk, uncertainties and other factors. Actual results could differ materially because of the factors discussed in “Risks Factors” elsewhere in this Form 10-K, and other factors that we may not know. All amounts are expressed in United States dollars.
OVERVIEW
Our Business
SinoHub, Inc. and subsidiaries (collectively the “Company”) is an electronics company based in Shenzhen, PR China which services clients worldwide. The Company is engaged in two business segments: electronics product manufacturing and sales (ICM, Integrated Contract Manufacturing), and electronic component sales and services (ECSS) which is comprised of electronic component sales (known as ECP) and electronic component supply chain management services (known as SCM). We now report on ICM and ECSS as separate business segments.
SinoHub’s business operations are organized to take full advantage of the power of information exchange between its two business segments: ICM and ECSS. In this sense, SinoHub has become a market maker for our ECSS mobile phone design house customers by using them as suppliers in our ICM business.
In 2011, our business mix was 46% ICM and 54% ECSS as compared to 31% ICM and 69% ECSS in 2010. By 2012, we expect a significant majority of our revenue will come from our ICM segment. For further information on our performance by reportable segment, see Note 19 of the Notes to the Consolidated Financial Statements.
History and Basis of Reporting
SinoHub, Inc. (formerly known as Liberty Alliance, Inc.) is a Delaware corporation, originally incorporated in Utah in 1986, and subsequently merged and reorganized as Liberty Alliance, Inc. in Delaware in 1991. In May 2008, Liberty Alliance, Inc., its wholly-owned subsidiary SinoHub Acquisition Corp., SinoHub, Inc., and Steven L. White, the principal stockholder of Liberty Alliance, Inc., entered into an Agreement and Plan of Merger pursuant to which SinoHub Acquisition Corp. merged with and into SinoHub, Inc. and SinoHub, Inc. became a wholly-owned subsidiary of Liberty Alliance, Inc. After completion of the merger, the original stockholders of Liberty Alliance held approximately 6% of the issued and outstanding shares of Liberty Alliance, Inc. common stock on a fully diluted basis and the former stockholders of SinoHub, Inc., including the shares issued to consultants for services rendered in connection with the merger, held approximately 94% of Liberty Alliance, Inc. issued and outstanding shares of common stock. Subsequent to the completion of the merger, on July 18, 2008, Liberty Alliance, Inc. amended its certificate of incorporation to change its name to SinoHub, Inc. and affect a 3.5-to-1 reverse stock split of all issued and outstanding shares of its common stock.
For financial reporting purposes, the reverse takeover of the Company has been accounted for as a recapitalization of the Company with SinoHub International as the accounting acquirer whereby the historical financial statements and operations of SinoHub International, Inc. became the historical financial statements of the Company, with no adjustment of the carrying value of the assets and liabilities. When we refer in this Form 10-K to business and financial information for periods prior to the consummation of the reverse acquisition, we are referring to the business and financial information of SinoHub International, Inc. on a consolidated basis unless the context suggests otherwise.
Business Operations
SinoHub uses its Hong Kong warehouse as a staging point for ECSS procurement-fulfillment programs in which the Company purchases components associated with a bill of materials. SinoHub also supports customers by providing a sourcing channel for electronic components that are not part of a specific procurement-fulfillment program. In these cases, SinoHub utilizes its industry knowledge and relationships with components suppliers to source products at competitive prices and within time constraints. SinoHub responds to these “spot” orders from customers, sources the product, confirms pricing, and executes delivery as required.
SinoHub carries inventory for its ICM business. We also carry electronic components that we are staging for ECSS procurement-fulfillment projects. Generally, we only buy components in our ECSS business when we have corresponding orders from our customers to purchase the components.
Consolidated Results of Operations
The Company derived revenue and gross profit in 2011 from electronics product manufacturing and sales (ICM, Integrated Contract Manufacturing), and electronic component sales and services (ECSS), which is comprised of electronic component sales (known as ECP) and electronic component supply chain management services (known as SCM).
SCM services are generally provided to all customers (these services are integrated into the ECP and ICM businesses). The Company recognizes revenue from SCM services when the services are provided. Revenue from ICM and from ECP is based on quoted prices and is recognized at the time of shipment to customers. It is our policy to record sales net of discounts and allowances, if granted, but to date we have not offered any discounts or allowances to our customers. In all cases, revenue is recognized when there is persuasive evidence of an arrangement, delivery has occurred or services rendered, the sales price is determinable, and collectability is reasonably assured.
Cost of sales for SCM services primarily represents direct costs incurred for providing SCM services, including logistics and delivery services, import/export services, warehouse services and a number of ancillary services such as transportation, kitting, insurance, repackaging and re-labeling and does not include cost of inventory. For electronic component sales, we purchase electronic components from independent third parties and hold them in inventory, valued at cost, until they are shipped to our customers. Cost of sales for ECP primarily represents the cost of components and expenses directly related to component procurement. Cost of sales for ICM represents all costs associated with the operation of the Topology factory, the cost of designs purchased from design houses, and the cost of components that go into the manufacturing process.
SCM pricing is negotiated based on a percentage of the value of the goods handled. For ECP, the Company makes a margin based on the difference between the price at which it buys electronic components and the price at which it sells these parts to the customer. The price of products and services delivered in the ICM business unit is based on negotiation and gross margin varies with each order. Typically the same mobile phone will be ordered by a customer in a number of different purchase orders over a period of three to four months. Because the price of components generally declines through time, the gross margin on a particular phone generally increases with repeat orders.
Selling, general and administrative expenses include salaries paid to employees, employee related expenses, professional fees, marketing costs, technology costs, sales commissions, depreciation, rent, and related office and facility expenses.
Fiscal Year Ended December 31, 2011 Compared to December 31, 2010
Overall Results
The Company reported net income for the year ended December 31, 2011 of $6.7 million compared to $19.7 million in 2010, a decrease of 66%.
Net Sales
Net sales for the year ended December 31, 2011 were $196.2 million, roughly equivalent to the $196.7 million recorded in 2010.
In the year ended December 31, 2011, net sales of the ECSS segment decreased 22.4% to $105.1 million from $135.5 million in 2010. In the year ended December 31, 2011, net sales of the ICM segment increased 48.9% to $91.1 million from $61.2 million in 2010. Over half of the sales in the ICM segment for 2011 were recorded in the fourth quarter marking substantial recovery in sales volume from the loss of our largest customer in early 2011, which led to a low level of sales in the second and third quarters.
Gross Profit
The Company recorded gross profit of $24.1 million in the year of 2011 compared with $37.8 million in 2010. The gross profit margin for the year of 2011 decreased to 12.3% from 19.2% in 2010 primarily because of declining margins in ECSS and much lower gross margins in ICM to enable us to attract new customers and utilize capacity following the loss of our largest ICM customer at the end of the first quarter of 2011. Due to the Company’s lack of success in implementing a higher margin brokerage model for its ECSS business, the Company intends to deemphasize the electronic component sales aspect of its ECSS business over time and to focus on improving margins in ICM.
Operating Expenses
Total operating expenses were $13.2 million or 6.7% of revenues in 2011, which increased 11.9% from $11.8 million, or 6.0% of revenues, in 2010. Selling, general and administrative expenses decreased to $9.6 million in 2011 from $10.1 million in 2010, representing approximately 4.9% of revenues in 2011 compared to 5.2% in 2010. The increase in operating expenses was primarily the result of two non-cash items:
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a 77% increase in depreciation ($2.3 million in 2011 versus $1.3 million in 2010) associated with having a full year of the 8 SMT lines in our factory in 2011 as opposed to 2010 when the first 4 lines were not installed until July and the balance in the fourth quarter of the year; and
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an increase in our allowance for doubtful accounts of approximately $950,000 associated with the increase in days sales outstanding caused by the tightened credit situation in the PRC.
The decrease in SG&A was accomplished despite higher head count and the expense of the factory and the ICM sales office in the Che Gong Miao location in Shenzhen for the full year.
Income from Operations
The Company recorded income from operations of $11.0 million in 2011, as compared with income from operations of $26.1 million in 2010, primarily as a result of the decrease in gross profits.
Income Taxes
The Company recorded income tax expense of $4.6 million in 2011, as compared with $6.7 million in 2010. The Company’s effective tax rate was 41% in 2011 compared to 25% in 2010. The reason for the sharp increase in the tax rate is that profits in subsidiaries that were profitable decreased and losses in unprofitable subsidiaries increased. Since our profits are taxed at 25% and there is no credit for losses, this meant a big jump in our overall effective tax rate. Income tax estimates in interim periods have varied as the Company has adjusted provisions and accruals in light of actual tax filings.
Foreign Currency Translation Gain and Comprehensive Net Income
The Company reported foreign currency translation gains of $4.2 million in 2011, compared with foreign currency translation gains of $1.9 million in 2010 reflecting increasing valuation of RMB against the United States Dollar (“USD”) during 2011. Comprehensive net income (net income plus foreign currency translation gains) was $10.9 million in 2011 compared with $21.6 million in 2010.
