UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2012

or

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

For the transition period from ____ to _____

Commission File Number:  000-28767

China 3C Group

(Exact name of registrant as specified in its charter)

368 HuShu Nan Road

HangZhou City, Zhejiang Province, China 310014

(Address of Principal Executive Offices) (Zip Code)

086-0571-88381700

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: 

Yes x   No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yesx    No ¨

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

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

As of November 9, 2012, the registrant had 93,911,327 shares of common stock outstanding.

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

Item 1.  Financial Statements

CHINA 3C GROUP AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands)

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

CHINA 3C GROUP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

NINE MONTHS ENDED SEPTEMBER 30, 2012 and 2011 (UNAUDITED)

(in thousands)

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

CHINA 3C GROUP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

THREE MONTHS ENDED SEPTEMBER 30, 2012 and 2011 (UNAUDITED)

(in thousands)

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

CHINA 3C GROUP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

NINE MONTHS ENDED SEPTEMBER 30, 2012 and 2011 (UNAUDITED)

(in thousands)

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

CHINA 3C GROUP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2012 AND 2011 (UNAUDITED)

Note 1 - ORGANIZATION

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

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

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

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

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

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

We sell and distribute products through retail stores and secondary distributors. We operate most of our retail operations through our “store in store” model. Under this model, the Company leases space in major department stores and retailers. Leasing costs can vary based on the percentage of sales, or can be fixed. In the three and nine months ended September 30, 2012 and 2011 all of our stores in stores leases were variable based on sales.

Following the acquisition of Jinhua, the Company began providing logistic service to businesses in addition to its traditional business of resale and distribution of third party products. 

ORGANIZATIONAL CHART

Our corporate structure as of September 30, 2012 is as follows:

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

** These entities ceased operation as of September 30, 2012.

Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying consolidated financial statements were prepared in conformity with accounting principles generally accepted in the United States of America (“US GAAP”).  The Company’s subsidiaries – Wang Da, Yiwu, Joy & Harmony, Sanhe, Jinhua and Zhejiang’s functional currency is the Chinese Renminbi (“RMB”), however, the accompanying consolidated financial statements were translated and presented in United States Dollars (“$”, or “USD”). China 3C is the parent company that was incorporated on August 20, 1998 under the laws of the State of Nevada. The parent company has no operations; therefore, it has no sales. The main activities of China 3C were incurring public company expenses. China 3C pays all of its expenses in USD. Therefore, we believe China 3C’s functional currency is USD. Capital was incorporated on July 22, 2004 under the laws of the BVI. Capital is a holding company and has no operations. As a result, we determined that China 3C and Capital’s functional currency is USD.

Going Concern

The accompanying consolidated financial statements were prepared on a going concern basis which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company realized net losses of $52,844 and $24,927 for the years ended December 31, 2011 and 2010, respectively, as well as $12,337 through the first nine months of 2012, accumulating a deficit of $39,968 as of September 30, 2012. In addition, the Company’s cash position has continued to deteriorate since 2010. There can be no assurance the Company will become profitable or that it will survive as a public company. These issues raise substantial doubt regarding the Company’s ability to continue as a going concern.

Principles of Consolidation

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

Reclassifications

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

Currency Translation

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

Use of Estimates

The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Risks and Uncertainties

The Company is subject to risks from, among other things, 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 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 judgment. In assessing loss contingencies arising from 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 it is probable that a material loss was incurred and the amount of the liability can be reasonably estimated, then the estimated liability is accrued in the Company’s financial statements. If the assessment indicates a potential material loss contingency is not probable but reasonably possible, or is probable but cannot be reasonably 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 is disclosed.

Accounts Receivable

The Company maintains reserves for potential credit losses on accounts receivable. Management reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these reserves. Terms of the sales vary. Reserves are recorded primarily on a specific identification basis. Allowance for doubtful accounts was $253 (unaudited) and $751 as of September 30, 2012 and December 31, 2011, respectively.

