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TMCNet:  ACL SEMICONDUCTORS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

[November 19, 2012]

ACL SEMICONDUCTORS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion highlights the principal factors that have affected our financial condition and results of operations as well as our liquidity and capital resources for the periods described.



The information contained in this Form 10-Q is intended to update the information contained in our annual report on Form 10-K for the year ended December 31, 2011, (the "Form 10-K"), filed with the Securities and Exchange Commission ("SEC"), and presumes that readers have access to, and will have read, the "Management's Discussion and Analysis of Financial Condition and Results of Operation," our consolidated financial statements and the notes thereto, and other information contained in the Form 10-K. The following discussion and analysis also should be read together with our condensed consolidated financial statements and the notes to the condensed consolidated financial statements and the notes thereto included elsewhere in this Form10-Q.

Forward-Looking Statements Information included in this Form 10-Q may contain forward-looking statements.

Except for the historical information contained in this discussion of the business and the discussion and analysis of financial condition and results of operations, the matters discussed herein are forward looking statements. These forward looking statements include but are not limited to the Company's plans for sales growth and expectations of gross margin, expenses, new product introduction, and the Company's liquidity and capital needs. This information may involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by any forward-looking statements. Forward-looking statements, which involve assumptions and describe our future plans, strategies and expectations, are generally identifiable by use of the words "may," "will," "should," "expect," "anticipate," "estimate," "believe," "intend" or "project" or the negative of these words or other variations on these words or comparable terminology. In addition to the risks and uncertainties described in "Risk Factors" contained in the Form 10-K, these risks and uncertainties may include consumer trends, business cycles, scientific developments, changes in governmental policy and regulation, currency fluctuations, economic trends in the U.S. and inflation.

Forward-looking statements are based on assumptions that may be incorrect, and there can be no assurance that any projections or other expectations included in any forward-looking statements will come to pass. Our actual results could differ materially from those expressed or implied by the forward-looking statements as a result of various factors. Except as required by applicable laws, we undertake no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.

Company Overview and Background The Company has been primarily engaged in the business of distribution of memory products mainly under "Samsung" brand name which principally comprised Dynamic Random Access Memory ("DRAM"), Graphic Random Access Memory ("Graphic RAM"), and Flash for the Hong Kong Special Administrative Region ("Hong Kong") and People's Republic of China ("PRC" or the "China") markets formerly by itself and after April 1, 2012 indirectly through its wholly owned subsidiary Atlantic Components Limited ("Atlantic"), a Hong Kong incorporated company. The Company, through its wholly owned subsidiary ACL International Holdings Limited, owns 30% equity interest in ATMD (Hong Kong) Limited ("ATMD"), the joint venture with Tomen Devices Corporation ("Tomen"). Through the acquisition of Jussey Investments Limited ("Jussey") on September 28, 2012, the Company has diversified its product portfolio and customers network, obtained design and manufacturing capabilities, and tapped into the blooming telecommunication industry with access to the 3G baseband licenses.

ATMD, a company incorporated in Hong Kong, integrated both Atlantic and Tomen's Samsung business in Hong Kong and PRC regions. On April 1, 2012, ATMD entered into a distribution agreement with Samsung Electronics Hong Kong Co., Ltd. and began to sell and distribute Samsung's products to the Greater China market, as consented to and approved by Samsung. Apart from the original authorized distribution of products distributed by Atlantic, ATMD is also authorized to distribute Applicable System LSI and Applicable System LCD products including, but not limited to wifi modules, camera modules, and smartphone panels which used in the rapidly growing segments such as smartphones, netbooks, tablets, personal navigation devices, digital TV, Set Top Box, and wireless handheld PDAs. ACL Holdings owns 30% equity interest of ATMD and Tomen owns the remaining 70% equity interest of ATMD. Mr. Chung-Lun Yang ("Mr. Yang"), the Company's Chief Executive Officer was appointed the Chief Executive Officer of ATMD. Since ATMD is a newly established company, there will be a transitional period for account setup on both its suppliers and customers' systems. Atlantic will continue conducting its business with its customers during this transitional period. Around 35% of the sales were transferred to ATMD as of September 30, 2012. This percentage is estimated to increase to 90% when the transition is completed. Since the Company has moved its Samsung sales team to ATMD commencing from April 1, 2012, the Company will compensate ATMD for the services provided to the Company relating to the sales of Samsung memory products during this transitional period. Subsequent to the start of the operations of ATMD, the relationships between sales, cost of sales, and operating expenses reflected in the financial information included in this document regarding the Company are expected to change in accordance with the transition of the Company's business as described above.

