UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
(Amendment No. 2)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2008
or
o 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 o
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 o Accelerated filer x Non-accelerated filer (Do not check if a smaller reporting company) o Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes x No
As of August 8, 2008 the registrant had 53,194,844 shares of common stock outstanding.
EXPLANATORY NOTE
We are filing this Amendment No. 2 to Quarterly Report on Form 10-Q/A to amend (a) Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations of Part I, (b) Item 4 Controls and Procedures, of Part I and (c) the notes to the financial statements contained in the Report of Independent Registered Public Accounting Firm.
Except as specifically referenced herein, this Amendment No. 2 to Quarterly Report on Form 10-Q/A does not reflect any event occurring subsequent to August 11, 2008, the filing date of the original report.
TABLE OF CONTENTS
| PART I. FINANCIAL INFORMATION | ||
| Item 1. Financial Statements: | ||
| Report of Independent Registered Public Accounting Firm | 1 | |
| Consolidated Balance Sheets as of June 30, 2008 (Unaudited) and December 31, 2007 | 2 | |
| Consolidated Statements of Income for the Six Months Ended June 30, 2008 and 2007 (Unaudited) | 3 | |
| Consolidated Statements of Income for the Three Months Ended June 30, 2008 and 2007 (Unaudited) | 4 | |
| Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2008 and 2007 (Unaudited) | 5 | |
| Consolidated Statement of Stockholders’ Equity for the Six Months Ended June 30, 2008 (Unaudited) and the Year Ended December 31, 2007 | 6 | |
| Notes to Consolidated Financial Statements | 7 - 24 | |
| Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations | 25 | |
| Item 3. Qualitative and Quantitative Disclosure about Market Risk | 34 | |
| Item 4. Controls and Procedures | 35 | |
| PART II. OTHER INFORMATION | ||
| Item 1. Legal Proceedings | 35 | |
| Item 1A. Risk Factors | 35 | |
| Item 2. Unregistered Sales of Equity Securities and Use of Proceeds | 40 | |
| Item 3. Defaults Upon Senior Securities | 40 | |
| Item 4. Submission of Matters to a Vote of Security Holders | 40 | |
| Item 5. Other Information | 40 | |
| Item 6. Exhibits | 40 | |
| Signatures | 41 |
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
MORGENSTERN, SVOBODA & BAER, CPA’s, P.C.
CERTIFIED PUBLIC ACCOUNTANTS
40 Exchange Place, Suite 1820
New York, NY 10005
TEL: (212) 925-9490
FAX: (212) 226-9134
E-MAIL: MORGENCPA@CS.COM
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders of
China 3C Group
We have reviewed the accompanying consolidated balance sheets of China 3C Group as of June 30, 2008 and the consolidated statements of operations for the six months ended June 30, 2008 & 2007 and consolidated statements of cash flows and shareholders equity for the six months then ended. These financial statements are the responsibility of the Company's management.
We conducted our review in accordance with standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should be made to the accompanying interim financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States of America.
We have previously audited, in accordance with auditing standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of China 3C Group as of December 31, 2007 and the related consolidated statements of income retained earnings and comprehensive income, and consolidated statements of cash flows for the year then ended; and in our report dated March 4, 2008 we expressed an unqualified opinion on those financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2007, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
Morgenstern, Svoboda & Baer CPA’s P.C.
Certified Public Accountants
New York, New York
August 6, 2008
1
CHINA 3C GROUP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET S
AS OF JUNE 30, 2008 AND DECEMBER 31, 2007
| 6/30/2008 | 12/31/2007 | |||||||
| ASSETS | ||||||||
| Current Assets | ||||||||
| Cash and cash equivalents | $ | 25,993,638 | $ | 24,952,614 | ||||
| Accounts receivable, net | 19,099,910 | 8,077,533 | ||||||
| Inventory | 12,991,176 | 6,725,371 | ||||||
| Advance to supplier | 2,478,134 | 2,572,285 | ||||||
| Prepaid expenses | 147,185 | 382,769 | ||||||
| Total Current Assets | 60,710,043 | 42,710,572 | ||||||
| Property & equipment, net | 79,709 | 89,414 | ||||||
| Goodwill | 20,348,278 | 20,348,278 | ||||||
| Refundable deposits | 52,619 | 48,541 | ||||||
| Total Assets | $ | 81,190,649 | $ | 63,196,805 | ||||
| LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||
| Current Liabilities | ||||||||
| Accounts payable and accrued expenses | $ | 5,210,024 | $ | 3,108,235 | ||||
| Income tax payable | 2,428,862 | 2,684,487 | ||||||
| Total Current Liabilities | 7,638,886 | 5,792,722 | ||||||
| Stockholders' Equity | ||||||||
Common stock, $.001 par value, 100,000,000 shares authorized, 52,673,938 and 52,673,938 issued and outstanding | 52,674 | 52,674 | ||||||
| Additional paid in capital | 19,465,776 | 19,465,776 | ||||||
| Subscription receivable | (50,000 | ) | (50,000 | ) | ||||
| Statutory reserve | 7,234,295 | 7,234,295 | ||||||
| Other comprehensive income | 4,694,974 | 1,872,334 | ||||||
| Retained earnings | 42,154,044 | 28,829,004 | ||||||
| Total Stockholders' Equity | 73,551,763 | 57,404,083 | ||||||
| Total Liabilities and Stockholders' Equity | $ | 81,190,649 | $ | 63,196,805 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
2
CHINA 3C GROUP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE SIX MONTHS ENDING JUNE 30, 2008 AND 2007
| 2008 | 2007 | |||||||
| Sales, net | $ | 146,668,847 | $ | 149,021,667 | ||||
| Cost of sales | 123,246,750 | 123,651,187 | ||||||
| Gross profit | 23,422,097 | 25,370,480 | ||||||
| General and administrative expenses | 6,312,088 | 6,740,395 | ||||||
| Income from operations | 17,110,009 | 18,630,085 | ||||||
| Other (Income) Expense | ||||||||
| Interest income | (65,567 | ) | (31,446 | ) | ||||
| Other (income) expense | (311,929 | ) | 5,693 | |||||
| Gain on asset disposal | (2,161 | ) | - | |||||
| Total Other (Income) Expense | (379,657 | ) | (25,753 | ) | ||||
| Income before income taxes | 17,489,666 | 18,655,838 | ||||||
| Provision for income taxes | 4,164,627 | 6,690,523 | ||||||
| Net income | $ | 13,325,039 | $ | 11,965,315 | ||||
| Net income per share: | ||||||||
| Basic | $ | 0.25 | $ | 0.23 | ||||
| Diluted | $ | 0.25 | $ | 0.23 | ||||
| Weighted average number of shares outstanding: | ||||||||
| Basic | 52,673,938 | 52,608,938 | ||||||
| Diluted | 53,073,938 | 52,608,938 | ||||||
| Comprehensive Income | ||||||||
| Net Income | $ | 13,325,039 | $ | 11,965,315 | ||||
| Foreign curreny translation adjustment | 2,822,640 | 386,280 | ||||||
| Comprehensive Income | $ | 16,147,679 | $ | 12,351,595 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
3
CHINA 3C GROUP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDING JUNE 30, 2008 AND 2007
| 2008 | 2007 | |||||||
| Sales, net | $ | 78,515,392 | $ | 64,498,473 | ||||
| Cost of sales | 65,639,675 | 53,060,275 | ||||||
| Gross profit | 12,875,717 | 11,438,198 | ||||||
| General and administrative expenses | 3,326,044 | 3,014,233 | ||||||
| Income from operations | 9,549,673 | 8,423,965 | ||||||
| Other (Income) Expense | ||||||||
| Interest income | (29,472 | ) | (17,655 | ) | ||||
| Other (income) expense | (326,904 | ) | (1,171 | ) | ||||
| Total Other (Income) Expense | (356,376 | ) | (18,826 | ) | ||||
| Income before income taxes | 9,906,049 | 8,442,791 | ||||||
| Provision for income taxes | 2,354,054 | 2,941,264 | ||||||
| Net income | $ | 7,551,995 | $ | 5,501,527 | ||||
| Net income per share: | ||||||||
| Basic | $ | 0.14 | $ | 0.10 | ||||
| Diluted | $ | 0.14 | $ | 0.10 | ||||
| Weighted average number of shares outstanding: | ||||||||
| Basic | 52,673,938 | 52,608,938 | ||||||
| Diluted | 53,073,938 | 52,608,938 | ||||||
| Comprehensive Income | ||||||||
| Net Income | $ | 7,551,995 | $ | 5,501,527 | ||||
| Foreign currency translation adjustment | 1,222,590 | 393,131 | ||||||
| Comprehensive Income | $ | 8,774,585 | $ | 5,894,658 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
4
CHINA 3C GROUP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2008 AND 2007
| 2008 | 2007 | |||||||
| CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||
| Net Income | $ | 13,325,040 | $ | 11,965,315 | ||||
| Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
| Depreciation | 20,069 | 21,767 | ||||||
| Gain on asset disposition | (2,161 | ) | - | |||||
| Provision for bad debts | 17,445 | 2,419 | ||||||
| Stock based compensation | 226,293 | 851,400 | ||||||
| Amortization of deferred consulting expense | - | |||||||
| (Increase) / decrease in assets: | ||||||||
| Accounts receivables | (11,039,822 | ) | 726,962 | |||||
| Inventory | (6,265,805 | ) | (2,094,249 | ) | ||||
| Prepaid expense | 9,291 | 28,585 | ||||||
| Advance to supplier | 94,151 | (30,695 | ) | |||||
| Deposits | (4,078 | ) | (37,649 | ) | ||||
| Increase / (decrease) in current liabilities: | ||||||||
| Accounts payable and accrued expenses | 2,101,789 | 1,092,296 | ||||||
| Income tax payable | (255,625 | ) | 381,880 | |||||
| Total Adjustments | (15,098,453 | ) | 942,716 | |||||
| Net cash provided by (used in) operating activities | (1,773,413 | ) | 12,908,031 | |||||
| CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||
| Purchase of property & equipment | (10,650 | ) | (62,253 | ) | ||||
| Proceeds from asset sales | 2,447 | - | ||||||
| Net cash used in investing activities | (8,203 | ) | (62,253 | ) | ||||
| CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||
| Payments of notes- other | - | (4,500,000 | ) | |||||
| Net cash used in financing activities | (4,500,000 | ) | ||||||
| Effect of exchange rate changes on cash and cash equivalents | 2,822,640 | 386,280 | ||||||
| Net change in cash and cash equivalents | 1,041,024 | 8,732,058 | ||||||
| Cash and cash equivalents, beginning balance | 24,952,614 | 6,498,450 | ||||||
| Cash and cash equivalents, ending balance | $ | 25,993,638 | $ | 15,230,508 | ||||
| SUPPLEMENTAL DISCLOSURES: | ||||||||
| Cash paid during the year for: | ||||||||
| Income tax payments | $ | 4,420,252 | $ | 6,308,643 | ||||
| Interest payments | $ | - | $ | - | ||||
The accompanying notes are an integral part of these consolidated financial statements.
5
CHINA 3C GROUP AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 2008 AND THE YEAR ENDED DECEMBER 31, 2007
| Additional | Other | Total | ||||||||||||||||||||||||||||||
| Common Stock | Paid-In | Comprehensive | Subscription | Statutory | Stockholders' | |||||||||||||||||||||||||||
Shares | Amount | Capital | Income | Receivable | Reserve | Retained Earnings | Equity | |||||||||||||||||||||||||
| Balance December 31, 2006 | 52,488,938 | $ | 52,489 | $ | 17,352,691 | $ | 427,616 | $ | (50,000 | ) | $ | 3,320,755 | $ | 9,822,844 | $ | 30,926,395 | ||||||||||||||||
| Foreign currency translation adjustments | 1,444,718 | 1,444,718 | ||||||||||||||||||||||||||||||
| Income for the years ended December 31, 2007 | 22,919,700 | 22,919,700 | ||||||||||||||||||||||||||||||
| Stock based compensation | 185,000 | 185 | 2,113,085 | 2,113,270 | ||||||||||||||||||||||||||||
| Transferred To statutory reserve | 3,913,540 | (3,913,540 | ) | - | ||||||||||||||||||||||||||||
| Balance December 31, 2007 | 52,673,938 | 52,674 | 19,465,776 | 1,872,334 | (50,000 | ) | 7,234,295 | 28,829,004 | 57,404,083 | |||||||||||||||||||||||
| Foreign currency translation adjustments | 2,822,640 | 2,822,640 | ||||||||||||||||||||||||||||||
| Income for the three months ended June 30, 2008 | 13,325,040 | 13,325,040 | ||||||||||||||||||||||||||||||
| Balance June 30, 2008 | 52,673,938 | $ | 52,674 | $ | 19,465,776 | $ | 4,694,974 | $ | (50,000 | ) | $ | 7,234,295 | $ | 42,154,044 | $ | 73,551,763 | ||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements
6
CHINA 3C GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008
Note 1 - ORGANIZATION
China 3C Group was incorporated on August, 20, 1998 under the laws of the State of Nevada. Capital Future Developments Limited - BVI (Capital) was incorporated on July 22, 2004 under the laws of the British Virgin Islands. Zhejiang Yong Xin Digital Technology Co., Ltd. (Zhejiang), Yiwu Yong Xin Communication Ltd. (Yiwu), Hangzhou Wandga Electronics Co., Ltd. (Wang Da), Hangzhou Sanhe Electronic Technology, Limited (“Sanhe”), and Shanghai Joy & Harmony Electronics Company Limited (Joy & Harmony) were incorporated under the laws of Peoples Republic of China on July 11, 2005, July 18, 1997, March, 30, 1998, April 12, 2004, and August 20, 2003, respectively.
