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EX-32.1 - Yosen Group, Inc.v169928_ex32-1.htm
EX-32.2 - Yosen Group, Inc.v169928_ex32-2.htm
EX-31.1 - Yosen Group, Inc.v169928_ex31-1.htm
EX-31.2 - Yosen Group, Inc.v169928_ex31-2.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q/A
(Amendment No. 1)

x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended     March 31, 2009

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).  Yes ¨ 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 x Non-accelerated filer (Do not check if a smaller reporting company) ¨    Smaller reporting company  ¨

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

As of May 12, 2009 the registrant had 52,834,055 shares of common stock outstanding.

 
 

 

EXPLANATORY NOTE

We are filing this Amendment No. 1 to Quarterly Report on Form 10-Q/A to amend (a) Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations of Part I and (b) Item 4 Controls and Procedures of Part I.

Except as specifically referenced herein, this Amendment No. 1 to Quarterly Report on Form 10-Q/A does not reflect any event occurring subsequent to May 15, 2009, the filing date of the original report.

 
 

 

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
 
     
Item 1. Financial Statements:
 
     
 
Consolidated Balance Sheets as of March 31, 2009 (Unaudited) and December 31, 2008
1
     
 
Consolidated Statements of Income for the Three Months Ended March 31, 2009 and 2008 (Unaudited)
2
     
 
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2009 and 2008 (Unaudited)
3
     
 
Notes to Consolidated Financial Statements
4 - 15
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
16
   
Item 3. Qualitative and Quantitative Disclosure about Market Risk
22
    
 
Item 4. Controls and Procedures
23
     
PART II. OTHER INFORMATION
 
     
Item 1. Legal Proceedings
23
     
Item 1A. Risk Factors
23
   
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
23
     
Item 3. Defaults Upon Senior Securities
24
   
Item 4. Submission of Matters to a Vote of Security Holders
24
     
Item 5. Other Information
24
     
Item 6. Exhibits
24
     
Signatures
25
 
 
 

 
 
CHINA 3C GROUP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
 
  
 
March 31,
   
December
31,
 
  
 
2009
   
2008
 
   
(Unaudited)
   
(Audited)
 
ASSETS
           
             
Current assets:
           
Cash and cash equivalents
 
$
28,667,084
   
$
32,157,831
 
Accounts receivable, net
   
23,469,578
     
23,724,587
 
Inventories
   
11,339,434
     
8,971,352
 
Advances to suppliers
   
2,337,268
     
2,491,518
 
Prepaid expenses and other current assets
   
45,210
     
87,773
 
Total current assets
   
65,858,574
     
67,433,061
 
Property, plant and equipment, net
   
60,732
     
64,100
 
Goodwill
   
20,348,278
     
20,348,278
 
Deposit for acquisition of subsidiary
   
14,607,923
     
7,318,501
 
Refundable deposits
   
29,812
     
32,076
 
Total assets
 
$
100,905,319
   
$
95,196,016
 
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
                 
Current liabilities:
               
Accounts payable and accrued expenses
 
$
8,766,553
   
$
5,417,327
 
Income tax payable
   
1,197,700
     
2,140,624
 
Total liabilities
   
9,964,253
     
7,557,951
 
                 
Stockholders' equity
               
Common stock, $0.001 par value, 100,000,000 million shares
         
authorized, 52,834,055 and 52,673,938 issued and outstanding as of
         
March 31, 2009 and December 31, 2008, respectively
   
52,834
     
52,674
 
Additional paid-in capital
   
19,465,616
     
19,465,776
 
Subscription receivable
   
(50,000
)
   
(50,000
)
Statutory reserve
   
11,109,379
     
11,109,379
 
Other comprehensive income
   
5,135,530
     
5,272,104
 
Retained earnings
   
55,227,707
     
51,788,132
 
Total stockholders' equity
   
90,941,066
     
87,638,065
 
Total liabilities and stockholders' equity
 
$
100,905,319
   
$
95,196,016
 

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

 
1

 
 
CHINA 3C GROUP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2009 and 2008 (UNAUDITED)
 
   
2009
   
2008
 
Net sales
 
$
77,411,560
   
$
68,153,455
 
Cost of sales
   
67,352,831
     
57,607,075
 
Gross profit
   
10,058,729
     
10,546,380
 
Selling, general and administrative expenses
   
5,486,276
     
2,986,044
 
Income from operations
   
4,572,453
     
7,560,336
 
Other (income) expense
               
Interest income
   
(29,108
)
   
(36,095
)
Other income
   
(148,127
)
   
-
 
Other expense
   
111,222
     
12,813
 
Total other (income) expense
   
(66,013
)
   
(23,282
)
Income before income taxes
   
4,638,466
     
7,583,618
 
Provision for income taxes
   
1,198,891
     
1,810,573
 
Net income
   
3,439,575
     
5,773,045
 
Foreign currency translation adjustments
   
(136,574
)
   
1,600,050
 
Comprehensive income
 
$
3,303,001
   
$
7,373,095
 
                 
Net income available to common shareholders per share:
         
Basic
 
$
0.07
   
$
0.11
 
Diluted
 
$
0.07
   
$
0.11
 
                 
Weighted average shares outstanding:
               
Basic
   
52,834,055
     
52,673,938
 
Diluted
   
52,834,055
     
53,073,938
 

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

 
2

 
 
CHINA 3C GROUP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2009 and 2008  (UNAUDITED)

   
2009
   
2008
 
             
CASH FLOW FROM OPERATING ACTIVITIES
           
Net income
 
$
3,439,575
   
$
5,773,045
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation
   
6,648
     
9,946
 
Gain on asset disposition
   
-
     
(2,161
)
Provision for bad debts
   
-
     
13,498
 
Stock based compensation
   
-
     
117,557
 
(Increase) / decrease in assets:
               
Accounts receivable
   
208,083
     
(6,740,422
)
Other receivable
   
25,736
     
-
 
Inventories
   
(2,388,278
)
   
(4,251,886
)
Prepaid expenses and other current assets
   
16,712
     
587
 
Refundable deposits
   
2,186
     
(5,927
)
Advance to suppliers
   
149,449
     
926,777
 
Increase / (decrease) in current liabilities:
               
Accounts payable and accrued expenses
   
3,363,214
     
1,869,349
 
Income tax payable
   
(939,604
)
   
(837,248
)
Net cash provided by operating activities
   
3,883,721
     
(3,126,885
)
                 
CASH FLOW FROM INVESTING ACTIVITIES
               
Purchase of property and equipment
   
(2,763
)
   
(6,581
)
Proceeds from asset sales
   
-
     
2,447
 
Deposit for acquisition of subsidiary
   
(7,289,422
)
   
-
 
Net cash used in investing activities
   
(7,292,185
)
   
(4,134
)
                 
Effect of exchange rate changes on cash and cash equivalents
   
(82,283
)
   
1,600,050
 
                 
Net increase (decrease) in cash
   
(3,490,747
)
   
(1,530,969
)
Cash, beginning of period
   
32,157,831
     
24,952,614
 
Cash, end of period
 
$
28,667,084
   
$
23,421,645
 
                 
Supplemental disclosure of cash flow information:
               
Interest paid
 
$
-
   
$
-
 
Income taxes paid
 
$
2,141,815
   
$
2,647,821
 
 
The accompanying notes are an integral part of these consolidated financial statements.

 
3

 
 
CHINA 3C GROUP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009

Note 1 - ORGANIZATION

China 3C Group (the “Company”) 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. 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”) were incorporated under the laws of Peoples Republic of China on July 11, 2005, July 18, 1997, March, 30, 1998, April 12, 2004, and August 20, 2003, respectively. 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 December 21, 2005, Capital became a wholly owned subsidiary of China 3C Group through a reverse merger (“Merger Transaction”). China 3C Group 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 Group, 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 Group and, in exchange for the Capital shares, China 3C Group 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 Group at that time and a cash consideration of $500,000.
 