28 PART I - FINANCIAL INFORMATION ACL SEMICONDUCTORS INC. AND SUBSIDIARIES On September 28, 2012, the Company acquired Jussey, a company incorporated in British Virgin Islands, which owns 100% equity interest in eVision Telecom Limited ("eVision"), a Hong Kong incorporated company, and 80% equity interest in USmart Electronic Products Limited ("USmart"), a Hong Kong incorporated company, which owns 100% equity interest of Dongguan Kezheng Electronics Limited ("Kezheng"), a wholly foreign-owned enterprise ("WFOE") organized under the laws of the People's Republic of China (the "PRC").

USmart was founded in 2006 and it conducts its business through either itself or Kezheng, which has a factory located in Dongguan, PRC. USmart provides both ODM (Original Design Manufacturing) and OEM (Original Equipment Manufacturing) services for various electronic products, such as computer and peripherals, flash storage devices and home electronic products. USmart has its own research and development ("R&D") and production teams. With the support from eVision, the business of which is described below, USmart is capable of providing its customers with total solutions from design to manufacture. USmart also holds its own brands - USmart and VSmart, which can be used on a broad spectrum of products including covering memory storage devices, visual and audio products such as digital flat screen television, DAB (Digital Audio Broadcasting) radios, digital photo frames, and other home electronic products. In 2010, USmart began its business development in the telecommunication industry, and successfully obtained the W-CDMA (Wideband CDMA is one of the third-generation ("3G") wireless standards) license from Intel Mobile Communications GmbH., which offers cellular platforms for global phone makers. W-CDMA baseband is adapted by China Unicom, one of the three major telecommunication carriers in the PRC.

Founded in 2011, eVision is a Hong Kong based solution house that specializes in CDMA2000 (also known as Evolution-Data Optimized or "EV-DO") platform. CDMA2000 is one of the 3G wireless standards. This standard is adapted by China Telecom, one of the three major telecommunication carriers in China. The principal function of eVision is to provide CDMA2000 solution to USmart. In May 2011, eVision entered into an exclusive R&D servicing agreement (the "Servicing Agreement") with an independent third party in the PRC (the "R&D House"), a solution house that works closely with South China University of Technology and has a R&D team consisting of members with advanced academic qualifications. The R&D House holds, on behalf of eVision, a CDMA2000 software license granted by VIA Telecom Co. Ltd. According to the Servicing Agreement, the R&D House provides R&D services relating to CDMA2000 technology exclusively to eVision, and eVision holds the sole and exclusive right, title and interest to and in the aforementioned license and any R&D results/products obtained or developed by the R&D House during the term of the Servicing Agreement. eVision will also hold all the intellectual property rights that are obtained or developed by the R&D House in the course of such research.

On March 23, 2010, the Company concluded that Aristo Technologies Limited ("Aristo"), a related company solely owned by Mr. Yang, is a variable interest entity under FASB ASC 810-10-25 and is therefore subject to consolidation with the Company beginning fiscal year 2007 under the guidance applicable to variable interest entities. Atlantic sells Samsung memory chips to Aristo and allows long grace periods for Aristo to repay the open accounts receivable. Being the biggest creditor, the Company does not require Aristo to pledge assets or enter into any agreements to bind Aristo to specific repayment terms. The Company does not provide any bad debt provision or experience derived from Aristo. Although, the Company is not involved in Aristo's daily operation, it believes that there will not be significant additional risk derived from the trading relationship and transactions with Aristo. Aristo is engaged in the marketing, selling and servicing of computer products and accessories including semiconductors, LCD products, mass storage devices, consumer electronics, computer peripherals and electronic components for different generations of computer related products. In addition to Samsung-branded products, Aristo carries various brands of products, such as sells Hynix, Micron, Qimonda, Lexar, Dane-Elec, Elixir, SanDisk and Winbond. Aristo also provides value-added services to its products and resells it to its customers. Aristo 2011 and 2010 sales were around 14 million and 15 million; it was a small distributor that accommodated special requirementsfor specific customers.

