ITEM 1. BUSINESS
Overview
China 3C Group (referred to herein as the “Company”, “China 3C,” “we” or “us”) was incorporated on August 20, 1998 under the laws of the State of Nevada. Before July 2009, we were only engaged in the business of resale and distribution of third party products and generated 100% of our revenue from resale of items such as mobile phones, facsimile machines, DVD players, stereos, speakers, MP3 and MP4 players, iPods, electronic dictionaries, CD players, radio Walkmans and audio systems. On July 6, 2009, we completed the acquisition of Jinhua Baofa Logistic Ltd (“Jinhua”). Thus, we started providing transportation logistics services to businesses in Eastern China.
In 2007 we began operating under a “store in store” business model. As of December 31, 2009 we established and operated 915 “stores in stores.” We operate under the brand names Hangzhou Wang Da, Yiwu YongXin, Shanghai Joy & Harmony and Hangzhou Sanhe. The “store in store” business operation model resulted in expanded marketing channels, thus, positively stimulated the growth of sales in 2007 and 2008. However, in 2009, we had declining sales under the “stores in stores” model due to higher competition from direct stores and large department stores as well as the impact of the economic slow down. Therefore, we decided to open direct stores and franchises. As of December 31, 2009, Zhejiang has established three direct and four franchise stores, which are currently operating.
On July 6, 2009, China 3C and its subsidiary Zhejiang and Yiwu acquired 100% interest of Jinhua. Jinhua provides transportation logistics services to businesses.
Under the stores in stores model, we distribute our products mainly via so-called concessionaire agreements with larger department stores, supermarkets, large electronics retail stores, and other retailers. The retail distribution of many products in China, including those we sell, is conducted through the concessionaire model. Under this model, companies such as China 3C own their own outlets within larger stores and in so doing assume responsibility for most financial and operational aspects of those outlets including capital cost, inventory, wages, selection, pricing, and general management. Our retail partners are compensated via margin they earn on the products we sell. This model is similar to that employed by many department stores in the U.S. However, this model is also different from the model found at large electronic retailers like Best Buy and general retailers like Wal-Mart. We have found that many investors are curious as to why the model in China differs from the one found in the U.S. We believe, the main reasons are:
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We decrease the financial risk for our retail partners by assuming responsibility for the inventory and capital expense associated with distributing our products.
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We decrease operational risk for our retail partners by hiring and managing employees and handling logistics issues such as wholesale purchase and delivery and returns and after-sales service.
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We decrease merchandising risk for our retail partners by bringing product expertise and specific market knowledge that is difficult for large retailers to develop on their own across a broad range of product categories.
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China’s size, regional differences, logistical difficulties, managerial challenges, underdeveloped credit markets, and rapid growth rate increases risk for all retailers and drive the need to mitigate risk which is why our retail partners rely on us.
Organizational Structure
China 3C was incorporated on August 20, 1998 under the laws of the State of Nevada. Capital Future Developments Limited - BVI (“Capital”) was incorporated on July 22, 2004 under the laws of the British Virgin Islands. Zhejiang Yong Xin Digital Technology Company Limited (“Zhejiang”), Yiwu Yong Xin Communication Limited (“Yiwu”), Hangzhou Wang Da Electronics Company Limited (“Wang Da”), Hangzhou Sanhe Electronic Technology Limited (“Sanhe”), and Shanghai Joy & Harmony Electronics Company Limited (“Joy & Harmony”) were incorporated under the laws of Peoples Republic of China (“PRC”) on July 11, 2005, July 18, 1997, March, 30, 1998, April 12, 2004, and August 20, 2003, respectively. On March 10, 2009 Zhejiang set up a new operating entity, Hangzhou Letong Digital Technology Co., Ltd. (“Letong”). During 2009, Letong did not have any operation. On July 6, 2009, Zhejiang and Yiwu completed acquisition of Jinhua Baofa Logistic Ltd (“Jinhua”). Jinhua was incorporated under the laws of PRC on December 27, 2001.
On December 21, 2005, Capital became a wholly- owned subsidiary of China 3C Group through a reverse merger (“Merger Transaction”). China 3C Group acquired all of the issued and outstanding capital stock of Capital pursuant to a Merger Agreement dated at December 21, 2005 by and among China 3C Group, XY Acquisition Corporation, Capital and the shareholders of Capital (the “Merger Agreement”). Pursuant to the Merger Agreement, Capital became a wholly owned subsidiary of China 3C Group and, in exchange for the Capital shares, China 3C Group issued 35,000,000 shares of its common stock to the shareholders of Capital, representing 93% of the issued and outstanding capital stock of China 3C Group at that time and cash of $500,000.
On August 3, 2006, Capital purchased 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 purchased 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, Capital entered into contractual agreements with Zhejiang whereby Capital owns a 100% interest in the revenues of Zhejiang. Capital does not have an equity interest in Zhejiang, but enjoys all the economic benefits. Under this structure, Zhejiang is now a wholly foreign owned enterprise of Capital. The contractual agreements give Capital and its equity owners an obligation, and having ability to absorb, any losses, and rights to receive returns. Capital will be unable to make significant decisions about the activities of Zhejiang and cannot carry out its principal activities without financial support. These characteristics as defined in Accounting Standard Codification (“ASC”) Topic 810-10 , previously 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.
Acquisitions
On July 6, 2009, China 3C and its subsidiary Zhejiang and Yiwu purchased 100% interest of Jinhua for RMB 120 million (approximately $17.5 million) in cash. Zhejiang acquired 90% and Yiwu acquired 10% of the entire equity interests in Jinhua.
Jinhua provides transportation logistics services to businesses. Jinhua operates primarily in Eastern China and covers many of the most developed cities in the Eastern China such as Shanghai, Hangzhou and Nanjing.
The purchase price and related allocation to the estimated fair values of the assets acquired and liabilities assumed, after proportionately allocating the goodwill resulting from the transaction in accordance with ASC 805 “Business Combinations” was as follows:
(dollar amounts in thousands of US dollars)
Following the acquisition of Jinhua, the Company began providing logistic service to businesses in addition to its traditional business of resale and distribution of third party products such as mobile phones, facsimile machines, DVD players, stereos, speakers, MP3 and MP4 players, iPods, electronic dictionaries, CD players, radio Walkmans and audio systems.
Our corporate structure as of December 31, 2009 is as follows:
Our Business
Information About Our Segments
During fiscal year 2009, we operated five reportable segments:
a.
Yiwu Yong Xin Telecommunication Company, Limited, or “Yiwu,” focuses on the selling, circulation and modern logistics of fax machines and cord phone products.
b.
Hangzhou Wang Da Electronics Company, Limited, or “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.
c.
Hangzhou Sanhe Electronic Technology Limited “Sanhe,” focuses on the selling, circulation and modern logistics of home electronics, including DVD players, audio systems, speakers, televisions and air conditioners.
d.
Shanghai Joy & Harmony Electronics Company Limited or “Joy & Harmony,” focuses on the selling, circulation and modern logistics of consumer electronics, including MP3 players, MP4 players, iPod, electronic dictionary, radios, and Walkmans.
e.
Jinhua Baofa Logistic Company Litmited or “Jinhua” provides transportation logistics services to businesses. Jinhua operates primarily in Eastern China and covers many of the most developed cities in the Eastern China such as Shanghai, Hangzhou and Nanjing
Financial information about our segments is included in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, and Note 13, Segment Information, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.
Yiwu Yong Xin Telecommunication Company, Limited (“Yiwu”)
Yiwu is an authorized sales agent, focusing on the selling, circulation and modern logistics of fax machines and cord phone products in China. Yiwu mainly distributes Philips fax machines and China’s top local brands Feng Da and CJT fax machines. Yiwu sells its products through retail “stores in stores” located in major department stores throughout the Huadong Region of China (consisting of the Chinese provinces of Zhejiang, Jiangsu and Anhui). Yiwu had 272 retail locations in 2009. Yiwu contributed 20.2% of revenue to the Company in 2009.
The five largest suppliers for Yiwu are Feng Da High Technology Company Limited, Hangzhou Senruida Trade Company Limited, Shanghai Zhongfang Electronics Company Limited, Ninbo Zhongxun Electronics Company Limited and Wenzhou Jingwei Company. The top five suppliers contributed 74% of purchases of Yiwu in 2009.The five largest customers for Yiwu are Shanghai GOME Electrical Appliances Limited, Suning Appliance Company Limited, Zhejiang GOME Appliances Company, Shanghai Suning Appliance Company Limited, Yongle China Appliance Company Limited. The top five customers contributed 34% of revenue of Yiwu in 2009.
Yiwu has a diverse customer base and, the loss of any single customer is not expected to have a material adverse affect on Yiwu’s business and operations. Yiwu did not spend a material amount of money on research and development, and did not have a significant backlog as of December 31, 2009.
The main competitors of Yiwu are Hangzhou Yin Dun Company, Hangzhou Si Tong Company, and Zhejiang Shen You Electrical Appliance Company, Shanghai Haodi Communication Equipment Co., Ltd and Zhejiang Xincheng Technology Co., Ltd. Yiwu has many years of long term relationships with well-known brands, which provides Yiwu with advantages in purchase price compared to its competitors. In addition, Yiwu has the competitive advantage of maintaining an extensive distribution network.
Hangzhou Wang Da Electronics Company, Limited (“Wang Da”)
Wang Da is an authorized sales agent focusing on the selling, circulation and modern logistics of cell phones, cell phone products, IT products (including notebook or laptop computers), and digital products (including digital cameras, digital camcorders, MP3 players, PDAs, flash disks, and removable hard disks) in China. Wang Da mainly distributes its products through retail “stores in stores” located in major department stores throughout the “Huadong” region of China (consisting of the Chinese provinces of Zhejiang, Jiangsu and Anhui). Wang Da had 215 retail locations in 2009. Wang Da contributed 27.5% of revenue to the Company in 2009.
The five largest suppliers for Wang Da are Shenzhen Tianyin Telecommunication Company Limited, Shanghai Post & Telecom Appliances Company - Hangzhou Branch,, Hangzhou Qiuxin Internet Equipment Company Limited Hangzhou Tianchen Digital Telecommunication Company Limited and Hangzhou Weihua Telecommunication Company Limited. The five largest suppliers contributed 46% of the purchases of Wang Da in 2009. The five largest customers for Wang Da are Zhejiang Suning Appliance Company Limited, Zhejiang GOME Appliances Company, Shanghai Jiadeli Supermarket Group, Shanghai Guangda Comunication Terminate products Sales Co.Ltd and Suzhou Meijia Supermarket Group. The top five customers contributed 17% of revenue of Wang Da in 2009.
Wang Da has a diverse customer base and the loss of any single customer is not expected to have a material adverse affect on the Company’s business and operations. Wang Da did not spend a material amount of money on research and development and did not have a significant backlog as of December 31, 2009.
The main competitors of Wang Da include Telephone World, Hangzhou Yindun, Shanghai Guangda, Changjiang Tianyin and Hangzhou Zhenghua. Additionally, there are Ningbo Haishu and Zhongyu. Wang Da has many years of experiences in mobile phone sales. Wang Da has a wide distribution network in Zhejiang, Shanghai, Jiangsu and other regions. These competitors use different business models such as “store in stores”, free standing stores and distribution channels. The competitors have smaller scale of operation and smaller distribution regions compared to Wang Da. Therefore, these competitors typically have only a fraction of our sales.
Hangzhou Sanhe Electronic Technology Limited (“Sanhe”)
Sanhe is a home electronics retail chain in Eastern China, headquartered in HangZhou City. It had 210 retail “store in stores” in Shanghai City, Zhejiang Province and Jiangsu Province in 2009. Sanhe specializes in the sale of home electronics, including air conditioners, audio systems, speakers and DVD players. In 2006, Sanhe expanded its business to the television sets, and has received sales agent licenses from TCL, Chuangwei and Haier. Sanhe contributed 25% of revenue to the Company in 2009.
The five largest suppliers for Sanhe are Zhejiang Zhuocheng Digital Electronics Company Limited, Hangzhou Xietong Trade Co., Limited, Shanghai Haier Industrial and Trade Company, Zhejiang Saixin Technology Limited , Shenzhen Chuangwei-RGB Electronics Company. The five largest suppliers contributed 62% of the purchases of Sanhe in 2009. The five largest customers for Sanhe are Lianhua Supermarket Group, Hangzhou Lianhua Huashang Group, Jiangsu Times Supermarket Company Limited, Shanghai Lotus Supercenter and Zhejiang Huarun Vanguard Company Limited. The top five customers contributed 29% of revenue of Sanhe in 2009.
Sanhe has a diverse customer base and, the loss of any one customer would not likely have an adverse effect on the Company’s sales. The Company did not spend a material amount of money on research and development, and did not have a significant backlog for 2009.
The main competitors of Sanhe include Hangzhou Meidi, Hangzhou Danong, Nanjing Mingci, Shanghai Feitong and Jiangshu Huayi. Additionally, there is Baicheng Group with sales of approximately $30 million per year and Shanghai Feiteng with sales of approximately $30-40 million per year. Sanhe has many years of experience in the sale of home electronics which has allowed it to build good relationships with brand name companies such as TCL, Skyworth, Meidi, Longdi and Galanz. In addition, Sanhe has the competitive advantage of maintaining an extensive distribution network.
Shanghai Joy & Harmony Electronics Company Limited (“Joy & Harmony”)
Joy & Harmony is a consumer electronics retail chain in Eastern China. It had 218 retail outlets in Shanghai City and Jiangsu Province in 2009. Joy & Harmony specializes in the sale of consumer electronics, including MP3 players, MP4 players, iPods, electronic dictionaries, CD players, radios, Walkmans, audio systems and speakers. The company is the authorized sales agent for well-known manufacturers in China, including Tecsun Radio and Changhong ZARVA. Joy & Harmony contributed 25% of revenue to the Company in 2009.
The five largest suppliers for Joy & Harmony are Shanghai Ganshun Trade Company Limited, Huaqi Information Digital Technology Company Limited (Aigo) - Shanghai, SONY-Shanghai Company Limited, Shanghai Jingming Technology Company Limited and Shanghai China-tex Electronic System Company Limited. The five largest suppliers contributed 49% of the purchases of Joy & Harmony in 2009. The five largest customers for Joy & Harmony are Shanghai No. 1 Department Store Company Limited, Shanghai Lanle Trade Company Limited, Da Run Fa Company Limited, Hualian Jimai Sheng Company Limited, Shanghai Lanle Trade Company Limited and Shanghai Lian Jia Supermarket Company Limited. The top five customers contributed 2% of revenue of Joy & Harmony in 2009.
As a retailer with hundreds of locations, the Company is not reliant on any one customer or on a few customers. The loss of any one customer would not likely have an adverse effect on Joy & Harmony’s sales. Joy & Harmony did not have any material backlog of orders at December 31, 2009. Joy & Harmony did not spend a material amount of money on research and development in 2009.
The main competitors of Joy & Harmony include Shanghai Huaning, Shanghai Juexiang, Shanghai Wansi and Shanghai Feitong. Joy & Harmony’s competitors are a combination of a large number of very small stores who lack the Company’s economies and scale, as well as a small number of large players such as large department stores. Additional competitors include Shanghai Yonguan Digital with sales of approximately $45 million per year, Shanghai Dongqi with sales of approximately of $7-8 million per year, and Shanghai Yidunj of sales of $4-5 million per year. Joy & Harmony has a large number of retail locations compared to its competitors. In addition, Joy & Harmony has built good relationships with suppliers of well-known brands such as Apple, Sony, Meizu, Desheng and Aigo.
Jinhua Baofa Logistic Litmited (“Jinhua”)
Jinhua has been in operation since 2001. Jinhua transports electronics, machinery and equipment, metal products, chemical materials, garments and handcrafted goods for businesses in the Eastern China region in which China 3C operates, such as Shanghai, Hangzhou and Nanjing.
The five largest vendors for Jinhua are Zhejiang Sheng Tong Logistic Co. Ltd, Hang Zhou Shen Zhou Transportation Co. Ltd, Shanghai Sheng Hui Transportation Co. Ltd Shanghai Hong Wei Transportation Co. Ltd and Jiaxing Guohong Vehicle Transpportation Co. Ltd. The five largest vendors contributed to 34% of direct cost of Jinhua in 2009. The five largest customers for Jinhua are Guangzhou Shuntong Transportation Co. Ltd, Wuhan Tianda Transportation Co. Ltd, Xiamen Shida Transportation Co. Ltd, Hefei Yuanshunda Huoyun Co. Ltd. and Shenzhen Jingpeng Kuaiyun Co. Ltd. The top five customers contributed 10% of revenue of Jinhua in 2009.
The main competitors of Jinhua include Hangzhou Hongrun Transportation Co., Ltd, Hangzhou Tianzhao Logistics Co., Ltd, Hangzhou Huishen Logistics Co., Ltd, Terry Logistics Group Co., Ltd, Shanghai Yanfu Logistics Co., Ltd, Shanghai Zhicheng Logistics Co., Ltd and Shanghai Jiaje Express Co., Ltd
Intellectual Property
We consider our logos important to our business. We applied to register 10 logos with the State Administration of Industry and Commerce in China and are currently awaiting the administration’s approval.
