U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

x QUARTERLY REPORT UNDER SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2011

¨ TRANSITION REPORT UNDER SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______________ to ______________

Commission File Number: 000-54107

COLORSTARS GROUP

 (Exact name of registrant as specified in its charter)

                                     10F, No. 566 Jung Jeng Rd. Sindian City, Taipei County 231 Taiwan, R.O.C. 

(Address of principal executive offices)

(989) 509-5924

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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 website, 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 ¨

Check whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Check whether the issuer is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  ¨    No  x

As of May 13, 2011, there were 67,448,890 shares of common stock, par value $0.001, issued and outstanding.

COLORSTARS GROUP

FORM 10-Q

INDEX

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PART I---FINANCIAL INFORMATION

Item 1. Financial Statements.

COLORSTARS GROUP AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 (IN US$)

The accompanying notes are an integral part of the financial statements.

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COLORSTARS GROUP AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF OPERATIONS

(UNAUDITED)

 (IN US$)

The accompanying notes are an integral part of the financial statements.

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COLORSTARS GROUP AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED)

The accompanying notes are an integral part of the financial statements.

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COLORSTARS GROUP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – Nature of Business and Basis of Presentation

Nature of Business – Circletronics Inc., now ColorStars Group (“the Company”), was incorporated in Canada on January 21, 2005. Circletronics Inc., was redomiciled to Nevada and its name changed to ColorStars Group on November 3, 2005. ColorStars Group owns 100% of the shares of ColorStars Inc.

Color Stars Inc. (Color Stars TW) was incorporated as a limited liability company in Taiwan, Republic of China in April 2003 and commenced its operations in May 2003. The Subsidiary is mainly engaged in manufacturing, designing and selling light-emitting diode and lighting equipment.

Basis of Presentation – The accompanying unaudited consolidated condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to the Quarterly Report on Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for a complete presentation of the financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for fair presentation have been included in the accompanying financial statements. For further information, refer to the consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010.

Note 2 - Recently Issued Accounting Pronouncements

In December 2010, the FASB issued ASU 2010-28, Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts. ASU 2010-28 modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that goodwill impairment exists, an entity must consider whether there are any adverse qualitative factors indicating impairment may exist. ASU 2010-28 is effective for fiscal years, and interim periods within those years, beginning December 15, 2010 (the first quarter of fiscal 2011 for the Company). The adoption of this ASU is not expected to have a material impact on the Company’s goodwill impairment evaluation as the Company does not currently have reporting units with zero or negative carrying amounts.

In December 2010, the FASB issued ASU 2010-29, Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations. ASU 2010-29 requires that if a public entity presents comparative financial statements, the entity should disclose only revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period. This ASU also expands the disclosure requirements regarding supplemental pro forma adjustments to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. ASU 2010-29 is effective prospectively for business combinations for which the acquisition date is on or after the first annual reporting period beginning on or after December 15, 2010 (fiscal 2011 for the Company). The Company will provide the supplementary pro forma information in connection with any future business combinations.

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Note 3 –Comprehensive Income (Loss)

U.S. GAAP generally requires that recognized revenues, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities are reported as separate components of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income or (loss). 

The ending accumulated other comprehensive income is as follows:

The reconciliation from net earnings to comprehensive (loss) is as follows:

Note 4 – Earnings per share

Basic net income (loss) per share is computed by dividing net income (loss) for the period by the weighted average number of shares of common stock outstanding during the period.

The following table sets forth the computation of basic and diluted net income (loss) per share for the periods indicated:

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Note 5 – Long term investment

Anteya Technology Corp is a private company incorporated in Taiwan.  The equity interest held by the Company is 20%.  Accordingly, the Company adopted the equity method of accounting with respect to the investment in Anteya. 

On July 5, 2010, the Company’s board of directors approved the sale of 30.4% equity (or 456,000 shares) in Fin-Core Corporation (FCC) to a third party at the consideration of NTD13,680,000.  After the disposal, the equity interest of the Company in FCC decreased from 50.4% to 20%. 

