UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended     March 31, 2012

 

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 x   No ¨

 

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

 

Large accelerated filer ¨

Accelerated filer ¨

Non-accelerated filer  ¨ (Do not check if a smaller reporting company)

Smaller reporting company x

 

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

 

As of May 15, 2012, the registrant had 58,911,327 shares of common stock, $0.001 par value per share, issued and outstanding.

 

  

TABLE OF CONTENTS

 

		PAGE
PART I. FINANCIAL INFORMATION		3
Item 1. Financial Statements		3
Consolidated Balance Sheets as of March 31, 2012 (Unaudited) and December 31, 2011		3
Consolidated Statements of Operations and Comprehensive Loss for the Three Months Ended March 31, 2012 and 2011 (Unaudited)		4
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2012 and 2011 (Unaudited)		5
Notes to Consolidated Financial Statements		6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		19
Item 3. Quantitative and Qualitative Disclosure About Market Risk		27
Item 4. Controls and Procedures		27
PART II. OTHER INFORMATION		27
Item 1. Legal Proceedings		27
Item 1A. Risk Factors		28
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		28
Item 3. Defaults Upon Senior Securities		28
Item 4. Mine Safety Disclosures		28
Item 5. Other Information		28
Item 6. Exhibits		28
Signatures		29

 

  

PART I. FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

CHINA 3C GROUP AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands)

 

		March 31,				December 31,
		2012				2011
		(Unaudited)				(Audited)
ASSETS
Current assets:
Cash and equivalents		$	4,123			$	5,778
Accounts receivable, net			3,807				9,967
Inventories			3,015				3,358
Advances to suppliers			634				1,666
Prepaid expenses and other current assets			167				145
Total current assets			11,746				20,914
Property, plant and equipment, net			84				93
Total assets		$	11,830			$	21,007
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable		$	1,354			$	2,572
Accrued expenses			571				3,667
Income tax payable			1,088				1,409
Total liabilities			3,013				7,648
Commitments and contingencies
Stockholders' equity:
Common stock, $0.001 par value, 100,000,000 shares authorized, 58,911,327 issued and outstanding			59				59
Additional paid-in capital			21,816				21,674
Subscription receivable			(50	)			(50	)
Statutory reserve			11,543				11,543
Other comprehensive income			7,858				7,763
Accumulated deficit			(32,409	)			(27,630	)
Total stockholders' equity			8,817				13,359
Total liabilities and stockholders' equity		$	11,830			$	21,007

 

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

 

 

CHINA 3C GROUP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

THREE MONTHS ENDED MARCH 31, 2012 and 2011 (UNAUDITED)

(in thousands)

		2012				2011
Net sales		$	7,713			$	18,031
Cost of sales			7,818				16,937
Gross profit (loss)			(105	)			1,094
Selling, general and administrative expenses			3,016				3,618
Loss from continuing operations			(3,121	)			(2,524	)
Other (income) expense
Interest income			(4	)			(13	)
Other income			(1	)			(1	)
Other expense			375				147
Total other expense			370				133
Loss from continuing operations before income taxes			(3,491	)			(2,657	)
Provision for income taxes			38				91
Net loss from continuing operations			(3,529	)			(2,748	)
Net loss from discontinued operations, net of income taxes			(1,250	)			(1,711	)
Net loss			(4,779	)			(4,459	)
Foreign currency translation adjustments			94				246
Comprehensive loss		$	(4,685	)		$	(4,213	)
Basic and diluted loss per share:
Continuing operations		$	(0.06	)		$	(0.05	)
Discontinued operations			(0.02	)			(0.03	)
Net loss per share		$	(0.08	)		$	(0.08	)
Weighted average shares outstanding:
Basic and Diluted			58,911,327				58,511,327

 

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

 

 

CHINA 3C GROUP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

THREE MONTHS ENDED MARCH 31, 2012 and 2011 (UNAUDITED)

(in thousands)

 

		2012				2011
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss		$	(4,779	)		$	(4,459	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation			10				24
Amortization of intangible assets			-				351
Stock based compensation			141				609
(Increase) / decrease in assets:
Accounts receivable			6,237				(1,997	)
Other receivables			(23	)			129
Inventories			365				(240	)
Prepaid expenses and other current assets			21				194
Refundable deposits			(20	)			2
Advance to suppliers			1,046				2
(Increase) / decrease in current liabilities:
Accounts payable			(1,282	)			15
Accrued expenses			(3,080	)			(2,906	)
Income tax payable			331				28
Net cash used in operating activities		$	(1,695	)		$	(8,248	)
Effect of exchange rate changes on cash and equivalents			40				380
Net decrease in cash			(1,655	)			(7,868	)
Cash and equivalents, beginning of period			5,778				26,249
Cash and equivalents, end of period		$	4,123			$	18,381
Supplemental disclosure of cash flow information:
Interest paid		$	-			$	-
Income taxes paid		$	359			$	57

 

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

 

 

 

CHINA 3C GROUP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2012 AND 2011 (UNAUDITED)

 

Note 1 - ORGANIZATION

 

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

 

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

 

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

 

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

 

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

 

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

 

We sell and distribute products through retail stores and secondary distributors. We operate most of our retail operations through our “store in store” model. Under this model, the Company leases space in major department stores and retailers. Leasing costs can vary based on the percentage of sales, or can be fixed. In the three months ended March 31, 2011 and 2010 all of our stores in stores leases were variable based on sales.