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. Nevertheless, at times, China can experience particularly inclement weather in January and February which can serious disrupt the Company’s supply chain management systems. As our business model is to operate only on several days of inventory, the effects of such weather disruptions can be severe in certain years.
Working Capital
We fund our business operations through a combination of available cash and cash equivalents, short-term investments and cash flows generated from operations.
Due to the global economic slowdown, we have extended the payment terms for all our retail partners from 30 days to 45 days and wholesale department from 10 days to 15 days. This will lead to an increase in our accounts receivable. The increase in accounts receivable will cause a decrease in working capital.
We believe that our currently available working capital, primarily cash from operation, is adequate to execute our current business plan.
Customers
We do not have a significant concentration of sales with any individual customer and, therefore, the loss of any one customer would not have a material impact on our business. No single customer has accounted for 10% or more of our total revenue in 2009.
Backlog
We do not have a material amount of backlog orders.
Government Contracts
No material portion of our business is subject to renegotiation of profits or termination of contracts or subcontracts at the election of the Chinese government.
Competition
We compete against other consumer electronics retailers and wholesalers. We compete principally on the basis of product assortment and availability and value pricing, customer service; store location and convenience and after-sales services. We believe our broad product assortment, competitive pricing and convenient store locations differentiate us from most competitors. Our stores compete by emphasizing a complete product and service solution and value pricing. In addition, our trained and knowledgeable sales and service staffs allow us to tailor the offerings to meet the needs of our customers.
Research and Development
We have not engaged in any material research and development activities during the past three fiscal years.
Environmental Matters
We are subject to China’s National Environmental Protection Law, as well as a number of other national and local laws and regulations regulating air, water and noise pollution and setting pollutant discharge standards. We believe that all our operations are in material compliance with all applicable environmental laws. We did not incur any costs to comply with environmental laws in 2009 and 2008.
Employees
The Company currently has 2,205 employees, all of which are full time employees located in China. Zhejiang has 69 employees, Yiwu has 338 employees, Wang Da has 528 employees, Sanhe has 528 employees, Joy & Harmony has 349 employees and Jinhua has 393 employees.
The Company has no collective bargaining agreements with any unions.
ITEM 1A.
ITEM 1A. RISK FACTORS
Risk Factors Associated with Our Business
A general economic downturn, a recession in China or sudden disruption in business conditions may affect consumer purchases of discretionary items, including consumer and business products, which could adversely affect our business. Consumer spending is generally affected by a number of factors, including general economic conditions, the level of unemployment, inflation, interest rates, energy costs, gasoline prices and consumer confidence generally, all of which are beyond our control. Consumer purchases of discretionary items tend to decline during recessionary periods, when disposable income is lower, and may impact sales of our products. In addition, sudden disruptions in business conditions as a result of a terrorist attack, retaliation and the threat of further attacks or retaliation, war, adverse weather conditions and climate changes or other natural disasters, pandemic situations or large scale power outages can have a short or, sometimes, long-term impact on consumer spending. A downturn in the economies in China, including any recession or a sudden disruption of business conditions in China’s economy, could adversely affect our business, financial condition, and results of operation.
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.
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.
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.
If we do not anticipate and respond to changing consumer preferences in a timely manner, our operating results could materially suffer. Our business depends, in large part, on our ability to introduce successfully new products, services and technologies to consumers, the frequency of such introductions, the level of consumer acceptance, and the related impact on the demand for existing products, services and technologies. Failure to predict accurately constantly changing consumer tastes, preferences, spending patterns and other lifestyle decisions, or to address effectively consumer concerns, could have a material adverse effect on our revenue, results of operations and standing with our customers.
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.
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.
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 Jian Zhang, 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.
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.
Certain political and economic considerations relating to China could adversely affect our company. China is transitioning from a planned economy to a market economy. While the PRC government has pursued economic reforms since its adoption of the open-door policy in 1978, a large portion of the Chinese economy is still operating under five-year plans and annual state plans. Through these plans and other economic measures, such as control on foreign exchange, taxation and restrictions on foreign participation in the domestic market of various industries, the PRC government exerts considerable direct and indirect influence on the economy. Many of the economic reforms carried out by the PRC government are unprecedented or experimental, and are expected to be refined and improved. Other political, economic and social factors can also lead to further readjustment of such reforms. This refining and readjustment process may not necessarily have a positive effect on our operations or future business development. Our operating results may be adversely affected by changes in China’s economic and social conditions as well as by changes in the policies of the PRC government, such as changes in laws and regulations, or the official interpretation thereof, which may be introduced to control inflation, changes in the interest rate or method of taxation, and the imposition of additional restrictions on currency conversion.
Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof, and could require us to divest ourselves of any interest we then hold in Chinese properties or joint ventures.
Due to various restrictions under PRC laws on the distribution of dividends by our PRC operating companies, we may not be able to pay dividends to our stockholders. The Wholly Foreign Owned Enterprise Law (1986), as amended and The Wholly Foreign Owned Enterprise Law Implementing Rules (1990), as amended, contain the principal regulations governing dividend distributions by wholly foreign owned enterprises. Under these regulations, wholly foreign owned enterprises, such as Zhejiang, Wang Da and Joy & Harmony, may pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. Additionally, Zhejiang, Wang Da and Joy & Harmony are required to set aside a certain amount of any accumulated profits each year (a minimum of 10%, and up to an aggregate amount equal to half of its registered capital), to fund certain reserve funds. These reserves are not distributable as cash dividends except in the event of liquidation and cannot be used for working capital purposes. The PRC government also imposes controls on the conversion of RMB into foreign currencies and the remittance of currencies out of the PRC. If we ever determine to pay a dividend, we may experience difficulties in completing the administrative procedures necessary to obtain and remit foreign currency for the payment of such dividends from the profits of Zhejiang, Wang Da and Joy & Harmony.
Currency conversion and exchange rate volatility could adversely affect our financial condition and the value of our common stock. The PRC government imposes control over the conversion of Renminbi, or RMB, into foreign currencies. Under the current unified floating exchange rate system, the People’s Bank of China, or PBOC, publishes an exchange rate, which we refer to as the PBOC exchange rate, based on the previous day’s dealings in the inter-bank foreign exchange market. Financial institutions authorized to deal in foreign currency may enter into foreign exchange transactions at exchange rates within an authorized range above or below the PBOC exchange rate according to market conditions.
Pursuant to the Foreign Exchange Control Regulations of the PRC issued by the State Council which came into effect on April 1, 1996, and the Regulations on the Administration of Foreign Exchange Settlement, Sale and Payment of the PRC which came into effect on July 1, 1996, regarding foreign exchange control, conversion of RMB into foreign exchange by Foreign Investment Enterprises, or FIEs, for use on current account items, including the distribution of dividends and profits to foreign investors, is permissible. FIEs are permitted to convert their after-tax dividends and profits to foreign exchange and remit such foreign exchange to their foreign exchange bank accounts in China. Conversion of RMB into foreign currencies for capital account items, including direct investment, loans, and security investment, is still under certain restrictions. On January 14, 1997, the State Council amended the Foreign Exchange Control Regulations and added, among other things, an important provision, which provides that the PRC government shall not impose restrictions on recurring international payments and transfers under current account items.
Enterprises in China, including FIEs, which require foreign exchange for transactions relating to current account items, if within a certain limited amount may, without approval of the State Administration of Foreign Exchange, or SAFE, effect payment from their foreign exchange account or convert and pay at the designated foreign exchange banks by providing valid receipts and proofs.
Convertibility of foreign exchange in respect of capital account items, such as direct investment and capital contribution, is still subject to certain restrictions, and prior approval from the SAFE or its relevant branches must be sought.
Our wholly owned subsidiaries, Zhejiang, Wang Da and Joy & Harmony are FIEs to which the Foreign Exchange Control Regulations are applicable. There can be no assurance that we will be able to obtain sufficient foreign exchange to pay dividends or satisfy other foreign exchange requirements in the future.
Between 1994 and 2004, the exchange rate for RMB against the U.S. dollar remained relatively stable, most of the time in the region of RMB8.28 to US$1.00. However, in 2005, the Chinese government announced it would begin pegging the exchange rate of the RMB against a number of currencies, rather than just the U.S. dollar. As our operations are primarily in China, any significant revaluation of the RMB may materially and adversely affect our cash flows, revenues, financial condition and the value of our common stock. For example, to the extent that we need to convert U.S. dollars into RMB for our operations, appreciation of this currency against the U.S. dollar could have a material adverse effect on our business, financial condition, results of operations and the value of our common stock. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of declaring dividends on our common stock or for other business purposes and the U.S. dollar appreciates against the RMB, the U.S. dollar equivalent of our earnings from our subsidiaries in China would be reduced.
The legal system in China has inherent uncertainties that may limit the legal protections available in the event of any claims or disputes with third parties. The legal system in China is based on written statutes. Prior court decisions may be cited for reference but have limited precedential value. Since 1979, the central government has promulgated laws and regulations dealing with economic matters such as foreign investment, corporate organization and governance, commerce, taxation and trade. As China’s foreign investment laws and regulations are relatively new and the legal system is still evolving, the interpretation of many laws, regulations and rules is not always uniform and enforcement of these laws, regulations and rules involve uncertainties, which may limit the remedies available in the event of any claims or disputes with third parties. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention.
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.
Our common stock may be deemed penny stock with a limited trading market. Our common stock is currently listed for trading in the OTC Bulletin Board, which is generally considered to be a less efficient market 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 OTC Bulletin Board, 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. We have no plans for declaring or paying dividends in the foreseeable future. We intend to retain earnings, if any, to provide funds for the implementation of our new business plan. 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. Also, see risk factor titled “Due to various restrictions under PRC laws on the distribution of dividends by our PRC operating companies, we may not be able to pay dividends to our stockholders.”
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
The Company does not own any real estate properties; all of the properties are leased. The lease terms are as follows:
Yiwu
1.
Yiwu headquarter office: lease term: one year (Aug. 2009 - Aug. 2010).
2.
Apartments: Yiwu building, Yiwu village, Lease term: two years (July 2008 - July 2010).
3.
Wenzhou Office: lease term: one year (June 2009 -June 2010).
Wang Da
1.
Nanjing Office: lease term one year (May 2009- May 2010).
Sanhe
1.
Hangzhou office: lease term five year (May 2009 - May 2014).
2.
Hangzhou Office: lease term : five years (Aug. 2006 - Aug. 2011).
3.
Wuxi Office: lease term: two years (Sep. 2008 - Sep. 2010).
4.
Shanghai Office: lease term: two years (Apr. 2009 - Apr. 2011).
Joy & Harmony
1.
Wuxi Tower office: lease term one and half year (June 2009 - Nov. 2010).
Jinhua
1.
Hangzhou office and warehouse: lease term 3 years (May 2007 - Apr. 2010).
2.
Parking lot: lease term 2 years (Sep. 2009 - Aug. 2011).
3.
Airport parking: lease term: 1 year(Sep. 2009 - Aug. 2010).
4.
Other leases - parking, warehouse, distribution and dorm.
The Company believes its leased spaces are adequate and suitable to maintain and develop its business operations.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are not a party to any material pending legal proceedings.
ITEM 4.
ITEM 4. RESERVED FOR FUTURE USE BY THE SECURITIES AND EXCHANGE COMMISSION
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company’s common stock is quoted on the OTC Bulletin Board under the symbol “CHCG.OB.” The following table sets forth the range of quarterly high and low closing bids of the common stock as reported during the years ending December 31, 2008 and December 31, 2009 and through March 31, 2010:
*
The quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions.
Stockholders
As of the close of business on April 15, 2009, there were approximately 73 holders of record of the Company’s common stock. However, we believe there are additional beneficial owners of our common stock who own their shares in “street name.”
Dividends
The Company did not pay any dividends during 2008 and 2009. The Company has no plans to declare cash dividends on its common stock in the future. If the Company ever determines to pay a dividend, it may experience difficulties in completing the administrative procedures necessary to obtain and remit foreign currency from the PRC for the payment of such dividends from the profits of its operating subsidiaries in China. Please see additional discussion under Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations; Financial Condition, Liquidity and Capital Resources.
Equity Compensation Plan Information
On January 15, 2009, the Company’s Board of Directors (“BOD”) adopted the China 3C Group 2008 Omnibus Securities and Incentive Plan (the “2008 Plan”). The 2008 Plan provides for the granting of distribution equivalent rights, incentive stock options, non-qualified stock options, performance share awards, performance unit awards, restricted stock awards, stock appreciation rights, tandem stock appreciation rights, unrestricted stock awards or any combination of the foregoing, as may be best suited to the circumstances of the particular employee, director or consultant. Under the 2008 Plan 2,000,000 shares of the Company’s common stock were initially available for issuance for awards. Each award shall remain exercisable for a term of ten (10) years from the date of its grant. The price at which a share of common stock may be purchased upon exercise of an option shall not be less than the closing sales price of the common stock on the date such option is granted. The 2008 Plan shall continue in effect, unless sooner terminated, until the tenth anniversary of the date on which it is adopted by the Board. As of March 31, 2010, 2,728 shares of the Company’s common stock were available for issuance of awards.
Securities authorized for issuance under equity compensation plans
The following is a summary of all of our equity compensation plans as of December 31, 2009.
Repurchase of Securities
We did not repurchase any of shares of our common stock during the fourth quarter of 2009.
Recent Sales of Unregistered Securities
On May 7, 2007 the BOD appointed Joseph J. Levinson to serve as a member of the BOD of the Company and to be in charge of the Company’s investor relations. As compensation for his services, Mr. Levinson received: (1) $60,000 per year, payable in equal quarterly installments; (2) a monthly grant during his term of his services of 1,000 shares of the Company’s common stock; (3) an initial annual grant of a stock option to purchase 300,000 shares of the Company's common stock, with an exercise price of $6.15 per share (the “2007 Stock Option”) under the China 3C Group 2005 Equity Incentive Plan; and (4) a subsequent annual grant of a stock option to purchase an additional 300,000 shares of the Company's common stock, with an exercise price of $1.82 (the “2008 Stock Option”) under the China 3C Group 2005 Equity Incentive Plan. In addition, the Company agreed that Mr. Levinson would receive (1) $2,500 for each Board meeting that he attends, (2) $2,000 for each meeting of a committee of the Board that he attends, (3) $5,000 upon being named the chairman of any Board committee, and (4) $4,500 as a one time bonus upon joining the Board. It was later determined that due to the expiration of the China 3C Group 2005 Equity Incentive Plan on December 31, 2006, the 2007 Stock Option and the 2008 Stock Option were not validly granted. Pursuant to the terms of the Compensation Agreement dated as of November 27, 2008 between Mr. Levinson and the Company, Mr. Levinson acknowledged that the 2007 Stock Option and the 2008 Stock Option were not and will not be granted and in consideration for his services as a Director accepted the issuance of 125,000 shares of the Company’s common stock. The 125,000 shares of the Company’s common stock were issued to Mr. Levinson on January 7, 2009.
On January 15, 2009, the Company’s BOD adopted the China 3C Group, Inc. 2008 Omnibus Securities and Incentive Plan (the “2008 Plan”). The 2008 Plan provides for the granting of distribution equivalent rights, incentive stock options, non-qualified stock options, performance share awards, performance unit awards, restricted stock awards, stock appreciation rights, tandem stock appreciation rights, unrestricted stock awards or any combination of the foregoing, as may be best suited to the circumstances of the particular employee, director or consultant. Under the 2008 Plan 2,000,000 shares of the Company’s common stock were available for issuance for awards. Each award shall remain exercisable for a term of ten (10) years from the date of its grant. The price at which a share of common stock may be purchased upon exercise of an option shall not be less than the closing sales price of the common stock on the date such option is granted. The 2008 Plan shall continue in effect, unless sooner terminated, until the tenth anniversary of the date on which it is adopted by the BOD. In May and October 2009, the Company issued 1,097,272 and 900,000 shares of common stocks, respectively, pursuant to two consulting agreements for 3 years consulting service under the 2008 Plan.
In June 2009, pursuant to an employment agreement, an option grant to purchase 100,000 shares of common stock of the Company was issued to Mr. Jian Zhang for his service as the Company’s chief financial officer.
In December 2009, pursuant to aboard of directors agreement, an option grant to purchase 30,000 shares of common stock of the Company was issued to Mr. Kenneth T. Berents for serving as a director of the Company.
Forward Looking Statements
We have included and from time to time may make in our public filings, press releases or other public statements, certain statements, including, without limitation, those under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7. In some cases these statements are identifiable through the use of words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “project,” “target,” “can,” “could,” “may,” “should,” “will,” “would” and similar expressions. You are cautioned not to place undue reliance on these forward-looking statements. In addition, our management may make forward-looking statements to analysts, investors, representatives of the media and others. These forward-looking statements are not historical facts and represent only our beliefs regarding future events, many of which, by their nature, are inherently uncertain and beyond our control.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated statement of income and comprehensive income data for the years ended December 31, 2009, 2008 and 2007 and the selected consolidated balance sheet data as of December 31, 2009 and 2008 are derived from our audited consolidated financial statements included elsewhere in this Annual Report.