On July 5, 2010, the Company’s board of directors approved the participation in subscribing FCC's newly issued shares and maintains the overall equity interest of 20%.  The Company subscribed 500,000 shares at consideration of NTD10,000,000.  The Company adopted the equity method of accounting to the investment in FCC.

Phocos AG is a private company incorporated in Germany.  The equity interest held by the Company is 2.38%.

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Note 5 – Long term investment (continued)

The unaudited financial information of Anteya Technology Corp. as of March 31, 2011 and December 31, 2010 and for three months ended March 31, 2011 and 2010 (in US dollars) are as follows:

Note 6 – Inventory

Inventories stated at the lower of cost or market value are as follows:

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Note 7 – Income taxes

The Company is subject to U.S. federal income tax as well as income tax in states and foreign jurisdictions. For the major taxing jurisdictions, the tax years 2006 through 2009 remain open for state and federal examination.  The Company believes assessments, if any, would be immaterial to its consolidated financial statements.  With respect to the foreign jurisdiction, the Company is no longer subject to income tax audits for the year 2009 (inclusive). 

The income tax provision information is provided as follows:

Note 8 – Accrued expenses

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Note 9 – Bank short term debt

The Company signed a revolving credit agreement with banks. The interest rate on short-term borrowings outstanding as of March 2011 ranges from 2.808% to 3.069% per annum, as of December 31, 2010, interest rate ranges from 2.604% to 3.070% per annum.  The short term debts were secured by:

1. personal guarantee from director
2. the realty property of spouse of director

Note 10 - Geographic Information

Product revenues for the three months ended March 31, 2011 and 2010 are as follows:

Note 11 – Related Party Transactions

The Company has recorded expenses for the following related party transactions for three months ended March 31, 2011 and 2010:

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Note 11 – Related Party Transactions (continued)

As of the balance sheet date indicated, the Company had the following liabilities recorded with respect to related party transactions:

The Company leases office space from Mr. Wei-Rur Chen which the term for the agreement is from November 2010 to November 2015. 

The Company conducted business with related party companies, Anteya Technology Corp and Fin-Core Corporation. The Company owns 20% of the outstanding common stock of Anteya Technology Corp and Fin-Core Corporation as of March 31, 2011.  All transactions were at market-based prices.

Note 12 – Commitments

The company leases offices in Taiwan and in California , US under operating leases.  Minimum future rental payments due under non-cancelable operating leases with remaining terms in excess of one year at March 31, 2011 are as follows:

Note 13 – Subsequent Events

The Company evaluated all events subsequent to March 31, 2011 through the date of the issuance of the financial statements and concluded that there are no significant or material transactions to be reported.

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

Forward Looking Statements

                Certain statements, other than purely historical information, including estimates, projections, statements relating to our business plans, objectives, and expected operating results, and the assumptions upon which those statements are based, are “forward looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  These forward-looking statements generally are identified by the words “believes”, “project”, “expects”, “anticipates”, “estimates”, “intends”, “strategy”, “plan”, “may”, “will”, “would”, “will be”, “will continue”, “will likely result”, and similar expressions.  We intend such forward-looking statements to be covered by the safe-harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and we are including this statement for purposes of complying with those safe-harbor provisions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements.  Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain.  Factors which could have a material adverse effect on our operations and future prospects on a consolidated basis include, but are not limited to: changes in economic conditions, legislative/regulatory changes, availability of capital, interest rates, competition, and generally accepted accounting principles.  These risks and uncertainties should also be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.  We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.  Further information concerning our business, including additional factors that could materially affect our financial results, is included herein and in our other filings with the SEC.

Overview

(a)           Business Overview.

ColorStars Group (“we”, “us”, “our”, the “Company”) was initially incorporated in the Province of Ontario, Canada on January 21, 2005.  On November 3, 2005, we converted to a Nevada corporation.  We are a vertically integrated lighting company that develops light emitting diodes (“LED”) based lighting products for general consumer applications as well as LED lighting products for professional lighting installations. Our LED lighting application development activity ranges from LED packaging to optical lens and heat management, from retrofit LED lamps and bulbs to lighting fixtures designed for general and special lighting applications.

