Unassociated Document
 
 


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q
 
(Mark one)

x QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2008
or

o TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to _________
 
Commission file number: 000-33123
 
China Automotive Systems, Inc.
(Exact name of registrant as specified in its charter)

Delaware
 
33-0885775
(State or other jurisdiction of incorporation or
organization)
 
(I.R.S. employer identification number)
 
No. 1 Henglong Road, Yu Qiao Development Zone, Shashi District,
Jing Zhou City, Hubei Province, People’s Republic of China
(Address of principal executive offices)
  
 
Issuer’s telephone number: (86) 716- 832- 9196
Issuer’s fax number: (86) 716-832-9298
 
 
Not Applicable
(Former name, former address and former fiscal year, if changed since last report.)

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

Yes x   No o 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer o
Accelerated filer o
Non-accelerated filer o
(Do not check if a smaller reporting company)
Smaller reporting company x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o  No x

As of June 30, 2008, the Company had 26,983,244 shares of common stock issued and outstanding.
 


 
CHINA AUTOMOTIVE SYSTEMS, INC.
INDEX
 
 
 
Page
 
 
 
Part I — Financial Information
 
 
 
 
 
Item 1.  Financial Statements
 
3
Condensed Consolidated Statements of Operations (Unaudited) for the Three Months and Six Months Ended June 30, 2008 and 2007
 
3
Condensed Consolidated Statements of Comprehensive Income (Unaudited) for the Three Months and Six Months Ended June 30, 2008 and 2007
 
6
Condensed Consolidated Balance Sheets at June 30, 2008 (Unaudited) and December 31, 2007
 
7
Consolidated Statements of Stockholders’ Equity for the Six Months Ended June 30, 2008 (Unaudited) and the Year Ended December 31, 2007
 
8
Condensed Consolidated Statements of Cash Flows (Unaudited) for the Six Months Ended June 30, 2008 and 2007
 
9
Notes to Condensed Consolidated Financial Statements (Unaudited) for the Three Months and Six Months Ended June 30, 2008 and 2007
 
12
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
34
Item 3.  Quantitative and Qualitative Disclosures About Market Risk
 
49
Item 4.  Controls and Procedures
 
49
 
   
Part II — Other Information
   
Item 1.  Legal Proceedings
 
51
Item 1A.  Risk Factors
 
51
ITEM 2.  Unregistered Sales Of Equity Securities And Use Of Proceeds
 
57
ITEM 3.  Defaults Upon Senior Securities
 
57
ITEM 4.  Submission Of Matters To A Vote Of Security Holders
 
57
ITEM 5.  Other Information
 
57
Item 6.  Exhibits
 
57
Signature
 
60
 
 
- 2 -

 
PART 1 — FINANCIAL INFORMATION

ITEM 1.
FINANCIAL STATEMENTS

China Automotive Systems, Inc.
Condensed Consolidated Statements of Operations (Unaudited)

   
Three Months Ended June 30,
 
 
 
2008 
 
2007
 
Net product sales, including $747,405 and $1,173,244 to related parties for the three months ended June 30, 2008 and 2007
 
$
46,508,340
 
$
36,312,338
 
Cost of product sold, including $2,651,000 and $1,414,954 purchased from related parties for the three months ended June 30, 2008 and 2007
   
32,045,336
   
24,218,532
 
Gross profit
   
14,463,004
   
12,093,806
 
Add: Gain on other sales
   
117,710
   
147,993
 
Less: Operating expenses-
         
Selling expenses
   
2,936,835
   
2,813,166
 
General and administrative expenses
   
4,151,633
   
2,080,578
 
R&D expenses
   
563,295
   
468,517
 
Depreciation and amortization
   
1,451,064
   
935,173
 
Total Operating expenses
   
9,102,827
   
6,297,434
 
Income from operations
   
5,477,887
   
5,944,365
 
Add: Other income, net (note 20)
   
   
 
Financial income (expenses) net (note 21)
   
(459,140
)
 
(16,495
)
Gain (loss) on change in fair value of derivative
   
995,153
   
 
Income before income taxes
   
6,013,900
   
5,927,870
 
Less: Income tax expenses (benefits) (note 22)
   
(415,458
)   
1,067,535
 
Income before minority interests
   
6,429,358
   
4,860,335
 
Less: Minority interests
   
1,685,003
   
2,405,181
 
Net income
 
$
4,744,355
 
$
2,455,154
 
Net income per common share-
         
Basic  
$
0.19
 
$
0.10
 
Diluted (note 2)
 
$
0.18
 
$
0.10
 
 
         
Weighted average number of common shares outstanding –
         
Basic
   
24,880,071
   
23,959,702
 
Diluted
   
28,834,380
   
23,962,153
 

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

- 3 -

 
China Automotive Systems, Inc.
Condensed Consolidated Statements of Comprehensive Income (Unaudited)

 
 
Three Months Ended June 30,
 
 
 
2008
 
2007
 
Net income
 
$
4,744,355
 
$
2,455,154
 
Other comprehensive income:
         
Foreign currency translation gain
   
2,350,934
   
1,265,553
 
Comprehensive income
 
$
7,095,289
 
$
3,720,707
 

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

- 4 -


China Automotive Systems, Inc.
Condensed Consolidated Statements of Operations (Unaudited)

 
 
Six Months Ended June 30,
 
 
 
2008 
 
2007
 
Net product sales, including $2,798,487 and $2,075,828 to related parties for the six months ended June 30, 2008 and 2007
 
$
87,975,383
 
$
64,695,730
 
Cost of product sold, including $4,603,390 and $2,466,434 purchased from related parties for the six months ended June 30, 2008 and 2007
   
61,300,009
   
43,410,018
 
Gross profit
   
26,675,374
   
21,285,712
 
Add: Gain on other sales
   
251,900
   
260,087
 
Less: Operating expenses-
         
Selling expenses
   
5,412,176
   
4,406,812
 
General and administrative expenses
   
5,767,783
   
3,589,605
 
R&D expenses
   
738,973
   
587,982
 
Depreciation and amortization
   
2,745,791
   
1,828,424
 
Total Operating expenses
   
14,664,723
   
10,412,823
 
Income from operations
   
12,262,551
   
11,132,976
 
Add: Other income, net (note 20)
   
199,459
   
38,462
 
Financial income (expenses) net (note 21)
   
(438,447
)
 
(411,492
)
Gain (loss) on change in fair value of derivative
   
995,153
   
 
Income before income taxes
   
13,018,716
   
10,759,946
 
Less: Income tax expenses (note 22)
   
408,937
   
2,361,615
 
Income before minority interests
   
12,609,779
   
8,398,331
 
Less: Minority interests
   
3,435,250
   
4,300,076
 
Net income
 
$
9,174,529
 
$
4,098,255
 
Net income per common share-
         
Basic  
$
0.37
 
$
0.17
 
Diluted (note 2)
 
$
0.36
 
$
0.17
 
 
         
Weighted average number of common shares outstanding –
         
Basic
   
24,422,429
   
23,948,950
 
Diluted
   
27,394,392
   
23,956,740
 

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

- 5 -


China Automotive Systems, Inc.
Condensed Consolidated Statements of Comprehensive Income (Unaudited)

 
 
Six Months Ended June 30,
 
 
 
2008
 
2007
 
Net income
 
$
9,174,529
 
$
4,098,255
 
Other comprehensive income:
         
Foreign currency translation gain
   
4,734,820
   
1,265,553
 
Comprehensive income
 
$
13,909,349
 
$
5,363,808
 

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

- 6 -


China Automotive Systems, Inc.
Condensed Consolidated Balance Sheets

 
 
June 30, 2008
 
December 31, 2007
 
 
 
(Unaudited)
 
 
 
ASSETS
         
Current assets:
             
Cash and cash equivalents
 
$
28,431,206
 
$
19,487,159
 
Pledged cash deposits (note 3)
   
4,356,164
   
4,645,644
 
Accounts and notes receivable, net, including $989,921 and $1,869,480 from related parties at June 30, 2008 and December 31, 2007, net of an allowance for doubtful accounts of $3,460,274 and $3,827,838 at June 30, 2008 and December 31, 2007 (note 4)
   
104,331,962
   
82,022,643
 
Advance payments and other, including $502,729 and $55,323 to related parties at June 30, 2008 and December 31, 2007
   
2,459,167
   
922,578
 
Inventories (note 6)
   
26,210,406
   
20,193,286
 
Total current assets
 
$
165,788,905
 
$
127,271,310
 
Long-term Assets:
         
Property, plant and equipment, net (note 7)
 
$
49,349,170
 
$
46,585,041
 
Intangible assets, net (note 8)
   
605,548
   
589,713
 
Other receivables, net, including $499,595 and $638,826 from related parties at June 30, 2008 and December 31, 2007, net of an allowance for doubtful accounts of $1,157,549 and $652,484 at June 30, 2008 and December 31, 2007 (note 5)
   
898,728
   
888,697
 
Advance payments for property, plant and equipment, including $2,881,471 and $1,560,378 to related parties at June 30, 2008 and December 31, 2007.
   