The selected consolidated balance sheet data as of December 31, 2007, 2006 and 2005, and the selected consolidated financial data for the years ended December 31, 2007 and 2006, are derived from our audited consolidated financial statements not included in this Annual Report.
The following selected consolidated historical financial information should be read in conjunction with our consolidated financial statements and related notes and the information contained in Item 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto appearing elsewhere in this Form 10-K. 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-K.
Overview
China 3C was incorporated on August, 20, 1998 under the laws of the State of Nevada. Capital Future Developments Limited (“CFDL”) was incorporated on July 22, 2004 under the laws of the British Virgin Islands. Zhejiang Yong Xin Digital Technology Company Limited (“Zhejiang”), Yiwu Yong Xin Communication Limited (“Yiwu”), Hangzhou Wandda Electronics Company Limited (“Wang Da”), Hangzhou Sanhe Electronic Technology, Limited (“Sanhe”), and Shanghai Joy & Harmony Electronic Development Company Limited (“Joy & Harmony”) were incorporated under the laws of 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 Joy & Harmony and Sanhe. Until August 14, 2007, when it made the change to its ownership structure described in the next paragraph in order to comply with certain requirements of PRC law, CFDL owned 100% of the capital stock of Zhenjiang. Zhejiang owns 90% and Yiwu owns 10% of Wang Da. Zhejiang owns 90% and Wang Da owns 10% of Yiwu. On March 10, 2009 Zhejiang set up a new operating entity, Hangzhou Letong Digital Technology Co., Ltd. (“Letong”) to establish an electronic retail franchise operation for China 3C Group. On July 6, 2009, Zhejiang and Yiwu completed acquisition of Jinhua Baofa Logistic Ltd (“Jinhua”). Jinhua was incorporated under the laws of PRC on December 27, 2001.
Collectively the nine corporations are referred to herein as the Company.
On December 21, 2005, CFDL became a wholly owned subsidiary of China 3C through a merger with a wholly owned subsidiary of the Company (the “Merger Transaction”). China 3C acquired all of the issued and outstanding capital stock of CFDL pursuant to a Merger Agreement dated at December 21, 2005 by and among China 3C, XY Acquisition Corporation, CFDL and the shareholders of CFDL (the “Merger Agreement”). Pursuant to the Merger Agreement, CFDL became a wholly owned subsidiary of China 3C Group and, in exchange for the CFDL shares, China 3C issued 35,000,000 shares of its common stock to the shareholders of CFDL, representing 93% of the issued and outstanding capital stock of China 3C at that time and a cash consideration of $500,000. 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 ASC 810, Consolidation of Variable Interest Entities (VIEs), qualifies the business operations of Zhejiang to be consolidated with CFDL and ultimately with China 3C.
As a result of the Merger Agreement, the reorganization was treated as an acquisition by the accounting acquiree that is being accounted for as a recapitalization and as a reverse merger by the legal acquirer for accounting purposes. Pursuant to the recapitalization, all capital stock shares and amounts and per share data have been retroactively restated. Accordingly, the financial statements include the following:
(1) The balance sheet consists of the net assets of the accounting acquirer at historical cost and the net assets of the legal acquirer at historical cost.
(2) The statements of operations include the operations of the accounting acquirer for the period presented and the operations of the legal acquirer from the date of the merger.
Pursuant to a share exchange agreement, dated August 3, 2006, we issued 915,751 shares of restricted common stock, to the former shareholders of Sanhe. The shares were valued at $3,750,000, 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 Joy & Harmony. 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.
On July 6, 2009, China 3C’s subsidiaries, Zhejiang and Yiwu completed acquisition of Jinhua, a company organized under the laws of the PRC. Zhejiang acquired 90% and Yiwu acquired 10% of the entire equity interests in Jinhua from the shareholders of Jinhua for a total purchase price of RMB 120,000,000 (approximately $17.5 million) in cash.
The Company is engaged in the business of resale and distribution of third party products and generates approximately 100% of its revenue from resale of items such as mobile phones, facsimile machines, DVD players, stereos, speakers, MP3 and MP4 players, iPod, electronic dictionaries, CD players, radios, Walkmans, and audio systems. We sell and distribute products through retail stores and secondary distributors. We operate substantially all of our retail operations through our “store in store” model. Under this model, the Company leases space in major department stores and retailers. Leasing costs can vary based on a percentage of sales, or can be fixed. For the year ended December 31, 2009, all of our stores in stores leases were variable based on sales. After acquisition of Jinhua in July 2009, the Company started provideing transportation service to business in Eastern China.
Results of Operations
Year Ended December 31, 2009 compared to Year Ended December 31,
Reportable Operating Segments
The Company reports financial and operating information in the following five 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 “Joy & Harmony”
e)
Jinhua Baofa Logistic Limited or “Jinhua”
a)
Yiwu Yong Xin Telecommunication Company, Limited or “Yiwu”
Yiwu focuses on the selling, circulation and modern logistics of fax machines and cord phone products.
All amounts, except percentage of revenues, in thousands of U.S. dollars.
For the year ended December 31, 2009, Yiwu generated revenue of $42,064, a decrease of $21,306 or 33.62% compared to $63,370 for the year ended December 31, 2008. Gross profit decreased $7,160 or 71.76% from $9,978 for the year ended 2008 to $2,818 for the year ended 2009. Operating losses was $612 in 2009, a decrease of $8,227 or 108.04% compared to operating income of $7,615 in 2008. Such decrease in revenue was primarily due to the shrinking market in office communication products. The decrease in revenue was also a result of closing 23 stores in stores in 2009.
Gross profit margin decreased from 15.75% in 2008 to 6.7% in 2009, a decrease of 9.05%. Such decrease is primarily due to of the more competitive fax machines and telephone market in China as compared to 2008. In order to maintain market shares, we had to launch more promotions which negatively affected the gross margin. In addition, sales rebate paid to suppliers as a percentage of sales increased in 2009, which led to lower gross margin of Yiwu.
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.
For the year ended December 31, 2009, Wang Da generated revenue of $57,432, a decrease of $45,503 or 44.21% compared to $102,935 for the year ended December 31, 2008. Gross profit decreased $11,025 or 67.58% from $16,313 for the year ended 2008 to $5,288 for the year ended 2009. Operating losses was $262 in 2009, a decrease of $8,227 or 102.27% compared to operating income of $11,527 in 2008. The decrease in revenue was primarily due to the high competition from government-owned large telecommunication service providers. Telecommunication service providers started to open their direct operating stores to sell communication products and also launched promotions such as “free phone with service contract” in 2009. In addition, the introduction of 3G phones caused lower demand for the old model mobile phones. Meanwhile, the 3G network is still in the trial period, customers are waiting to upgrade to 3G phones until the 3G network is complete. The decrease in revenue was also attributed to the closing of 42 stores in stores in 2009.
Gross profit margin decreased from 15.85% in 2008 to 9.21% in 2009. The decrease was due to lower unit price of old model mobile phones as a result of the introduction of the 3G phones.
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.
For the year ended December 31, 2009, Sanhe generated revenue of $51,674, a decrease of $18,569 or 26.44% compared to $70,243 for the year ended December 31, 2008. Gross profit decreased $5,528 or 44.43% from $12,444 for the year ended 2008 to $6,916 for the year ended 2009. Operating losses was $741 in 2009, a decrease of $8,250 or 109.87% compared to operating income of $7,509 in 2008. The increase in revenue was primarily due to the shrinking market in DVD players and small home electronics as well as the closing of 24 stores in 2009.
Gross profit margin decreased from 17.72% in 2008 to 13.38% in 2009. The decrease in gross profit and operation income was primarily due to the change in sales revenue mix. In 2009, due to the lesser sales of DVD players and other small home electronics, sales volume of TV sets, which has a lower margin, comparatively increased. Therefore, gross margin for Sanhe decreased in 2009.
d) Shanghai Joy & Harmony Electronics Company Limited or “Joy & Harmony”
Joy & Harmony focuses on the selling, circulation and modern logistics of consumer electronics, including MP3 players, MP4 players, iPod, electronic dictionary, radios, and Walkman.
All amounts, except percentage of revenues, in thousands of U.S. dollars.
For the year ended December 31, 2009, Joy & Harmony generated revenue of $51,489, a decrease of $22,607 or 30.51% compared to $74,096 for the year ended December 31, 2008. Gross profit decreased $5,656 or 57.10% from $9,906 for the year ended 2008 to $4,250 for the year ended 2009. Operating income was $1,012 in 2009, a decrease of $6,394 or 86.34% compared to $7,406 in 2008. The decrease in revenue was primarily due to closing of 12 stores in 2009. In addition, manufacturers have been introducing new products at a slower rate and the old products currently on the market have become out-dated. This has caused the unit price of consumer electronics to drop and sales to decline.
Gross profit margin decreased from 13.37% in 2008 to 8.25% in 2009. The global financial crisis caused many small electronics manufacturers to exit the market and large manufacturers to raise the price of consumer electronics. Therefore, the cost for Joy & Harmony has increased, which led to a significant decline in gross margin.
e) Jinhua Baofa Logistic Limited or “Jinhua”
Jinhua provides transportation service to business and transports freight, including electronics, machinery and equipment, metal products, chemical materials, garments and handicraft goods, in more than 20 cities in Eastern China. Its transportation services cover many of the most developed cities in Eastern China such as Shanghai, Hangzhou and Nanjing.
China 3C acquired Jinhua on July 6, 2009. Therefore, the consolidated statement of income (loss) and comprehensive income (loss) of China 3C for the year ended December 31, 2009 includes Jinhua’s operating results from the date of acquisition to December 31, 2009.
All amounts, except percentages of revenues, are in thousands of U.S. dollars.
Net sales
Net sales for 2009 totaled $208,490, representing a year-over-year decrease of 32.88% compared to $$310,645 for 2008. The decrease was attributable to the closing of 101 stores in stores in 2009 as well as the negative effect of global economic slowdown.
Percentage of sales
In 2009, the Company earned approximately 69% of its sales from its retail operations and 31% from its wholesale operations compared to 68% from retail operations and 32% from wholesale in 2008.
Percentage of sales from retail operations and wholesale operations for each segment is as follows:
Cost of Sales
Cost of sales for 2009 totaled $187,476, or 89.92% of net sales compared to $262,003, or 84.34% for 2008. The decrease in the cost of sales was a direct result of the corresponding decrease in sales. The cost of sales as a percentage increased during 2009 primarily due to increased costs of electronics products as well as increase in sales rebate paid to suppliers.
Top Ten Suppliers of Each of Our Subsidiaries in 2009
Yiwu
Wang Da
Sanhe
Joy & Harmony
Jinhua
Fengda Technology Company Limited
Shanghai Post&Telecom Appliances Co - Hangzhou
Zhejiang Zhuocheng Digital Electronics Company Limited
Shanghai Ganshun Trade Company Limited
Zhejiang Sheng Tong Logistic Company Limited
Hangzhou Shenruida Trade Company Limited
Shenzhen Tianyin Telecommunication Company Limited
Hangzhou Xietong Trade Co., Limited
Huaqi Information Digital Technology Company Limited (aigo) - Shanghai
Shanghai Hong Wei Transportation Company Limited
Shanghai Zhongfang Electronics Company Limited
Hangzhou Tianchen Digital Telecommunication Company Limited
Shanghai Haier Industrial and Trade Company
SONY-Shanghai Company Limited
Hangzhou Shenzhou Transportation Company Limited
Wenzhou Jingwei Company
Hangzhou Qiuxin Internet Equipment Company Limited
Zhejiang Saixin Technology Limited
Shanghai Jingming Technology Company Limited
Jiaxingshi Guohong Vehicle Transportation Company Limited
Ninbo Zhongxun Electronics Company Limited
Hangzhou Weihua Telecommunication Company Limited
Shenzhen Chuangwei-RGB Electronics Company
Shanghai China-tex Electronic System Company Limited
Shanghai Sheng Hui Transportation Company Limited
Shanghai Hongyi Office Supplies Company Limited
Hangzhou Chaoyue Telecommunication Company Limited
TCL Electronics Company Limited
Shanghai Caitong Digital Technology Company Limited
Guangzhou Shuntong Transportation Company Limited
Shanghai Guangdian Equipment Company Limited
Shenzhen Liansheng Technology Company Limited
Qingdao Haixin Electronics Limited　Hangzhou branch
Beijing Broadcom Information Technology Company Limited
Shanghai Shenghui Transportation Company Limited
Yiwu Wantong Telecom Equipment Company Limited
Hangzhou Huayu Telecommunication Appliances Company Limited
Dongguang Lebang Electronics Limited
Chongqing Zhaohua Digital Technology Company Limited
Hefei Yuan Shun Da Transportation Company Limited
Shanghai Rongduo Business Company Limited
Shenzhen Jinfeng Datong Technology Company Limited
Zhongshan Longdi Electronics Limited
Shanghai Jinling Network Equipment Company Limited
Zhuhai Zhijie Transportation Company Limited
Shanghai Huoke Electronics Company Limited
Shenzhen Jiepulin Company Limited
Shenzhen Aosike Electronics Company Limited
Shenzhen Dejing Electronics Company Limited
Sanming Yunlin Vehicle Transportation Company Limited
Gross Profit Margin
Gross profit margin in 2009 decreased to 10.08% compared to 15.66% in 2008. The gross profit margin decrease was mainly attributed to the fact that many small manufacturers of computers, communication and consumer products exited the market and current manufacturers raised the cost of goods due to the global economic slowdown. The decrease in gross margin was also due to the increase in sales rebate paid to suppliers.
Because the Company does not include the costs related to its distribution network in cost of sales, its gross profit and gross profit as a percentage of net sales (“gross profit margin”) may not be comparable to those of other retailers that may include all costs related to their distribution network in cost of sales and in the calculation of gross profit and gross margin.
General and Administrative Expenses
General and administrative expenses for 2009 totaled $21,621, or 10.37% of net sales, compared to $14,132, or 4.55% of net sales for 2008. General and administration expense as a percentage of net sales increased 7.32% due to salary increase of $4,600 in 2009 compared to 2008, additional $1,116 general and administration expense due to acquisition of Jinhua, increase in management fee and additional expenses in relation to the new direct stores and franchise stores. .
Income (Loss) from Operations
Operating loss for 2009 was $608, or (0.29)% of net sales compared to Operating income of $34,509, or 11.11% of net sales for 2008, a decrease of 101.76%. Declined sales and gross margin and increased general and administration expenses led to the decline in income from operations.
Provision for income taxes
Provision for income taxes for 2009 was $714, representing year-over-year decrease of 91.71% compared to $8,611 for 2008. The significant decrease in income tax expenses was due to Yiwu, Wang Da and Sanhe having net losses in 2009 and therefore not having income tax expenses. In addition, Joy & Harmony’s income from operations also declined in 2009 compared to 2008, therefore, had a lesser income tax expense. Although we added one subsidiary - Jinhua in 2009, Jinhua’s income tax expense was not significant.
Net Income (loss)
Net loss was $1,213 or (0.58) % of net sales for 2009 compared to $26,834 net income or 8.64% of net sales for 2008. Net income decreased primarily due to sales decline and increase in general administration expenses.
Year Ended December 31, 2008 compared to Year Ended December 31,
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 “Joy & Harmony”
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.
For the year ended December 31, 2008, Yiwu generated revenue of $63,370, an increase of $1,985 or 3.23% compared to $61,385 for the year ended December 31, 2007. Gross profit increased $773 or 8.40% from $9,205 for the year ended 2007 to $9,978 for the year ended 2008. Operating income was $7,615 in 2008, an increase of $237 or 3.21% compared to $7,378 in 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.
Gross profit margin increased from 15% in 2007 to 15.75% in 2008, an increase of 0.75%. Such increase is primarily due to our strong bargaining power in purchase of fax machines. Fax machines are China 3C’s most established product line. We have long term relationships with our suppliers which gives us competitive advantage in purchase cost.
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.
For the year ended December 31, 2008, Wang Da generated revenue of $102,935, an increase of $19,439 or 23.28% compared to $83,496 for the year ended December 31, 2007. Gross profit increased $2,680 or 19.66% from $13,633 for the year ended 2007 to $16,313 for the year ended 2008. Operating income was $11,527 in 2008, an increase of $268 or 2.38% compared to $11,259 in 2007. The increase in revenue, gross profit and operating income were due to the expansion of Wang Da’s distribution networks, as well as opening of new stores.
Gross profit margin decreased from 16.33% in 2007 to 15.85% in 2008. The decrease was a result of a slight increase in promotional sales on cell phones within the Wang Da's store in store locations. The unit sales price of cell phones decreased in 2008 compared to the unit price in 2007, which caused the gross margin to decrease. However, Wang Da has been continuously introducing new cell phone models in an effort to maintain the gross margin.
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.
For the year ended December 31, 2008, Sanhe generated revenue of $70,243, an increase of $3,086 or 4.60% compared to $67,157 for the year ended December 31, 2007. Gross profit decreased $3,790 or 23.35% from $16,234 for the year ended 2007 to $12,444 for the year ended 2008. Operating income was $7,509 in 2008, a decrease of $3,995 or 34.73% compared to $11,504 in 2007. The increase in revenue was primarily due to opening of 24 new stores in 2008. The decreases in gross profit and operation income were primarily due to a more competitive sales environment on home electronics.