On August 3, 2006, Capital completed the acquisition of a 100% interest in Sanhe for a cash and stock transaction valued at approximately $8,750,000. The consideration consisted of 915,751 newly issued shares of the Company’s common stock and $5,000,000 in cash.  
 
On November 28, 2006, Capital completed the acquisition of a 100% interest in Joy & Harmony for a cash and stock transaction valued at approximately $18,500,000. The consideration consisted of 2,723,110 shares of the Company’s common stock and $7,500,000 in cash. 
 
On August 15, 2007, the Company changed its ownership structure. As a result, instead of Capital owning 100% of Zhejiang, Capital entered into contractual agreements with Zhejiang whereby Capital owns a 100% interest in the revenues of Zhejiang. Capital does not have an equity interest in Zhejiang, but enjoys all the economic benefits. Under this structure, Zhejiang is now a wholly foreign owned enterprise of Capital. The contractual agreements give Capital and its equity owners an obligation, and having ability to absorb, any losses, and rights to receive returns. Capital will be unable to make significant decisions about the activities of Zhejiang and cannot carry out its principal activities without financial support. These characteristics as defined in Financial Accounting Standards Board (“FASB”) Interpretation 46, Consolidation of Variable Interest Entities (VIEs), qualifies the business operations of Zhejiang to be consolidated with Capital and ultimately with China 3C Group. Zhejiang owns 90% of the issued and outstanding capital stock of each of Wang Da and Yiwu. 

 
4

 
 
 
The Company is engaged in the business of resale and distribution of third party products and generates approximately 100% of our revenue from resale of items such as mobile phones, facsimile machines, DVD players, stereos, speakers, MP3 and MP4 players, iPods, electronic dictionaries, CD players, radio Walkmans and audio systems.
 
On December 19, 2008, China 3C Group’s subsidiaries, Zhejiang and Yiwu entered into an acquisition agreement (the “Jinhua Agreement”) with Jinhua Baofa Logistic Ltd., a company organized under the laws of the People’s Republic of China (“Jinhua”) and the shareholders of Jinhua, who own 100% of the equity interest in Jinhua in the aggregate. Pursuant to the Jinhua Agreement Zhejiang will acquire 90% and Yiwu will acquire 10% of the entire equity interests in Jinhua from the shareholders of Jinhua for a total purchase price of RMB 120,000,000 payable as follows: (i) RMB 50,000,000, within 10 business days after the execution of the Jinhua Agreement; (ii) RMB 50,000,000 within 10 business days following the completion of the audit of Jinhua’s financial statements for the fiscal year ending December 31, 2008, in accordance with generally accepted accounting principles in the U.S. (the “Audit”), which Audit shall be completed no later than March 31, 2009; and (iii) the remaining RMB 20,000,000 no later than three months after the completion of Jinhua’s Audit. The source of the cash to be used for the purchase of 100% of the equity of Jinhua will be from working capital of China 3C Group.

Jinhua was founded in 2001 and is a well-known transportation logistics company in Eastern China and has been a long time transportation provider for China 3C Group. Jinhua has approximately 280 customers and operates a fleet of more than 70 trucks 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 service covers many of the most developed cities in the Eastern China region such as Shanghai, Hangzhou and Nanjing.

On April 4, 2009, Zhejiang and Yiwu entered into an amendment to the Jinhua Agreement (the “Amended Agreement”) with the shareholders of Jinhua. The Amended Agreement changed from March 31, 2009 to June 30, 2009 the date by which the parties have agreed that the Audit is required to be completed. In the event that the audit is not completed by June 30, 2009, the Agreement may be terminated.
 
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying condensed consolidated financial statements have been 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, however the accompanying condensed consolidated financial statements have been translated and presented in United States Dollars.

Principles of Consolidation

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

 
5

 
 
Currency Translation

The accounts of Zhejiang, Wang Da, Yiwu, Sanhe, and Joy & Harmony were maintained, and its financial statements were expressed, in Chinese Yuan Renminbi (“CNY”). Such financial statements were translated into U.S. Dollars (“USD”) in accordance with Statement of Financial Accounts Standards (“SFAS”) No. 52, “Foreign Currency Translation,” with the CNY as the functional currency. According to SFAS No. 52, all monetary assets and liabilities were translated at the ending exchange rate, non-monetary assets and stockholders’ equity are 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 SFAS No. 130, “Reporting Comprehensive Income,” as a component of shareholders’ equity. Transaction gains and losses are reflected in the condensed consolidated income and comprehensive income statement.

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.

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. Allowance for doubtful debts was $362,700 (unaudited) and $365,318 as of March 31, 2009 and December 31, 2008, respectively.
 
Inventories

Inventories are valued at the lower of cost (determined on a weighted average basis) or market.  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 March 31, 2009 and December 31, 2008, inventory consisted entirely of finished goods valued at $11,339,434 (unaudited) and $8,971,352, respectively. 

 
6

 
 
Property, Plant & Equipment, net
 
Property, plant and equipment are stated at cost. Expenditures for maintenance and repairs are charged to earnings 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 March 31, 2009 and December 31, 2008, property and equipment consisted of the following:

   
2009
   
2008
 
   
(Unaudited)
       
Automotive
 
$
132,627
   
$
132,627
 
Office equipment
   
119,980
     
116,700
 
Sub Total
   
252,607
     
249,327
 
Less: accumulated depreciation
   
(191,875
)
   
(185,227
)
Total
 
$
60,732
   
$
64,100
 
 
Long-Lived Assets
 
The Company periodically evaluates the carrying value of long-lived assets to be held and used in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144). SFAS 144 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 March 31, 2009 and December 31, 2008, there were no significant impairments of its long-lived assets.
 
Fair Value of Financial Instruments
 
SFAS No. 107, “Disclosures about Fair Value of Financial Instruments,” requires the Company to 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.
 
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. Approximately 68% and 65% of the Company's revenue comes from sales to individual customers at outlets installed inside department stores etc. (i.e. store in store model) during the three months ended March 31, 2009 and 2008, respectively and is mainly achieved through two broad categories:

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.
 
 
7

 
 
2.  
Wholesale. Approximately 32% and 35% of the Company's revenue comes from wholesale during the three months ended March 31, 2009 and 2008, respectively. Recognition of wholesale income is based on the contract terms. In 2009, the main contract terms on wholesale were that payments be paid 10 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

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 certain 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.  
Wholesales:

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 fro 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.

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 gross 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 the products, they follow the same return policy as retail customers. We do not honor any return from wholesale customers other than if the products don’t meet laws and regulations or quality requirements. If the 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 entry 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 engage in assessing 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.

 
8

 
 
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.

Because the Company does not include the costs related to its distribution network in cost of sales, its gross profit and gross profit as a percentage of net sales (“gross margin”) may not be comparable to those of other retailers that may include all costs related to their distribution network in cost of sales and in the calculation of gross profit and gross margin.

Shipping and handling fees

The Company follows Emerging Issues Task Force (“EITF”) No. 00-10, Accounting for Shipping and Handling Fees and 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 which were $53,705 and $59,875 for the three months ended March 31, 2009 and 2008, respectively.

Vendor Discounts

The Company has negotiated preferred pricing arrangements with certain 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 or “selling at an allowance (discount)”. The management fees are accounted for (1) in the form of service charges which are reflected in general and administrative expenses, or (2) in the form of “selling at an allowance (discount)”, as a deduction of sales, which means, the expenses are directly deducted at a certain percentage on sales. Such management fees were $485,520 and $218,400 in general and administrative expenses and deductions of $2,364,934 and $2,110,394 in sales for the three months ended March 31, 2009 and 2008, respectively.
 
Share Based Payment
 
In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure-an amendment of SFAS 123.” This statement amended SFAS 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary charge to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amended the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results.

Advertising

Advertising expenses consist primarily of costs of promotion for corporate image and product marketing and costs of direct advertising. The Company expenses all advertising costs as incurred. Advertising expense was $56,836 and $107,353 for the three months ended March 31, 2009 and 2008.
 