9,454,039
   
6,260,443
 
Long-term investments
   
78,727
   
73,973
 
Deferred income tax assets
   
1,801,170
   
1,315,510
 
Total assets
 
$
227,976,287
 
$
182,984,687
 
LIABILITIES AND STOCKHOLDERS' EQUITY
         
Current liabilities:
         
Bank loans (note 9)
 
$
7,289,586
 
$
13,972,603
 
Accounts and notes payable, including $1,028,014 and $1,134,817 to related parties at June 30, 2008 and December 31, 2007 (note 10)
   
60,059,051
   
47,530,383
 
Customer deposits
   
600,163
   
135,627
 
Accrued payroll and related costs
   
2,819,597
   
2,664,464
 
Accrued expenses and other payables (note 11)
   
13,714,500
   
14,938,055
 
Accrued pension costs (note 12)
   
4,016,853
   
3,622,729
 
Taxes payable (note 13)
   
7,077,652
   
9,080,493
 
Amounts due to shareholders/directors (note 14)
   
250,820
   
304,601
 
Total current liabilities
 
$
95,828,222
 
$
92,248,955
 
Long-term liabilities:
         
Advances payable (note 15)
   
355,665
   
334,600
 
Derivative liabilities(note 16)
   
927,047
   
 
Convertible notes payable, net (note 17)
   
32,678,740
   
 
Total liabilities
 
$
129,789,674
 
$
92,583,555
 
Minority interests (note 18)
 
$
20,769,924
 
$
23,166,270
 
Related Party Translations (note 24)
         
Commitments and contingencies (note 25)
         
Stockholders' equity:
         
Preferred stock, $0.0001 par value - Authorized - 20,000,000 shares, Issued and outstanding – None
 
$
 
$
 
Common stock, $0.0001 par value - Authorized - 80,000,000 shares
         
Shares Issued and Outstanding - 26,983,244 shares and 23,959,702 shares at June 30, 2008 and December 31, 2007, respectively
   
2,698
   
2,396
 
Additional paid-in capital (note 19)
   
26,398,126
   
30,125,951
 
Retained earnings-
         
Appropriated
   
7,525,777
   
7,525,777
 
Unappropriated
   
32,765,804
   
23,591,275
 
Accumulated other comprehensive income
   
10,724,284
   
5,989,463
 
Total stockholders' equity
 
$
77,416,689
 
$
67,234,862
 
Total liabilities and stockholders' equity
 
$
227,976,287
 
$
182,984,687
 

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

- 7 -


China Automotive Systems, Inc. and Subsidiaries
Consolidated Statements of Stockholders’ Equity
Period Ended June 30, 2008 (unaudited) and 2007

   
Common Stock
     
Retained Earnings
         
 
 
Shares
 
Par value
 
Additional
Paid-in
Capital
 
Appropriated
 
Unappropriated 
 
Accumulated
Other
Comprehensive
Income
 
Total
 
Balance at December 31, 2006
   
23,851,581
 
$
2,385
 
$
28,651,959
 
$
6,209,909
 
$
16,047,237
 
$
2,468,800
 
$
53,380,290
 
Foreign currency translation gain
   
   
   
   
   
   
3,520,663
   
3,520,663
 
Sale of common stock
   
108,121
   
11
   
1,145,489
   
   
   
   
1,145,500
 
Increase in connection with minority shareholders’ abandonment of all its right and interest in Joint-venture
   
   
   
174,828
   
   
   
   
174,828
 
Issuance of stock options to independent directors
   
   
   
153,675
               
153,675
 
Net income for the year ended December 31, 2007
   
   
   
   
   
8,859,906
   
   
8,859,906
 
Appropriation of retained earnings
   
   
   
   
1,315,868
   
(1,315,868
)
 
   
 
Balance at December 31, 2007
   
23,959,702
 
$
2,396
 
$
30,125,951
 
$
7,525,777
 
$
23,591,275
 
$
5,989,463
 
$
67,234,862
 
Foreign currency translation gain
   
   
   
   
   
   
4,734,821
   
4,734,821
 
Difference between the book value of and Consideration paid for the 35.5% equity interest of Henglong
   
   
   
(25,912,921
)
 
   
   
   
(25,912,921
)
Issuance of common stock
   
3,023,542
   
302
   
22,089,696
                     
22,089,998
 
Net income for the period ended June 30, 2008
   
   
   
   
   
9,174,529
   
   
9,174,529
 
Issuance of stock options to independent directors
   
   
   
95,400
   
   
   
   
95,400
 
Balance at June 30, 2008 (unaudited)
   
26,983,244
 
$
2,698
 
$
26,398,126
 
$
7,525,777
 
$
32,765,804
 
$
10,724,284
 
$
77,416,689
 
 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

- 8 -

 
China Automotive Systems, Inc.
Condensed Consolidated Statements of Cash Flows (Unaudited)

 
 
Six Months Ended June 30,
 
 
 
2008
 
2007
 
Cash flows from operating activities:
         
Net income
 
$
9,174,529
 
$
4,098,255
 
Adjustments to reconcile net income from continuing operations to net cash provided by operating activities:
         
Minority interests
   
3,435,250
   
4,300,076
 
Stock-based compensation
   
95,400
   
 
Depreciation and amortization
   
4,766,575
   
3,440,985
 
Allowance for doubtful accounts (Recovered)
   
218,515
   
(107,765
)
Deferred income taxes assets
   
(398,551
)
 
 
Amortization for discount of convertible note payable
   
181,328
   
 
Gain (loss) on change in fair value of derivative
   
(995,153
)
 
 
Other operating adjustments
   
(4,203
)
 
5,622
 
Changes in operating assets and liabilities:
         
(Increase) decrease in:
         
Pledged deposits
   
602,009
   
734,198
 
Accounts and notes receivable
   
(16,249,120
)
 
(11,092,496
)
Advance payments and other
   
(1,444,927
)
 
(280,899
)
Inventories
   
(4,680,059
)
 
(1,425,194
)
Increase (decrease) in:
             
Accounts and notes payable
   
9,349,207
   
3,825,270
 
Customer deposits
   
456,276
   
116,009
 
Accrued payroll and related costs
   
(13,849
)
 
457,740
 
Accrued expenses and other payables
   
699,033
 
 
(537,559
)
Accrued pension costs
   
155,338
   
68,177
 
Taxes payable
   
(2,591,573
)
 
1,520,988
 
Advances payable
   
(2,876
)
 
 
Net cash provided by (used in) operating activities
 
$
2,753,149
 
$
5,123,407
 
Cash flows from investing activities:
         
(Increase) decrease in other receivables
   
(408,139
)
 
(34,753
)
Cash received from equipment sales
   
96,317
   
146,412
 
Cash paid to acquire property, plant and equipment
   
(7,573,715
)
 
(6,064,201
)
Cash paid to acquire intangible assets
   
(101,601
)
 
(28,717
)
Cash paid for the acquisition of 35.5% of Henglong
   
(10,000,000
)
 
 
Net cash (used in) investing activities
 
$
(17,987,138
)
$
(5,981,259
)
Cash flows from financing activities:
         
(Decrease) in proceeds from bank loans
   
(7,564,564
)
 
(4,156,545
)
Dividends paid to the minority interest holders of Joint-venture companies
   
(4,697,780
)
 
(4,377,448
)
(Decrease) in amounts due to shareholders/directors
   
(82,610
)
 
100
 
Proceeds from issuance of common stock
   
   
1,145,500
 
Proceeds from issuance of convertible note payable
   
35,000,000
   
 
Net cash provided by (used in) financing activities
 
$
22,655,046
 
$
(7,388,393
)
Cash and cash equivalents effected by foreign currency
 
$
1,522,990
 
$
455,351
 
Net increase (decrease) in cash and cash equivalents
   
8,944,047
   
(7,790,894
)
Cash and cash equivalents at beginning of period
   
19,487,159
   
27,418,500
 
Cash and cash equivalents at end of period
 
$
28,431,206
 
$
19,627,606
 

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

- 9 -


China Automotive Systems, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited) (continued)
 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
 
 
 
Six Months Ended June 30,
 
 
 
2008
 
2007
 
Cash paid for interest
 
$
501,138
 
$
422,902
 
Cash paid for income taxes
 
$
2,019,073
 
$
366,832
 
 
- 10 -


SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
 
 
 
Six Months Ended June 30,
 
 
 
2008
 
2007
 
Acquisition of 35.5% of Henglong from the minority shareholder on a cashless basis
 
$
(22,090,000
)
$
 
Liability result from issuance of common stock to acquire 35.5% of Henglong's equity
   
22,090,000
   
 
Issuance of a warrants to purchase common stock
   
798,626
   
 
Derivative liabilities
   
1,703,962
   
 
Warrants and derivative liabilities for issuance of Convertible Debt are considered as discount of Convertible Debt.
   