Gross profit margin decreased from 24.17% in 2007 to 17.72% in 2008. The decrease was due to a more competitive sales environment on home electronics, which led to a lower gross margin.
d) Shanghai Joy & Harmony Electronics Company Limited or “Joy & Harmony”
Joy & Harmony focuses on the selling, circulation and modern logistics of consumer electronics, including MP3 players, MP4 players, iPod, electronic dictionary, radios, and Walkman.
All amounts, except percentage of revenues, in thousands of U.S. dollars.
For the year ended December 31, 2008, Joy & Harmony generated revenue of $74,096, an increase of $10,108 or 15.80% compared to $63,988 for the year ended December 31, 2007. Gross profit decreased $392 or 3.81% from $10,298 for the year ended 2007 to $9,906 for the year ended 2008. Operating income was $7,406 in 2008, a decrease of $1,349 or 15.41% compared to $8,755 in 2007. The increase in revenue was due to opening of 43 new stores in 2008 and expansion of distribution networks. Gross profit and operation income decreased as a result of a slight increase in promotional sales.
Gross profit margin decreased from 16.09% in 2007 to 13.37% in 2008. The decrease was a result of a slight increase in promotional sales.
Net sales
Net sales for 2008 totaled $310,645, representing a year-over-year increase of 12.54% as compared to $276,027 for 2007. The increase was attributable to the introduction of new consumer electronic products, increased marketing initiatives within the Company's store in store locations, as well as opening new stores in 2008.
Percentage of sales
In 2008, the Company earned approximately 68% of its sales from its retail operations and 32% of its sales from its wholesale operations compared to 65% from retail operations and 35% from wholesale operations in 2007.
Percentage of sales from retail operations and wholesale operations for each segment is as follows:
Cost of Sales
Cost of sales for 2008 totaled $262,003, or approximately 84.34% of net sales compared to $226,656, or approximately 82.11% for 2007. The increase in the cost of sales was a direct result of the corresponding increase in sales. The cost of sales as a percentage increased slightly during 2008 primarily due to increased costs of home electronics products.
Top Ten Suppliers of Each of Our Subsidiaries in 2008
Yiwu
Wang Da
Sanhe
SH&J
Fengda Technology Company Limited
Shanghai Post&Telecom Appliances Co - Hangzhou
Zhejiang Shaixinke Company Limited
Shanghai Ganshun Trade Company Limited
Hangzhou Shenruida Trade Company Limited
Shenzhen Tianyin Telecommunication Company Limited
Zhongshan Longde Home Electronics Company Limited
Huaqi Information Digital Technology Company Limited (aigo) - Shanghai
Shanghai Zhongfang Electronics Company Limited
Hangzhou Tianchen Digital Telecommunication Company Limited
Zhejiang Zhuocheng Digital Electronics Company Limited
SONY-Shanghai Company Limited
Wenzhou Jingwei Company
Hangzhou Qiuxin Internet Equipment Company Limited
Shenzhen Chuangwei-RGB Electronics Company Limited
Shanghai Jingming Technology Company Limited
Ninbo Zhongxun Electronics Company Limited
Hangzhou Weihua Telecommunication Company Limited
Shenzhen Aosike Electronics Company Limited
Shanghai China-tex Electronic System Company Limited
Shanghai Hongyi Office Supplies Company Limited
Hangzhou Chaoyue Telecommunication Company Limited
Shanghai Haier Industrial and Trade Company
Shanghai Caitong Digital Technology Company Limited
Shanghai Guangdian Equipment Company Limited
Shenzhen Liansheng Technology Company Limited
TCL Electronics Company Limited
Beijing Broadcom Information Technology Company Limited
Yiwu Wantong Telecom Equipment Company Limited
Hangzhou Huayu Telecommunication Appliances Company Limited
Shenzhen Deheyuan Electronics Company
Chongqing Zhaohua Digital Technology Company Limited
Shanghai Rongduo Business Company Limited
Shenzhen Jinfeng Datong Technology Company Limited
Shenzhen Angel Drinking Water Industrial Group
Shanghai Jinling Network Equipment Company Limited
Shanghai Huoke Electronics Company Limited
Shenzhen Jiepulin Company Limited
Guangzhou Shengshida Electronics Company Limited
Shenzhen Dejing Electronics Company Limited
Gross Profit Margin
Gross profit margin in 2008 decreased to 15.66% compared to 17.89% in 2007. The gross profit margin decrease was mainly due to the decrease of 6.45% of gross profit margin of Sanhe and the decrease of 2.72% of gross profit margin of Joy & Harmony in 2008. The decrease in gross profit margin was a result of a slight increase in promotional sales in 2008.
Because the Company does not include the costs related to its distribution network in cost of sales, its gross profit and gross profit as a percentage of net sales (“gross profit margin”) may not be comparable to those of other retailers that may include all costs related to their distribution network in cost of sales and in the calculation of gross profit and gross margin.
General and Administrative Expenses
General and administrative expenses for 2008 totaled $14,132, or approximately 4.55% of net sales, compared to $13,615, or approximately 4.93% of net sales for 2007. General and administration expense as a percentage of net sales decreased 0.38% as a result of strict cost controls implemented by the Company.
Income from Operations
Income from operations for 2008 was $34,509, or 11.11% of net sales as compared to income from operations of $35,756, or 12.95% of net sales for 2007, a decrease of 3.49%. Competitive pricing led to the slight decline in income from operations.
Provision for income taxes
Provision for income taxes for 2008 was $8,611, representing year-over-year decrease of 32.99% as compared to $12,850 for 2007. The effective income tax rate for 2008 and 2007 was 25% and 33%, respectively. The decrease in provision for income taxes was because a lower Enterprise Income Tax rate of 25% became effective January 1, 2008 for both domestic enterprises and FIEs pursuant to China’s new Enterprise Income Tax Law.
Net Income
Net income was $26,834 or 8.64% of net sales for 2008 compared to $22,920 or 8.30% of net sales for 2007. Net income increased primarily due to the decrease in income tax expenses using the new EIT tax rate of 25% pursuant to China’s new Enterprise Income Tax Law. The increase of new income was also a result of additional income generated from value-added services such as after-sales support services compared to 2007.
Retail locations
The following table reflects a roll forward during the fiscal year ended December 31, 2007, 2008 and 2009 of our retail locations during each year (i.e. number of stores opened, number of stores closed and number of stores open at the end of the period). “Store in store” refers to the sales counter where the Company’s products are displayed for sale within large-scale supermarket stores, department stores and other operation sites for the Company. At present, we have “store in stores” in four main areas, Shanghai, Zhejiang, Jiangsu and Anhui. The Company’s retail locations are all “store in store” locations in 2007, 2008 and 2009.
The following table reflects the square footage of each store space during the fiscal year ended December 31, 2007, 2008 and 2009.
The following table reflects net sales per square foot for the fiscal year ended December 31, 2007, 2008 and 2009.
The following table reflects the amount of comparable or same store sales for each period (i.e. the change in sales from stores that were open for each of the fiscal years presented). A “comparable store” is defined as the same “store in store,” for which sales of that “store in store” is compared in the same month or same quarter of different years, such as the comparison of the sales occurring during March 2008 and March 2009 in the same “store in store.”
In assessing whether stores are “comparable”, it is based on whether:
(1) stores are in the same address;
(2) relatively same business area (e.g. if the business area of a store has changed in no more than 30%, it is regarded as having same business area; if the change in business area is more than 30%, the change in business area will be regarded as too significant as to be comparable;
(3) relatively same business layout (e.g. if the layout of sales counter in a store remains unchanged over time, then that store would be regarded as a comparable store; if there is significant change in layout of a sales counter in a store, that store will not be regarded as a comparable store);
(4) stores with same product mix would be regarded as comparable; if there is significant change in product mix in a store, that store will not be regarded as a comparable store;
(5) with respect to net sales per square foot each year and how we treat changes in square footage, this depends on the materiality of the impact on sales per square foot as a result of an increase or decrease in square footage. By way of example only, if a store with an area of 130 square feet had sales of $14,000 per month in 2006, which results in approximately $108 in sales per square foot. In 2007, if the same store increased the area of operation to 140 square feet and had sales of $16,000 per month that would result in approximately $114 in sales per square foot. We would deem the $6 increase in sales per square foot to be immaterial. Accordingly, in this case, we will use the area of 130 square feet to compare same store sales, and the additional 10 square feet will be ignored in the calculation of same store sales.
We consider changes in store square footage of more than 30% to be material. Stores that undergo such changes will not be accounted for as “comparable stores” because the change is too significant.
(6) with respect to net sales per square foot each year and how we treat relocated stores, if a “store in store” is relocated to a different retail location, which we would refer to as a different operating environment, during the period, then that “store in store” will not be used in the same store comparison. However, if the “store in store” is relocated to another location within the same retail location (or same operating environment) then the “store in store” sales will be used in the calculation of the same store comparison; and
(7) with respect to net sales per square foot each year and how we treat closed stores, we treat a closed “store in store” the same way we treat a “store in store” relocated to different retail location. A closed “store in store” is not used in the same store comparison.
Opened and closed “stores in stores” are primarily recognized based on the duration of the agreements with the shopping centers, as well as the sale and profits of a “store in store.” Prior to opening a new “store in store” we are usually approached by a large-scale department store or supermarket that offers us the opportunity to open a “store in store.” Our decision is based on our study of the population traffic flow, the department store and supermarkets themselves, and the level of expected profitability of a potential “store in store.” Following our inspection, we sign contracts with the department store and supermarkets, which specifically address the terms and conditions of opening, closing and relocating the “stores in stores.”
QUARTERLY RESULTS OF OPERATIONS
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. Nevertheless, at times, China can experience particularly inclement weather in January and February which can serious disrupt the Company’s supply chain management systems. As our business model is to operate only on several days of inventory, the effects of such weather disruptions may be severe in certain years.
The following table sets forth, for the periods presented, our unaudited quarterly results of operations for the eight quarters ended December 31, 2009. The data has been derived from our consolidated financial statements and, in our management’s opinion, they have been prepared on substantially the same basis as the audited consolidated financial statements and include all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of the financial results for the periods presented. This information should be read in conjunction with the annual consolidated financial statements included elsewhere in this Form 10-K. The operating results in any quarter are not necessarily indicative of the results that may be expected for any future period.
(amounts in thousand of US dollars)
Liquidity and Capital Resources (amounts in thousand of US dollars)
Cash has historically been generated from operations. Operations and liquidity needs are funded primarily through cash flows from operations and short-term borrowings.
Cash and cash equivalents were $29,908 at December 31, 2009 and current assets totaled $57,567 at December 31, 2009. The Company’s total current liabilities were $7,776 at December 31, 2009. Working capital at December 31, 2009 was $49,791. During 2009, net cash provided by operating activities was $7,113.
Cash and cash equivalents were $32,158 at December 31, 2008 and current assets totaled $67,433 at December 31, 2008. The Company’s total current liabilities were $7,558 at December 31, 2008. Working capital at December 31, 2008 was $59,875. During 2008, net cash provided by operating activities was $12,690.
The Company does not have any debt as of December 31, 2009.
The Wholly Foreign Owned Enterprise Law (1986), as amended and The Wholly Foreign Owned Enterprise Law Implementing Rules (1990), as amended, contain the principal regulations governing dividend distributions by wholly foreign owned enterprises. Under these regulations, wholly foreign owned enterprises, such as Zhejiang, Yiwu, Wang Da, Sanhe and Joy & Harmony may pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. Additionally, Zhejiang, Yiwu, Wang Da, Sanhe and Joy & Harmony are required to set aside a certain amount of any accumulated profits each year (a minimum of 10%, and up to an aggregate amount equal to half of its registered capital), to fund certain reserve funds. These reserves are not distributable as cash dividends except in the event of liquidation and cannot be used for working capital purposes. The PRC government also imposes controls on the conversion of RMB into foreign currencies and the remittance of currencies out of the PRC. The Company’s two operating subsidiaries in China paid $525,460 in dividends during 2005, however, we do not intend to pay dividends on our common stock in the foreseeable future. If we ever determine to pay a dividend, we may experience difficulties in completing the administrative procedures necessary to obtain and remit foreign currency for the payment of such dividends from the profits of Zhejiang, Yiwu, Wang Da, Sanhe and Joy & Harmony and Jinhua.
In summary, our cash flows were (in thousands):
In light of the three components of cash flows i.e. operating, investing and financing activities for the years ended December 31, 2007, 2008 and 2009.
Operating Activities
Net cash generated from operating activities decreased to $7,113 thousand in 2009 from $12,690 thousand in 2008. This decrease was mainly attributable to the $2,369 thousand net losses incurred in 2009 compared to $26,834 net income in 2008.
Net cash generated from operating activities decreased to $11,133 thousand in 2008 from $21,574 thousand in 2007. This decrease was mainly attributable to several factors, including (i) the increase of accounts receivable of $15,909 thousand resulting from the extension of repayment terms from 15 days to 30 days for retail customers; (ii) the increase of $2,246 thousand in inventories as a result of increased level of inventories in 2008 to maintain an adequate level for all stores as a precaution for possible incidents such as the snow storm in early 2008 ; (iii) the decrease in income taxes payable of $544 thousand, offset by an increase of $2,309 thousand in accounts payable and accrued expenses and an the increase in add-back of non-cash expenses, mainly consisting of share-based compensation of $337 thousand in 2008.
Using 2007 as base year, there was a decrease in net cash generated from the operating activities in 2009, a decrease of 67.01%. The significant decrease in net cash generated by operating activities in 2009 was in line with the decrease in net sales.
Using 2007 as base year, there was a decrease in net cash generated from the operating activities in 2008, a decrease of 41.18%, while net sales increased 12.54%. The significant decrease in net cash generated by operating activities in 2008 was primarily due to the increase in accounts receivable attributed to the extension of terms with retail customers from 15 days to 30 days. The increase in accounts receivable in 2008 was due to the extension of payment terms from all the Company's retail partners from 15 days to 30 days. Although the amount of accounts receivable increased during 2008, the Company still maintain a healthy accounts receivable turnover. The collection of debt is based on the terms of legal binding documents. The Company has not changed its policy on reserving for bad debt and has not found any abnormal increases in bad debt.
Investing activities
Net cash used in investing activities increased to $8,590 in 2009 and $7,327 in 2008 from $64 in 2007 as a result of the acquisition of Jinhua. On December 19, 2008, Zhejiang and Yiwu entered into an agreement to acquire Jinhua. Pursuant to the acquisition agreement, Zhejiang and Yiwu were required to pay RMB 50,000 thousand within 10 business days after the execution of the agreement to Jinhua’s shareholders. Therefore, China 3C made a purchase deposit of $7,319 thousand to the shareholders of Jinhua in 2008. In July 2009, China 3C completed the acquisition of Jinhua and therefore paid $7,784,494 to Jinhua. In 2009, China 3C also made $805,992 investment in fixed assets to open new direct stores.
Financing Activities
There was no cash used in financing activities in 2009 and 2008. Net cash used in financing activities was $4,500 thousand in 2007 due to payment of notes of $4,500 thousand for the acquisition of Joy & Harmony in 2007.
All the above components adding up or compensate each other giving cash contributions to the Company.
Net change in cash and cash equivalents
Cash and cash equivalent
Capital Expenditures
Total capital expenditures for purchase of fixed assets during 2009, 2008 and 2007 were $805,992, $11,088 and $64,325, respectively. The low level of capital expenditures in 2008 and 2007 were due to the low capital requirements needed to open additional “stores in stores” the Company believes its funds are sufficient to support its organic growth. In 2009, capital expenditure significantly increased due to the new business plan of opening new direct stores and franchise stores. Direct stores and franchise stores have higher capital requirements than “stores in stores”.
Working Capital Requirements
Historically operations and short term financing have been sufficient to meet our cash needs. We believe that we will be able to generate revenues from sales and raise capital through private placement offerings of our equity securities to provide the necessary cash flow to meet anticipated working capital requirements. However, our actual working capital needs for the long and short term will depend upon numerous factors, including operating results, competition, and the availability of credit facilities, none of which can be predicted with certainty. Future expansion will be limited by the availability of financing products and raising capital.
Off-Balance Sheet Arrangements
We have never entered into any off-balance sheet financing arrangements and have never established any special purpose entities. We have not guaranteed any debt or commitments of other entities or entered into any options on non-financial assets.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.
An accounting policy is considered to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimates are made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur, could materially impact the consolidated financial statements. We believe the following critical accounting policies reflect the more significant estimates and assumptions used in the preparation of the consolidated financial statements.
Revenue Recognition
Our revenues are generated from sales of electronics products. All of our revenue transactions contain standard business terms and conditions. We determine the appropriate accounting for these transactions after considering (1) whether a contract exists; (2) when to recognize revenue on the deliverables; and (3) whether all elements of the contract have been fulfilled and delivered. In addition, our revenue recognition policy requires an assessment as to whether collection is reasonably assured, which inherently requires us to evaluate the creditworthiness of our customers. Changes in judgments on these assumptions and estimates could materially impact the timing or amount of revenue recognition.
Please refer to Note 2 in the footnotes to the financial statements for detailed description of our revenue recognition policy.
