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 UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q/A

(Amendment No. 1)

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2011

 

or

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ____ to _____

 

Commission File Number:  000-28767

 

China 3C Group

(Exact name of registrant as specified in its charter)

 

Nevada 88-0403070

(State or other jurisdiction of incorporation or

organization)

(I.R.S. Employer Identification No.)

 

368 HuShu Nan Road

HangZhou City, Zhejiang Province, China 310014

 

(Address of Principal Executive Offices) (Zip Code)

 

086-0571-88381700

(Registrant’s telephone number, including area code)

 


(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: 

Yes x   No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yesx  No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated

filer ¨

  Accelerated filer ¨  

Non-accelerated filer ¨

(Do not check if a smaller

reporting company)

 

Smaller reporting

company x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule No 12b-2 of the Exchange Act). Yes ¨  No x

As of November 20, 2011, the registrant had 58,911,327 shares of common stock outstanding.

 

 
 

 

EXPLANATORY NOTE

 

This Amendment No. 1 to our Quarterly Report on Form 10-Q/A ("Form 10-Q/A") is being filed to amend our Quarterly Report on 10-Q for the period ended September 30, 2011 ("Form 10-Q"), which was originally filed with the Securities and Exchange Commission (the "SEC") on November 21, 2011. We are filing this amendment to include disclosure consistent with comments received by the SEC. We are amending and restating Items 1, 2, and 4 in this Form 10-Q/A.

 

Below is a summary of these errors and the related corrections:

 

·The Company reclassified fees paid to department stores from a contra revenue account to selling, general and administrative expenses. The amount of $758 and $1,072 were previously classified in contra-revenue account as a deduction to net sales for the three months ended September 30, 2011 and 2010.  The Company moved the amount to selling expenses, and it is reported as selling, general and administrative expenses in the statement of operations and comprehensive loss.  The reclassification caused a $758 increase in net sales from $28,543 to $29,301 and a corresponding increase of $758 in Selling, general and administrative expenses from $7,421 to $8,179 in the third quarter 2011; a $1,072 increase in net sales from $36,308 to $37,380 and a corresponding increase of $1,072 in Selling, general and administrative expenses from $5,074 to $6,146 in the third quarter 2010; The gross profit increased $758 and $1,072 respectively in the third quarter 2011 and 2010. The loss from operations and net loss remained unchanged.  The impact of the restatement was limited to the presentation of the consolidated statements of operations and comprehensive income (loss). The consolidated balance sheets, the consolidated statements of stockholders’ equity and the related consolidated statements of cash flows remained unaffected.  See changes in Item 1.

 

·The Company amended Item 1 and 2 to clarify the fact that Capital did not sell its equity ownership in Zhejiang upon executing the contractual agreements in 2007. Capital remains as the owner of 100% equity of Zhejiang through shareholding entrustment agreements.

 

·The restatement above also affected the disclosure of segment reporting. As a result, we have amended Item 1, Note 14 - SEGMENT INFORMATION and Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

·The Company amended Item 4 revising our conclusions on the effectiveness of disclosure controls and procedures to “ineffective.”

 

In addition, this Form 10-Q/A contains new certifications by our Chief Executive Officer and our Chief Financial Officer, filed as exhibits hereto.

 

 
 

 

TABLE OF CONTENTS

 

    PAGE
PART I. FINANCIAL INFORMATION   3
     
Item 1. Financial Statements   3
     
Consolidated Balance Sheets as of September 30, 2011 (Unaudited) and December 31, 2010   3
     
Consolidated Statements of Operations and Comprehensive Loss for the Nine Months Ended September 30, 2011 and 2010 (Unaudited)   4
     
Consolidated Statements of Operations and Comprehensive Loss for the Three Months Ended September 30, 2011 and 2010 (Unaudited)   5
     
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2011 and 2010 (Unaudited)   6
     
Notes to Consolidated Financial Statements   7
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations   23
     
Item 4. Controls and Procedures   34
     
PART II. OTHER INFORMATION   34
     
Item 6. Exhibits   34
     
Signatures   34

 

2
 

 

PART I. FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

CHINA 3C GROUP AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands)

 

   September 30,   December 31, 
   2011   2010 
   (Unaudited)     
ASSETS          
           
Current assets:          
Cash and equivalents  $10,256   $26,249 
Accounts receivable, net   12,371    11,026 
Inventories   7,144    7,284 
Advances to suppliers   2,282    2,201 
Taxes receivable   -    1,200 
Prepaid expenses and other current assets   215    591 
Total current assets   32,268    48,551 
           
Property, plant and equipment, net   480    191 
Intangible asset, net   12,423    13,153 
Goodwill   -    11,229 
Refundable deposits   25    7 
Total assets  $45,196   $73,131 
           
LIABILITIES AND STOCKHOLDERS' EQUITY          
           
Current liabilities:          
Accounts payable  $4,809   $4,139 
Accrued expenses   2,241    4,536 
Income tax payable   -    736 
Total liabilities   7,050    9,411 
           
Stockholders' equity          
Common stock, $0.001 par value, 100,000,000 million shares authorized, 58,911,327 and 54,831,327 issued and outstanding as of September 30, 2011 and December 31, 2010, respectively   59    55 
Additional paid-in capital   21,485    20,252 
Subscription receivable   (50)   (50)
Statutory reserve   11,543    11,543 
Other comprehensive income   7,881    6,706 
Accumulated deficit   (2,772)   25,214 
Total stockholders' equity   38,146    63,720 
Total liabilities and stockholders' equity  $45,196   $73,131 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

3
 

 

CHINA 3C GROUP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

NINE MONTHS ENDED SEPTEMBER 30, 2011 and 2010 (UNAUDITED)

(in thousands)

 

   2011
(restated)
   2010
(restated)
 
Net sales  $103,058   $118,165 
Cost of sales   97,224    104,664 
Gross profit   5,834    13,501 
Selling, general and administrative expenses   23,466    19,407 
Goodwill impairment   11,229    - 
Loss from operations   (28,861)   (5,906)
           
Other (income) expense          
Interest income   (55)   (71)
Other income   (324)   (7)
Other expense   65    119 
Total other (income) expense   (314)   41 
           
Loss before income taxes   (28,547)   (5,947)
Provision for income taxes   152    254 
Net loss   (28,699)   (6,201)
Foreign currency translation adjustment   1,175    (10)
Comprehensive loss  $(27,524)  $(6,211)
           
Net loss available to common shareholders per share:          
Basic and Diluted  $(0.50)  $(0.11)
           
Weighted average shares outstanding:          
Basic and Diluted   57,896,822    54,831,327 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4
 

 

CHINA 3C GROUP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

THREE MONTHS ENDED SEPTEMBER 30, 2011 and 2010 (UNAUDITED)

(in thousands)

 

   2011
(restated)
   2010
(restated)
 
Net sales  $29,301   $37,380 
Cost of sales   28,856    33,725 
Gross profit   445    3,655 
Selling, general and administrative expenses   8,179    6,146 
Goodwill impairment   11,229    - 
Loss from operations   (18,963)   (2,491)
           
Other (income) expense          
Interest income   (19)   (24)
Other income   (462)   - 
Other expense   -    75 
Total other (income) expense   (481)   51 
           
Loss before income taxes   (18,482)   (2,542)
Provision for income taxes   23    64 
Net loss   (18,505)   (2,606)
Foreign currency translation adjustments   481    (184)
Comprehensive loss  $(18,024)  $(2,790)
           
Net loss available to common shareholders per share:          
Basic and Diluted  $(0.32)  $(0.05)
           
Weighted average shares outstanding:          
Basic and Diluted   58,585,240    54,831,327 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

5
 

 

CHINA 3C GROUP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

NINE MONTHS ENDED SEPTEMBER 30, 2011 and 2010 (UNAUDITED)

(in thousands)

 

   2011   2010 
         
CASH FLOWS FROM OPERATING ACTIVITIES          
Net loss  $(28,699)  $(6,201)
Adjustments to reconcile net loss to net cash used in operating activities:          
Depreciation   109    14 
Amortization of intangible assets   1,048    1,047 
Goodwill impairment   11,229    - 
Stock based compensation   892    376 
(Increase) / decrease in assets:          
Accounts receivable   (926)   3,943 
Taxes receivable   1,234    - 
Inventories   408    298 
Prepaid expenses and other current assets   206    29 
Refundable deposits   (17)   6 
Advance to suppliers   2    87 
Other receivables   189    1 
(Increase) / decrease in current liabilities:          
Advance from customers   -    24 
Accounts payable   511    32 
Accrued expenses   (3,268)   (1,087)
Income tax payable   (71)   40 
Net cash used in operating activities   (17,153)   (1,391)
           
CASH FLOW FROM INVESTING ACTIVITIES          
Purchase of property and equipment   (427)   (18)
Net cash used in investing activities   (427)   (18)
           
Effect of exchange rate changes on cash and equivalents   1,587    624 
           
Net decrease in cash   (15,993)   (785)
Cash and equivalents, beginning of period   26,249    29,908 
Cash and equivalents, end of period  $10,256   $29,123 
           
Supplemental disclosure of cash flow information:          
Income taxes paid  $888   $844 
Interest paid  $-   $- 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

6
 

 

CHINA 3C GROUP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2011 AND 2010 (UNAUDITED) AND DECEMBER 31, 2010 (AUDITED)

 

Note 1 - ORGANIZATION

 

China 3C Group (including its subsidiaries unless the context indicates otherwise, the “Company,” “China 3C,” “we,” “us,” or “our”) was incorporated on August 20, 1998 under the laws of the State of Nevada. Capital Future Developments Limited - BVI (“Capital”) was incorporated on July 22, 2004 under the laws of the British Virgin Islands (“BVI”). Zhejiang Yong Xin Digital Technology Company Limited (“Zhejiang”), Yiwu Yong Xin Communication Limited (“Yiwu”), Hangzhou Wang Da Electronics Company Limited (“Wang Da”), Hangzhou Sanhe Electronic Technology Limited (“Sanhe”), and Shanghai Joy & Harmony Electronics Company Limited (“Joy & Harmony”), Jinhua Baofa Logistic Ltd (“Jinhua”) were incorporated under the laws of Peoples Republic of China (“PRC”) on July 11, 2005, July 18, 1997, March, 30, 1998, April 12, 2004, August 20, 2003 and December 27, 2001, respectively. All dollar amounts are in thousands, unless otherwise indicated.