 

 

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.

 

ORGANIZATIONAL CHART

 

Our corporate structure as of March 31, 2012 is as follows:

 

  

* These entities ceased operation as of December 31, 2011.

 

 

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 subsidiaries – Wang Da, Yiwu, Joy & Harmony, Sanhe, Jinhua and Zhejiang’s functional currency is the Chinese Renminbi (“RMB”), however, the accompanying consolidated financial statements were translated and presented in United States Dollars (“$”, or “USD”). China 3C is the parent company that was incorporated on August 20, 1998 under the laws of the State of Nevada. The parent company has no operations; therefore, it has no sales. The main activities of China 3C were incurring public company expenses. China 3C pays all of its expenses in USD. Therefore, we believe China 3C’s functional currency is USD. CFDL was incorporated on July 22, 2004 under the laws of the BVI. CFDL is a holding company and it does not have operations. As a result, we determined that China 3C and CFDL’s functional currency is USD.

 

Going Concern

 

The accompanying consolidated financial statements have been prepared on a going concern basis which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company realized net losses of $52,844 and $24,927 for 2011 and 2010, respectively. The Company had an accumulated deficit of $32,409 as of March 31, 2012. In addition, the Company’s cash position substantially deteriorated from 2010. There can be no assurance the Company will become profitable or that it will survive as a public company. These issues raise substantial doubt regarding the Company’s ability to continue as a going concern.

 

Principles of Consolidation

 

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

 

Reclassifications

 

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

 

Currency Translation

 

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

 

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 accounts was $662 (unaudited) and $751 as of March 31, 2012 and December 31, 2011, respectively.

 

Inventories

 

Inventories are valued at the lower of cost (determined on a weighted average basis) or market value.  Management compares the cost of inventories with the market value and allowance is made for writing down their inventories to market value, if lower. As of March 31, 2012 and December 31, 2011, inventory consisted entirely of finished goods valued at $3,015 (unaudited) and $3,358, respectively.

 

Property and Equipment, net

 

Property 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, 2012 and December 31, 2011, property and equipment consisted of the following: 

 

		2012				2011
		(Unaudited)
Automotive		$	650			$	650
Office equipment			206				206
Sub Total			856				856
Less: accumulated depreciation			(772	)			(763	)
Total		$	84			$	93

 

Long-Lived Assets

 

The Company periodically evaluates the carrying value of long-lived assets to be held and used in accordance with FASB ASC 360 “Property, Plant and Equipment”, which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amounts. In that event, a loss is recognized based on the amount by which the carrying amount exceeds the fair market value of the long-lived assets. Losses on long-lived assets to be disposed of are determined in a similar manner, except that fair market values are reduced for the cost of disposal. Based on its review, the Company believes that, as of March 31, 2012 (unaudited) and December 31, 2011, there were no significant impairments of its long-lived assets.

 

Fair Value of Financial Instruments

 

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

 

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. 68.7% of the Company's revenue came from sales to customers at outlets installed inside department stores (i.e. store in store model) during the first three months of 2012 and 2011, and was mainly achieved through two broad categories:

 

a.

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

 

 

b.

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

 

2.

Wholesale. 31.3% of the Company's revenue came from wholesale during the first three months of 2012 and 2011. Recognition of income in wholesales is based on the contract terms. The main contract terms on wholesale agreed that payments be paid 15 days after receipt of goods and that ownership and all risks associated with the goods are transferred to the customers on the date of goods received and payments will be made 15 days therefrom.

 

Sales revenue is therefore recognized on the following basis:

 

1.

Store in store model:

 

a.

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

 

b.

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

 

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

 

2.

Wholesale:

 

a.

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

 

Return policies

 

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

 

 

The return rights granted to wholesale customers are similar to the rights granted to retail customers. Once wholesale customers purchase 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.  Goods return policy strictly complies with the laws and regulations in China on consumer rights and product quality requirements. If the conditions and requirements as set out in the relevant laws and regulations are met, customers are able to return the goods unconditionally. In such cases, the Company shall accept the returns unconditionally. Goods returned will be redirected back to the manufacturers or suppliers who shall meet all losses on returns in accordance the laws and regulations. The Company will only be responsible for assisting the process of execution of goods return. The Company shall not bear any loss from goods returned. As a result, we do not provide any accrual on subsequent return of goods sold.