CONSOLIDATED FINANCIAL CONDITION AND LIQUIDITY
Liquidity and Capital Resources
SinoHub’s strategic plan is focused on the growth of our ICM business segment. In 2012 the Company will continue to focus on mobile phone and tablet sales in developing countries. This will require investment in inventory for ICM orders, and, depending on our growth, additional investment in our manufacturing and assembling facilities. As a result of the working capital investments necessary to support these plans, the Company will continue to require cash and financing resources to meet and exceed its objectives. The Company’s cost of capital from equity sales decreased to 5.6% with the private financings we closed in March 2011 due to market conditions and the lower fees of the investment bank we used as placement agent. Our cost of capital with China Construction Bank, Industrial Bank, Hangzhou Bank and Bank of Ningbo was approximately 5.4% at December 31, 2011. Some of the working capital the Company intends to raise in the near to medium term is expected to come from Chinese banks, which, to date, have not been affected by the global credit crisis nearly as much as the US and European banks, although the credit available through banks in China has been adversely affected by Chinese monetary policies. We will also seek to raise additional capital from multinational banks. Finally, as we reduce our ECP business, we should be able to reduce accounts receivable to generate more cash.
We believe SinoHub’s integrated contract manufacturing business can grow rapidly with the expansion of our manufacturing facility and with additional inventory. Additional working capital would enable us to purchase more electronic components from our suppliers, which should lower our costs, and thus enhance our profitability. We believe increased volume would also likely enable the Company to receive improved payment terms from suppliers (we are currently mainly buying from suppliers on a C.O.D. basis) which would lessen our need for additional financing from third parties. Accordingly, if SinoHub is unsuccessful in raising additional working capital and does not obtain payment terms from suppliers, the Company’s growth may be adversely affected.
We intend to raise additional funds through the use of additional debt, long-term debt financings, and operating cash flows. Due to the risk factors discussed elsewhere in this report, there can be no assurance that we will be successful in raising the additional funds necessary to carry out management’s plans for the future on acceptable terms or at all. Our ability to obtain additional capital will also depend on market conditions, national and global economies and other factors beyond our control. We cannot be sure that we will be able to implement or capitalize on various financing alternatives. The terms of any debt or equity funding that we may obtain in the future may be unfavorable to us and to our stockholders.
At December 31, 2011 and December 31, 2010, the Company had cash and cash equivalents of $7.7 million and $4.5 million, respectively. During 2011, the net amount of cash used in the Company’s operating activities was $10.4 million, the net amount of cash used in investing activities was $34.1 million, and the net amount of cash provided by financing activities was $47.0 million.
The Company must generally pay the purchase price of electronic components for procurement-fulfillment customers and then recoup the purchase price from the customer after delivery. We only purchase standard components which are readily saleable. In 2011 we experienced collection delays related to some of the procurement-fulfillment projects we funded because Chinese banks tightened credit to small and medium sized enterprises. The Company’s borrowings vary based on the timing of procurement-fulfillment projects, large spot component sales, use of our VAT import line and use of our export reimbursement line.
Chinese law mandates that all foreign companies appropriate 10% of the retained earnings of their Chinese subsidiaries, up to a maximum aggregate amount of 50% of the registered capital of each such subsidiary, to ensure that money that might otherwise be used to pay Chinese employee claims should they arise is not repatriated outside of China. Other than this appropriation requirement there are no other regulatory restrictions on the net assets of SinoHub’s Chinese subsidiaries. We do not believe that the appropriation requirement materially affects our liquidity or ability to pay dividends since it represents only about 2% of total retained earnings. The aggregate amount of retained earnings appropriated from SinoHub’s subsidiaries in China was $1,125,000 at December 31, 2011. Of SinoHub’s five subsidiaries in China, only two have had retained earnings as of December 31, 2011. The other three Chinese subsidiaries had yet to generate profits as of December 31, 2011 and so no appropriations were made for these companies. Below is a table listing the maximum appropriation and actual appropriation made as of December 31, 2011 for each subsidiary. Variance in exchange rates have led to a total appropriation for SinoHub SCM Shenzhen Limited which is slightly higher than the maximum appropriation determined based on 50% of initial registered capital. The reason for this difference is that this calculation must be denominated in RMB and in the three years in which appropriations were made for this subsidiary to get to the maximum amount the exchange rates which were used were 7.98189 RMB per USD in 2006, 7.6172 in 2007 and 6.96225 in 2008 which meant that the USD value of the contributions progressively increased.
(1) As stated above, the maximum appropriation for each subsidiary is equal to 50% of the registered capital of such subsidiary.
(2) As stated above, variance in exchange rates have led to a total appropriation for SinoHub SCM Shenzhen Limited which is slightly higher than the maximum appropriation determined based on 50% of initial registered capital.
Cash Flows from Operating Activities
The Company maintains a significant investment in working capital, primarily accounts receivable and inventories. Accounts receivable at December 31, 2011 were $40.0 million, a decrease of $5.3 million, or 11.7%, as compared to accounts receivable of $45.3 million at December 31, 2010. Accounts receivable and inventories represented approximately 46.6% of total assets at December 31, 2011, as compared to 54.4% at December 31, 2010.
The net amount of cash used in the Company’s operating activities during the year of 2011 was $10.4 million which primarily included earnings from operations that were offset by investments in inventory and accounts receivable, as well as deposits to suppliers to support the Company’s business growth and changes in income taxes and other taxes payable.
The net amount of cash used in the Company’s operating activities during the year of 2010 was $496,000, which primarily included earnings from operations that were offset by investments in accounts receivable and inventory, as well as deposit to suppliers to support the Company’s business growth.
Cash Flows from Investing Activities
The net amount of cash used by investing activities during 2011 was $34.1 million, the result of restricted cash buildup and building out our ICM manufacturing infrastructure.
The net amount of cash used by investing activities during the year of 2010 was $33.9 million which was also primarily the result of restricted cash buildup and building out our ICM manufacturing infrastructure.
Cash Flows from Financing Activities
The net amount of cash provided by financing activities during the year of 2011 was $47.0 million, which primarily included proceeds from bank borrowings of $169.6 million and private placement stock offerings yielding net proceeds of $10.4 million, offset by payments on bank loans of $135.5 million.
The net amount of cash provided by financing activities during the year of 2010 was $29.7 million, which included proceeds from bank borrowings of $57.7 million, private placement stock offerings yielding net proceeds of $4.5 million, offset by payments on bank loans of $31.7 million.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to our investors.
CRITICAL ACCOUNTING POLICIES
The preparation of our financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including but not limited to those related to income taxes and impairment of long-lived assets. We base our estimates on historical experience and on various other assumptions and factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Based on our ongoing review, we plan to adjust to our judgments and estimates where facts and circumstances dictate. Actual results could differ from our estimates.
We believe the following critical accounting policies are important to the portrayal of our financial condition and results and require our management's most difficult, subjective or complex judgments, often because of the need to make estimates about the effect of matters that are inherently uncertain.
Concentrations and Risks
Substantially all of Company's assets are located in the PRC and Hong Kong and roughly ninety percent of the Company’s revenues in 2011 were derived from business related to the mobile phone industry. In addition, financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash and cash equivalents, restricted cash and accounts receivable. The Company mitigates credit risk through procedures that include determination of credit limits, credit approvals, and related monitoring procedures to ensure delinquent receivables are collected.
Cash and Cash Equivalents
For the purpose of the statements of cash flows, cash and cash equivalents include cash on hand and demand deposits with a bank with a maturity of less than three months. Cash amounts held as security for the Company’s bank loans are reported as restricted cash and are not included with cash and cash equivalents on the balance sheet until the security for such funds has been released.
Accounts Receivable
The Company extends unsecured credit to its customers in the ordinary course of business but mitigates the associated risks by performing credit checks and actively pursuing past due accounts. An allowance for doubtful accounts is established and recorded based on managements’ assessment of customer credit history, overall trends in collections and write-offs, and expected exposures based on facts and prior experience.
Inventories
Inventories are stated at lower of cost or market, cost being determined on a first in first out method. No allowance is made for excess or obsolete inventories as inventories are held for a short period of time and are substantially related to specific customer order commitments. Inventory consists of electronic components purchased from suppliers and electronics products the Company manufactured.
Property and Equipment
Property and equipment are stated at cost, less accumulated depreciation. Expenditures for additions, major renewals and betterments are capitalized and expenditures for maintenance and repairs are charged to expense as incurred.
Depreciation is provided on a straight-line basis, less estimated residual values over the assets’ estimated useful lives. The estimated useful lives are as follows:
Long-lived assets held and used by the Company are reviewed for impairment whenever changes in circumstances or events indicate that the carrying amount of an asset may not be recoverable. For purposes of evaluating the recoverability of long-lived assets, the Company considers various factors, including future cash flows, to determine whether the carrying amount exceeds fair value, and in that case, the asset is written down to fair value.
Financial Instruments
The Company analyzes all financial instruments that may have features of both liabilities and equity under ASC Topic 480-10 and ASC Topic 815. At present, there are no such instruments in the financial statements. The Company also analyzes registration rights agreements associated with any equity instruments issued to determine if penalties triggered for late filing should be accrued under ASC Topic 825. At present, there are no registration rights as to which late filing penalties may apply.