Inventories

Inventories are valued at the lower of cost (determined on a weighted average basis) or market value.  Management compares the cost of inventories with the market value and allowance is made for writing down their inventories to market value, if lower. As of September 30, 2012 and December 31, 2011, inventory consisted entirely of finished goods valued at $2,581(unaudited) and $3,358, respectively.

Property and Equipment, net

Property and equipment are stated at cost. Expenditures for maintenance and repairs are charged to earnings as incurred; additions, renewals and betterments are capitalized. When property and equipment are retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the respective accounts, and any gain or loss is included in operations. Depreciation of property and equipment is provided using the straight-line method for substantially all assets with estimated lives of:

As of September 30, 2012 and December 31, 2011 (audited), 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 FASB ASC 360 “Property, Plant and Equipment”, which requires impairment losses 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 value (“FV”) of the long-lived assets. Losses on long-lived assets to be disposed of are determined in a similar manner, except that FVs are reduced for the cost of disposal. Based on its review, the Company believes that, as of September 30, 2012 and December 31, 2011 (audited), there were no significant impairments of its long-lived assets.

Fair Value of Financial Instruments

FASB ASC Topic 825 “Financial Instruments” requires that the Company disclose estimated FVs 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 FV.

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:

Sales revenue is therefore recognized on the following basis:

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.

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 will accept 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 which 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 contract with the producer or supplier. However, when goods are returned, the Company loses the profit margin that it records when revenue is recognized, regardless of whether the production factory or supplier takes the product back or not.

The return rights granted to wholesale customers are similar to the rights granted to retail customers. Once wholesale customers purchase the products, they follow the same return policy as retail customers. We only honor returns from wholesale customers 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 the subsequent return of products. As a result we do not engage in assessing levels of inventory in the distribution channel, product obsolescence and/or introductions of new products, as none of those factors have any impact on us with respect to estimating losses on subsequent sale of returned goods.  Goods return policy complies with the laws and regulations in China on consumer rights and product quality requirements. If the conditions and requirements as set out in the relevant laws and regulations are met, customers are able to return the goods unconditionally. In such cases, the Company shall accept the returns unconditionally. Goods returned will be redirected back to the manufacturers or suppliers which shall meet all losses on returns in accordance with the laws and regulations. The Company will only be responsible for assisting the process of execution of goods returned. The Company shall not bear any loss from goods returned. As a result, we do not provide any accrual on subsequent return of goods sold.

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

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

Cost of Sales

Cost of sales (“COS”) consists of actual product cost, which is the purchase price of the product less any discounts.  COS excludes freight charges, purchase and delivery costs, internal transfer, freight charges and the other costs of the Company’s distribution network, which are identified in general and administrative (“G&A”) expenses.

General and Administrative Expenses

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

Shipping and Handling Fees

The Company follows FASB ASC 605-45, “Handling Costs, Shipping Costs”.  The Company does not charge its customers for shipping and handling. The Company classifies shipping and handling fees as part of G&A expenses.

Shipping and handling fees during the three and nine months ended September 30, 2012 and 2011, were as follows: 

Vendor Discounts

The Company has negotiated preferred pricing arrangements with certain vendors on certain products. These arrangements are not contingent on any levels of volume and are considered vendor discounts as opposed to rebates. The Company records these discounts along with the purchase of the discounted items, resulting in lower inventory cost and a corresponding lower COS as the products are sold.

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

Under the “store in store” business operation model, the Company may pay management fees to the department stores, which are in the form of service charges. The management fees are reflected in G&A expenses.

Management fees during the three and nine months ended September 30, 2012 and 2011, were as follows: 

Share Based Payment

The Company follows FASB ASC 718-10, “Stock Compensation”, which addresses the accounting for transactions in which an entity exchanges its equity instruments for goods or services, with a primary focus on transactions in which an entity obtains employee services in share-based payment transactions. ASC 718-10 requires measurement of the cost of employee services received in exchange for an award of equity instruments based on the grant-date FV 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 expenses during the three and nine months ended September 30, 2012 and 2011, were as follows: 

Income Taxes

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

Basic and Diluted Loss per Share

Loss per share is calculated in accordance with FASB ASC Topic 260, “Earnings per Share”. Basic earnings (loss) per share is based upon the weighted average number of common shares outstanding. Diluted earnings (loss) per share is based on the assumption that all dilutive convertible shares and stock options were converted or exercised. Dilution is computed by applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period. If convertible shares and stock options are anti-dilutive, the impact of conversion is not included in the diluted net income (loss) per share. Excluded from the calculation of diluted (loss) per share for the three and nine months ended September 30, 2012 and 2011 was 50,000 options, as they were not dilutive.

