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, 2012

¨ 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 x  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 15, 2012, there were 67,448,890 shares of common stock, par value $0.001, issued and outstanding.

COLORSTARS GROUP

FORM 10-Q

INDEX

      2

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.

COLORSTARS GROUP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)

(IN US$)

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

COLORSTARS GROUP AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED)

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

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, 2011.

Note 2 - Recently Issued Accounting Pronouncements

Balance Sheet – the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-11 in December 2011, Balance sheet – Disclosures about Offsetting Assets and Liabilities.  The new requirements state that entities must disclose both gross information and net information about both instruments and transactions eligible for offset in the balance sheet, and instruments and transactions subject to an agreement similar to a master netting arrangement. The scope of the requirements includes derivatives, sales and repurchases agreements, reverse sale and repurchase agreements, and securities borrowing and securities lending arrangements. The requirements are effective for annual periods beginning on or after January 1, 2013, and interim periods within those annual periods.  The Company does not expect that the adoption will have a material effect on the consolidated financial statements.

Note 3 –Concentration of Credit Risk

Financial instruments that potentially subject the Company to significant concentration of credit risk consist principally of accounts receivable, cash and cash equivalents. The Company’s cash and cash equivalents are maintained with high quality institutions, the compositions and maturities of which are regularly monitored by management. Through March 31, 2012, the Company had not experienced any losses on such deposits.

COLORSTARS GROUP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 3 –Concentration of Credit Risk

Accounts receivable include amounts due from customers primarily in the manufactory industry. The Company performs ongoing credit evaluations of its customers’ financial condition and limits the amount of credit extended when deemed necessary, but generally requires no collateral. The Company also maintains allowances for potential credit losses. In estimating the required allowances, the Company takes into consideration the overall quality and aging of the receivable portfolio, the existence of a limited amount of credit insurance and specifically identified customer risks. Through March 31, 2012, such losses have been within management’s expectations.

For the three months ended March 31, 2012, products sold to the Company’s largest customer, accounted for approximately 6.76%.  Products purchased from the Company’s first two largest suppliers were accounted for approximately 46.42% of the total purchases. 

As of March 31, 2012, the largest three customers exceeded 37% of the total consolidated accounts receivable balance.

Note 4 – Earnings per share

Basic net loss per share is computed by dividing net 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 loss per share for the periods indicated:

COLORSTARS GROUP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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.  There were 200,000 bonus shares issued in 2011 to the Company. The equity interest held by the Company remains unchanged.

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 (equivalent to USD 429,000).  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 maintain the overall equity interest of 20%.  The Company subscribed 500,000 shares at consideration of NTD$10,000,000 (equivalent of USD 320,000).  The Company adopted the equity method of accounting to the investment in FCC.

In October 2011, the associated company, Fin-Core Corporation, decided to increase its capital by issuing 3,000,000 new shares at par value of NTD10 per share.  The Company was entitled to subscribe for up to 600,000 shares for NTD6,000,000.  However the Company chose not to participate in the subscription of any newly issued shares of Fin-Core.  As a result, on November 4, 2011 the Company’s equity interest in Fin-Core decreased to 11.43% from 20% after issuance of 3,000,000 new shares.  The Company recorded the investment in Fin-Core Corporation at cost on the date when the Company ceased to have significant influence over the investee.

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

COLORSTARS GROUP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 5 – Long term investment (continued)

The unaudited financial information of Anteya Technology Corp. as of March 31, 2012 and December 31, 2011 and for three months ended March 31, 2012 and 2011 (in US dollars) are as follows:

Note 6 – Inventory

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

COLORSTARS GROUP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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 2011 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 2011 (inclusive).

The income tax provision information is provided as follows:

Note 8 – Accrued expenses

COLORSTARS GROUP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 9 - Bank short term debt

The Company signed revolving credit agreements with a lending institution. The interest rate on short-term borrowings outstanding as of March 31, 2012 ranges from 3.023% to 3.175% per annum, as of December 31, 2011, interest rate ranges from 2.946% to 3.175% per annum.  The short term debt is secured by:

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

Note 10- Geographic Information

Product revenues for the three months ended March 31 2012 and 2011 are as follows:

Note 11 – Related Party Transactions

The Company has recorded expenses and revenues for the following related party transactions for three months ended March 31, 2012 and 2011:

COLORSTARS GROUP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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% and 11.43% of the outstanding common stock of Anteya Technology Corp and Fin-Core Corporation as of March, 2012.  All transactions were at market-based prices.

The stockholder, Mr. Wei-Rur Chen, provided a personal loan of USD$100,000 to the company.  The personal loan is unsecured, repayable on demand and interest bearing at applicable federal short-term rate in effect for each day on outstanding loan principal and unpaid accrued interest.  The effective interest rate is 0.19% and the interest paid to Mr. Chen is $48 for three months ended March 31, 2012.

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 at March 31, 2011 are as follows:

Note 13– Subsequent Events

The Company evaluated all events subsequent to March 31, 2012 through the date of the issuance of the financial statements. There are no other significant or material transactions to be reported.

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)          Significant Business Transactions Overview. 