Fair Value of Financial Instruments
ASC Topic 825 requires certain disclosures regarding the fair value of financial instruments. Fair value of financial instruments is made at a specific point in time, based on relevant information about financial markets and specific financial instruments. As these estimates are subjective in nature, involving uncertainties and matters of significant judgment, they cannot be determined with precision. Changes in assumptions can significantly affect estimated fair values.
ASC Topic 820 defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value, the Company considers the principal or most advantageous market in which it would transact and it considers assumptions that market participants would use when pricing the asset or liability.
ASC Topic 820 establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. ASC Topic 820 establishes three levels of inputs that may be used to measure fair value:
Level 1 - Level 1 applies to assets or liabilities for which there are quoted prices in active markets for identical assets or liabilities.
Level 2 - Level 2 applies to assets or liabilities for which there are inputs other than quoted prices included within Level 1 that are observable for the asset or liability such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical assets or liabilities in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which significant inputs are observable or can be derived principally from, or corroborated by, observable market data.
Level 3 - Level 3 applies to assets or liabilities for which there are unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of the assets or liabilities.
The following table sets forth our estimate of fair value of our financial instruments that are liabilities as of December 31, 2011:
The following table sets forth a summary of changes in fair value of our derivative liability for the years ended December 31, 2011 and 2010:
The carrying value of cash and cash equivalents, accounts receivable, accounts payable, accrued expenses, bank borrowings, and other liabilities approximate their fair values because of the short-term nature of these instruments. Management believes the Company is not exposed to significant interest or credit risks arising from these financial instruments.
The Company’s operations are primarily based in the PRC, which may give rise to significant foreign currency risks and opportunities from fluctuations and the degree of volatility of foreign exchange rates between the USD and the RMB. In July 2005, the PRC allowed the RMB to fluctuate within a narrow range ending its decade-old valuation peg to the USD. Since this change in 2005, the RMB has experienced positive trends in valuation against the USD; such trends are reflected in part by the foreign currency translation gains reported in the Company’s financial statements.
Derivative Instruments
For derivative instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in fair value of these warrants are recognized in earnings each reporting period. For warrants derivative instruments, the Company uses the Black-Scholes model to value the derivative instruments at inception and subsequent valuation dates. The classification of derivative instruments, including whether such instruments should be recorded as a liability or as equity, is re-assessed at the end of each reporting period, in accordance with FASB ASC Topic 815, Derivatives and Hedging. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not the net-cash settlement of the derivative instrument could be required within 12 months of the balance sheet date.
Stock-Based Compensation
The Company adopted ASC Topic 718. This Statement requires a public entity to measure the cost of services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost will be recognized over the period during which services are received. Stock compensation for stock granted to non-employees has been determined in accordance with ASC Topic 718 and ASC Topic 505-50, as the fair value of the consideration received or the fair value of equity instruments issued, whichever is more reliably measured.
Revenue and Cost Recognition
The Company reports revenue from ICM and ECSS, which is comprised of ECP and SCM.
Revenues for SCM services are earned from both the SCM and procurement-fulfillment programs and are primarily based on a percentage of inventory value handled for a customer. The Company recognizes revenue from SCM services when the services are provided. Revenues from ECP and ICM businesses are based on quoted prices and are recognized at the time of shipment to customers. Revenues are recognized on the gross amount billed to customers. It is our policy to record sales net of discounts and allowances, if granted, but to date we have not offered any discounts or allowances to our customers. In all cases, revenue is recognized when there is persuasive evidence of an arrangement, delivery has occurred or services rendered, the sales price is determinable, and collectability is reasonably assured.
Revenues for SCM services are earned from both the logistics services and procurement-fulfillment programs provided. We recognize revenues for our SCM services when services are provided. The components of SCM service revenue are: delivery services, import/export services, warehouse services and a number of ancillary services and are primarily based on a percentage of inventory value handled for a customer. Cost of sales for SCM services primarily represents direct costs incurred for providing SCM services such as transportation, kitting, insurance, repackaging and re-labeling.
Cost of goods sold in ICM business includes the direct raw material cost, direct labor cost, manufacturing overheads including depreciation of production equipment, rent, shipping and handling costs, and local transportation charges consistent with the revenue earned.
Cost of sales for SCM services does not include cost of inventory. For electronic component sales, we purchase electronic components from independent third parties and hold them in inventory, valued at cost, until they are shipped to our customers.
Income Taxes
The Company accounts for income taxes under ASC Topic 740. Under ASC Topic 740, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates 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 taxes in the period that included the enactment date.
Foreign Currency Translation
SinoHub, Inc., SinoHub International, Inc., B2B Chips, Ltd., and SinoHub Technology Hong Kong, Ltd. maintain accounting records using the functional currencies, USD and Hong Kong Dollars (“HKD”) respectively. SinoHub SCM Shenzhen, Ltd., SinoHub Electronics Shenzhen, Ltd., SinoHub SCM Shanghai, Ltd., SinoHub Electronics Shanghai, Ltd. and Topology Communication Technology (Shenzhen), Ltd. maintain accounting records using RMB as the functional currency.
The Company uses USD as its reporting currency. The Company accounts for foreign currency translation pursuant to ASC Topic 830. The functional currencies of the Company’s operating subsidiaries are HKD and RMB. Under ASC Topic 830, all assets and liabilities are translated into United States dollars using the current exchange rate at the balance sheet date. The capital and various reserves are translated at historical exchange rates prevailing at the time of the transactions while income and expenses items are translated at the average exchange rate for the period. Translation adjustments are included in other comprehensive income (loss) for the period.
Foreign currency transactions during the year are translated to their functional currencies at the approximate rates of exchange on the dates of transactions. Monetary assets and liabilities denominated in foreign currencies at the balance sheet date are translated to the reporting currency at the approximate rates of exchange at that date. Non-monetary assets and liabilities are translated at the rates of exchange prevailing at the time the asset or liability was acquired. Exchange gains or losses are recorded in the statement of operations.
Comprehensive Income
The foreign currency translation gain or loss resulting from the translation of the financial statements expressed in HKD and RMB to USD is reported as other comprehensive income in the statements of operations and stockholders’ equity.
Earnings Per Share
Earnings per share in accordance with the provisions of ASC Topic 260 requires presentation of basic and diluted earnings per share in conjunction with the disclosure of the methodology used in computing such earnings per share. Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted average common shares outstanding during the period. Diluted earnings per share takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock using the treasury method.
Segments
The Company operates in two segments: electronics product manufacturing and sales (ICM) and electronic component sales and services (ECSS). Segment disclosure is presented in Note 19, “Segment information.”
Rounding
The accompanying consolidated financial statements herein contain rounding to the nearest thousands.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2011, the FASB issued new accounting guidance that will require disclosure of information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. The new disclosure requirements mandate that entities disclose both gross and net information about instruments and transactions eligible for offset in the statement of financial position as well as disclosure of collateral received and posted in connection with these instruments. This new guidance is effective for annual reporting periods beginning on or after January 1, 2013, and interim periods therein, with retrospective application required. The Company expects that the adoption of this new guidance will not have a material impact on its financial position, results of operations or cash flows.
In June 2011, the FASB issued new accounting guidance on the presentation of comprehensive income. The new guidance is intended to improve the overall quality of financial reporting by increasing the prominence of items reported in other comprehensive income and aligning the presentation of other comprehensive income in financial statements prepared in accordance with U.S. GAAP with those prepared in accordance with IFRS. The new guidance requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This new guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Adoption of this new guidance did not have an impact on the Company's financial position, results of operations or cash flows.
In May 2011, the Financial Accounting Standards Board (FASB) issued new accounting guidance to achieve common fair value measurements and disclosure requirements in generally accepted accounting principles (U.S. GAAP) and International Financial Reporting Standards (IFRS). Some of the provisions of the new accounting guidance include requiring (1) that only nonfinancial assets should be valued based on a determination of their best use, (2) disclosure of quantitative information about unobservable inputs used in Level 3 fair value measurements and (3) disclosure of the level within the fair value hierarchy for each class of assets or liabilities not measured at fair value in the statement of financial position but for which the fair value is disclosed. This new guidance is effective for interim and annual periods beginning after December 15, 2011. The Company expects that the adoption of this new guidance will not have a material impact on its financial position, results of operations or cash flows.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The Company is subject to certain market risks, including changes in interest rates and currency exchange rates. The Company does not undertake any specific actions to limit those exposures.
Item 8.
Item 8. Financial Statements and Supplementary Data.
The consolidated financial statements listed in Item 15(a) are incorporated herein by reference and are filed under this Item 8 as a part of this report and follow the signature pages to this Annual Report on Form 10-K on page 58.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Evaluation of Disclosure Controls and Procedures.
We are required to maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer (also our principal executive officer) and our chief financial officer (also our principal financial and accounting officer) to allow for timely decisions regarding required disclosure.
Pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934 (“Exchange Act”), the Company carried out an evaluation, with the participation of the Company’s management, including the Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) (the Company’s principal financial and accounting officer), of the effectiveness of the Company’s disclosure controls and procedures (as defined under Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon that evaluation, and taking the matters described above into account, including the determination that, as described below, there was a material weakness in our internal control over financial reporting at December 31, 2010, the Company’s CEO and CFO concluded that (i) the Company has remediated the material weaknesses in internal control over financial reporting relating to the accounting for stock purchase warrants, as described in Item 9A of our Amended Annual Report on Form 10-K/A for the fiscal year ended December 31, 2010 and (ii) the Company’s disclosure controls and procedures were effective as of December 31, 2011 to ensure that information required to be disclosed by the Company in the reports that the Company files or submits under the Exchange Act, is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including the Company’s CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure.
Management Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Rule 13a-15(f) or Rule 15d-15(f) of the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements prepared for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and disposition of the Company's assets; (b) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and (c) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements.
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation to assess the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on the evaluation performed, our management concluded that (i) the Company has remediated the material weaknesses in internal control over financial reporting relating to the accounting for stock purchase warrants, as described in Item 9A of our Amended Annual Report on Form 10-K/A for the fiscal year ended December 31, 2010 and (ii) the Company's internal control over financial reporting was effective as of December 31, 2011.
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the SEC adopted as of September 21, 2010 that permit the Company to provide only management’s report in this annual report.
Remediation
Management has been actively engaged in remediating the material weakness that was identified for the fiscal year ended December 31, 2010. Implementation of the remediation plan consists of redesigning quarterly procedures to enhance management's identification, capture, review, approval and recording of contractual terms included in equity arrangements. The Company has retained the services of a consulting firm to aid in all aspects of US GAAP compliance. Management believes the foregoing efforts have effectively remediated the material weakness. As the Company continues to evaluate and work to improve its internal control over financial reporting, management may execute additional measures to address potential control deficiencies or modify the remediation plan described above. Management will continue to review and make necessary changes to the overall design of the Company's internal control environment, as well as to policies and procedures to improve the overall effectiveness of internal control over financial reporting.
Changes in Internal Control Over Financial Reporting
The Company has made changes to internal control over financial reporting (as such term is defined in Rules 13a-15(f) under the Exchange Act) during the fiscal period to which this report relates. We have implemented an additional step in our review process to make sure all issues surrounding complex transactions are addressed. We define complex transactions as transactions that may be affected by a subsequent event, such as anti-dilution provisions in securities we issue or transactions which would require a subsequent marking to market of acquired assets. We have also engaged a consultant to review any identified complex transaction to advise us on its treatment under US GAAP.
The Company’s management, including the Company’s CEO and CFO, does not expect that the Company’s internal control over financial reporting will prevent all errors and all fraud. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree or compliance with the policies or procedures may deteriorate.
Item 9B.
Item 9B. Other Information.
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
Information with respect to this item is incorporated by reference from our definitive proxy statement (or amendment to this Annual Report on Form 10-K) to be filed with the SEC within 120 days of the end of the fiscal year ended December 31, 2011.
Item 11.
Item 11. Executive Compensation.
Information with respect to this item is incorporated by reference from our definitive proxy statement (or amendment to this Annual Report on Form 10-K) to be filed with the SEC within 120 days of the end of the fiscal year ended December 31, 2011.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Information with respect to this item is incorporated by reference from our definitive proxy statement (or amendment to this Annual Report on Form 10-K) to be filed with the SEC within 120 days of the end of the fiscal year ended December 31, 2011.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
Information with respect to this item is incorporated by reference from our definitive proxy statement (or amendment to this Annual Report on Form 10-K) to be filed with the SEC within 120 days of the end of the fiscal year ended December 31, 2011.
Item 14.
Item 14. Principal Accountant Fees and Services.
Information with respect to this item is incorporated by reference from our definitive proxy statement (or amendment to this Annual Report on Form 10-K) to be filed with the SEC within 120 days of the end of the fiscal year ended December 31, 2011.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules.
(a)(1) Financial Statements
See Index to Consolidated Financial Statements commencing on Page 59.
(a)(2) Financial Statement Schedules
All supplemental schedules have been omitted since the required information is not present in amounts sufficient to require submission of the schedule, or because the required information is included in the consolidated financial statements or notes thereto.
(b) Exhibits
The following exhibits are filed as part of this report:
EXHIBITS
* Filed herewith.
** Certification is not deemed “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section. Such certification is not deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the Registrant specifically incorporates it by reference.
*** To be filed by amendment
SIGNATURES
In accordance with the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: March 30, 2012
By:
/s/De Hai Li
De Hai Li
Chief Financial Officer
(Principal Financial Officer and Principal Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ Henry T. Cochran
Director and Chief Executive Officer
March 30, 2012
Henry T. Cochran
(Principal Executive Officer)
/s/ De Hai Li
Chief Financial Officer
March 30, 2012
De Hai Li
(Principal Financial Officer and Principal Accounting Officer)
/s/ Lei Xia
Director and President
March 30, 2012
Lei Xia
/s/ Daniel Chi Keung Lui
Director
March 30, 2012
Daniel Chi Keung Lui
/s/ Jeff Qi He
Director
March 30, 2012
Jeff Qi He
/s/ Ted Liangche Shen
Director
March 30, 2012
Ted Liangche Shen
SINOHUB, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors of:
SinoHub, Inc.
We have audited the accompanying consolidated balance sheets of SinoHub, Inc. and subsidiaries as of December 31, 2011 and 2010 (restated) and the related consolidated statements of operations and comprehensive income, stockholders’ equity and cash flows for the years ended December 31, 2011 and 2010 (restated). The Company’s management is responsible for these financial statements. 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 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 audit 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 financial statement presentation. 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 SinoHub, Inc. and subsidiaries as of December 31, 2011 and 2010 (restated), and the results of its operations and its cash flows for the years ended December 31, 2011 and 2010 (restated), in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 2, the Company restated its consolidated financial statements for the year ended December 31, 2010.
/s/ Baker Tilly Hong Kong Limited
BAKER TILLY HONG KONG LIMITED
Certified Public Accountants
Hong Kong
Date: March 30, 2012
SINOHUB, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these consolidated financial statements.
SINOHUB, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
The accompanying notes are an integral part of these consolidated financial statements.
SINOHUB, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
The accompanying notes are an integral part of these consolidated financial statements.
SINOHUB, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these consolidated financial statements.
SINOHUB, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ORGANIZATION
Overview
SinoHub, Inc. and subsidiaries (collectively the “Company”) is an electronics company based in Shenzhen, People’s Republic of China (“PRC” or “China”) which services clients worldwide. The Company is currently engaged in two business segments: electronics product manufacturing and sales (Integrated Contract Manufacturing or ICM), and electronic component sales and services (“ECSS”) which is comprised of electronic component sales (“ECP”) and electronic component supply chain management services (“SCM”). We now report on each of ICM and ECSS as separate business segments.
History and Basis of Reporting
SinoHub, Inc. (formerly known as Liberty Alliance, Inc.) is a Delaware corporation, originally organized in Utah in 1986, and subsequently merged and reorganized as Liberty Alliance, Inc. in Delaware in 1991. Liberty Alliance, Inc. filed for bankruptcy in 1994 and the filing was closed in 1995. Liberty Alliance, Inc. remained dormant until 2006 when it began preparing to become a public shell company and seek new business opportunities. In August 2006 the Company changed its name to Vestige, Inc., and in September 2006 the Company changed its name back to Liberty Alliance, Inc.
In May 2008, Liberty Alliance, Inc., SinoHub Acquisition Corp., known as the Merger Sub, SinoHub, Inc., known as the Acquired Sub, and Steven L. White, the principal stockholder of Liberty Alliance, Inc., entered into an Agreement and Plan of Merger pursuant to which the Merger Sub agreed to merge with and into the Acquired Sub, with the Acquired Sub being the surviving corporation. In connection with the merger, Liberty Alliance, Inc. issued to the stockholders of the Acquired Sub 18,290,000 shares (as adjusted for the 1 for 3.5 reverse stock split described below) of the Company’s common stock in exchange for all the outstanding shares of the Acquired Sub’s preferred and common stock and the Company assumed options exercisable for additional shares of common stock. At the closing, Liberty Alliance, Inc. also issued 510,000 shares (as adjusted for the reverse stock split) of the Company’s common stock to certain consultants for services rendered in connection with the Merger. Immediately following the merger, the Company had 20,000,000 shares of common stock outstanding and options exercisable for an additional 489,451 shares (as adjusted for the reverse stock split) of common stock. The conclusion of these events was deemed to be a reverse takeover transaction, or RTO, after which the original stockholders of the Company held approximately 6% of the issued and outstanding shares of the Company’s common stock on a fully diluted basis and the Acquired Sub’s stockholders, including the shares issued to consultants, held approximately 94% of the Company’s issued and outstanding shares of common stock.
In June 2008, the Company approved a reverse stock split of 1 share for every 3.5 common stock outstanding whereupon outstanding common stock and stock options were adjusted to account for the effects of the reverse stock split.
In July 2008, the Company changed its name from Liberty Alliance, Inc. to SinoHub, Inc. and the Acquired Sub changed its name from SinoHub, Inc. to SinoHub International, Inc.
For financial reporting purposes, the RTO has been accounted for as a recapitalization of the Company whereby the historical financial statements and operations of the Acquired Sub become the historical financial statements of the Company, with no adjustment to the carrying value of assets and liabilities. Share and per share amounts reflect the effects of the recapitalization and reverse stock split for all periods presented. In addition, the presentation for all periods includes equity transactions of the Acquired Sub as adjusted for the effects of the recapitalization and reverse stock split.
