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EX-31.1 - DBUB GROUP, INCv185386_ex31-1.htm
EX-31.2 - DBUB GROUP, INCv185386_ex31-2.htm
EX-32.1 - DBUB GROUP, INCv185386_ex32-1.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended     March 31, 2010

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 ¨  
 
Non-accelerated filer   x
(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 14, 2010, the registrant had 54,831,327 shares of common stock outstanding.



TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
 
     
Item 1. Financial Statements:
 
     
 
Consolidated Balance Sheets as of March 31, 2010 (Unaudited) and December 31, 2009
1
     
 
Consolidated Statements of Income for the Three Months Ended March 31, 2010 and 2009 (Unaudited)
2
     
 
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2010 and 2009 (Unaudited)
3
     
 
Notes to Consolidated Financial Statements
4 - 18
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
19
   
Item 3. Qualitative and Quantitative Disclosure about Market Risk
28
   
 
Item 4. Controls and Procedures
29
     
PART II. OTHER INFORMATION
 
     
Item 1. Legal Proceedings
29
     
Item 1A. Risk Factors
30
   
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
30
     
Item 3. Defaults Upon Senior Securities
30
   
Item 4. (Removed and Reserved)
30
     
Item 5. Other Information
30
     
Item 6. Exhibits
30
     
Signatures
30
 
 
 

 

CHINA 3C GROUP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)

   
March 31,
   
December
31,
 
   
2010
   
2009
 
   
(Unaudited)
   
(Audited)
 
ASSETS
           
             
Current assets:
           
Cash and equivalents
  $ 27,256     $ 29,908  
Accounts receivable, net
    17,981       18,232  
Inventories
    7,627       6,764  
Advances to suppliers
    2,274       2,370  
Tax receivable
    1,157       1,157  
Prepaid expenses and other current assets
    246       294  
Total current assets
    56,541       58,725  
Property, plant and equipment, net
    251       279  
Goodwill
    20,820       20,820  
Intangible asset, net
    14,206       14,557  
Refundable deposits
    13       15  
Total assets
  $ 91,831     $ 94,396  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
                 
Current liabilities:
               
Accounts payable and accrued expenses
  $ 6,032     $ 6,838  
Income tax payable
    972       938  
Total liabilities
    7,004       7,776  
                 
Stockholders' equity
               
Common stock, $0.001 par value, 100,000,000 shares
               
authorized, 54,831,327 issued and outstanding as of
               
March 31, 2010 and December 31, 2009, respectively
    55       55  
Additional paid-in capital
    19,877       19,751  
Subscription receivable
    (50 )     (50 )
Statutory reserve
    11,535       11,535  
Other comprehensive income
    5,189       5,180  
Retained earnings
    48,221       50,149  
Total stockholders' equity
    84,827       86,620  
Total liabilities and stockholders' equity
  $ 91,831     $ 94,396  
 
The accompanying notes are an integral part of these consolidated financial statements.
   
1

 
CHINA 3C GROUP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS)
FOR THE THREE MONTHS ENDED MARCH 31, 2010 and 2009
(IN THOUSANDS)
 
   
2010
   
2009
 
   
(Unaudited)
   
(Unaudited)
 
Sales, net
  $ 40,798     $ 77,412  
Cost of sales
    37,433       67,353  
Gross profit
    3,365       10,059  
General and administrative expenses
    5,214       5,486  
Income from operations (loss)
    (1,849 )     4,573  
Other (income) expense
               
Interest income
    (25 )     (29 )
Other income
    (4 )     (148 )
Other expense
    -       111  
Total other (income) expense
    (29 )     (66 )
Income (loss) before income taxes
    (1,820 )     4,639  
Provision for income taxes
    107       1,199  
Net income (loss)
    (1,927 )     3,440  
Foreign currency translation adjustments
    8       (137 )
Comprehensive income (loss)
  $ (1,919 )   $ 3,303  
                 
Basic
  $ (0.04 )   $ 0.07  
Diluted
  $ (0.04 )   $ 0.07  
                 
Weighted average shares outstanding:
               
Basic
    54,831,327       52,834,055  
Diluted
    54,831,327       52,834,055  

 
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, 2010 and 2009 
(IN THOUSANDS)
 
   
2010
   
2009
 
   
(Unaudited)
   
(Unaudited)
 
             
CASH FLOW FROM OPERATING ACTIVITIES
           
Net income (loss)
  $ (1,927 )   $ 3,440  
Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities:
               
Depreciation
    29       7  
Amortization of intangible assets
    345       -  
Stock based compensation
    125       -  
(Increase) / decrease in assets:
               
Accounts receivable
    254       208  
Other receivable
    13       26  
Inventories
    (862 )     (2,388 )
Prepaid expenses and other current assets
    35       17  
Refundable deposits
    3       2  
Advance to suppliers
    96       149  
Increase / (decrease) in current liabilities:
               
Advance from customers
    23       -  
Accounts payable and accrued expenses
    (773 )     3,363  
Income tax payable
    34       (940 )
Net cash provided by (used in) operating activities
    (2,605 )     3,884  
                 
CASH FLOW FROM INVESTING ACTIVITIES
               
Purchase of property and equipment
    -       (3 )
Deposit for acquisition of subsidiary
    -       (7,289 )
Net cash used in investing activities
    -       (7,292 )
                 
Effect of exchange rate changes on cash and cash equivalents
    (47 )     (83 )
                 
Net increase (decrease) in cash
    (2,652 )     (3,491 )
Cash, beginning of period
    29,908       32,158  
Cash, end of period
  $ 27,256     $ 28,667  
                 
Supplemental disclosure of cash flow information:
               
Interest paid
  $ -     $ -  
Income taxes paid
  $ 69     $ 2,142  
 
The accompanying notes are an integral part of these consolidated financial statements.