Other Income 
 
Other income was $148,127 for the three months ended March 31, 2009. Other income consists of the following: 
 
Advertising service income
 
$
103,220
 
Repair service income
   
14,756
 
Commission income from China Unicom
   
30,151
 
Total other income
 
$
148,127
 
 
 
9

 
 
Advertising service income is the fee we receive from electronic product manufacturers when we advertise their products in our retail locations. Commission income from China Unicom is derived from the sales of China Unicom’s wireless service and products, i.e. rechargeable mobile phone cards.

Income Taxes
 
The Company utilizes SFAS No. 109, “Accounting for Income Taxes,” which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, 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 Earnings per Share
 
Earnings per share are calculated in accordance with SFAS No. 128, “Earnings per Share.” Basic earnings per share is based upon the weighted average number of common shares outstanding. Diluted earnings per share is 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 per share. Excluded from the calculation of diluted earnings per share for the three months ended March 31, 2009 was 50,000 options, as they were not dilutive.
 
Statement of Cash Flows
 
In accordance with SFAS No. 95, “Statement of Cash Flows,” cash flows from the Company’s operations are calculated based upon the functional currency, in our case the CNY. 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 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 are 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

SFAS No. 131, “Disclosure about Segments of an Enterprise and Related Information,” 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. The Company operates in four segments (see Note 13).

Recent Accounting Pronouncements
 
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115.” This statement permits entities to choose to measure many financial instruments and certain other items at fair value. This statement is expected to expand the use of fair value measurement, which is consistent with the Board’s long-term measurement objectives for accounting for financial instruments. This statement was effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. The adoption of this statement had no effect on the Company’s consolidated financial statements.

 
10

 
 
In December 2007, FASB issued SFAS No. 141 (Revised 2007), “Business Combinations.” SFAS 141R changes how a reporting enterprise accounts for the acquisition of a business. SFAS 141R requires an acquiring entity to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value, with limited exceptions, and applies to a wider range of transactions or events. SFAS 141R is effective for fiscal years beginning on or after December 15, 2008 and early adoption and retrospective application is prohibited. Effective January 1, 2009, the Company adopted SFAS 141(R). The adoption of SFAS 141(R) had no impact on the Company’s condensed consolidated financial statements but will have a material impact on future acquisitions. We will account for future business acquisitions in accordance with these standards.

In December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements.” This Statement amends ARB 51 to establish accounting and reporting standards for the non-controlling (minority) interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. The Company adopted SFAS 160 on January 1, 2009. The adoption of this statement had no effect on the Company’s consolidated financial statements.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities.” The new standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The new standard also improves transparency about the location and amounts of derivative instruments in an entity’s financial statements; how derivative instruments and related hedged items are accounted for under Statement 133; and how derivative instruments and related hedged items affect its financial position, financial performance, and cash flows. The Company adopted SFAS 161 on January 1, 2009. The adoption of this statement had no effect on the Company’s consolidated financial statements.

In May 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement). FSP APB 14-1 clarifies that convertible debt instruments that may be settled in cash upon either mandatory or optional conversion (including partial cash settlement) are not addressed by paragraph 12 of APB Opinion No. 14, Accounting for Convertible Debt and Debt issued with Stock Purchase Warrants. Additionally, FSP APB 14-1 specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entity’s non-convertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The Company adopted FSP APB 14-1 beginning in the first quarter of 2009, and this standard must be applied on a retroactive basis. This Statement did not have an effect on the Company’s consolidated financial statements.

On May 8, 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles,” which will provide framework for selecting accounting principles to be used in preparing financial statements that are presented in conformity with US GAAP for nongovernmental entities. With the issuance of SFAS No. 162, the GAAP hierarchy for nongovernmental entities will move from auditing literature to accounting literature.  Management does not expect that this statement will have an effect on the Company’s consolidated financial statements.

On June 16, 2008, the FASB issued final Staff Position (FSP) No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities,” to address the question of whether instruments granted in share-based payment transactions are participating securities prior to vesting. As provided in the FSP, unvested share-based payment awards that contain rights to dividend payments should be included in earnings per share calculations. The guidance will be effective commencing in the year ended December 31, 2009. We are currently evaluating the requirements of EITF 03-6-1 as well as the impact of the adoption on our condensed consolidated financial statements.

In June 2008, the FASB ratified Emerging Issues Task Force Issue No. 07-5, “Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock” (“EITF 07-5”). EITF 07-5 mandates a two-step process for evaluating whether an equity-linked financial instrument or embedded feature is indexed to the entity’s own stock.  Warrants that a company issues that contain a strike price adjustment feature, upon the adoption of EITF 07-5, are no longer being considered indexed to the company’s own stock. Accordingly, adoption of EITF 07-5 will change the current classification (from equity to liability) and the related accounting for such warrants outstanding at that date. EITF 07-5 is effective for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. This Statement did not have an effect on the Company’s condensed consolidated financial statements.

In April 2009, the FASB issued FSP SFAS 107-1 and Accounting Principles Board Opinion (“APB”) 28-1, "Interim Disclosures about Fair Value of Financial Instruments", or FSP 107-1, which will require that the fair value disclosures required for all financial instruments within the scope of SFAS 107, "Disclosures about Fair Value of Financial Instruments", be included in interim financial statements. This FSP also requires entities to disclose the method and significant assumptions used to estimate the fair value of financial instruments on an interim and annual basis and to highlight any changes from prior periods. FSP 107-1 will be effective for interim periods ending after June 15, 2009. The adoption of FSP 107-1 is not expected to have a material affect.  

 
11

 

Note 3 – ADVANCES TO SUPPLIERS
 
Advances to suppliers represent advance payments to suppliers for the purchase of inventory. As of March 31, 2009 and December 31, 2008, the Company paid $2,337,268 and $2,491,518, respectively, as advances to suppliers.
 
Note 4 - COMMON STOCK
 
On December 21, 2005, the Company announced a plan named the China 3C Group 2005 Equity Incentive Plan (the “2005 Plan”) for providing incentives to attract, retain and motivate eligible persons whose presence and potential contributions are important to the success of the Company. 5,000,000 shares of the Company’s common stock were allocated to the 2005 Plan.

On December 21, 2005, the Company agreed to issue 4,980,000 shares under the 2005 Plan to a number of consultants who were engaged to provide various services to the Company during the period from January 1, 2005 to December 20, 2005. These shares were valued at $0.10 per share, or $498,000, and were expensed as consulting fees in the statements of operations. The shares were issued subsequently in 2006.

Pursuant to share exchange agreement, dated August 3, 2006, the Company issued 915,751 shares of restricted common stock, to the former shareholders of Sanhe. The shares were valued at $3,750,000, which was the fair value of the shares at the date of exchange agreement. This amount is included in the cost of net assets and goodwill purchased.

Pursuant to share exchange agreement, dated November 28, 2006, the Company issued 2,723,110 shares of common stock to the former shareholders of Joy & Harmony. The shares were valued at $11,000,000, which was the fair value of the shares at the date of exchange agreement. This amount is included in the cost of net assets and goodwill purchased.

The Company appointed Joseph Levinson to serve as a member of the Company’s Board of Directors on May 7, 2007. Joseph Levinson resigned as a member of the Company’s Board of Directors on January 27, 2009.  There were no disagreements between Mr. Levinson and the Company on any matter related to the Company’s operations, policies or practices which resulted in his resignation.  Pursuant to the Agreement dated May 3, 2007 the Company agreed to issue to Mr. Levinson, as compensation for his services, a monthly grant of 1,000 shares of the Company’s common stock.  The Company has issued 20,000 shares in total to M. Levinson representing the 1,000 share per month payments.  In addition, the Company agreed to grant Mr. Levinson the following awards under the 2005 Plan: (i) an initial annual grant of a stock option to purchase 300,000 shares of the Company’s common Stock, with an exercise price of $6.15 per share (the “2007 Stock Option”); and (ii) a subsequent annual grant of a stock option to purchase an additional 300,000 shares of the Company’s common stock, with an exercise price of $1.82 (the “2008 Stock Option”).  It was later determined that due to the expiration of the 2005 Plan on December 31, 2006, the 2007 Stock Option and the 2008 Stock Option could not be validly granted.  Pursuant to the terms of the Compensation Agreement dated as of November 27, 2008 between Mr. Levinson and the Company, Mr. Levinson acknowledged that the 2007 Stock Option and the 2008 Stock Option were not and could  not be granted and,  in consideration for his services as a Director accepted the issuance of 125,000 shares of the Company’s common stock.