(2,502,588
)
 
 
Decrease in minority interests as a result of minority shareholder’s withdrawal from Joint-venture.
   
   
(2,830,545
)
Withdrawal of invested intangible assets by minority shareholder of Joint-venture.
   
   
2,600,204
 
Increase in equity in connection with minority shareholder’s withdrawal from Joint-venture.
 
$
 
$
230,341
 
 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

- 11 -


China Automotive Systems, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
Three Months and Six Months Ended June 30, 2008 and 2007

1. Organization and business

China Automotive Systems, Inc., “China Automotive”, was incorporated in the State of Delaware on June 29, 1999 under the name Visions-In-Glass, Inc. China Automotive, including, when the context so requires, its subsidiaries and the subsidiaries’ interests in the Sino-foreign joint ventures described below, is referred to herein as the “Company”. The Company is primarily engaged in the manufacture and sale of automotive systems and components, as described below.

Great Genesis Holdings Limited, a company incorporated on January 3, 2003 under The Companies Ordinance in Hong Kong as a limited liability company, “Great Genesis”, is a wholly-owned subsidiary of the Company.
 
Henglong USA Corporation, “HLUSA”, which was incorporated on January 8, 2007 in Troy, Michigan, is a wholly-owned subsidiary of the Company, and mainly engages in marketing of automotive parts in North America, and provides after sales service and research and development support accordingly.

The Company owns the following aggregate net interests in eight Sino-foreign joint ventures organized in the PRC as of June 30, 2008 and 2007.

 
 
Percentage Interest
 
Name of Entity
 
June 30, 2008
 
June 30, 2007
 
Shashi Jiulong Power Steering Gears Co., Ltd., "Jiulong"
   
81.00
%
 
81.00
%
Jingzhou Henglong Automotive Parts Co., Ltd., "Henglong"
   
80.00
%
 
44.50
%
Shenyang Jinbei Henglong Automotive Steering System Co., Ltd., “Shenyang"
   
70.00
%
 
70.00
%
Zhejiang Henglong & Vie Pump-Manu Co., Ltd., "Zhejiang"
   
51.00
%
 
51.00
%
Universal Sensor Application Inc., “USAI”
   
75.90
%
 
85.71
%
Wuhan Jielong Electric Power Steering Co., Ltd., “Jielong”
   
85.00
%
 
85.00
%
Wuhu HengLong Automotive Steering System Co., Ltd., “Wuhu”
   
77.33
%
 
77.33
%
Jingzhou Hengsheng Automotive System Co., Ltd, “Hengsheng”
   
100.00
%
 
 
 
Jiulong was established in 1993 and mainly engaged in the production of integral power steering gears for heavy-duty vehicles.
 
Henglong was established in 1997 and mainly engaged in the production of rack and pinion power steering gear for cars and light duty vehicles.

On March 31, 2008, the Company’s wholly-owned subsidiary, Great Genesis, and Wiselink, both controlled by Hanlin Chen and his family, entered into an equity transfer agreement, the “Henglong Agreement”, pursuant to which Wiselink agreed to transfer and assign its 35.5% equity interest in Jingzhou Henglong, one of the Company’s currently consolidated subsidiaries, to Great Genesis for a total consideration of US$32,090,000. The Company now holds an 80% equity interest in Jingzhou Henglong.
 
Under the terms of the Henglong Agreement, Great Genesis is deemed to be the owner of Jingzhou Henglong commencing from January 1, 2008. The Henglong Acquisition is considered as a business combination of companies under common control and is being accounted for in a manner of pooling of interests.

- 12 -


Shenyang was established in 2002 and focuses on power steering parts for light duty vehicles. 
 
Zhejiang was established in 2002 to focus on power steering pumps.
 
USAI was established in 2005 and mainly engaged in production and sales of sensor modulars.

Jielong was established in 2006 and mainly engaged in production and sales of electric power steering, “EPS”.
  
Wuhu was established in 2006 and mainly engaged in production and sales of automobile steering systems.
 
Hengsheng was established in 2007 and mainly engaged in production and sales of automobile steering systems.

2. Basis of Presentation and Significant Accounting Policies

Basis of Presentation - For the six months ended June 30, 2008 and 2007, the accompanying unaudited consolidated financial statements include the accounts of the Company and its subsidiaries. The subsidiaries include eight Sino-foreign Joint-ventures mentioned in Note 1. Significant inter-company balances and transactions have been eliminated upon consolidation. The unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America.
 
Foreign Currencies - The Company maintains its books and records in Renminbi, “RMB”, the currency of the PRC, its functional currency. Foreign currency transactions in RMB are reflected using the temporal method. Under this method, all monetary items are translated into the functional currency at the rate of exchange prevailing at the balance sheet date. Non-monetary items are translated at historical rates. Income and expenses are translated at the rate in effect on the transaction dates. Transaction gains and losses, if any, are included in the determination of net income for the period.
 
In translating the financial statements of the Company from its functional currency into its reporting currency in United States dollars, balance sheet accounts are translated using the closing exchange rate in effect at the balance sheet date and income and expense accounts are translated using an average exchange rate prevailing during the reporting period. Adjustments resulting from the translation, if any, are included in cumulative other comprehensive income (loss) in stockholders’ equity.
 
Income Per Share - Basic income per share is calculated by dividing net income by the weighted average number of common shares outstanding during the period. Diluted income per share is calculated based on the treasury stock method, assuming the issuance of common shares, if dilutive, resulting from the exercise of warrants. The dilutive effect of convertible securities is reflected in diluted earnings per share by application of the “if converted” method. 
 
The calculations of diluted income per share were:
 
 
 
Three Months Ended June 30,
 
 
 
2008
 
2007
 
Numerator:
         
Net income
 
$
4,744,355
 
$
2,455,154
 
Add: interest expenses of convertible notes payable
   
262,500
   
 
Add: Amortization for discount of convertible notes payable
   
81,879
   
 
 
 
$
5,088,734
 
$
2,455,154
 
Denominator:
         
Weighted average shares outstanding
   
24,880,071
   
23,959,702
 
Effect of dilutive securities
   
3,954,309
   
2,451
 
     
28,834,380
   
23,962,153
 
Net income per common share- diluted
 
$
0.18
 
$
0.10
 
 
- 13 -


 
 
Six Months Ended June 30,
 
 
 
2008
 
2007
 
Numerator:
         
Net income
 
$
9,174,529
 
$
4,098,255
 
Add: interest expenses of convertible notes payable
   
393,750
   
 
Add: Amortization for discount of convertible notes payable
   
181,328
   
 
 
 
$
9,749,607
 
$
4,098,255
 
Denominator:
         
Weighted average shares outstanding
   
24,422,429
   
23,948,950
 
Effect of dilutive securities
   
2,971,963
   
7,790
 
 
   
27,394,392
   
23,956,740
 
Net income per common share- diluted
 
$
0.36
 
$
0.17
 

During the three months and six months ended June 30, 2008, the options and warrants outstanding have not been included in the computation of diluted income per share, except the options issued on June 26, 2008, because such inclusion would have had an anti-dilutive effect. The shares issuable upon conversion of Convertible Debt have been included in the computation.

During the three months and six months ended June 30, 2007, the 156,250 shares underlying warrants issued to Cornell Capital Partners, LP on March 20, 2006, and 22,500 options issued to independent directors on July 16, 2006 have not been included in the computation of diluted income per share because such inclusion would have had an anti-dilutive effect.

Stock-Based Compensation - The Company may periodically issue shares of common stock for services rendered or for financing costs. Such shares will be valued based on the market price on the transaction date. The Company may periodically issue stock options to employees and stock options or warrants to non-employees in non-capital raising transactions for services and for financing costs.
 
In July 2004, the Company adopted a stock incentive plan. The maximum number of common shares for issuance under this plan is 2,200,000 with a period of 10 years. The stock incentive plan provides for the issuance, to the Company’s officers, directors, management and employees, of options to purchase shares of the Company’s common stock. As of June 30, 2008, the Company has issued 112,500 stock options under this plan and there remain 2,087,500 stock options issuable in the future.  

- 14 -


The Company has adopted Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Accounting for Stock-Based Compensation”, which establishes a fair value method of accounting for stock-based compensation plans. In accordance with SFAS No. 123R, the cost of stock options and warrants issued to employees and non-employees is measured on the grant date based on the fair value. The fair value is determined using the Black-Scholes option pricing model. The resulting amount is charged to expense on the straight-line basis over the period in which the Company expects to receive benefit, which is generally the vesting period.