3

 
CHINA 3C GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010 AND 2009 (UNAUDITED)
(DOLLARS IN THOUSANDS)

Note 1 – ORGANIZATION


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 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 cash of $500.

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. The consideration consisted of 915,751 newly issued shares of the Company’s common stock and $5,000 in cash.

On November 28, 2006, Capital completed the acquisition of a 100% interest in Joy & Harmony for a cash and stock transaction valued at approximately $18,500. The consideration consisted of 2,723,110 shares of the Company’s common stock and $7,500 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 Accounting Standards Codification (“ASC”) 810, Consolidation of Variable Interest Entities (VIEs), qualify the business operations of Zhejiang to be consolidated with Capital and ultimately with China 3C.

4

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

The purchase price and related allocation to the estimated fair values of the assets acquired and liabilities assumed, after proportionately allocating the goodwill resulting from the transaction in accordance with ASC 805 “Business Combinations” is as follows:

Cash paid for acquisition of  Jinhua
 
$
17,508
 
         
Assets acquired :
       
Cash
 
$
2,406
 
Accounts receivable, net
   
715
 
Other receivables, net
   
60
 
Prepaid expenses
   
133
 
Property, plant and equipment
   
216
 
Intangible asset - transportation network
   
15,182
 
Goodwill
   
472
 
Assets acquired
   
19,184
 
         
Liabilities assumed:
       
Accounts payable
   
315
 
Accrued expenses and other payables
   
547
 
Income taxes payable
   
-
 
Due to shareholders
   
814
 
Liabilities assumed
   
1,676
 
         
Net assets acquired
 
$
17,508
 

Following the acquisition of Jinhua, the Company began providing logistic service to businesses in addition to its traditional business of resale and distribution of third party products such as mobile phones, facsimile machines, DVD players, stereos, speakers, MP3 and MP4 players, iPods, electronic dictionaries, CD players, radio Walkmans and audio systems.
 
5

 

Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

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

Principles of Consolidation

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

6

 
Currency Translation

The accounts of Zhejiang, Wang Da, Yiwu, Sanhe, Joy & Harmony and Jinhua 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 Accounting Standards Codification (“ASC”) 830-10, “Foreign Currency Translation,” with the CNY as the functional currency. According to ASC 830-10, assets and liabilities were translated at the ending exchange rate, stockholders’ equity is translated at the historical rates and income statement items are translated at the average exchange rate for the period. The resulting translation adjustments are reported as other comprehensive income in accordance with ASC 220, “Reporting Comprehensive Income,” as a component of shareholders’ equity. Transaction gains and losses are reflected in the  consolidated income (loss) and comprehensive income (loss) 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 $394 and $404 (audited) as of March 31, 2010 and December 31, 2009, respectively.

7

 
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, 2010 and December 31, 2009, inventory consisted entirely of finished goods valued at $7,627 (unaudited) and $6,764, respectively.
 
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, 2010 and December 31, 2009, property and equipment consisted of the following:

(amounts in thousands of dollars)

   
 
2010
   
2009
 
 
 
(Unaudited)
       
Automotive
 
$
877
   
$
877
 
Office equipment
   
132
     
132
 
Leasehold improvement
   
67
     
67
 
Plant and machinery
   
3
     
3
 
Sub Total
   
1,079
     
1,079
 
Less: accumulated depreciation
   
(828
)
   
(800
)
Total
 
$
251
   
$
279
 
 
Long-Lived Assets
 
The Company periodically evaluates the carrying value of long-lived assets to be held and used in accordance with ASC 360 “Property, Plant and Equipment” 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, 2010 and December 31, 2009, there were no significant impairments of its long-lived assets.

8

 
Fair Value of Financial Instruments
 
ASC 825 “Financial Instruments” requires that the Company disclose estimated fair values of financial instruments. The carrying amounts reported in the statements of financial position for current assets and current liabilities qualifying as financial instruments are a reasonable estimate of fair value.
 
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. 69% and 68% 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, 2010 and 2009, respectively and is mainly achieved through two broad categories:

 
a.
Purchase contracts. The terms for sales by purchase contracts were 45 days from the transfer of goods to the customer in the first quarter 2010 and 30 days in 2009. 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 the terms. The Company relieves its inventory and recognizes revenue upon receipt of confirmation from the customer.

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

 
2.
Wholesale. 31% and 32% of the Company’s revenue comes from wholesale during the three and nine months ended March 31, 2010 and 2009, respectively. Recognition of wholesale income is based on the contract terms. The main contract terms on wholesale were 15 days after receipt of goods in the first quarter 2010 and 10 days in 2009 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.
 