Statement of Cash Flows

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

Concentration of Credit Risk

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

Segment Reporting

FASB ASC Topic 280, “Segment Reporting”, requires use of the “management approach” model for segment reporting. The management approach model is based on the way a company’s management organizes segments within the company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, legal structure, management structure, or any other manner in which management disaggregates a company. The Company operated in four segments before the acquisition of Jinhua in July 2009. Since then, the Company operated in five segments until Sanhe and Joy & Harmony ceased operations at the end of 2011 and Yiwu and Jinhua ceased operations at the end of September 30, 2012. As a result, the Company operated only in mobile phone segment in the third quarter of 2012 (see Note 14).

Recent Accounting Pronouncements

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

In December 2011, FASB issued ASU 2011-11, Disclosures about offsetting Assets and Liabilities, requiring additional disclosure about offsetting and related arrangements. ASU 2011-11 is effective retrospectively for periods beginning on or after January 1, 2013. The adoption of ASU 2011-11 will not have a material impact on the Company’s future financial position or results of operations.

In July 2012, FASB issued ASU 2012-02, Intangibles—Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment. ASU 2012-02 simplifies the guidance for testing the decline in the realizable value (impairment) of indefinite-lived intangible assets other than goodwill. ASU 2012-02 allows an entity the option of first performing a qualitative assessment to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired. The adoption of ASU 2012-02 will not have a material impact on the Company’s consolidated financial statements. 

Note 3 – ADVANCES TO SUPPLIERS

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

Note 4 – SHORT TERM LOANS

As of September 30, 2012, the Company had short term loans of $2,532 between the Company and Zhejiang Chouzhou Commercial Bank. The loans were dated July 16, 2012, due July 15, 2013, with an annual interest rate of 7.26% payable monthly. The loans are personally guaranteed by the Company’s Chief Executive Officer, Zhenggang Wang, and four other non related party individuals.

Note 5 – STOCK BASED COMPENSATION

On January 17, 2011, China 3C entered into a Registered Trademark Transfer Agreement to purchase the registered trademark, “Lotour.”  The trademark expires July 6, 2020.  The consideration for the trademark was RMB 2,280,000 ($346), which was paid in the form of 1.08 million shares of the Company’s common stock, valued at $0.32 per share.   

On January 20, 2011, Zhejiang entered into a Design and Development Engagement Agreement to design and develop an electronic book product under the brand name “Lotour.” The total consideration for the design and development of the electronic book product is RMB 3,160,000 ($480), which was paid in the form of 1.6 million shares of the Company’s common stock, valued at $0.30 per share. The term of the Development Agreement was from January 20, 2011 to July 19, 2011, at which date, the design and development agreement was completed and the “Lotour” electronic book started trial production.

On March 7, 2011, the Company issued 1,000,000 shares to 23 managing members of China 3C and its subsidiaries, pursuant to the 2011 Restricted Stock Plan.

On September 14, 2011, the Company issued 400,000 shares, under the 2011 plan, to our CFO and former CFO as stock compensations, pursuant to the 2011 Restricted Stock Plan.

On May 17, 2012, the Company amended the 2011 Restricted Stock Plan and increased the number of shares of common stock that may be granted to 20,500,000.

Effective May 17, 2012, the Company granted 17,500,000 shares of restricted common stock to our CEO pursuant to his employment agreement. The shares shall vest over three years with 5,833,333 vesting on the first anniversary of the grant date, 5,833,333 on the second and 5,833,334 on the third. The common stock was valued at grant date with a FV of $1,050. During the three and nine months ended September 30, 2012, $88 and $131 was recognized as stock based compensation expense.