On December 21, 2005 Capital became a wholly owned subsidiary of China 3C Group through a reverse merger. China 3C Group acquired all of the issued and outstanding capital stock of Capital pursuant to a Merger Agreement dated as of December 21, 2005 by and among China 3C Group, XY Acquisition Corporation, Capital and the shareholders of Capital (the “Merger Agreement”). Pursuant to the Merger Agreement, Capital became a wholly owned subsidiary of China 3C Group and, in exchange for the Capital shares, China 3C Group issued 35,000,000 new shares of its common stock to the shareholders of Capital, representing 93% of the then issued and outstanding capital stock of China 3C Group and a cash consideration of $500,000.
On August 3, 2006, Capital completed the acquisition of a 100% interest in Sanhe for a cash and stock transaction valued at approximately $8,750,000. The consideration consisted of 915,751 newly issued shares of the Company’s common stock and $5,000,000 in cash.
On November 28, 2006, Capital completed the acquisition of a 100% interest in Joy & Harmony for a cash and stock transaction valued at approximately $18,500,000. The consideration consisted of 2,723,110 shares of the Company’s common stock and $7,500,000 in cash.
On August 15, 2007, the Company changed its ownership structure. As a result, instead of Capital owning 100% of Zhejiang, as previously was the case, Capital entered into contractual agreements with Zhejiang whereby Capital owns a 100% interest in the revenues of Zhejiang. Capital does not have an equity interest in Zhejiang, but is deemed to have all the economic benefits and liabilities by contract. Under this structure, Zhejiang is now a wholly foreign owned enterprise (WOFE) of Capital. The contractual agreements give Capital and its’ equity owners an obligation to absorb any losses and rights to receive revenue. Capital will be unable to make significant decisions about the activities of Zhejiang and cannot carry out its principal activities without financial support. These characteristics as defined in Financial Accounting Standards Board (FASB) interpretation 46, Consolidation of Variable Interest Entities (VIEs), qualifies the business operations of Zhejiang to be consolidated with Capital and ultimately with China 3C Group. Zhejiang owns 90% of the issued and outstanding capital stock of each of Wang Da and Yiwu.
7
The Company is engaged in the business of the resale and distribution of mobile phone, facsimile machines, DVD players, stereos, speakers, MP3 and MP4 players, iPods, electronic dictionaries, CD players, radios, Walkman, and audio systems.
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. The Company's functional currency is the Chinese Renminbi, however the accompanying consolidated financial statements have been translated and presented in United States Dollars.
Translation Adjustment
As of June 30, 2008 and December 31, 2007, the accounts of Zhejiang, Wang Da, Yiwu, Sanhe, and Joy & Harmony were maintained, and its financial statements were expressed, in Chinese Yuan Renminbi (CNY). Such financial statements were translated into U.S. Dollars (USD) in accordance with Statement of Financial Accounts Standards (SFAS) No. 52, Foreign Currency Translation, with the CNY as the functional currency. According to the Statement, all assets and liabilities were translated at the current exchange rate, stockholders equity are translated at the historical rates and income statement items are translated at the average exchange rate for the period. The resulting translation adjustments are reported under other comprehensive income in accordance with SFAS No. 130, Reporting Comprehensive Income as a component of shareholders equity. Transaction gains and losses are reflected in the income statement.
8
CHINA 3C GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles 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.
Principles of Consolidation
The consolidated financial statements include the accounts of China 3C Group and its wholly owned subsidiaries Capital, Zhejiang, Wang Da, Yiwu, Joy & Harmony, and Sanhe, collectively referred to within as the Company. All material intercompany accounts, transactions and profits have been eliminated in consolidation.
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 may 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 and legal counsel assess 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 legal counsel 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 would be 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.
9
CHINA 3C GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED )
Cash and Cash Equivalents
Cash and cash equivalents include cash in hand and cash in time deposits, certificates of deposit and all highly liquid debt instruments with original maturities of three months or less.
Accounts Receivable
The Company maintains reserves for potential credit losses on accounts receivable. Management reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these reserves. Terms of the sales vary. Reserves are recorded primarily on a specific identification basis. Allowance for doubtful debts amounted to $128,017 and $103,803 as at June 30, 2008 and December 31, 2007, respectively.
Inventories
Inventories are valued at the lower of cost (determined on a weighted average basis) or market. The 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 June 30, 2008 and December 31, 2007 inventory consisted of finished goods valued at $12,991,176 and $6,725,371, respectively.
Property, Plant & Equipment
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:
| Furniture and Fixtures & Office Equipment | 5 years |
| Automobile | 5 years |
As of June 30, 2008 and December 31, 2007 Property, Plant & Equipment consist of the following:
| 2008 | 2007 | |||||||
| Automobile | $ | 132,627 | $ | 138,330 | ||||
| Office equipment | 116,262 | 105,612 | ||||||
| 248,889 | 243,942 | |||||||
| Accumulated depreciation | (169,180 | ) | (154,528 | ) | ||||
| $ | 79,709 | $ | 89,414 | |||||
10
CHINA 3C GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSJUNE 30, 2008
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED )
Long-Lived Assets
Effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144), which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, and the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations for a Disposal of a Segment of a Business. The Company periodically evaluates the carrying value of long-lived assets to be held and used in accordance with SFAS 144. SFAS 144 requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets carrying amounts. In that event, a loss is recognized based on the amount by which the carrying amount exceeds the fair market value of the long-lived assets. Loss on long-lived assets to be disposed of is 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 June 30, 2008 there were no significant impairments of its long-lived assets.
Fair Value of Financial Instruments
Statement of Financial Accounting Standard No. 107, Disclosures about fair value of 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
The Company’s revenue recognition policies are in compliance with Staff Accounting Bulletin (SAB) 104. Sales revenue is recognized at the date of shipment to customers when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, no other significant obligations of the Company exist and collectibility is reasonably assured. Payments received before all of the relevant criteria for revenue recognition are satisfied are recorded as unearned revenue.
Share Based Payment
In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure-an amendment of SFAS 123.” This statement amended SFAS 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary charge to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amended the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. Effective for 2006 the Company adopted SFAS 123 (R), “Share-Based Payment” which supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees” and eliminates the intrinsic value method that was provided in SFAS 123 for accounting of stock-based compensation to employees. The Company made no employee stock-based compensation grants before December 31, 2005 and therefore has no unrecognized stock compensation related liabilities or expense unvested or vested prior to 2006.
11
CHINA 3C GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED )
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.
Income Taxes
The Company utilizes SFAS No. 109, Accounting for Income Taxes, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.
Basic and Diluted Earnings per Share
Earnings per share are calculated in accordance with the Statement of Financial Accounting Standards No. 128 (SFAS No. 128), Earnings per share. SFAS No. 128 superseded Accounting Principles Board Opinion No.15 (APB 15). Net loss per share for all periods presented has been restated to reflect the adoption of SFAS No. 128. Basic net loss per share is based upon the weighted average number of common shares outstanding. Diluted net loss per share is based on the assumption that all dilutive convertible shares and stock options were converted or exercised. Dilution is computed by applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period.
Statement of Cash Flows
In accordance with Statement of Financial Accounting Standards No. 95, Statement of Cash Flows, cash flows from the Company’s operations is based upon the local currencies. As a result, amounts related to assets and liabilities reported on the statement of cash flows will not necessarily agree with changes in the corresponding balances on the balance sheet.
12
CHINA 3C GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk are cash, accounts receivable and other receivables arising from its normal business activities. The Company places its cash in what it believes to be credit-worthy financial institutions. The Company has a diversified customer base, most of which are in China. The Company controls credit risk related to accounts receivable through credit approvals, credit limits and monitoring procedures. The Company routinely assesses the financial strength of its customers and, based upon factors surrounding the credit risk, establishes an allowance, if required, for uncollectible accounts and, as a consequence, believes that its accounts receivable credit risk exposure beyond such allowance is limited.
Segment Reporting
Statement of Financial Accounting Standards No. 131, Disclosure about Segments of an Enterprise and Related Information requires use of the management approach¨ model for segment reporting. The management approach model is based on the way a company's management organizes segments within the company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, legal structure, management structure, or any other manner in which management disaggregates a company.
Recent accounting pronouncements
In December 2004, the FASB issued FASB Statement No. 123R, "Share-Based Payment”, an Amendment of FASB Statement No. 123" ("FAS No. 123R"). FAS No. 123R requires companies to recognize in the statement of operations the grant-date fair value of stock options and other equity-based compensation issued to employees. FAS No. 123R is effective beginning in the Company's first quarter of fiscal 2006.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections." This statement applies to all voluntary changes in accounting principle and requires retrospective application to prior periods' financial statements of changes in accounting principle, unless this would be impracticable. This statement also makes a distinction between "retrospective application" of an accounting principle and the "restatement" of financial statements to reflect the correction of an error. This statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005.
In June 2005, the EITF reached consensus on Issue No. 05-6, Determining the Amortization Period for Leasehold Improvements ("EITF 05-6.") EITF 05-6 provides guidance on determining the amortization period for leasehold improvements acquired in a business combination or acquired subsequent to lease inception. The guidance in EITF 05-6 will be applied prospectively and is effective for periods beginning after June 29, 2005. EITF 05-6 is not expected to have a material effect on its consolidated financial position or results of operations.
13
CHINA 3C GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In June 2005, the FASB Staff issued FASB Staff Position 150-5 (FSP 150-5), Issuers Accounting under FASB Statement No. 150 for Freestanding Warrants and Other Similar Instruments on Shares that are Redeemable. FSP 150-5 addresses whether freestanding warrants and other similar instruments on shares that are redeemable, either puttable or mandatorily redeemable, would be subject to the requirements of FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity, regardless of the timing or the redemption feature or the redemption price. The FSP is effective after June 30, 2005.
On February 16, 2006, FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments. SFAS No. 155 amends SFAS No 133, Accounting for Derivative Instruments and Hedging Activities, and SFAF No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. SFAS No. 155, permits fair value re-measurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133, establishes a requirement to evaluate interest in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and amends SFAS No. 140 to eliminate the prohibition on the qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. This statement is effective for all financial instruments acquired or issued after the beginning of the Company’s first fiscal year that begins after September 15, 2006.
In March 2006, the FASB issued FASB Statement No. 156, Accounting for Servicing of Financial Assets - an amendment to FASB Statement No. 140. Statement 156 requires that an entity recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a service contract under certain situations. The new standard is effective for fiscal years beginning after September 15, 2006. The Company does not expect its adoption of this new standard to have a material impact on its financial position, results of operations or cash flows.
In July 2006, the FASB issued Interpretation No. 48, Accounting for uncertainty in Income Taxe s - an interpretation of FASB Statement 109 (FIN 48) . FIN 48 clarifies the accounting for Income Taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. It also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition and clearly scopes income taxes out of SFAS No. 5, Accounting for Contingencies . FIN 48 is effective for fiscal years beginning after December 15, 2006. We did not have a material impact on our consolidated financial position, results of operations or cash flows.