9

 
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.
Wholesale:

 
a.
Revenue is recognized at the date the goods are received by the 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 from 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.

10

 
Cost of Sales

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

General and Administrative Expenses

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

Shipping and handling fees

The Company follows ASC 605-45, “Handling Costs, Shipping Costs”.  The Company does not charge its customers for shipping and handling. The Company classifies shipping and handling fees as part of General and administrative expenses During the three months ended March 31, 2010 and 2009, the Company incurred shipping and handling fees and costs of $51 and $54, 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 accounted as general and administrative expenses were $136 and $486 during the three months ended March 31, 2010 and 2009, respectively. Management fees accounted for deductions of sales were $1,260 and $2,365 in sales for the three months ended March 31, 2010 and 2009, respectively.
 
Share Based Payment
 
The Company adopted ASC 718-10, “Stock Compensation”, which addresses the accounting for transactions in which an entity exchanges its equity instruments for goods or services, with a primary focus on transactions in which an entity obtains employee services in share-based payment transactions. ASC 718-10 is a revision to SFAS No. 123, “Accounting for Stock-Based Compensation,” ASC 718-10 requires measurement of the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). Incremental compensation costs arising from subsequent modifications of awards after the grant date must be recognized.

11

 
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 $86 and$57 for the three months ended March 31, 2010 and 2009, respectively.
 
Other Income 

Other income consists of the following: 

 
 
Three months ended 
March 31,
 
 
 
2010
 
 
2009
 
Advertising service income
 
$
-
   
$
103
 
Repair service income
   
-
     
15
 
Commission income from China Unicom
   
-
     
30
 
Others
   
4
     
-
 
Total other income
 
$
4
   
$
148
 

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

Basic and Diluted Earnings (Loss) per Share
 
Earnings (loss) per share are calculated in accordance with ASC 260, “Earnings per Share”. Basic earnings (loss) per share is based upon the weighted average number of common shares outstanding. Diluted earnings (losses) 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, 2010 was 100,000 options, as they were not dilutive.
 
12

 
Statement of Cash Flows
 
In accordance with ASC 230 “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, advances to suppliers and other receivables arising from its normal business activities. The Company places its cash in what it believes to be credit-worthy financial institutions. The Company has a diversified customer base, most of which is in China. The Company controls credit risk related to accounts receivable through credit approvals, credit limits and monitoring procedures. The Company routinely assesses the financial strength of its customers and, based upon factors surrounding the credit risk, establishes an allowance, if required, for uncollectible accounts and, as a consequence, believes that its accounts receivable credit risk exposure beyond such allowance is limited.
 
Segment Reporting

ASC 280, “Segment Reporting” requires use of the “management approach” model for segment reporting. The management approach model is based on the way a company’s management organizes segments within the company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, legal structure, management structure, or any other manner in which management disaggregates a company. The Company operates in five segments (see Note 13).

Recent Accounting Pronouncements

ASC 805 “Business Combinations”, previously SFAS No. 141(R) “Business Combinations”. SFAS No. 141(R) changes how a reporting enterprise accounts for the acquisition of a business. SFAS 141(R) 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 141(R) is effective for fiscal years beginning on or after December 15, 2008 and early adoption and retrospective application is prohibited. Effective January 1, 2009. ASC 805 revised SFAS No. 141, “Business Combinations” and addresses the accounting and disclosure for identifiable assets acquired, liabilities assumed, and noncontrolling interests in a business combination. The Company adopted ASC 805. The Company accounted for the acquisition of Jinhua in accordance with these standards.

ASC 810 “Consolidation”, previously SFAS No. 160 “Noncontrolling Interests in Consolidated Financial Statement”.  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.
 
13

 
ASC 815 “Derivatives and Hedging”, previously SFAS No. 161 “Disclosures about Derivative Instruments and Hedging Activities”. SFAS No. 161 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 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.

ASC 825 “Financial Instruments”, previously FSP SFAS No. 107-1 “Interim Disclosures about Fair Value of Financial Instruments”The guidance requires 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 was effective for interim periods ending after June 15, 2009. The adoption of FSP 107-1 did not have a material effect on the Company’s consolidated financial statements.
 
ASC 860 “Transfers and servicing”, previously SFAS No. 166 “Accounting for Transfers of Financial Assets”. SFAS No. 166 requires more information about transfers of financial assets and where companies have continuing exposure to the risks related to transferred financial assets. SFAS 166 is effective at the start of a company’s first fiscal year beginning after November 15, 2009, or January 1, 2010 for companies reporting earnings on a calendar-year basis. The adoption of this statement did not have a material effect on the Company’s financial statements.

ASC 810 “Consolidation”, previously SFAS NO. 167 “Amendments to FASB Interpretation No. 46(R)”. SFAS No. 167 will change how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. Under SFAS 167, determining whether a company is required to consolidate an entity will be based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. SFAS 167 is effective at the start of a company’s first fiscal year beginning after November 15, 2009, or January 1, 2010 for companies reporting earnings on a calendar-year basis. The adoption of SFAS No. 167 did not have any impact on our financial statements.