 

On December 21, 2005, Capital became a wholly owned subsidiary of China 3C through a reverse merger (the “Merger Transaction”). China 3C acquired all of the issued and outstanding capital stock of Capital pursuant to a Merger Agreement dated December 21, 2005 by and among China 3C, XY Acquisition Corporation, Capital and the shareholders of Capital (the “Merger Agreement”). Pursuant to the Merger Agreement, Capital became a wholly owned subsidiary of China 3C and, in exchange for the Capital shares, China 3C issued 35,000,000 shares of its common stock to the shareholders of Capital, representing 93% of the issued and outstanding capital stock of China 3C at that time and cash of $500.

 

On August 3, 2006, Capital completed the acquisition of 100% of the equity of Sanhe for a combination of cash and stock valued at $8,750 (consisting of 915,751 newly issued shares of the Company’s common stock and $5,000 in cash).

 

On November 28, 2006, Capital completed the acquisition of 100% of the equity of Joy & Harmony for a combination of cash and stock valued at $18,500 (consisting of 2,723,110 shares of the Company’s common stock and $7,500 in cash).

 

On August 15, 2007, we executed a series of contractual agreements between Capital and Zhejiang. The contractual agreements give Capital and its equity owners an obligation, and having ability to absorb, any losses, and rights to receive returns; however, these contractual agreements did not change the equity ownership of Zhejiang. We did not dispose Capital’s actual equity ownership of Zhejiang when we execute the contractual agreements. Capital entered into share-holding entrustment agreements with five individuals - Zhenggang Wang, Yimin Zhang, Huiyi Lv, Xiaochun Wang and Zhongsheng Bao to hold 35%, 20%, 20%, 15% and 10%, respectively, of the equity interest of Zhejiang on behalf of Capital on November 21, 2005. The entrustment agreements confirm that Capital is the actual owner of Zhejiang. Capital enjoys the actual shareholder’s rights and has the right to obtain any benefits received by the nominal holders. Zhenggang Wang is the CEO and shareholder of China 3C Group. Yimin Zhang, Huiyi Lv, Xiaochun Wang and Zhongsheng Bao have no other relationship with China 3C Group. No consideration was given to these individuals who held the equity of Zhejiang on behalf of Capital.

 

On July 6, 2009, China 3C and its subsidiary Zhejiang and Yiwu purchased 100% of Jinhua for RMB 120 million ($17,500) in cash.  Zhejiang acquired 90% and Yiwu acquired 10% of the equity interests in Jinhua.

 

7
 

 

Following the acquisition of Jinhua, the Company began providing logistical services to businesses in addition to its traditional business of resale and distribution of third party products such as mobile phones, facsimile machines, DVD players, stereos, speakers, MP3 and MP4 players, iPods, electronic dictionaries, CD players, radios and audio systems. 

 

ORGANIZATIONAL CHART

 

Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

The accompanying consolidated financial statements were prepared in conformity with accounting principles generally accepted in the United States of America (“US GAAP”).  The Company’s functional currency is the Chinese Renminbi (“RMB”), however, the accompanying consolidated financial statements have been translated and presented in United States Dollars (“$”, or “USD”).

 

8
 

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of China 3C and its wholly owned subsidiaries Capital, Wang Da, Yiwu, Joy & Harmony, Sanhe and Jinhua and variable interest entity Zhejiang, collectively referred to as the Company, unless the context indicates otherwise. All material intercompany accounts, transactions and profits were eliminated in consolidation.

 

Reclassifications

 

Certain prior period amounts were reclassified to conform to current period presentation, none of which changed total assets, liabilities, stockholder’s equity, net loss, or net loss per share.

 

Currency Translation

 

The accounts of Zhejiang, Wang Da, Yiwu, Sanhe, Joy & Harmony and Jinhua were maintained, and its financial statements were expressed, in RMB. Such financial statements were translated into USD in accordance with FASB ASC 830-10, “Foreign Currency Translation,” with the RMB as the functional currency. According to FASB ASC Topic 830-10, assets and liabilities were translated at the ending exchange rate, stockholders’ equity is translated at the historical rates and income statement items are translated at the average exchange rate for the period. The resulting translation adjustments are reported as other comprehensive income in accordance with FASB ASC Topic 220, “Reporting Comprehensive Income,” as a component of shareholders’ equity. Transaction gains and losses are reflected in the consolidated operations and comprehensive loss statements.

 

Use of Estimates

 

The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Risks and Uncertainties

 

The Company is subject to substantial risks from, among other things, intense competition associated with the industry in general, other risks associated with financing, liquidity requirements, rapidly changing customer requirements, limited operating history, foreign currency exchange rates and the volatility of public markets.

 

 Contingencies

 

Certain conditions may exist as of the date the financial statements are issued, which could result in a loss to the Company but which will only be resolved when one or more future events occur or fail to occur. The Company’s management assesses such contingent liabilities, and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against the Company or unasserted claims that may result in such proceedings, the Company’s management evaluates the perceived merits of any legal proceedings or unasserted claims as well as the perceived merits of the amount of relief sought or expected to be sought.

 

9
 

 

If the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability can be estimated, then the estimated liability is accrued in the Company’s financial statements. If the assessment indicates that a potential material loss contingency is not probable but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability, together with an estimate of the range of possible loss if determinable and material would be disclosed.

 

Loss contingencies considered to be remote by management are generally not disclosed unless they involve guarantees, in which case the guarantee would be disclosed.

 

Accounts Receivable

 

The Company maintains reserves for potential credit losses on accounts receivable. Management reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these reserves. Terms of the sales vary. Reserves are recorded primarily on a specific identification basis.

 

Inventories

 

Inventories are valued at the lower of cost (determined on a weighted average basis) or market value.  Management compares the cost of inventories with the market value and allowance is made for writing down their inventories to market value, if lower. As of September 30, 2011 and December 31, 2010, inventory consisted entirely of finished goods valued at $7,144 and $7,284, respectively.

 

Property, Plant and Equipment, net

 

Property, plant and equipment are stated at cost. Expenditures for maintenance and repairs are expensed as incurred; additions, renewals and betterments are capitalized. When property and equipment are retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the respective accounts, and any gain or loss is included in operations. Depreciation of property and equipment is provided using the straight-line method for substantially all assets with estimated lives of:

 

Automotive 5 years
Office Equipment 5 years

 

As of September 30, 2011 and December 31, 2010, property and equipment consisted of the following:

 

   2011   2010 
Automotive  $733   $738 
Office equipment   594    195 
Leasehold improvements   -    65 
Plant and Equipment   3    3 
Sub Total   1,330    1,001 
Less: accumulated depreciation   (850)   (810)
Total  $480   $191 

 

10
 

 

Long-Lived Assets

 

The Company periodically evaluates the carrying value of long-lived assets to be held and used in accordance with FASB ASC 360 “Property, Plant and Equipment”, which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amounts. In that event, a loss is recognized based on the amount by which the carrying amount exceeds the fair market value of the long-lived assets. 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 of disposal. Based on its review, the Company believes that, as of September 30, 2011 and December 31, 2010, there were no significant impairments of its long-lived assets.

 

Fair Value of Financial Instruments

 

FASB ASC Topic 825 “Financial Instruments” requires that the Company disclose estimated fair values of financial instruments. The carrying amounts reported in the statements of financial position for current assets and current liabilities qualifying as financial instruments are a reasonable estimate of fair value.

 

Impairment of Goodwill

 

Goodwill is the excess of purchase price over the fair value of the identifiable assets and liabilities acquired as a result of the Company’s acquisitions of interests in its subsidiaries. Under FASB ASC Topic 350, goodwill is no longer amortized, but tested for impairment upon first adoption and annually, thereafter, or more frequently if events or changes in circumstances indicate that it might be impaired. Impairment testing is performed at a reporting unit level. An impairment loss generally would be recognized when the carrying amount of the reporting unit exceeds its fair value, with the fair value of the reporting unit determined using discounted cash flow (“DCF”) analysis. A number of significant assumptions and estimates are involved in the application of the DCF analysis to forecast operating cash flows, including the discount rate, the internal rate of return, and projections of realizations and costs to produce. Management considers historical experience and all available information at the time the fair values of its reporting units are estimated. At September 30, 2011, the Company determined and recorded $4,507, $6,250 and $472 impairment charges to goodwill of Sanhe, Joy & Harmony and Jinhua, respectively, due to the continuous slow-down of sales of the Company’s products, increased competition and higher operating costs. All three of these subsidiaries incurred net losses for the nine months ended September 30, 2011, and the Company expects continuous losses for the foreseeable future.

 

Revenue Recognition

 

In accordance with Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin (“SAB”) 104, the Company recognizes revenues when there is persuasive evidence of an arrangement, product delivery and acceptance have occurred, the sales price is fixed and determinable, and collectability of the resulting receivable is reasonably assured.