In September, 2006, FASB issued SFAS No. 157, Fair Value Measurements. This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. This statements applies under other accounting pronouncements that require or permit fair value measurements, the Board having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this statement does not require any new fair value measurements. However, for some entities, the application of this statement will change current practice. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The management is currently evaluating the effect of this pronouncement on financial statements.
14
CHINA 3C GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In September 2006, FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R). This statement improves financial reporting by requiring an employer to recognize the over funded or under funded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded statues in the year in which the changes occur through comprehensive income of a business entity or changes in unrestricted net assets of a not-for-profit organization. This statement also improves financial reporting by requiring an employer to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. An employer with publicly traded equity securities is required to initially recognize the funded status of a defined benefit postretirement plan and to provide the required disclosures as of the end of the fiscal year ending after December 15, 2006. An employer without publicly traded equity securities is required to recognize the funded status of a defined benefit postretirement plan and to provide the required disclosures as of the end of the fiscal year ending after June 15, 2007. However, an employer without publicly traded equity securities is required to disclose the following information in the notes to financial statements for a fiscal year ending after December 15, 2006, but before June 16, 2007, unless it has applied the recognition provisions of this statement in preparing those financial statements.
| a. | A brief description of the provisions of this statement | |
| b. | The date that adoption is required | |
| c. | The date the employer plans to adopt the recognition provisions of this statement, if earlier. |
The requirement to measure plan assets and benefit obligations as of the date of the employer’s fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008.
The Company believes that the adoption of these standards will have no material impact on its financial statements.
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108 (SAB 108). SAB 108 was issued to provide interpretive guidance on how the effects of the carryover reversal of prior year misstatements should be considered in quantifying a current year misstatement. The provisions of SAB 108 are effective for the Company for its December 31, 2006 year-end. The adoption of SAB 108 had no impact on the Company’s consolidated financial statements.
In February, 2007, FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FABS Statement No. 115. This statement permits entities to choose to measure many financial instruments and certain other items at fair value. This statement is expected to expand the use of fair value measurement, which is consistent with the Board’s long-term measurement objectives for accounting for financial instruments. This statement is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. The management is currently evaluating the effect of this pronouncement on financial statements.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements. This Statement amends ARB 51 to establish accounting and reporting standards for the noncontrolling (minority) interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. SFAS No. 160 is effective for the Company’s fiscal year beginning October 1, 2009. Management is currently evaluating the effect of this pronouncement on financial statements.
15
CHINA 3C GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In March 2008, the FASB issued FASB No. 161, Disclosures about Derivative Instruments and Hedging Activities. The new standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The new standard also improves transparency about the location and amounts of derivative instruments in an entity’s financial statements; how derivative instruments and related hedged items are accounted for under Statement 133; and how derivative instruments and related hedged items affect its financial position, financial performance, and cash flows. Management is currently evaluating the effect of this pronouncement on financial statements.
In May, 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles, which will provide framework for selecting accounting principles to be used in preparing financial statements that are presented in conformity with U.S. generally accepted accounting principles (GAAP) for nongovernmental entities. With the issuance of SFAS No. 162, the GAAP hierarchy for nongovernmental entities will move from auditing literature to accounting literature. The Company is currently assessing the impact of SFAS No. 162 on its financial position and results of operations.
In May 2008, the FASB issued SFAS No. 163, Accounting for Financial Guarantee Insurance Contracts. SFAS No. 163 clarifies how SFAS No. 60, Accounting and Reporting by Insurance Enterprises, applies to financial guarantee insurance contracts issued by insurance enterprises, and addresses the recognition and measurement of premium revenue and claim liabilities. It requires expanded disclosures about contracts, and recognition of claim liability prior to an event of default when there is evidence that credit deterioration has occurred in an insured financial obligation. It also requires disclosure about (a) the risk-management activities used by an insurance enterprise to evaluate credit deterioration in its insured financial obligations, and (b) the insurance enterprise's surveillance or watch list. The Company is currently evaluating the impact of SFAS No. 163.
Note 3 - ADVANCE TO SUPPLIER
Advance to suppliers represents payments to suppliers for payments of finished goods. As of June 30, 2008 and December 31, 2007 the Company had paid $ 2,478,134 and $2,572,285, respectively as advances to suppliers.
Note 4 - COMMON STOCK
On December 20, 2005, the Company completed a private offering of 1,000,000 shares of its common stock at a per share price of $0.10 to an unaffiliated individual, resulting in gross proceeds to the Company of $100,000. The proceeds were to be used for the Company’s proposed plan to identify and complete a merger or acquisition with private entities.
On December 20, 2005, the Company issued a warrant to purchase 4,000,000 shares of its common stock to two individuals at $0.10 per share, which was the fair value of the shares at the date of issuance. The warrant was issued as consideration for financial consulting services to be provided from December 20, 2005 to December 19, 2006. The warrants were exercised on December 30, 2005. The shares were issued subsequently in 2006.
On December 21, 2005, the Company agreed to purchase all of the issued and outstanding shares of Capital from its shareholders for approximately $500,000 in cash and 35,000,000 shares of the Company’s common stock, or approximately 93% of the total issued and outstanding shares.
16
CHINA 3C GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008
Note 4 - COMMON STOCK (CONTINUED)
On December 21, 2005, the Company announced a plan named the China 3C Group 2005 Equity Incentive Plan (¨Plan¨) for providing incentives to attract, retain and motivate eligible persons whose presence and potential contributions are important to the success of the Company. 5,000,000 shares of common stock were allocated to the Plan.
On December 21, 2005, the Company agreed to issue 4,980,000 shares under the Plan to a number of consultants who were engaged to provide various services to the Company during the period from January 1, 2005 to December 20, 2005. These shares were valued at $0.10 per share, or $498,000, and were expensed as consulting fees in the statements of operations. The shares were issued subsequently in 2006.
On March 6, 2007, the Company issues 180,000 shares of common stock, $.001 par value, issuable pursuant to the China 3C Group amended 2005 Equity Incentive Plan. Under Rule 405 and Rule 144, of the Securities Act of 1933, as amended, these securities are deemed “restricted securities”.
On December 21, 2005, the Company issued 2,256,795 shares of the Company’s common stock to a company for guarantee fees related to the acquisition of Capital. The guarantee was valued at $225,680, which was the fair value of the shares issued at the date of the transaction and was expensed as consulting fees in the statement of operations.
Pursuant to share exchange agreement, dated August 3, 2006, the company issued 915,751 shares of restricted common stock, to the former shareholders of Hangzhou Sanhe Electronic Technology Ltd. The shares were valued at $3,750,000, which was the fair value of the shares at the date of exchange agreement. This amount is included in the cost of net assets and goodwill purchased.
Pursuant to share exchange agreement, dated November 28, 2006, the company issued 2,723,110 shares of newly issued shares of Common Stock to the former shareholders of Shanghai Joy & Harmony Electronics Company Limited. The shares were valued at $11,000,000, which was the fair value of the shares at the date of exchange agreement. This amount is included in the cost of net assets and goodwill purchased.
Note 5 - ACQUISITIONS
(a) Hangzhou Sanhe Electronic Technology Ltd.
On August 3, 2006, the Company completed the acquisition of a 100% interest in Hangzhou Sanhe Electronic Technology Ltd. ("HSET") for a cash and stock transaction valued at approximately US$8.75 million (“HSET Share Exchange Transaction”). This amount is included in the cost of net assets and goodwill purchased.
The stock consideration consisted of 915,751 newly issued shares of the Company’s common stock, which were divided proportionally among the HSET shareholders in accordance with their respective ownership interests in HSET immediately before the completion of the HSET Share Exchange Transaction. The cash consideration consisted of $5,000,000 in cash, again divided proportionally among the HSET shareholders in accordance with their respective ownership interests in HSET immediately before the completion of the HSET Share Exchange Transaction and payable no later than the first anniversary of the Merger Transaction, as defined elsewhere in this Quarterly Report on Form 10-Q/A. The obligation to pay the cash consideration is evidenced by two interest-free promissory notes between the Company and each of the HSET shareholders. The form of the promissory note is attached as an exhibit to the Share Exchange Agreement.
HSET is a home electronics retail chain in Eastern China. It has 200 retail stores in Shanghai City, Zhejiang Province and Jiangsu Province. HSET specializes in the sale of home electronics, including DVD players, audio systems, speakers, televisions and air conditioners.
17
CHINA 3C GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008
Note 5 - ACQUISITIONS (CONTINUED)
The main purpose of the acquisition of the 100% interest in HSET is to increase the Company’s presence, distribution markets, and increase product lines. The purchase price was determined based on arms' length negotiations between China 3C and Hangzhou Sanhe Electronic Technology, Ltd.
The acquisition had been accounted for as a purchase business combination and the results of operations from the acquisition date have been included in the Company's consolidated financial statements in accordance with SFAS 94. The allocation of the purchase price is as follows:
| Cash acquired | $ | 1,235,283 | ||
| Other tangible assets acquired | ||||
| Accounts Receivable | 1,207,653 | |||
| Inventory | 667,504 | |||
| Trade Deposits | 694,695 | |||
| Prepaid Expenses | 2,333 | |||
| Property Plant & Equipment | 966 | |||
| Goodwill | 5,854,096 | |||
| Total assets acquired | 9,662,530 | |||
| Liabilities assumed | ||||
| Accounts & Income Taxes payable | 626,091 | |||
| Statutory reserves | 286,439 | |||
| Total | $ | 8,750,000 |
The excess of purchase price over tangible assets acquired and liabilities assumed of $5,854,096 was recorded as goodwill. At the time of the acquisition no identifiable intangibles assets existed under the contractual-legal or the separability criterion as required under SFAS 141.
Prior to the acquisition, Hangzhou Sanhe Electronic Technology, Ltd. prepared its financial statements under accounting principles generally accepted in the United States of America.
(b) Shanghai Joy & Harmony Electronics Company Limited
On November 28, 2006, the Company completed the acquisition of a 100% interest in Shanghai Joy & Harmony Electronics Company Limited (“Joy & Harmony”) for a cash and stock transaction valued at approximately US$18.5 million (“Joy & Harmony Share Exchange Transaction”). This amount is included in the cost of net assets and goodwill purchased.
The stock consideration consisted of 2,723,110 shares of the Company’s common stock, which were divided proportionally among the Joy & Harmony shareholders in accordance with their respective ownership interests in Joy & Harmony immediately before the completion of the Joy & Harmony Share Exchange Transaction. The cash consideration consisted of $7,500,000 in cash, again divided proportionally among the Joy & Harmony shareholders in accordance with their respective ownership interests in Joy & Harmony immediately before the completion of the Joy & Harmony Share Exchange Transaction. The cash component was payable by the Company as follows: $3,000,000 within 10 business days after the closing and $4,500,000 is payable six months after the closing as evidenced by a promissory note.
18
CHINA 3C GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008
Note 5 - ACQUISITIONS (CONTINUED)
Joy & Harmony is engaged in the business of distributing MP3 and MP4 players, iPods, electronic dictionaries, CD players, radios, Walkman, and audio systems and speakers at company maintained shops at various retail establishments.
The main purpose of the acquisition of the 100% interest in Joy & Harmony is to increase the Company’s presence, distribution markets, and increase product lines. The purchase price was determined based on arms' length negotiations between China 3C and Shanghai Joy & Harmony Electronics Company Limited.
The acquisition had been accounted for as a purchase business combination and the results of operations from the acquisition date have been included in the Company's consolidated financial statements in accordance with SFAS 94. The allocation of the purchase price is as follows:
| Cash acquired | $ | 214,561 | ||
| Other tangible assets acquired | ||||
| Accounts Receivable | 3,599,680 | |||
| Inventory | 1,021,435 | |||
| Trade Deposits | 300,304 | |||
| Prepaid Expenses | 4,387 | |||
| Property Plant & Equipment | 11,342 | |||
| Goodwill | 14,494,182 | |||
| Total assets acquired | 19,645,891 | |||
| Liabilities assumed | ||||
| Accounts & Income Taxes payable | 767,277 | |||
| Statutory reserves | 378,614 | |||
| Total | $ | 18,500,000 |
The excess of purchase price over tangible assets acquired and liabilities assumed of $14,494,182 was recorded as goodwill. At the time of the acquisition no identifiable intangibles assets existed under the contractual-legal or the separability criterion as required under SFAS 141.
Prior to the acquisition, Joy & Harmony prepared its financial statements under accounting principles generally accepted in the United States of America.