After Sales Service
The after-sales services that we provide to our customers are primarily repair and maintenance. If a customer buys a product from us and needs repairs, we can usually arrange to have the manufacturer repair the product. In certain cases, clerks in our stores are able to make the repairs directly.
Tabular Disclosure of Contractual Obligations
The following table sets forth our contractual obligations as of December 31, 2009.
(amounts in thousand of US dollars):
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE 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 year ended December 31, 2009, all of our sales were denominated in foreign currencies. We expect that foreign currencies will continue to represent a similarly significant percentage of our sales in the future. Selling, marketing and administrative costs related to these sales are largely denominated in the same respective currency, thereby mitigating our transaction risk exposure. We therefore believe that the risk of a significant impact on our operating income from foreign currency fluctuations is not substantial. However, for sales not denominated in U.S. dollars, if there is an increase in the rate at which a foreign currency is exchanged for U.S. dollars, it will require more of the foreign currency to equal a specified amount of U.S. dollars than before the rate increase. In such cases and if we price our products in the foreign currency, we will receive less in US. dollars than we did before the rate increase went into effect. If we price our products in U.S. dollars and competitors price their products in local currency, an increase in the relative strength of the U.S. dollar could result in our price not being competitive in a market where business is transacted in the local currency.
All of our sales denominated in foreign currencies are denominated in the Chinese Renminbi. Our principal exchange rate risk therefore exists between the U.S. dollar and this currency. Fluctuations from the beginning to the end of any given reporting period result in the re-measurement of our foreign currency-denominated receivables and payables, generating currency transaction gains or losses that impact our non-operating income/expense levels in the respective period and are reported in other (income) expense, net in our 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.
Interest Rate Risk
Changes in interest rates may affect the interest paid (or earned) and therefore affect our cash flows and results of operations. However, we do not believe that this interest rate change risk is significant.
Inflation
Inflation has not had a material impact on the Company’s business in recent years.
Currency Exchange Fluctuations
All of the Company’s revenues are denominated in Chinese Renminbi, while its expenses are denominated primarily in Chinese Renminbi (“RMB”). The value of the RMB-to-U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in political and economic conditions. Since 1994, the conversion of Renminbi into foreign currencies, including U.S. dollars, has been based on rates set by the People’s Bank of China (“PBOC”), which are set daily based on the previous day’s inter-bank foreign exchange market rates and current exchange rates on the world financial markets. Since 1994, the official exchange rate for the conversion of Renminbi to U.S. dollars had generally been stable and the Renminbi had appreciated slightly against the U.S. dollar. However, on July 21, 2005, the Chinese government changed its policy of pegging the value of Chinese Renminbi to the U.S. dollar. Under the new policy, Chinese Renminbi may fluctuate within a narrow and managed band against a basket of certain foreign currencies. Recently there has been increased political pressure on the Chinese government to decouple the Renminbi from the United States dollar. At the recent quarterly regular meeting of PBOC, its Currency Policy Committee affirmed the effects of the reform on Chinese Renminbi exchange rate. Since February 2006, the new currency rate system has been operated; the currency rate of Renminbi has become more flexible while basically maintaining stable and the expectation for a larger appreciation range is shrinking. The Company has never engaged in currency hedging operations and has no present intention to do so.
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:
o
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.
o
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.
o
If the Company is unable to derive any revenues from Greater China, it would have a significant, financially disruptive effect on the normal operations of the Company.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements of the Company are included following the signature page to this Form 10-K.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A(T).
ITEM 9A(T). 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 December 31, 2009, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based on this evaluation, our principal executive officer and principal financial officer have concluded that during the period covered by this report, the Company’s disclosure controls and procedures were effective.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Internal control over financial reporting refers to the process designed by, or under the supervision of, our principal executive and principal financial officers, and effected by the Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
1. Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets;
2. Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorization of our management and directors; and
3. Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisitions, use or disposition of our assets that could have a material effect on the financial statements.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation, our principal executive officer and principal financial officer have concluded that during the period covered by this report, our internal controls over financial reporting were effective.
This Annual Report on Form 10-K does not include an attestation report of our registered public accounting firm, Goldman Parks Kurland Mohidin LLP, regarding internal control over financial reporting because we are a non-accelerated filer. Our management’s report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit us to provide only our management’s report in this Annual Report.
Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting that occurred during the fourth fiscal quarter of the fiscal year covered by this Annual Report on Form 10-K that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The following table sets forth the name, age and position of each of our officers and directors as of April 15, 2010.
Name
Age
Position
Zhenggang Wang
Chief Executive Officer and Chairman of the Board
Jian Zhang
Chief Financial Officer
Xiang Ma
President
Chenghua Zhu
Director
Mingjun Zhu
Director
Rongjin Weng
Director
Wei Kang Gu
Director
Kenneth T. Berents
Director, Chairman Audit Committee
There are no family relationships between or among any of the executive officers or directors of the Company. Below are brief descriptions of the backgrounds and experiences of the officers and directors:
Zhenggang Wang, Chief Executive Office and Chairman of the Board
Mr. Wang, has been the Company’s chief executive officer and chairman of its BOD since December 2005. He is also the founder, chairman and chief executive officer of Zhejiang Yong Xin Digital Technology Company Limited, a holding company for the purpose of holding interests in Hangzhou Wang Da Electronics Company, Limited and Yiwu Yong Xin Telecommunication Company, Limited, both of which are based in China. Mr. Wang established Yiwu Yong Xin Telecommunication Company, Limited in 1997, and he serves as its chairman and chief executive officer. In 1998, Mr. Wang established Hangzhou Wang Da Electronics Company, Limited, which is in the business of distributing cellular telephone phones. Mr. Wang is the chairman and chief executive officer of Hangzhou Wang Da Electronics Company, Limited. Mr. Wang does not hold any other directorships with reporting companies in the United States.
Jian Zhang, Chief Financial Officer
Mr. Zhang has been the Company’s chief financial officer since June 2009. Mr. Zhang has over ten years of experience in financial accounting and reporting. From October 2006 to June 2009, he served as Chief Accounting Officer of Zhejiang Yong Xin Digital Technology Company Limited, a subsidiary of China 3C where he was responsible for the coordination of audits and proper filing of the Company's quarterly and annual reports. He also played a role in the oversight of the accounting department to ensure the proper maintenance of all accounting systems and functions. From October 2006 to October 1999, Mr. Zhang served as Deputy Chief of Accounting with Guangdong Xidea Technology Group, a large-scale diversified manufacturer and investment company. From October 1998 to October 1999, Mr. Zhang served as Deputy Chief of Accounting with Guangdong Shunde Hongji Group, a furniture manufacturer with more than 200 employees. Mr. Zhang holds a Bachelor's Degree in Accounting from Renmin University of China.
Xiang Ma, President
Mr. Ma has been president of the Company since December 2005. Mr. Ma was President of Yiwu Yong Xin Telecommunication Company Limited, China 3C’s largest subsidiary, from 1999 to the present. During the past six years, Mr. Ma’s expertise in marketing and management have contributed significantly to the Company’s rapid growth, where it has gone from a small business in the distribution of 3C products, particularly fax machines, in Eastern China to being a major presence in that market. Prior to that, from 1996 to 1999, Mr. Ma was the manager of Zhejiang Transfer Company Limited, a high-tech publicly traded company in China. During his time at Zhejiang Transfer Company Limited, Mr. Ma was also responsible for the company’s corporate communications. Mr. Ma received his Bachelor degree from Zhejiang University with a concentration in business management. Mr. Ma does not hold any other directorships with reporting companies in the United States.
Chenghua Zhu, Director
Ms. Zhu has been a director of the Company since June 2006. Ms. Zhu is a senior project manager of Shanghai Shengzhang, a certified public accounting firm. She was project manager at two CPA firms prior to joining Shanghai Shengzhang, Shanghai Jiarui and Hubei Dahua. Ms. Zhu does not hold any other directorships with reporting companies in the United States.
Mingjun Zhu, Director
Mr. Zhu has been a director of the Company since June 2006. Mr. Zhu is General Manager of Zhejiang Mingda, a certified public accounting firm. He was General Manager of Zhejiang Mingda Management Consulting Company. From 1993 to 2004, he was Deputy Director of Yiwu Zhicheng, a CPA firm. Mr. Zhu does not hold any other directorships with reporting companies in the United States.
Rongjin Weng, Director
Mr. Weng has been a director of the Company since December 2005. Mr. Weng is Chairman of Langsha Group, which is the largest sock manufacturer in China with an annual revenue of $100 million. Mr. Weng established Langsha Knitting Company Limited in 1995, and has served as its chairman and chief executive officer since that time. Mr. Weng holds a master degree in Business Administration from Shanghai Jiao Tong University. Mr. Weng does not hold any other directorships with reporting companies in the United States.
Wei Kang Gu, Director
Mr. Gu has been a director of the Company since December 2005. Mr. Gu is a Professor of Electronic Engineering at Zhejiang University. Founded in 1897, the University has always been ranked among the few top universities in China and is today the third most recognized university in China. It is a major research university comprised of 22 colleges. Mr. Gu also serves on the Board of Bird Ningbo Company. Founded in 1992, Bird Ningbo has grown to be China’s leading domestic manufacturer of mobile phones. He is also Vice Chairman of Zhejiang Electronic Association. Mr. Gu received a bachelors’ degree from Zhejiang University. Mr. Gu does not hold any other directorships with reporting companies in the United States.
Kenneth T. Berents, Director, Chairman Audit Committee
Mr. Berents has been a director of the Company since December 2006. Mr. Berents is a former managing director and senior portfolio manager for Goldman Sachs Asset Management in Tampa, Fla., which manages $30 billion in growth stocks. Before joining Goldman Sachs, he was the managing director and director of equity research for First Union Securities, now Wachovia Securities, from 1993 to 2000. He holds a bachelor’s in history from Villanova University and a master’s degree in journalism from the University of Missouri-Columbia. He also was an Alfred P. Sloan Fellow in economics at Princeton University. He has appeared on ABC’s Nightline, CNN, CNBC and is widely quoted in national and trade publications. Mr. Berents does not hold any other directorships with reporting companies in the United States.
Weidong Huang
On June 15, 2009, Weidong Huang who has served as our Chief Financial Officer since October 2007 advised the Company that effective immediately, he resigned from his position. There were no disagreements between Mr. Huang and the Company on any matter relating to the Company’s operations, policies or practices, which resulted in his resignation.
Joseph J. Levinson
Joseph J. Levinson served as a member of the Board of Directors from May 2007 until his resignation in January 2009.
Term
Each director serves for a one year term after which they may stand for re-election at the Company’s annual meeting of stockholders.
Director Qualifications
We seek directors with established strong professional reputations and experience in areas relevant to the strategy and operations of our businesses. We also seek directors who possess the qualities of integrity and candor, who have strong analytical skills and who are willing to engage management and each other in a constructive and collaborative fashion. We also seek directors who have the ability and commitment to devote significant time and energy to service on the Board and its committees. We believe that all of our directors meet the foregoing qualifications.
Our directors have backgrounds in a variety of different areas including electronics business, marketing, strategic business development, finance, investor relations and management. We believe the backgrounds and skills of our directors bring a diverse range of perspectives to the Board.
Board Leadership Structure
The BOD believes that Mr. Wang’s service as both Chairman of the Board and Chief Executive Officer is in the best interest of the Company and its stockholders. Mr. Wang possesses detailed and in-depth knowledge of the issues, opportunities and challenges facing the Company and its business and is thus best positioned to develop agendas that ensure the Board’s time and attention are focused on the most critical matters. His combined role enables decisive leadership, ensures clear accountability, and enhances the Company’s ability to communicate its message and strategy clearly and consistently to the Company’s shareholders, employees and customers.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), requires the executive officers and directors of the Company and every person who is directly or indirectly the beneficial owner of more than 10% of any class of security of the Company to file reports of ownership and changes in ownership with the Securities and Exchange Commission. Such persons also are required to furnish our company with copies of all Section 16(a) forms they file. Based solely on our review of copies of such forms received by us, we believe that during the fiscal year 2009, the executive officers and directors of the Company and every person who is directly or indirectly the beneficial owner of more than 10% of any class of security of the Company complied with the filing requirements of Section 16(a) of the Exchange Act.
Code of Ethics
In 2007 we adopted a corporate code of ethics. We believe our code of ethics is reasonably designed to deter wrongdoing and promote honest and ethical conduct; provide full, fair, accurate, timely and understandable disclosure in public reports; comply with applicable laws; ensure prompt internal reporting of code violations; and provide accountability for adherence to the code of ethics. The code of ethics was filed as Exhibit 14 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2007. A written copy of the code of ethics will be provided upon request at no charge by writing to our Chief Financial Officer, China 3C Group, 368 HuShu Nan Road, HangZhou City, Zhejiang Province, China 310014.
Board Committees and Designated Directors
The BOD has a Compensation Committee, a Nominating and Corporate Governance Committee and an Audit Committee.
Audit Committee
The BOD has established an audit committee in accordance with Section 3(a)(58)(A) of the Exchange Act. The Audit Committee consists of Kenneth T. Berents, Chairman and members Rongjin Weng and Chenghua Zhu. The Board of Directors of the Company has determined that Mr. Berents is an “audit committee financial expert” under Item 407(d) of Regulation S-K.
Compensation Committee
Our Compensation Committee consists of Wei Kang Gu, Chairman and member Rongjin Weng. The Compensation Committee makes recommendations to the BOD concerning salaries and incentive compensation for our officers, including our Chief Executive Officer, and employees and administers our stock option plans. Each of the members of the Committee is independent and none have served as an officer or employee of the Company.
Nominating and Corporate Governance Committee
Our Nominating and Corporate Governance Committee consists of Mingjun Zhu, Chairman and member Wei Kang Gu. The Nominating and Corporate Governance Committee assists the BOD in identifying qualified individuals to become board members, in determining the composition of the Board and in monitoring a process established to assess Board effectiveness. Each of the members of the Committee is independent and none have served as an officer or employee of the Company.
Changes in Director Nomination Process for Stockholders
There have been no material changes to the procedures by which security holders may recommend nominees to the Company’s BOD since the filing of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Compensation Discussion And Analysis
The Compensation Committee of our BOD and our Chief Executive Officer, Chief Financial Officer and head of Human Resources are collectively responsible for implementing and administering all aspects of our benefit and compensation plans and programs, as well as developing specific policies regarding compensation of our executive officers. The members of our Compensation Committee, Mingjun Zhu and Wei Kang Gu, are independent directors.
Compensation Objectives
Our primary goal with respect to executive compensation has been to set compensation at levels that attract and retain the most talented and dedicated executives possible. Individual executive compensation is set at levels believed to be comparable with executives in other companies of similar size and stage of development operating in China. We also link long-term stock-based incentives to the achievement of specified performance objectives and to align executives’ incentives with stockholder value creation.
Elements of Compensation
Base Salary. All full time executives are paid a base salary. Executives who are Chinese nationals, including our Chief Executive Officer and Chairman, do not have employment agreements. Base salaries for our executives are established based on the scope of their responsibilities, taking into account competitive market compensation paid by other companies in our industry for similar positions, professional qualifications, academic background, and the other elements of the executive’s compensation, including stock-based compensation. Our intent is to set executives’ base salaries near the median of the range of salaries for executives in similar positions with similar responsibilities at comparable companies, in line with our compensation philosophy. Base salaries are reviewed annually, and may be increased to align salaries with market levels after taking into account the subjective evaluation described previously.
The Company currently has no foreign employees and the amount of salary is primarily determined by job requirements and each employee’s level in the corporate hierarchy. The Company’s personnel department then makes salary decisions based on these factors along with and job performance and market conditions.
Equity Incentive Compensation. We believe that long-term performance is achieved through an ownership culture participated in by our executive officers through the use of stock-based awards. Currently, we do not maintain any incentive compensation plans based on pre-defined performance criteria. The Compensation Committee has the general authority, however, to award equity incentive compensation, i.e. stock options, to our executive officers in such amounts and on such terms as the committee determines in its sole discretion. The Committee does not have a determined formula for determining the number of options available to be granted. Incentive compensation is intended to compensate officers for accomplishing strategic goals such as mergers and acquisitions and fund raising. The Compensation Committee will review each executive’s individual performance and his or her contribution to our strategic goals periodically and determine the amount of incentive compensation towards the end of the fiscal year. Our Compensation Committee grants equity incentive compensation at times when we do not have material non-public information to avoid timing issues and the appearance that such awards are made based on any such information.
Determination of Compensation
Our Chief Executive Officer, Chief Financial Officer and head of Human Resources meet frequently during the last several weeks of our fiscal year to evaluate each non-executive employee’s performance and determine his or her compensation for the following year.
The following table sets forth the cash and other compensation paid by us in 2009 to all individuals who served as our Chief Executive Officer and Chief Financial Officer, who we collectively refer to as the named executive officers (“NEOs”). No executive received total compensation greater than $100,000 in 2009.
SUMMARY COMPENSATION TABLE
(1) Jian Zhang was appointed as Chief Financial Officer of the Company effective June 16, 2009. Valuation based on the dollar amount of option grants recognized for financial statement reporting purposes pursuant to ASC 718.