On July 24, 2005, we entered into an acquisition agreement with ColorStars, Inc., a Taiwanese corporation (“ColorStars Taiwan”), pursuant to which, on February 14, 2006, the shareholders of ColorStars Taiwan were issued shares of our Company in exchange for their shares of ColorStars Taiwan.  This resulted in ColorStars Taiwan becoming a wholly owned subsidiary of the Company. Specifically, for each share of common stock outstanding of ColorStars Taiwan (1,500,000 shares of ColorStars Taiwan were issued and outstanding at such time), 20 shares of our common stock were issued in exchange for each such share (the aggregate of 30,000,000 shares of our common stock).

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 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.

In October 2011, Fin-Core decided to increase its capital by issuing 3,000,000 new common shares at par value of NTD $10 per share.  The Company was entitled to subscribe for up to 600,000 common shares for NTD $6,000,000.  However, the Company chose not to participate in the subscription of any newly issued common shares of Fin-Core.  As a result, on November 4, 2011, the Company’s equity interest in Fin-Core decreased to 11.43% from 20% after the issuance of 3,000,000 new common shares. 

Results of Operations

Comparison of Three Months Ended March 31, 2012 to Three Months Ended March 31, 2011

               Net Sales.  Net  sales decreased to $711,214 for the three months ended March 31, 2012 from $954,862 for the three months ended March 31, 2011. The decrease in sales was due to the European market shrinkage as a result of the current economic turndown.

               Cost of Goods Sold.  Cost of goods sold decreased to $482,603 for the three months ended March 31, 2012 from $655,563 for the three months ended March 31, 2011. The decrease in cost of goods sold was due to a decrease in net sales.

               Gross Profit.  Gross profit decreased to $228,611 (32.14%) for the three months ended March 31, 2012 from $299,299 (31.34%) for the three months ended March 31, 2011. The decrease in gross profit was due to a decrease in net sales.

Gross Profit Percentage.  Gross profit percentage increased to 32.14% for the three months ended March 31, 2012 from 31.34% for the three months ended March 31, 2011. The increase in gross profit percentage was due to the introduction of certain new products to the market that have high profit margins.

               Selling, General and Administrative Expenses.   Selling, general and administrative expenses increased to $328,596 for the three months ended March 31, 2012 from $271,537 for the three months ended March 31, 2011. The increase in selling, general and administrative expenses is primarily related to an increase in expenses for trade shows and advertisement.

               Research and Development Expenses.  Research and development (R&D) expenses decreased to $25,833 for the three months ended March 31, 2012 from $40,020 for the three months ended March 31, 2011.  The decrease in R&D expenses is due to less investment in tooling for new products.

               Depreciation and Amortization.  Depreciation and amortization increased to $11,442 for the three months ended March 31, 2012 from $5,394 for the three months ended March 31, 2011 as a result of an increase of tooling investments for new products and their depreciation.

               Net Income (loss).  For the three months ended March 31, 2012, we incurred a net loss of $(157,292) as compared to a net loss of $(45,611) for the three months ended March 31, 2011.  The net loss was primarily a result of increased expenses in trade shows, marketing and foreign exchange conversion loss.

Financial Condition, Liquidity and Capital Resources

Our revenues are primarily derived from the sale of LED devices and systems. 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.

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.

Net cash provided by (used in) operating activities.  During the three months ended March 31, 2012, net cash used in operating activities was $(244,108) compared with $36,647  provided by operating activities for the three months ended March 31, 2011.  The cash flow used in operating activities in the three months ended March 31, 2012 was primarily the result of increase of net loss, inventory, and decrease of account payable. The cash flow provided operating activities in the three months ended March 31, 2011 was primarily the result of a decrease of pre-paid expenses and an increase of receipts in advance.

Net cash provided by (used in) investing activities. During the three months ended March 31, 2012, net cash used in investing activities was $(51,085) compared with $(28,737) used in investing activities for the three months ended March 31, 2011.  The cash flow used in investing activities in the three months ended March 31, 2012 was primarily the result of investment of tooling for new products and show room. The cash flow used in investing activities in the three months ended March 31, 2011 was primarily the result of our investments in tooling for our new products. ,

Net cash provided by (used in) financing activities. During the three months ended March 31, 2012, net cash used in financing activities was $3,130 compared with $2,978 used in financing activities for the three months ended March 31, 2011.  The cash flow used in financing activities in the three months ended March 31, 2012 was primarily derived from interest paid for bank loan. The cash flow used in financing activities in the three months ended March 31, 2011 was primarily the result of interest paid for bank loan.

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 February 22, 2012, December 26, 2011, and January 30, 2012, respectively.  The terms of the loan agreements are described in further detail in the chart below:

(1) NTD $3,000,000 is approximately USD $99,056

(2)  NTD $6,000,000 is approximately USD $198,112

(3)  The loan term stated herein initially expired on Jan. 29, 2012 but was extended to July 29, 2012 and the interest rate increased to 3.023% per annum.

(4)  The loan term stated herein initially expired on February 22, 2012 but was extended to August 22, 2012 and the interest rate increased to 3.023% per annum.

               Additionally, on July 20, 2011, our Chairman, Mr. Wei-Rur Chen, provided a personal loan to the Company in an amount equal to One Hundred Thousand and No/100 Dollars (US $100,000). We did not enter into a loan agreement with Mr. Chen. The personal loan is unsecured, repayable on demand and interest bearing at Applicable Federal Short-Term rates in effect from time to time.

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.

 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.

               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.  Mine Safety Disclosures.

               Not applicable.

Item 5.  Other Information.

               None.

Item 6. Exhibits.

                                                                           INDEX TO EXHIBITS

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.