On July 19, 2012, the Company’s Board of Directors (“BOD”) adopted the China 3C Group, Inc. 2012 Omnibus Securities and Incentive Plan (the “2012 Plan”).  The 2012 Plan provides for 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 2012 Plan, 17,500,000 shares of the Company’s common stock are available for issuance for awards.  Each award shall remain exercisable for a term of 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 2012 Plan shall continue in effect, unless sooner terminated, until the tenth anniversary of the date on which it is adopted by the BOD. $1,750,000 was recognized as stock based compensation expense during the three and nine months ended September 30, 2012.

Note 6 - OPTIONS

Options issued have a 10-year life and were fully vested upon issuance. The option holder has no voting or dividend rights. The grant price was the market price at the date of grant. The Company records the expense of the stock options over the related vesting period. The options were valued using the Black-Scholes option-pricing model (“BSOPM”) at the date of grant stock option pricing.

Outstanding options by exercise price consisted of the following as of September 30, 2012:

During 2011 and 2012, the Company did not issue any stock options. The 50,000 stock options outstanding as of September 30, 2012 were issued in 2007 to our former director Mr. Kenneth Berents, which have a 10-year term and vested immediately upon issuance.

The Company estimates the FV of stock options at grant date using the BSOPM, consistent with the provisions of ASC 718-10 “Stock Compensation”. Key inputs and assumptions used to estimate the FV of stock options include the grant price of the award, the expected option term, volatility of the company’s stock, the risk-free rate and the Company’s dividend yield.

The following table presents the weighted-average assumptions used in the valuation at the grant date and the resulting weighted average FV per option granted:

Note 7 - COMPENSATED ABSENCES

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

Note 8 - INCOME TAXES

The Company recognizes interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. The Company did not have any accrued interest or penalties associated with any unrecognized tax benefits nor was any interest expense recognized during the nine months ended September 30, 2012 and 2011.

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

The US entity, China 3C is subject to the US federal income tax at 34%. The US entity does not conduct any operations and only incurs public company expenses, such as legal fees, accounting fees, investor relations expenses and filing fees. In applying step one, we determined it is more likely than not that all of the Company’s deferred tax assets will not be realized. As of September 30, 2012, the US entity has incurred net accumulated operating losses of $3,947 for income tax purposes. As a result, $1,342 of valuation allowance was recorded to reduce the deferred tax asset to zero. The net change in valuation allowance was $660, $72, $835 and $382 for the three and nine months ended September 30, 2012 and 2011, respectively for the US entity.

The PRC subsidiaries, Sanhe, Wang Da, Joy& Harmony, Yiwu and Zhejiang are subject to the PRC income tax at 25%. Jinhua is subject to PRC income tax using simplified tax system. During the three and nine months ended September 30, 2012 and 2011, the PRC subsidiaries incurred an adjusted net operating loss of $935, $4,199, $1,010 and $2,910. In applying step one, management believes these subsidiaries will continue to incur losses in the near future due to high market competition, slowing market demand, rising labor and fuel costs. We believe it is more likely than not that the subsidiaries will not be able to benefit from the deferred tax assets in association with the operating losses. The net change in valuation allowance was $234, $252, $1,050 and $747 for the three and nine months ended September 30, 2012 and 2011, respectively for the PRC subsidiaries.

The components of deferred income tax assets and liabilities as of September 30, 2012 and December 31, 2011 (audited) are as follows:

Reconciliation of the differences between the statutory US federal income tax rate and the effective rate for the three and nine months ended September 30, 2012 and 2011 is as follows:

Note 9 - COMMITMENTS

The Company leases office facilities under operating leases that terminate through 2015.