(b)           Recent Transactions.

On March 20, 2009, ColorStars Taiwan acquired 50.4% of the outstanding common shares of Fin-Core Corporation, a Taiwanese corporation (“Fin-Core”) for a cash consideration of US $468,262.  This resulted in Fin-Core becoming a subsidiary of ours. The purchase price for the common shares of Fin-Core was determined through private negotiations between the parties and was not based upon any specific criteria of value. Fin-Core is principally engaged in the design and manufacturing of thermal management devices, the design and manufacturing of electrical and lighting devices and trade, and the import and export of electrical and lighting devices.

On July 7, 2010, ColorStars Taiwan sold 30.4% of its common shares of Fin-Core to Meiloon Industrial Co., Ltd., a publicly traded company on the Taiwan Stock Exchange, for a cash offering of US $434,000.  As a result of this transaction, ColorStars Taiwan now owns only 20% of the outstanding common shares of Fin-Core.

On August 10, 2009, ColorStars Taiwan acquired a 51% equity interest in Jun Yee Industrial Co., Ltd., a Taiwanese corporation (“Jun Yee”) for a cash consideration of US $536,000.  The purchase price for the equity interest in Jun Yee was determined through private negotiations between the parties and was not based upon any specific criteria of value.  Upon acquiring the equity interest, Jun Yee became a subsidiary of ours.  The principal activity of Jun Yee is the manufacturing of LED light.

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On November 26, 2010, ColorStars Taiwan entered into two related stock purchase agreements whereby ColorStars Taiwan sold all of its shares of Jun Yee common stock to Mr. Ming-Chun Tung and Ms. Ming-Fong Tung. Pursuant to the stock purchase agreement entered into with Mr. Ming-Chun Tung, ColorStars Taiwan sold 265,000 shares of its Jun Yee common stock to Mr. Ming-Chun Tung at a price per share of NTD $23 (USD $0.76) for a total purchase price of NTD $6,095,000 (USD $200,427).  Furthermore, pursuant to the stock purchase agreement entered into with Ms. Ming-Fong Tung, ColorStars Taiwan sold 500,000 shares of its Jun Yee common stock to Ms. Ming-Fong Tung at a price per share of NTD $23 (USD $0.76) for a total purchase price of NTD $11,500,000 (USD $378,165).  As a result of the transactions consummated above, Jun Yee is no longer our subsidiary.

Results of Operations

Comparison of Three Months Ended March 31, 2011 to Three Months Ended March 31, 2010

                Net Sales.  Net sales decreased to $954,862.00 for the three months ended March 31, 2011 from $1,422,509.00 for the three months ended March 31, 2010. The decrease in sales was due to the equity disposition of Jun Yee and Fin-Core, and as a result of their equity dispositions, the Company no longer including their revenues in its consolidated financial report.

                Cost of Goods Sold.  Cost of goods sold decreased to $655,563.00 for the three months ended March 31, 2011 from $1,136,374.00, for the three months ended March 31, 2010. The decrease in cost of goods sold was due to a decrease of net sales.

                Gross Profit.  Gross profit increased to $299,299.00 for the three months ended March 31, 2011 from $286,135.00 for the three months ended March 31, 2010. The increase in gross profit was due to an improved gross margin following the disposition of Jun Yee and Fin-Core. Gross margin percentage increased to 31.34% for the three months ended March 31, 2011 from 20.11% for the three months ended March 31, 2010.  The increase in gross margin percentage was due to the equity disposition of Jun Yee and Fin-Core, which are factory based operations with a much lower gross margin percentage.

                Selling, General and Administrative Expenses.   Selling, general and administrative expenses decreased to $271,537.00 for the three months ended March 31, 2011 from $442,139.00 for the three months ended March 31, 2010. The decrease in selling, general and administrative expenses is primarily related to the equity disposition of Jun Yee and Fin-Core.