 

The Company records revenues when title and the risk of loss pass to the customer.  Generally, these conditions occur on the date the customer takes delivery of the product.  Revenue is generated from sales of China 3C products through two main revenue streams:

 

  1. Retail. 67.5%, 69.3%, 68.6% , 69.0% of the Company's revenue came from sales to individual customers at outlets installed inside department stores etc. (i.e., store in store model) during the three and nine months ended September 30, 2011 and 2010, respectively, and was mainly achieved through two broad categories:

 

11
 

 

  a. Purchase contracts. Sales by purchase contracts have terms of thirty days from the transfer of goods to the customer. Under this method, the Company delivers goods to places designated by the customers and receives confirmation of delivery. At that time, ownership and all risks associated to the goods are transferred to the customers and payment is made within 30 days. The Company relieves its inventory and recognizes revenue upon receipt of confirmation from the customer.

 

  b. Point of sale transfer of ownership. Under this method, the Company’s products are placed in third party stores and sold by the Company’s sales people. Upon purchase of the item by the customer, the Company relieves its inventory and recognizes revenue related to that item.

 

  2. Wholesale. 32.5%, 30.7%, 31.4%, 31.0% of the Company's revenue came from wholesale during the three and nine months ended September 30, 2011 and 2010, respectively. Recognition of income in wholesales is based on the contract terms. The main contract terms on wholesale agreed that payments be paid 15 days after receipt of goods and that ownership and all risks associated with the goods are transferred to the customers on the date of goods received and payments will be made 15 days later.

 

Sales revenue is therefore recognized on the following basis:

 

  1. Store in store model:

 

  a. For goods sold under sales and purchase contracts, revenue is recognized when goods are received by customers.

 

  b. For goods at customer outlets which the Company’s sales people operate, and inventory of goods is under joint control by the customers and the Company, revenue is recognized at the point of sale to the end buyer.

 

During public holidays or department store celebration periods, we provide sales incentives to retail customers to increase sales, such as gift giving and price reductions. These are the only temporary incentives during the specified periods. Sales made to our retail customers as a result of incentives are immaterial as a percentage of total sales revenue.

 

  2. Wholesale:

 

  a. Revenue is recognized at the date of goods are received by wholesale customers. We operate our wholesale business by selling large volume orders to second-tier distributors and large department stores. Revenues from wholesale are recognized as net sales after confirmation with distributors. Net sales already take into account revenue dilution as they exclude inventory credit, discount for early payment, product obsolescence and return of products and other allowances. Net sales also take into account the return of products in accordance with relevant laws and regulations in China.

 

12
 

 

 Return policies

 

Our return policy complies with China’s laws and regulations on consumer’s rights and product quality. In accordance with Chinese law, consumers can return or exchange used products within seven days only if the goods do not meet safety and health requirements, endanger a person’s property, or do not meet the advertised performance. If the conditions and requirements as set out in the relevant laws and regulations are met, the retail stores are entitled to accept a return of the goods from the consumer. In such cases, the Company shall accept the returns unconditionally. Goods returned will be redirected to the production factory or supplier who shall bear all losses on the returns in accordance the laws and regulations. Consumer returns or exchanges of products that have not been used, where the packaging has not been damaged, are honored if such return or exchange is within seven days. If a consumer returns a product, the Company must refund the invoice price to the consumer. The Company will then be responsible for returning the goods to the production factory or supplier. At that time the Company can recover the price based on the purchase and sale contract with the producer or supplier. However, when goods are returned, the Company loses the profit margin that it records when revenue is recognized, regardless of whether the production factory or supplier takes the product back or not.

 

The return rights granted to wholesale customers are similar to the rights granted to retail customers. Once wholesale customers purchase products, they follow the same return policy as retail customers. We do not honor returns from wholesale customers except for products which don’t meet laws and regulations or quality requirements. If our wholesale customers have a high inventory level or product obsolescence caused by lower market demands or other operational issues, the wholesale customers bear their own losses. When a wholesale customer returns products, the Company will return the products to the suppliers or manufacturers. A sales return and allowance is recorded at the sales price. Meanwhile, a purchase return and allowance is recorded at the invoice price because the suppliers or manufacturers bear the losses. The net effect is that the Company derecognizes the gross profit when a return takes place, but does not record any loss on the cost of the returned item back to the supplier or manufacturer.  

 

In light of the aforesaid PRC laws and regulations and the Company's arrangements with suppliers, we do not provide an accrual for any estimated losses on subsequent sale of the return of products.  As a result we do not assess levels of inventory in the distribution channel, product obsolescence and/or introductions of new products, as none of those factors have any impact on us with respect to estimating losses on subsequent sale of returned goods.  Third party market research report and consumer demand study is not used to make estimates of goods returned.

 

Cost of Sales

 

Cost of sales consists of actual product cost, which is the purchase price of the product less any discounts.  Cost of sales excludes freight charges, purchase and delivery costs, internal transfer, freight charges and the other costs of the Company’s distribution network, which are identified in general and administrative expenses.

 

General and Administrative Expenses

 

General and administrative expenses are comprised principally of payroll and benefits costs for retail and corporate employees, occupancy costs of corporate facilities, lease expenses, management fees, traveling expenses and other operating and administrative expenses, including freight charges, purchase and delivery costs, internal transfer freight charges and other distribution costs.

 

Shipping and handling fees

 

The Company follows FASB ASC 605-45, “Handling Costs, Shipping Costs”.  The Company does not charge its customers for shipping and handling. The Company classifies shipping and handling fees as part of General and administrative expenses. During the three and nine months ended September 30, 2011 and 2010, the Company incurred shipping and handling fees and costs of $70, $68, $186 and $175, respectively.

 

13
 

 

 Vendor Discounts

 

The Company has preferred pricing arrangements with vendors on certain products. These arrangements are not contingent on any levels of volume and are considered vendor discounts as opposed to rebates. The Company records these discounts along with the purchase of the discounted items, resulting in lower inventory cost and a corresponding lower cost of sales as the products are sold.

 

Management fees paid to the department stores under “store in store” model

 

Under the “store in store” business operation model, the Company may pay management fees to the department stores, which are in the form of service charges. The management fees are reflected in general and administrative expenses. Such management fees were $1,050, $1,297, $4,036 and $4,282 in selling, general and administrative expenses during the three and nine months ended September 30, 2011 and 2010 respectively.

 

Share Based Payment

 

The Company follows FASB ASC 718-10, “Stock Compensation”, which addresses the accounting for transactions in which an entity exchanges its equity instruments for goods or services, with a primary focus on transactions in which an entity obtains employee services in share-based payment transactions. ASC 718-10 requires measurement of the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). Incremental compensation costs arising from subsequent modifications of awards after the grant date must be recognized.

 

 Advertising

 

Advertising expenses consist primarily of costs of promotion for corporate image and product marketing and costs of direct advertising. The Company expenses advertising costs as incurred. Advertising expense was $98, $1,645, $298 and $2,285 for the three and nine months ended September 30, 2011 and 2010, respectively.

 

Income Taxes

 

The Company utilizes FASB ASC Topic 740 “Income Taxes”. Deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.

 

Basic and Diluted (Loss) per Share

 

(Loss) per share is calculated in accordance with FASB ASC Topic 260, “Earnings per Share”. Basic earnings (loss) per share are based upon the weighted average number of common shares outstanding. Diluted earnings (losses) per share are based on the assumption that all dilutive convertible shares and stock options were converted or exercised. Dilution is computed by applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period. If convertible shares and stock options are anti-dilutive, the impact of conversion is not included in the diluted net income (loss) per share. Excluded from the calculation of diluted (loss) per share for the three and nine months ended September 30, 2011 and 2010 was 50,000 and 100,000 options, as they were not dilutive.

 

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Statement of Cash Flows

 

In accordance with FASB ASC Topic 230 “Statement of Cash Flows”, cash flows from the Company’s operations are calculated based upon the functional currency, in our case the RMB.  As a result, amounts related to changes in assets and liabilities reported on the statement of cash flows will not necessarily agree with the changes in the corresponding balances on the balance sheet.

 

Concentration of Credit Risk

 

Financial instruments that potentially subject the Company to concentrations of credit risk are cash, accounts receivable, advances to suppliers and other receivables arising from its normal business activities. The Company places its cash in what it believes to be credit-worthy financial institutions. The Company has a diversified customer base, most of which is in China. The Company controls credit risk related to accounts receivable through credit approvals, credit limits and monitoring procedures. The Company routinely assesses the financial strength of its customers and, based upon factors surrounding the credit risk, establishes an allowance, if required, for uncollectible accounts and, as a consequence, believes that its accounts receivable credit risk exposure beyond such allowance is limited.

 

Segment Reporting

 

FASB ASC Topic 280, “Segment Reporting” requires use of the “management approach” model for segment reporting. The management approach model is based on the way a company’s management organizes segments within the company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, legal structure, management structure, or any other manner in which management disaggregates a company. Since the acquisition of Jinhua in July 2009, the Company operates in five segments (see Note 14).

 

Recent Accounting Pronouncements

 

FASB ASC Topic 860 “Transfers and Servicing” requires more information about transfers of financial assets and where companies have continuing exposure to the risks related to transferred financial assets. ASC 860 was effective at the start of a company’s first fiscal year beginning after November 15, 2009, or January 1, 2010 for companies reporting earnings on a calendar-year basis. The adoption of this statement had no material effect on the Company’s financial statements.

 

Revisions under FASB ASC Topic 810 “Consolidation”, revises how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. Under ASC 810, determining whether a company is required to consolidate an entity will be based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. ASC 810 is effective at the start of a company’s first fiscal year beginning after November 15, 2009, or January 1, 2010 for companies reporting earnings on a calendar-year basis. The adoption of ASC 810 had no impact on our financial statements.