Rent expense during the three and nine months ended September 30, 2012 and 2011, was as follows: 

The future minimum obligations under these agreements are as follows by years as of September 30, 2012:

Note 10 - STATUTORY RESERVE

In accordance with the laws and regulations of the PRC, a Wholly Foreign Owned Entity’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% of the profit after tax to the surplus reserve fund and additional 5-10% to the public affair fund. The public welfare fund reserve was limited to 50% of the registered capital. Effective January 1, 2006, there is now only one fund requirement. The reserve is 10% of income after tax, not to exceed 50% 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 September 30, 2012, the Company had allocated $11,543 to these non-distributable reserve funds.

Note 11 – DISCONTINUED OPERATIONS

In 2011, Sanhe closed all its 210 stores in stores. Joy & Harmony closed all its 196 stores in stores. Letong closed its direct retail and franchise operation. In the nine months ended September 30, 2012, Yiwu closed all its 153 stores in stores. Jinhua closed its logistics operation. All five entities ceased operation as of September 30, 2012. As such, Sanhe, Joy & Harmony, Letong, Yiwu and Jinhua were reported as discontinued operations in the financial statements, and accordingly, the results of operations were reclassified for all periods to conform to the current period presentation.

The following table summarizes the assets and liabilities of the discontinued operations as of September 30, 2012 and December 31, 2011 (audited) included in the Consolidated Balance Sheets:

The following table summarizes the operating results of the discontinued operations for the three and nine months ended September 30, 2012 and 2011 included in the Consolidated Statements of Operations and Comprehensive Loss:

Note 12 - OTHER COMPREHENSIVE INCOME

Other comprehensive income as included in stockholders’ equity for the three and nine months ended September 30, 2012 and 2011, represents foreign currency translation adjustments.

Note 13 - CURRENT VULNERABILITY DUE TO CERTAIN RISK FACTORS

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

Note 14 - MAJOR CUSTOMERS AND CREDIT RISK

During the three and nine months ended September 30, 2012 and 2011, no customer accounted for more than 10% of the Company’s sales or accounts receivable and no vendor accounted for more than 10% of the Company’s purchases.

Note 15 - SEGMENT INFORMATION

We separately operate and prepare accounting and other financial reports to management for two business organizations (Wang Da and Zhejiang). Starting from the third quarter 2012, mobile phones businesses are split between Wang Da and Zhejiang. Wang Da focuses on distributing Samsung, Nokia and domestic brands mobile phones. Zhejiang will focus on distributing Apple brand products. As a result, Zhejiang’s operations, together with Wang Da, are reported in “Mobile Phones” segment for the three and nine months ended September 30, 2012, as disclosed in the Consolidated Statements of Operations and Comprehensive Loss.

“Other” segment includes China 3C (the US holding company) and Capital; China 3C and Capital have no operations except for incurring public company expenses. All segments are accounted for using the same principles as described in Note 2.

We only have one reportable segment - mobile phones, required by ASC 280, “Segment Reporting”, operated by Wang Da and Zhejiang. The operating results for mobile phones segment for the three and nine months ended September 30, 2012 are disclosed in the Consolidated Statements of Operations and Comprehensive Loss.

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

Forward Looking Statements

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

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

Overview (All dollar amounts in thousands)

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

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

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

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

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

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

Yiwu, Wang Da, Sanhe and Joy & Harmony were engaged in the resale and distribution of third party products and generated approximately 100% of their revenue from resale of items such as mobile phones, facsimile machines, DVD players, stereos, speakers, MP3 and MP4 players, iPod, electronic dictionaries, CD players, radios, and audio systems. We sell and distribute products through retail stores and secondary distributors. We operate most of our retail operations through our “store in store” model. Under this model, the Company leases space in major department stores and retailers. Leasing costs can vary based on a percentage of sales, or can be fixed. In the three and nine months ended September 30, 2012 and 2011, all of our stores in stores leases were variable based on sales. Following the acquisition of Jinhua, the Company began providing logistical services to businesses in addition to its traditional business of resale and distribution of third party products such as mobile phones, facsimile machines, DVD players, stereos, speakers, MP3 and MP4 players, iPods, electronic dictionaries, CD players, radios and audio systems.