                Depreciation, Amortization, and Depletion.  Depreciation, amortization, and depletion decreased to $5,394.00 for the three months ended March 31, 2011 from $30,965.00 for the three months ended March 31, 2010 as a result of the equity disposition of Jun Yee and Fin-Core.

                Interest Expense.  Interest expense decreased to $2,978.00 for the three months ended March 31, 2011 compared with $8,795.00 for the three months ended March 31, 2010. The decrease in interest expense was due to the equity disposition of Jun Yee and Fin-Core.

                Net Income (loss).  For the three months ended March 31, 2011, we incurred a net loss of $45,611.00 as compared to a net loss of $90,675.00 for the three months ended March 31, 2010.  The decrease in net loss was a result of an increase in gross profit and less overhead expenses as a result of the disposition of Jun Yee and Fin-Core.

Financial Condition, Liquidity and Capital Resources

Our revenues are primarily derived from sales of the LED devices and systems described above. Although our financial results are mainly dependent on sales, general and administrative, compensation and other operating expenses, our financial results have also been dependent on the level of market adoption of LED technology as well as general economic conditions.

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Lighting products remained relatively static for 50 years until recently, when lighting became one of the last major markets to be transformed substantially by new technology. Because LED technology remains an emerging and expensive technology that has only recently become more economically viable, market adoption has been slow. Given the current economic downturn, liquidity has been constrained forcing institutions and individuals to substantially reduce capital spending to focus only on critical path expenditures. LED lighting products have been a discretionary rather than mandatory investment, and as a result, sales of our devices and systems have been negatively impacted. We believe that as the global economy grows and provides institutions and individuals with greater liquidity, sales of our devices and systems will increase.

Increased market awareness of the benefits of LED lighting, increasing energy prices and the social movement influencing individuals and institutions towards greater investment in energy-efficient products and services will have, we believe, an increasingly positive impact on our sales in the future. Additionally, we intend to utilize our strategic partnerships to help us reduce the component and production costs of our devices and systems in order to offer them at competitive prices. Further, we believe our ability to provide attractive financing options to our clients with respect to the purchase of our devices and systems will positively affect our sales. Similar to many manufacturing companies, we expect to benefit from economies of scale, meaning that as unit sales increase, our cost of production per unit should decrease, which would positively impact our financial results. Our financial results for recent periods, however, do not support this contention. We believe that this contention is not supported because of our prior investments in Fin-Core and Jun Yee.  Fin-Core and Jun Yee, as manufacturing factories, have lower gross margins. As a result, these lower gross margins cause the overall gross margin from the previous period to decrease.  Also, Jun Yee relocated their manufacturing factory in February of 2010, and during the relocation, the factory was completely shut down for an entire week.  As a consequence, this relocation increased the operating costs of Jun Yee and further decreased the overall consolidated gross margin.

As described in further detail in the Recent Transactions section of Item 2, ColorStars Taiwan acquired controlling interests in Fin-Core and Jun Yee in 2009 and then disposed of these interests in July and November 2010, respectively.

ColorStars Taiwan initially acquired Fin-Core due to the fact that Fin-Core has a very effective and unique heat-sink design and patent for building certain LED lighting products for commercial applications.  We believed that Fin-Core’s ability to efficiently and effectively develop LED Lighting products using their unique heat –sink design would help us to develop more world-wide sales channels in the commercial lighting segment for our LED products.   However, by the end of June 2010, Fin-Core's financial situation had deteriorated as it had spent most of its capital in product development, certification, and production machinery.  At that time, we were unable to provide additional funding to Fin-Core.  As such, in order to provide more funding for the continuation and operation of Fin-Core, on July 7, 2010, ColorStars Taiwan sold 30.4% of its common shares of Fin-Core to Meiloon Industrial Co., Ltd., a publicly traded company on the Taiwan Stock Exchange, for a cash offering of US $434,000.00.  As a result of this transaction, ColorStars Taiwan now owns only 20% of the outstanding common shares of Fin-Core.