Comprehensive Income - The Company has adopted the provisions of Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income” (“SFAS No. 130”). SFAS No. 130 establishes standards for the reporting and display of comprehensive income, its components and accumulated balances in a full set of general purpose financial statements. SFAS No. 130 defines comprehensive income to include all changes in equity except those resulting from investments by owners and distributions to owners, including adjustments to minimum pension liabilities, accumulated foreign currency translation, and unrealized gains or losses on marketable securities.
 
Estimation -The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, 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.
 
Financial instruments - Derivative financial instruments, as defined in Financial Accounting Standard No. 133, Accounting for Derivative Financial Instruments and Hedging Activities (FAS 133), consist of financial instruments or other contracts that contain a notional amount and one or more underlying, e.g. interest rate, security price or other variable, require no initial net investment and permit net settlement. Derivative financial instruments may be free-standing or embedded in other financial instruments. Further, derivative financial instruments are initially, and subsequently, measured at fair value and recorded as liabilities or, in rare instances, assets.

The Company generally does not use derivative financial instruments to hedge exposures to cash-flow, market or foreign-currency risks. However, we have entered into certain other financial instruments and contracts, such as debt financing arrangements that embody features that are either (i) not afforded equity classification, (ii) embody risks not clearly and closely related to host contracts, or (iii) may be net-cash settled by the counterparty. As required by FAS 133, these instruments are required to be carried as derivative liabilities, at fair value, in our financial statements.

Registration Payment Arrangements - The Company has entered into registration payment arrangements with certain investors that provide for the payment of damages for failures to register common shares underlying the investor’s financial instruments. FASB Staff Position 00-19-2, Accounting for Registration Payment Arrangements, provides for the exclusion of registration payments, such as the liquidated damages, from the consideration of classification of financial instruments. Rather, such registration payments would be accounted for pursuant to Financial Accounting Standard No. 5 Accounting for Contingencies, which is our current accounting practice. That is, all registration payments will require recognition when they are both probable and reasonably estimable. We do not currently believe that damages are probable.
 
Fair Value Measurements-Effective January 1, 2008, we adopted the provisions of FAS 157, Fair Value Measurements, except as it applies to those nonfinancial assets and nonfinancial liabilities as noted in proposed FSP FAS 157-b. The partial adoption of FAS 157 did not have a material impact on our consolidated financial position, results of operations or cash flows. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This statement does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information. In February 2008, the FASB issued FASB Staff Position (“FSP”) 157-2, Effective Date of FASB Statement No.157, which delays the effective date of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually).

- 15 -


Comments - The accompanying interim condensed consolidated financial statements are unaudited, but in the opinion of management of the Company, contain all adjustments, which include normal recurring adjustments, necessary to present fairly the financial position, the results of operations and cash flows for the three months and six months ended June 30, 2008 and 2007.
 
The consolidated balance sheet as of December 31, 2007 is derived from the Company’s audited financial statements.
 
Certain information and footnote disclosures normally included in financial statements that have been prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission, although the Company’s management believes that the disclosures contained in these financial statements are adequate to make the information presented therein not misleading. For further information, refer to the financial statements and the notes thereto included in the Company’s 2007 Annual Report on Form 10-K, as filed with the Securities and Exchange Commission.
 
The results of operations for the six months ended June 30, 2008 are not necessarily indicative of the results of operations to be expected for the full fiscal year ending December 31, 2008.

3. Pledged cash deposits 

The Company’s pledged cash deposits at June 30, 2008 (unaudited) and December 31, 2007 are summarized as follows:

 
 
June 30, 2008
 
December 31, 2007
 
Pledged as guarantee for the Company's notes payable
 
$
4,356,164
 
$
4,645,644
 
Balance at the end of the period
 
$
4,356,164
 
$
4,645,644
 
 
4. Accounts and notes receivable
 
The Company’s accounts receivable at June 30, 2008 (unaudited) and December 31, 2007 are summarized as follows:
 
 
 
June 30, 2008
 
December 31, 2007
 
Accounts receivable
 
$
63,755,685
 
$
49,605,411
 
Notes receivable
   
44,098,047
   
36,245,070
 
Less: allowance for doubtful accounts
   
(3,521,770
)
 
(3,827,838
)
Balance at the end of the period
 
$
104,331,962
 
$
82,022,643
 
 
- 16 -

Notes receivable represent accounts receivable in the form of bills of exchange whose acceptances and settlements are handled by banks.

The activity in the Company’s allowance for doubtful accounts during the six months ended June 30, 2008 (unaudited) and the year ended December 31, 2007 are summarized as follows:
 
 
 
June 30, 2008
 
December 31, 2007
 
           
Balance at beginning of period
 
$
3,827,838
 
$
4,086,218
 
Less: amounts recovered during the period
   
(535,271
)
 
(532,392
)
Add: foreign currency translation
   
229,203
   
274,012
 
Balance at the end of the period
 
$
3,521,770
 
$
3,827,838
 
 
5. Other receivables
 
The Company’s other receivables at June 30, 2008 (unaudited) and December 31, 2007 are summarized as follows:
 
 
 
June 30, 2008
 
December 31, 2007
 
           
Other receivables
 
$
2,056,277
 
$
1,541,181
 
Less: allowance for doubtful accounts
   
(1,157,549
)
 
(652,484
)
Balance at the end of the period
 
$
898,728
 
$
888,697
 
 
Other receivables consist of amounts advanced to both related and unrelated parties, primarily as unsecured demand loans, with no stated interest rate or due date.
 
The activity in the Company’s allowance for doubtful accounts of other receivable during the six months ended June 30, 2008 (unaudited) and the year ended December 31, 2007 are summarized as follows:
 
 
 
June 30, 2008
 
December 31, 2007
 
Balance at beginning of the period
 
$
652,484
 
$
898,203
 
Add: amounts provided (recovered) during the period
   
461,011
   
(297,870
)
Add: foreign currency translation
   
44,054
   
52,151
 
Balance at the end of the period
 
$
1,157,549
 
$
652,484
 
 
- 17 -


6. Inventories
 
The Company’s inventories at June 30, 2008 (Unaudited) and December 31, 2007 consisted of the following:
 
 
 
June 30, 2008
 
December 31, 2007
 
Raw materials
 
$
8,934,533
 
$
7,904,167
 
Work in process
   
5,090,063
   
4,181,248
 
Finished goods
   
13,608,943
   
9,586,709
 
 
   
27,633,539
   
21,672,124
 
Less: provision for loss
   
(1,423,133
)
 
(1,478,838
)
Balance at the end of the period
 
$
26,210,406
 
$
20,193,286
 
 
7. Property, plant and equipment

The Company’s property, plant and equipment at June 30, 2008 (unaudited) and December 31, 2007 are summarized as follows:
 
 
 
June 30, 2008
 
December 31, 2007
 
Land use rights and buildings
 
$
25,626,832
 
$
23,101,634
 
Machinery and equipment
   
49,142,700
   
42,512,900
 
Electronic equipment
   
4,100,531
   
3,480,008
 
Motor vehicles
   
2,630,378
   
2,427,375
 
Construction in progress
   
491,177
   
1,542,865
 
 
   
81,991,618
   
73,064,782
 
Less: Accumulated depreciation
   
(32,642,448
)
 
(26,479,741
)
Balance at the end of the period
 
$
49,349,170
 
$
46,585,041
 
 
Depreciation charge for the six months ended June 30, 2008 and the year ended December 31, 2007 are $4,641,957 and $7,079,313 respectively.

8. Intangible assets
 
The activities in the Company’s intangible asset account at June 30, 2008 (unaudited) and December 31, 2007 are summarized as follows:

 
 
June 30, 2008
 
December 31, 2007
 
Balance at beginning of period
 
$
589,713
 
$
3,140,548
 
Add: additions during the period-
         
Patent technology
   
   
144,390
 
Management software license
   
101,601
   
143,356
 
Less: decrease during the period-
         
Patent technology*
   
   
(2,600,204
)
Foreign currency translation
   
38,852
   
31,856
 
 
   
730,166
   
859,946
 
Less: Amortization at end of the period
   
(124,618
)
 
(270,233
)
Balance at the end of the period
 
$
605,548
 
$
589,713
 
 
- 18 -


*When USAI was established in 2005, Sensor contributed $3,000,000 as capital, being the fair market value of the intangible assets, namely the sensor product and the technology for sensor production, as well as the Joint-venture’s technical personnel training. As of March 30, 2007 Sensor withdrew from USAI, abandoned all its right and interest of the Joint-venture, and repossessed the rights to the intangible assets at the carrying value of the intangible assets was $2,600,204.