 

Unlike the US retail market, sellers do not accept returns caused by any change in the sales market or change in customers’ preferences in China. Therefore, the Company generally does not honor any return except for a product defect. As such, situations relating to return of goods from overstock in distribution channels, product obsolescence and over-budgeted goods from launching of new products will not exist.

 

The reported sales do not include estimate of returns due to defects for the period presented because we do not offer customers the right to return in China. We do not allow the customers to return the products for cash refunds, credit, or exchange for other products through general rights of return. If the products are defective, manufacturers are directly responsible for the defects. China 3C, as a distributor, only assists customers in returning the defective products to manufacturers. The manufacturers send replacement products to customers directly.

 

Cost of Sales

 

Cost of sales (“COS”) consists of actual product cost, which is the purchase price of the product less any discounts.  COS 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 (“G&A”) expenses.

 

General and Administrative Expenses

 

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

 

 

Shipping and handling fees

 

The Company follows FASB ASC 605-45, “Handling Costs, Shipping Costs”.  The Company does not charge its customers for shipping and handling. The Company classifies shipping and handling fees as part of G&A expenses. During the three months ended March 31, 2012 and 2011, the Company incurred shipping and handling fees and costs of $14 and $19, 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 COS as the products are sold.

 

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

 

Under the “store in store” business operation model, the Company may pay management fees to the department stores, which are in the form of service charges. The management fees are reflected in G&A expenses. Such management fees were $315 and $1,932 in selling, general and administrative expenses for the three months ended March 31, 2012 and 2011, respectively.

 

Share Based Payment

 

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

 

Advertising

 

Advertising expenses consist primarily of costs of promotion for corporate image and product marketing and costs of direct advertising. The Company expenses all advertising costs as incurred. Advertising expense was $131 and $34 for the three months ended March 31, 2012 and 2011, respectively.

 

Income Taxes

 

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

 

Basic and Diluted Loss per Share

 

Loss per share are calculated in accordance with FASB ASC Topic 260, “Earnings per Share”. Basic earnings (loss) per share are based upon the weighted average number of common shares outstanding. Diluted earnings (losses) per share are based on the assumption that all dilutive convertible shares and stock options were converted or exercised. Dilution is computed by applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period. If convertible shares and stock options are anti-dilutive, the impact of conversion is not included in the diluted net income (loss) per share. Excluded from the calculation of diluted (loss) per share for the three months ended March 31, 2012 and 2011 was 50,000 options, as they were not dilutive.

 

 

Statement of Cash Flows

 

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

 

Concentration of Credit Risk

 

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

 

Segment Reporting

 

FASB ASC Topic 280, “Segment Reporting”, requires use of the “management approach” model for segment reporting. The management approach model is based on the way a company’s management organizes segments within the company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, legal structure, management structure, or any other manner in which management disaggregates a company. The Company operated in four segments before the acquisition of Jinhua in July 2009. Since then, the Company operated in five segments until Sanhe and Joy & Harmony ceased operations at the end of 2011. As a result, the Company actively operates in three segments in 2012 (see Note 13).

 

Recent Accounting Pronouncements

 

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

 

In June 2011, FASB issued ASU 2011-05, Comprehensive Income (ASC Topic 220):  Presentation of Comprehensive Income.  Under the amendments in this update, an entity has the option to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. Under both options, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income and a total amount for comprehensive income. In a single continuous statement, the entity is required to present the components of net income and total net income, the components of other comprehensive income and a total for other comprehensive income, along with the total of comprehensive income in that statement. In the two-statement approach, an entity is required to present components of net income and total net income in the statement of net income. The statement of other comprehensive income should immediately follow the statement of net income and include the components of other comprehensive income and a total for other comprehensive income, along with a total for comprehensive income. In addition, the entity is required to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented.  The amendments in this update should be applied retrospectively and are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of this statement had no impact on the Company’s consolidated financial statements. 

 

 

Note 3 – ADVANCES TO SUPPLIERS

 

Advances to suppliers represent advance payments to suppliers for the purchase of inventory.

 

Note 4 - OPTIONS

 

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

 

Outstanding options by exercise price consisted of the following as of March 31, 2012.

 

Options Outstanding																Options Exercisable
Exercise Price				Number of Shares				Weighted Average Remaining Life (Years)				Weighted Average Exercise Price				Number of Shares				Weighted Average Exercise Price
$	4.16				50,000				5.75			$	4.16				50,000			$	4.16

 

Note 5 - COMPENSATED ABSENCES

 

Regulation 45 of the labor laws in the PRC entitles employees to annual vacation leave after 1 year of service. In general all leave must be utilized annually, with proper notification. Any unutilized leave is cancelled.

 

Note 6 - INCOME TAXES

 

The Company recognizes 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 were any interest expense recognized during the three months ended March 31, 2012 and 2011.