On January 15, 2009, the Company’s Board of Directors adopted the China 3C Group, Inc. 2008 Omnibus Securities and Incentive Plan (the “2008 Plan”).  The 2008 Plan provides for the granting of distribution equivalent rights, incentive stock options, non-qualified stock options, performance share awards, performance unit awards, restricted stock awards, stock appreciation rights, tandem stock appreciation rights, unrestricted stock awards or any combination of the foregoing, as may be best suited to the circumstances of the particular employee, director or consultant.  Under the 2008 Plan 2,000,000 shares of the Company’s common stock are available for issuance for awards.  Each award shall remain exercisable for a term of ten (10) years from the date of its grant. The price at which a share of common stock may be purchased upon exercise of an option shall not be less than the closing sales price of the common stock on the date such option is granted.  The 2008 Plan shall continue in effect, unless sooner terminated, until the tenth anniversary of the date on which it is adopted by the Board.

Note 5 - STOCK WARRANTS, OPTIONS, AND COMPENSATION
 
The Company appointed Kenneth T. Berents to serve as a member of the Company’s Board of Directors on December 8, 2006.  Under the Board of Directors Agreement between the Company and Mr. Berents, dated December 8, 2006, the Company agreed to issue to Mr. Berents as a compensation for his services under the 2005 Plan, an initial grant of a stock option to purchase 50,000 shares of the Company’s common stock upon execution of the Board of Directors Agreement and an option to purchase 30,000 shares of the Company’s common stock on each anniversary of the Board of Directors Agreement , provided Mr. Berents is a member of the Board of Directors at such time.  It was later determined that due to the expiration of the 2005 Plan on December 31, 2006 the grants of stock options to Mr. Berents could not be validly granted.  In order to meet its obligations under the Board of Directors Agreement, the Company entered into the following agreements with Mr. Berents (i) Stock Option Agreement - Director Non-Qualified Stock Option dated as of December 1, 2008 and effective as of January 15, 2009 for the issuance of 50,000 shares of the Company’s common stock, with an exercise price of $4.29 per share under the Company’s 2008 Plan to Mr. Berents, (ii) Stock Option Agreement - Director Non-Qualified Stock Option dated as of December 1, 2008 and effective as of January 15, 2009 for the issuance of 30,000 shares of the Company’s common stock, with an exercise price of $4.27 per share under the Company’s 2008 Plan to Mr. Berents, and (iii) Stock Option Agreement - Director Non-Qualified Stock Option dated as of December 1, 2008 and effective as of January 15, 2009 for the issuance of 30,000 shares of the Company’s common stock, with an exercise price of $0.90 per share under the Company’s 2008 Plan to Mr. Berents.

The Company appointed Todd L. Mavis to serve as a member of the Company’s Board of Directors on January 2, 2007. Mr. Mavis resigned as a member of the Board of Directors effective as of December 17, 2007.  There were no disagreements between Mr. Mavis and the Company on any matter related to the Company’s operations, policies or practices which resulted in his resignation.   As a compensation for his services,  the Company agreed to issue to Mr. Mavis under the 2005 Plan, an initial annual grant of a stock option to purchase 50,000 shares of the Company’s common stock, with an exercise price of $3.80 per share (the “Mavis Stock Option”).  Under the Board of Directors Agreement between the Company and Mr. Mavis, dated January 2, 2007, in the event that Mr. Mavis is no longer a member of the Board of Directors, his exercise period for all vested options is twenty-four months from the anniversary date of his departure from the Board of Directors.  It was later determined that due to the expiration of the 2005 Plan on December 31, 2006 the Mavis Stock Option could not be validly granted.  Pursuant to the terms of the Stock Option Agreement with Todd L. Mavis dated as of April 21, 2009 between Mr. Mavis and the Company, Mr. Mavis was granted an option to purchase 50,000 shares of the Company’s common stock (the “New Mavis Stock Option”), for an exercise price per share of common stock equal to $3.46.  All or any part of the New Mavis Stock Option may be exercised by Mr. Mavis, no later than December 17, 2009.

Stock options— All 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 equal 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.

The expected term represents the estimated average period of time that the options remain outstanding. The expected volatility is based on the historical volatility of the Company’s stock price. No dividend payouts were assumed, as the Company has no plans to declare dividends during the expected term of the stock options. The risk-free rate of return reflects the weighted average interest rate offered for zero coupon treasury bonds over the expected term of the options. Based upon this calculation and pursuant to EITF 96-18, the Company recorded expenses of $117,557 for the three months ending March 31, 2008.

 
12

 
 
Note 6 - COMPENSATED ABSENCES
 
Regulation 45 of the labor laws in the People’s Republic of China (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.

Note 7 - INCOME TAXES

The Company, through its subsidiaries, Zhejiang, Wang Da, Sanhe, Joy & Harmony and Yiwu, is governed by the Income Tax Laws of the PRC. The US entity, China 3C Group, Inc, has incurred net accumulated operating losses of approximately $2,503,752 of public company expenses as of March 31, 2009 for income tax purposes. However, a 100% allowance has been recorded on the deferred tax asset of approximately $851,000 due to the fact that the US entity does not have any operations and only incurs public expenses every year and it is more likely than not that all of the Company’s deferred tax assets will not be realized.
 
FIN 48 provides guidance on interest and penalties on unrecognized deferred tax benefit. 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 unrecognized tax benefit, and therefore, no accrued interest or penalties associated with any unrecognized tax benefits was recorded.

Pursuant to the PRC Income Tax Laws, from January 1, 2008, the Enterprise Income Tax (“EIT) is at a statutory rate of 25%.
 
The following is a reconciliation of income tax expense:

March 31, 2009
 
U.S.
   
State
   
International
   
Total
 
Current
 
$
-
   
$
-
   
$
-
   
$
1,198,891
 
Deferred
   
-
     
-
     
-
     
-
 
Total
 
$
-
   
$
-
   
$
-
   
$
1,198,891
 
 
March 31, 2009
 
U.S.
   
State
   
International
   
Total
 
Current
 
$
-
   
$
-
   
$
-
   
$
1,810,573
 
Deferred
   
-
     
-
     
-
     
-
 
Total
 
$
-
   
$
-
   
$
-
   
$
1,810,573
 

Reconciliation of the differences between the statutory U.S. Federal income tax rate and the effective rate is as follows:
 
   
For the three months ended
March 31,
 
   
2009
   
2008
 
US statutory tax rate
   
34
%
   
34
%
Tax rate difference
   
(9
)%
   
(9
)%
Increase in valuation allowance
   
0.8
%
   
(1
)%
Effective rate
   
25.8
%
   
24
%
 
Note 8 - COMMITMENTS
 
The Company leases office facilities under operating leases that terminate through 2011. Rent expense for the three months ended March 31, 2009 and 2008 was $51,174 and $62,799, respectively. The future minimum obligations under these agreements are as follows by years as of March 31, 2009:
 
2009 
 
$
274,000
 
2010 
   
72,400
 
2011
   
16,400
 
   
Note 9 - STATUTORY RESERVE

In accordance with the laws and regulations of the PRC, a wholly-owned Foreign Invested Enterprise’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 percent 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 percent of the registered capital. Effective January 1, 2006, there is now only one fund requirement. The reserve is 10 percent of income after tax, not to exceed 50 percent of registered capital.

 
13

 
 
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 March 31, 2009 and December 31, 2008, the Company had allocated $11,109,379 to these non-distributable reserve funds.
  