As of September 30, 2012, ACL had more than 30 customers in Hong Kong and Southern China.

29 PART I - FINANCIAL INFORMATION ACL SEMICONDUCTORS INC. AND SUBSIDIARIES Corporate Structure [[Image Removed]] Financial Highlights Reduced demand and decreased average selling prices continued for the DRAM market in the third quarter of 2012. Although NAND flash market demand was quiet in the beginning of the third quarter of 2012 due to slow economic recovery worldwide, Toshiba's announcement of capacity cuts and the arrival of Apple's iPhone 5 in September have provided positive market stimulation. Slightly tight supply of NAND flash can be seen in September. According to DRAMeXchange, a research division of TrendForce, in the third quarter of 2012 NAND flash average selling price declined by 3%, while bit shipment volume rose by 10% compared to the second quarter of 2012.

As the Company's business of memory products distribution under the "Samsung" brand is gradually being transferred to its investing joint venture, ATMD, the net sales decreased significantly compared to the same period in 2011. The Company's net sales for the three months ended September 30, 2012 ("third quarter of 2012") was $49,488,031, decrease of $24,526,236 or 33.1% from $74,014,267 for the three months ended September 30, 2011 ("third quarter of 2011"). The decrease in our net sales was mainly due to the transfer of "Samsung" business to the new joint venture, ATMD.

The Company's gross profit for the third quarter of 2012 was $861,540, representing a decrease of $2,860,398 over a gross profit of $3,721,938 in the same period of 2011. Gross profit margin for the third quarter of 2012 decreased to 1.7% from gross profit margin of 5.0% in the same period of 2011. The reduced selling prices of DRAM have caused the low gross profit margin.

For the three months ended September 30, 2012, the Company recorded operating expenses of $1,158,969, down $357,782 or 23.6% from $1,516,751 for three months ended September 30, 2011; this decrease was mainly due to a decrease of directors' remuneration and entertainment expenses. Other income for the three months ended September 30, 2012 were $1,485,188, up $1,574,714 from expenses of $89,526 for three months ended September 30, 2011; this increase in other income was mainly due to the write back of bad debts provision of $1,648,390.

With the large reduction in total expenses for the third quarter of 2012, the impact of the reduction in net sales and gross profit margin for the same period is reduced. The Company recorded a net income of $1,154,809 for the third quarter of 2012, down $763,430 from $1,918,239 for the same period of 2011.

30 PART I - FINANCIAL INFORMATION ACL SEMICONDUCTORS INC. AND SUBSIDIARIES Although the market condition continues to be weak and volatile for DRAM market, the Company is optimistic about the Company's prospects for the fourth quarter of 2012. NAND flash sales are expected to increase as ultrabooks, smartphones and tablets are expected to drive the demand. However, revenues generated from the sales of DRAM are expected to remain to be influenced by global economic conditions. Since the Company's Samsung business will be gradually transferred to ATMD, the Company expects that its net sales will continue to decrease in the coming quarters. Eventually, the Company expects that approximately 90% of its sales of Samsung products will be transferred to ATMD, and the Company will receive 30% of ATMD's net income based on the Company's ownership interest in ATMD. As a whole, the Company expects to see growth in the fourth quarter. With the acquisition of Jussey, the Company does not expect revenue derived from Jussey will have a great influence in the Company's net sales. However, the Company foresees that it will gradually increase the Company's gross profit margin.