Organization Structure
The current operations of the Company include the following subsidiaries:
SinoHub International, Inc. was incorporated in March 1999 as a Delaware C corporation in the United States of America. This company is the holding company for the Chinese and Hong Kong subsidiaries listed below. SinoHub International, Inc. is wholly owned by SinoHub, Inc.
SinoHub Electronics Shenzhen, Ltd. was incorporated in September 2000 in the People’s Republic of China to provide one-stop SCM services for electronic manufacturers and distributors in southern China. SinoHub Electronics Shenzhen, Ltd. is wholly owned by SinoHub International, Inc.
SinoHub SCM Shenzhen, Ltd. was incorporated in December 2001 in the PRC to hold an import and export license in the PRC. SinoHub SCM Shenzhen, Ltd. purchases and sells electronic component parts and also provides customs clearance services to our customers. 100% of the equity interest in SinoHub SCM Shenzhen, Ltd. was held on behalf of SinoHub by SinoHub Electronics Shenzhen, Ltd. through a Declaration of Trust with SinoHub Electronics Shenzhen, Ltd. dated January 30, 2008. On August 21, 2009 our wholly-owned subsidiary SinoHub Electronics Shenzhen, Ltd. exercised its rights under a declaration of trust with the spouse of a director who is a citizen of the PRC and a shareholder of the Company, as trustee (the "Trustee") to cause the shares of SinoHub SCM Shenzhen, Ltd. previously registered in the name of the Trustee to be registered in the name of SinoHub Electronics Shenzhen, Ltd. SinoHub SCM Shenzhen, Ltd. is now directly and solely owned by SinoHub Electronics Shenzhen, Ltd.
SinoHub SCM Shanghai, Ltd. was incorporated in March 2005 in the PRC to provide one-stop SCM services for electronic manufacturers and distributors in northern China. SinoHub SCM Shanghai, Ltd. is wholly owned by SinoHub Electronics Shenzhen, Ltd.
SinoHub Electronics Shanghai, Ltd. was incorporated in July 2005 in the PRC to provide one-stop SCM services for electronic manufacturers and distributors in the PRC. SinoHub Electronics Shanghai, Ltd. is wholly owned by SinoHub International, Inc.
B2B Chips, Limited was incorporated in June 2006 in Hong Kong to purchase and sell electronic components. In 2010 the business conducted through B2B Chips, Limited was expanded to include the electronics product manufacturing and sales business. B2B Chips, Limited is wholly owned by SinoHub Electronics Shenzhen, Ltd.
SinoHub Technology (Hong Kong) Limited was incorporated in May 2007 in Hong Kong and has not yet commenced business. SinoHub Technology (Hong Kong) Limited is wholly owned by B2B Chips, Limited.
Topology Communication Technology (Shenzhen), Ltd. was incorporated in April 2010 in Shenzhen to manufacture mobile phones and other electronic devices. Topology Communication Technology (Shenzhen), Ltd. is wholly owned by B2B Chips, Limited.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount 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 from those estimates.
Concentrations and Risks
Substantially all of Company's assets are located in the PRC and Hong Kong and substantially all of the Company's revenues were derived from customers located in the PRC. In addition, financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash and cash equivalents, restricted cash and accounts receivable. The Company mitigates credit risk through procedures that include determination of credit limits, credit approvals, and related monitoring procedures to ensure delinquent receivables are collected.
Cash and Cash Equivalents
For purpose of the statements of cash flows, cash and cash equivalents include cash on hand and demand deposits with a bank with a maturity of less than three months. Cash amounts held as security for the Company’s bank loans is reported as restricted cash and is not included with cash or cash equivalents on the balance sheet until the lien against such funds has been released.
Accounts Receivable
The Company extends unsecured credit to its customers in the ordinary course of business but mitigates the associated risks by performing credit checks and actively pursuing past due accounts. An allowance for doubtful accounts is established and recorded based on managements’ assessment of customer credit history, overall trends in collections and write-offs, and expected exposures based on facts and prior experience.
Inventories
Inventories are stated at lower of cost or market, cost being determined on a first in first out method. No allowance is made for excess or obsolete inventories as inventories are held for a short period of time and are substantially related to specific customer order commitments. Inventory consists of electronic components purchased from suppliers and electronics products the Company manufactured.
Property and Equipment
Property and equipment are stated at cost, less accumulated depreciation. Expenditures for additions, major renewals and betterments are capitalized and expenditures for maintenance and repairs are charged to expense as incurred.
Depreciation is provided on a straight-line basis, less estimated residual values over the assets’ estimated useful lives. The estimated useful lives are as follows:
Long-lived assets held and used by the Company are reviewed for impairment whenever changes in circumstances or events indicate that the carrying amount of an asset may not be recoverable. For purposes of evaluating the recoverability of long-lived assets, the Company considers various factors, including future cash flows, to determine whether the carrying amount exceeds fair value, and in that case, the asset is written down to fair value.
Financial Instruments
The Company analyzes all financial instruments that may have features of both liabilities and equity under ASC Topic 480-10 and ASC Topic 815. At present, there are no such instruments in the financial statements. The Company also analyzes registration rights agreements associated with any equity instruments issued to determine if penalties triggered for late filing should be accrued under ASC Topic 825. At present, there are no registration rights as to which late filing penalties may apply.
Fair Value of Financial Instruments
ASC Topic 825 requires certain disclosures regarding the fair value of financial instruments. Fair value of financial instruments is made at a specific point in time, based on relevant information about financial markets and specific financial instruments. As these estimates are subjective in nature, involving uncertainties and matters of significant judgment, they cannot be determined with precision. Changes in assumptions can significantly affect estimated fair values.
ASC Topic 820 defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value, the Company considers the principal or most advantageous market in which it would transact and it considers assumptions that market participants would use when pricing the asset or liability.
ASC Topic 820 establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. ASC Topic 820 establishes three levels of inputs that may be used to measure fair value:
Level 1 - Level 1 applies to assets or liabilities for which there are quoted prices in active markets for identical assets or liabilities.
Level 2 - Level 2 applies to assets or liabilities for which there are inputs other than quoted prices included within Level 1 that are observable for the asset or liability such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical assets or liabilities in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which significant inputs are observable or can be derived principally from, or corroborated by, observable market data.
Level 3 - Level 3 applies to assets or liabilities for which there are unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of the assets or liabilities.
The following table sets forth our estimate of fair value of our financial instruments that are liabilities as of December 31, 2011:
The following table sets forth a summary of changes in fair value of our derivative liability for the years ended December 31, 2011 and 2010:
The carrying value of cash and cash equivalents, accounts receivable, accounts payable, accrued expenses, bank borrowings, and other liabilities approximate their fair values because of the short-term nature of these instruments. Management believes the Company is not exposed to significant interest or credit risks arising from these financial instruments.
The Company’s operations are primarily based in the PRC, which may give rise to significant foreign currency risks and opportunities from fluctuations and the degree of volatility of foreign exchange rates between the United States dollar (“USD”) and the Chinese Renminbi (“RMB”). In July 2005, the PRC allowed the RMB to fluctuate within a narrow range ending its decade-old valuation peg to the USD. Since this change in 2005, the RMB has experienced positive trends in valuation against the USD; such trends are reflected in part by the foreign currency translation gains reported in the Company’s financial statements.
Derivative Instruments
For derivative instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in fair value of these warrants are recognized in earnings each reporting period. For warrants derivative instruments, the Company uses the Black-Scholes model to value the derivative instruments at inception and subsequent valuation dates. The classification of derivative instruments, including whether such instruments should be recorded as a liability or as equity, is re-assessed at the end of each reporting period, in accordance with FASB ASC Topic 815, Derivatives and Hedging. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not the net-cash settlement of the derivative instrument could be required within 12 months of the balance sheet date.
Stock-Based Compensation
The Company adopted ASC Topic 718. This Statement requires a public entity to measure the cost of services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost will be recognized over the period during which services are received. Stock compensation for stock granted to non-employees has been determined in accordance with ASC Topic 718 and ASC Topic 505-50, as the fair value of the consideration received or the fair value of equity instruments issued, whichever is more reliably measured.
Revenue and Cost Recognition
The Company reports revenue from ICM, and ECSS, which is comprised of ECP and SCM.
Revenues for SCM services are earned from both the SCM and procurement-fulfillment programs and are primarily based on a percentage of inventory value handled for a customer. The Company recognizes revenue from SCM services when the services are provided. Revenues from ECP and ICM businesses are based on quoted prices and are recognized at the time of shipment to customers. Revenues are recognized on the gross amount billed to customers. In all cases, revenue is recognized when there is persuasive evidence of an arrangement, delivery has occurred or services rendered, the sales price is determinable, and collectability is reasonably assured.
The components of SCM service revenue are: delivery services, import/export services, warehouse services and a number of ancillary services and are primarily based on a percentage of inventory value handled for a customer. Cost of sales for SCM services primarily represents direct costs incurred for providing SCM services such as transportation, kitting, insurance, repackaging and re-labeling.