Note 10 - OTHER COMPREHENSIVE INCOME
  
The detail of other comprehensive income as included in stockholders’ equity at March 31, 2009 (unaudited) and December 31, 2008 are as follows is as follows:
 
    
Foreign
Currency
Translation
Adjustment
   
Total
Accumulated
Other
Comprehensive
Income
 
Balance at December 31, 2007
 
$
1,872,334
   
$
1,872,334
 
Change for 2008
   
3,399,770
     
3,399,770
 
Balance at December 31, 2008
 
$
5,272,104
   
$
5,272,104
 
Change for first quarter 2009
   
(136,574
)
   
(136,574
)
Balance at March 31, 2009
 
$
5,135,530
   
$
5,135,530
 

Note 11 - CURRENT VULNERABILITY DUE TO CERTAIN RISK FACTORS

The Company’s operations are carried out 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 12 - MAJOR CUSTOMERS AND CREDIT RISK

During the three months ended March 31, 2009, no customer accounted for more than 10% of the Company’s sales or accounts receivable. At March 31, 2009 two (2) vendors comprised approximately 29% of the Company’s accounts payable.

During the three months ended March 31, 2008, no customer accounted for more than 10% of the Company’s sales or accounts receivable. At March 31, 2008 three (3) vendors comprised approximately 35% of the Company’s accounts payable.

Note 13 -   SEGMENT INFORMATION

We separately operate and prepare accounting and other financial reports to management for four major business organizations (Wang Da, Sanhe, Yiwu and Joy & Harmony). Each of the individual operating companies corresponds to different product groups.  Wang Da is mainly operating mobile phones, Sanhe is mainly operating home appliances, Yiwu is mainly operating office communication products, and Joy & Harmony is mainly operating consumer electronics. All segments are accounted for using the same principals as described in Note 2.

We have identified four reportable segments required by SFAS 131: (1) mobile phone, (2) home electronics, (3) office communication product, and (4) consumer electronics.

 
14

 

The following tables present summarize information by segment (in thousands):

   
Quarter Ended March 31, 2009
 
   
Mobile
Phones
   
Home
Electronics
   
Office
Communication
Products
   
Consumer
Electronics
   
Other
   
Total
 
Sales, net
  $ 25,744       16,593     $ 15,802     $ 19,273     $ -     $ 77,412  
Cost of sales
    22,784       13,344       14,105       17,120       -       67,353  
Gross profit
    2,960       3,249       1,697       2,153       -       10,059  
Income from operations
    1,116       1,138       502       1,279       537       4,572  
Total assets
  $ 16,679     $ 17,746     $ 16,598     $ 16,069     $ 33,813     $ 100,905  

   
Quarter Ended March 31, 2008
 
   
Mobile
Phones
   
Home
Electronics
   
Office
Communication
Products
   
Consumer
Electronics
   
Other
   
Total
 
Sales, net
  $ 21,782     $ 16,890     $ 13,117     $ 16,364     $ -     $ 68,153  
Cost of sales
    18,228       13,912       11,285       14,182       -       57,607  
Gross profit
    3,554       2,978       1,832       2,182       -       10,546  
Income from operations
    2,547       1,864       1,190       1,660       299       7,560  
Total assets
  $ 21,294     $ 18,269     $ 14,452     $ 16,818     $ 769     $ 71,602  

 
15

 

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 Item 2.  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” and elsewhere in this Form 10-Q.

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

Overview

China 3C Group was incorporated on August, 20, 1998 under the laws of the State of Nevada. Capital Future Developments Limited (“CFDL”) was incorporated on July 22, 2004 under the laws of the British Virgin Islands. Zhejiang Yong Xin Digital Technology Co., Ltd. (“Zhejiang”), Yiwu Yong Xin Communication Ltd. (“Yiwu”), Hangzhou Wandga Electronics Co., Ltd. (“Wang Da”), Hangzhou Sanhe Electronic Technology, Limited (“Sanhe”), and Shanghai Joy & Harmony Electronic Development Co., Ltd. (“SJHE”) were incorporated under the laws of Peoples Republic of China on July 11, 2005, July 18, 1997, March 30, 1998, April 12, 2004, and August 25, 2003, respectively. China 3C Group owns 100% of CFDL and CFDL own 100% of the capital stock of SJHE 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, CFDL 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. Collectively the seven corporations are referred to herein as the Company.

On December 21, 2005 CFDL became a wholly owned subsidiary of China 3C Group through a merger with a wholly owned subsidiary of the Company. China 3C Group acquired all of the issued and outstanding capital stock of CFDL pursuant to a Merger Agreement dated at December 21, 2005 by and among China 3C Group, XY Acquisition Corporation, CFDL and the shareholders of CFDL (the “Merger Agreement”). Pursuant to the Merger Agreement, CFDL became a wholly owned subsidiary of China 3C Group and, in exchange for the CFDL shares, China 3C Group issued 35,000,000 shares of its common stock to the shareholders of CFDL, representing 93% of the issued and outstanding capital stock of China 3C Group at that time and a cash consideration of $500,000. On August 15, 2007, in order to comply with the requirements of PRC law, the Company recapitalized its ownership structure. As a result, instead of CFDL owning 100% of Zhejiang as previously was the case, CFDL entered into contractual agreements with Zhejiang whereby CFDL owns a 100% interest in the revenues of Zhejiang. CFDL does not have an equity interest in Zhejiang, but is deemed to have all the economic benefits and liabilities by contract. Under this structure, Zhejiang is now a wholly foreign owned enterprise (WOFE) of CFDL. The contractual agreements give CFDL and its’ equity owners an obligation to absorb, any losses, and rights to receive revenue. CFDL will be unable to make significant decisions about the activities of Zhejiang and can not carry out its principal activities without financial support. These characteristics as defined in Financial Accounting Standards Board (FASB) interpretation 46, Consolidation of Variable Interest Entities (VIEs), qualifies the business operations of (Zhejiang) to be consolidated with (CFDL) and ultimately with China 3C Group.
 
As a result of the Merger Agreement, the reorganization was treated as an acquisition by the accounting acquiree that is being accounted for as a recapitalization and as a reverse merger by the legal acquirer for accounting purposes. Pursuant to the recapitalization, all capital stock shares and amounts and per share data have been retroactively restated. Accordingly, the financial statements include the following:
 
(1) The balance sheet consists of the net assets of the accounting acquirer at historical cost and the net assets of the legal acquirer at historical cost.
 
(2) The statements of operations include the operations of the accounting acquirer for the period presented and the operations of the legal acquirer from the date of the merger.

Pursuant to a share exchange agreement, dated August 3, 2006, we issued 915,751 shares of restricted common stock, to the former shareholders of Hangzhou Sanhe Electronic Technology Ltd. The shares were valued at $3,750,000, which was the fair value of the shares at the date of exchange agreement. This amount is included in the cost of net assets and goodwill purchased.

 
16

 
 
Pursuant to a share exchange agreement, dated November 28, 2006, we issued 2,723,110 shares of newly issued shares of Common Stock to the former shareholders of Shanghai Joy & Harmony Electronics Company Limited. The shares were valued at $11,000,000, which was the fair value of the shares at the date of exchange agreement. This amount is included in the cost of net assets and goodwill purchased.

The Company is engaged in the business of the resale and distribution of mobile phones, facsimile machines, DVD players, stereos, speakers, MP3 and MP4 players, iPods, electronic dictionaries, CD players, radios, Walkmans, and audio systems. We sell and distribute these products through retail stores and secondary distributors.
 
On December 19, 2008, China 3C Group’s subsidiaries, Zhejiang and Yiwu entered into an acquisition agreement (the “Jinhua Agreement”) with Jinhua Baofa Logistic Ltd., a company organized under the laws of the People’s Republic of China (“Jinhua”) and the shareholders of Jinhua, who own 100% of the equity interest in Jinhua in the aggregate. Pursuant to the Jinhua Agreement Zhejiang will acquire 90% and Yiwu will acquire 10% of the entire equity interests in Jinhua from the shareholders of Jinhua for a total purchase price of RMB 120,000,000 payable as follows: (i) RMB 50,000,000, within 10 business days after the execution of the Jinhua Agreement; (ii) RMB 50,000,000 within 10 business days following the completion of the audit of Jinhua’s financial statements for the fiscal year ending December 31, 2008, in accordance with generally accepted accounting principles in the U.S. (the “Audit”), which Audit shall be completed no later than March 31, 2009; and (iii) the remaining RMB 20,000,000 no later than three months after the completion of Jinhua’s Audit. The source of the cash to be used for the purchase of 100% of the equity of Jinhua will be from working capital of China 3C Group.