 

 In April 2010, FASB issued ASU 2010-13, Compensation – Stock Compensation (Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades. ASU 2010-13 provides guidance on the classification of a share-based payment award as either equity or a liability. A share-based payment that contains a condition that is not a market, performance, or service condition is required to be classified as a liability. ASU 2010-13 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010. The adoption of this statement had no significant impact on the Company’s financial statements.

 

15
 

 

In April 2010, the FASB issued ASU 2010-17, “Revenue Recognition—Milestone Method (Topic 605): Milestone Method of Revenue Recognition”. This Update provides guidance on the recognition of revenue under the milestone method, which allows a vendor to adopt an accounting policy to recognize all of the arrangement consideration that is contingent on the achievement of a substantive milestone (milestone consideration) in the period the milestone is achieved. The pronouncement is effective on a prospective basis for milestones achieved in fiscal years and interim periods within those years, beginning on or after June 15, 2010. The adoption of this ASU had no material impact on the Company’s consolidated financial statements.

 

In July 2010, the FASB issued ASU 2010-20, “Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses”. The amendments in this Update are to provide financial statement users with greater transparency about an entity’s allowance for credit losses and the credit quality of its financing receivables. The disclosures about activity that occurs during the reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010.  The adoption of this statement had no significant impact on the Company’s financial statements.

 

In December 2010, the FASB issued ASU 2010-29, “Business Combinations” (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations”. This ASU specifies that when financial statements are presented, the revenue and earnings of the combined entity should be disclosed as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. ASU 2010-29 is effective for business combinations with acquisition dates on or after January 1, 2011. The adoption of this statement had no impact on the Company’s consolidated financial statements.

 

In June 2011, FASB issued ASU 2011-05, Comprehensive Income (ASC Topic 220):  Presentation of Comprehensive Income.  Under the amendments in this update, an entity has the option 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. Under both options, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income and a total amount for comprehensive income. In a single continuous statement, the entity is required to present the components of net income and total net income, the components of other comprehensive income and a total for other comprehensive income, along with the total of comprehensive income in that statement. In the two-statement approach, an entity is required to present components of net income and total net income in the statement of net income. The statement of other comprehensive income should immediately follow the statement of net income and include the components of other comprehensive income and a total for other comprehensive income, along with a total for comprehensive income. In addition, the entity is required to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented.  The amendments in this update should be applied retrospectively and are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company is currently assessing the impact of adopting this statement on our financial statements.

 

 Note 3 – ADVANCES TO SUPPLIERS

 

Advances to suppliers represent advance payments to suppliers for the purchase of inventory. As of September 30, 2011, we paid $2,282 in advance payments to 14 suppliers, of which one supplier received $312 and ten suppliers received $156 each. The remaining three suppliers received $390 in total. As of September 30, 2010, we paid $2,331 in advance payments. The five largest suppliers received $1,075, of which one supplier received $299, one received $179 and three received $149 each.

 

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Note 4– ACCRUED EXPENSES

 

Accrued expenses as of September 30, 2011 and December 31, 2010 consist of the following:

 

   2011   2010 
         
Accrued expenses and other payables  $1,550   $4,512 
VAT tax payable   692    24 
Total  $2,242   $4,536 

 

Accrued expenses include accrued salaries, staff welfare, accrued advertising and rent. Other payables include social insurance and miscellaneous tax payables.

 

Note 5 - COMMON STOCK

 

On January 17, 2011, China 3C entered into a Registered Trademark Transfer Agreement to purchase the registered trademark, “Lotour.”  The trademark expires July 6, 2020.  The consideration for the trademark was RMB 2,280,000 ($346), which was paid in the form of 1.08 million shares of the Company’s common stock, valued at $0.32 per share.   

 

On January 20, 2011, Zhejiang entered into a Design and Development Engagement Agreement to design and develop an electronic book product under the brand name “Lotour.” The total consideration for the design and development of the electronic book product is RMB 3,160,000 ($480), which was paid in the form of 1.6 million shares of the Company’s common stock, valued at $0.30 per share. The term of the Development Agreement was from January 20, 2011 to July 19, 2011, at which date, the design and development agreement was completed and the “Lotour” electronic book started trial production.

 

Note 6 - STOCK WARRANTS, OPTIONS, AND COMPENSATION

 

Stock options— Options issued have a ten-year life and were fully vested upon issuance. The option holder has no voting or dividend rights. The grant price was the market price at the date of grant. The Company records the expense of the stock options over the related vesting period. The options were valued using the Black-Scholes option-pricing model at the date of grant stock option pricing.

 

 Outstanding options by exercise price consisted of the following as of September 30, 2011.

 

Options Outstanding   Options Exercisable 
Exercise Price   Number of
Shares
   Weighted
Average
Remaining
Life (Years)
   Weighted
Average
Exercise Price
   Number
of Shares
   Weighted
Average
Exercise
Price
 
$4.16    50,000    6.00   $4.16    50,000   $4.16 

 

Note 7 - COMPENSATED ABSENCES

 

Regulation 45 of the labor laws in the PRC entitles employees to annual vacation leave after 1 year of service. In general all leave must be utilized annually, with proper notification. Any unutilized leave is cancelled. As of September 30, 2011and December 31, 2010, there was no accrued unutilized leave.

 

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Note 8 - INCOME TAXES

 

The Company, through its subsidiaries, Zhejiang, Wang Da, Sanhe, Joy & Harmony, Yiwu and Jinhua is subject to the Income Tax Laws of the PRC.

 

China 3C, which is a U.S. entity, is subject to the US Federal income tax at the rate of 34%. China 3C has incurred net operating losses of $3,597 as of September 30, 2011 for income tax purposes. China 3C does not conduct any operations and only incurs expenses related to the public entity such as legal, accounting and investor relations, etc.  Therefore, it is more likely than not that all of the Company’s deferred tax assets will not be realized. A 100% allowance was recorded on the deferred tax asset of $1,223 as of September 30, 2011.

 

The Company’s policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. The Company did not have any accrued interest or penalty associated with any unrecognized tax benefits, nor was any interest expense recognized during the three and nine months ended September 30, 2011 and 2010.

 

Pursuant to the PRC Income Tax Laws, from January 1, 2008, the Enterprise Income Tax (“EIT”) is calculated against net income in a fiscal year at a statutory rate of 25%.

 

The following details a reconciliation of income tax expense for the nine months ended September 30, 2011 and 2010:

 

2011  U.S.   State   International   Total 
Current  $-   $-   $152   $152 
Deferred   -    -    -    - 
Total  $-   $-   $152   $152 

 

2010  U.S.   State   International   Total 
Current  $-   $-   $254   $254 
Deferred   -    -    -    - 
Total  $-   $-   $254   $254 

 

The following details a reconciliation of income tax expense for the three months ended September 30, 2011 and 2010:

 

2011  U.S.   State   International   Total 
Current  $-   $-   $23   $23 
Deferred   -    -    -    - 
Total  $-   $-   $23   $23 

 

2010  U.S.   State   International   Total 
Current  $-   $-   $64   $64 
Deferred   -    -    -    - 
Total  $-   $-   $64   $64 

 

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During the three months ended September 30, 2011, all subsidiaries except for Zhejiang had operating losses. Jinhua was the only subsidiary that incurred income tax expenses of $43 since it uses simplified tax, which imposes taxes on sales instead of operating income. Zhejiang had a tax refund of $20 as a result of accumulated losses for the nine months ended September 30, 2011.

 

 Reconciliation of the differences between the statutory U.S. Federal income tax rate and the effective rate is as follows:

 

Three Months Ended September 30,  2011   2010 
(Credit) tax at US statutory rate   (34.0)%   (34.0)%
Tax rate difference   8.9%   9.0%
Other   0.1%   - 
Valuation allowance   25.1%   22.5%
Effective rate   0.1%   (2.5)%

 

Nine Months Ended September 30,  2011   2010 
(Credit) tax at US statutory rate   (34.0)%   (34.0)%
Tax rate difference   8.6%   9.0%
Other   0.5%   - 
Valuation allowance   25.4%   20.7%
Effective rate   0.5%   (4.3)%

 

Note 9 - COMMITMENTS

 

The Company leases office facilities under operating leases.  Rent expense for the three and nine months ended September 30, 2011 and 2010 was $152, $104, $399 and $359, respectively. The future minimum obligations are as follows, by years, as of September 30, 2011:

 

    Operating lease obligations     Advertising obligations     E-book contract obligations  
2012   $ 232       318       87  
2013     68       -       -  
    $ 300       318       87  

 

Note 10 - STATUTORY RESERVE

 

In accordance with the laws and regulations of the PRC, a WFOE’s income, after the payment of the PRC income taxes, shall be allocated to the statutory surplus reserves and statutory public welfare fund. Prior to January 1, 2006, the proportion of allocation for reserve was 10% of the profit after tax to the surplus reserve fund and additional 5-10 percent to the public affair fund. The public welfare fund reserve was limited to 50% of the registered capital. Effective January 1, 2006, there is now only one fund requirement. The reserve is 10% of income after tax, not to exceed 50% of registered capital.

 

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Statutory reserve funds are restricted for set off against losses, expansion of production and operation or increase in register capital of the respective company. Statutory public welfare fund is restricted to the 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. As of September 30, 2011, the Company had allocated $11,543 to these non-distributable reserve funds.