 

Under ASC 740-10-25, evaluation of a tax position is a two-step process. The first step is to determine whether it is more-likely-than-not that a tax position will be sustained upon examination, including the resolution of any related appeals or litigation based on the technical merits of that position. The second step is to measure a tax position that meets the more-likely-than-not threshold to determine the amount of benefit to be recognized in the financial statements.

 

The US entity, China 3C is subject to the US federal income tax at a rate of 34%. The US entity does not conduct any operations and only incurs public company expenses, such as legal fees, accounting fees, investor relations expenses and filing fees. In the process of applying step one, we determined it is more likely than not that all of the Company’s deferred tax assets will not be realized. As of March 31, 2012, the US entity has incurred net accumulated operating losses of $3,771 for income tax purposes. As a result, $1,282 of valuation allowance was recorded to reduce the deferred tax asset to zero. The net change in valuation allowance was $90 and $239 for the three months ended March 31, 2012 and 2011, respectively for the US entity.

 

 

 

The PRC subsidiaries, Sanhe, Wang Da, Joy& Harmony, Yiwu and Zhejiang are subject to the PRC income tax at 25%. Jinhua is subject to PRC income tax using simplified tax system. During the three months ended March 31, 2012, the PRC subsidiaries incurred an adjusted net operating loss of $4,139. In applying step one, management believes these subsidiaries will continue to incur losses in the near future due to high market competition, slowing market demand, rising labor and fuel costs. We believe it is more likely than not that the subsidiaries will not be able to benefit from the deferred tax assets in association with the operating losses. The net change in valuation allowance was $1,035 and $935 for the three months ended March 31, 2012 and 2011, respectively for the PRC subsidiaries.

 

The components of deferred income tax assets and liabilities as of March 31, 2012 and December 31, 2011 are as follows:

 

		2012				2011
Deferred tax assets:
U.S. net operating losses		$	90			$	300
PRC net operating losses			1,035				12,939
Total deferred tax assets			1,125				13,239
Less valuation allowance			(1,125	)			(13,239	)
		$	-			$	-

 

Reconciliation of the differences between the statutory US Federal income tax rate and the effective rate for the three months ended March 31, 2012 and 2011 are as follows:

 

		2012				2011
(Credit) tax at US Statutory Rate			(34.0	)%			(34.0	)%
Tax rate difference			8.2	%			6.6	%
Other			1.1	%			2.7	%
Valuation allowance			25.8	%			28.1	%
Effective rate			1.1	%			3.4	%

 

Note 7 - COMMITMENTS

 

The Company leases office facilities under operating leases that terminate through 2014. Rent expense for the three months ended March 31, 2012 and 2011 was $101 and $127, respectively. The future minimum obligations under these agreements are as follows by years as of March 31, 2012:

 

2013		$	360
2014			175
2015			57
		$	592

 

 

Note 8 - STATUTORY RESERVE

 

In accordance with the laws and regulations of the PRC, a WFOE’s income, after the payment of the PRC income taxes, shall be allocated to the statutory surplus reserves and statutory public welfare fund. Prior to January 1, 2006, the proportion of allocation for reserve was 10 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, 2012, the Company had allocated $11,543 to these non-distributable reserve funds.

 

Note 9 – DISCONTINUED OPERATIONS

 

In 2011, Sanhe closed all its 210 stores in stores. Joy & Harmony closed all its 196 stores in stores. Letong closed its direct retail and franchise operation. All three entities ceased operation as of December 31, 2011. Sanhe, Joy & Harmony and Letong will be legally dissolved in 2012. As such, Sanhe, Joy & Harmony and Letong met the conditions to be reported as discontinued operations in the financial statements, and accordingly, the results of operations have been reclassified for all periods to conform to the current period's presentation.

 

The following table summarizes the assets and liabilities of the discontinued operations as of March 31, 2012 and December 31, 2011 included in the Consolidated Balance Sheets:

 

		2012				2011
Cash		$	138			$	7,610
Accounts receivable, net			-				6,821
Inventories			-				3,482
Intercompany receivable			16,882				1,938
Advance to suppliers			-				458
Taxes receivable			-				708
Prepaid expenses and other assets			4				20
Property, plant and equipment			4				8
Goodwill			-				10,757
Total assets			17,028				31,802
Accounts payable			-				920
Accrued expenses			-				620
Income tax payable			3				30
Other payable			7				-
Allowance for bad debt			55				-
Intercompany payable			480				-
Total liabilities			545				1,570
Net assets		$	16,483			$	30,232

 

 

The following table summarizes the operating results of the discontinued operations included in the Consolidated Statements of Operations and Comprehensive Loss: 

 

		2012				2011
Sales, net		$	-			$	21,062
Cost of sales			-				19,126
Gross profit			-				1,936
General and administrative expenses			618				3,654
Loss from discontinued operations			(618	)			(1,718	)
Other Income (Expense)			(632	)			7
Loss before income taxes			(1,250	)			(1,711	)
Provision for income taxes			-				-
Net loss from discontinued operations, net of income tax		$	(1,250	)		$	(1,711	)

 

Note 10- OTHER COMPREHENSIVE INCOME

 

Other comprehensive income as included in stockholders’ equity for the three months ended March 31, 2012 and 2011, represents foreign currency translation adjustment.