Results of Operations Three Months Ended Nine Months Ended September 30, September 30, September 30, September 30, 2012 2011 2012 2011 (Unaudited) (Unaudited) (Unaudited) (Unaudited) Net sales $ 49,488,031 $ 74,014,267 $ 123,266,932 $ 295,783,014 Cost of sales 48,626,491 70,292,329 121,650,790 290,462,833 Gross profit 861,540 3,721,938 1,616,142 5,320,181 Operating expensesSales and marketing expenses 69,580 22,918 237,220 83,408 General and administrative expenses 1,089,389 1,493,833 3,228,567 4,303,609 Profit (loss) from operations (297,429 ) 2,205,187 (1,849,645 ) 933,164 Other (income) expenses (1,485,188 ) 89,526 (1,052,031 ) 180,047 Income (loss) before income taxes 1,187,759 2,115,661 (797,614 ) 753,117 Income taxes 32,950 197,422 32,950 197,422 Net income (loss) $ 1,154,809 $ 1,918,239 $ (830,564 ) $ 555,695 Dividend paid - - 7 - 1,154,809 1,918,239 (830,571 ) 555,695 Earnings (loss) per share - basic and diluted $ 0.04 $ 0.07 $ (0.03 ) $ 0.02 Net sales Net sales are recognized upon the transfer of the legal title of the products to the customers. The quantity of products the Company selling fluctuates with changes in demand from its customers. The suggested prices set by our suppliers that we charge our customers are subject to change by us based on prevailing economic conditions and its impact on the market.

Cost of sales Cost of sales consists of costs of goods purchased from Samsung, and purchases from other Samsung authorized distributors. Many factors affect our gross margin, including, but not limited to, the volume of production orders placed on behalf of its customers, the competitiveness of the memory products industry and the availability of cheaper Samsung memory products from overseas Samsung distributors due to regional demand and supply situations. Nevertheless, our procurement operations are supported by Samsung pursuant to a distributorship agreement between the Company and Samsung. Our cost of goods, as a percentage of total revenues, amounted to approximately 98.3% for the three months ended September 30, 2012 and approximately 95.0% for the three months ended September 30, 2011.

31 PART I - FINANCIAL INFORMATION ACL SEMICONDUCTORS INC. AND SUBSIDIARIES Operating expenses Our operating expenses for the three months ended September 30, 2012 and 2011 were comprised of sales and marketing expenses, and general and administrative expenses only.

Sales and marketing expenses consisted primarily of costs associated with advertising and marketing activities.

General and administrative expenses include all corporate and administrative functions that serve to support our current and future operations and provide an infrastructure to support future growth. Major items in this category include management and staff salaries, rent/leases, professional services, and travel and entertainment. We expect these expenses to increase as a result of increased legal and accounting fees anticipated in connection with our compliance with ongoing reporting and accounting requirements of the SEC and as a result of anticipated expansion by the Company of its business operations. Sales and marketing expenses are expected to fluctuate as a percentage of sales due to the addition of sales personnel and various marketing activities planned throughout the year.

Interest expense, including finance charges, relates primarily to the Company's short-term and long-term bank borrowings.

Unaudited Comparisons for Three and Nine Months ended September 30, 2012 to the Three and Nine Months Ended September 30, 2011 Net Sales The following table presents our net sales for the three and six months ended September 30, 2012 and 2011, respectively: Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 % Change 2012 2011 % Change $ 49,488,031 $ 74,014,267 -33.1 % $ 123,266,932 $ 295,783,014 -58.3 % Net sales decreased by $24,526,236 or 33.1%, from $74,014,267 for the three months ended September 30, 2011 to $49,488,031 for the three months ended September 30, 2012. For the nine months ended September 30, 2012 net sales decreased by $172,516,082 or 58.3%, from $295,783,014 for the nine months ended September 30, 2011 to $123,266,932. These decreases in net sales were mainly due to significant reductions in demand and decreasing average selling prices of our products and the transfer of business to the newly established joint venture, ATMD.