FASB Accounting Standards Codification (Accounting Standards Update “ASU” 2009-1). In June 2009, the  FASB approved its Accounting Standards Codification (“Codification”) as the single source of authoritative United States accounting and reporting standards applicable for all non-governmental entities, with the exception of the SEC and its staff. The Codification is effective for interim or annual financial periods ending after September 15, 2009 and impacts our financial statements as all future references to authoritative accounting literature will be referenced in accordance with the Codification. There have been no changes to the content of our financial statements or disclosures as a result of implementing the Codification.

Note 3 – ADVANCES TO SUPPLIERS
 
Advances to suppliers represent advance payments to suppliers for the purchase of inventory. As of March 31, 2010 and December 31, 2009, the Company had $2,275 and $2,370 (audited), respectively, as advances to suppliers.
 
14

 
Note 4– ACCOUNTS PAYABLE AND ACCRUED EXPENSES

Accounts payable and accrued expenses as of March 31, 2010 (unaudited) and December 31, 2009 consist of the following:

(amounts in thousands of dollars)
 
 
2010
 
 
2009
 
Accounts payable
 
$
3,884
 
 
$
3,729
 
Accrued expenses and other payable
   
1,916
     
2,874
 
VAT tax payable
   
209
     
235
 
Advance from customers
   
23
     
-
 
Total
 
$
6,032
   
$
6,838
 
   
Note 5 - COMMON STOCK

On January 15, 2009, the Company’s Board 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 of Directors.

In April and October 2009, the Company issued 1,997,272 shares of common stock under the 2008 Plan. The cost is expected to be recognized over a three year period. $125 was recognized as stock based compensation expense during the three months ended March 31, 2010,.

Note 6 - STOCK WARRANTS, OPTIONS, AND COMPENSATION

Stock options— Options issued have a ten-year life and were fully vested upon issuance. The option holder has no voting or dividend rights. The grant price was 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.  

Outstanding options by exercise price consisted of the following as of March 31, 2010.
 
Options Outstanding
   
Options Exercisable
 
Exercise Price
   
Number of
Shares
   
Weighted
Average
Remaining
Life (Years)
   
Weighted
Average
Exercise Price
   
Number
of Shares
   
Weighted
Average
Exercise
Price
 
$ 3.80       50,000       0.75     $ 3.80       50,000     $ 3.80  
  4.16       50,000       7.75       4.16       50,000       4.16  
 
15

 
Note 8 - 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 9 - INCOME TAXES

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

The US entity, China 3C Group, Inc is subject to the United States federal income tax at a tax rate of 34%. The US entity has incurred net accumulated operating losses of approximately $2,930 as of March 31, 20010 for income tax purposes. The US entity does not conduct any operations and only incurs public expenses every year.  Therefore, it is more likely  than  not  that all of the Company’s  deferred  tax  assets  will  not be realized. A 100% allowance was recorded on the deferred tax asset of approximately $996.
 
The Company’s policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. The Company did not have any accrued interest or penalties associated with any unrecognized tax benefits, nor was any interest expense recognized during the three months ended March 31, 2010 and 2009.

Pursuant to the PRC Income Tax Laws, from January 1, 2008, the Enterprise Income Tax (“EIT) is calculated against the net income in a fiscal year at a statutory rate of 25%.
The following is a reconciliation of income tax expense for the three months ended March 31, 2010 and 2009:

2010
 
U.S.
 
 
State
 
 
International
 
 
Total
 
Current
 
$
-
   
$
-
   
$
107
   
$
107
 
Deferred
   
-
     
-
     
-
     
-
 
Total
 
$
-
   
$
-
   
$
107
   
$
107
 

During the three months ended March 31, 2010, Wan Da, Sanhe, Joy & Harmony and Yiwu had operating losses and therefore no income tax expenses. Zhejiang and Jinhua were the only subsidiaries that reported an operating income during the three months ended March 31, 2010 and incurred income tax expense of $107.

2009
 
U.S.
 
 
State
 
 
International
 
 
Total
 
Current
 
$
-
   
$
-
   
$
1,199
   
$
1,199
 
Deferred
   
-
     
-
     
-
     
-
 
Total
 
$
-
   
$
-
   
$
1,199
   
$
1,199
 

Reconciliation of the differences between the statutory U.S. Federal income tax rate and the effective rate for the three months ended March 31, 2010 and 2009, is as follows:
 
16

 
 
 
2010
   
2009
 
US statutory tax rate
   
34.0
%
   
34.0
%
Tax rate difference
   
(9.0
)%
   
(9.0
)%
other
   
3.5
%
   
0.8
%
Effective rate
   
28.5
%
   
25.8
%
 
Note 10 - COMMITMENTS
 
The Company leases office facilities under operating leases that terminate through 2011. Rent expense for the three months ended March 31, 2010 and 2009 was $136 and $51, respectively. The future minimum obligations under these agreements are as follows by years as of March 31, 2010:

2010
 
$
245
 
2011 
   
59
 
2012
   
17
 
Total
 
321
 
   
Note 11 - 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.

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, 2010 and December 31, 2009, the Company had allocated $11,535 to these non-distributable reserve funds. 