During 2011, Zhejiang closed all direct stores and franchise stores. Sanhe closed all its 210 stores in stores. Joy & Harmony closed all its 196 stores in stores. All three entities ceased operation as of December 31, 2011. In the nine months ended September 30, 2012, Yiwu closed all its 153 stores in stores. Jinhua closed its logistics operation. Yiwu and Jinhua ceased operation as of September 30, 2012. As a result, the Company only focuses on distributing mobile phones through Wang Da and Zhejiang.

Results of Operations for the three and nine months ended September 30, 2012 and 2011

Reportable Operating Segments

In 2011, Sanhe closed all its 210 stores in stores. Joy & Harmony closed all its 196 stores in stores. Letong closed its direct retail and franchise operation. In the nine months ended September 30, 2012, Yiwu closed all its 153 stores in stores. Jinhua closed its logistics operation. All five entities ceased operation as of September 30, 2012. As such, Sanhe, Joy & Harmony, Letong, Yiwu and Jinhua were reported as discontinued operations in the financial statements.

The Company reports financial and operating information in continuing operations only in the mobile phones segment through Wang Da and Zhejiang:

Wang Da focuses on the selling, circulation and modern logistics of cell phones.

For the nine months ended September 30, 2012, Wang Da generated revenue of $14,820, a decrease of $15,383 or 50.9% compared to $30,203 for the nine months ended September 30, 2011. Gross profit decreased $916 or 56.9% from $1,610 for the nine months ended September 30, 2011 to $694 for the nine months ended September 30, 2012. Profit margin decreased from 5.3% in the nine months ended September 30, 2012 to 4.7% in the nine months ended September 30, 2011, a decrease of 0.6%.

For the three months ended September 30, 2012, Wang Da generated revenue of $4,452, a decrease of $4,005 or 47.4% compared to $8,457 for the three months ended September 30, 2011. Gross profit decreased $119 or 50.6% from $235 for the three months ended September 30, 2011 to $116 for the three months ended September 30, 2012. Profit margin decreased from 2.8% in the three months ended September 30, 2011 to 2.6% in the three months ended September 30, 2012, a decrease of 0.2%.

The decrease in revenue was primarily due to the closing of 115 stores in stores during the nine months and 17 during the three months ended September 30, 2012. Lower market demand also led to lower revenue. The decrease in gross profit and profit margin was due to increased cost for cell phones but sales price remained flat or went down. As a result, smaller spread between cost and sales price caused gross profit and profit margin to decrease.

Operating loss was $2,568 and $418 for the nine and three months ended September 30, 2012 compared to $2,837 and $1,064 for the nine and three months ended September 30, 2011. Operating loss decreased during the three and nine months ended September 30, 2012 primarily due to closing of stores in stores to cut operating expenses.

Starting from the third quarter 2012, Zhejiang operated as part of the mobile phone business focusing on distribution Apple brand products.

Total Company Net Sales

Net sales for the nine months ended September 30, 2012 decreased by 47.9%, to $15,938 compared to $30,572 for the nine months ended September 30, 2011. Net sales for the three months ended September 30, 2012 decreased by 34.9%, to $5,570 compared to $8,550 for the three months ended September 30, 2011. The decrease was attributable to the increased competition in the mobile phone market in China as well as the closing of 153 and 17 stores in the nine and three months ended September 30, 2012.

Percentage of Sales

In the nine and three months ended September 30, 2012 and 2011, we earned 98.2% and 86.1% of our sales from our retail and 1.8% and 13.9% from our wholesale operations.

Cost of Sales

Cost of Sales (“COS”) for the nine months ended September 30, 2012 was $15,171 compared to $28,947 for the nine months ended September 30, 2011, a decrease of 47.6%. COS for the three months ended September 30, 2012 was $5,381 compared to $8,317 for the three months ended September 30, 2011, a decrease of 35.5%. The decreased COS for the three months was a result of the decrease in sales from the comparable period.

Profit Margin

Profit margin for the nine months ended September 30, 2012 was 4.8% compared to 5.3% for the nine months ended September 30, 2011. Profit margin for the three months ended September 30, 2012 was 3.4% compared to 2.7% for the three months ended September 30, 2011. The lower profit margin was primarily due to higher cost and decreased unit sales prices of consumer and business electronics in the competitive market in China.