9. Bank loans
 
At June 30, 2008, the Company, through its Sino-foreign joint ventures, had outstanding fixed-rate short-term bank loans of $7,289,586, with weighted average interest rate at 7.06% per annum. These loans are secured with some of the property and equipment of the Company, and are repayable within one year.

At December 31, 2007, the Company, through its Sino-foreign joint ventures, had outstanding fixed-rate short-term bank loans of $13,972,603, with weighted average interest rate at 6.40% per annum. These loans are secured with some of the property and equipment of the Company and are repayable within one year.

10. Accounts and notes payable

The Company’s accounts and notes payable at June 30, 2008 (unaudited) and December 31, 2007 are summarized as follows:

 
 
June 30, 2008
 
December 31, 2007
 
Accounts payable
 
$
43,136,095
 
$
32,511,812
 
Notes payable
   
16,922,956
   
15,018,571
 
Balance at the end of the period
 
$
60,059,051
 
$
47,530,383
 
 
Notes payable represent accounts payable in the form of bills of exchange whose acceptances and settlements are handled by banks.
 
The Company has pledged cash deposits, notes receivable and certain property plant and machinery to secure trade financing granted by banks.

11. Accrued expenses and other payables

The Company’s accrued expenses and other payables at June 30, 2008 (unaudited) and December 31, 2007 are summarized as follows:
 
 
 
June 30, 2008
 
December 31, 2007
 
Accrued expenses
 
$
1,644,282
 
$
1,957,146
 
Other payables
   
1,538,361
   
1,340,442
 
Warranty reserves*
   
6,472,423
   
4,919,491
 
Dividend payable to minority interest shareholders of Joint-ventures
   
3,479,046
   
6,720,976
 
Liabilities in connection with warrants**
   
580,388
   
 
Balance at the end of the period
 
$
13,714,500
 
$
14,938,055
 
 
- 19 -


*The Company provides for the estimated cost of product warranties when the products are sold. Such estimates of product warranties were based on, among other things, historical experience, product changes, material expenses, service and transportation expenses arising from the manufactured product. Estimates will be adjusted on the basis of actual claims and circumstances.
  
For the six months ended June 30, 2008 (unaudited) and the year ended December 31, 2007, the warranties activities were as follows:

 
 
June 30, 2008
 
December 31, 2007
 
Balance at the beginning of period
 
$
4,919,491
 
$
2,954,326
 
Additions during the period-
   
2,795,671
   
5,228,556
 
Settlement within period, by cash or actual material
   
(1,571,900
)
 
(3,529,875
)
Foreign currency translation
   
329,161
   
266,484
 
Balance at end of period
 
$
6,472,423
 
$
4,919,491
 
 
The Company has recorded $6,472,423 and $ 4,919,491 product warranty reserves for the six months ended June 30, 2008 (unaudited) and the year ended December 31, 2007, which were included in the accrued expenses and other payables in the accompanying unaudited consolidated financial statements.
 
**In connection with the Convertible Debt, the Company issued 1,317,864 of detachable warrants, “Warrants,” to purchase from the Company shares of common stock at the exercise price of US$ 8.8527 per share, subject to adjustments upon certain events occurring. The Warrants are exercisable immediately and will expire on February 15, 2009.

The exercise price or the number of shares to be converted by the Warrant will be adjusted in the event of no effective Registration Statement or delayed effectiveness of the Registration Statement. In addition a damage penalty will be paid if the delivery of share certificates occurs upon the Warrants conversion.

The Company will not effect any conversion of a Warrant, and each holder of any Warrant will not have the right to convert any portion of such Warrant to the extent that after giving effect to such conversion, each of these two holders would beneficially own in excess of 4.99% of the number of shares of Common Stock outstanding immediately after giving effect to such conversion.

If and whenever on or after the issuance date, the Company issues or sells its shares of common stock or other convertible securities for a consideration per share less than a price equal to the exercise price of a Warrant in effect on the issuance date immediately prior to such issue or sale, the exercise price of such Warrant then in effect will be adjusted.
 
The warrants issued in connection with the financial arrangement were derivative instruments. The warrants require net cash settlement in the event that there is a fundamental transaction, contractually defined as a merger, sale of substantially all assets, tender offer or share exchange.

As a result of FASB Staff Position (FSP) FAS 150-5, it appears that the warrants require liability classification due to the possible cash redemption upon the event of an all cash acquisition. The FSP clarifies that warrants that contain any redemption features, including contingent redemption features, must be recorded as liabilities and marked to fair value each reporting period. As of the issuance date, i.e, February 15, 2008, the fair value of warrants was $798,626. Such warrant liabilities will be adjusted to its estimated fair value at the completion of each reporting period until the maturity of February 15, 2009. As of June 30, 2008, the fair value of warrants was $580,388, which was determined using the Black-Scholes option pricing model. The income from adjustment of fair value of liabilities in connection with warrants has been recorded in the income statement as gain or loss on change in fair value of derivative.
 
- 20 -


12. Accrued pension costs
 
Since the Company’s operations are all located in China, all the employees are located in China. The Company records pension costs and various employment benefits in accordance with the relevant Chinese social security laws, which is substantially based on a total of 31% of base salary as required by local governments. Base salary levels are the average salary determined by the local governments.
 
The activities in the Company’s pension account during the six months ended June 30, 2008 (unaudited) and the year ended December 31, 2007 are summarized as follows:

 
 
June 30, 2008
 
December 31, 2007
 
Balance at beginning of the period
 
$
3,622,729
 
$
3,266,867
 
Amounts provided during the period
   
1,105,055
   
1,286,566
 
Settlement during the period
   
(949,717
)
 
(1,154,462
)
Foreign currency translation
   
238,786
   
223,758
 
Balance at end of period
 
$
4,016,853
 
$
3,622,729
 
  
13. Taxes payable

The Company’s taxes payable at June 30, 2008 (unaudited) and December 31, 2007 are summarized as follows:

 
 
June 30, 2008
 
December 31, 2007
 
Value-added tax payable
 
$
6,048,834
 
$
7,052,682
 
Income tax payable
   
965,022
   
1,883,185
 
Other tax payable
   
63,796
   
144,626
 
Balance at end of the period
 
$
7,077,652
 
$
9,080,493
 

- 21 -

 
14. Amounts due to shareholders/ directors

The activities in the amounts due to shareholders/directors at June 30, 2008 (unaudited) and December 31, 2007 are summarized as follows:

 
 
June 30, 2008
 
December 31, 2007
 
Balance at the beginning of period
 
$
304,601
 
$
358,065
 
Decrease during the period
   
(82,610
)
 
(84,476
)
Foreign currency translation
   
28,829
   
31,012
 
Balance at end of period
 
$
250,820
 
$
304,601
 

The amounts due to shareholders/directors were unsecured, interest-free and repayable on demand.
 
15. Advances payable
 
The amounts mainly represent advances made by the Chinese government to the Company as subsidy on interest on loans related to production facilities expansion. 
 
The balances are unsecured, interest-free and will be repayable to the Chinese government if the usage of such advance does not continue to qualify for the subsidy (see notes 20).

16. Derivative liabilities

The Company has evaluated the convertible notes for terms and conditions that are not clearly and closely associated with the risks of the debt-type host instrument (see Note 17). Generally, such features require separation from the host contract and treatment as derivative financial instruments. Certain features, such as the conversion option, were found to be exempt. Other features, such as puts and redemption features, were found to require bifurcation and recognition as derivative liabilities. These derivative liabilities are recognized initially at fair value, using forward cash-flow valuation techniques. As of February 15, 2008, the compound derivative value amounted to $1,703,962. This derivative will be adjusted to its estimated fair value at the completion of each reporting period until the debt arrangement is ultimately settled, converted or paid. As of June 30, 2008, the compound derivative value amounted to $927,047. The income from adjustment of fair value of compound derivative has been recorded in the income statement as gain or loss on change in fair value of derivative.

17. Convertible notes payable
 
In February 2008, the Company sold to two accredited institutional investors $35 million of convertible debt, the "Convertible Debt", with a scheduled maturity date of February 15, 2013. The Convertible Debt, including any accrued but unpaid interest, is convertible into common shares of the Company at a conversion price of $8.8527 per share, subject to adjustment upon the occurrence of certain events.
 
The Convertible Debt bears annual interest rates of 3%, 3.5%, 4%, 4.5% and 5% for each year of 2008, 2009, 2010, 2011 and 2012. The interest on the Convertible Debt shall be computed commencing from the issuance date and will be payable in cash in arrears semi-annually on January 15, and July 15 of each year with the first interest payable date being July 15, 2008. From and after the occurrence and during the continuance of an Event of Default defined in the relevant Convertible Debt agreements, the interest rate then in effect shall be increased by two percent (2%) until the event of default is remedied .
 