Note 12 - OTHER COMPREHENSIVE INCOME
 
The detail of other comprehensive income as included in stockholders’ equity at March 31, 2010 (unaudited) and December 31, 2009 are as follows:

 
 
Foreign
 
 
 
Currency
 
 
 
Translation
 
 
 
Adjustment
 
Balance at December 31, 2008
 
$
5,272
 
Change for 2009
   
(92
Balance at December 31, 2009
   
5,180
 
Change for three months ended March 31, 2010
   
9
 
Balance at March 31, 2010
 
$
5,189
 
 
17

 
Note 13 - 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 14 - MAJOR CUSTOMERS AND CREDIT RISK

During the three months ended March 31, 2010 and 2009, no customer accounted for more than 10% of the Company’s sales or accounts receivable. At March 31, 2010 and 2009, no vendor accounted for more than 10% of the Company’s accounts payable.

Note 15 -   SEGMENT INFORMATION

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

We identified five reportable segments required by SFAS 131: (1) mobile phones, (2) home electronics, (3) office communication products, (4) consumer electronics and (5) logistics.

The following tables present summarized information by segment:
 
   
Three Months Ended March 31, 2010
 
 
 
Mobile
   
Home
   
Communication
   
Consumer
                   
 
 
Phones
   
Electronics
   
Products
   
Electronics
   
Logistics
   
Other
   
Total
 
Sales, net
 
$
10,499
   
$
11,312
   
$
6,178
   
$
9,934
   
$
2,641
   
$
234
   
$
40,798
 
Cost of sales
   
9,731
     
10,077
     
5,671
     
9,696
     
2,045
     
213
     
37,433
 
Gross profit
   
768
     
1,235
     
507
     
238
     
596
     
21
     
3,365
 
Income from operations
   
(446
)
   
(516
)
   
(210
)
   
(508
)
   
250
     
(390
)
   
(1,820
)
Total assets at March 31, 2010
 
$
13,444
   
$
10,752
   
$
11,908
   
$
15,206
   
$
4,809
   
$
35,712
   
$
91,831
 
 
18


   
Three Months Ended March 31, 2009
 
 
 
Mobile
Phones
   
Home
Electronics
   
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 at March 31, 2009
 
$
16,679
   
$
17,746
   
$
16,598
   
$
16,069
   
$
33,813
   
$
100,905
 

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

Overview (All dollar amounts in thousands)

China 3C Group (“China 3C”) 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 Company Limited (“Zhejiang”), Yiwu Yong Xin Communication Limited (“Yiwu”), Hangzhou Wandda Electronics Company Limited (“Wang Da”), Hangzhou Sanhe Electronic Technology, Limited (“Sanhe”), and Shanghai Joy & Harmony Electronic Development Company Limited (“Joy & Harmony”) were incorporated under the laws of the Peoples Republic of China (“PRC” or “China”) on July 11, 2005, July 18, 1997, March 30, 1998, April 12, 2004, and August 25, 2003, respectively. China 3C Group owns 100% of CFDL and CFDL own 100% of the capital stock of Joy & Harmony and Sanhe. Until August 14, 2007, when it made the change to its ownership structure described in the next paragraph in order to comply with certain requirements of PRC law, 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. On July 6, 2009, Zhejiang and Yiwu completed acquisition of Jinhua Baofa Logistic Ltd (“Jinhua”).  Jinhua was incorporated under the laws of PRC on December 27, 2001.

References to “we,” “us,” “our,” or the “Company” refer collectively to the nine corporations described above.

On December 21, 2005, CFDL became a wholly owned subsidiary of China 3C through a merger with a wholly owned subsidiary of the Company (the “Merger Transaction”). China 3C acquired all of the issued and outstanding capital stock of CFDL pursuant to a Merger Agreement dated at December 21, 2005 by and among China 3C, 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 and, in exchange for the CFDL shares, China 3C 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 at that time and a cash consideration of $500. 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 ASC 810, Consolidation of Variable Interest Entities (VIEs), qualifies the business operations of Zhejiang to be consolidated with CFDL and ultimately with China 3C.

19

 
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 Sanhe. The shares were valued at $3,750, which was the fair value of the shares at the date of the share exchange agreement. This amount is included in the cost of net assets and goodwill purchased.

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 Joy & Harmony. The shares were valued at $11,000, 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.

On July 6, 2009, China 3C’s subsidiaries, Zhejiang and Yiwu completed acquisition of Jinhua, a company organized under the laws of the PRC. Zhejiang acquired 90% and Yiwu acquired 10% of the entire equity interests in Jinhua from the shareholders of Jinhua for a total purchase price of RMB 120,000,000 (approximately $17,500) in cash.

The Company is engaged in the business of resale and distribution of third party products and generates approximately 100% of its revenue from resale of items such as mobile phones, facsimile machines, DVD players, stereos, speakers, MP3 and MP4 players, iPod, electronic dictionaries, CD players, radios, Walkmans, and audio systems. We sell and distribute products through retail stores and secondary distributors. We operate substantially all of our retail operations through our “store in store” model. Under this model, the Company leases space in major department stores and retailers. Leasing costs can vary based on a percentage of sales, or can be fixed. For the year ended December 31, 2009, all of our stores in stores leases were variable based on sales. After acquisition of Jinhua in July 2009, the Company started provideing transportation service to business in Eastern China.
 