Cost of sales The following table presents our cost of sales for the three and nine months ended September 30, 2012 and 2011, respectively: Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 % Change 2012 2011 % Change $ 48,626,491 $ 70,292,329 -30.8 % $ 121,650,790 $ 290,462,833 -58.1 % Cost of sales decreased by $21,665,838 or 30.8%, from $70,292,329 for the three months ended September 30, 2011 to $48,626,491 for the three months ended September 30, 2012. For the nine months ended September 30, 2012, cost of sales decreased by $168,812,043 or 58.1%, from $290,462,833 for the nine months ended September 30, 2011 to $121,650,790. These decreases were mainly due to decrease of sales volume.

32 PART I - FINANCIAL INFORMATION ACL SEMICONDUCTORS INC. AND SUBSIDIARIES Gross Profit (Loss) The following table presents our gross profit for the three and six months ended September 30, 2012 and 2011, respectively: Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 % Change 2012 2011 % Change $ 861,540 $ 3,721,938 -76.9 % $ 1,616,142 $ 5,320,181 -69.6 % Gross profit decreased by $2,860,398, from gross profit of $3,721,938 for the three months ended September 30, 2011 to gross profit of $861,540 for the three months ended September 30, 2012. For the nine months ended September 30, 2012, gross profit decreased by $3,704,039 or 69.6%, from $5,320,181 for the nine months ended September 30, 2011 to $1,616,142. These decreases in gross profit were mainly due to reducing demand and decreasing average selling prices ofDRAM and NAND flash products.

Sales and Marketing Expenses The following table presents the sales and marketing expenses for the three and nine months ended September 30, 2012 and 2011, respectively: Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 % Change 2012 2011 % Change $ 69,580 $ 22,918 203.6 % $ 237,220 $ 83,408 184.4 % For the three months ended September 30, 2012, sales and marketing expenses increased by $46,662, or 203.6%, from $22,918 for the three months ended September 30, 2011 to $69,580. For the nine months ended September 30, 2012, sales and marketing expenses increased by $153,812 or 184.4%, from $83,408 for the nine months ended September 30, 2011 to $237,220. Such increases were directly attributable to the increase of sales compensation paid to ATMD for the services rendered by ATMD to us during the transitional period.

General and Administrative Expenses The following table presents the general and administrative expenses for the three and nine months ended September 30, 2012 and 2011, respectively: Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 % Change 2012 2011 % Change $ 1,089,389 $ 1,493,833 -27.1 % $ 3,228,567 $ 4,303,609 -25.0 % For the three months ended September 30, 2012, general and administrative expenses decreased by $404,444 or 27.1%, from $1,493,833 for the three months ended September 30, 2011 to $1,089,389. For the nine months ended September 30, 2012, general and administrative expenses decreased by $1,075,042 or 25.0%, from $4,303,609 for the nine months ended September 30, 2011 to $3,228,567. These decreases were principally attributable to a decrease in directors' remuneration, and entertainment expenses.

33 PART I - FINANCIAL INFORMATION ACL SEMICONDUCTORS INC. AND SUBSIDIARIES Income (loss) from Operations The following table presents the income from operations for the three and nine months ended September 30, 2012 and 2011, respectively: Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 % Change 2012 2011 % Change $ 1,350,961 $ 2,205,187 -38.7 % $ (201,255 ) $ 933,164 -121.6 % Income from operations for the three months ended September 30, 2012 decreased by $854,226 or 38.7%, from $2,205,187 for the three months ended September 30, 2011 to $1,350,961. For the nine months ended September 30, 2012, income from operations decreased by $1,134,419 or 121.6%, from $933,164 for the nine month ended September 30, 2011 to loss of $201,255. These decreases were mainly due to the write back of bad debts provision of $1,648,390 during the period and decrease of sales volume and the gross profit margin when compared to the same period last year.

Interest Income The following table presents the interest income for the three and nine months ended September 30, 2012 and 2011, respectively: Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 % Change 2012 2011 % Change $ 572 $ 667 -14.2 % $ 2,165 $ 1,564 38.4 % For the three months ended September 30, 2012, interest income decreased by $95 or 14.2%, from $667 for the three months ended September 30, 2011 to $572. This decrease was due to decrease of restricted deposit during the period.