The holders of the Convertible Debt will be entitled to convert any portion of the conversion amount into shares of common stock at the conversion price at any time or times on or after the thirtieth (30th) day after the issuance date and prior to the thirtieth (30th) Business Day prior to the expiry date of the Convertible Debt. A damage penalty will be paid if share certificates are not delivered timely after any conversion.

- 22 -


The Company will have the right to require the Convertible Debt holders to convert all or any portion of the conversion amount then remaining under the Convertible Debt obligation into shares of common stock, “ Mandatory Conversion”, if at any time during a six-month period, the beginning day of each such six-month period, a “Mandatory Conversion Period Start Date”, the arithmetic average of the weighted average price of the common stock for a period of at least thirty (30) consecutive trading days following the Mandatory Conversion Period Start Date equals or exceeds the percentage of $8.8527 set forth in the chart below as applicable to the indicated six month period:

0-6 months:
   
125
%
6-12 months:
   
125
%
12-18 months:
   
135
%
18-24 months:
   
135
%
24-30 months:
   
145
%
30-36 months:
   
145
%
36-42 months:
   
155
%
42-48 months:
   
155
%
 
On each six month anniversary of the issuance date beginning August 15, 2008, the conversion price will be adjusted downward to the Reset Reference Price, as defined below, if the weighted average price for the twenty (20) consecutive trading days immediately prior to the applicable six month anniversary, the “Reset Reference Price”, is less than 95% of the conversion price in effect as of such applicable six month anniversary date. The foregoing notwithstanding, the conversion price will not be reduced via such reset provision to less than $7.0822. The conversion price is also subject to weighted-average antidilution adjustments, but in no event will the conversion price be reduced to less than $6.7417. If and whenever on or after the issuance date, the Company issues or sells its shares of Common Stock or other convertible securities, except for certain defined exempt issuances, for a consideration per share less than a price equal to the conversion price in effect on the issuance date immediately prior to such issue or sale, the original conversion price then in effect shall be adjusted by a weighted-average antidilution formula, but in no event to a new conversion price less than $6.4717.

The Company will not effect any conversion of the Convertible Debt, and each holder of the Convertible Debt will not have the right to convert any portion of the Convertible Debt to the extent that after giving effect to such conversion, such holder would beneficially own in excess of 4.99% of the number of shares of Common Stock outstanding immediately after giving effect to such conversion.

The Company will not effect a Mandatory Conversion of more than twelve percent (12%) of the original principal amount of the Convertible Debt, with the applicable accrued but unpaid interest, in any six month period or twenty-four percent (24%) of the original principal amount of the Convertible Debt, with the applicable accrued but unpaid interest, in any twelve (12) month period.

Upon the occurrence of an event of default with respect to the Convertible Debt, the Convertible Debt holders may require the Company to redeem all or any portion of the Convertible Debt. Each portion of the Convertible Debt subject to redemption by the Company will be redeemed by the Company at a price equal to the sum of (i) the conversion amount to be redeemed and (ii) the Other Make Whole Amount. The “Other Make Whole Amount” will mean a premium to the conversion amount such that the total amount received by the Convertible Debt holder upon redemption represents a gross yield to the Convertible Debt holders on the original principal amount as of the redemption date equal to thirteen percent (13%), with interest computed on the basis of actual number of days elapsed over a 360-day year. The events of default includes the Company’s failure to cure a conversion failure by delivery of the required number of shares of Common Stock, the Company’s failure to pay to the Convertible Debt holder any amount of principal, interest, late charges or other amounts when and as due under the Convertible Debt and other events as defined in the Convertible Debt agreements.

- 23 -

 
Upon the consummation of a change of control as defined in the Convertible Debt agreements, the Convertible Debt holder may require the Company to redeem all or any portion of the Convertible Debt. The portion of the Convertible Debt subject to redemption shall be redeemed by the Company in cash at a price equal to the sum of the conversion amount of being redeemed and the Other Make Whole Amount as defined above.
 
On each of February 15, 2010 and February 15, 2011, the Convertible Debt holders will have the right, in their sole discretion, to require that the Company redeem the Convertible Debt in whole but not in part, by delivering written notice thereof to the Company. The portion of this Convertible Debt subject to redemption pursuant to this annual redemption right will be redeemed by the Company in cash at a price equal to the sum of the conversion amount being redeemed and the Annual Redemption Make Whole Amount. The “Annual Redemption Make Whole Amount” will mean a premium to the conversion amount such that the total amount received by the Convertible Debt holder upon any annual redemption represents a gross yield on the original principal amount of eleven percent (11%), with interest computed on the basis of actual number of days elapsed over a 360-day year.

In the event that the Company has not completed the necessary filings to list the conversion shares on its principal market by the date that is ninety (90) days after the issuance date or has not so listed the conversion shares by the date that is ninety (90) days after the issuance date or the shares of the Company’s common stock are terminated from registration under the Securities Act of 1933, the Convertible Debt holders will have the right, in its sole discretion, to require that the Company redeem all or any portion of the Convertible Debt. The portion of the Convertible Debt subject to redemption in connection with this listing default will be redeemed by the Company in cash at a price equal to the sum of the conversion amount being redeemed and the Other Make Whole Amount as mentioned above.
 
At anytime following February 15, 2009, if the weighted average for twenty (20) consecutive trading days is less than $3.98, the Convertible Debt holder shall have the right, in its sole discretion, to require that the Company redeem all or any portion of the Convertible Debt. The portion of this Convertible Debt subject to redemption in connection with the share price change of the underlying common stock will be redeemed by the Company in cash at a price equal to the sum of the conversion amount being redeemed and the Other Make Whole Amount as mentioned above.

In connection with the Convertible Debt, the Company issued 1,317,864 detachable warrants, the “Warrants,” to purchase from the Company shares of common stock of the Company at the exercise price of $8.8527 per share. The Warrants are exercisable immediately and will expire on February 15, 2009. The Warrants require net cash settlement in the event that there is a fundamental transaction, contractually defined as a merger, sale of substantially all assets, tender offer or share exchange. Due to this contingent redemption provision, the warrants require liability classification under SFAS 150 and must be recorded at fair value each reporting period. As of the issuance date, i.e, February 15, 2008, the fair value of warrants was $798,626, which was determined using the Black-Scholes option pricing model.

The Company has evaluated the convertible notes for terms and conditions that are not clearly and closely associated with the risks of the debt-type host instrument. Generally, such features require separation from the host contract and treatment as derivative financial instruments. Certain features, such as the conversion option, were found to be exempt. Other features, such as puts and redemption features, were found to require bifurcation and recognition as derivative liabilities. These derivative liabilities are recognized initially at fair value, using forward cash-flow valuation techniques. As of February 15, 2008, the compound derivative value amounted to $1,703,962. This derivative will be adjusted to its estimated fair value at the completion of each reporting period until the debt arrangement is ultimately settled, converted or paid.

When a financial instrument contains embedded derivatives that require bifurcation, such as the redemption put, and freestanding instruments that are recorded at fair value each period, such as the warrants, the accounting is to record the embedded derivative and the freestanding instruments at fair value on inception and the residual proceeds are allocated to the debt instrument. Based on this premise, upon inception of the debt instruments, we recorded the redemption put at fair value $1,703,962 and we recorded the warrants at fair value $798,626. The remaining proceeds were then allocated to the debt instrument.

- 24 -


Allocation of basis in the financing arrangement to the warrants and the derivative liability has resulted in an original issue discount to the face value of the convertible notes in the amount of $2,502,588, which amount is subject to amortization over the Convertible Debt’s term using the effective method. The Company recorded amortization expense during the six months ended June 30, 2008 of $181,328.
  
18. Minority interests
 
The Company’s activities in respect of the amounts of the minority interest’s equity at June 30, 2008 (unaudited) and December 31, 2007 are summarized as follows:
 
 
 
June 30, 2008
 
December 31, 2007
 
Balance at beginning of the period
 
$
23,166,270
 
$
23,112,667
 
Add: Additions during the period-
         
Minority interest’s income
   
3,435,250
   
9,646,339
 
Increase in connection with minority shareholders’ abandonment of all its right and interest in Joint-venture
   
   
55,512
 
Foreign currency translation
   
1,362,217
   
1,650,869
 
Less: decrease during the period-
         
Dividends declared to the minority interest holders of Joint-venture companies
   
(1,016,734
)
 
(8,468,572
)
Transfer and assign equity interest in Henglong and USAI by minority interest holders of Joint-venture companies*
   
(6,177,079
)
 
(2,830,545
)
Balance at end of period
 
$
20,769,924
 
$
23,166,270
 
 
*On March 31, 2008, the Company’s wholly-owned subsidiary, Great Genesis and Wiselink, both controlled by Hanlin Chen and his family, entered into an equity transfer agreement, pursuant to which Wiselink agreed to transfer and assign its 35.5% equity interest in Jingzhou Henglong, one of the Company’s currently consolidated subsidiaries, to Great Genesis for a total consideration of US$32,090,000.