Result of Operations

Results of Operations for the Three Months Ended March 31, 2010 and 2009

Reportable Operating Segments

The Company reports financial and operating information in the following five segments:
 
20

 
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 “Joy & Harmony”
e) 
Jinhua Baofa Logistic Limited or “Jinhua”

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
 
2010
   
2009
   
Change
 
Revenue
 
$
6,178
   
$
15,802
     
(60.90
)%
Gross Profit
 
$
507
   
$
1,697
     
(70.12
)%
Gross Margin
   
8.20
%
   
10.74
%
   
(2.54
)%
Operating (Loss)/Income
 
$
(210
 
$
502
     
(141.83
)%

For the three months ended March 31, 2010, Yiwu generated revenue of $6,178, a decrease of $9,624 or 60.9% compared to $15,802 for the three months ended March 31, 2009. The decrease was a result of lower market demand for office appliances as well as the effect of global economic slowdown. .

Gross profit decreased $1,190 or 70.12% from $1,697 for the three months ended March 31, 2009 to $507 for the three months ended March 31, 2010. Gross profit margin decreased 2.54% from 10.74% in the three months ended March 31, 2009 to 8.20% in the three months ended March 31, 2010. The decrease was a result of decline in demand of office appliances such as fax machines and telephones.

Operating loss was $210 for the three months ended March 31,2010, a decrease of $712 or 141.9% compared to operating income of $502 for the three months ended March 31, 2009. Operating income decreased primarily due to decreased gross profit. Meanwhile, when sales gross profit decreased 70.12%, operating expenses only decreased approximately 40% primarily due to an increase in base salary for all staff. As a result, Yiwu had an operating loss in the first quarter of 2010.

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.

 
 
Three months ended March
31,
   
Percentage
 
Wang Da
 
2010
   
2009
   
Change
 
Revenue
 
$
10,499
   
$
25,744
     
(59.22
)%
Gross Profit
 
$
768
   
$
2,960
     
(74.06
)%
Gross Margin
   
7.31
%
   
11.50
%
   
(4.19
)%
Operating (Loss)/Income
 
$
(446
 
$
1,116
     
(139.99
)%

21

 
For the three months ended March 31, 2010, Wang Da generated revenue of $10,499, a decrease of $15,245 or 59.22% compared to $25,744 for the three months ended March 31, 2009. The decrease in revenue and gross profit was primarily due to the high competition from government-owned large telecommunication service providers. Telecommunication service providers started to open their direct operating stores to sell communication products and also launched promotions such as “free phone with service contract”.

Gross profit decreased $2,192 or 74.06% from $2,960 for the three months ended March 31, 2009 to $768 for the three months ended March 31, 2010. Gross profit margin decreased from 11.50% in the three months ended March 31, 2009 to 7.31% in the three months ended March 31, 2010, a decrease of 4.19%.  The decrease in gross profit and gross margin was due to the decrease in demand of domestic cell phones, which had a higher gross margin than brand name cell phones. Meanwhile, sales rebate from suppliers also decreased which led to lower gross margin.

Operating loss was $446.3 for the three months ended March 31, 2010, a decrease of $1,562 or 139.99% compared to operating income of $1,116 for the three months ended March 31, 2009. Operating income decreased primarily due to decreased gross profit and increased operating expenses. When gross profit decreased 74.06%, operating expenses only decreased 34.2% primarily due to an increase in base salary for all staff and an increase in management fees paid to the department stores.

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
 
2010
   
2009
   
Change
 
Revenue
 
$
11,312
   
$
16,593
     
(31.83
)%
Gross Profit
 
$
1,235
   
$
3,249
     
(61.99
)%
Gross Margin
   
10.91
%
   
19.58
%
   
(8.67
)%
Operating (Loss)/Income
 
$
(516
 
$
1,138
     
(145.34
)%

For the three months ended March 31, 20010, Sanhe generated revenue of $11,312 , a decrease of $5,281 or 31.83% compared to $16,593 for the three months ended March 31, 2009. The decrease was a result of decline in market demand of DVD players and speakers.

Gross profit decreased $2,014 or 61.99% from $3,249 for the three months ended March 31, 2009 to $1,235 for the three months ended March 31, 2010. Gross profit margin decreased from 19.58% in 2009 to 10.91% in 2009, a decrease of 8.67%. The decrease was a result of higher sales volume of televisions in the first quarter of 2010 compared to higher sales in DVD players and speakers in the first quarter of 2009, which have higher gross margin compared to other home electronics products.

 
22

 

Operating loss was $516 for the three months ended March 31, 2010, a decrease of $1,654 or 145.34% compared to operating income of $1,138 for the three months ended March 31, 2009. Operating income decreased primarily due to decreased gross profit and increased operating expenses. When gross profit decreased 61.99%, operating expenses only decreased 17.12% primary due to an increase in base salary for all staff and an increase in management fees paid to the department stores.