 

Note 11 - OTHER COMPREHENSIVE INCOME

 

The detail of other comprehensive income, all of which arose from foreign currency translation, as included in stockholders’ equity at September 30, 2011 and December 31, 2010 are as follows:

 

Balance at December 31, 2009  $5,180 
Change for 2010   1,526 
Balance at December 31, 2010   6,706 
Change for nine months ended September 30, 2011   1,175 
Balance at September 30, 2011  $7,881 

 

Note 12 - CURRENT VULNERABILITY DUE TO CERTAIN RISK FACTORS

 

The Company’s operations are in the PRC. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environments in the PRC, by the general state of the PRC’s economy. The Company’s business may be influenced by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.

 

Note 13 - MAJOR CUSTOMERS AND VENDORS

 

During the three and nine months ended September 30, 2011 and 2010, no single customer accounted for more than 10% of the Company’s sales or accounts receivable and no single vendor accounted for more than 10% of the Company’s purchases.

 

Note 14 -   SEGMENT INFORMATION

 

We separately operate and prepare accounting and other financial reports to management for five business organizations: Wang Da, Sanhe, Yiwu, Joy & Harmony and Jinhua. Each operating company has different products and services.  Wang Da sells mainly mobile phones, Sanhe sells mainly home appliances, Yiwu sells mainly office communication products, Joy & Harmony sells mainly consumer electronics and Jinhua provides transportation logistics to businesses. All segments are accounted for using the same principles as described in Note 2.

 

We identified five reportable segments required by FASB ASC Topic 280: (1) mobile phones, (2) home electronics, (3) office communication products, (4) consumer electronics and (5) logistics.

 

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The following tables present summarized information by segment:

 

    Nine Months Ended September 30, 2011  
    Mobile     Home     Communication     Consumer                    
    Phones     Electronics     Products     Electronics     Logistics     Other     Total  

Sales, net

(restated)

  $ 30,204     $ 29,964     $ 10,731     $ 25,683     $ 6,107     $ 369     $ 103,058  
Cost of sales     28,592       27,914       9,793       23,139       7,430       356       97,224  

Gross profit (loss)

(restated)

    1,612       2,050       938       2,544       (1,323     13       5,834  

Income (loss) from operations

(restated)

    (9,087 )     (8,093 )     (1,390 )     (5,234 )     (2,515     (2,542 )     (28,861 )

 

  Nine months Ended September 30, 2010  
  Mobile     Home     Communication     Consumer                      
  Phones     Electronics     Products     Electronics     Logistics     Other     Total    

Sales, net

(restated)

$ 31,762     $ 32,322     $ 15,813     $ 29,681     $ 8,084     $ 503     $ 118,165    
Cost of sales   28,990       28,643       14,079       25,888       6,620       444       104,664    

Gross profit

(restated)

  2,772       3,679       1,734       3,793       1,464       59       13,501    

Income (loss) from operations

(restated)

  (1,322            (1,438     (801     (1,175     346       (1,516     (5,906

 

 

    Three Months Ended September 30, 2011  
    Mobile     Home     Communication     Consumer                    
    Phones     Electronics     Products     Electronics     Logistics     Other     Total  

Sales, net

(restated)

  $ 8,458     $ 8,741     $ 3,119     $ 7,171     $ 1,720     $ 92     $ 29,301  
Cost of sales     8,221       8,318       2,949       6,711       2,561       96       28,856  

Gross profit (loss)

(restated)

    237       423       170       460       (841     (4 )     445  

(Loss) from operations

(restated)

    (7,314 )     (5,789 )     (540 )     (3,194 )     (1,207     (919 )     (18,963 )

  

    Three Months Ended September 30, 2010  
    Mobile     Home     Communication     Consumer                    
    Phones     Electronics     Products     Electronics     Logistics     Other     Total  

Sales, net

(restated)

  $  10,311     $  10,269     $ 4,860     $     9,251     $    2,568     $   121     $ 37,380  
Cost of sales     9,456          9,240             4,413           8,214          2,298        104       33,725  

Gross profit

(restated)

       855          1,029       447       1,037            270          17       3,655  

Loss from operations

(restated)

    (497     (565     (315     (547     (102     (465     (2,491

 

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Total assets by segment as of September 30, 2011 and December 31, 2010 are as follows:

 

    Mobile     Home     Communication     Consumer                    
    Phones     Electronics     Products     Electronics     Logistics     Other     Total  
2011 (restated)   $ 7,043     $ 8,491     $ 10,065     $ 5,254     $ 13,496     $ 847     $ 45,196  
2010 (restated)   $ 10,993       14,988       9,967       18,536       15,837       2,810       73,131  

 

Note 15 - RESTATEMENT OF CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

 

China 3C operates most of its retail operations through “store in store” model. Under this model, the Company leases space in major department stores and retailers. The Company does not pay the department stores fixed leasing costs. Instead, China 3C deducts a percentage of sales each month as compensation to the department stores. China 3C records such costs as “sales discount” as a deduction from net sales.

 

In response to the SEC comments of December 19, 2011, the Company reviewed “sales discount” and determined they should be reclassified as management fees. As a result, we reclassified “sales discount” from a contra revenue account to management fees as part of the selling, general and administrative expenses. The amount of $758 and $1,072 were previously classified in contra-revenue account as a deduction to net sales for the three months ended September 30, 2011 and 2010.  The Company moved the amount to selling expenses, and it is reported as selling, general and administrative expenses in the statement of operations and comprehensive loss.  The reclassification caused a $758 increase in net sales from $28,543 to $29,301 and a corresponding increase of $758 in Selling, general and administrative expenses from $7,421 to $8,179 in the third quarter 2011; a $1,072 increase in net sales from $36,308 to $37,380 and a corresponding increase of $1,072 in Selling, general and administrative expenses from $5,074 to $6,146 in the third quarter 2010; The gross profit increased $758 and $1,072 respectively in the third quarter 2011 and 2010. The loss from operations and net loss remained unchanged.  The impact of the restatement was limited to the presentation of the consolidated statements of operations and comprehensive income (loss). The consolidated balance sheets, the consolidated statements of stockholders’ equity and the related consolidated statements of cash flows remained unaffected. 

 

The table below summarizes the restatement changes to the consolidated statements of operations and comprehensive income (loss): 

   Three months ended September 30, 2010 
   (as reported)   (as restated)   Change 
Net sales  $36,308    37,380   $1,072 
Gross profit   2,583    3,655    1,072 
Selling, general and administrative expenses   5,074    6,146    1,072 

 

   Three months ended September 30, 2011 
   (as reported)   (as restated)   Change 
Net sales  $28,543   $29,301   $758 
Gross profit   (313)   445    758 
Selling, general and administrative expenses   7,421    8,179    758 

 

   Nine months ended September 30, 2010 
   (as reported)   (as restated)   Change 
Net sales  $114,534   $118,165   $3,631 
Gross profit   9,870    13,501    3,631 
Selling, general and administrative expenses   15,776    19,407    3,631 

 

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   Nine months ended September 30, 2011 
   (as reported)   (as restated)   Change 
Net sales  $100,017   $103,058   $3,041 
Gross profit   2,793    5,834    3,041 
Selling, general and administrative expenses   20,425    23,466    3,041 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Forward Looking Statements

 

We have included and from time to time may make in our public filings, press releases or other public statements, certain statements, including, without limitation, those under “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. In some cases, these statements are identifiable through the use of words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “project,” “target,” “can,” “could,” “may,” “should,” “will,” “would” and similar expressions. You are cautioned not to place undue reliance on these forward-looking statements. In addition, our management may make forward-looking statements to analysts, investors, representatives of the media and others. These forward-looking statements are not historical facts and represent only our beliefs regarding future events, many of which, by their nature, are inherently uncertain and beyond our control.

 

The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto appearing elsewhere in this Form 10-Q.  The following discussion contains forward-looking statements.  Our actual results may differ significantly from those projected in the forward-looking statements.  Factors that may cause future results to differ materially from those projected in the forward-looking statements include, but are not limited to, those discussed in  “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2010 and elsewhere in this Form 10-Q.

 

Overview (All dollar amounts in thousands)

 

China 3C Group (including its subsidiaries unless the context indicates otherwise, “China 3C,” the “Company,” “we,” “us,” or “our”) was incorporated on August 20, 1998 under the laws of the State of Nevada. Capital Future Developments Limited (“Capital”) was incorporated on July 22, 2004 under the laws of the British Virgin Islands. Zhejiang Yong Xin Digital Technology Company Limited (“Zhejiang”), Yiwu Yong Xin Communication Limited (“Yiwu”), Hangzhou Wandda Electronics Company Limited (“Wang Da”), Hangzhou Sanhe Electronic Technology, Limited (“Sanhe”), and Shanghai Joy & Harmony Electronic Development Company Limited (“Joy & Harmony”) were incorporated under the laws of the Peoples Republic of China (“PRC” or “China”) on July 11, 2005, July 18, 1997, March 30, 1998, April 12, 2004, and August 25, 2003, respectively. China 3C owns 100% of Capital and Capital own 100% of the capital stock of Joy & Harmony and Sanhe. Until August 14, 2007, when it made the change to its ownership structure described in the next paragraph in order to comply with certain requirements of PRC law, Capital owned 100% of the capital stock of Zhenjiang. Zhejiang owns 90% and Yiwu owns 10% of Wang Da. Zhejiang owns 90% and Wang Da owns 10% of Yiwu. On March 10, 2009 Zhejiang set up a new operating entity, Hangzhou Letong Digital Technology Co., Ltd. (“Letong”) to establish an electronic retail franchise operation for China 3C Group. On July 6, 2009, Zhejiang and Yiwu acquired Jinhua Baofa Logistic Limited (“Jinhua”). Jinhua was incorporated under the laws of PRC on December 27, 2001.