For the nine months ended September 30, 2012, interest income increased by $601 or 38.4%, from $1,564 for the nine months ended September 30, 2011 to $2,165.

This increase was due to increase of average bank deposit rate when compared to the same period in 2011.

Interest Expense The following table presents the interest expense for the three and nine months ended September 30, 2012 and 2011, respectively: Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 % Change 2012 2011 % Change $ 265,807 $ 162,751 63.3 % $ 700,567 $ 372,628 88.0 % For the three months ended September 30, 2012, interest expense increased by $103,056 or 63.3%, from $162,751 for the three months ended September 30, 2011 to $265,807. For the nine months ended September 30, 2012, interest expense increased by $327,939 or 88%, from $372,628 for the nine months ended September 30, 2011 to $700,567. These changes were mainly due to increased interest on bank term loans and the usage of bank lines by the Company to deal with customers and suppliers during the period in 2012.

34 PART I - FINANCIAL INFORMATION ACL SEMICONDUCTORS INC. AND SUBSIDIARIES Reverse for provision of doubtful account The following table presents the reverse for provision of doubtful account for the three and nine months ended September 30, 2012 and 2011, respectively: Three Months Ended September 30, Nine MonthsEnded September 30, 2012 2011 % Change 2012 2011 % Change $ 1,648,390 $ - N/A $ 1,648,390 $ - N/A For the three months and nine months ended September 30, 2012, the amount of $1,648,390 incurred during the period was written back last year provision made on accounts receivable. No such income occurred for the same period in 2011. The reversal of bad debts provision was due to the decrease of accounts receivable in effect from the acquisition of Jussey on September 28, 2012 which rendered the accounts receivable to be eliminated in the consolidate process.

Income Tax Provision The following table presents the income tax provision for the three and nine months ended September 30, 2012 and 2011, respectively: Three Months Ended September 30, Nine MonthsEnded September 30, 2012 2011 % Change 2012 2011 % Change $ 32,950 $ 197,422 -83.3 % $ 32,950 $ 197,422 -83.3 % There are no tax provision made due to no profit being earned by the Company during the period of three months and nine months ended September 30, 2012. The amounted $32,950 incurred during the period was represented the audit adjustment of profit tax under provision for Atlantic 2011.

Liquidity and Capital Resources Our principal sources of liquidity have been cash from operations, bank lines of credit and credit terms from suppliers. Our principal uses of cash have been for operations and working capital. We anticipate these uses will continue to be our principal uses of cash in the future.

As of September 30, 2012, we had revolving lines of credit and loan facilities in the aggregate amount of $18,103,310, of which $1,323,982 was available for drawdown as short-term loans repayable within 90 days. Detailed disclosures on credit facilities are made in Note 8 and Note 9 of Notes to the Condensed Consolidated Financial Statements (Unaudited) for the quarter ended September 30, 2012, including the amounts of facilities, outstanding balances, maturity date, and pledges of assets.

Our ability to draw down under our various credit and loan facilities is, in each case, subject to the prior consent of the relevant lending institution to make advances at the time of the requested advance and each facility (other than with respect to certain long term mortgage loans) is payable within 90 days of drawdown. As a result of the general tightening of credit markets in Hong Kong and Asia, many lenders have revised the terms of their revolving credit lines to levels we did not deem commercially reasonable. Accordingly, on a case by case basis, we may elect to terminate or not renew several of our credit facilities resulting in significant reduction in our available short term borrowings.

To address the reduction in available credit facilities, we are relying on our own cash reserves and cash flows from operations to fund our ongoing operations and have tightened the credit terms we extend to our customers. As a result, the Company does not expect that the reduction in available credit facilities is going to have a materially adverse impact upon our operations for the foreseeable future.

We will continue to seek additional sources of available financing on acceptable terms; however, there can be no assurance that we will be able to obtain the necessary additional capital on a timely basis or on acceptable terms, if at all. In addition, if the results are negatively impacted and delayed as a result of political and economic factors beyond management's control, our capital requirements may increase.