(2) Weidong Huang was appointed as Chief Financial Officer of the Company effective October 8, 2007 and resigned as our Chief Financial Officer and Director on June 15, 2009.
Grants of Plan-Based Awards
No plan based award was granted to any of the Company’s NEOs during the year ended December 31, 2009, except for the grant of 100,000 options to purchase common stock made to Jian Zhang on June 16, 2009.
Outstanding Equity Awards At Fiscal Year-End
There were no outstanding unexercised options, unvested stock or other equity incentive plan awards held by any of the Company’s NEOs as of December 31, 2009, except for the grant of 100,000 options to purchase common stock held by Jian Zhang.
Option Exercises And Stock Vested
There were no exercises of stock options, stock appreciation rights and/or similar investment nor was there any vesting of stock, restricted stock, restricted stock units or similar instruments during the year ended December 31, 2009 for any of the Company’s NEOs.
Pension Benefits
We do not sponsor any pension benefit plans.
Nonqualified Deferred Compensation
We do not maintain any non-qualified defined contribution or deferred compensation plans. Our Compensation Committee, which is comprised solely of “outside directors” as defined for purposes of Section 162(m) of the Internal Revenue Code, may elect to provide our officers and other employees with non-qualified defined contribution or deferred compensation benefits if the Compensation Committee determines that doing so is in our best interests.
Potential Payments Upon Termination or Change in Control
None.
Employment Agreements
On June 16, 2009, the Company entered into a letter agreement with Jian Zhang, our Chief Financial Officer. The agreement provides for a monthly salary of $6,000. The term of Mr. Zhang’s employment shall continue until terminated by either party in accordance with the terms of the agreement. Mr. Zhang received an option grant to purchase 100,000 shares of common stock of the Company upon execution of the agreement and shall be entitled to receive option grants for 100,000 shares of common stock of the Company on each anniversary of the date of the agreement provided that Mr. Zhang continues to serve as the Company’s Chief Financial Officer on such date. The exercise price of the initial grant of 100,000 shares is $1.11, the closing price of the common stock of the Company on June 16, 2009, and for each future option grant the exercise price will be the closing price of the Company’s common stock on the anniversary of such date. All option grants vest upon issuance and will have an exercise period of ten years from the date of issuance so long as Mr. Zhang serves as the Company’s Chief Financial Officer at such time. In the event Mr. Zhang no longer serves as the Company’s Chief Financial Officer, the exercise period for all vested options will be twenty-four months from his departure. Under the agreement, Mr. Zhang will receive 14 vacation days per year. The agreement can be terminated by either party on one month’s notice or one month’s salary in lieu of notice.
On May 7, 2007, the BOD appointed Joseph J. Levinson to serve as a member of the BOD of the Company and to be in charge of the Company’s investor relations. As compensation for his services, Mr. Levinson received: (1) $60,000 per year, payable in equal quarterly installments; (2) a monthly grant during his term of service of 1,000 shares of the Company’s common stock; (3) an initial annual grant of a stock option to purchase 300,000 shares of the Company’s common stock, with an exercise price of $6.15 per share (the “2007 Stock Option”) under the China 3C Group 2005 Equity Incentive Plan; and (4) a subsequent annual grant of a stock option to purchase an additional 300,000 shares of the Company’s common stock, with an exercise price of $1.82 (the “2008 Stock Option”) under the China 3C Group 2005 Equity Incentive Plan. In addition, the Company agreed that Mr. Levinson would receive (1) $2,500 for each Board meeting he attends, (2) $2,000 for each meeting of a committee of the Board he attends, (3) $5,000 upon being named the chairman of any Board committee, and (4) $4,500 as a one time bonus upon joining the Board. It was later determined that due to the expiration of the China 3C Group 2005 Equity Incentive Plan on December 31, 2006, the 2007 Stock Option and the 2008 Stock Option were not validly granted. Pursuant to the terms of the Compensation Agreement dated as of November 27, 2008 between Mr. Levinson and the Company, Mr. Levinson acknowledged that the 2007 Stock Option and the 2008 Stock Option were not and will not be granted and in consideration for his services as a Director accepted the issuance of 125,000 shares of the Company’s common stock. The 125,000 shares of the Company’s common stock were issued to Mr. Levinson on January 7, 2009.
Compensation of Directors
Messrs. Berents and Levinson, prior to his resignation in January 2009, receive $2,500 per Board meeting they attend, $2,000 per meeting of a committee of the Board they attend, and an annual fee of $5,000 for serving as a chairman of a Board committee.
Upon joining the BOD on December 8, 2006, Ken Berents entered into a BOD Agreement with the Company, pursuant to which he receives an annual salary of $75,000 payable in monthly installments at the beginning of each month that Mr. Berents is a member of the BOD. In addition, Mr. Berents receives an annual fee of $5,000 for being named Chairman of the Audit Committee. Mr. Berents received an option grant to purchase 50,000 shares of common stock of the Company upon execution of his BOD Agreement and is entitled to receive 30,000 shares on each anniversary of such date thereafter, provided Mr. Berents is a member of the BOD at such time. The exercise price of the initial grant of 50,000 shares shall be based on the closing price of the common stock of the Company on December 7, 2006 and for each future option grant the closing price of the Company common stock on the anniversary of such date. All option grants will vest upon issuance and will have an exercise period of ten years from date of issuance so long as Mr. Berents is a member of the BOD at such time. In the event that Mr. Berents is no longer a member of the BOD, his exercise period for all vested options will be twenty-four months from the anniversary date of his departure from the BOD.
The following table summarizes compensation that our directors earned during 2009 for services as members of the Company’s Board.
DIRECTOR COMPENSATION
(1) Valuation based on the dollar amount of option grants recognized for financial statement reporting purposes pursuant to ASC 718.
(2) The BOD Agreement dated December 8, 2006 between the Company and Mr. Berents, provides for a stock option grant of 30,000 shares to be made to Mr. Berents in December 2009 at an exercise price equivalent to the prevailing market price of the stock on December 8, 2009, all of which options shall be vested and exercisable as of December 8, 2009.
(3) Joseph J. Levinson served as a member of the BOD from May 2007 until his resignation in January 2009.
Compensation Committee Interlocks and Insider Participation
During 2009 members of our Compensation Committee of the BOD were Mingjun Zhu and Wei Kang Gu. No member of our Compensation Committee was, or has been, an officer or employee of the Company or any of our subsidiaries.
No member of the Compensation Committee has a relationship that would constitute an interlocking relationship with executive officers or directors of the Company or another entity.
Compensation Committee Report (1)
The goal of the Company’s executive compensation policy is to ensure that an appropriate relationship exists between executive compensation and the creation of stockholder value, while at the same time attracting, motivating and retaining experienced executive officers.
The Compensation Committee has reviewed and discussed the discussion and analysis of the Company’s compensation which appears above with management, and, based on such review and discussion, the Compensation Committee recommended to the Company’s BOD that the above disclosure be included in this Annual Report on Form 10-K.
The members of the Compensation Committee are:
Mingjun Zhu, Chairman
Wei Kang Gu
(1) The material in the above Compensation Committee reports is not soliciting material, is not deemed filed with the SEC and is not incorporated by reference in any filing of the Company under the Securities Act of 1933, or the Securities Exchange Act of 1934, whether made before or after the date of this Form 10-K and irrespective of any general incorporation language in such filing.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth certain information, as of April 15, 2010, concerning shares of common stock of the Company, the only class of its securities that are issued and outstanding, held by (1) each shareholder known by the Company to own beneficially more than five percent of the common stock, (2) each director of the Company, (3) each executive officer of the Company, and (4) all directors and executive officers of the Company as a group:
* Less than One Percent.
(1)
Unless otherwise indicated in the footnotes to the table, each shareholder shown on the table has sole voting and investment power with respect to the shares beneficially owned by him, her or it. Unless otherwise indicated in the footnotes to the table, the address for each shareholder is c/o China 3C Group, 368 HuShu Nan Road, HangZhou City, Zhejiang Province, China 310014. Percentages of less than one percent have been omitted from the table.
(2)
Calculated on the basis of 54,831,327 shares of common stock issued and outstanding as of April 15, 2010 except that shares of common stock underlying options and warrants exercisable within 60 days of the date hereof are deemed to be outstanding for purposes of calculating the beneficial ownership of securities of the holder of such options or warrants.
(3)
Represents 5,000 shares of common stock and 140,000 shares of common stock issuable upon exercise of outstanding stock options (as described above).
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Transactions with Related Parties
There have not been any transactions, or proposed transactions, during the last two years, to which the Company was or is to be a party and the amount involved exceeds $120,000, and in which any director or executive officer of the Company, any nominee for election as a director, any security holder owning beneficially more than five percent of the common stock of the Company, or any member of the immediate family of the aforementioned persons had or is to have a direct or indirect material interest.
Director Independence
The following members of the Company’s Board of Directors are “independent” under Rule 4200(15) of the Nasdaq Stock Market listing standards: Rongjin Weng, Weikang Gu, Mingjun Zhu, Chenghua Zhu and Kenneth Berents.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
On January 5, 2009, the Company, on the recommendation of the Audit Committee of its Board of Directors, engaged Goldman Parks Kurland Mohidin LLP (“GPKM”) as its independent registered public accounting firm. From April 20, 2006 to January 5, 2009 Morgenstern, Svoboda & Baer CPA’s P.C. (Morgenstern) served as the Company’s independent registered public accounting firm.
The following represents fees for professional audit services rendered by GPKM and Morgenstern for the fiscal years ended December 31, 2009 and 2008.
Audit Fees
The aggregate fees billed by our current auditors, GPKM, for professional services rendered for the audit of our annual financial statements for the years ended December 31, 2009 and 2008 was $218,000 and $150,000, respectively.
The aggregate fees billed by Morgenstern for professional services rendered for the audit of the Company’s annual and quarterly financial statements for the years ended December 31, 2008 was $237,278.
Audit Related Fees
We incurred no audit related fees to GPKM during the years ended December 31, 2009 and 2008.
Tax Fees
GPKM did not render any services for tax compliance, tax advice and tax planning during the years ended December 31, 2009 and 2008.
We incurred $3,500 tax fees to Morgenstern during the year ended December 31, 2008.
All Other Fees
GPKM and Morgenstern did not bill us any additional fees that are not disclosed under audit fees, audit related fees or tax fees during the years ended December 31, 2009 and 2008.
Audit Committee Pre-Approval Process, Policies and Procedures
The Audit Committee has adopted pre-approval policies for all services, including both audit and non-audit services, provided by our independent auditors. For audit services, each year the independent auditor provides the Audit Committee with an engagement letter outlining the scope of the audit services proposed to be performed during the year, which must be formally accepted by the Audit Committee before the audit commences. The independent auditor also submits an audit services fee proposal, which also must be approved by the Committee before the audit commences. The audit, tax, and all other fees and services described above were pre-approved for 2008 and 2009.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) The following are filed with this Annual Report:
(1) The financial statements listed on the Financial Statements Table of Contents.
(2) Not applicable.
(3) The exhibits referred to below, which include the following managerial contracts or compensatory plans or arrangements:
·
Compensation Agreement, dated November 27, 2008, between China 3C Group and Joseph Levinson.
·
Board of Directors Agreement, dated December 8, 2006, among China 3C Group and Kenneth T. Berents.
·
China 3C Group 2008 Omnibus Securities and Incentive Plan.
·
Stock Option Agreement Director Non-Qualified Stock Option, dated December 1, 2008 and effective as of January 15, 2009, between China 3C Group and Kenneth Berents.
·
Stock Option Agreement Director Non-Qualified Stock Option, dated December 1, 2008 and effective as of January 15, 2009, between China 3C Group and Kenneth Berents.
·
Stock Option Agreement Director Non-Qualified Stock Option, dated December 1, 2008 and effective as of January 15, 2009, between China 3C Group and Kenneth Berents.
·
Stock Option Agreement with Todd L. Mavis, dated April 21, 2009, between China 3C Group and Todd L. Mavis.
·
Agreement dated May 3, 2007 between China 3C Group and Joseph Levinson.
·
Letter Agreement dated June 16, 2009 between China 3C Group and Jian Zhang.
(b) The exhibits listed on the Exhibit Index are filed as part of this Annual Report.
(c) Not applicable.
EXHIBIT INDEX
Exhibit
No
Document Description
3.1
Amended and Restated Articles of Incorporation of the Registrant (11)
3.2
By-laws of the Registrant (1 )
4.1
China 3C Group Amended 2005 Equity Incentive Plan. (2 )
10.1
Stock Purchase Agreement, dated as of October 17, 2005, by and among Sun Oil & Gas, Inc., EH&P Investments, John D. Swain, Fred Holcapek, PH Holding Group, Ma Cheng Ji, Zhou Wei, Zeng Xiu Lan, Gu Xiao Dong, Jacksonville Management Limited, Colin Wilson, Alliance Capital Management, Inc., Hanzhong Fang and China U.S. Bridge Capital, Limited (3)
10.2
Consulting Services Agreement dated as of November 1, 2005 between Capital Development Limited and Zhejiang Yong Xing Digital Technology Company Limited (4 )
10.3
Operating Agreement dated as of November 1, 2005 between Capital Development Limited and Zhejiang Yong Xing Digital Technology Company Limited (4 )
10.4
Proxy and Voting Agreement dated as of November 1, 2005 between Capital Development Limited and Zhejiang Yong Xing Digital Technology Company Limited (4 )
10.5
Option Agreement dated as of November 1, 2005 between Capital Development Limited and Zhejiang Yong Xing Digital Technology Company Limited (4 )
10.6
Equity Pledge Agreement dated as of November 1, 2005 between Capital Development Limited and Zhejiang Yong Xing Digital Technology Company Limited (4 )
10.7
Subscription Agreement, dated as of December 20, 2005, between the Registrant and Huiqi Xu. (5 )
10.8
Consulting Agreement, dated as of December 20, 2005, among the Registrant, Wen-An Chen and Huoqing Yang. (5 )
10.9
Guarantee Contract between the Registrant and Shenzhen Shiji Ruicheng Guaranty and Investment Company Limited, dated as of December 21, 2005. (6 )
10.10
Agreement and Plan of Merger, dated as of December 21, 2005, among the Registrant, YX Acquisition Corporation, Capital Future Development Limited, Zhenggang Wang, Yimin Zhang, Weiyi Lv, Xiaochun Wang, Zhongsheng Bao, Simple (Hongkong) Investment & Management Company Limited, First Capital Limited, Shenzhen Dingyi Investment & Consulting Limited and China US Bridge Capital Limited. (6 )
10.11
Form of Promissory Note dated December 21, 2005. (6 )
10.12
Share Exchange Agreement, dated as of November 28, 2006, among China 3C Group, Capital Future Development Limited (“CFDL”), Shanghai Joy & Harmony Electronics Company Limited, and the shareholders of CFDL. (7 )
10.13
Form of Securities Purchase Agreement, dated July 13, 2007, by and among the Registrant and certain subscribers (8 )
10.14
Letter of Intent for Strategic Partnership, dated November 22, 2007, between the Registrant’s subsidiary Zhejiang Yongxin Technology Limited and Hangzhou Xituo Network Technology Company (9 )
10.15
Consignment Agreement, dated January 2, 2008, between the Registrant’s subsidiary Hangzhou Shan He Electric Company Limited and Hangzhou Lotour Digital Products Business Company Limited (10 )
Consignment Agreement, dated January 3, 2008, between the Registrant’s subsidiary Hangzhou Wang Da Electric Company Limited and Hangzhou Lotour Digital Products Business Company Limited (10 )
10.17
Acquisition Agreement dated December 19, 2008 by and among Zhejiang Yong Xing Digital Technology Company Limited, Yiwu Yong Xin Communication Limited Jinhua Baofa Logistic Limited and the shareholders of Jinhua Baofa Logistic Limited (12)
10.18
Amendment to Acquisition Agreement dated April 4, 2009 by and among Zhejiang Yong Xing Digital Technology Company Limited, Yiwu Yong Xin Communication Limited and the shareholders of Jinhua Baofa Logistic Limited (13)
10.19
Compensation Agreement, dated November 27, 2009, between China 3C Group and Joseph Levinson (14)
10.20
Board of Directors Agreement, dated December 8, 2006, among China 3C Group and Kenneth T. Berents (15)
10.21
China 3C Group 2008 Omnibus Securities and Incentive Plan (16)
10.22
Stock Option Agreement Director Non-Qualified Stock Option, dated December 1, 2008 and effective as of January 15, 2009, between China 3C Group and Kenneth Berents (16)
10.23
Stock Option Agreement Director Non-Qualified Stock Option, dated December 1, 2008 and effective as of January 15, 2009, between China 3C Group and Kenneth Berents (16)
10.24
Stock Option Agreement Director Non-Qualified Stock Option, dated December 1, 2008 and effective as of January 15, 2009, between China 3C Group and Kenneth Berents (16)
10.25
Stock Option Agreement with Todd L. Mavis, dated April 21, 2009, between China 3C Group and Todd L. Mavis (16)
10.26
Agreement dated May 3, 2007 between China 3C Group and Joseph Levinson (16)
10.27
Letter Agreement dated June 16, 2009 between China 3C Group and Jian Zhang (17)
14.1
Code of Business Conduct and Ethics (11)
21.1
List of Subsidiaries, filed herewith
23.1
Consent of Goldman Parks Kurland Mohidin LLP, an independent registered public accounting firm, filed herewith.