Jinhua was founded in 2001 and is a well-known transportation logistics company in Eastern China and has been a long time transportation provider for China 3C Group. Jinhua has approximately 280 customers and operates a fleet of more than 70 trucks 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 service covers many of the most developed cities in the Eastern China region such as Shanghai, Hangzhou and Nanjing.

On April 4, 2009, Zhejiang and Yiwu entered into an amendment to the Jinhua Agreement (the “Amended Agreement”) with the shareholders of Jinhua. The Amended Agreement changed from March 31, 2009 to June 30, 2009 the date by which the parties have agreed that the Audit is required to be completed. In the event that the audit is not completed by June 30, 2009, the Agreement may be terminated.
 
Result of Operations

For the Three Months Ended March 31, 2009 and 2008

Reportable Operating Segments

The Company reports financial and operating information in the following four segments:
 
a)           Yiwu Yong Xin Telecommunication Company, Limited or “Yiwu”
b)           Hangzhou Wang Da Electronics Company, Limited or “Wang Da”
c)           Hangzhou Sanhe Electronic Technology Limited or “Sanhe”
d)           Shanghai Joy & Harmony Electronics Company Limited or “SJHE”

All dollar amounts reported here are in thousands:

a)           Yiwu Yong Xin Telecommunication Company Limited or “Yiwu”

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

   
Three months ended March
31,
   
Percentage
 
Yiwu
 
2009
   
2008
   
Change
 
Revenue
  $ 15,802     $ 13,117       20.47 %
Gross Profit
  $ 1,697     $ 1,832       (7.37 )%
Gross Margin
    10.74 %     13.97 %     (3.23 )%
Operating Income
  $ 502     $ 1,190       (57.81 )%

For the three months ended March 31, 2009, Yiwu generated revenue of $15,802 , an increase of $2,685  or 20.47% compared to $13,117  for the three months ended March 31, 2008.

Gross profit decreased $135  or 7.37% from $1,832  for the three months ended March 31, 2008 to $1,697  for the three months ended March 31, 2009. Gross profit margin decreased 3.23% from 13.97% in the three months ended March 31, 2008 to 10.74% in the three months ended March 31, 2009. The decrease was a result of lower unit sales price of fax machines and telephones due to a more competitive sales market.

Operating income was $502 for the three months ended March 31, 2009, a decrease of $688  or 57.81% compared to $1,190  for the three months ended March 31, 2008. Operating income decreased primarily due to decreased gross profit and increased operating expenses. The increase in operating expenses was primarily due to an increase in base salary for all staff. Other factors include an increase in marketing expenses, an increase in management fees paid to the department stores as well as additional expenses incurred to upgrade the sales counters in retail stores to enhance the business image.

b)           Hangzhou Wang Da Electronics Company Limited or “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.

 
17

 
 
   
Three months ended March
31,
   
Percentage
 
Wang Da
 
2009
   
2008
   
Change
 
Revenue
  $ 25,744     $ 21,782       18.18 %
Gross Profit
  $ 2,960     $ 3,554       (16.71 )%
Gross Margin
    11.50 %     16.32 %     (4.82 )%
Operating Income
  $ 1,116     $ 2,547       (56.18 )%

For the three months ended March 31, 2009, Wang Da generated revenue of $25,744 , an increase of $3,962  or 18.18% compared to $21,782  for the three months ended March 31, 2008.

Gross profit decreased $594  or 16.71% from $3,554  for the three months ended March 31, 2008 to $2,960  for the three months ended March 31, 2009. Gross profit margin decreased from 16.32% in the three months ended March 31, 2008 to 11.50% in the three months ended March 31, 2009, a decrease of 4.82%.  The decrease was a result of lower unit sales price of cell phones due to a more competitive sales market.

Operating income was $1,116  for the three months ended March 31, 2009, a decrease of $1,431  or 56.18% compared to $2,547  for the three months ended March 31, 2008. Operating income decreased primarily due to decreased gross profit and increased operating expenses. The increase in operating expenses was primarily due to an increase in base salary for all staff. Other factors include an increase in marketing expenses, an increase in management fees paid to the department stores as well as additional expenses incurred to upgrade the sales counters in retail stores to enhance the business image.

c)           Hangzhou Sanhe Electronic Technology Limited or “Sanhe”

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

   
Three months ended March
31,
   
Percentage
 
Sanhe
 
2009
   
2008
   
Change
 
Revenue
  $ 16,593     $ 16,890       (1.76 )%
Gross Profit
  $ 3,249     $ 2,978       9.10 %
Gross Margin
    19.58 %     17.63 %     1.95 %
Operating Income
  $ 1,138     $ 1,864       (38.96 )%

For the three months ended March 31, 2009, Sanhe generated revenue of $16,593 , a decrease of $297  or 1.76% compared to $16,890  for the three months ended March 31, 2008.

Gross profit increased $271  or 9.10% from $2,978  for the three months ended March 31, 2008 to $3,249  for the three months ended March 31, 2009. Gross profit margin increased from 17.63% in 2008 to 19.58% in 2009, an increase of 1.95%. The increase was a result of higher sales volume of DVD players and speakers which have higher gross margin compared to other home electronics products such as televisions and air conditioners.

Operating income was $1,138  for the three months ended March 31, 2009, a decrease of $726  or 38.96% compared to $1,864  for the three months ended March 31, 2008. Operating income decreased primarily due to higher operating expenses in the first quarter of 2009. The increase in operating expenses was primarily due to an increase in base salary for all staff. Other factors include an increase in marketing expenses, an increase in management fees paid to the department stores as well as additional expenses incurred to upgrade the sales counters in retail stores to enhance the business image.

d)           Shanghai Joy & Harmony Electronics Company Limited or “SJHE”

SJHE focuses on the selling, circulation and modern logistics of consumer electronics, including MP3 players, MP4 players, iPod, electronic dictionary, radios, and Walkman.

 
18

 
 
   
Three months ended March
31,
   
Percentage
 
SJHE
 
2009
   
2008
   
Change
 
Revenue
  $ 19,273     $ 16,364       17.78 %
Gross Profit
  $ 2,153     $ 2,182       (1.33 )%
Gross Margin
    11.17 %     13.33 %     (2.16 )%
Operating Income
  $ 1,279     $ 1,660       (22.97 )%

For the three months ended March 31, 2009, SJHE generated revenue of $19,273 , an increase of $2,909  or 17.78% compared to $16,364  for the three months ended March 31, 2008.

Gross profit decreased $29  or 1.33% from $2,182  for the three months ended March 31, 2008 to $2,153  for the three months ended March 31, 2009. Gross profit margin decreased from 13.33% in 2008 to 11.17% in 2009, a decrease of 2.16%.  The slight decrease was due to a more competitive market in consumer digital products which caused the unit sales price to fall in the first quarter of 2009.

Operating income was $1,279  for the three months ended March 31, 2009, a decrease of $381  or 22.97% compared to $1,660  for the three months ended March 31, 2008. Operating income decreased primarily due to higher operating expenses in the first quarter 2009. The increase in operating expenses was primarily due to an increase in base salary for all staff. Other factors include an increase in marketing expenses , an increase in management fees paid to the department stores as well as additional expenses incurred to upgrade the sales counters in retail stores to enhance the business image.

Net Sales

Net sales for the three months ended on March 31, 2009 increased by 13.58%, to $77,412 compared with $68,153 for the three months ended March 31, 2008. We had a significant snowstorm in China during the first two months of 2008 which created a backlog in our distribution channels. Therefore, we had fewer sales in the first quarter 2008. Management believes that the sales revenue for the three months ended on March 31, 2009 is considered at a normal level.