General and Administrative Expenses

General and Administrative (“G&A”) expenses for the nine months ended September 30, 2012 were $6,624 or 41.6% of net sales, compared to $5,657 or 18.5% of net sales for the nine months ended September 30, 2011, an increase of 17.1%. G&A expenses for the three months ended September 30, 2012 were $2,844 or 51.1% of net sales, compared to $1,559 or 18.2% of net sales for the three months ended September 30, 2011, an increase of 82.4%. The increase in G&A expenses for the three and nine months ended September 30, 2012 was primarily due to increase in stock compensation expenses. For the three and nine months ended September 30, 2012, stock compensation expenses were $1,898 and $2,223 compared to $125 and $856 for the same periods in 2011, an increase of $1,773 and $1,367.

Loss from Continuing Operations

Operating loss for the nine months ended September 30, 2012 was $5,857 or 36.7% of net sales compared to $4,032 or 13.2% of net sales for the nine months ended September 30, 2011, an increase of 45.3%. Operating loss for the three months ended September 30, 2012 was $2,655 or 47.7% of net sales compared to $1,326 or 15.5% of net sales for the three months ended September 30, 2011, an increase of 100.2%. Lower sales, lower gross profit as well as increased stock compensation expenses of $1,898 and $2,223 were the key factors for the increase in loss from operations during the three and nine months ended September 30, 2012 compared to 2011.

Provision for Income Taxes

The provision for income taxes for the nine months ended September 30, 2012 was $0 compared to $1 for the nine months ended September 30, 2011. The provision for income taxes for the three months ended September 30, 2012 was $0 compared to a tax benefit of $20 for the three months ended September 30, 2011. Zhejiang was the only entity that paid income taxes during the first half of 2011. However, Zhejiang also incurred losses in the third quarter of 2011. As a result, Zhejiang had a tax benefit of $20 due to the refund of its overpaid taxes.

Net Loss from Continuing Operations

Net loss was $6,723 or 42.2% of net sales for the nine months ended September 30, 2012 compared to $4,014 or 13.1% of net sales for the nine months ended September 30, 2011, an increase of 67.4%. Net loss was $2,900 or 52.1% of net sales for the three months ended September 30, 2012 compared to $1,205 or 14.1% of net sales for the three months ended September 30, 2011, a decrease of 140.7%. Decreased sales revenue, lower gross profit and higher operating expenses were the critical factors which contributed to the decrease in net income.

Net Loss from Discontinued Operations

Net loss from discontinued operations for the nine months ended September 30, 2012 was $5,614 compared to $24,685 for 2011, a decrease of $19,071. Net loss from discontinued operations for the three months ended September 30, 2012 was $1,301 compared to $17,300 for 2011, a decrease of $15,999. The decrease in net loss from discontinued operations was due to Sanhe, Joy & Harmony and Yiwu closing stores in stores to cut losses. Jinhua also ceased operation to avoid the operating losses from deteriorating.

Net Loss

Net loss was $12,337 or 77.4% of net sales for the nine months ended September 30, 2012 compared to $28,699 or 93.9% of net sales for the nine months ended September 30, 2011, a decrease of 57.0%. The decrease in net loss was primarily due to the closing of Yiwu and Jinhua to cut losses.

Net loss was $4,201 or 75.4% of net sales for the three months ended September 30, 2012 compared to $18,505 or 216.4% of net sales for the three months ended September 30, 2011, a decrease of 77.3%. The decrease in net loss was primarily due to the closing of Yiwu and Jinhua to cut losses.

Foreign Currency Translation Adjustments

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

Transaction gains or losses arising from exchange rate fluctuation on transactions denominated in a currency other than the functional currency were included in the consolidated results of operations. As a result of the translation, China 3C recorded a foreign currency gain (loss) of $86, $(13), $1,175 and $481 in the nine and three months of 2012 and 2011, which is a separate line item on the Statements of Operations and Comprehensive Loss.