31.1
Certification of Principal 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, filed herewith.
31.2
Certification of the Principal Accounting and 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, filed herewith.
32.1
Certification of Principal Executive Officer Pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002), filed herewith.
32.2
Certification of Principal Accounting and Financial Officer Pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002), filed herewith.
(1)
Incorporated by reference from the Registrant’s Current Report filed with the SEC on Form 8-K on January 3, 2007.
(2)
Incorporated by reference from the Registrant’s Registration Statement on Form S-8 (File No. 333-141173) dated March 9, 2007.
(3)
Incorporated by reference from the Registrant’s Current Report filed with the SEC on Form 8-K on October 21, 2005.
(4)
Incorporated by reference from the Registrant’s Current Report filed with the SEC on Form 8-K on September 11, 2007.
(5)
Incorporated by reference from the Registrant’s Current Report filed with the SEC on Form 8-K on December 20, 2005.
(6)
Incorporated by reference from the Registrant’s Current Report filed with the SEC on Form 8-K on December 22, 2005.
(7)
Incorporated by reference from the Registrant’s Current Report filed with the SEC on Form 8-K on December 11, 2006.
(8)
Incorporated by reference from the Registrant’s Current Report filed with the SEC on Form 8-K on July 17, 2007.
(9)
Incorporated by reference from the Registrant’s Current Report filed with the SEC on Form 8-K on November 28, 2007.
(10)
Incorporated by reference from the Registrant’s Current Report filed with the SEC on Form 8-K on January 17, 2008.
(11)
Incorporated by reference from the Registrant’s Annual Report filed with the SEC on Form 10-K on March 27, 2008.
(12)
Incorporated by reference from the Registrant’s Current Report filed with the SEC on Form 8-K on December 29, 2008.
(13)
Incorporated by reference from the Registrant’s Current Report filed with the SEC on Form 8-K on April 9, 2009.
(14)
Incorporated by reference from the Registrant’s Annual Report filed with the SEC on Form 10-K on April 16, 2009.
(15)
Incorporated by reference from the Registrant’s Current Report filed with the SEC on Form 8-K on December 14, 2006.
(16)
Incorporated by reference from the Registrant’s Registration Statement on Form S-8 (File No. 333-159200) dated May 13, 2009.
(17)
Incorporated by reference from the Registrant’s Current Report filed with the SEC on Form 8-K on June 22, 2009.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 15th day of April 2010.
Pursuant to the requirements of the Securities Exchange Act of 1934, this amended report has been signed below by the following persons on behalf of the Company and in the capacities indicated below and on the dates indicated.
Signatures
Title
Date
/s/ Zhenggang Wang
April 15, 2010
Zhenggang Wang
Chief Executive Officer and
Chairman (Principal Executive
Officer)
/s/ Xiang Ma
Xiang Ma
President
April 15, 2010
/s/ Jian Zhang
Jian Zhang
Chief Financial Officer (Principal
April 15, 2010
Accounting and Financial Officer)
/s/ Chenghua Zhu
Chenghua Zhu
Director
April 15, 2010
/s/ Mingjun Zhu
Mingjun Zhu
Director
April 15, 2010
/s/ Rongjin Weng
Rongjin Weng
Director
April 15, 2010
/s/ Wei Kang Gu
Wei Kang Gu
Director
April 15, 2010
/s/ Kenneth T. Berents
Kenneth T. Berents
Director
April 15, 2010
CHINA 3C GROUP AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders of China 3C Group:
We have audited the accompanying consolidated balance sheets of China 3C Group (the “Company” ) and subsidiaries as of December 31, 2009 and 2008 and the related consolidated statements of income and other comprehensive income, shareholders’ equity, and cash flows for the years ended December 31, 2009 and 2008. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have an audit of internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of China 3C Group and Subsidiaries as of December 31, 2009 and 2008 and the consolidated results of their operations and their consolidated cash flows for the years ended December 31, 2009 and 2008, in conformity with U.S. generally accepted accounting principles.
Goldman Park Kurland Mohidin
Encino, California
April 13,
CHINA 3C GROUP
CONSOLIDATED BALANCE SHEETS
(in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
CHINA 3C GROUP
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
CHINA 3C GROUP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
YEARS ENDED DECEMBER 31, 2009, 2008 and 2007
(in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
CHINA 3C GROUP
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
CHINA 3C GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009 AND 2008
Note 1 - ORGANIZATION
China 3C Group (the “Company” or “China 3C”) was incorporated on August 20, 1998 under the laws of the State of Nevada. Capital Future Developments Limited - BVI (“Capital”) was incorporated on July 22, 2004 under the laws of the British Virgin Islands. Zhejiang Yong Xin Digital Technology Company Limited (“Zhejiang”), Yiwu Yong Xin Communication Limited (“Yiwu”), Hangzhou Wang Da Electronics Company Limited (“Wang Da”), Hangzhou Sanhe Electronic Technology Limited (“Sanhe”), and Shanghai Joy & Harmony Electronics Company Limited (“Joy & Harmony”) 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 (“Merger Transaction”). China 3C Group acquired all of the issued and outstanding capital stock of Capital pursuant to a Merger Agreement dated at December 21, 2005 by and among China 3C Group, XY Acquisition Corporation, Capital and the shareholders of Capital (the “Merger Agreement”). Pursuant to the Merger Agreement, Capital became a wholly owned subsidiary of China 3C Group and, in exchange for the Capital shares, China 3C Group issued 35,000,000 shares of its common stock to the shareholders of Capital, representing 93% of the issued and outstanding capital stock of China 3C Group at that time and cash of $500,000.
On August 3, 2006, Capital completed the acquisition of a 100% interest in Sanhe for a cash and stock transaction valued at approximately $8.75 million. The consideration consisted of 915,751 newly issued shares of the Company’s common stock and $5 million 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 $18.5 million. The consideration consisted of 2,723,110 shares of the Company’s common stock and $7.5 million in cash.
On August 15, 2007, the Company changed its ownership structure. As a result, instead of Capital owning 100% of Zhejiang, Capital entered into contractual agreements with Zhejiang whereby Capital owns a 100% interest in the revenues of Zhejiang. Capital does not have an equity interest in Zhejiang, but enjoys all the economic benefits. Under this structure, Zhejiang is now a wholly foreign owned enterprise of Capital. The contractual agreements give Capital and its equity owners an obligation, and having ability to absorb, any losses, and rights to receive returns. Capital will be unable to make significant decisions about the activities of Zhejiang and cannot carry out its principal activities without financial support. These characteristics as defined in Accounting Standards Codification (“ASC”) 810, Consolidation of Variable Interest Entities (VIEs), qualify the business operations of Zhejiang to be consolidated with Capital and ultimately with China 3C.
Acquisitions
On July 6, 2009, China 3C and its subsidiary Zhejiang and Yiwu purchased 100% interest of Jinhua for RMB 120 million (approximately $17.5 million) in cash. Zhejiang acquired 90% and Yiwu acquired 10% of the entire equity interests in Jinhua.
Jinhua provides transportation logistics services to businesses. Jinhua operates primarily in Eastern China and covers many of the most developed cities in the Eastern China such as Shanghai, Hangzhou and Nanjing.
The purchase price and related allocation to the estimated fair values of the assets acquired and liabilities assumed, after proportionately allocating the goodwill resulting from the transaction in accordance with ASC 805 “Business Combinations” is as follows:
CHINA 3C GROUP AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The accompanying unaudited pro forma condensed consolidated balance sheet as of December 31, 2009 and the accompanying unaudited pro forma condensed consolidated statements of income for the years ended December 31, 2009 and 2008 gives effect to the acquisition as if it had been consummated on January 1, 2008.
The unaudited pro forma condensed consolidated financial statements should be read in conjunction with the historical financial statements of Jinhua as well as China 3C’s Form 10-K for the year ended December 31, 2008. The unaudited pro forma condensed consolidated financial statements do not purport to be indicative of the financial position or results of operations that would have actually been obtained had such transactions been completed as of the assumed dates and for the periods presented, or which may be obtained in the future. The pro forma adjustments are described in the accompanying notes and are based upon available information and certain assumptions that China 3C believes are reasonable.
CHINA 3C GROUP AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
AS OF DECEMBER 31, 2009
(IN THOUSANDS)
See accompanying notes to Unaudited Pro Forma Condensed Consolidated Financial Statements.
CHINA 3C GROUP AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
YEAR ENDED DECEMBER 31, 2009
(IN THOUSANDS)
See accompanying notes to Unaudited Pro Forma Condensed Consolidated Financial Statements.
CHINA 3C GROUP AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
YEAR ENDED DECEMBER 31, 2008
(IN THOUSANDS)
See accompanying notes to Unaudited Pro Forma Condensed Consolidated Financial Statements.
CHINA 3C GROUP AND SUBSIDIARIES
NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(a) To record the cash consideration paid for acquisition of 100% of the equity of Jinhua.
(b) To record the step-up to fair value of assets upon acquisition.
(c) To allocate the purchase price to intangible assets on acquisition.
(d) To eliminate the stockholders' equity of Jinhua.
(e) To allocate the purchase price to goodwill.
(f) To record amortization of acquired intangible assets.
(g) To record the estimated decrease in interest income earned on the reduced cash.
(h) To adjust the total tax provision to reflect the tax benefit arising from amortization of intangible assets and the decrease in interest income.
(i) To eliminate intercompany transactions between China 3C and Jinhua and give effect to the acquisition as if it had been consummated on January 1, 2008.
Following the acquisition of Jinhua, the Company began providing logistic service to businesses in addition to its traditional business of resale and distribution of third party products such as mobile phones, facsimile machines, DVD players, stereos, speakers, MP3 and MP4 players, iPods, electronic dictionaries, CD players, radio Walkmans and audio systems.
The Company is engaged in the business of resale and distribution of third party products and generates approximately 100% of our revenue from resale of items such as mobile phones, facsimile machines, DVD players, stereos, speakers, MP3 and MP4 players, iPods, electronic dictionaries, CD players, radio Walkmans and audio systems.
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements were prepared in conformity with accounting principles generally accepted in the United States of America (“US GAAP”). The Company’s functional currency is the Chinese Renminbi, however the accompanying consolidated financial statements have been translated and presented in United States Dollars.
Principles of Consolidation
The consolidated financial statements include the accounts of China 3C Group and its wholly owned subsidiaries Capital, Wang Da, Yiwu, Joy & Harmony, Sanhe and Jinhua and variable interest entity Zhejiang, collectively referred to as the Company. All material intercompany accounts, transactions and profits were eliminated in consolidation.
Currency Translation
The accounts of Zhejiang, Wang Da, Yiwu, Sanhe, Joy & Harmony and Jinhua were maintained, and its financial statements were expressed, in Chinese Yuan Renminbi (“CNY”). Such financial statements were translated into U.S. Dollars (“USD”) in accordance with Accounting Standards Codification (“ASC”) 830-10, “Foreign Currency Translation,” with the CNY as the functional currency. According to ASC 830-10, assets and liabilities were translated at the ending exchange rate, stockholders’ equity is translated at the historical rates and income statement items are translated at the average exchange rate for the period. The resulting translation adjustments are reported as other comprehensive income in accordance with ASC 220, “Reporting Comprehensive Income,” as a component of shareholders’ equity. Transaction gains and losses are reflected in the income statement.
Use of Estimates
The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Risks and Uncertainties
The Company is subject to substantial risks from, among other things, intense competition associated with the industry in general, other risks associated with financing, liquidity requirements, rapidly changing customer requirements, limited operating history, foreign currency exchange rates and the volatility of public markets.
Contingencies
Certain conditions may exist as of the date the financial statements are issued, which could result in a loss to the Company but which will only be resolved when one or more future events occur or fail to occur. The Company’s management assesses such contingent liabilities, and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against the Company or unasserted claims that may result in such proceedings, the Company’s management evaluates the perceived merits of any legal proceedings or unasserted claims as well as the perceived merits of the amount of relief sought or expected to be sought.
If the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability can be estimated, then the estimated liability is accrued in the Company’s financial statements. If the assessment indicates that a potential material loss contingency is not probable but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability, together with an estimate of the range of possible loss if determinable and material would be disclosed.
Loss contingencies considered to be remote by management are generally not disclosed unless they involve guarantees, in which case the guarantee would be disclosed.
Accounts Receivable
The Company maintains reserves for potential credit losses on accounts receivable. Management reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these reserves. Terms of the sales vary. Reserves are recorded primarily on a specific identification basis. Allowance for doubtful debts were $404 and $365 as of December 31, 2009 and 2008, respectively.
Inventories
Inventories are valued at the lower of cost (determined on a weighted average basis) or market. Management compares the cost of inventories with the market value and allowance is made for writing down their inventories to market value, if lower. As of December 31, 2009 and 2008, inventory consisted entirely of finished goods valued at $6,764 and $8,971, respectively.
Property, Plant & Equipment
Property, plant and equipment are stated at cost. Expenditures for maintenance and repairs are charged to earnings as incurred; additions, renewals and betterments are capitalized. When property and equipment are retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the respective accounts, and any gain or loss is included in operations. Depreciation of property and equipment is provided using the straight-line method for substantially all assets with estimated lives of:
Automotive
years
Office Equipment
years
As of December 31, 2009 and 2008, property and equipment consisted of the following:
Long-Lived Assets
The Company periodically evaluates the carrying value of long-lived assets to be held and used in accordance with ASC 360 “Property, Plant and Equipment” requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amounts. In that event, a loss is recognized based on the amount by which the carrying amount exceeds the fair market value of the long-lived assets. Losses on long-lived assets to be disposed of are determined in a similar manner, except that fair market values are reduced for the cost of disposal. Based on its review, the Company believes that, as of December 31, 2009 and December 31, 2008, there were no significant impairments of its long-lived assets.
Fair Value of Financial Instruments
ASC 825 “Financial Instruments” requires that the Company disclose estimated fair values of financial instruments. The carrying amounts reported in the statements of financial position for current assets and current liabilities qualifying as financial instruments are a reasonable estimate of fair value.
Revenue Recognition
In accordance with Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin (“SAB”) 104, the Company recognizes revenues when there is persuasive evidence of an arrangement, product delivery and acceptance have occurred, the sales price is fixed and determinable, and collectability of the resulting receivable is reasonably assured.
The Company records revenues when title and the risk of loss pass to the customer. Generally, these conditions occur on the date the customer takes delivery of the product. Revenue is generated from sales of China 3C products through two main revenue streams:
1.
Retail. Approximately 69% and 68% of the Company's revenue comes from sales to individual customers at outlets installed inside department stores etc. (i.e. store in store model) during 2009 and 2008 , respectively and is mainly achieved through two broad categories:
a.
Purchase contracts. Sales by purchase contracts have terms of thirty days from the transfer of goods to the customer. Under this method, the Company delivers goods to places designated by the customers and receives confirmation of delivery. At that time, ownership and all risks associated to the goods are transferred to the customers and payment is made within 30 days. The Company relieves its inventory and recognizes revenue upon receipt of confirmation from the customer.
b.
Point of sale transfer of ownership. Under this method, the Company’s products are placed in third party stores and sold by the Company’s sales people. Upon purchase of the item by the customer, the Company relieves its inventory and recognizes revenue related to that item.
2.
Wholesale. Approximately 31% and 32% of the Company's revenue comes from wholesale during 2009 and 2008, respectively. Recognition of income in wholesales is based on the contract terms. In 2009, the main contract terms on wholesale agreed that payments be paid 15 days after receipt of goods and that ownership and all risks associated with the goods are transferred to the customers on the date of goods received and payments will be made 15 days therefrom.
Sales revenue is therefore recognized on the following basis:
1.
Store in store model:
a.
For goods sold under sales and purchase contracts, revenue is recognized when goods are received by customers.
b.
For goods at customer outlets which the Company’s sales people operate, and inventory of goods is under joint control by the customers and the Company, revenue is recognized at the point of sale to the end buyer.
During public holidays or department store celebration periods, we provide certain sales incentives to retail customers to increase sales, such as gift giving and price reductions. These are the only temporary incentives during the specified periods. Sales made to our retail customers as a result of incentives are immaterial as a percentage of total sales revenue.
2.
Wholesales:
a.
Revenue is recognized at the date of goods are received by wholesale customers. We operate our wholesale business by selling large volume orders to second-tier distributors and large department stores. Revenues from wholesale are recognized as net sales after confirmation with distributors. Net sales already take into account revenue dilution as they exclude inventory credit, discount fro early payment, product obsolescence and return of products and other allowances. Net sales also take into account the return of products in accordance with relevant laws and regulations in China.