Cost of goods sold in ICM business includes the direct raw material cost, direct labor cost, manufacturing overheads including depreciation of production equipment, rent, shipping and handling costs, and local transportation charges consistent with the revenue earned.
Cost of sales for SCM services does not include cost of inventory. For electronic component sales, we purchase electronic components from independent third parties and hold them in inventory, valued at cost, until they are shipped to our customers.
Income Taxes
The Company accounts for income taxes under ASC Topic 740. Under ASC Topic 740, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates 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 taxes in the period that included the enactment date.
Foreign Currency Translation
SinoHub, Inc., SinoHub International, Inc., B2B Chips, Ltd., and SinoHub Technology Hong Kong, Ltd. maintain accounting records using the functional currencies, USD and Hong Kong Dollars (“HKD”) respectively. SinoHub SCM Shenzhen, Ltd., SinoHub Electronics Shenzhen, Ltd., SinoHub SCM Shanghai, Ltd., SinoHub Electronics Shanghai, Ltd. and Topology Communication Technology (Shenzhen), Ltd. maintain accounting records using RMB as the functional currency.
The Company uses USD as its reporting currency. The Company accounts for foreign currency translation pursuant to ASC Topic 830. The functional currencies of the Company’s operating subsidiaries are HKD and RMB. Under ASC Topic 830, all assets and liabilities are translated into United States dollars using the current exchange rate at the balance sheet date. The capital and various reserves are translated at historical exchange rates prevailing at the time of the transactions while income and expenses items are translated at the average exchange rate for the period. Translation adjustments are included in other comprehensive income (loss) for the period.
Foreign currency transactions during the year are translated to their functional currencies at the approximate rates of exchange on the dates of transactions. Monetary assets and liabilities denominated in foreign currencies at the balance sheet date are translated to the reporting currency at the approximate rates of exchange at that date. Non-monetary assets and liabilities are translated at the rates of exchange prevailing at the time the asset or liability was acquired. Exchange gains or losses are recorded in the statement of operations.
Comprehensive Income
The foreign currency translation gain or loss resulting from the translation of the financial statements expressed in HKD and RMB to USD is reported as other comprehensive income in the statements of operations and stockholders’ equity.
Earnings Per Share
Earnings per share in accordance with the provisions of ASC Topic 260 requires presentation of basic and diluted earnings per share in conjunction with the disclosure of the methodology used in computing such earnings per share. Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted average common shares outstanding during the period. Diluted earnings per share takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock using the treasury method.
Segments
The Company operates in two segments: electronics product manufacturing and sales (ICM) and electronic component sales and services (ECSS). Segment disclosure is presented in Note 19, “Segment information.”
Rounding
The accompanying consolidated financial statements herein contain rounding to the nearest thousands.
Reclassifications
Certain amounts reported for prior years have been reclassified to conform to the current year’s presentation.
Recent Accounting Pronouncements
In December 2011, the FASB issued new accounting guidance that will require disclosure of information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. The new disclosure requirements mandate that entities disclose both gross and net information about instruments and transactions eligible for offset in the statement of financial position as well as disclosure of collateral received and posted in connection with these instruments. This new guidance is effective for annual reporting periods beginning on or after January 1, 2013, and interim periods therein, with retrospective application required. The Company expects that the adoption of this new guidance will not have a material impact on its financial position, results of operations or cash flows.
In June 2011, the FASB issued new accounting guidance on the presentation of comprehensive income. The new guidance is intended to improve the overall quality of financial reporting by increasing the prominence of items reported in other comprehensive income and aligning the presentation of other comprehensive income in financial statements prepared in accordance with U.S. GAAP with those prepared in accordance with IFRS. The new guidance requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This new guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Adoption of this new guidance did not have an impact on the Company's financial position, results of operations or cash flows.
In May 2011, the Financial Accounting Standards Board (FASB) issued new accounting guidance to achieve common fair value measurements and disclosure requirements in generally accepted accounting principles (U.S. GAAP) and International Financial Reporting Standards (IFRS). Some of the provisions of the new accounting guidance include requiring (1) that only nonfinancial assets should be valued based on a determination of their best use, (2) disclosure of quantitative information about unobservable inputs used in Level 3 fair value measurements and (3) disclosure of the level within the fair value hierarchy for each class of assets or liabilities not measured at fair value in the statement of financial position but for which the fair value is disclosed. This new guidance is effective for interim and annual periods beginning after December 15, 2011. The Company expects that the adoption of this new guidance will not have a material impact on its financial position, results of operations or cash flows.
2. RESTATEMENT OF PREVIOUSLY REPORTED CONSOLIDATED FINANCIAL STATEMENTS
On May 16, 2011, the Company filed with the Securities and Exchange Commission (“SEC”) a Current Report on Form 8-K, to report management’s determination that the Company’s financial statements for the year ended December 31, 2010, included in its Amended Annual Report on Form 10-K filed with the SEC on March 14, 2011 (the “2010 For 10-K”) , should no longer be relied upon due to an error in such financial statements with respect to the accounting for 816,670 common stock purchase warrants in connection with its March 2, 2010 private placement (the “2010 Warrants”). The Company determined that the historical financial statements for the year ended December 31, 2010 included in the Company’s 2010 Form 10-K require restatement to properly record the 2010 Warrants as a derivative liability.
The Company has performed a complete assessment of its outstanding 2010 Warrants and has concluded that its outstanding 2010 Warrants are within the scope of Accounting Standards Codification 815-40, “Derivatives and Hedging - Contracts in Entity’s Own Equity” (“ASC 815-40”), due to the inclusion in the Warrants of a provision requiring an adjustment to the exercise price of the 2010 Warrants in the event the Company issues common stock, or securities convertible into or exercisable for common stock, at a price per share lower than such exercise price. Accordingly, ASC 815-40, formerly EITF 07-05, which was effective as of January 1, 2009, should have been applied resulting in a reclassification of the warrants as a liability, measured at fair value, with changes in fair value recognized as part of other income or expense for each reporting period thereafter. Because the reset provision contained in the Company’s warrants issued in 2008 (the “2008 Warrants”) expired on September 10, 2009, no change in the Company’s historical financial statements is required with respect to the 2008 Warrants.
On May 24, 2011, the Company filed an amended Annual report on Form 10-K reflecting the restatement of the financial statements for the fiscal year ended December 31, 2010.
The amended Annual Report on Form 10-K for the fiscal year ended December 31, 2010 incorporates corrections made in response to the accounting errors described above by restating the Company’s financial statements presented herein for the year ended December 31, 2010. The corrections to the annual information in this amended Form 10-K had no impact on the Company’s previously reported operations or cash flows for the periods being restated.
The following tables show the effects of the restatement on the Company's consolidated balance sheet as of December 31, 2010 and consolidated statements of operations and comprehensive income and consolidated statements of cash flows for the year ended December 31, 2010:
SinoHub, Inc. and Subsidiaries
Consolidated Balance Sheet
SinoHub, Inc. and Subsidiaries
Consolidated Statements of Operations and Comprehensive Income
The gain resulting from the change in fair value of derivative warrant liability for the year ended December 31, 2010, was incurred at the corporate level (a Delaware corporation). The Company did not recognize any net income tax expense associated with the change in fair value in the year ended December 31, 2010. Therefore, the restatement did not have an effect on the Company’s taxable income for the year ended December 31, 2010.
SinoHub, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
3. ACCOUNTS RECEIVABLE, NET
Accounts receivable at December 31, 2011 and 2010 consisted of the following:
For the years ended December 31, 2011 and 2010, the Company recorded provision for bad debts of $1,279,000 and $329,000, respectively.
4. INVENTORIES, NET
Inventories at December 31, 2011 and 2010 consisted of the following:
For the years ended December 31, 2011 and 2010, the Company recorded provision for obsolete inventories of $189,000 and $Nil, respectively.
5. PREPAID EXPENSES AND OTHER CURRENT ASSETS
Prepaid expenses and other current assets at December 31, 2011 and 2010 consisted of the following:
6. PROPERTY AND EQUIPMENT, NET
The following is a summary of property and equipment at December 31, 2011 and 2010:
Depreciation expenses for the years ended December 31, 2011 and 2010 were $4.0 million and $1.6 million respectively.
As of December 31, 2011, cost of equipments held under capital lease (refer to Note 10) and accumulated depreciation associated with the capital lease were $2,749,000 and $741,000, respectively.
7. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses and other current liabilities at December 31, 2011 and 2010 and consisted of the following:
8. BANK BORROWINGS AND FINANCING ARRANGEMENTS
The Company has secured financing facilities with certain PRC banks to support its business operations. The bank facilities include:
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Lines of credit facility with China Construction Bank in the amount of $22,244,000 to support our component sales business. Restricted cash balances are required as security for draws against the facility. The facility renews each year and is available through January 2013. As of December 31, 2011, the Company had unused lines of credit facilities amounting to $4.9 million.
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Lines of credit facility with Industrial Bank in the amount of $7,477,000 to support our business. Restricted cash balances are required as security for draws against the facility. In addition, the bank requires third party guarantees from a third party, two subsidiaries, SinoHub Electronics Shenzhen, Ltd. and Topology Communication Technology (Shenzhen) Ltd. and an executive officer. The facility is available through December, 2012. As of December 31, 2011, the Company had unused lines of credit facilities amounting to $2 million.