The results of operations for Hangzhou Sanhe Electronic Technology Ltd. and Shanghai Joy & Harmony Electronics Company Limited have been included in the Company’s consolidated statements of operations since the completion of the acquisitions during the year ended December 31, 2006. The following unaudited pro forma financial information presents the combined results of the Company and the 2006 acquisitions as if the acquisitions had occurred at the beginning of 2005 (in thousands, except per share amounts):
| Year Ended | Year Ended | |||||||
| December 31, | December 31, | |||||||
2006 | 2005 | |||||||
| Net revenues | $ | 193,591 | $ | 58,768 | ||||
| Net income (loss) | $ | 15,457 | $ | 3,538 | ||||
| Net income (loss) per share — basic | $ | .33 | $ | .09 | ||||
| Net income (loss) per share — diluted | $ | .33 | $ | .09 | ||||
19
CHINA 3C GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008
Note 6 - STOCK WARRANTS, OPTIONS, AND COMPENSATION
On December 20, 2005, the Company issued a warrant for 4,000,000 shares to two individuals with an exercise price of $0.10. The warrants were issued for consulting services to be provided from December 20, 2005 to December 19, 2006. The warrant was exercisable immediately and was exercised on December 30, 2005.
The Company is amortizing the fair value of the warrants, $400,000, over the period of the agreement. The fair value of the warrants was calculated assuming 293% volatility, term of the warrant of 3 years, risk free rate of 4% and dividend yield of 0%. For the year ended December 31, 2006 and December 31, 2005, $387,945 and $12,055 of consulting fees were expensed relating to the warrants, respectively.
On December 8, 2006, the Company issued, to a newly appointed Board member, an option grant (incentive stock options) to purchase 50,000 shares of common stock at the closing price as of December 7, 2006. The options expire 10 years from issuance.
On January 2, 2007, the Company issued, to an other newly appointed Board member, an option grant (incentive stock options) to purchase 50,000 shares of common stock at the closing price as of January 2, 2007. The options expire 10 years from issuance. As of December 17, 2007, the Board member resigned.
On May 7, 2007, the Board of Directors appointed Joseph Levinson to serve as a member of the Board of Directors of the Company. Mr. Levinson has been named chairman of the Nominating Committee of the Company. In addition, Mr. Levinson is in charge of investor relations for the Company.
As compensation for the services set forth herein, Mr. Levinson receives:
| · | A monthly grant during his Term of 1,000 shares of the Company’s Common Stock, |
| · | An annual grant of Stock Options to purchase 300,000 shares of common stock of the Company. The annual grant of Stock Options shall vest immediately upon issuance. The exercise price of the initial grant of Stock Options shares shall be based on the closing price of the common stock of the Company on May 7, 2007. On May 7, 2008, Mr. Levinson became vested in an additional grant of Stock Options to purchase an additional 300,000 shares of common stock of the Company based on the closing price of the common stock on May 7, 2008 of $1.82. |
Stock options—The three stock option grants have a ten-year life and were fully vested upon issuance. The option holder has no voting or dividend rights. The grant price was equal the market price at the date of grant. The Company records the expense of the stock options over the related vesting period. The options were valued using the Black-Scholes option-pricing model at the date of grant stock option pricing.
| Six Months ended | ||||
| June 30, 2008 | ||||
| Expected Volatility | 153 | % | ||
| Expected term (in years) | ||||
| Todd L. Mavis | 2 | |||
| Kenneth T. Berents | 9 | |||
| Joseph Levinson | 9 | |||
| Expected dividends | - | |||
| Risk-free rate of return (weighted average) | 3 | % | ||
| Weighted average grant-date fair value | 3.8-6.15 | |||
Expected volatility is based on the historical volatility of the Company’s stock price. The expected term represents the estimated average period of time that the options remain outstanding. No dividend payouts were assumed, as the Company has no plans to declare dividends during the expected term of the stock
20
CHINA 3C GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008
Note 6 - STOCK WARRANTS, OPTIONS, AND COMPENSATION (CONTINUED)
options. The risk-free rate of return reflects the weighted average interest rate offered for zero coupon treasury bonds over the expected term of the options. Based upon this calculation and pursuant to ETIF 96-18 the company recorded a $226,293 and a $899,952 service period expense for these warrants for the six months ending June 30, 2008 and the year ending December 31, 2007.
| Aggregate | |||||||||
| Exercise | Remaining | Intrinsic | |||||||
| Total | Price | Life | Value | ||||||
| Outstanding, December 31, 2007 | 400,000 | ||||||||
| Granted in 2008 | - | ||||||||
| Exercised in 2008 | - | ||||||||
| Outstanding, June 30, 2008 | 400,000 | ||||||||
Note 7 – STOCK EXCHANGE AGREEMENT
On December 21, 2005 Capital Future Developments Ltd - BVI became a wholly owned subsidiary of China 3C Group through a reverse merger. China 3C Group acquired all of the issued and outstanding capital stock of Capital Future Developments Ltd. - BVI pursuant to a Merger Agreement dated at December 21, 2005 by and among China 3C Group, XY Acquisition Corporation, Capital Future Developments Ltd. - BVI and the shareholders of Capital Future Developments Ltd - BVI (the "Merger Agreement"). Pursuant to the Merger Agreement, Capital Future Developments Ltd. - BVI became a wholly owned subsidiary of China 3C Group and, in exchange for the Capital Future Developments Ltd. BVI shares, China 3C Group issued 35,000,000 shares of its common stock to the shareholders of Capital Future Developments Ltd. - BVI, representing 93% of the issued and outstanding capital stock of China 3C Group at that time and a cash consideration of $500,000. As a result of the exchange agreement, the reorganization was treated as an acquisition by the accounting acquirer that is being accounted for as a recapitalization and as a reverse merger by the legal acquirer for accounting purposes. Pursuant to the recapitalization, all capital stock shares and amounts and per share data were retroactively restated.
Note 8 - COMPENSATED ABSENCES
Regulation 45 of local PRC labor law entitles employees to annual vacation leave after one year of service. In general all leave must be utilized annually, with proper notification, any unutilized leave is cancelled.
Note 9 - INCOME TAXES
The Company through its subsidiaries, Zhejiang, Wang Da, Sanhe, and Yiwu, is governed by the Income Tax Laws of the PRC. Operations in the United States of America have incurred net accumulated operating losses of approximately $2,300,000 as of December 31, 2007 for income tax purposes. However, a hundred percent allowance has been created on the deferred tax asset of approximately $920,000 due to uncertainty of its realization.
Pursuant to the PRC Income Tax Laws, the Enterprise Income Tax (“EIT) is at a statutory rate of 25%, which is comprises of 22% national income tax and 3% local income tax.
21
CHINA 3C GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008
Note 9 - INCOME TAXES (CONTINUED)
The following is a reconciliation of income tax expense:
| 6/30/2008 | U.S. | State | International | Total | ||||||||||||
| Current | $ | - | $ | - | $ | 4,164,627 | $ | 4,164,627 | ||||||||
| Deferred | - | - | ||||||||||||||
| Total | $ | - | $ | - | $ | 4,164,627 | $ | 4,164,627 | ||||||||
| 6/30/2007 | U.S. | State | International | Total | ||||||||||||
| Current | $ | - | $ | - | $ | 6,690,523 | $ | 6,690,523 | ||||||||
| Deferred | - | - | - | - | ||||||||||||
| Total | $ | - | $ | - | $ | 6,690,523 | $ | 6,690,523 | ||||||||
Reconciliation of the differences between the statutory U.S. Federal income tax rate and the effective rate is as follows:
| 6/30/2008 | 6/30/2007 | |||||
| US statutory tax rate | 34 | % | 34 | % | ||
| Foreign income not recognized in US | (34 | )% | (34 | )% | ||
| PRC income tax | 25 | % | 34 | % | ||
| Effective rate | 25 | % | 34 | % | ||
Note 10 - COMMITMENTS
The Company leases various office facilities under operating leases that terminate thru 2011. The Company also has management agreements that terminated in 2007 and were subsequently renewed in 2008. Rent expense for the six months ending June 30, 2008 and 2007 was $99,181 and $59,377 respectively. The future minimum obligations under these agreements are as follows:
| 2009 | $ | 135,875 | ||
| 2010 | $ | 59,304 | ||
| 2011 | $ | 27,935 | ||
| 2012 | $ | 4,373 |
In addition, the Company is committed to pay $111,516 under a advertising agreement expiring March 31, 2009.
22
CHINA 3C GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008
Note 11 - STATUTORY RESERVE
In accordance with the laws and regulations of the PRC, a wholly-owned Foreign Invested Enterprises 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 June 30, 2008 and December 31, 2007, the Company had allocated $7,234,295 to these non-distributable reserve funds.
Note 12 - OTHER COMPREHENSIVE INCOME
Balances of related after-tax components comprising accumulated other comprehensive income, included in stockholders equity, at June 30, 2008 and December 31, 2007 are as follows:
Foreign Currency Translation Adjustment | Accumulated Other Comprehensive Income | |||||||
| Balance at December 31, 2006 | $ | 427,616 | $ | 427,616 | ||||
| Change for 2007 | 1,444,718 | 1,444,718 | ||||||
| Balance at December 31, 2007 | 1,872,334 | 1,872,334 | ||||||
| Change for 2008 | 2,822,640 | 2,822,640 | ||||||
| Balance at June 30, 2008 | $ | 4,694,974 | $ | 4,694,974 | ||||
Note 13 - CURRENT VULNERABILITY DUE TO CERTAIN RISK FACTORS
The Company’s operations are carried out in the PRC. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environments in the PRC and by the general state of the PRC's economy. The Company’s business may be influenced by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.
Note 14 – MAJOR CUSTOMERS AND CREDIT RISK
During the period ended June 30, 2008, no customer accounted for more than 10% of the Company’s sales or accounts receivable. At June 30, 2008 four (4) vendors comprised more than 57% of the Company’s accounts payable. No vendors accounted for more than 10% of the Company’s purchases during 2008.
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Note 15 - SEGMENT INFORMATION
The Company separately operates and prepares accounting and other financial reports to management for four of its major business organizations (Wang Da, Sanhe, Yiwu and Joy & Harmony). Each of the individual operating companies corresponds to different product groups. Wang Da is mainly operating mobile phones, Sanhe is mainly operating home appliances, Yiwu is mainly operating office communication products, and Joy & Harmony is mainly operating consumer electronics. All segments are accounted for using the accounting principals described in Note 2.
The Company has identified four reportable segments required by SFAS 131: (1) mobile phones, (2) home electronics, (3) office communication products, and (4) consumer electronics.
The following tables present summarized information by segment (in thousands):
| Three Months Ended June 30, 2008 | ||||||||||||||||||||||||
Mobile Phones | Home Electronics | Office Communication Products | Consumer Electronics | Other | Total | |||||||||||||||||||
| Sales, net | $ | 25,529 | $ | 18,648 | $ | 17,030 | $ | 17,309 | $ | - | $ | 78,516 | ||||||||||||
| Cost of sales | 21,769 | 15,137 | 14,112 | 14,621 | - | 65,639 | ||||||||||||||||||
| Gross profit | 3,760 | 3,511 | 2,918 | 2,688 | - | 12,877 | ||||||||||||||||||
| Income from operations | 2,371 | 2,399 | 2,222 | 2,097 | 461 | 9,550 | ||||||||||||||||||
| Total assets | $ | 22,326 | $ | 21,739 | $ | 16,418 | $ | 19,251 | $ | 1,456 | $ | 81,190 | ||||||||||||
| Three Months Ended June 30, 2007 | ||||||||||||||||||||||||
Mobile Phones | Home Electronics | Office Communication Products | Consumer Electronics | Other | Total | |||||||||||||||||||
| Sales, net | $ | 19,482 | $ | 16,057 | $ | 14,362 | $ | 14,598 | $ | - | $ | 64,499 | ||||||||||||
| Cost of sales | 16,435 | 11,950 | 12,452 | 12,223 | - | 53,060 | ||||||||||||||||||
| Gross profit | 3,047 | 4,107 | 1,910 | 2,375 | - | 11,439 | ||||||||||||||||||
| Income from operations | 2,385 | 2,918 | 1,366 | 2,058 | (303) | 8,424 | ||||||||||||||||||
| Total assets | $ | 12,522 | $ | 12,221 | $ | 10,673 | $ | 13,052 | $ | 1,696 | $ | 50,164 | ||||||||||||
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Forward Looking Statements
We have included, and from time to time may make in our public filings, press releases or other public statements, certain statements, including, without limitation, those under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 2. In some cases, these statements are identifiable through the use of words such as “anticipate”, “believe”, “estimate”, “expect”, “intend”, “plan”, “project”, “target”, “can”, “could”, “may”, “should”, “will”, “would”, and similar expressions. You are cautioned not to place undue reliance on these forward-looking statements. In addition, our management may make forward-looking statements to analysts, investors, representatives of the media and others. These forward-looking statements are not historical facts and represent only our beliefs regarding future events, many of which, by their nature, are inherently uncertain and beyond our control.