Return policies
Our return policy complies with China’s laws and regulations on consumer’s rights and product quality. In accordance with Chinese law, consumers can return or exchange used products within seven days only if the goods do not meet safety and health requirements, endanger a person’s property, or do not meet the advertised performance. If the conditions and requirements as set out in the relevant laws and regulations are met, the retail stores are entitled to accept a return of the goods from the consumer. In such cases, the Company shall accept the returns unconditionally. Goods returned will be redirected to the production factory or supplier who shall bear all losses on the returns in accordance the laws and regulations. Consumer returns or exchanges of products that have not been used, where the packaging has not been damaged, are honored if such return or exchange is within seven days. If a consumer returns a product, the Company must refund the invoice price to the consumer. The Company will then be responsible for returning the goods to the production factory or supplier. At that time the Company can recover the price based on the purchase and sale contract with the producer or supplier. However, when goods are returned, the Company loses the gross margin that it records when revenue is recognized, regardless of whether the production factory or supplier takes the product back or not.
The return rights granted to wholesale customers are similar to the rights granted to retail customers. Once wholesale customers purchase the products, they follow the same return policy as retail customers. We do not honor any return from wholesale customers other than if the products don’t meet laws and regulations or quality requirements. If the wholesale customers have a high inventory level or product obsolescence caused by lower market demands or other operational issues, the wholesale customers bear their own losses. When a wholesale customer returns products, the Company will return the products to the suppliers or manufacturers. A sales return and allowance is recorded at the sales price. Meanwhile, a purchase return and allowance entry is recorded at the invoice price because the suppliers or manufacturers bear the losses. The net effect is that the Company derecognizes the gross profit when a return takes place, but does not record any loss on the cost of the returned item back to the supplier or manufacturer.
In light of the aforesaid PRC laws and regulations and the Company's arrangements with suppliers, we do not provide an accrual for any estimated losses on subsequent sale of the return of products. As a result we do not engage in assessing levels of inventory in the distribution channel, product obsolescence and/or introductions of new products, as none of those factors have any impact on us with respect to estimating losses on subsequent sale of returned goods. Third party market research report and consumer demand study is not used to make estimates of goods returned.
Cost of Sales
Cost of sales consists of actual product cost, which is the purchase price of the product less any discounts. Cost of sales excludes freight charges, purchase and delivery costs, internal transfer, freight charges and the other costs of the Company’s distribution network, which are identified in general and administrative expenses.
General and Administrative Expenses
General and administrative expenses are comprised principally of payroll and benefits costs for retail and corporate employees, occupancy costs of corporate facilities, lease expenses, management fees, traveling expenses and other operating and administrative expenses, including freight charges, purchase and delivery costs, internal transfer freight charges and other distribution costs.
Shipping and handling fees
The Company follows ASC 605-45, “Handling Costs, Shipping Costs”. The Company does not charge its customers for shipping and handling. The Company classifies shipping and handling fees as part of General and administrative expenses which were $226 and $244 for 2009 and 2008, respectively.
Vendor Discounts
The Company has negotiated preferred pricing arrangements with certain vendors on certain products. These arrangements are not contingent on any levels of volume and are considered vendor discounts as opposed to rebates. The Company records these discounts along with the purchase of the discounted items, resulting in lower inventory cost and a corresponding lower cost of sales as the products are sold.
Management fees paid to the department stores under “store in store” model
Under the “store in store” business operation model, the Company may pay management fees to the department stores, which are in the form of service charges or “selling at an allowance (discount)”. The management fees are accounted for (1) in the form of service charges which are reflected in general and administrative expenses, or (2) in the form of “selling at an allowance (discount)”, as a deduction of sales, which means, the expenses are directly deducted at a certain percentage on sales. Such management fees were $1,118,and $3,824 in general and administrative expenses and deductions of $10,505 and $12,687 in sales for 2009 and 2008, respectively.
Share Based Payment
The Company adopted ASC 718-10, “Stock Compensation”, which addresses the accounting for transactions in which an entity exchanges its equity instruments for goods or services, with a primary focus on transactions in which an entity obtains employee services in share-based payment transactions. ASC 718-10 is a revision to SFAS No. 123, “Accounting for Stock-Based Compensation,” ASC 718-10 requires measurement of the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). Incremental compensation costs arising from subsequent modifications of awards after the grant date must be recognized.
Advertising
Advertising expenses consist primarily of costs of promotion for corporate image and product marketing and costs of direct advertising. The Company expenses all advertising costs as incurred. Advertising expense was $405 and $360 for 2009 and 2008, respectively.
Other Income
Other income was $163 and $1,150 for the years ended December 31, 2009 and 2008. Other income consists of the following:
Advertising service income is the service fee we received from electronic product manufacturers when we advertise their products in our retail locations. Commission income from China Unicom is related to the sales of China Unicom’s wireless service and products, i.e. rechargeable mobile phone cards.
Income Taxes
The Company utilizes ASC 740 “Income Taxes”. Deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.
Basic and Diluted Earnings per Share
Earnings (loss) per share are calculated in accordance with ASC 260, “Earnings per Share”. Basic earnings (loss) per share is based upon the weighted average number of common shares outstanding. Diluted earnings (losses) per share is based on the assumption that all dilutive convertible shares and stock options were converted or exercised. Dilution is computed by applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period. If convertible shares and stock options are anti-dilutive, the impact of conversion is not included in the diluted net income per share. Excluded from the calculation of diluted earnings per share for 2009 and 2008 were 100,000 and 430,000 options, respectively, as they were not dilutive.
Statement of Cash Flows
In accordance with ASC 230 “Statement of Cash Flows”, cash flows from the Company’s operations are calculated based upon the functional currency, in our case the CNY. As a result, amounts related to changes in assets and liabilities reported on the statement of cash flows will not necessarily agree with the changes in the corresponding balances on the balance sheet.
Supplemental Cash Flow Disclosure
Cash from operating, investing and financing activities exclude the effect of the acquisition of Jinhua Baofa Logistics Limited (See Note 2).
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
ASC 280, “Segment Reporting” requires use of the “management approach” model for segment reporting. The management approach model is based on the way a company’s management organizes segments within the company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, legal structure, management structure, or any other manner in which management disaggregates a company. The Company operates in five segments (see Note 13).
Recent Accounting Pronouncements
ASC 805 “Business Combinations”, previously SFAS No. 141(R) “Business Combinations”. SFAS No. 141(R) changes how a reporting enterprise accounts for the acquisition of a business. SFAS 141(R) requires an acquiring entity to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value, with limited exceptions, and applies to a wider range of transactions or events. SFAS 141(R) is effective for fiscal years beginning on or after December 15, 2008 and early adoption and retrospective application is prohibited. Effective January 1, 2009. ASC 805 revised SFAS No. 141, “Business Combinations” and addresses the accounting and disclosure for identifiable assets acquired, liabilities assumed, and noncontrolling interests in a business combination. The Company adopted ASC 805. The Company accounted for the acquisition of Jinhua in accordance with these standards.
ASC 810 “Consolidation”, previously SFAS No. 160 “Noncontrolling Interests in Consolidated Financial Statement”. This Statement amends ARB 51 to establish accounting and reporting standards for the non-controlling (minority) interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. The Company adopted SFAS 160 on January 1, 2009. The adoption of this statement had no effect on the Company’s consolidated financial statements.
ASC 815 “Derivatives and Hedging”, previously SFAS No. 161 “Disclosures about Derivative Instruments and Hedging Activities”. SFAS No. 161 is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Standard also improves transparency about the location and amounts of derivative instruments in an entity’s financial statements; how derivative instruments and related hedged items are accounted for under Statement 133; and how derivative instruments and related hedged items affect its financial position, financial performance, and cash flows. The Company adopted SFAS 161 on January 1, 2009. The adoption of this statement had no effect on the Company’s consolidated financial statements.
ASC 825 “Financial Instruments”, previously FSP SFAS No. 107-1 “Interim Disclosures about Fair Value of Financial Instruments”. The guidance requires that the fair value disclosures required for all financial instruments within the scope of SFAS 107, “Disclosures about Fair Value of Financial Instruments”, be included in interim financial statements. This FSP also requires entities to disclose the method and significant assumptions used to estimate the fair value of financial instruments on an interim and annual basis and to highlight any changes from prior periods. FSP 107-1 was effective for interim periods ending after June 15, 2009. The adoption of FSP 107-1 did not have a material effect on the Company’s consolidated financial statements.
ASC 860 “Transfers and servicing”, previously SFAS No. 166 “Accounting for Transfers of Financial Assets”. SFAS No. 166 requires more information about transfers of financial assets and where companies have continuing exposure to the risks related to transferred financial assets. SFAS 166 is effective at the start of a company’s first fiscal year beginning after November 15, 2009, or January 1, 2010 for companies reporting earnings on a calendar-year basis. The adoption of this statement is not expected to have a material effect on the Company’s financial statements.
ASC 810 “Consolidation”, previously SFAS NO. 167 “Amendments to FASB Interpretation No. 46(R)”. SFAS No. 167 will change how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. Under SFAS 167, determining whether a company is required to consolidate an entity will be based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. SFAS 167 is effective at the start of a company’s first fiscal year beginning after November 15, 2009, or January 1, 2010 for companies reporting earnings on a calendar-year basis. The adoption of SFAS No. 167 will not have any impact on our financial statements.
FASB Accounting Standards Codification (Accounting Standards Update “ASU” 2009-1). In June 2009, the FASB approved its Accounting Standards Codification (“Codification”) as the single source of authoritative United States accounting and reporting standards applicable for all non-governmental entities, with the exception of the SEC and its staff. The Codification is effective for interim or annual financial periods ending after September 15, 2009 and impacts our financial statements as all future references to authoritative accounting literature will be referenced in accordance with the Codification. There have been no changes to the content of our financial statements or disclosures as a result of implementing the Codification.
Note 3 - ADVANCES TO SUPPLIERS
Advances to suppliers represent advance payments to suppliers for the purchase of inventory. As of December 31, 2009 and 2008, the Company had paid $2,370 and $2,492, respectively, as advances to suppliers.
Note 4 - COMMON STOCK
Joseph Levinson joined the Board of Directors of the Company and became in charge of Investor Relations for the Company in May 2007. As compensation for his services, the Company agreed to pay Mr. Levinson a monthly grant during his term of his services of 1,000 shares of the Company’s common stock. As of December 31, 2008, Mr. Levinson has received 20,000 shares of common stock. Mr. Levinson resigned in January 2009.
Pursuant to the terms of the Compensation Agreement dated as of November 27, 2008 between Mr. Levinson and the Company, Mr. Levinson acknowledged that (1) the initial annual grant of a stock option to purchase 300,000 shares of the Company’s common stock, with an exercise price of $6.15 per share under the China 3C Group 2005 Plan, and (2) a subsequent annual grant of a stock option to purchase an additional 300,000 shares of the Company's common stock, with an exercise price of $1.82 under the China 3C Group 2005 Plan were not and will not be granted and in consideration for his services as a Director accepted the issuance of 125,000 shares of the Company’s common stock.
On January 15, 2009, the Company’s Board adopted the China 3C Group, Inc. 2008 Omnibus Securities and Incentive Plan (the “2008 Plan”). The 2008 Plan provides for the granting of distribution equivalent rights, incentive stock options, non-qualified stock options, performance share awards, performance unit awards, restricted stock awards, stock appreciation rights, tandem stock appreciation rights, unrestricted stock awards or any combination of the foregoing, as may be best suited to the circumstances of the particular employee, director or consultant. Under the 2008 Plan 2,000,000 shares of the Company’s common stock are available for issuance for awards. Each award shall remain exercisable for a term of ten (10) years from the date of its grant. The price at which a share of common stock may be purchased upon exercise of an option shall not be less than the closing sales price of the common stock on the date such option is granted. The 2008 Plan shall continue in effect, unless sooner terminated, until the tenth anniversary of the date on which it is adopted by the of Directors.
In April and October 2009, the Company issued 1,997,272 shares of common stock under the 2008 Plan. The Company recognized $287,452 compensation expenses and there was $1,216,060 of unrecognized compensation expense related to the nonvested stocks as of December 31, 2009. The cost is expected to be recognized over a three year period.
Note 5 - STOCK WARRANTS, OPTIONS, AND COMPENSATION
Stock options- Options issued have a ten-year life and were fully vested upon issuance. The option holder has no voting or dividend rights. The grant price was equal the market price at the date of grant. The Company records the expense of the stock options over the related vesting period. The options were valued using the Black-Scholes option-pricing model at the date of grant stock option pricing.
The expected term represents the estimated average period of time that the options remain outstanding. The expected volatility is based on the historical volatility of the Company’s stock price. No dividend payouts were assumed, as the Company has no plans to declare dividends during the expected term of the stock 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 ASC 718, the Company recorded expenses of $337 for 2008 and none for 2009.
The following summarizes the option activity for the year ended 2009.
Outstanding options by exercise price consisted of the following as of December 31, 2009.
Note 6 - COMPENSATED ABSENCES
Regulation 45 of the labor laws in the People’s Republic of China (PRC) entitles employees to annual vacation leave after 1 year of service. In general all leave must be utilized annually, with proper notification, any unutilized leave is cancelled.
Note 7 - INCOME TAXES
The Company, through its subsidiaries, Zhejiang, Yiwu, Wang Da, Sanhe, Joy & Harmony and Jinhua, is governed by the Income Tax Laws of the PRC.
The US entity, China 3C Group, Inc is subject to the United States federal income tax at a tax rate of 34%. The US entity has incurred net accumulated operating losses of approximately $3,107 as of December 31, 2009 for income tax purposes. The US entity does not conduct any operations and only incurs public company expenses every year, such as legal fees, accounting fees, investor relations expenses and filing fees. Therefore, it is more likely than not that all of the Company’s deferred tax assets will not be realized. A 100% allowance was recorded on the deferred tax asset for approximately $1,056.
The Company’s policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. The Company did not have any accrued interest or penalties associated with any unrecognized tax benefits, nor were any interest expense recognized during 2009 and 2008.
Pursuant to the PRC Income Tax Laws, from January 1, 2008, the Enterprise Income Tax (“EIT) is calculated against the net income in a fiscal year at a statutory rate of 25%.
During the first two quarters of 2009, Yiwu, Wang Da, Sanhe and Joy & Harmony all had net income and prepaid income taxes quarterly. During third and fourth quarter 2009, the four subsidiary each incurred net loss and the amount of loss of Yiwu, Wang Da , Sanhe exceeded the income recognized in the first two quarters. Therefore, Yiwu, Wang Da and Sanhe each had a net loss for year 2009. Pursuant to the PRC Income Tax Laws, EIT is settled on an annual basis but is paid quarterly with adjustments either refunded or carried forward for five years. Therefore, the prepaid income tax of $1,157 was recorded as tax receivable in the consolidated balance sheet to offset future year’s tax liabilities.
Income tax expense consisted of the following for 2009 and 2008.
Reconciliation of the differences between the statutory U.S. Federal income tax rate and the effective rate is as follows for 2009 and 2008.
Note 8 - COMMITMENTS
The Company leases various office facilities under operating leases that terminate through 2011. Rent expense for 2009 and 2008 was $518 and $274, respectively. The future minimum obligations under these agreements are as follows as of December 31, 2009:
In addition, as of December 31, 2009, the Company is committed to pay $101 under various advertising agreements expiring within one year.
Note 9 - STATUTORY RESERVE
In accordance with the laws and regulations of the PRC, a wholly-owned Foreign Invested Enterprise’s income, after the payment of the PRC income taxes, shall be allocated to the statutory surplus reserves and statutory public welfare fund. Prior to January 1, 2006, the proportion of allocation for reserve was 10 percent of the profit after tax to the surplus reserve fund and additional 5-10 percent to the public affair fund. The public welfare fund reserve was limited to 50 percent of the registered capital. Effective January 1, 2006, there is now only one fund requirement. The reserve is 10 percent of income after tax, not to exceed 50 percent of registered capital.
Statutory reserve funds are restricted for set off against losses, expansion of production and operation or increase in register capital of the respective company. Statutory public welfare fund is restricted to the capital expenditures for the collective welfare of employees. These reserves are not transferable to the Company in the form of cash dividends, loans or advances. These reserves are therefore not available for distribution except in liquidation. As of December 31, 2009 and 2008, the Company had allocated $11,535 and $11,109, respectively, to these non-distributable reserve funds.
Note 10 - OTHER COMPREHENSIVE INCOME
The detail of other comprehensive income as included in stockholders’ equity for 2009 and 2008 is as follows:
Note 11 - CURRENT VULNERABILITY DUE TO CERTAIN RISK FACTORS
The Company’s operations are carried out in the PRC. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environments in the PRC, by the general state of the PRC’s economy. The Company’s business may be influenced by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.
Note 12 - MAJOR CUSTOMERS AND CREDIT RISK
During 2009 and 2008, no customer accounted for more than 10% of the Company’s sales. As of December 31, 2009 and 2008, the Company had no individual customers or vendors that comprised more than 10% of the Company’s accounts receivable or accounts payable.
Note 13 - SEGMENT INFORMATION
We separately operate and prepare accounting and other financial reports to management for five major business organizations (Wang Da, Sanhe, Yiwu ,Joy & Harmony and Jinhua). Each of the 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. Jinhua provides logistics to businesses in Eastern China. All segments are accounted for using the same principals as described in Note 2.
We have identified four reportable segments required by ASC 280: (1) mobile phone, (2) home electronics, (3) office communication product, (4) consumer electronics and (5) Logistics.
The following tables present summarized information by segment (in thousands):