 

Note 11 - CURRENT VULNERABILITY DUE TO CERTAIN RISK FACTORS

 

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

 

Note 12 - MAJOR CUSTOMERS AND CREDIT RISK

 

During the three months ended March 31, 2012 and 2011, no single customer accounted for more than 10% of the Company’s sales or accounts receivable and no single vendor accounted for more than 10% of the Company’s purchases.

 

Note 13 -   SEGMENT INFORMATION

 

We separately operate and prepare accounting and other financial reports to management for three business organizations (Wang Da, Yiwu, and Jinhua). Each of the individual operating companies corresponds to different product groups.  Wang Da is mainly operating mobile phones, Yiwu is mainly operating office communication products. Jinhua provides logistics to businesses in Eastern China. Zhejiang’s operation is reported in “Other” segment. All segments are accounted for using the same principals as described in Note 2.

 

We identified five reportable segments required by ASC 280, “Segment Reporting”: (1) mobile phone, (2) office communication product, (4) Logistics.

 

The following tables present summarized information by segment:

 

		Three Months Ended March 31, 2012
		Mobile				Communication
		Phones				Products				Logistics				Other				Total
Sales, net		$	5,242			$	965			$	1,506			$	-			$	7,713
Cost of sales			4,868				927				2,023				-				7,818
Gross profit (loss)			374				38				(517	)			-				(105	)
Loss from operations		$	(1,227	)		$	(613	)		$	(763	)		$	(518	)		$	(3,121	)

 

  

		Three Months Ended March 31, 2011
		Mobile				Communication
		Phones				Products				Logistics				Other				Total
Sales, net		$	11,586			$	4,243			$	2,202			$	-			$	18,031
Cost of sales			10,798				3,844				2,294				-				16,937
Gross profit (loss)			788				399				(92	)			-				1,117
Loss from operations		$	(745	)		$	(345	)		$	(441	)		$	(993	)		$	(2,524	)

 

Total assets by segment as of March 31, 2012 (unaudited) and December 31, 2011 are as follows:

 

		Mobile				Communication
		Phones				Products				Logistics				Other				Total
2012		$	6,707			$	3,181			$	1,589			$	353			$	11,830
2011		$	9,293			$	4,046			$	1,098			$	777			$	15,214

 

For the three months ended March 31, 2012, the enterprise-wide revenue derived from each group of products was as follows:

 

Ÿ

Mobile phones was $4,705, TVs $163, computers $234 and other accessories $140.

Ÿ

Office equipment was $965, including fax machines $462, telephones $111, printers $78, computers $242 and other accessories $69.

Ÿ

Logistics was $1,506.

 

For the three months ended March 31, 2011, the enterprise-wide revenue derived from each group of products was as follows:

 

Ÿ

Mobile phones was $11,586.

Ÿ

Office equipment was $4,243, including fax machines $2,478, telephones $777, printers $259, computers $385 and other accessories $344.

Ÿ

Logistics was $2,202.

 

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

 

Forward Looking Statements

 

We have included and from time to time may make in our public filings, press releases or other public statements, certain statements, including, without limitation, those under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7. In some cases these statements are identifiable through the use of words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “project,” “target,” “can,” “could,” “may,” “should,” “will,” “would” and similar expressions. You are cautioned not to place undue reliance on these forward-looking statements. In addition, our management may make forward-looking statements to analysts, investors, representatives of the media and others. These forward-looking statements are not historical facts and represent only our beliefs regarding future events, many of which, by their nature, are inherently uncertain and beyond our control.

 

 

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

 

Overview (All dollar amounts in thousands)

 

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

 

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

 

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

 

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

 

In 2009, Zhejiang started establishing direct electronic retail stores and franchise operation.

 

 

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

 

Yiwu, Wang Da, Sanhe and Joy & Harmony were engaged in the resale and distribution of third party products and generate approximately 100% of their revenue from resale of items such as mobile phones, facsimile machines, DVD players, stereos, speakers, MP3 and MP4 players, iPod, electronic dictionaries, CD players, radios, and audio systems. We sell and distribute products through retail stores and secondary distributors. We operate most of our retail operations through our “store in store” model. Under this model, the Company leases space in major department stores and retailers. Leasing costs can vary based on a percentage of sales, or can be fixed. In the three months ended March 31, 2012 and 2011, all of our stores in stores leases were variable based on sales. Following the acquisition of Jinhua, the Company began providing logistical services to businesses in addition to its traditional business of resale and distribution of third party products such as mobile phones, facsimile machines, DVD players, stereos, speakers, MP3 and MP4 players, iPods, electronic dictionaries, CD players, radios and audio systems.