35 PART I - FINANCIAL INFORMATION ACL SEMICONDUCTORS INC. AND SUBSIDIARIES The short-term borrowings from banks to finance the cash flow required to finance the purchase of products from suppliers which must be made a day in advance of the release of goods before receiving payments from customers upon physical delivery of such goods in Hong Kong which, in most instances, take approximately two days from the date of such delivery.

The following factors, among others, could have negative impacts on our results of operations and financial position: the termination or change in terms of the Distributorship Agreement; pricing pressures in the industry; a continued downturn in the economy in general or in the memory products sector; an unexpected decrease in demand for Samsung's memory products; our ability to attract new customers; an increase in competition in the memory products market; and the ability of some of our customers to obtain financing.

Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We are under no duty to update any of the forward-looking statements after the date of this report to conform them to actual results or to make changes in our expectations.

Net Cash Provided by Operating Activities For the nine months ended September 30, 2012, net cash provided by operating activities was $2,181,469 while for the nine months ended September 30, 2011, net cash provided by operating activities was $4,466,736, a decrease in cash provided of $2,285,267. This decrease was primarily due to a decrease of accounts receivable, accounts payable and increase of deposit received from customers as of September 30, 2012.

Net Cash Used for Investing Activities For the nine months ended September 30, 2012, net cash used for investing activities was $1,535,199 while for the nine months ended September 30, 2011, net cash used for investing activities was $6,349,337, a decrease in cash used of $4,814,138. This decrease was primarily due to decrease of amounts due from Aristo / Mr. Yang and restricted cash as of September 30, 2012.

Net Cash Used for Financing Activities For the nine months ended September 30, 2012, net cash used for financing activities was $1,021,105 while for the nine months ended September 30, 2011, net cash provided by financing activities was $1,764,303, an increase in cash used of $2,785,408. This increase was due to the increase of cash outflow in repayment on lines of credit and notes payable loans as of September 30, 2012 offset by the increase of cash inflow by the bank borrowing for term.

Principles of Consolidation The consolidated financial statements of ACL Semiconductors Inc. include the accounts of Atlantic Components Ltd., a Hong Kong subsidiary, ACL Holdings International Ltd., a Hong Kong subsidiary, Alpha Perform Technology Limited, a BVI subsidiary, and Aristo Technologies Ltd., a Hong Kong company, a variable interest entity deemed to be a subsidiary. All significant inter-company transactions and balances are eliminated in consolidation.

Critical Accounting Policies The SEC recently issued Financial Reporting Release No. 60, "Cautionary Advice Regarding Disclosure About Critical Accounting Policies" ("FRR 60"), suggesting companies provide additional disclosure and commentary on their most critical accounting policies. In FRR 60, the SEC defined the most critical accounting policies as the ones that are most important to the portrayal of a company's financial condition and operating results, and require management to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, our most critical accounting policies include: inventory valuation, which affects cost of sales and gross margin; policies for revenue recognition, allowance for doubtful accounts, and stock-based compensation. The methods, estimates and judgments we use in applying these most critical accounting policies have a significant impact on the results we report in our consolidated financial statements.

Revenue Recognition The Company derives revenues from resale of computer memory products. The Company recognizes revenue in accordance with the ASC 605 "Revenue Recognition".

Under ASC 605, revenue is recognized when there is persuasive evidence of an arrangement, delivery has occurred or services are rendered, the sales price is determinable, and collectability is reasonably assured. Revenue typically is recognized at time of shipment. Sales are recorded net of discounts, rebates, and returns, which historically were not material.

36 PART I - FINANCIAL INFORMATION ACL SEMICONDUCTORS INC. AND SUBSIDIARIES Impairment of long-lived assets We account for impairment of property, plant and equipment in accordance with FASB ASC 360 "Property, Plant and Equipment" and ASC 350 "Intangibles - Goodwill and Other". The carrying value of a long-lived asset is considered impaired when the anticipated undiscounted cash flow from such asset is separately identifiable and is less than its carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair market value of the long-lived asset. Fair market value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved. Losses on long-lived assets to be disposed of are determined in a similar manner, except that fair market values are reduced for the cost to dispose. During the reporting years, there was no impairment loss incurred.