 

23
 

 

On December 21, 2005, Capital became a wholly owned subsidiary of China 3C through a merger with a wholly owned subsidiary of the Company (the “Merger Transaction”). China 3C acquired all of the issued and outstanding capital stock of Capital pursuant to a Merger Agreement dated at December 21, 2005 by and among China 3C, XY Acquisition Corporation, Capital and the shareholders of Capital (the “Merger Agreement”). Pursuant to the Merger Agreement, Capital became a wholly owned subsidiary of China 3C and, for the Capital shares, China 3C issued 35,000,000 shares of its common stock to the shareholders of Capital, representing 93% of the issued and outstanding capital stock of China 3C at that time and cash of $500. On August 15, 2007, we executed a series of contractual agreements between Capital and Zhejiang. The contractual agreements give Capital and its equity owners an obligation, and having ability to absorb, any losses, and rights to receive returns; however, these contractual agreements did not change the equity ownership of Zhejiang. We did not dispose Capital’s actual equity ownership of Zhejiang when we execute the contractual agreements. Capital entered into share-holding entrustment agreements with five individuals - Zhenggang Wang, Yimin Zhang, Huiyi Lv, Xiaochun Wang and Zhongsheng Bao to hold 35%, 20%, 20%, 15% and 10%, respectively, of the equity interest of Zhejiang on behalf of Capital on November 21, 2005. The entrustment agreements confirm that Capital is the actual owner of Zhejiang. Capital enjoys the actual shareholder’s rights and has the right to obtain any benefits received by the nominal holders. Zhenggang Wang is the CEO and shareholder of China 3C Group. Yimin Zhang, Huiyi Lv, Xiaochun Wang and Zhongsheng Bao have no other relationship with China 3C Group. No consideration was given to these individuals who held the equity of Zhejiang on behalf of Capital.

 

On August 3, 2006, Capital completed the acquisition of 100% of the equity of Sanhe for a combination of cash and stock valued at $8,750 (consisting of 915,751 newly issued shares of the Company’s common stock and $5,000 in cash).

 

On November 28, 2006, Capital completed the acquisition of 100% of the equity of Joy & Harmony for a combination of cash and stock valued at $18,500 (consisting of 2,723,110 shares of the Company’s common stock and $7,500 in cash).

 

On July 6, 2009, Zhejiang and Yiwu acquired Jinhua, a company organized under the laws of the PRC. Zhejiang acquired 90% and Yiwu acquired 10% of the entire equity interests in Jinhua from the shareholders of Jinhua for RMB 120,000,000 ($17,500) in cash.

 

Yiwu, Wangda, Sanhe and Joy & Harmony are engaged in the resale and distribution of third party products and generate 100% of their revenue from resale of items such as mobile phones, facsimile machines, DVD players, stereos, speakers, MP3 and MP4 players, iPod, electronic dictionaries, CD players, radios and audio systems. We sell and distribute products through retail stores and secondary distributors. We operate most of our retail operations through our “store in store” model. Under this model, the Company leases space in major department stores and retailers. Leasing costs can vary based on a percentage of sales, or can be fixed. In the three and nine months ended September 30, 2011 and 2010, all of our stores in stores leases were variable based on sales.

 

Following the acquisition of Jinhua, the Company began providing logistical services to businesses in addition to its traditional business of resale and distribution of third party products such as mobile phones, facsimile machines, DVD players, stereos, speakers, MP3 and MP4 players, iPods, electronic dictionaries, CD players, radios and audio systems.

 

In 2009, Zhejiang started establishing direct electronic retail stores and franchise operation. Zhejiang opened three direct stores and two franchise stores during the trial operating period. As of September 30, 2011, all 5 stores were closed due to the intense competition from larger electronics department stores such as Gomei and Suning. The 5 stores accumulated total deficit of $302 in 2010 and $295 for the nine months ended September 30, 2011.

 

24
 

 

Results of Operations for the Three and Nine Months Ended September 30, 2011 and 2010

 

Reportable Operating Segments

 

The Company reports financial and operating information in the following five segments:

 

a)Yiwu

 

b)Wang Da

 

c)Sanhe

 

d)Joy & Harmony

 

e)Jinhua

 

a)Yiwu

 

Yiwu focuses on the selling, circulation and modern logistics of fax machines and cord phone products.

 

   Nine months ended September 30,    
Yiwu 

2011

(restated)

  

2010

(restated)

   Percentage
Change
 
Revenue  $10,731   $15,813    (32.1)%
Gross Profit   938    1,734    (45.9)%
Profit Margin   8.7%   11.0%   (2.3)%
Operating Loss   (1,390)   (801)   (73.5)%

 

   Three months ended September 30,    
Yiwu 

2011

(restated)

  

2010

(restated)

   Percentage
Change
 
Revenue  $3,119   $4,860    (35.8)%
Gross Profit   170    447    (62.0)%
Profit Margin   5.5%   9.2%   (3.7)%
Operating Loss   (540)   (315)   (71.4)%

 

For the nine months ended September 30, 2011, Yiwu generated revenue of $10,731, a decrease of $5,082 or 32.1% compared to $15,813 for the nine months ended September 30, 2010. Gross profit decreased $796 or 45.9% from $1,734 for the nine months ended September 30, 2010 to $938 for the nine months ended September 30, 2011. Profit margin decreased 2.3% from 11.0% in the nine months ended September 30, 2010 to 8.7% in the nine months ended September 30, 2011.

 

For the three months ended September 30, 2011, Yiwu generated revenue of $3,119, a decrease of $1,741 or 35.8% compared to $4,860 for the three months ended September 30, 2010. Gross profit decreased $277 or 62.0% from $447 for the three months ended September 30, 2010 to $170 for the three months ended September 30, 2011. Profit margin decreased 3.7% from 9.2% in the three months ended September 30, 2010 to 5.5% in the three months ended September 30, 2011.

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The decrease in revenue was a result of lower market demand for office appliances such as fax machines and telephones. Lower profit margin was also due to shrinking demand as well as increased promotional events in 2011 to maintain market share. Since market demand decreased, Yiwu did not have the bargaining power to increase unit sales price as much as the increase in purchase costs of office appliances.

 

Operating loss was $1,390 and $540 for the nine and three months ended September 30, 2011, an increase of $589 and $225 compared to $801 and $315 for the nine and three months ended September 30, 2010. Operating loss increased primarily due to decreased gross profit, increase in labor cost and management fees paid to department stores. 

 

b) Wang Da

 

Wang Da focuses on the selling, circulation and modern logistics of cell phones, cell phones products, and digital products, including digital cameras, digital camcorders, PDAs, flash disks, and removable hard disks.

 

   Nine months ended September 30,    
Wang Da  2011
(restated)
   2010
(restated)
   Percentage
Change
 
Revenue  $30,204   $31,762    (4.9)%
Gross Profit   1,612    2,772    (41.8)%
Profit Margin   5.3%   8.7%   (3.4)%
Operating Loss   (2,837)   (1,322)   (114.6)%

 

   Three months ended September 30,    
Wang Da  2011
(restated)
   2010
(restated)
   Percentage
Change
 
Revenue  $8,458   $10,311    (18.0)%
Gross Profit   237    855    (72.3)%
Profit Margin   2.8%   8.3%   (5.5)%
Operating Loss   (1,064)   (497)   (114.1)%

 

For the nine months ended September 30, 2011, Wang Da generated revenue of $30,204, a decrease of $1,558 or 4.9% compared to $31,762 for the nine months ended September 30, 2010. Gross profit decreased $1,160 or 20.5% from $2,772 for the nine months ended September 30, 2010 to $1,612 for the nine months ended September 30, 2011. Profit margin decreased from 8.7% in the nine months ended September 30, 2010 to 5.3% in the nine months ended September 30, 2011, a decrease of 3.4%. 

 

For the three months ended September 30, 2011, Wang Da generated revenue of $8,458, a decrease of $1,853 or 18.0% compared to $10,311 for the three months ended September 30, 2010. The decrease in revenue was primarily attributable to the decline in demand for domestic cell phones. While the global cellular market rapidly upgraded to smart phones, domestic cell phones failed to keep up the pace. Failure to introduce high quality domestic smart phones caused the demand for domestic phones to decline. Therefore, revenue decreased for Wang Da. Gross profit decreased $618 or 72.3% from $855 for the three months ended September 30, 2010 to $237 for the three months ended September 30, 2011. Profit margin decreased from 8.3% in the three months ended September 30, 2010 to 2.8% in the three months ended September 30, 2011, a decrease of 5.5%.  The decrease of gross profit and profit margin was primarily attributable to the decrease in demand for domestic cell phones which had higher profit margin than international brands such as Nokia, Motorola and Samsung.

 

26
 

 

Operating loss was $2,837 and $1,064 for the nine and three months ended September 30, 2011, an increase of $1,515 and $567 compared to $1,322 and $497 for the nine and three months ended September 30, 2010. Operating loss increased primarily due to decreased gross profit, an increase in labor cost and management fees paid to department stores.

 

c)Sanhe

 

Sanhe focuses on the selling, circulation and modern logistics of home electronics, including DVD players, audio systems, speakers, televisions and air conditioners.

 

   Nine months ended September 30,    
Sanhe  2011
(restated)
   2010
(restated)
   Percentage
Change
 
Revenue  $29,964   $32,322    (7.3)%
Gross Profit   2,050    3,679    (44.3)%
Profit Margin   6.8%   11.4%   (4.6)%
Operating Loss   (8,093)   (1,438)   (462.8)%

 

   Three months ended September 30,    
Sanhe  2011
(restated)
   2010
(restated)
   Percentage
Change
 
Revenue  $8,741   $10,269    (14.9)%
Gross Profit   423    1,029    (58.9)%
Profit Margin   4.8%   10.0%   (5.2)%
Operating Loss   (5,789)   (565)   (924.6)%

 

For the nine months ended September 30, 2011, Sanhe generated revenue of $29,964, a decrease of $2,358 or 7.3% compared to $32,322 for the nine months ended September 30, 2010. Gross profit decreased $1,629 or 44.3% from $3,679 for the nine months ended September 30, 2010 to $2,050 for the nine months ended September 30, 2011. Profit margin decreased from 11.4% in 2010 to 6.8% in 2011, a decrease of 4.6%.