 

During 2011, Zhejiang closed all direct stores and franchise stores. Sanhe closed all its 210 stores in stores. Joy & Harmony closed all its 196 stores in stores. All three entities ceased operation as of December 31, 2011. As a result, the Company focuses on distributing office appliances, mobile phones and digital products as well as providing logistic service.

 

Results of Operations for the Three months Ended March 31, 2012 and 2011

 

Reportable Operating Segments

 

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

 

a)

Yiwu

 

b)

Wang Da

 

c)

Jinhua

 

a)

Yiwu

 

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

  

		Three Months Ended March 31,								Percentage
Yiwu		2012				2011				Change
Revenue		$	965			$	4,243				(77.6	)%
Gross Profit		$	38			$	399				(90.5	)%
Profit Margin			3.9	%			9.4	%			(5.5	)%
Operating (Loss)		$	(613	)		$	(345	)			(77.7	)%

 

For the three months ended March 31, 2012, Yiwu generated revenue of $965, a decrease of $3,278 or 77.6% compared to $4,243 for the three months ended March 31, 2011. The decrease was a result of lower market demand for office appliances and the closing of 67 stores in stores in the first quarter of 2012. In addition, Yiwu is transferring computer businesses to Wang Da, which also contributed to the decrease in revenue.

 

 

Gross profit decreased $361 or 90.5% from $399 for the three months ended March 31, 2011 to $38 for the three months ended March 31, 2012. Profit margin decreased 5.5% from 9.4% in the three months ended March 31, 2011 to 3.9% in the three months ended March 31, 2012. The decrease was a result of increased promotion events in the first quarter of 2012. Yiwu is planning to exit the office appliances market. As a result, Yiwu had clearance sales in the first quarter of 2012 which caused gross profit margin to decrease.

 

Operating loss was $613 for the three months ended March 31, 2012, an increase of $268 or 77.7% compared to $345 for the three months ended March 31, 2011. Operating loss increased primarily due to decreased sales and gross profit.

 

b)

Wang Da

 

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

 

		Three Months Ended March 31,								Percentage
Wang Da		2012				2011				Change
Revenue		$	5,242			$	11,586				(54.8	)%
Gross Profit		$	374			$	788				(52.5	)%
Profit Margin			7.1	%			6.8	%			0.3	%
Operating (Loss)		$	(1,227	)		$	(745	)			(64.7	)%

 

For the three months ended March 31, 2012, Wang Da generated revenue of $5,242, a decrease of $6,344 or 54.8% compared to $11,586 for the three months ended March 31, 2011. The decrease in revenue was primarily due to the closing of 75 stores in stores during the first quarter of 2012.

 

Gross profit decreased $414 or 52.5% from $788 for the three months ended March 31, 2011 to $374 for the three months ended March 31, 2012. Profit margin increased slightly from 6.8% in the three months ended March 31, 2011 to 7.1% in the three months ended March 31, 2012, an increase of 0.3%.  The decrease in gross profit was a result of decrease in sales.

 

Operating loss was $1,227 for the three months ended March 31, 2012, an increase of $482 or 64.7% compared to $745 for the three months ended March 31, 2011. Operating loss increased primarily due to lower gross profit and higher bad debt expenses.

 

c)

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.

 

		Three Months Ended March 31,								Percentage
Jinhua		2012				2011				Change
Revenue		$	1,506			$	2,202				(31.6	)%
Gross Profit (Loss)		$	(517	)		$	(92	)			(462.0	)%
Profit Margin			(34.3	)%			(4.2	)%			(30.2	)%
Operating (Loss)		$	(763	)		$	(441	)			(73.0	)%

 

 

Revenue decreased 31.6% from $2,202 in the three months ended March 31, 2011 to $1,506 in 2012, a decrease of $696. Revenue decreased primarily due to Jinhua’s distribution center in Yiwu city is under Government’s compulsory relocation. However, the new logistic center built by the government is still under construction and not ready for use. As a result, we used a temporary distribution center for operations. This affected Jinhua’s operations and caused Jinhua’s revenue to decrease. Profit margin decreased 30.2% from (4.2)% in the three months ended March 31, 2011 to (34.3)% in 2012 primarily due to the increased fuel cost and toll charges. Operating losses increased primarily due to decreased profit margin. Higher operating expenses, in particular, labor costs also caused operating losses to increase.

 

Net Sales

 

Net sales for the three months ended March 31, 2012 decreased by 57.7%, to $7,713 compared to $18,031 for the three months ended March 31, 2011. The decrease was attributable to the increased competition in the electronics market in China as well as the closing of 142 stores in the first quarter 2012.

 

Percentage of sales

 

In the first quarter of 2012 and 2011, we earned 68.7% of our sales from our retail and 31.3% from our wholesale operations.