The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto appearing elsewhere in this Form 10-Q/A. 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/A.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Overview
China 3C Group was incorporated on August 20, 1998 under the laws of the State of Nevada. Capital Future Developments Limited (“CFDL”) was incorporated on July 22, 2004 under the laws of the British Virgin Islands. Zhejiang Yong Xin Digital Technology Co., Ltd. (“Zhejiang”), Yiwu Yong Xin Communication Ltd. (“Yiwu”), Hangzhou Wandga Electronics Co., Ltd. (“Wang Da”), Hangzhou Sanhe Electronic Technology, Limited (“Sanhe”), and Shanghai Joy & Harmony Electronic Development Co., Ltd. (“SJHE”) were incorporated under the laws of Peoples Republic of China on July 11, 2005, July 18, 1997, March 30, 1998, April 12, 2004, and August 25, 2003, respectively. China 3C Group owns 100% of CFDL and CFDL own 100% of the capital stock of SJHE and Sanhe. Until August 14, 2007, when it made the change to its ownership structure described in the next paragraph in order to comply with certain requirements of PRC law, CFDL owned 100% of the capital stock of Zhenjiang. Zhejiang owns 90% and Yiwu owns 10% of Wang Da. Zhejiang owns 90% and Wang Da owns 10% of Yiwu. Collectively the six corporations are referred to herein as the Company.
On December 21, 2005 CFDL became a wholly owned subsidiary of China 3C Group through a merger with a wholly owned subsidiary of the Company (“Merger Transaction”). China 3C Group acquired all of the issued and outstanding capital stock of CFDL pursuant to a Merger Agreement dated at December 21, 2005 by and among China 3C Group, XY Acquisition Corporation, CFDL and the shareholders of CFDL (the “Merger Agreement”). Pursuant to the Merger Agreement, CFDL became a wholly owned subsidiary of China 3C Group and, in exchange for the CFDL shares, China 3C Group issued 35,000,000 shares of its common stock to the shareholders of CFDL, representing 93% of the issued and outstanding capital stock of China 3C Group at that time and a cash consideration of $500,000. On August 15, 2007, in order to comply with the requirements of PRC law, the Company recapitalized its ownership structure. As a result, instead of CFDL owning 100% of Zhejiang as previously was the case, CFDL entered into contractual agreements with Zhejiang whereby CFDL owns a 100% interest in the revenues of Zhejiang. CFDL does not have an equity interest in Zhejiang, but is deemed to have all the economic benefits and liabilities by contract. Under this structure, Zhejiang is now a wholly foreign owned enterprise (WOFE) of CFDL. The contractual agreements give CFDL and its’ equity owners an obligation to absorb, any losses, and rights to receive revenue. CFDL will be unable to make significant decisions about the activities of Zhejiang and can not carry out its principal activities without financial support. These characteristics as defined in Financial Accounting Standards Board (FASB) interpretation 46, Consolidation of Variable Interest Entities (VIEs), qualifies the business operations of (Zhejiang) to be consolidated with (CFDL) and ultimately with China 3C Group.
As a result of the Merger Agreement, the reorganization was treated as an acquisition by the accounting acquiree that is being accounted for as a recapitalization and as a reverse merger by the legal acquirer for accounting purposes. Pursuant to the recapitalization, all capital stock shares and amounts and per share data have been retroactively restated. Accordingly, the financial statements include the following:
25
(1) The balance sheet consists of the net assets of the accounting acquirer at historical cost and the net assets of the legal acquirer at historical cost.
(2) The statements of operations include the operations of the accounting acquirer for the period presented and the operations of the legal acquirer from the date of the merger.
Pursuant to a share exchange agreement, dated August 3, 2006, we issued 915,751 shares of restricted common stock, to the former shareholders of Hangzhou Sanhe Electronic Technology Ltd. The shares were valued at $3,750,000, which was the fair value of the shares at the date of exchange agreement. This amount is included in the cost of net assets and goodwill purchased.
Pursuant to a share exchange agreement, dated November 28, 2006, we issued 2,723,110 shares of newly issued shares of Common Stock to the former shareholders of Shanghai Joy & Harmony Electronics Company Limited. The shares were valued at $11,000,000, which was the fair value of the shares at the date of exchange agreement. This amount is included in the cost of net assets and goodwill purchased.
The Company is engaged in the business of the resale and distribution of mobile phones, facsimile machines, DVD players, stereos, speakers, MP3 and MP4 players, iPods, electronic dictionaries, CD players, radios, Walkmans, and audio systems. We sell and distribute these products through retail stores and secondary distributors.
Result of Operations
For the Six and Three Months Ended June 30, 2008 and 2007
Reportable Operating Segments
The Company reports financial and operating information in the following four segments:
a) Yiwu Yong Xin Telecommunication Company, Limited or “Yiwu”
b) Hangzhou Wang Da Electronics Company, Limited or “Wang Da”
c) Hangzhou Sanhe Electronic Technology Limited or “Sanhe”
d) Shanghai Joy & Harmony Electronics Company Limited or “SJHE”
a) Yiwu Yong Xin Telecommunication Company Limited or “Yiwu”
Yiwu focuses on the selling, circulation and modern logistics of fax machines and cord phone products.
All amounts, except percentage of revenues, in thousands of U.S. dollars.
Six months ended June 30, | Percentage | |||||||||||
| Yiwu | 2008 | 2007 | Change | |||||||||
| Revenue | $ | 30,469 | $ | 34,615 | (11.98) | % | ||||||
| Gross Profit | $ | 4,798 | $ | 4,714 | 1.78 | % | ||||||
| Gross Margin | 15.75 | % | 13.62 | % | 2.13 | % | ||||||
| Operating Income | $ | 3,412 | $ | 3,852 | (11.42) | % | ||||||
Three months ended June 30, | Percentage | |||||||||||
| Yiwu | 2008 | 2007 | Change | |||||||||
| Revenue | $ | 17,030 | $ | 14,362 | 18.58 | % | ||||||
| Gross Profit | $ | 2,918 | $ | 1,910 | 52,77 | % | ||||||
| Gross Margin | 17.13 | % | 13.30 | % | 3.83 | % | ||||||
| Operating Income | $ | 2,222 | $ | 1,366 | 62.66 | % | ||||||
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For the six months ended June 30, 2008, Yiwu generated revenue of $30,469 thousand, a decrease of $4,146 thousand or 11.98% compared to $34,615 thousand for the six months ended June 30, 2007. Gross profit increased $84 thousand or 1.78% from $4,714 thousand for the six months ended June 30, 2007 to $4,798 thousand for the six months ended June 30, 2008. Operating income was $3,412 thousand for the six months ended June 30, 2008, a decrease of $440 thousand or 11.42% compared to $3,852 thousand for the six months ended June 30, 2007. Such decreases in revenue and operation income were primarily due to the unprecedented snow storm in China during the first two months of the year which created a backlog in our distribution channels.
For the three months ended June 30, 2008, Yiwu generated revenue of $17,030 thousand, an increase of $2,668 thousand or 18.58 % compared to $14,362 thousand for the three months ended June 30, 2007. Gross profit increased $1,008 thousand or 52.77% from $1,910 thousand for the three months ended June 30, 2007 to $2,918 thousand for the three months ended June 30, 2008. Operating income was $2,222 thousand for the three months ended June 30, 2008, an increase of $856 thousand or 62.66% compared to $1,366 thousand for the three months ended June 30, 2007. Such increases in revenue, gross profit and operation income were primarily due to the expansion of the Company’s distribution networks as well as opening of new stores.
b) Hangzhou Wang Da Electronics Company Limited or “Wang Da”
Wang Da focuses on the selling, circulation and modern logistics of cell phones, cell phones products, and digital products, including digital cameras, digital camcorders, PDAs, flash disks, and removable hard disks.
All amounts, except percentage of revenues, in thousands of U.S. dollars.
Six months ended June 30, | Percentage | |||||||||||
| Wang Da | 2008 | 2007 | Change | |||||||||
| Revenue | $ | 47,777 | $ | 46,172 | 3.48 | % | ||||||
| Gross Profit | $ | 7,275 | $ | 6,880 | 5.74 | % | ||||||
| Gross Margin | 15.23 | % | 14.90 | % | 0.33 | % | ||||||
| Operating Income | $ | 4,918 | $ | 5,667 | (13.22) | % | ||||||
| Three months ended June 30, | Percentage | |||||||||||
| Wang Da | 2008 | 2007 | Change | |||||||||
| Revenue | $ | 25,529 | $ | 19,482 | 31.04 | % | ||||||
| Gross Profit | $ | 3,760 | $ | 3,047 | 23.40 | % | ||||||
| Gross Margin | 14.73 | % | 15.64 | % | (0.91) | % | ||||||
| Operating Income | $ | 2,371 | $ | 2,385 | (0.59) | % | ||||||
For the six months ended June 30, 2008, Wang Da generated revenue of $47,777 thousand, an increase of $1,605 thousand or 3.48% compared to $46,172 thousand for the six months ended June 30, 2007. Gross profit increased $395 thousand or 5.74% from $6,880 thousand for the six months ended June 30, 2007 to $7,275 thousand for the six months ended June 30, 2008. Operating income was $4,918 thousand for the six months ended June 30, 2008, a decrease of $749 thousand or 13.22 % compared to $5,667 thousand for the six months ended June 30, 2007. The slight increase in revenue and gross profit were due to the expansion of Wang Da’s distribution networks, as well as opening of new stores, offset by the negative effect of the unprecedented snow storm in China during the first two months of the year which created a backlog in our distribution channels.
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For the three months ended June 30, 2008, Wang Da generated revenue of $25,529 thousand, an increase of $6,047 thousand or 31.04% compared to $19,482 thousand for the three months ended June 30, 2007. Gross profit increased $713 thousand or 23.40% from $3,047 thousand for the three months ended June 30, 2007 to $3,760 thousand for the three months ended June 30, 2008. Operating income was $2,371 thousand for the three months ended June 30, 2008, a decrease of $14 thousand or 0.59% compared to $2,385 thousand for the three months ended June 30, 2007. The increase in revenue and gross profit were due to the expansion of Wang Da’s distribution networks, as well as opening of new stores.
Gross profit margin decreased from 15.64% in the three months ended June 30, 2007 to 14.73% in the three months ended June 30, 2008, a decrease of 0.91%. The decrease was a result of a slight increase in promotional sales on cell phones within the Wang Da’s store in store locations.
c) Hangzhou Sanhe Electronic Technology Limited or “Sanhe”
Sanhe focuses on the selling, circulation and modern logistics of home electronics, including DVD players, audio systems, speakers, televisions and air conditioners.
All amounts, except percentage of revenues, in thousands of U.S. dollars.
Six months ended June 30, | Percentage | |||||||||||
| Sanhe | 2008 | 2007 | Change | |||||||||
| Revenue | $ | 35,138 | $ | 34,261 | 2.56 | % | ||||||
| Gross Profit | $ | 6,484 | $ | 8,133 | (20.28) | % | ||||||
| Gross Margin | 18.45 | % | 23.74 | % | (5.29) | % | ||||||
| Operating Income | $ | 4,263 | $ | 5,785 | (26.31) | % | ||||||
Three months ended June 30, | Percentage | |||||||||||
| Sanhe | 2008 | 2007 | Change | |||||||||
| Revenue | $ | 18,648 | $ | 16,057 | 16.14 | % | ||||||
| Gross Profit | $ | 3,511 | $ | 4,107 | (14.51) | % | ||||||
| Gross Margin | 18.83 | % | 25.58 | % | (6.75) | % | ||||||
| Operating Income | $ | 2,399 | $ | 2,918 | (17.79) | % | ||||||
For the six months ended June 30, 2008, Sanhe generated revenue of $35,138 thousand, an increase of $877 thousand or 2.56% compared to $34,261 thousand for the six months ended June 30, 2007. Gross profit decreased $1,649 thousand or 20.28% from $8,133 thousand for the six months ended June 30, 2007 to $6,484 thousand for the six months ended June 30, 2008. Operating income was $4,263 thousand for the six months ended June 30, 2008, a decrease of $1,522 thousand or 26.31 % compared to $5,785 thousand for the six months ended June 30, 2007. The slight increase in revenue was due to the expansion of Sanhe’s distribution networks, as well as opening of new stores, offset by the negative effect of the unprecedented snow storm in China during the first two months of the year which created a backlog in our distribution channels. Gross profit and operating income decreased due to a more competitive sales environment on home electronics.