Liquidity and Capital Resources

Operations and liquidity needs are funded primarily through cash flows from operations. Cash and equivalents were $2,208 at September 30, 2012, compared to $10,256 at September 30, 2011, and $5,778 at December 31, 2011.

We believe the funds available to us are adequate to meet our operating needs for the remainder of 2012.

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

Operating Activities

Net cash used in operating activities was $6,260 for the nine months ended September 30, 2012 compared to $17,153 for the nine months ended September 30, 2011, a 63.5% decrease.  The decrease was mainly attributable to several factors, including (i) net loss of $12,337 in 2012 compared to $28,699 in 2011; (ii) decrease in accounts receivable of $6,922; and (iii) decrease in advance to suppliers of $1,639, offset by the increase in accounts payable of $1,534 and accrued expense of $3,230 in the nine months ended September 30, 2012, and add back stock compensation of $2,156.

Accounts receivable decreased 68.8% in the first nine months of 2012 while sales decreased 47.9%. Management monitors and periodically assesses the collectability of accounts receivable to ensure the allowance for bad debt account is reasonably estimated. Our accounts receivable department has periodically reviewed the allowance for doubtful accounts. The bad debt allowance is based on the aging of receivables, credit history and credit quality of the customers, the term of the contracts as well as the balance outstanding. If an account receivable item is considered probable to be uncollectible, it will be charged to bad debts immediately.

Cash and equivalents as of September 30, 2012 and December 31, 2011 were solely bank accounts in US and China. Specifically, cash and equivalents for each subsidiary as of September 30, 2012 and December 31, 2011 included:

(all amounts are denominated at thousands)

Cash equivalents held in the PRC subsidiaries are not freely transferrable outside the country. The amounts not freely transferable as of September 30, 2012 and December 31, 2011 were RMB 13,951 ($2,208) and RMB 36,541 ($5,752).

Capital Expenditures

We did not have any material capital expenditures during the nine months ended September 30, 2012. For the nine months ended September 30, 2011, we spent $427 primarily to purchase a mold custom designed for the “Lotour” brand E-book.

Working Capital Requirements

Historically operations and short term financing have been sufficient to meet our cash needs. We believe we will be able to generate revenues from sales and raise capital through private placement offerings of our equity securities to provide the necessary cash flow to meet anticipated working capital requirements. However, our working capital needs for the long and short term will depend upon numerous factors, including operating results, competition, and the availability of credit facilities, none of which can be predicted with certainty. Future expansion will be limited by the availability of financing products and raising capital.

Off-Balance Sheet Arrangements

We have never entered into any off-balance sheet arrangements nor 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 were 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 uncertain at the time the estimates are made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur, could materially impact the consolidated financial statements. We believe the following critical accounting policies reflect the more significant estimates and assumptions used in the preparation of the consolidated financial statements.

Revenue Recognition

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

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

Inflation

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

After Sales Service

The after-sales services we provide to our customers are primarily repair and maintenance. If a customer buys a product from us and needs repairs, we typically arrange to have the manufacturer repair the product. In certain cases, clerks in our stores are able to make the repairs directly.

Tabular Disclosure of Contractual Obligations

Not applicable.

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

Not applicable.

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, our management conducted an evaluation of our disclosure controls and procedures as of September 30, 2012, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based on this evaluation, our principal executive officer and principal financial officer concluded that, as of such date, the Company’s disclosure controls and procedures were not effective due to the material weakness in our internal controls identified in our Form 10-K for the year ended December 31, 2011.

Disclosure controls and procedures are designed to ensure that information required to be disclosed by us in our Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosures.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting (“ICFR”) that occurred during the nine months ended September 30, 2012 covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our ICFR.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

We are not currently a party to any material legal proceedings. From time to time, however, we may become involved in various lawsuits and legal proceedings which arise in the ordinary course of business.

Item 1A. Risk Factors.

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

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

None.

Item 3.  Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosures.

Not Applicable.

Item 5. Other Information.

None.

Item 6. Exhibits.

SIGNATURES

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

EXHIBIT INDEX