 

For the three months ended September 30, 2011, Sanhe generated revenue of $8,741, a decrease of $1,528 or 14.9% compared to $10,269 for the three months ended September 30, 2010. Gross profit decreased $606 or 58.9% from $1,029 for the three months ended September 30, 2010 to $423 for the three months ended September 30, 2011. Profit margin decreased from 10.0% in 2010 to 4.8% in 2011, a decrease of 5.2%.

 

The decrease in revenue was a result of decline in market demand of DVD players and speakers. The decrease in gross profit and profit margin was a result of higher sales of televisions in the first nine months of 2011 compared to higher sales in DVD players and speakers in the same period of 2010, which have higher profit margin compared to other home electronics products.

 

Operating loss was $8,093 and $5,789 for the nine and three months ended September 30, 2011, an increase of $6,665 and $5,224 compared to $1,438 and $565 for the nine and three months ended September 30, 2010. Operating loss increased primarily due to decreased gross profit, increase in labor cost and management fees paid to department stores as well as $4,507 in goodwill impairment.

 

27
 

 

d)Joy & Harmony

 

Joy & Harmony focuses on the selling, circulation and modern logistics of consumer electronics, including MP3 players, MP4 players, iPods, electronic dictionaries, and radios.

 

   Nine months ended September 30,    
Joy & Harmony  2011
(restated)
   2010
(restated)
   Percentage
Change
 
Revenue  $25,683   $29,681    (13.5)%
Gross Profit   2,544    3,793    (32.9)%
Profit Margin   9.9%   12.8%   (2.9)%
Operating Loss   (11,484)   (1,175)   (877.4)%

 

   Three months ended September 30,    
Joy & Harmony  2011
(restated)
   2010
(restated)
   Percentage
Change
 
Revenue  $7,171   $9,251    (22.5)%
Gross (Loss)/Profit   460    1,037    (55.6)%
Profit Margin   6.4%   11.2%   (4.8)%
Operating Loss   (9,444)   (547)   (1,626.5)%

 

For the nine months ended September 30, 2011, Joy & Harmony generated revenue of $25,683, a decrease of $3,998 or 13.5% compared to $29,681 for the nine months ended September 30, 2010. Gross profit decreased $1,249 or 32.9% from $3,793 for the nine months ended September 30, 2010 to $2,544 for the nine months ended September 30, 2011. Profit margin decreased from 12.8% in 2010 to 9.9% in 2011, a decrease of 2.9%.

 

For the three months ended September 30, 2011, Joy & Harmony generated revenue of $7,171, a decrease of $2,080 or 22.5% compared to $9,251 for the three months ended September 30, 2010. Gross profit decreased $577 or 55.6% from $1,037 for the three months ended September 30, 2010 to $460 for the three months ended September 30, 2011. Profit margin decreased from 11.2% in 2010 to 6.4% in 2011, a decrease of 4.8%.

 

The decrease in revenue was due to a lower demand for small digital products such as MP3 and MP4. The decrease in profit margin was primarily due to a higher percentage of sales from international brands, which usually have lower profit margin than domestic brands. In addition, the high percentage of sales rebate paid to department stores led to the further decreases of gross profit. As a result of the low profit margin and high sales rebate, Joy & Harmony had gross loss for the three months ended September 30, 2011.

 

Operating loss was $11,484 and $9,444 for the nine and three months ended September 30, 2011, an increase of $10,309 and $8,897 compared to $1,175 and $547 for the nine and three months ended September 30, 2010. Operating loss increased primarily due to decreased gross profit and increased operating expenses including an increase in labor cost of $578 or 41.6% for the nine months ended September 30, 2011 compared to the same period in 2010, and an increase in promotional expenses of $1,711 to market the new E-book reader under the brand “Lotour”. In addition, Joy & Harmony incurred $6,250 in goodwill impairment.

 

e)Jinhua

 

Jinhua provides transportation service to business and transports freight, including electronics, machinery and equipment, metal products, chemical materials, garments and handicraft goods, in more than 20 cities in Eastern China. Its transportation services cover many of the most developed cities in Eastern China such as Shanghai, Hangzhou and Nanjing.

 

28
 

 

   Nine months ended September 30,   Percentage 
Jinhua  2011   2010   Change 
Revenue  $6,107   $8,084    (24.5)%
Gross (Loss)/Profit   (1,323)   1,464    (190.4)%
Profit Margin   (21.7)%   18.1%   (39.8)%
Operating (Loss)/Income   (2,515)   346    (826.9)%

 

   Three months ended September 30,   Percentage 
Jinhua  2011   2010   Change 
Revenue  $1,720   $2,568    (33.0)%
Gross Profit/(Loss)   (841)   270    (411.5)%
Profit Margin   (48.9)%   10.5%   (59.4)%
Operating (Loss)   (1,207)   (102)   (1,083.3)%

 

For the nine months ended September 30, 2011, Jinhua generated revenue of $6,107, a decrease of $1,977 or 24.5% compared to $8,084 for the nine months ended September 30, 2010. Gross profit decreased $2,787 or 190.4% from $1,464 for the nine months ended September 30, 2010 to $(1,323) for the nine months ended September 30, 2010. Profit margin decreased from 18.1% in 2010 to (21.7)% in 2011, a decrease of 39.8%. Operating loss was $2,515 for the nine months ended September 30, 2010, a decrease of $2,861 or 826.9% compared to operating income of $346 for the nine months ended September 30, 2010.

 

For the three months ended September 30, 2011, revenue decreased from $2,568 for the three months ended September 30, 2011 to $1,720, a decrease of $848 or 33.0%. Gross profit decreased $1,111 or 411.5% from $270 for the three months ended September 30, 2010 to $(841) for the three months ended September 30, 2011. Profit margin decreased 59.4% from 10.5% for the three months ended September 30, 2010 to (48.9)% for the three months ended September 30, 2011. Operating loss was $1,207 for the three months ended September 30, 2011, an increase of $1,105 or 1,083.3% compared to $102 for the three months ended September 30, 2010.

 

The logistics industry is experiencing a downturn. While fuel and labor costs continue to rise, and toll rates remain high, the price for transportation did not increase accordingly. Therefore, revenue and profit margin decreased. Operating income decreased primarily due to decreased gross profit. Higher operating expenses, labor cost in particular, also caused operating income to decrease. Jinhua also incurred an impairment of goodwill of $472 in the third quarter of 2011. 

For the three months ended September 30, 2011, revenue and gross profit decreased substantially. The decrease was a result of land expropriation in the area in Yiwu where Jinhua’s distribution center located. The expropriation affected Jinhua’s normal operation which led to lower revenue in the third quarter of 2011. Currently Jinhua is searching for a new distribution center to solve the issue.

 

Net Sales

 

Net sales for the nine months ended September 30, 2011 decreased by 12.8% to $103,058 compared to $118,165 for the nine months ended September 30, 2010. Net sales for the three months ended September 30, 2011 decreased by 21.6%, to $29,301 compared to $37,380 for the three months ended September 30, 2010. Management believes the sales decrease was a result of various factors including a slowdown in the retail markets in general, weaker demand for consumer and business electronics as well as the pressure of increased competitions from supermarkets, internet commerce and increased TV shopping networks.

 

29
 

 

Cost of Sales

 

Cost of sales (“COS”) for the nine months ended September 30, 2011 was $97,224 compared to $104,664 for the nine months ended September 30, 2010, a decrease of 7.1%. COS for the three months ended September 30, 2011 was $28,856 compared to $33,725 for the three months ended September 30, 2010, a decrease of 14.4%. The decreased COS for the three months was a result of the decrease in sales from the comparable period. In addition, higher fuel cost and higher cost of consumer electronics also contributed to the increased COS.

 

Profit Margin

 

Profit margin for the nine months ended September 30, 2011 was 5.7% compared to 11.4% for the nine months ended September 30, 2010. Profit margin for the three months ended September 30, 2011 was 1.5% compared to 9.8% for the three months ended September 30, 2010. The lower profit margin was primarily due to the decreased unit sales prices of consumer and business electronics in the competitive market in China. In addition, international brand name electronics represented a higher percentage of sales in the first nine months of 2011 compared to 2010. The increased sales of brand name electronics led to lower profit margin since brand name electronics have lower profit margins compared to domestic products. A higher percentage of sales rebate paid to department stores also caused profit margin to decrease. For the logistics segment, the decrease in profit margin was primarily due to increased fuel cost.

 

General and Administrative Expenses

 

General and administrative expenses for the nine months ended September 30, 2011 were $23,466 or 22.8% of net sales, compared to $19,407 or 16.4% of net sales for the nine months ended September 30, 2010, an increase of 20.9%. General and administrative expenses for the three months ended September 30, 2011 were $8,179 or 27.9% of net sales, compared to $6,146 or 16.4% of net sales for the three months ended September 30, 2010, an increase of 33.1%. The increase in general and administrative expenses for the three and nine months ended September 30, 2011 was primarily due to an increase in labor cost of $1,187 and an increase in advertising and promotional expenses of $1,711 to market “Lotour” E-book reader for the nine months ended September 30, 2011.