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Lines of credit facility with Bank of Ningbo in the amount of $7,000,000 to support our electronics product manufacturing and sales business. Restricted cash balances are required as security for draws against the facility. The facility renews each year and is available through July 2012. This facility had not been used as of December 31, 2011 and therefore there was no restricted cash associated with it at that date.
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Bank’s Acceptance Bill facility with Bank of Shanghai in the amount of $4,767,000 to support purchasing of raw material for our electronics product manufacturing and sales business. Restricted cash balances are required as security for draws against the facility. In addition, the bank requires third party guarantees from a subsidiary, SinoHub Electronics Shenzhen, Ltd. and the unlimited personal guaranty of an executive officer and his spouse. The facility renews each year and is available through October 2012. As of December 31, 2011, the Company had unused Bank’s Acceptance Bill facility amounting to $1.7 million.
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Lines of credit facility with Bank of Jiangsu in the amount of $15,534,000 to support our electronics product manufacturing and sales business. Restricted cash balances are required as security for draws against the facility. In addition, the bank requires third party guarantees from two subsidiaries, SinoHub Electronics Shenzhen, Ltd. and Topology Communication Technology (Shenzhen) Ltd. and an executive officer. The facility renews each year and is available through July 2012. As of December 31, 2011, the Company had unused lines of credit facilities amounting to $7 million.
As of December 31, 2011, the Company had unused letter of credit facilities amounting to $7.6 million.
Borrowings against these facilities at December 31, 2011 and 2010 were as follows:
Interest expense for the years ended December 31, 2011 and 2010 was $3,116,000 and $459,000 respectively. The weighted average interest rate paid on the line of credit outstanding borrowings during the year ended December 31, 2011 was 3%.
As of December 31, 2011 SinoHub had restricted cash and bank loan balances of $57.6 million related to non-deliverable forward (NDF) contracts. The Company assumes no risk for the NDF contracts in these transactions. Under each NDF contract, The Company is obligated to deposit an agreed amount of money in RMB with the bank for one year and the bank is obligated to loan the Company an amount of US Dollars or Hong Kong Dollars at a small discount to current exchange rates that is paid directly to a supplier outside of PR China. As an example, if the Company owed a supplier in Hong Kong $1 million, in the third quarter of 2011 Chinese banks were willing to loan the Company $1 million for one year at a fixed rate of interest to pay the supplier as long as SinoHub was willing to deposit an amount of RMB (less than the current exchange rate) for one year in their bank. At the end of the one year period, the bank will use the deposit to pay off the loan and keep the difference, if any, resulting from any appreciation of the RMB against the dollar during the period. If the value of the RMB versus the US dollar declines, the bank will make up the difference, and the Company would not be required to make any payments to the bank to pay off the loan other than the deposit.
We have considered whether the NDF contracts that require assessment under FASB ASC Topic 815 should be accounted for as derivative instruments and concluded that these NDF contracts are loan commitments and are not derivative instruments and therefore FASB ASC Topic 815 does not apply.
9. COLLATERALIZED BANK ADVANCES
Collateralized bank advances at December 31, 2011 consisted of purchases financed by two banks for which bank charges of 0.05% on the invoice amount is incurred and guaranteed by the Company’s restricted cash, a subsidiary of the Company and an executive officer of the Company. Collateralized bank advances are due at various dates from February 21, 2012 through May 4, 2012 and bank advance charges due will be settled on the date of acceptance.
10. CAPITAL LEASE OBLIGATIONS
Certain of the equipment included in fixed assets have been acquired under a capital lease. The capital lease obligations are as follows:
The lease is guaranteed by equipment with a total cost of $2,749,000. Depreciation expenses associated with the capital lease were $509,000 and $208,000 for the years ended December 31, 2011 and 2010 respectively. Interest expenses associated with capital leases were $91,000 and $65,000 for the years ended December 31, 2011 and 2010 respectively.
11. WARRANT DERIVATIVES
The Warrants issued in connection with the private placement the Company consummated on September 10, 2008 (the “2008 Warrants) and on March 2, 2010 (the “2010 Warrants”) include a reset provision triggered if the Company issues common shares below the exercise price as defined in the respective warrants. Effective January 1, 2009, the reset provision of these warrants preclude equity accounting treatment under ASC 815. Accordingly, effective January 1, 2009, the Company was required to reclassify the Warrants at their fair value to liabilities each reporting period under ASC 815-40. The reset provision in the 2008 Warrants expired on September 10, 2009.
At December 31, 2011, the fair value of the Company’s derivative warrants liability was $225,000. The Company used the Black-Scholes valuation model to estimate the fair value of the Warrants. Significant assumptions used at December 31, 2011 were as follows:
(1)
The estimated market value of the stock on the date of grant/reporting was based on a calculation by management after consideration of price per share received in the private offerings and reported public market prices.
(2)
The risk-free interest rate was determined by management using the U.S. Treasury zero-coupon yield over the contractual term of the option on date of grant.
(3)
Management determined the dividend yield to be 0% based upon its expectation that there will not be earnings available to pay dividends in the near term.
(4)
Expected life is remaining contractual life of the warrants.
Changes in fair value of these warrants are recognized in earnings each reporting period.
12. COMMITMENTS AND CONTINGENCIES
Employee Benefits
The full time employees of subsidiaries based in the PRC are entitled to employee benefits including medical care, welfare subsidies, unemployment insurance and pension benefits through a Chinese government mandated multi-employer defined contribution plan. The Company is required to accrue for those benefits based on certain percentages of the employees’ salaries and make contributions to the plans out of the amounts accrued for medical and pension benefits. The total provision and contributions made for such employee benefits for the years ended December 31, 2011 and 2010 were $192,000 and $194,000 respectively. The Chinese government is responsible for the medical benefits and the pension liability to be paid to these employees.
Commitments
The Company leases factory, warehouse, office spaces and equipment from third parties under operating leases which expire at various dates from June 2012 through March 2015. Rent expense for the years ended December 31, 2011 and 2010 was $1,516,000 and $983,000 respectively. At December 31, 2011, the Company has outstanding commitments with respect to operating leases, which are due as follows:
The Company leases equipment under a non-cancelable capital lease agreement. Future minimum lease payments under the capital lease are as follows:
Capital Commitment
As of December 31, 2011, the Company has a capital commitment in respect of a capital injection to a PRC subsidiary of $2,051,000 by April 2012.
Contingencies
The Company accounts for loss contingencies in accordance with ASC Topic 450-20. As of December 31, 2011, there was no loss contingency.
13. EARNINGS PER SHARE
The elements for calculation of earnings per share for the years ended December 31, 2011 and 2010 were as follows:
In 2011, options to purchase 616,004 shares of common stock and warrants to purchase 3,577,502 shares of common stock with exercise prices greater than the average fair market value of the Company’s stock were not included in the calculation because the effect is anti-dilutive.
In 2010, options to purchase 428,400 shares of common stock and warrants to purchase 2,103,410 shares of common stock with exercise prices greater than the average fair market value of the Company’s stock were not included in the calculation because the effect is anti-dilutive.
14. STOCKHOLDERS’ EQUITY
Equity Share Transactions
On March 16, 2011, SinoHub, Inc. (the “Company”) entered into a securities purchase agreement (the “Purchase Agreement”) with a select number of institutional investors to issue and sell 4,791,097 shares of common stock and warrants to purchase up to 1,437,329 shares of common stock. On March 21, 2011, the Company completed the sale of the common stock and warrants under the Purchase Agreement. For each share of common stock purchased by an investor under the Purchase Agreement, such investor received a warrant to purchase 0.3 shares of common stock at an initial exercise price of $3.00 per whole share of common stock. The warrants shall be non-exercisable for six months and have a term of exercise of thirty months from the date of issuance. Each share of common stock, together with the related warrant, was sold at a negotiated price of $2.30 per share of common stock. The Company received gross proceeds from the offering of approximately $11 million, before deducting placement agents’ fees and estimated offering expenses. The Company intends to use the net proceeds from the sale of the common stock and warrants pursuant to the offering for general corporate purposes and working capital.
During the first quarter of 2011, certain employees exercised their stock options to purchase an aggregate of 7,567 shares of common stock for an aggregate price of $1,337.
During the first quarter of 2011, certain employees exercised stock options using net-share settlement resulting in the issuance of an aggregate of 9,897 shares of common stock and yielding no cash proceeds to the Company.
During the second quarter of 2011, certain employees exercised their stock options to purchase an aggregate of 72,983 shares of common stock for an aggregate price of $13,345.
During the second quarter of 2011, certain employees exercised stock options using net-share settlement resulting in the issuance of an aggregate of 2,500 shares of common stock and yielding no cash proceeds to the Company.