Competitive pricing pressure and changes in interest rates, could materially and adversely affect our estimates of future net cash flows to be generated byour long-lived assets.

Inventory Valuation Our policy is to value inventories at the lower of cost or market on a part-by-part basis. In addition, we write down unproven, excess and obsolete inventories to net realizable value. This policy requires us to make a number of estimates and assumptions including market and economic conditions, product lifecycles and forecast demand for our product to value our inventory. To the extent actual results differ from these estimates and assumptions, the balances of reported inventory and cost of products sold will change accordingly. Since Aristo supplies different generations of computer related products, older generation products will sell more slowly owing to lower market demand.

According to the management experience and estimation of the actual market situation, old generation products carrying on hand for ten years will have no re-sell value. Therefore, these inventories on hand over ten years will be written off by Aristo immediately.

Allowance for Doubtful Accounts.

We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. Our allowance for doubtful accounts is based on our assessment of the collectability of specific customer accounts, the aging of accounts receivable, our history of bad debts, and the general condition of the industry. If a major customer's credit worthiness deteriorates, or our customers' actual defaults exceed our historical experience, our estimates could be changed and impact our reported results.

Jointly-controlled entity A jointly-controlled entity is a corporate joint venture that is subject to joint control, resulting in none of the participating parties having unilateral control over the economic activity of the jointly-controlled entity. The Group's investment in a jointly-controlled entity is stated in equity method for the consolidated statement of financial position the Group's shares of the equity of a jointly-controlled entity and the consolidated income statement and consolidated reserves, respectively.

New Accounting Pronouncements In August 2012, the FASB has issued Accounting Standards Update (ASU) No.

2012-03, Technical Amendments and Corrections to SEC Sections. This ASU amends various SEC paragraphs pursuant to SAB 114, SEC Release No. 33-9250, and ASU 2010-22, which amend or rescind portions of certain SAB Topics.

In October 2012, the FASB has issued Accounting Standards Update (ASU) No.

2012-04, Technical Corrections and Improvements. This ASU make technical corrections, clarifications, and limited-scope improvements to various Topics throughout the Codification. The amendments in this ASU that will not have transition guidance will be effective upon issuance for both public entities and nonpublic entities. For public entities, the amendments that are subject to the transition guidance will be effective for fiscal periods beginning after December 15, 2012. For nonpublic entities, the amendments that are subject to the transition guidance will be effective for fiscal periods beginning after December 15, 2013.

In October 2012, the FASB has issued Accounting Standards Update (ASU) No.

2012-06, Business Combinations (Topic 805): Subsequent Accounting for an Indemnification Asset Recognized at the Acquisition Date as a Result of a Government-Assisted Acquisition of a Financial Institution. This ASU addresses the diversity in practice about how to interpret the terms on the same basis and contractual limitations when subsequently measuring an indemnification asset recognized in a government-assisted (Federal Deposit Insurance Corporation or National Credit Union Administration) acquisition of a financial institution that includes a loss-sharing agreement (indemnification agreement). For public and nonpublic entities, the amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2012. Early adoption is permitted. The amendments should be applied prospectively to any new indemnification assets acquired after the date of adoption and to indemnification assets existing as of the date of adoption arising from a government-assisted acquisition of a financial institution.

37 PART I - FINANCIAL INFORMATION ACL SEMICONDUCTORS INC. AND SUBSIDIARIES Under the guidance in this ASU, an entity also has the option to bypass the qualitative assessment for any indefinite-lived intangible asset in any period and proceed directly to performing the quantitative impairment test. An entity will be able to resume performing the qualitative assessment in any subsequent period.

The amendments in this ASU are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted, including for annual and interim impairment tests performed as of a date before July 27, 2012, if a public entity's financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance.

The Company has considered all new accounting pronouncements and has concluded that there are no new pronouncements that may have a material impact on results of operations, financial condition, or cash flows, based on current information.

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