 

Goodwill impairment

 

During the third quarter of 2011, Sanhe, Joy & Harmony and Jinhua all incurred net losses, and the Company expects continuous losses for the foreseeable future. As a result, Sanhe, Joy & Harmony and Jinhua recognized goodwill impairment loss of $4,507, $6,250 and $472, respectively. The total amount of $11,229 of goodwill impairment was recorded in the income statement as a separate line item.

 

Loss from Operations

 

Operating loss for the nine months ended September 30, 2011 was $28,861 or (28.0)% of net sales compared to $5,906 or (5.0)% of net sales for the nine months ended September 30, 2010, a decrease of 388.7%. Operating loss for the three months ended September 30, 2011 was $18,963 or (64.7)% of net sales compared to $2,491 or (6.7)% of net sales for the three months ended September 30, 2010, a decrease of 661.3%. Lower sales, lower profit margin, increased operating expenses and impairment of goodwill of $11,229 were the key factors for the increase in loss from operations during the three and nine months ended September 30, 2011 compared to 2010.

 

30
 

 

Provision for Income Taxes

 

The provision for income taxes for the nine months ended September 30, 2011 was $152 compared to $254 for the nine months ended September 30, 2010. The provision for income taxes for the three months ended September 30, 2011 was $23 compared to $64 for the three months ended September 30, 2010. Income tax expense was not significant due to all subsidiaries of China 3C having losses in the three and nine months ended September 30, 2011. Jinhua was the only subsidiary that incurred nominal income tax expenses because Jinhua uses simplified tax system, which imposes taxes on sales instead of operating income.

 

Net Loss

 

Net loss was $28,699 or 27.8% of net sales for the nine months ended September 30, 2011 compared to $6,201 or 5.2% of net sales for the nine months ended September 30, 2010, an increase of 362.8%. Net loss was $18,505 or 63.2% of net sales for the three months ended September 30, 2011 compared to $2,606 or 7.0% of net sales for the three months ended September 30, 2010, an increase of 610.0%. Decreased sales revenue, lower profit margin, higher operating expenses and impairment of goodwill were the critical factors which contributed to the decrease in net income.

 

Liquidity and Capital Resources

 

Operations and liquidity needs are funded primarily through cash flows from operations. Cash and equivalents were $10,256 at September 30, 2011, compared to $29,123 at September 30, 2010, and $26,249 at December 31, 2010.

 

We believe the funds available to us are adequate to meet our operating needs for the remainder of 2011.

 

Our cash flows for the nine month periods are summarized as follows:

 

   Nine months ended September 30, 
   2011   2010 
Net cash (used in) operating activities  $(17,153)  $(1,391)
Net cash (used in) investing activities   (427)   (18)
Effect of exchange rate change on cash and equivalents   1,587    624)
Net decrease in cash and equivalents   (15,993)   (785)
Cash and equivalents at beginning of period   26,249    29,908 
Cash and equivalents at end period  $10,256   $29,123 

 

Operating Activities

 

Net cash used in operating activities was $16,673 for the nine months ended September 30, 2011 compared to $1,391 for the nine months ended September 30, 2010, a 1,098.6% increase.  The increase was mainly attributable to several factors, including (i) net loss of $28,699; (ii) increase in accounts receivable of $926; (iii) decrease in accrued expenses of $2,788, offset by the decrease in tax receivable of $1,234 and increase in accounts payable of $511 in the nine months ended September 30, 2011, and add back stock compensation of $892, amortization expense of $1,048 and goodwill impairment of $11,229.

 

31
 

 

   Nine months ended September 30, 
   2011   2010   Percentage
Change
 
                
Sales, Net  $100,017   $114,534    (12.7)%
             
    September
30, 2011
   December 31,
2010
     
   (Unaudited)         
Accounts receivable  $12,371   $14,619    (15.4)%

 

 Accounts receivable decreased 15.4% in the first nine months of 2011 while sales decreased 12.7%. The change in accounts receivable is in line with the change in sales. Management monitors and periodically assesses the collectability of accounts receivable to ensure the allowance for bad debt account is reasonably estimated. Collection of debt is based on the terms of legal binding documents. Our account receivable department has periodically reviewed the allowance for doubtful accounts. The bad debt allowance is based on the aging of receivables, credit history and credit quality of the customers, the term of the contracts as well as the balance outstanding. If an account receivable item is considered probable to be uncollectible, it will be charged to bad debts immediately.

 

Capital Expenditures

 

We did not have any material capital expenditures for the first nine months of 2010. In the first nine months of 2011, we purchased a mold custom designed for the “Lotour” brand E-book for $421 and office equipment for $6.

 

Working Capital Requirements

 

Historically operations and short term financing have been sufficient to meet our cash needs. We believe we will be able to generate revenues from sales and raise capital through private placement offerings of our equity securities to provide the necessary cash flow to meet anticipated working capital requirements. However, our working capital needs for the long and short term will depend upon numerous factors, including operating results, competition, and the availability of credit facilities, none of which can be predicted with certainty. Future expansion will be limited by the availability of financing products and raising capital.

 

Off-Balance Sheet Arrangements

 

We have never entered into any off-balance sheet arrangements and have never established any special purpose entities. We have not guaranteed any debt or commitments of other entities or entered into any options on non-financial assets.

 

Critical Accounting Policies

 

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which were prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe are 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. Actual results may differ from these estimates.

 

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An accounting policy is considered to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimates are made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur, could materially impact the consolidated financial statements. We believe the following critical accounting policies reflect the more significant estimates and assumptions used in the preparation of the consolidated financial statements.

 

Revenue Recognition

 

Our revenues are generated from sales of electronics products. All of our revenue transactions contain standard business terms and conditions. We determine the appropriate accounting for these transactions after considering (1) whether a contract exists; (2) when to recognize revenue on the deliverables; and (3) whether all elements of the contract have been fulfilled and delivered. In addition, our revenue recognition policy requires an assessment as to whether collection is reasonably assured, which inherently requires us to evaluate the creditworthiness of our customers. Changes in judgments on these assumptions and estimates could materially impact the timing or amount of revenue recognition.

 

Please refer to Note 2 in the footnotes to the financial statements for detailed description of our revenue recognition policy.

 

Inflation

 

Neither inflation nor changing prices has had a material impact on the Company’s net sales, revenues or income from continuing operations during the past three fiscal years.

 

After Sales Service

 

The after-sales services we provide to our customers are primarily repair and maintenance. If a customer buys a product from us and needs repairs, we typically arrange to have the manufacturer repair the product. In certain cases, clerks in our stores are able to make the repairs directly.

 

Tabular Disclosure of Contractual Obligations

 

The following table sets forth our contractual obligations as of September 30, 2011:

 

   Payment Due by Period  
         Less than 1       
Contractual Obligations   Total     year     1-3 years  
Operating lease obligations  $299,263   $231,674   $67,589 
Advertising obligations   318,278    318,278    - 
E-Book contract obligations   87,214    87,214    - 
Total contractual obligations  $704,755   $637,166   $67,589 

 

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Item 4. Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures

 

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, our management conducted an evaluation of our disclosure controls and procedures as of September 30, 2011, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based on this evaluation, our principal executive officer and principal financial officer concluded that, as of such date, the Company’s disclosure controls and procedures were were not effective due to: the current staff in our accounting department are inexperienced in US GAAP. They need substantial training to meet the demands of a US public company. The accounting skills and understanding necessary to fulfill the requirements of US GAAP-based reporting, including the preparation of financial statements and consolidation, are inadequate.

 

Disclosure controls and procedures are designed to provide that information required to be disclosed by us in reports that we file or submit under the Exchange Act is accumulated, recorded, processed, summarized, communicated to our management, including our principal executive officer and principal financial officer and reported within the time periods specified in Securities and Exchange Commission rules and forms.

 

Changes in Internal Control over Financial Reporting

 

Other than the changes relating to the material weakness described above, there was no change in our internal control over financial reporting that occurred during the third quarter of 2011 covered by this Quarterly Report on Form 10-Q/A that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

 PART II. OTHER INFORMATION

 

Item 6. Exhibits.

 

Exhibit

No.

  Document Description
31.1   Certification of the Chief Executive Officer pursuant to Rule 13A-14(A)/15D-14(A) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
31.2   Certification of the Chief Financial Officer pursuant to Rule 13A-14(A)/15D-14(A) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
32.1   Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002).

 

The following financial statements from China 3C Group’s Quarterly Report on Form 10-Q/A for the quarterly period ended September 30, 2011 formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets (unaudited); (ii) the Consolidated Statements of Operations and Comprehensive Loss (unaudited); (iii) the Consolidated Statements of Cash Flows (unaudited); and, (iv) the Notes to Consolidated Financial Statements, tagged as blocks of text.

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

  CHINA 3C GROUP
     
Date: June 4, 2012 By: /s/ Zhenggang Wang
  Name:   Zhenggang Wang
  Title: Chief Executive Officer and Chairman
  (Principal Executive Officer)

 

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Date: June 4, 2012 By: /s/ Weiping Wang
  Name:   Weiping Wang
  Title: Chief Financial Officer (Principal Accounting and Financial Officer)

 

EXHIBIT INDEX

 

Exhibit
No.

  Document Description
31.1   Certification of the Chief Executive Officer pursuant to Rule 13A-14(A)/15D-14(A) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
31.2   Certification of the Chief Financial Officer pursuant to Rule 13A-14(A)/15D-14(A) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
32.1   Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002).

 

The following financial statements from China 3C Group’s Quarterly Report on Form 10-Q/A for the quarterly period ended September 30, 2011 formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets (unaudited); (ii) the Consolidated Statements of Operations and Comprehensive Loss (unaudited); (iii) the Consolidated Statements of Cash Flows (unaudited); and, (iv) the Notes to Consolidated Financial Statements, tagged as blocks of text.

 

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