Under the terms of the above agreement, Great Genesis is deemed to be the owner of the equity concerned commencing from January 1, 2008. In accordance with FASB 141 and APB 14, the acquisition is considered as a business combination of companies under common control and is being accounted for in a manner of pooling of interests.

As of January 1, 2008, the net book value of 35.5% equity of Henglong, which was transferred from minority shareholders, was $6,177,079.
 
- 25 -


19. Additional paid-in capital
 
The Company’s activities in the Company’s additional paid-in capital account during the six months ended June 30, 2008 (unaudited) and the year ended December 31, 2007 are summarized as follows:

 
 
June 30, 2008
 
December 31, 2007
 
Balance at beginning of the period
 
$
30,125,951
 
$
28,651,959
 
Add: Additions during the period-
         
Issuance of common stock for cash in accordance with the standby equity distribution agreement with Cornell Capital Partners, LP.
   
   
1,199,989
 
Issuance of stock options to independent directors
   
95,400
   
153,675
 
Issuance of common stock*
   
22,089,696
   
 
Increase in connection with minority shareholders’ abandonment of all its right and interest in Joint-venture
   
   
174,828
 
Less: decrease during the period-
         
Cash paid for retaining fee, commissions and placement agent fee in connection with offering
   
   
(54,500
)
35.5% Henglong equity acquisition**
   
(25,912,921
)
 
 
Balance at end of period
 
$
26,398,126
 
$
30,125,951
 
  
*On March 31, 2008, Wiselink Holdings Limited, “Wiselink”, Great Genesis Holdings Limited, “Great Genesis”, a wholly-owned subsidiary of China Automotive Systems, Inc., “the Company” and other parties entered into an equity transfer transaction, the “Acquisition”, documented by an Equity Transfer Agreement, the “Agreement”, pursuant to which Wiselink agreed to transfer and assign a 35.5% equity interest in Jingzhou Henglong Automotive Parts Co. Ltd., “Jingzhou Henglong” to Great Genesis for a total consideration of $32,090,000, the “Consideration”.
 
Under the terms of the Agreement, the Consideration is to be paid as follows: $10,000,000 cash was paid by Great Genesis to Wiselink on April 30, 2008, and the balance of the purchase price ($22,090,000) was paid by issuance of 3,023,542 shares of common stock of the Registrant, in its capacity as the 100% parent company of Great Genesis.

On April 22 and June 30, 2008, the Company issued 1,170,000 and 1,853,542 shares of common stock, respectively, at an issuance price of $7.3060, par value of $0.0001. The difference between issuance price and par value was credited into additional paid-in capital.
 
**On March 31, 2008, the Company’s wholly-owned subsidiary, Great Genesis and Wiselink, both controlled by Hanlin Chen and his family, entered into an equity transfer agreement, pursuant to which Wiselink agreed to transfer and assign its 35.5% equity interest in Jingzhou Henglong, one of the Company’s currently consolidated subsidiaries, to Great Genesis for a total consideration of US$32,090,000.
 
Under the terms of the above agreement, Great Genesis is deemed to be the owner of the equity concerned commencing from January 1, 2008. In accordance with FASB 141 and APB 14, the above acquisition is considered as a business combination of companies under common control and is being accounted for in a manner of pooling of interests.

As of January 1, 2008, the net book value of 35.5% equity of Henglong was $6,177,079. The difference between the acquisition consideration of US$32,090,000 and 35.5% equity of Henglong, which was $25,912,921, has been debited to additional paid-in capital.
 
- 26 -


20. Other Income
 
During the three months ended June 30, 2008 and 2007 (unaudited), the Company recorded other income, government subsidies, of $199,459 and $38,462, respectively. 
 
Government subsidies represent refunds by the Chinese Government of interest paid to banks by companies entitled to such subsidies. This applies only to interest on loans related to production facilities expansion. Commencing in 2004 and 2005, the Company had used this type of special loan to improve its production lines by increasing capacity and enhancing quality. The expansion was completed and began to operate at the end of 2006 and 2007. During 2008 and 2007, the Chinese Government sent experts to review and assess the Company’s usage of its improved production facilities on site to confirm that the Company’s improvements had achieved its goals and thereby qualify for the subsidy. The Company recorded the refunded interest which achieved its goals into Other income, and refunded interest which has not achieved its goals into advances payable.

21. Financial income (expenses)

During the three months and six months ended June 30, 2008 (unaudited) and December 31, 2007, the Company recorded financial income (expenses) which is summarized as follows:

 
 
Three Months Ended June 30,
 
 
 
2008
 
2007
 
Interest income(expenses),net
 
$
(394,615
)
$
(4,526
)
Foreign exchange gain (loss), net
   
(30,522
)
 
52,293
 
Income (loss) of note discount, net
   
74,009
   
(53,606
)
Amortization for discount of convertible note payable
   
(81,879
)
 
 
Handling charge
   
(26,133
)
 
(10,656
)
Total
 
$
(459,140
)
$
(16,495
)

 
 
Six Months Ended June 30,
 
 
 
2008
 
2007
 
Interest income(expenses),net
 
$
(658,384
)
$
(206,853
)
Foreign exchange gain (loss), net
   
346,116
   
(80,854
)
Income (loss) of note discount, net
   
92,045
   
(105,284
)
Amortization for discount of convertible note payable
   
(181,328
)
 
 
Handling charge
   
(36,896
)
 
(18,501
)
Total
 
$
(438,447
) 
$
(411,492
)

22. Income Taxes

The Company’s subsidiaries registered in the PRC are subject to state and local income taxes within the PRC at the applicable tax rate on the taxable income as reported in their PRC statutory financial statements in accordance with the relevant income tax laws applicable to foreign invested enterprise. The Company’s PRC subsidiaries which are in the stage of its enterprise income tax exemption currently, are to remain subject to enterprise fixed income tax at a statutory rate of 33%, which comprises 30% national income tax and 3% local income tax.
 
On January 1, 2007, one of the subsidiaries of the Company, Jiulong, has used up its enterprise income tax exemption. During 2007, Jiulong was subject to enterprise income tax at a rate of 30%, and 25% for 2008.
 
- 27 -


On January 1, 1999, one of the subsidiaries of the Company, Henglong, was granted an enterprise income tax holiday of a 100% enterprise income tax exemption for two years commencing from 1999, and a 50% enterprise national income tax deduction and a 100% local income tax deduction for the next nine years thereafter, from 2001 to 2009, for income tax purposes. Henglong is subject to enterprise national income tax at a rate of 15% for 2008 and 2009, and is subject to enterprise income tax at a rate of 25% commencing from January 1, 2010.
  
On January 1, 2003, one of the subsidiaries of the Company, Shenyang, was granted an enterprise income tax holiday of a 100% enterprise income tax exemption for two years commencing from 2003, a 75% enterprise national income tax deduction and a 100% local income tax deduction for the next three years thereafter, from 2005 to 2007, and a 50% enterprise national income tax deduction, from January 1, 2008, for income tax purposes. During 2008, Shenyang is subject to enterprise income tax at a rate of 18%, which comprises of 15% enterprise national income tax and 3% local income tax.

On January 1, 2004, one of the subsidiaries of the Company, Zhejiang, was granted an enterprise income tax holiday of a 100% enterprise income tax exemption for two years commencing from 2004, and a 50% enterprise national income tax deduction, and a 50% local income tax deduction for the next three years thereafter, from 2006 to 2008, for income tax purposes. During 2008, Zhejiang is subject to enterprise income tax at a rate of 16.5%, which comprises of 15% enterprise national income tax and 1.5% local income tax, and is subject to enterprise income tax at a rate of 25% commencing from January 1, 2009.
 
USAI, Wuhu, Jielong and Hengsheng are at their start up stage in 2008 and 2007, accordingly, there is no assessable profit for the three months and six months ended June 30, 2008 subject to PRC enterprise income tax. They have an enterprise income tax exemption in 2008 and 2009, and are subject to enterprise income tax at a rate of 16.5% for the next three years thereafter, from 2010 to 2012, and a 25% enterprise national income tax for the years commencing from January 1, 2013.
 
No provision for Hong Kong tax is made as Great Genesis is an investment holding company, and has no assessable income in Hong Kong for the three months and six months ended June 30, 2008 and 2007. The enterprise income tax of Hong Kong is 17.5%.

No provision for US tax is made as the Company has no assessable income in the US for the three months and six months ended June 30, 2008 and 2007. The enterprise income tax of US is 30%.
 