Warrants
Following is a summary of the status of warrants outstanding and exercisable at December 31, 2011 and December 31, 2010:
Appropriated Retained Earnings
The Company’s PRC subsidiaries are required to make appropriations to reserve funds, comprising the statutory surplus reserve, statutory public welfare fund and discretionary surplus reserve, based on the after-tax net income determined in accordance with the laws and regulations of the PRC. Prior to January 1, 2006 the appropriation to the statutory surplus reserve should be at least 10% of the after tax net income determined in accordance with the laws and regulations of the PRC until the reserve is equal to 50% of the entities’ registered capital. Appropriations to the statutory public welfare fund are at 5% to 10% of the after tax net income determined by the Board of Directors. Effective January 1, 2006, the Company is only required to contribute to one statutory reserve fund at 10% of net income after tax per annum, such contributions not to exceed 50% of the respective companies’ registered capital.
The statutory reserve funds are restricted for use to set off against prior period losses, expansion of production and operation or for the increase in the registered capital of the Company. The statutory public welfare fund is restricted for use in capital expenditures for the collective welfare of employees. These reserves are not transferable to the Company in the form of cash dividends, loans or advances. These reserves are therefore not available for distribution except in liquidation. During 2011 and 2010, the Company appropriated $192,000 and $146,000 respectively, to the reserve funds based in accordance with the laws and regulations of the PRC.
15. STOCK OPTIONS
The Company has granted qualified stock options under the Company’s 2000 Stock Incentive Plan (the “2000 ISOP”) and 2008 Stock Plan, as amended and restated (the “2008 ISOP”). At December 31, 2011, stock options to purchase 675,029 shares of common stock at an exercise price ranging from $0.20 to $4.36 per share were outstanding. Prior to becoming publicly traded, the exercise prices were determined by the Board at the time of grant. In each such case the exercise price was not less than the fair market value of the common stock as determined by the Board in good faith taking into account such factors as recent issuances of preferred stock with an appropriate discount factored in relative to the common shares. The exercise prices for options issued under the 2000 ISOP following the sale of preferred stock by the Company during November and December of 2007 represent a discount to the issuance price of $0.78 for such preferred stock taking into account the added value of the conditions in the preferred stock (for example, it was redeemable with 10% appreciation). The exercise prices for options issued under the 2008 ISOP represent the closing price of the Company’s common stock on the business day preceding the grant date. The stock options granted become exercisable (“vested”) as to 25% of the original number of shares on the first anniversary of the grant date and as to an additional 6.25% of the original number of shares at the end of each successive three-month period following the first anniversary of the grant date until the fourth anniversary of the grant date. Unless earlier terminated, these stock options granted shall expire ten years after the grant date. Following the reverse merger, all shares of preferred stock which were convertible on the basis of one share of preferred stock for one share of common stock issued were exchanged for common stock of Liberty Alliance, Inc. retroactively adjusted for all periods presented.
The fair value of stock options granted was estimated at the date of grant using the Black-Scholes option-pricing model with the following assumptions:
Expected Volatility: Expected volatility is computed based on the standard deviation of the continuously compounded rate of return of days when the stock price changed over a historical period matching the expected life of the options.
Dividend Yield: The expected dividend yield is zero. The Company has not paid a dividend and does not anticipate paying dividends in the foreseeable future.
Risk Free Rate: The risk-free interest rate was based on U.S. Treasury interest rates at the time of the grant whose term is consistent with expected life of the stock options.
Expected Life: The expected life (estimated period of time outstanding) of stock options granted was estimated based on historical exercise and termination activity.
Stock compensation expense was recognized based on awards expected to vest. There was no estimated forfeiture as the Company has a short history of issuing options. ASC Topic 718 requires forfeiture to be estimated at the time of grant and revised in subsequent periods, if necessary, if actual forfeitures differ from those estimates.
The following is a summary of the stock options activity:
Of the total options granted, options to purchase an aggregate of 261,571 shares of common stock are fully vested, exercisable and non-forfeitable. The aggregate intrinsic value of options vested and exercisable was $5,404.
As of December 31, 2011, there was a total of $636,012 of unrecognized compensation cost related to unvested stock options expected to be recognized over a weighted average period of approximately two years.
The following is a summary of the status of options outstanding at December 31, 2011 and 2010:
For the years ended December 31, 2011 and 2010, stock compensation expenses were $Nil and $263,000, respectively.
For the years ended December 31, 2011 and 2010, stock option compensation amortization expenses were $341,000 and $433,000, respectively.
16. RELATED PARTY TRANSACTIONS
In 2011, an executive officer and his spouse provided guarantees to a bank for banking facilities in the amount of $4,767,000 extended to the Company.
In 2011, an executive officer provided guarantees to two banks for banking facilities in the aggregate amount of $12,244,000 extended to the Company.
In 2010, a director and his spouse as well as an executive officer provided guarantees to a bank for banking facilities in the amount of $7,100,000 extended to the Company.
In 2010, a director and an executive officer provided guarantees to a bank for banking facilities in the amount of $5,300,000 extended to the Company.
In 2010, an executive officer provided an unlimited personal guaranty to two banks for banking facilities for the Company in the aggregate principal amount of $16,000,000.
17. INCOME TAXES
The Company and its subsidiaries are subject to income taxes on an “entity” basis that is, on income arising in or derived from the tax jurisdiction in which each entity is domiciled. It is management's intention to reinvest all the income earned by the Company’s subsidiaries outside of the US. Accordingly, no US federal income taxes have been provided on earnings of foreign based subsidiaries.
The Company and its wholly owned subsidiary, SinoHub International, Inc. are incorporated in the United States and have incurred operating losses since inception. These operating loss carry forwards (NOLs) will expire, if not utilized, commencing in 2028. Management believes the realization of tax benefits from these NOLs is uncertain due to the Company’s current operating history and continuing losses in the US for tax purposes. Accordingly, no net deferred tax benefit has been recorded.
The Company’s subsidiaries in Hong Kong are subject to Hong Kong profits tax at a statutory rate of 16.5%. No provision for Hong Kong profits tax was required as these entities incurred losses during 2011 and 2010. Management believes the realization of tax benefits from the net operating losses is uncertain due to the Company’s current operating history and continuing losses. Accordingly, no net deferred tax benefit has been recorded.
The Company’s subsidiaries in China would be subject to China income tax at a statutory rate of 25% in 2011 and 2010. However, these subsidiaries are located in special economic regions and/or qualify as “new or high-technology enterprises” that are allowed special tax reductions until 2012. The Company’s subsidiaries in China were subject to a special tax rate was 24% and 22% in 2011 and 2010 respectively.
Income tax expense for 2011 and 2010 is summarized as follows:
Provision for income taxes mainly represents the PRC income taxes calculated at the applicable rate on SinoHub Electronics Shenzhen, Limited and SinoHub SCM Shenzhen, Limited.
The reconciliation of income taxes computed at the statutory income tax rates to total income taxes for the years ended December 31, 2011 and 2010 is as follows:
Deferred tax assets and liabilities are recorded for the estimated tax impact of temporary differences between the tax and book basis of assets and liabilities, and are recognized based on the enacted statutory tax rates for the year in which the Company expects the differences to reverse. A valuation allowance is established against a deferred tax asset when it is more likely than not that the asset or any portion thereof will not be realized. The Company provided a full valuation allowance against the deferred tax benefits related to net operating losses for the year ended December 31, 2011 and 2010.
An analysis of the Company’s deferred tax liabilities and deferred tax assets as of December 31, 2011 and 2010 was as follows:
18. CONCENTRATIONS AND RISKS
Substantially all of Company's assets are located in the PRC and Hong Kong.
During 2011 and 2010, 70% and 40% of revenues were derived from overseas sales, respectively.
Major customers and sales to those customers as a percentage of total sales were as follows:
19. SEGMENT INFORMATION
Since the Company began engaging in electronic products manufacturing and sales (ICM) in 2010, the Company has been organized as two business segments, electronics product manufacturing and sales (ICM) and electronic component sales and services (ECSS). The Company follows the provision of authoritative pronouncement issued by the FASB regarding disclosures about segments of an enterprise and related information, which establishes standards for reporting information about operating segments. Operating segments are defined as components of an enterprise about which discrete financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance.
The Company's chief operating decision maker is the Chief Executive Officer. The following were details of the Company's reportable segments:
20. GEOGRAPHICAL REVENUE
Of SinoHub’s $196.2 million in revenue in 2011, approximately $58.2 million was from sales in PR China and $138 million was from sales in Hong Kong.
21. SUBSEQUENT EVENTS
On February 13, 2012, the Company entered into a Joint Venture Agreement (the “Agreement”) with Ciao Telecom, Inc. (“Ciao Telecom”) relating to the manufacture and sale of mobile communications devices in Brazil. Pursuant to the terms of the Agreement, the joint venture will create a Brazilian corporation to be named CiaoHub, S.A. (“CiaoHub”). SinoHub and Ciao Telecom will each initially own 46.5% of CiaoHub, with the remaining 7% to be equally divided among the seven directors of CiaoHub. The Agreement provides that Ciao Telecom will be responsible for obtaining land, government permits and debt financing for the construction of a factory in Brazil and for organizing and completing the construction of the factory. Ciao will also be responsible for the marketing of the products produced by the factory. The Agreement further provides that SinoHub will be responsible for developing a business plan to facilitate CiaoHub’s fund-raising efforts, managing the operations of the factory and assisting in the sale of the products produced by the factory.