For the three months ended June 30, 2008, Sanhe generated revenue of $18,648 thousand, an increase of $2,591 thousand or 16.14% compared to $16,057 thousand for the three months ended June 30, 2007. Gross profit decreased $596 thousand or 14.51% from $4,107 thousand for the three months ended June 30, 2007 to $3,511 thousand for the three months ended June 30, 2008. Operating income was $2,399 thousand for the three months ended June 30, 2008, a decrease of $519 thousand or 17.79% compared to $2,918 thousand for the three months ended June 30, 2007. Gross profit and operating income decreased due to a more competitive sales environment on home electronics.
Gross profit margin decreased from 25.58% in the three months ended June 30, 2007 to 18.83% in the three months ended June 30, 2008, a decrease of 6.75%. Gross margin income decreased due to a more competitive sales environment on home electronics which caused the unit sales price to decrease.
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d) Shanghai Joy & Harmony Electronics Company Limited or “SJHE”
SJHE focuses on the selling, circulation and modern logistics of consumer electronics, including MP3 players, MP4 players, iPod, electronic dictionary, radios, and Walkman.
All amounts, except percentage of revenues, in thousands of U.S. dollars.
Six months ended June 30, | Percentage | |||||||||||
| SJHE | 2008 | 2007 | Change | |||||||||
| Revenue | $ | 33,285 | $ | 33,974 | (2.03) | % | ||||||
| Gross Profit | $ | 4,866 | $ | 5,644 | (13.78) | % | ||||||
| Gross Margin | 14.62 | % | 16.61 | % | (1.99) | % | ||||||
| Operating Income | $ | 3,757 | $ | 4,865 | (22.77) | % | ||||||
Three months ended June 30, | Percentage | |||||||||||
| SJHE | 2008 | 2007 | Change | |||||||||
| Revenue | $ | 17,309 | $ | 14,598 | 18.57 | % | ||||||
| Gross Profit | $ | 2,688 | $ | 2,375 | 13.18 | % | ||||||
| Gross Margin | 15.53 | % | 16.27 | % | (0.74) | % | ||||||
| Operating Income | $ | 2,097 | $ | 2,058 | 1.90 | % | ||||||
For the six months ended June 30, 2008, SJHE generated revenue of $33,285 thousand, a decrease of $689 thousand or 2.03% compared to $33,974 thousand for the six months ended June 30, 2007. Gross profit decreased $778 thousand or 13.78% from $5,644 thousand for the six months ended June 30, 2007 to $4,866 thousand for the six months ended June 30, 2008. Operating income was $3,757 thousand for the six months ended June 30, 2008, a decrease of $1,108 thousand or 22.77% compared to $4,865 thousand for the six months ended June 30, 2007. Such decreases in revenue, gross profit and operation income were primarily due to the unprecedented snow storm in China during the first two months of the year which created a backlog in our distribution channels.
For the three months ended June 30, 2008, SJHE generated revenue of $17,309 thousand, an increase of $2,711 thousand or 18.57% compared to $14,598 thousand for the three months ended June 30, 2007. Gross profit increased $313 thousand or 13.18% from $2,375 thousand for the three months ended June 30, 2007 to $2,688 thousand for the three months ended June 30, 2008. Operating income was $2,097 thousand for the three months ended June 30, 2008, an increase of $39 thousand or 1.90% compared to $2,058 thousand for the three months ended June 30, 2007. The increase in revenue, gross profit and operating income was due to the expansion of SJHE’s distribution networks, as well as opening of new stores.
Gross profit margin slightly decreased from 16.27% in the three months ended June 30, 2007 to 15.53% in the three months ended June 30, 2008, a decrease of 0.74%. The lower gross profit margin was due to increasing unit purchase prices and unit sales prices that did not increase as much as purchases.
Net Sales
Net sales for the six months ended June 30, 2008 decreased by 2%, to $146,668,847 as compared to $149,021,667 for the six months ended June 30, 2007. Net sales for the three months ended June 30, 2008 increased by 22%, to $78,515,392 as compared to $64,498,473 for the three months ended June 30, 2007. Management believes that the lower sales were a result of various factors including a slowdown in the retail markets in general, a significant snowstorm in China during the first two months of 2008 which created a backlog in our distribution channels, and the pressure of increased competition within the markets in which we operate.
Cost of Sales
Cost of sales for the six months ended June 30, 2008 totaled $123,246,750 as compared to $123,651,187 for the six months ended June 30, 2007, a decrease of 0.3%. Cost of sales for the three months ended June 30, 2008 totaled $65,639,675 as compared to $53,060,275 for the three months ended June 30, 2007, an increase of 24%. The decreased cost of sales for the six months was a direct result of the decrease in the number of sales during the same period.
Gross Profit Margin
Gross profit margin for the six months ended June 30, 2008 was 16.0% as compared to 17.0% for the six months ended June 30, 2007. Gross profit margin for the three months ended June 30, 2008 was 16.4% as compared to 17.7% for the three months ended June 30, 2007. The lower gross profit margin was due to increasing unit purchase prices and unit sales prices that did not increase in line with increasing inflation in China. With the increasing competition, we could not offset the cost of operations with higher selling prices.
29
General and Administrative Expenses
General and administrative expenses for the six months ended June 30, 2008 totaled $6,312,088 or approximately 4% of net sales, as compared to $6,740,395 or approximately 5% of net sales for the six months ended June 30, 2007, an decrease of 6%. General and administrative expenses for the three months ended June 30, 2008 totaled $3,326,044 or approximately 4% of net sales, as compared to $3,014,233 or approximately 5% of net sales for the three months ended June 30, 2007, an increase of 10%. The decrease was primarily due to strengthening cost controls such as a rationalization of management structure and increasingly sophisticated use of computerized systems.
Income from Operations
Income from operations for the six months ended June 30, 2008 was $17,110,009 or 12% of net sales as compared to income from operations of $18,630,085 or 13% of net sales for the six months ended June 30, 2007, a decrease of 8%. Income from operations for the three months ended June 30, 2008 was $9,549,673 or 12% of net sales as compared to income from operations of $8,423,965 or 13% of net sales for the three months ended June 30, 2007, an increase of 13%. Lower sales, higher product costs, and logistical costs, such as higher distribution costs, were the key factors for the decrease in income from operations during the six months ended June 30, 2008.
Provision for Income Taxes
The provision for income taxes for the six months ended June 30, 2008 was $4,164,627 as compared to $6,690,523 for the six months ended June 30, 2007. The provision for income taxes for the three months ended June 30, 2008 was $2,354,054 as compared to $2,941,264 for the three months ended June 30, 2007. The decrease was mainly attributed to the lower statutory tax rates effective for 2008 in China.
Net Income
Net income was $13,325,039 or 9.1% of net sales for the six months ended June 30, 2008 as compared to $11,965,315 or 8.0% of net sales for the six months ended June 30, 2007, an increase of 11%. Net income was $7,551,995 or 9.6% of net sales for the three months ended June 30, 2008 as compared to $5,501,527 or 8.5% of net sales for the three months ended June 30, 2007, an increase of 37%. Strengthening cost controls and lower statutory tax rates were the critical factors which contributed to the increase in net income.
Liquidity and Capital Resources
Operations and liquidity needs are funded primarily through cash flows from operations. Cash and cash equivalents were $25,993,638 at June 30, 2008, as compared to $15,230,508 at June 30, 2007, and compared to $24,952,614 at December 31, 2007.
30
Under the Joy & Harmony share exchange agreement, dated November 28, 2006, in exchange of surrendering all their ownership in Joy & Harmony, the Joy & Harmony shareholders received both stock consideration and cash consideration. The cash consideration consisted of $7,500,000 in cash is payable as follows: $3,000,000 within 10 business days after the closing of the transaction, and $4,500,000 payable six months after the closing of the transaction as evidenced by promissory notes issued by us to the Joy & Harmony’s shareholders. The $4,500,000 loan was repaid in the second quarter of 2007.
We believe that the funds available to us are adequate to meet our operating needs for the remainder of 2008.
| Six months ended | ||||||||
| June 30, 2008 | June 30, 2007 | |||||||
| (in thousands) | (in thousands) | |||||||
| Net cash (used in) provided by operating activities | $ | (1,774 | ) | $ | 12,908 | |||
| Net cash (used in) investing activities | $ | (8 | ) | $ | (62 | ) | ||
| Effect of exchange rate change on cash and cash equivalents | $ | 2,823 | $ | 386 | ||||
| Net increase in cash and cash equivalents | $ | 1,041 | $ | 8,732 | ||||
| Cash and cash equivalents at beginning of period | $ | 24,953 | $ | 6,499 | ||||
| Cash and cash equivalents at end period | $ | 25,994 | $ | 15,231 | ||||
Operating Activities
Net cash generated from operating activities decreased from $12,908 thousand for the three months ended June 30, 2007 to $(1,774) thousand for the three months ended June 30, 2008, approximately a 113.74% decrease. The decrease was mainly attributable to several factors, including (i) the substantial increase in accounts receivable of $11,040 thousand in the three months ended June 30, 2008; (ii) the increase in inventory of $6,266 thousand in the three months ended June 30, 2008; (iii) the increase in income tax payable of $256 thousand in the three months ended June 30, 2008, offset by the increase in accounts payable and accrued expenses of $2,102 thousand.
| Six months ended | ||||||||
| June 30, 2008 | June 30, 2007 | |||||||
| (in thousands) | (in thousands) | |||||||
| Sales Net | $ | 78,515 | $ | 64,498 | ||||
In view of increase in market competition, the Company successfully maintained a moderate increase in net sales, even though the repayment period from accounts receivable treads are longer than before which resulted in a decrease in net cash generated from operating activities.
| Six months ended | ||||||||
| June 30, 2008 | June 30, 2007 | |||||||
| (in thousands) | (in thousands) | |||||||
| a) Increase in inventory | $ | 6,266 | $ | 2,094 | ||||
| b) Increase in Accounts Receivable | $ | 11,040 | $ | 727 | ||||
| c) Increase in inventory and accounts receivables as a whole a) + b) | $ | 17,306 | $ | 2,821 | ||||
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On the control side of distribution of products, the focus is always on the holding cost of inventory and the value of accounts receivable as a whole comparing to net sales.
| Six months ended | ||||||||
| June 30, 2008 | June 30, 2007 | |||||||
| (in thousands) | (in thousands) | |||||||
| d) Accounts payable and accrued charges | $ | 2,102 | $ | 1,092 | ||||
| Six months ended | ||||||||
| June 30, 2008 | June 30, 2007 | |||||||
| (in thousands) | (in thousands) | |||||||
| d) Accounts payable and accrued charges | $ | 2,102 | $ | 1,092 | ||||
The Company has developed its own brand name over the past years and has been successful in receiving support from its creditors.
The Company used $4,420 thousand in operating activities for the six months ended June 30, 2008.
Investing Activities
Net cash used in investing activities decreased to $8 thousand during the three months ended June 30, 2008 from $62 thousand during the three months ended June 30, 2007, primarily due to the combined effect of decrease in purchase of additional office equipments and increase in proceeds from asset sales.
| Six months ended | ||||||||
| June 30, 2008 | June 30, 2007 | |||||||
| (in thousands) | (in thousands) | |||||||
| Net cash used investment activities | $ | (8 | ) | $ | (62 | ) | ||
The Company’s activities focused on the distribution of products. As a result, investment in fixed assets were moderate and hence there is little effect to the utilization of cash resources over the period.
Financing Activities
The Company did not carry out any financing activities during the six months ended June 30, 2008 and 2007.
| Six months ended | ||||||||
| June 30, 2008 | June 30, 2007 | |||||||
| (in thousands) | (in thousands) | |||||||
| Net change in cash and cash equivalents | $ | 1,041 | $ | 8,732 | ||||
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| Six months ended | ||||||||
| June 30, 2008 | June 30, 2007 | |||||||
| (in thousands) | (in thousands) | |||||||
| Cash and cash equivalent at June 30, 2007 and 2008 | $ | 25,994 | $ | 15,231 | ||||
With effective internal control systems in place the Company maintained healthy net cash flows over period and achieved a healthy cash position of $25,994 thousand at June 30, 2008.