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

Joy & Harmony focuses on the selling, circulation and modern logistics of consumer electronics, including MP3 players, MP4 players, iPod, electronic dictionary, radios, and Walkman.
 
  
 
Three months ended March
31,
   
Percentage
 
Joy & Harmony
 
2010
   
2009
   
Change
 
Revenue
 
$
9,934
   
$
19,273
     
(48.45
)%
Gross Profit
 
$
238
   
$
2,153
     
(88.94
)%
Gross Margin
   
2.4
%
   
11.17
%
   
(8.77
)%
Operating (Loss)/Income
 
$
(508
 
$
1,279
     
(139.72
)%

For the three months ended March 31, 2010, Joy & Harmony generated revenue of $9,934, a decrease of $9,339 or 48.45% compared to $19,273 for the three months ended March 31, 2009. Gross profit decreased $1,915 or 88.94% from $2,153 for the three months ended March 31, 2009 to $238 for the three months ended March 31, 2010. Gross profit margin decreased from 11.17% in 2009 to 2.4% in 2010, a decrease of 8.77%.  The global financial crisis caused many small electronics manufacturers to exit the market and large manufacturers to raise the price of consumer electronics. Therefore, the cost for Joy & Harmony increased, which led to a significant decline in gross margin. The closedown of many small electronics manufacturers also caused some of our products to discontinue. Therefore, we had a big sales event for those products in the first quarter 2010, which led to lower sales revenue.

Operating loss was $508 for the three months ended March 31, 2010, a decrease of $1,787 or 139.72% compared to operating income of $1,279  for the three months ended March 31, 2009. Operating income decreased primarily due to decreased gross profit and increased operating expenses. When gross profit decreased 88.94%, operating expenses only decreased 15% primary due to an increase in base salary for all staff, an increase in marketing expenses and management fees paid to the department stores.

e)           Jinhua Baofa Logistic Limited or “Jinhua”

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

China 3C acquired Jinhua on July 6, 2009. Therefore, the consolidated statement of income (loss) and comprehensive income (loss) of China 3C for the period ended March 31, 2009 did not includes Jinhua’s operating results.

 
23

 

Jinhua
 
Three months ended March
31, 2010
 
Revenue
 
$
2,641
 
Gross Profit
 
$
596
 
Gross Margin
   
22.57
%
Operating Income
 
$
250
 

Net Sales

Net sales for the three months ended on March 31, 2010 decreased by 47.30%, to $40,798 compared to $77,412 for the three months ended March 31, 2009. The decrease was attributable to the closing of 101 stores in stores in 2009 as well as the negative effect of global economic slowdown.

Cost of Sales

Cost of sales for the three months ended on March 31, 2010 totaled $37,433 compared to $67,353 for the three months ended on March 31, 2009, a decrease of 44.42%. The increased cost of sales was a direct result of the decrease in sales.

Gross Profit Margin

Gross profit margin for the three months ended March 31, 2010 was 8.25% compared to 12.99% for the three months ended March 31, 2009. 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 increased.

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the three months ended March 31, 2010 totaled $5,214 or 12.78% of net sales, compared to $5,486 or 7.09% of net sales for the three months ended March 31, 2009, a decrease of 4.96%. Net sales decreased 47.30% but operating expenses only decreased 4.96% primarily due to an increase in base salary for all staff, an increase in marketing expenses and management fees paid to the department stores.

Income from Operations

Operating loss for the three months ended March 31, 2010 was $1,820 or (4.46)% of net sales as compared to income from operations of $4,572 or 5.91% of net sales for the three months ended March 31, 2009, a decrease of 139.80%. 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, 2010 was $107 compared with $1,199 for the three months ended March 31, 2009. The decrease in income tax expenses was due to Yiwu, Wang Da, Joy & Harmony and Sanhe having net losses in the first quarter of 2010 and therefore not having income tax expenses. Jinhua and Zhejiang were the only two subsidiaries having operating income and the amount was not significant.

 
24

 

Net (Loss)/Income

Net loss was $1,927 or (4.72)% of net sales for the three months ended on March 31, 2010 compared to $3,440 or 4.44% of net sales for the three months ended on March 31, 2009, a decrease of 156.02%. Significant decrease in sales, 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 equivalents were $27,256 at March 31, 2010, as compared to $28,667 at March 31, 2009, and compared to $29,908 at December 31, 2009.
 
We believe that the funds available to us are adequate to meet our operating needs for the remainder of 2010.

In summary, our cash flows were: 
   
Three months ended
 
   
March 31,
2010
   
March 31,
2009
 
Net cash (used in) provided by operating activities
 
$
(2,605
 
$
3,883
 
Net cash (used in) investing activities
 
$
-
   
$
(7,292
)
Effect of exchange rate change on cash and cash equivalents
 
$
(47
)
 
$
(82
Net increase (decrease) in cash and cash equivalents
 
$
(2,652
)
 
$
(3,491
)
Cash and cash equivalents at beginning of period
 
$
29,908
   
$
32,158
 
Cash and cash equivalents at end period
 
$
27,256
   
$
28,667
 

Operating Activities

Net cash used in operating activities was $2,605 for the three months ended March 31, 2010 compared to net cash proceeds from operating activities of $3,883 for the three months ended March 31, 2009, approximately a 167.09% decrease.  The decrease was mainly attributable to several factors, including (i) net loss of 1,927; (ii) the decrease in accounts payable and accrued expenses of $830; (iii) the increase in inventory of $862, offset by the decrease in accounts receivable of $253.
 