 

Percentage of sales from retail and wholesale operations for each segment is as follows:

 

		Yiwu				Wang Da				Total
Retail			60.9	%			76.4	%			68.7	%
Wholesale			39.1	%			23.6	%			31.3	%

 

Cost of Sales

 

Cost of sales (“COS”) for the three months ended March 31, 2012 was $7,818 compared to $16,937 for the three months ended March 31, 2011, a decrease of 54.8%. The decreased COS for the three months was a result of the decrease in sales from the comparable period. In addition, higher fuel cost and higher cost of consumer electronics also contributed to the increased cost of sales.

 

Gross profit (loss)

 

Gross loss for the three months ended March 31, 2012 was $(105) compared to gross profit of 1,094 for the three months ended March 31, 2011, a decrease of 109.6%. The decreased gross profit for the three months was due to lower sales.

 

Profit Margin

 

Profit margin for the three months ended March 31, 2012 was (1.4)% compared to 6.1% for the three months ended March 31, 2011. The lower profit margin was primarily due to the decreased unit sales prices of consumer and business electronics in the competitive market in China. In addition, international brand name electronics represented a higher percentage of sales in the first three months of 2012 compared to 2011. The increased sales of brand name electronics led to lower profit margin since brand name electronics have lower profit margins compared to domestic products. For the logistics segment, the decrease in profit margin was primarily due to increased fuel cost.

 

General and Administrative Expenses

 

General and administrative (“G&A”) expenses for the three months ended March 31, 2012 were $3,016 or 39.1% of net sales, compared to $3,618 or 20.1% of net sales for the three months ended March 31, 2011, an increase of 19.0% of sales. The increase in G&A expenses for the first quarter was primarily due to an increase in labor cost and higher bad debt expenses.

 

 

Operating Loss from Continuing Operations

 

Operating loss for the three months ended March 31, 2012 was $3,121 or (40.5)% of net sales compared to $2,524 or 14.0% of net sales for the three months ended March 31, 2011, an increase of 24.8%. Lower sales, lower gross profit as well as increased operating expenses were the key factors for the increase in loss from operations during the three months ended March 31, 2012 compared to 2011.

 

Provision for Income Taxes

 

The provision for income taxes for the three months ended March 31, 2012 was $38 compared to $91 for the three months ended March 31, 2011. Jinhua was the only entity paying income taxes, even though it had operating losses. This was due to Jinhua using the simplified tax system.

 

Net Loss from Continuing Operations

 

Net loss was $3,529 or (45.8)% of net sales for the three months ended March 31, 2012 compared to $2,748 or (15.2)% of net sales for the three months ended March 31, 2011, a decrease of 29.6%. Decreased sales revenue, lower gross profit and higher operating expenses were the critical factors which contributed to the decrease in net income.

 

Net Loss from Discontinued Operations

 

Net loss from discontinued operations for the three months ended March 31, 2012 was $(1,250) compared to $(1,711) for 2011, a decrease of $461.

 

Net Loss

 

Net loss was $4,779 or (62.0)% of net sales for the three months ended March 31, 2012 compared to $4,459 or (24.7)% of net sales for the three months ended March 31, 2011, a decrease of 7.2%. The increase in net loss was primarily due to lower sales revenue and gross profit.

 

 Foreign Currency Translation Adjustments

 

The impact of foreign translation from our accounts in RMB to US dollar on China 3C’s operating results was not material. During the translation process, the assets and liabilities of all PRC subsidiaries are translated into US dollars at period-end exchange rates. The revenues and expenses are translated into US dollars at average exchange rates of the periods. Resulting translation adjustments are recorded as a component of accumulated other comprehensive income within stockholders’ equity.

 

		Three months ended March 31,
		2012				2011
RMB/$ exchange rate at period end			0.1584				0.1527
Average RMB/$ exchange rate for the periods			0.1588				0.1522

 

Transaction gains or losses arising from exchange rate fluctuation on transactions denominated in a currency other than the functional currency were included in the consolidated results of operations. As a result of the translation, China 3C recorded a foreign currency gain of $94 in the first quarter 2012 and $246 in 2011, which is a separate line item on the Statements of Operations.

 

 

Liquidity and Capital Resources

 

Cash has historically been generated from operations. Operations and liquidity needs are funded primarily through cash flows from operations. Cash and equivalents were $4,123 at March 31, 2012, compared to $5,778 at December 31, 2011.

 

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

 

		March 31,
		2012				2011
Net cash used in operating activities		$	(1,695	)		$	(8,248	)
Effect of exchange rate change on cash and equivalents			40				380
Net decrease in cash and equivalents			(1,655	)			(7,868	)
Cash and equivalents at beginning of  period			5,778				26,249
Cash and equivalents at end of period		$	4,123			$	18,381

 

Operating Activities

 

Net cash used in operating activities was $1,695 for the three months ended March 31, 2012 compared to $8,248 for the three months ended March 31, 2011, a 79.5% decrease.  Net cash used in operating activities was mainly attributable to several factors, including (i) net loss of $4,779; (ii) decrease in accounts receivable of $6,237; (iii) decrease in advance to suppliers of $1,046, (iv) decrease in accounts payable and accrued expenses of $4,362, offset by the add back of stock compensation of $141.