Cost of Sales

Cost of sales for the three months ended on March 31, 2009 totaled $67,353compared to $57,607 for the three months ended on March 31, 2008, an increase of 16.92%. The increased cost of sales was a direct result of the increase in sales.

Gross Profit Margin

Gross profit margin for the three months ending March 31, 2009 was 12.99% compared to 15.47% for the three months ending March 31, 2008. The lower gross profit margin was because the unit sales prices for many electronic products decreased due to the highly competitive market environment but the purchase prices remained flat.

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the three months ending March 31, 2009 totaled $5,486 or approximately 7% of net sales, compared to $2,986 or approximately 4% of net sales for the three months ended March 31, 2008, an increase of 83.73%. The increase in operating expenses was primarily due to an increase in base salary for all staff. Other factors include an increase in marketing expenses, an increase in management fees paid to the department stores as well as additional expenses incurred to upgrade the sales counters in retail stores to enhance the business image.

Income from Operations

Income from operations for the three months ended March 31, 2009 was $4,572 or 5.91% of net sales as compared to income from operations of $7,560 or 11.09% of net sales for the three months ending March 31, 2008, a decrease of 39.52%. Lower gross margin and higher operating expenses were the key factors for the decrease in income from operations.

Provision for Income Taxes

The provision for income taxes for the three months ended March 31, 2009 was $1,199 as compared with $1,811 for the three months ended March 31, 2008. The decrease was attributed to the decrease in taxable income.

 
19

 
 
Net Income

Net income was $3,440 or 4.44% of net sales for the three months ended on March 31, 2009 compared to $5,773 or 8.47% of net sales for the three months ended on March 31, 2008, a decrease of 40.42%. Lower gross margin and high operating expenses 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 cash equivalents were $28,667 at March 31, 2009, as compared to $23,422 at March 31, 2008, and compared to $32,158 at December 31, 2008.
 
We believe that the funds available to us are adequate to meet our operating needs for the remainder of 2009.

   
Three months ended
 
   
March 31,
2009
   
March 31,
2008
 
Net cash (used in) provided by operating activities
  $ 3,883     $ (3,127 )
Net cash (used in) investing activities
  $ (7,292 )   $ (4 )
Effect of exchange rate change on cash and cash equivalents
  $ (82 )   $ 1,600  
Net increase (decrease) in cash and cash equivalents
  $ (3,491 )   $ (1,531 )
Cash and cash equivalents at beginning of period
  $ 32,158     $ 24,953  
Cash and cash equivalents at end period
  $ 28,667     $ 23,422  

Operating Activities

Net cash generated from operating activities was $3,883  for the three months ended March 31, 2009 compared to net cash used in operating activities of $3,127  for the three months ended March 31, 2008, approximately a 224.20% increase.  The increase was mainly attributable to several factors, including (i) net income of 3,440; (ii) the substantial increase in accounts payable and accrued expenses of $3,363; (iii) decrease in accounts receivable of $208, offset by the increase in inventory of $2,388  and decrease in income taxes payable of $940  in the three months ended March 31, 2009.
 
   
Three months ended
 
   
March 31,
2009
   
March 31,
2008
 
a) Increase in accounts payable and accrued charges
  $ 3,363     $ 1,869  

The Company has developed its own brand name over the past years and has been successful in receiving support from its creditors.
 
   
Three months ended
 
   
March 31,
2009
   
March 31,
2008
 
b) Increase (decrease) in accounts receivable
  $ (208 )   $ 6,740  
 
At year end 2008, the contract terms were i) 30 days from the transfer of goods to the customers on retail and ii) 10 days after receipt of goods on wholesale.

Beginning in March 2009, the Company has renewed the contracts with customers and new terms were negotiated as follows: i) 45 days from the transfer of goods to the customers on retail and ii) 15 days after receipt of goods on wholesale.

At March 31, 2009, the accounts receivable balance was $23,470, which represented a one percent decrease compared to $23,725 at December 31, 2008. However, sales in the first quarter of 2009 decreased $7,507 or 8.8%.

Accounts receivable did not decrease in line with the decrease in sales due to the fact that the Company began extending the payment terms of its customers in late March 2009. The extension in payment terms resulted in an increase in accounts receivable which offset the decrease in accounts receivable caused by the decline in sales.

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 estimate of bad debt allowance is based on the aging of the receivables, the 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 highly probable that it is uncollectible, then it will be charged to bad debt immediately in that period.
 
In 2008, the accounts receivable turnover was approximately 12 times per year. At March 31, 2009, the accounts receivable turnover was approximately 9 times per year. The accounts receivable turnover ratio is in line with contract terms. Management assessed the collectability of accounts receivable and determined that all accounts remained collectible. No bad debt provision was necessary during the first quarter 2009 for the current accounts receivables.

 
20

 
 
   
Three months ended
 
   
March 31,
2009
   
March 31,
2008
 
c) Increase in inventory
  $ 2,388     $ 4,252  
 
As a result of the unprecedented snow storm in 2008, there was a shortage of inventory available to our stores during the first quarter 2008.  As a precautionary measure, the Company decided to increase its level of inventory in order to maintain an adequate level for all stores in the event of other unexpected incidents.  Therefore, inventory increased $4,252  in the first quarter 2008. During the first quarter 2009, inventory increased $2,388, the increased inventory balance at March 31, 2009 was due to the slowdown in sales after the Chinese New Year holiday.
 
At December 31, 2008, inventory level of $9 million was relatively low because it is the peek season for holiday shopping and we have high inventory turnover during the holiday season.  At March 31, 2009, inventory was $11.3 million. Sales slowed down after the Chinese New Year in late February and March 2009 which caused inventory  turnover to slow down, and the Company needed some time to adjust the inventory to a normal level.

The Company did not change its inventory policy in 2009 and the inventory turnover remained approximately 15 days.

As a result of the factors above, the Company generated $3,884  in operating activities for the three months ended March 31, 2009.

Investing Activities

Net cash used in investing activities increased to $7,292  in the first quarter 2009 from $4  in 2008. The significant increase was due to the second installment payment for acquisition of Jinhua Baofa Logistic Ltd, pursuant to the acquisition agreement dated December 29, 2008. The Company made the second installment payment in advance of its due date in order to change the business license registration of Jinhua.

   
Three months ended
 
   
March 31,
2009
   
March 31,
2008
 
Net cash (used in) investment activities
  $ (7,292 )   $ (4 )
 
The source of the cash to be used for the purchase of 100% of the equity of Jinhua will be from working capital of China 3C Group.
 
Financing Activities

The Company did not carry out any financing activities during the three months ended March 31, 2009 and 2008.

   
Three months ended
 
   
March 31,
2009
   
March 31,
2008
 
Net change in cash and cash equivalents
  $ (3,491 )   $ (1,531 )

   
Three months ended
 
   
March 31,
2009
   
March 31,
2008
 
   
(in
thousands)
   
(in
thousands)
 
Cash and cash equivalent at March 31, 2009 and 2008
  $ 28,667     $ 23,421  

With effective internal control systems in place the Company maintained healthy net cash flows over period and achieved a healthy cash position of $28,667 thousand at March 31, 2009.

Capital Expenditures

Total capital expenditures for the first three months of 2009 were $3 for purchase of fixed assets as compared to $7 for the first three months of 2008.

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 to provide the necessary cash flow to meet anticipated working capital requirements. However, our actual 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.

 
21

 
 
Off-Balance Sheet Arrangements

We have never entered into any off-balance sheet financing 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.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Foreign Currency Exchange Rate Risk

Our financial statements are expressed in U.S. dollars but the functional currency of our operating subsidiaries is RMB. The value of stockholders’ investment in our stock will be affected by the foreign exchange rate between U.S. dollars and RMB. To the extent we hold assets denominated in U.S. dollars any appreciation of the RMB against the U.S. dollar could result in a change to our statement of operations and a reduction in the value of our U.S. dollar denominated assets. On the other hand, a decline in the value of RMB against the U.S. dollar could reduce the U.S. dollar equivalent amounts of our financial results, the value of stockholders’ investment in our company and the dividends we may pay in the future, if any, all of which may have a material adverse effect on the price of our stock.