   
Three months ended March 31,
 
   
2010
   
2009
   
Percentage
Change
 
                   
Sales Net 
  $ 40,798     $ 77,412       (47.30 )%
                         
Accounts receivable 
  $ 17,981     $ 18,232       (1.40 )%
 
Accounts receivable did not decrease in line with the decrease in sales due to the terms of payment changed from 30 days to 45 days from on retail from 10 days to 15 days on wholesale. Management assessed the collectability of accounts receivable and determined that all accounts remained collectible. 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.

 
25

 

Investing Activities

Net cash used in investing activities was $7,292 in the first quarter of 2009, due to the second installment payment for acquisition of Jinhua Baofa Logistic Ltd. The Company made the second installment payment in advance of its due date in order to change the business license registration of Jinhua. There was no investing activity in the first quarter of 2010.

   
Three months ended
 
   
March 31,
2010
   
March 31,
2009
 
Net cash (used in) investing activities
 
$
-
   
$
(7,292
)
 
Capital Expenditures

Total capital expenditures for the first three months of 2009 were $3 for purchase of fixed assets and none for 2010.

Working Capital Requirements  

Historically operations and short term financing have been sufficient to meet our cash needs. We believe that we will be able to generate revenues from sales and raise capital through private placement offerings of our equity securities to provide the necessary cash flow to meet anticipated working capital requirements. However, our 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.

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.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

 
26

 

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

Revenue Recognition

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

After Sales Service

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

Tabular Disclosure of Contractual Obligations
 
The following table sets forth our contractual obligations as of March 31, 2010.

  
  
Payment Due by Period
  
  
  
 
  
  
Less than 1
  
  
 
  
  
 
  
  
More than
  
Contractual Obligations
 
Total
   
year
   
1-3 years
   
3-5 years
   
5 years
 
Operating lease obligations
 
$
333
     
244
     
76
     
13
   
$
-
 
Advertising obligations
   
-
     
-
     
-
     
-
     
 
Total contractual obligations
 
$
333
     
244
     
76
     
13
   
$
-
 

 
27

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Foreign Currency Exchange Rate Risk
 
Fluctuations in the rate of exchange between the U.S. dollar and foreign currencies, primarily the Chinese Renminbi, could adversely affect our financial results. During the first quarter ended March 31, 2010, all of our sales were denominated in foreign currencies. We expect that foreign currencies will continue to represent a similarly significant percentage of our sales in the future. Selling, marketing and administrative costs related to these sales are largely denominated in the same respective currency, thereby mitigating our transaction risk exposure. We therefore believe that the risk of a significant impact on our operating income from foreign currency fluctuations is not substantial. However, for sales not denominated in U.S. dollars, if there is an increase in the rate at which a foreign currency is exchanged for U.S. dollars, it will require more of the foreign currency to equal a specified amount of U.S. dollars than before the rate increase. In such cases and if we price our products in the foreign currency, we will receive less in US. dollars than we did before the rate increase went into effect. If we price our products in U.S. dollars and competitors price their products in local currency, an increase in the relative strength of the U.S. dollar could result in our price not being competitive in a market where business is transacted in the local currency.

All of our sales denominated in foreign currencies are denominated in the Chinese Renminbi. Our principal exchange rate risk therefore exists between the U.S. dollar and this currency. Fluctuations from the beginning to the end of any given reporting period result in the re-measurement of our foreign currency-denominated receivables and payables, generating currency transaction gains or losses that impact our non-operating income/expense levels in the respective period and are reported in other (income) expense, net in our consolidated financial statements. We do not currently hedge our exposure to foreign currency exchange rate fluctuations. We may, however, hedge such exposure to foreign currency exchange rate fluctuations 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 [for the Company’s three most recent fiscal years.

Currency Exchange Fluctuations

All of the Company’s revenues are denominated in Chinese Renminbi, while its expenses are denominated primarily in Chinese Renminbi (“RMB”). 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 (“PBOC”), 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 PBOC, 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.

 
28

 

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:

 
·
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.

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, 2010, 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 was no change in our internal control over financial reporting that occurred during the first fiscal quarter of 2010 covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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.

 
29

 

Item 1A. Risk Factors.

None.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds.   
 None.

Item 3.  Defaults Upon Senior Securities.
 
Not Applicable.

Item 4.  (Removed and Reserved).

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 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 and Chief Financial Officer pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002).
 
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 17th day of May, 2010.
 
 
CHINA 3C GROUP
   
 
By:
/s/ Zhenggang Wang
 
 
Name:   Zhenggang Wang
 
Title: Chief Executive Officer and Chairman (Principal Executive Officer)
 
 
By:  
/s/ Jian Zhang
 
 
Name:   Jian Zhang
 
Title: Chief Financial Officer (Principal
Accounting and Financial Officer)

 
30

 

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 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 and Chief Financial Officer pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002).

 
31