Since December 31, 2007, our accounts receivable balance increased due to a slow down in accounts receivable turnover, which was partly due to the impact of a slowdown in the global economy, so there has been a general decrease in customers’ ability to make payments quickly, it could have had an effect on our bad debt allowances. However, although such turnover slowed in comparison to prior periods, we took good control of accounts receivable by changing the contract terms only for our retail department store customers, where we maintain a store in-store model, to extend the period for repayment from 15 days to 30 days. The extension of repayment terms has lead to the increase in accounts receivable, but considering the extension is only for an additional 15 days, we don’t expect these accounts receivables to be long-term compared to other accounts receivable. For customers who want to further extend the repayment terms, we will carefully review customers’ credit, percentage of sales and payment history to determine whether we should extend the terms. If there is a high risk that the account receivables become uncollectible, we will not extend the repayment terms.
Collection of debt is based on the terms of legal binding documents. We have not changed our policy on reserving for bad debt, but have found a means to accommodate customers given the financial crisis by extending payment terms. Since December 31, 2007, the account receivable department has periodically reviewed the allowance for doubtful accounts. The estimate of bad debt allowance is based on the aging of the receivables, the credit history and credit quality of the customers, the term of the contracts as well as the balance outstanding. If an account receivable item is considered highly probable that it is uncollectible, then it will be charged to bad debt immediately in that period. Since then we have not found any abnormal increase in bad debt.
As a result of the unprecedented snow storm in 2008, there was a shortage of inventory available to our stores during the first quarter 2008. This shortage had a negative impact on our first quarter sales for 2008. As a precautionary measure, the Company decided to increase its level of inventory in order to maintain an adequate level for all stores in the event of other unexpected incidents. The Company' has adopted a policy to appropriately increase its inventory to ensure sufficient product turnover to meet customer’s demand and avoid a shortage of goods. The increase in inventory has had a negative impact on cash flows and liquidity. However, the Company firmly believes that the benefits of this change in policy outweighs the losses. The Company believes that an appropriate increase in inventory level is a beneficial policy enhancing individual stores ability to response to sales change and in return building up the Company's goodwill thereby securing sales growth. This change in inventory policy will reduce the Company’s cash liquidity in the short term but it won’t affect the future cash flow in the long term. The current economic environment will not affect the Company’s ability to sell inventory currently in hand because the Company has high inventory turnover. Days inventory on hand is approximately 38 days. Therefore, even if the economy environment changes, the Company can still sell inventory currently in hand within a short period.
Capital Expenditures
Total capital expenditures for the first six months of 2008 were $10,650 for purchase of fixed assets as compared to $62,353 for the first six months of 2007.
Working Capital Requirements
Historically operations and short term financing have been sufficient to meet our cash needs. We believe that we will be able to generate revenues from sales 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.
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Off-Balance Sheet Arrangements
We have never entered into any off-balance sheet financing arrangements and have never established any special purpose entities. We have not guaranteed any debt or commitments of other entities or entered into any options on non-financial assets.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Foreign Currency Exchange Rate Risk
Fluctuations in the rate of exchange between the U.S. dollar and foreign currencies, primarily the Chinese Renminbi, could adversely affect our financial results. During the fiscal quarter ended June 30, 2008, approximately all of our sales were denominated in foreign currencies. We expect that foreign currencies will continue to represent a similarly significant percentage of our sales in the future. Selling, marketing and administrative costs related to these sales are largely denominated in the same respective currency, thereby mitigating our transaction risk exposure. We therefore believe that the risk of a significant impact on our operating income from foreign currency fluctuations is not substantial. However, for sales not denominated in U.S. dollars, if there is an increase in the rate at which a foreign currency is exchanged for U.S. dollars, it will require more of the foreign currency to equal a specified amount of U.S. dollars than before the rate increase. In such cases and if we price our products in the foreign currency, we will receive less in U.S. dollars than we did before the rate increase went into effect. If we price our products in U.S. dollars and competitors price their products in local currency, an increase in the relative strength of the U.S. dollar could result in our price not being competitive in a market where business is transacted in the local currency.
All of our sales denominated in foreign currencies are denominated in the Chinese Renminbi. Our principal exchange rate risk therefore exists between the U.S. dollar and this currency. Fluctuations from the beginning to the end of any given reporting period result in the re-measurement of our foreign currency-denominated receivables and payables, generating currency transaction gains or losses that impact our non-operating income/expense levels in the respective period and are reported in other (income) expense, net in our combined consolidated financial statements. We do not currently hedge our exposure to foreign currency exchange rate fluctuations. We may, however, hedge such exposure to foreign currency exchange rate fluctuations in the future.
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Interest Rate Risk
Changes in interest rates may affect the interest paid (or earned) and therefore affect our cash flows and results of operations. However, we do not believe that this interest rate change risk is significant.
Inflation
During the quarter ended June 30, 2008, inflation had an impact on net income. We were unable to offset the increased costs of operations resulting from higher inflation by increasing the prices of our products.
Currency Exchange Fluctuations
All of the Company’s revenues are denominated in Chinese Renminbi, and its expenses are denominated primarily in Chinese Renminbi. The value of the Renminbi-to-U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in political and economic conditions. Since 1994, the conversion of Renminbi into foreign currencies, including U.S. dollars, has been based on rates set by the People’s Bank of China, which are set daily based on the previous day’s inter-bank foreign exchange market rates and current exchange rates on the world financial markets. Since 1994, the official exchange rate for the conversion of Renminbi to U.S. dollars had generally been stable and the Renminbi had appreciated slightly against the U.S. dollar. However, on July 21, 2005, the Chinese government changed its policy of pegging the value of Chinese Renminbi to the U.S. dollar. Under the new policy, Chinese Renminbi may fluctuate within a narrow and managed band against a basket of certain foreign currencies. Recently there has been increased political pressure on the Chinese government to decouple the Renminbi from the United States dollar. At the recent quarterly regular meeting of People’s Bank of China, its Currency Policy Committee affirmed the effects of the reform on Chinese Renminbi exchange rate. Since the new currency rate system has been in operation, the currency rate of Renminbi has become more flexible while basically maintaining stable and the expectation for a larger appreciation range is shrinking. The Company has never engaged in currency hedging operations and has no present intention to do so.
Concentration of Credit Risk
Credit risk represents the accounting loss that would be recognized at the reporting date if counterparties failed completely to perform as contracted. Concentrations of credit risk (whether on or off balance sheet) that arise from financial instruments exist for groups of customers or counterparties when they have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions as described below:
| · | The Company’s business is characterized by rapid technological change, new product and service development, and evolving industry standards and regulations. Inherent in the Company’s business are various risks and uncertainties, including the impact from the volatility of the stock market, limited operating history, uncertain profitability and the ability to raise additional capital. |
| · | All of the Company’s revenue is derived from Asia and Greater China. Changes in laws and regulations, or their interpretation, or the imposition of confiscatory taxation, restrictions on currency conversion, devaluations of currency or the nationalization or other expropriation of private enterprises could have a material adverse effect on our business, results of operations and financial condition. |
| · | If the Company is unable to derive any revenues from Greater China, it would have a significant, financially disruptive effect on the normal operations of the Company. |
Seasonality and Quarterly Fluctuations
Our businesses experience fluctuations in quarterly performance. Traditionally, the first quarter from January to March has a higher number of sales reflected by our electronics business due to the New Year holidays in China occurring during that period.
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures as of June 30, 2008, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based on this evaluation, our principal executive officer and principal financial officer have concluded that during the period covered by this report, the Company’s disclosure controls and procedures were not effective as of such date to ensure that information required to be disclosed by us in our Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosures. Our management identified that the ineffectiveness was due to not having internal personnel with sufficient expertise and knowledge of the requirements for disclosure of the information that have been collected and reported, as required under the securities laws and disclosures required under U.S. GAAP.
We plan to take the following steps to remediate the deficiencies in disclosure controls and procedures that are identified above:
| · | Management will provide additional training to our staff, and in particular to our key accounting personnel, with respect to the disclosure requirements under securities law and U.S. GAAP. |
Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting that occurred during the second fiscal quarter of 2008 covered by this Quarterly Report on Form 10-Q/A that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
Neither the Company nor its property is a party to any pending legal proceeding. The Company’s management does not believe that there are any proceedings to which any director, officer, or affiliate of the Company, any owner of record of beneficially held or owner of more than five percent (5%) of the Company’s common stock, or any associate of any such director, officer, affiliate of the Company, or security holder is a party adverse to the Company, or has a material interest adverse to the Company.
Item 1A. Risk Factors.
Risks Associated With Our Common Stock
There is a limited public market for our common stock. There is currently a limited public market for the common stock. Holders of our common stock may, therefore, have difficulty selling their common stock, should they decide to do so. In addition, there can be no assurances that such markets will continue or that any shares of common stock, which may be purchased may be sold without incurring a loss. Any such market price of the common stock may not necessarily bear any relationship to our book value, assets, past operating results, financial condition or any other established criteria of value, and may not be indicative of the market price for the common stock in the future. Further, the market price for the common stock may be volatile depending on a number of factors, including business performance, industry dynamics, news announcements or changes in general economic conditions.
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Our common stock may be deemed penny stock with a limited trading market . Our common stock is currently listed for trading in the Over-The-Counter Market on the NASD Electronic Bulletin Board, which is generally considered to be a less efficient markets than markets such as NASDAQ or other national exchanges, and which may cause difficulty in conducting trades and difficulty in obtaining future financing. Further, our securities are subject to the “penny stock rules” adopted pursuant to Section 15 (g) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The penny stock rules apply to non-NASDAQ companies whose common stock trades at less than $5.00 per share or which have tangible net worth of less than $5,000,000 ($2,000,000 if the company has been operating for three or more years). Such rules require, among other things, that brokers who trade “penny stock” to persons other than “established customers” complete certain documentation, make suitability inquiries of investors and provide investors with certain information concerning trading in the security, including a risk disclosure document and quote information under certain circumstances. Many brokers have decided not to trade “penny stock” because of the requirements of the penny stock rules and, as a result, the number of broker-dealers willing to act as market makers in such securities is limited. In the event that we remain subject to the “penny stock rules” for any significant period, there may develop an adverse impact on the market, if any, for our securities. Because our securities are subject to the “penny stock rules,” investors will find it more difficult to dispose of our securities. Further, for companies whose securities are traded in the Over-The-Counter Market, it is more difficult: (i) to obtain accurate quotations, (ii) to obtain coverage for significant news events because major wire services, such as the Dow Jones News Service, generally do not publish press releases about such companies, and (iii) to obtain needed capital.
We do not intend to pay dividends on our common stock. The Company’s two operating subsidiaries in China paid $525,460 in dividends during 2005, but there are no plans for paying dividends in the foreseeable future. We intend to retain earnings, if any, to provide funds for the implementation of our new business plan. We do not intend to declare or pay any dividends in the foreseeable future. Therefore, there can be no assurance that holders of common stock will receive any additional cash, stock or other dividends on their shares of common stock until we have funds, which the Board of Directors determines, can be allocated to dividends.
If we are unable to successfully integrate the businesses we acquire, our ability to expand our product offerings and geographic reach may be significantly limited. In order to expand our product offerings and grow our customer base by reaching new customers through expanded geographic coverage, we may continue to acquire businesses that we believe are complimentary to our growth strategy. Acquisitions involve numerous risks, including difficulties in the assimilation of acquired operations, loss of key personnel, distraction of management’s attention from other operational concerns, failure to maintain supplier relationships, inability to maintain goodwill of customers from acquired businesses, and the inability to meet projected financial results that supported how much was paid for the acquired businesses.
Our business will be harmed if we are unable to maintain our supplier alliance agreements with favorable terms and conditions. We have licensing/distribution agreements with key suppliers in a number of major product categories. Our business will be harmed if we are unable to maintain these favorable agreements or are limited in our ability to gain access to additional like agreements with our key suppliers.