The account of income tax as of the June 30, 2008 and 2007 (unaudited) is summarized as follows:

 
 
Three Months Ended June 30,
 
 
 
2008
 
2007
 
 
 
 
 
 
 
Current tax provision
 
$
1,452,699
 
$
1,593,807
 
Income tax refund*
   
(1,631,591
)
 
(526,272
)
Deferred tax (benefit) relating to the origination and reversal of temporary differences
   
(236,566
)
 
 
Income tax expenses (income)
 
$
(415,458
)
$
1,067,535
 
 
- 28 -


 
 
Six Months Ended June 30,
 
 
 
2008
 
2007
 
Current tax provision
 
$
2,706,923
 
$
2,887,887
 
Income tax refund*
   
(1,899,435
)
 
(526,272
)
Deferred tax (benefit) relating to the origination and reversal of temporary differences
   
(398,551
)
 
 
Income tax
 
$
408,937
 
$
2,361,615
 

*For the three months and six months ended June 30, 2008 and 2007 (unaudited), the income tax refunds received by the Company’s Sino-foreign joint ventures for purchase of domestic equipment have been reflected as a reduction to income tax expense in the respective period of the Company’s consolidated statements of operations.

23. Significant concentrations
 
The Company grants credit to its customers, generally on an open account basis. The Company’s customers are all located in the PRC.
 
During the six months ended June 30, 2008 (unaudited), the Company’s ten largest customers accounted for 72.6% of the Company’s consolidated net sales, with each of four customers individually accounting for more than 10% of consolidated net sales, i.e. 14.7%, 12.5%, 10.6% and 10.6% individually, or an aggregate of 48.4%.  At June 30, 2008, approximately 36.1% of accounts receivable were from trade transactions with the aforementioned four customers.
 
During the six months ended June 30, 2007 (unaudited), the Company’s ten largest customers accounted for 75.6% of the Company’s consolidated net sales, with each of four customers individually accounting for more than 10% of consolidated net sales, i.e. 17.6%, 12.4%, 12.0% and 10.7% individually, or an aggregate of 52.7%.  At June 30, 2007, approximately 37.1% of accounts receivable were from trade transactions with the aforementioned four customers.
 
24. Related party transactions and balances

Related party transactions with companies with common directors are as follows:

Related sales (unaudited):
 
 
 
Three Months Ended June 30,
 
 
 
2008
 
2007
 
Merchandise Sold to Related Parties
 
$
747,405
 
$
1,173,244
 

 
 
Six Months Ended June 30,
 
 
 
2008
 
2007
 
Merchandise Sold to Related Parties
 
$
2,798,487
 
$
2,075,828
 


- 29 -


Related purchases (unaudited):
 
 
 
Three Months Ended June 30,
 
 
 
2008
 
2007
 
Materials Purchased from Related Parties
 
$
2,651,000
 
$
1,414,954
 
Equipment Purchased from Related Parties
   
1,698,772
   
113,618
 
Total
 
$
4,349,772
 
$
1,528,572
 

 
 
Six Months Ended June 30,
 
 
 
2008
 
2007
 
Materials Purchased from Related Parties
 
$
4,603,390
 
$
2,466,434
 
Technology Purchased from Related Parties
   
   
64,103
 
Equipment Purchased from Related Parties
   
2,116,210
   
294,836
 
Total
 
$
6,719,600
 
$
2,825,373
 

Purchase of 35.5% equity interest in Jingzhou Henglong (refer to note 19)
 
Related receivables (June 30, 2008 unaudited):
 
 
 
June 30, 2008
 
December 31, 2007
 
Accounts receivable
 
$
989,921
 
$
1,869,480
 
Other receivables
   
499,595
    638,826  
Total
 
$
1,489,516
 
$
2,508,306
 

Related advances (June 30, 2008 unaudited):
 
 
 
June 30, 2008
 
December 31, 2007
 
Advanced Equipment Payment to Related Parties
 
$
2,881,471
 
$
1,560,378
 
Advanced Expenses and Others to Related Parties
   
502,729
    55,323  
Total
 
$
3,384,200
 
$
1,615,701
 
 
Related payables (June 30, 2008 unaudited)
 
 
 
June 30, 2008
 
December 31, 2007
 
Accounts payable:
 
$
1,028,014
 
$
1,134,817
 
 
- 30 -

 
These transactions were consummated under similar terms as those with the Company's customers and suppliers.
 
25. Commitments and contingencies:

Legal Proceedings - The Company is not currently a party to any threatened or pending legal proceedings, other than incidental litigation arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company's consolidated financial position, results of operations or cash flows.
 
The following table summarizes the Company’s major contractual payment obligations and commitments as of June 30, 2008 (unaudited):

 
 
Payment Obligations by Period
 
 
 
2008 (a)
 
2009
 
2010
 
2011
 
Thereafter
 
Total
 
Obligations for service agreements
 
$
 
$
110,000
 
$
110,000
 
$
110,000
 
$
 
$
330,000
 
Obligations for purchasing agreements
   
5,335,005
   
1,092,711
 
$
 
$
   
   
6,427,716
 
Total
 
$
5,335,005
 
$
1,202,711
 
$
110,000
 
$
110,000
 
$
 
$
6,757,716
 

(a) Remaining 6 months in 2008

26. Off-balance sheet arrangements

At June 30, 2008 and 2007, the Company did not have any transactions, obligations or relationships that could be considered off-balance sheet arrangements.
 
27. Segment reporting
 
The accounting policies of the product sectors are the same as those described in the summary of significant accounting policies except that the disaggregated financial results for the product sectors have been prepared using a management approach, which is consistent with the basis and manner in which management internally disaggregates financial information for the purposes of assisting them in making internal operating decisions. Generally, the Company evaluates performance based on stand-alone product sector operating income and accounts for inter segment sales and transfers as if the sales or transfers were to third parties, at current market prices.
  
During the three months and six months ended June 30, 2008 and 2007 (unaudited), the Company had nine product sectors, five of them were principal profit makers, which were reported as separate sectors which engaged in the production and sales of power steering (Henglong), power steering (Jiulong), power steering (Shenyang), power pumps (Zhejiang), and power steering (Wuhu). The other four sectors which were established in 2005, 2006 and 2007 respectively, engaged in the production and sales of sensor modular (USAI), electronic power steering (Jielong), power steering (Hengsheng), and provider of after sales and R&D services (HLUSA). Since the revenues, net income and net assets of these four sectors are less than 10% of its segment in the consolidated financial statements, the Company incorporated these four sectors into “other sectors”.
 
- 31 -

 
The Company’s product sectors information is as follows:
 
 
 
 
Henglong
 
 
Jiulong
 
 
Shenyang
 
 
Zhejiang
 
 
Wuhu
 
 
Other sector
 
 
Other (1)
 
 
Total
 
For the Three Months Ended:
                                 
June 30, 2008
                                 
Revenue
                                 
Net product sales – external
 
$
18,286,893
 
$
13,564,407
 
$
4,316,729
 
$
4,037,146
 
$
6,138,859
 
$
164,306
   
 
$
46,508,340
 
Net product sales – internal
   
8,291,834
   
876,373
   
1,746,252
   
213,002
   
   
   
(11,127,461
)
 
 
Gain on other sales
   
34,278
   
23,979
   
41,236
   
14,824
   
4,893
   
   
(1,500
)
 
117,710
 
Total revenue
 
$
26,613,005
 
$
14,464,759
 
$
6,104,217
 
$
4,264,972
 
$
6,143,752
 
$
164,306
 
$
(11,128,961
)
$
46,626,050
 
Net income
 
$
3,495,217
 
$
721,840
 
$
474,525
 
$
367,270
 
$
(192,753
)
$
(310,995
)
$
189,251
 
$
4,744,355
 
 
 
 
Henglong
 
Jiulong
 
Shenyang
 
Zhejiang
 
Wuhu
 
Other sector
 
Other (1)
 
Total
 
For the Three Months Ended:
                                 
June 30, 2007
                                 
Revenue
                                 
Net product sales – external
 
$
11,227,899
 
$
9,929,409
 
$
5,623,382
 
$
3,528,630
 
$
5,989,690
 
$
13,328
 
$
 
$
36,312,338
 
Net product sales – internal
   
9,271,479
   
794,417
   
808,420
   
21,423
   
   
   
(10,895,739
)
 
 
Gain on other sales
   
106,461
   
32,405
   
10,176
   
(1,619
)
 
2,499
   
(579
)
 
(1,350
)
 
147,993
 
Total revenue
 
$
20,605,839
 
$
10,756,231
 
$
6,441,978
 
$
3,548,434
 
$
5,992,189
 
$
12,749
 
$
(10,897,089
)
$
36,460,331