 

		Three months ended March 31,
		2012				2011				Percentage Change
Sales, Net		$	7,713			$	18,031				(57.2	)%
Accounts receivable		$	3,807			$	9,967				(61.8	)%

 

Accounts receivable decreased 61.8% in the first quarter of 2012 while sales decreased 57.2%. The change in accounts receivable is in line with the change in sales. Management monitors and periodically assesses the collectability of accounts receivable to ensure the allowance for bad debts account is reasonably estimated. Collection of accounts receivable is based on the terms of legal binding documents. Our accounts receivable department has periodically reviewed the allowance for doubtful accounts. The bad debts allowance is based on the aging of receivables, credit history and credit quality of the customers, the term of the contracts as well as the balance outstanding. If an account receivable item is considered probable to be uncollectible, it will be charged to bad debts immediately.

 

Cash and equivalents as of March 31, 2012 and December 31, 2011 were solely bank accounts in US and China. Specifically, cash and equivalents for each subsidiary as of March 31, 2012 and December 31, 2011 included:

 

(all amounts are denominated at thousands)

 

Name of Entities

Region

Currency

March 31, 2012

December 31, 2011

China 3C Group

US entity

USD

1

26

Zhejiang

Chinese entity

RMB

2,070

4,847

Yiwu

Chinese entity

RMB

7,552

4,611

Wang Da

Chinese entity

RMB

8,194

20,182

Jinhua

Chinese entity

RMB

7,331

2,852

 

 

 

Cash equivalents held in the PRC subsidiaries are not freely transferrable outside the country. The amounts not freely transferable as of March 31, 2012 and December 31, 2011 were RMB 26,015 ($4,122) and RMB 36,541 ($5,752).

 

 Capital Expenditures

 

We did not have any capital expenditure for the first three months of 2012 and 2011.

 

Working Capital Requirements

 

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

 

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

 

Revenue Recognition

 

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

 

 

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

 

Inflation

 

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

 

After Sales Service

 

The after-sales services we provide to our customers are primarily repair and maintenance. If a customer buys a product from us and needs repairs, we 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

 

Not applicable.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

 

Not applicable.

 

Item 4. Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures

 

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, our management conducted an evaluation of our disclosure controls and procedures as of March 31, 2012, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based on this evaluation, our principal executive officer and principal financial officer concluded that, as of such date, the Company’s disclosure controls and procedures were not effective due to the material weakness in our internal controls identified in our Form 10-K for the year ended December 31, 2011.

 

Disclosure controls and procedures are designed 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 quarter of 2012 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.

 

None.

 

 

Item 1A. Risk Factors.

 

There have been no material changes from the Risk Factors previously disclosed in the Company’s Form 10-K for its year ended December 31, 2011.

 

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

 

None.

 

Item 3.  Defaults Upon Senior Securities.

 

None.

 

Item 4. Mine Safety Disclosures.

 

Not Applicable.

 

Item 5. Other Information.

 

None.

 

Item 6. Exhibits.

 

Exhibit No.		Document Description
31.1		Certification of the Chief Executive Officer pursuant to Rule 13A-14(A)/15D-14(A) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
31.2		Certification of the Chief Financial Officer pursuant to Rule 13A-14(A)/15D-14(A) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
32.1		Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002).*

101.INS		XBRL Instance Document*
101.SCH		XBRL Taxonomy Extension Schema Document*
101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document*
101.DEF		XBRL Taxonomy Extension Definition Linkbase Document*
101.LAB		XBRL Taxonomy Extension Label Linkbase Document*
101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document*

 

* Filed Herewith

 

  

SIGNATURES

 

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

 

	CHINA 3C GROUP
Date: May 15, 2012	By:	/s/ Zhenggang Wang
		Name:   Zhenggang Wang
		Title: Chief Executive Officer and Chairman
		(Principal Executive Officer)

 

Date: May 15, 2012	By:	/s/ Weiping Wang
		Name:   Weiping Wang
		Title: Chief Financial Officer (Principal Accounting and Financial Officer)

  

EXHIBIT INDEX

 

Exhibit No.		Document Description
31.1		Certification of the Chief Executive Officer pursuant to Rule 13A-14(A)/15D-14(A) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
31.2		Certification of the Chief Financial Officer pursuant to Rule 13A-14(A)/15D-14(A) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
32.1		Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002).*

101.INS		XBRL Instance Document*
101.SCH		XBRL Taxonomy Extension Schema Document*
101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document*
101.DEF		XBRL Taxonomy Extension Definition Linkbase Document*
101.LAB		XBRL Taxonomy Extension Label Linkbase Document*
101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document*

 

* Filed Herewith