It is very difficult to predict the sales cycle for our products . If we are unable to successfully select and introduce new products or fail to keep pace with the rapid advances in technology, our business condition will be negatively impacted. The duration and product selection involved in our sales cycle is dependent on a number of factors, including immediate product availability, pricing, features, product complexity, economic environment, and customer financial condition. If potential customers take longer than we expect to decide to purchase our products, or if our customers decide on a different product/feature set than available from our existing supplier agreements, the financial condition and results of our operations will be adversely affected.
Because our operating/business model continues to evolve it is difficult to predict our future performance, and our business is difficult to evaluate. Our business model continues to evolve over time. We do not have an extensive operating history upon which you can easily and accurately evaluate our business, or our ongoing financial condition. As our model evolves over time and due to our numerous acquisitions, we face risks and challenges due to a lack of meaningful historical data upon which we can develop budgets and make forecasts.
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Future acquisitions may result in potentially dilutive issuances of equity securities, the incurrence of further indebtedness, and increased amortization expense. Our growth model has in the past and most probably in the future will involve acquisitions that may result in potentially dilutive issuances of equity securities or the incurrence of debt and unknown liabilities. Such acquisitions may result in significant write-offs and increased amortization expenses that could adversely affect our business and the results of our operations.
If our products fail to perform properly our business could suffer significantly. Although we do not currently develop or manufacturer our existing products, should they fail to perform we may suffer lost sales and customer goodwill, ongoing liability claims, license terminations, severe harm to our brand and overall reputation, unexpected costs, and reallocation of resources to resolve product issues.
Rapid and substantial growth is the key to our overall strategy, if we are unable to manage our growth profitably and effectively, we may incur unexpected expenses and be unable to meet our financial and customer obligations. In order for us to meet our financial objectives we will need to substantially expand our operations to achieve necessary market share. We cannot be certain that our IT infrastructure, financial controls, systems, and processes will be adequate to support our expansion. Our future results will depend on the ability of our officers and key employees to manage changing business conditions in administration, reporting, controls, and operations.
If we are unable to obtain additional financing for our future needs we may be unable to respond to competitive pressures and our business may be impaired. We cannot be certain that financing with favorable terms, or at all, will be available for us to pursue our expansion initiatives. We may be unable to take advantage of favorable acquisitions or to respond to competitive pressures. This inability may harm our operations or financial results.
If we are forced to lower our prices to compete, our financial performance may be negatively impacted. We derive our sales from the resale of products from a number of our suppliers. If we are forced to lower our prices due to added competition, inferior feature offerings, excess inventory, pressure for cash, declining economic climate, or any other reason, our business may become less profitable.
If we are unable to maintain existing supplier relationships or form new ones, our business and financial condition may suffer. We rely on our current suppliers along with new suppliers to provide us access to competitive products for resale. If we are unable to gain access to suppliers with needed product with favorable terms our business may be negatively impacted.
If we incur costs that exceed our existing insurance coverage in lawsuits brought to us in the future, it could adversely affect our business and financial condition. We maintain third party insurance coverage against liability risks associated with lawsuits. While we believe these arrangements are an effective way to insure against liability, the potential liabilities associated with such risks or other events could exceed the coverage provided by such insurance.
Risks Related to Doing Business in China
Our business operations take place primarily in China. Because Chinese laws, regulations and policies are continually changing, our Chinese operations will face several risks summarized below.
Limitations on Chinese economic market reforms may discourage foreign investment in Chinese businesses. The value of investments in Chinese businesses could be adversely affected by political, economic and social uncertainties in China. The economic reforms in China in recent years are regarded by China’s central government as a way to introduce economic market forces into China. Given the overriding desire of the central government leadership to maintain stability in China amid rapid social and economic changes in the country, the economic market reforms of recent years could be slowed, or even reversed.
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Any change in policy by the Chinese government could adversely affect investments in Chinese businesses. Changes in policy could result in imposition of restrictions on currency conversion, imports or the source of suppliers, as well as new laws affecting joint ventures and foreign-owned enterprises doing business in China. Although China has been pursuing economic reforms for the past two decades, events such as a change in leadership or social disruptions that may occur upon the proposed privatization of certain state-owned industries could significantly affect the government’s ability to continue with its reform.
We face economic risks in doing business in China. As a developing nation, China’s economy is more volatile than that of developed Western industrial economies. It differs significantly from that of the U.S. or a Western European Country in such respects as structure, level of development, capital reinvestment, resource allocation and self-sufficiency. Only in recent years has the Chinese economy moved from what had been a command economy through the 1970s to one that during the 1990s encouraged substantial private economic activity. In 1993, the Constitution of China was amended to reinforce such economic reforms. The trends of the 1990s indicate that future policies of the Chinese government will emphasize greater utilization of market forces. For example, in 1999 the Government announced plans to amend the Chinese Constitution to recognize private property, although private business will officially remain subordinated to the state-owned companies, which are the mainstay of the Chinese economy. However, there can be no assurance that, under some circumstances, the government’s pursuit of economic reforms will not be restrained or curtailed. Actions by the central government of China could have a significant adverse effect on economic conditions in the country as a whole and on the economic prospects for our Chinese operations.
The Chinese legal and judicial system may negatively impact foreign investors. In 1982, the National People’s Congress amended the Constitution of China to authorize foreign investment and guarantee the “lawful rights and interests” of foreign investors in China. However, China’s system of laws is not yet comprehensive. The legal and judicial systems in China are still rudimentary, and enforcement of existing laws is inconsistent. Many judges in China lack the depth of legal training and experience that would be expected of a judge in a more developed country. Because the Chinese judiciary is relatively inexperienced in enforcing the laws that do exist, anticipation of judicial decision-making is more uncertain than would be expected in a more developed country. It may be impossible to obtain swift and equitable enforcement of laws that do exist, or to obtain enforcement of the judgment of one court by a court of another jurisdiction. China’s legal system is based on written statutes; a decision by one judge does not set a legal precedent that is required to be followed by judges in other cases. In addition, the interpretation of Chinese laws may be varied to reflect domestic political changes.
The promulgation of new laws, changes to existing laws and the pre-emption of local regulations by national laws may adversely affect foreign investors. However, the trend of legislation over the last 20 years has significantly enhanced the protection of foreign investment and allowed for more control by foreign parties of their investments in Chinese enterprises. There can be no assurance that a change in leadership, social or political disruption, or unforeseen circumstances affecting China’s political, economic or social life, will not affect the Chinese government’s ability to continue to support and pursue these reforms. Such a shift could have a material adverse effect on our business and prospects.
The practical effect of the People’s Republic of China legal system on our business operations in China can be viewed from two separate but intertwined considerations. First, as a matter of substantive law, the Foreign Invested Enterprise laws provide significant protection from government interference. In addition, these laws guarantee the full enjoyment of the benefits of corporate Articles and contracts to Foreign Invested Enterprise participants. These laws, however, do impose standards concerning corporate formation and governance, which are not qualitatively different from the general corporation laws of the several states. Similarly, the People’s Republic of China accounting laws mandate accounting practices, which are not consistent with U.S. Generally Accepted Accounting Principles. China’s accounting laws require that an annual “statutory audit” be performed in accordance with People’s Republic of China accounting standards and that the books of account of Foreign Invested Enterprises are maintained in accordance with Chinese accounting laws. Article 14 of the People’s Republic of China Wholly Foreign-Owned Enterprise Law requires a Wholly Foreign-Owned Enterprise to submit certain periodic fiscal reports and statements to designated financial and tax authorities, at the risk of business license revocation. Second, while the enforcement of substantive rights may appear less clear than United States procedures, the Foreign Invested Enterprises and Wholly Foreign- Owned Enterprises are Chinese registered companies, which enjoy the same status as other Chinese registered companies in business-to-business dispute resolution. Generally, the Articles of Association provide that all business disputes pertaining to Foreign Invested Enterprises are to be resolved by the Arbitration Institute of the Stockholm Chamber of Commerce in Stockholm, Sweden applying Chinese substantive law. Any award rendered by this arbitration tribunal is, by the express terms of the respective Articles of Association, enforceable in accordance with the “United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (1958).” Therefore, as a practical matter, although no assurances can be given, the Chinese legal infrastructure, while different in operation from its United States counterpart, should not present any significant impediment to the operation of Foreign Invested Enterprises.
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Economic Reform Issues
China is a country that has been undergoing a process of privatization for much of the past three decades. Although the Chinese government owns the majority of productive assets in China, in the past several years the government has implemented economic reform measures that emphasize decentralization and encourage private economic activity. Because these economic reform measures may be inconsistent or ineffectual, there are no assurances that:
| · | We will be able to capitalize on economic reforms; |
| · | The Chinese government will continue its pursuit of economic reform policies; |
| · | The economic policies, even if pursued, will be successful; |
| · | Economic policies will not be significantly altered from time to time; and |
| · | Business operations in China will not become subject to the risk of nationalization. |
Since 1979, the Chinese government has reformed its economic systems. Because many reforms are unprecedented or experimental, they are expected to be refined and improved. Other political, economic and social factors, such as political changes, changes in the rates of economic growth, unemployment or inflation, or in the disparities in per capita wealth between regions within China, could lead to further readjustment of the reform measures. This refining and readjustment process may negatively affect our operations.
Over the last few years, China’s economy has registered a high growth rate. Recently, there have been indications that rates of inflation have increased. In response, the Chinese government recently has taken measures to curb this excessively expansive economy. These measures have included devaluations of the Chinese currency, the Renminbi (RMB), restrictions on the availability of domestic credit, reducing the purchasing capability of certain of its customers, and limited re-centralization of the approval process for purchases of some foreign products. These austerity measures alone may not succeed in slowing down the economy’s excessive expansion or control inflation, and may result in severe dislocations in the Chinese economy. The Chinese government may adopt additional measures to further combat inflation, including the establishment of freezes or restraints on certain projects or markets.
To date reforms to China’s economic system have not adversely impacted our operations and are not expected to adversely impact operations in the foreseeable future; however, there can be no assurance that the reforms to China’s economic system will continue or that we will not be adversely affected by changes in China’s political, economic, and social conditions and by changes in policies of the Chinese government, such as changes in laws and regulations, measures which may be introduced to control inflation, changes in the rate or method of taxation, imposition of additional restrictions on currency conversion and remittance abroad, and reduction in tariff protection and other import restrictions.
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Risk Factors Associated with Our Business
Non-performance by our suppliers may adversely affect our operations by delaying delivery or causing delivery failures, which may negatively affect demand, sales and profitability. We purchase various types of products from our suppliers. We would be materially and adversely affected by the failure of our suppliers to perform as expected. We could experience delivery delays or failures caused by production issues or delivery of non-conforming products if its suppliers failed to perform, and we also face these risks in the event any of its suppliers becomes insolvent or bankrupt.
We depend on the continued services of our executive officers and the loss of key personnel could affect our ability to successfully grow our business. We are highly dependent upon the services of our senior management team, particularly Zhenggang Wang, our Chairman and Chief Executive Officer and Weidong Huang, our Chief Financial Officer. The permanent loss for any of our key executives, could have a material adverse effect upon our operating results. We may not be able to locate suitable replacements for our executives if their services were lost. We do not maintain key man life insurance on any of these individuals.
With the markets being highly competitive, we may not be able to compete successfully. Many of our competitors have substantially greater revenues and financial resources than we do. We may not be able to compete favorably and increased competition may substantially harm our business, business prospects and results of operations. If we are not successful in our target markets, our sales could decline, our margins could be negatively impacted and we could lose market share, any of which could materially harm our business, results of operations and profitability.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Item 5. Other Information.
None.
Item 6. Exhibits.
Exhibit No. | Document Description | |
| 31.1 | Certification of Chief Executive Officer pursuant to Rule 13A-14(A)/15D-14(A) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 31.2 | Certification of the Principal Financial Officer pursuant to Rule 13A-14(A)/15D-14(A) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 32.1 | Certification of Chief Executive Officer Pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002). | |
| 32.2 | Certification of Principal Financial Officer Pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002). |
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 7th day of May, 2009.
| CHINA 3C GROUP | |
| By: | /s/ Zhenggang Wang |
| Name: Zhenggang Wang | |
| Title: Chief Executive Officer and Chairman | |
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Exhibit Index
Exhibit No. | Document Description | |
| 31.1 | Certification of Chief Executive Officer pursuant to Rule 13A-14(A)/15D-14(A) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 31.2 | Certification of the Principal Financial Officer pursuant to Rule 13A-14(A)/15D-14(A) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 32.1 | Certification of Chief Executive Officer Pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002). | |
| 32.2 | Certification of Principal Financial Officer Pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002). |