As Jun Yee is an expert in LED linear and panel lighting design and manufacturing, we initially acquired Jun Yee in order to expand our LED linear and panel lighting design product offering. However, after maintaining the controlling stake in Jun Yee for a year, we observed that Jun Yee had a high debt ratio, low current ratio, and no profit.  As such, on November 26, 2010, ColorStars Taiwan entered into two related stock purchase agreements whereby ColorStars Taiwan sold all of its shares of Jun Yee common stock to Mr. Ming-Chun Tung and Ms. Ming-Fong Tung, as discussed in further detail in the Recent Transactions section of Item 2.

Net cash provided by (used in) operating activities.  During the three months ended March 31, 2011, net cash provided by operating activities was $36,647.00 compared with ($216,973.00) used in operating activities for the three months ended March 31, 2010.  The cash flow provided by operating activities in the three months ended March 31, 2011 was primarily the result of a settlement of prepaid expenses and other current assets. The cash flow used in operating activities in the three months ended March 31, 2010 was primarily the result of a decrease of accounts payable.

Net cash provided by (used in) investing activities. During the three months ended March 31, 2011, net cash used in investing activities was ($28,737.00) compared with ($153,331.00) used in investing activities for the three months ended March 31, 2010.  The decrease in net cash used in investing activities was a result of a decrease of intangible assets after the disposition of Jun Yee.

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Net cash provided by (used in) financing activities. During the three months ended March 31, 2011, net cash used in financing activities was $0.00 compared with ($54,200.00) used in financing activities for the three months ended March 31, 2010.  This decrease in net cash used in financing activities was a result of no additional proceeds or repayment from or to the stockholders or banks.

We currently anticipate that our available cash in hand and cash resources from expected revenues will be sufficient to meet our anticipated working capital and capital expenditure requirements for at least the next twelve months.

We currently have outstanding short-term loans with Hua Nan Commercial Bank of Taiwan. We entered into three written, short-term loan agreements with this bank on August 25, 2009, June 24, 2010, and January 29, 2010, respectively.  The terms of the loan agreements are described in further detail in the chart below:

(1) NTD $3,000,000 is approximately USD $102,027.

(2) NTD $6,000,000 is approximately USD $204,054.

Our continued existence is dependent upon several factors, including increased sales volumes, collection of existing receivables and the ability to achieve profitability from the sale of our products. In order to increase our cash flow, we are continuing our efforts to stimulate sales.

Inflation

                At this time, we do not believe that inflation and changes in price will have a material effect on operations.

Off-Balance Sheet Arrangements

                We have no off-balance sheet arrangements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

                As we are a smaller reporting company, we are not required to provide the information required by this item.

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Item 4.  Controls and Procedures.

Evaluation of disclosure controls and procedures.

We maintain disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) that are designed to assure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.  As required by Exchange Act Rule 13a-15(b), as of the end of the period covered by this report, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of that date.

Changes in internal control over financial reporting.

                There were no changes in our internal controls over financial reporting that occurred during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

PART II---OTHER INFORMATION

Item 1.  Legal Proceedings.

                There are no legal proceedings that have occurred within the past five years concerning our directors or control persons which involved a criminal conviction, a criminal proceeding, an administrative or civil proceeding limiting one’s participation in the securities or banking industries, or a finding of securities or commodities law violations.

Item 1A.  Risk Factors.

                As we are a smaller reporting company, we are not required to provide the information required by this item.

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

(a)           Unregistered Sales of Equity Securities.

                None.

(b)           Use of Proceeds.

                Not applicable.

(c)           Affiliated Purchases of Common Stock.

                None.

Item 3.  Defaults Upon Senior Securities.

                None.

Item 4.  (Removed and Reserved).

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Item 5.  Other Information.

                None.

Item 6. Exhibits.

                                                                                INDEX TO EXHIBITS

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SIGNATURES

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

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