Our exposure to foreign exchange risk primarily relates to currency gains or losses resulting from timing differences between signing of sales contracts and settling of these contracts. Furthermore, we translate monetary assets and liabilities denominated in other currencies into RMB, the functional currency of our operating business. Our results of operations and cash flow are translated at average exchange rates during the period, and assets and liabilities are translated at the foreign exchange rate at the end of the period. Translation adjustments resulting from this process are included in accumulated other comprehensive income in our statement of shareholders’ equity. We have not used any forward contracts, currency options or borrowings to hedge our exposure to foreign currency exchange risk. We cannot predict the impact of future exchange rate fluctuations on our results of operations and may incur net foreign currency losses in the future.

Interest Rate Risk

Changes in interest rates may affect the interest paid (or earned) and therefore affect our cash flows and results of operations. However, we do not believe that this interest rate change risk is significant.

Inflation

Inflation has not had a material impact on the Company’s business in recent years.

Currency Exchange Fluctuations

All of the Company’s revenues are denominated in Chinese Renminbi, as are expenses. The value of the RMB-to-U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in political and economic conditions. Since 1994, the conversion of Renminbi into foreign currencies, including U.S. dollars, has been based on rates set by the People’s Bank of China, which are set daily based on the previous day’s inter-bank foreign exchange market rates and current exchange rates on the world financial markets. Since 1994, the official exchange rate for the conversion of Renminbi to U.S. dollars had generally been stable and the Renminbi had appreciated slightly against the U.S. dollar. However, on July 21, 2005, the Chinese government changed its policy of pegging the value of Chinese Renminbi to the U.S. dollar. Under the new policy, Chinese Renminbi may fluctuate within a narrow and managed band against a basket of certain foreign currencies. Recently there has been increased political pressure on the Chinese government to decouple the Renminbi from the United States dollar. At the recent quarterly regular meeting of People’s Bank of China, its Currency Policy Committee affirmed the effects of the reform on Chinese Renminbi exchange rate. Since February 2006, the new currency rate system has been operated; the currency rate of Renminbi has become more flexible while basically maintaining stable and the expectation for a larger appreciation range is shrinking. The Company has never engaged in currency hedging operations and has no present intention to do so.

Concentration of Credit Risk

Credit risk represents the accounting loss that would be recognized at the reporting date if counterparties failed completely to perform as contracted. Concentrations of credit risk (whether on or off balance sheet) that arise from financial instruments exist for groups of customers or counterparties when they have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions as described below:

 
22

 

 
·
The Company’s business is characterized by rapid technological change, new product and service development, and evolving industry standards and regulations. Inherent in the Company’s business are various risks and uncertainties, including the impact from the volatility of the stock market, limited operating history, uncertain profitability and the ability to raise additional capital.

 
·
All of the Company’s revenue is derived from Asia and Greater China. Changes in laws and regulations, or their interpretation, or the imposition of confiscatory taxation, restrictions on currency conversion, devaluations of currency or the nationalization or other expropriation of private enterprises could have a material adverse effect on our business, results of operations and financial condition.

 
·
If the Company is unable to derive any revenues from Greater China, it would have a significant, financially disruptive effect on the normal operations of the Company.

Seasonality and Quarterly Fluctuations

Our businesses experience fluctuations in quarterly performance. Traditionally, the first quarter from January to March has a higher number of sales reflected by our electronics business due to the New Year holidays in China occurring during that period.

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, we conducted an evaluation of our disclosure controls and procedures as of March 31, 2009, 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 have concluded that during the period covered by this report, the Company’s disclosure controls and procedures were effective as of such date to ensure that information required to be disclosed by us in our Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosures.

Changes in Internal Control over Financial Reporting
 
There were material changes in the Company’s internal control over financial reporting during the first quarter of 2009. .During the first quarter of 2009, the Company took the following actions to remediate the deficiencies identified at December 31, 2008:

 
·
The Company hired new accounting staff who is familiar with US GAAP and PCAOB requirements during the first quarter of 2009 to assist in the preparation of the Company’s financial statements in accordance with US GAAP. The Company also consults with its auditing firm to ensure the completeness and accuracy of the required disclosures.
 
·
The Company enhanced its internal control over financial reporting by implementing a routine review process to be performed by its principal accounting officer which will:
 
§
Clearly establish the date when the sale of merchandise occurs as the sales cut-off date, instead of the date of receipt of payment for the sold merchandise;
 
§
Include reviews of sales recorded near the fiscal period end to ensure sales are recorded in the correct period; and
 
§
Include approval by the principal accounting officer of all sales cut-off adjustment entries to assure accuracy.
 
·
The Company provided training to its accounting staff to explain the differences between US GAAP and Chinese Accounting Standards which caused the accounting error in sales cut-off.

PART II.  OTHER INFORMATION

Item 1.  Legal Proceedings.

Neither the Company nor its property is a party to any pending legal proceeding. The Company’s management does not believe that there are any proceedings to which any director, officer, or affiliate of the Company, any owner of record of beneficially held or owner of more than five percent (5%) of the Company’s common stock, or any associate of any such director, officer, affiliate of the Company, or security holder is a party adverse to the Company, or has a material interest adverse to the Company.

Item 1A. Risk Factors.

None.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds.   

The Company appointed Joseph Levinson to serve as a member of the Company’s Board of Directors on May 7, 2007. Joseph Levinson resigned as a member of the Company’s Board of Directors on January 27, 2009.  There were no disagreements between Mr. Levinson and the Company on any matter related to the Company’s operations, policies or practices which resulted in his resignation.  Pursuant to the Agreement dated May 3, 2007 the Company agreed to issue to Mr. Levinson, as compensation for his services, a monthly grant of 1,000 shares of the Company’s common stock.  The Company has issued 20,000 shares in total to M. Levinson representing the 1,000 share per month payments.  In addition, the Company agreed to grant Mr. Levinson the following awards under the China 3C Group 2005 Equity Incentive Plan (the “2005 Plan”): (i) an initial annual grant of a stock option to purchase 300,000 shares of the Company’s common Stock, with an exercise price of $6.15 per share (the “2007 Stock Option”); and (ii) a subsequent annual grant of a stock option to purchase an additional 300,000 shares of the Company’s common stock, with an exercise price of $1.82 (the “2008 Stock Option”).  It was later determined that due to the expiration of the 2005 Plan on December 31, 2006, the 2007 Stock Option and the 2008 Stock Option could not be validly granted.  Pursuant to the terms of the Compensation Agreement dated as of November 27, 2008 between Mr. Levinson and the Company, Mr. Levinson acknowledged that the 2007 Stock Option and the 2008 Stock Option were not and could  not be granted and,  in consideration for his services as a Director accepted the issuance of 125,000 shares of the Company’s common stock.

 
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Item 3.  Defaults Upon Senior Securities.
 
Not Applicable.

Item 4.  Submission of Matters to a Vote of Security Holders.

None.

Item 5.  Other Information.

None.

Item 6.  Exhibits.
 
Exhibit
No.
  
Document Description
31.1
 
Certification of 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 Accounting and 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 Chief Executive Officer pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002).
     
32.2
 
Certification of Chief Accounting and Financial Officer pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002).

 
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SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the Company has duly caused this  report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 24th day of December, 2009.
 
 
CHINA 3C GROUP
   
 
By:
/s/ Zhenggang Wang
 
 
Name:   Zhenggang Wang
 
Title: Chief Executive Officer and Chairman
 
 
By:  
/s/ Jian Zhang
 
 
Name:   Jian Zhang
 
Title: Chief Financial Officer (Principal
Accounting and Financial Officer)

 
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Exhibit Index
 
Exhibit
No.
  
Document Description
31.1
 
Certification of 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 Accounting and 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 Chief Executive Officer pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002).
     
32.2
 
Certification of Chief Accounting and Financial Officer pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002).

 
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