UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2004
[ ] 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.
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(Exact name of small business issuer as specified in its charter)
Delaware 33-0885775
------------------------------- ----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) 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) 716-8329196
Not Applicable
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(Former name, former address and former fiscal year, if changed
since last report.)
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the issuer was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
As of September 30, 2004, the Company had 22,574,542 shares of common
stock issued and outstanding.
Transitional Small Business Disclosure Format: Yes [ ] No [X]
Documents incorporated by reference: None.
CHINA AUTOMOTIVE SYSTEMS, INC.
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets - September 30, 2004 (Unaudited) and
December 31, 2003
Condensed Consolidated Statements of Operations (Unaudited) - Three
Months and Nine Months Ended September 30, 2004 and 2003
Condensed Consolidated Statements of Comprehensive Income (Loss)
(Unaudited) - Three Months and Nine Months Ended September 30, 2004 and 2003
Condensed Consolidated Statements of Cash Flows (Unaudited) - Nine
Months Ended September 30, 2004 and 2003
Notes to Condensed Consolidated Financial Statements (Unaudited) -
Three Months and Nine Months Ended September 30, 2004 and 2003
Item 2. Management's Discussion and Analysis or Plan of Operation
Item 3. Controls and Procedures
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
2
China Automotive Systems, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
September 30, December 31,
2004 2003
------------- -------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 11,012,193 $ 10,730,882
Pledged cash deposits 1,699,495 1,272,067
Accounts and notes receivable, including
$1,373,017 and $1,248,328 from related parties
at September 30, 2004 and December 31, 2003,
respectively, net of an allowance for doubtful
accounts of $3,055,277 and $2,757,374 at
September 30, 2004 and December 31, 2003,
respectively 33,814,199 38,680,011
Advance payments, including $656,640 and
$1,513,973 to related parties at September 30,
2004 and December 31, 2003, respectively, net
of an allowance for doubtful accounts of
$191,364 at September 30, 2004 and
December 31, 2003 9,903,719 9,980,367
Inventories 14,407,991 10,229,422
------------ ------------
Total current assets 70,837,597 70,892,749
------------ ------------
Property, plant and equipment 32,445,908 28,050,079
Less: Accumulated depreciation (7,559,277) (5,700,023)
------------ ------------
24,886,631 22,350,056
------------ ------------
Intangible assets, net 168,837 218,639
Other receivables, including $1,556,938 and
$1,472,758 from related parties at September
30, 2004 and December 31, 2003, respectively,
net of an allowance for doubtful accounts
of $1,164,678 and $1,053,047 at September
30, 2004 and December 31, 2003, respectively 3,434,160 2,313,017
Long-term investments 72,289 72,289
------------ ------------
Total assets $ 99,399,514 $ 95,846,750
============ ============
3
China Automotive Systems, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets (continued)
September 30, December 31,
2004 2003
------------ ------------
(Unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Bank loans $ 12,650,602 $ 9,638,554
Accounts and notes payable,
including $627,525 and
$1,175,006 to related parties
at September 30, 2004 and December
31, 2003, respectively 27,698,037 23,017,221
Customer deposits 435,517 907,519
Accrued payroll and related costs 1,940,363 1,173,576
Accrued expenses and other payables 2,581,686 1,992,207
Accrued pension costs 2,203,883 1,516,649
Liability related to acquisition of
joint venture assets -- 1,204,819
Taxes payable 4,755,586 6,268,803
Amounts due to shareholders/directors 598,744 5,229,281
------------ ------------
Total current liabilities 52,864,418 50,948,629
------------ ------------
Long-term liabilities 196,378 196,547
------------ ------------
Minority interests 16,890,933 18,686,712
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
Issued and Outstanding--
22,574,542 shares at September 30,
2004 and December 31, 2003 2,257 2,257
Additional paid-in capital 17,965,158 18,779,880
Retained earnings--
Appropriated 4,225,222 3,775,254
Unappropriated 7,252,179 3,461,621
Foreign currency translation gain
(loss) 2,969 (4,150)
------------ ------------
Total stockholders' equity 29,447,785 26,014,862
------------ ------------
Total liabilities and stockholders'
equity $ 99,399,514 $ 95,846,750
============ ============
See accompanying notes to condensed consolidated financial statements.
4
China Automotive Systems, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations (Unaudited)
Three Months Ended September 30,
--------------------------------
2004 2003
------------- ------------
(Restated -
Note 12)
Net sales, including $488,083
and $651,000 to related parties
in 2004 and 2003, respectively $ 14,598,707 $ 13,087,884
Cost of sales, including $412,390
and $56,934 purchased from
related parties in 2004 and
2003, respectively 8,944,911 7,428,901
------------ ------------
Gross profit 5,653,795 5,658,983
------------ ------------
Costs and expenses:
Selling 648,127 496,428
General and administrative 1,396,212 1,512,779
Depreciation and amortization 152,152 91,645
------------ ------------
Total costs and expenses 2,196,491 2,100,852
------------ ------------
Income from operations 3,457,304 3,558,131
------------ ------------
Other income (expense):
Other non-operating income 223,302 98,855
Financial expenses (212,138) (102,506)
------------ ------------
Other income (loss), net 11,164 (3,651)
------------ ------------
Income before income taxes 3,468,468 3,554,480
Income taxes 376,730 (37,811)
------------ ------------
Income before minority interest 3,091,738 3,592,291
Minority interests 1,062,140 1,638,153
------------ ------------
Net income $ 2,029,598 $ 1,954,138
============ ============
Net income per common share -
Basic $ 0.09 $ 0.09
Diluted $ 0.09 $ 0.09
Weighted average number of
common shares outstanding -
Basic 22,574,542 22,023,281
Diluted 22,575,637 22,411,383
See accompanying notes to condensed consolidated financial statements.
5
China Automotive Systems, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations (Unaudited)
Nine Months Ended September 30,
-------------------------------
2004 2003
------------ ------------
(Restated -
Note 12)
Net sales, including $1,145,606
and $2,666,000 to related parties
in 2004 and 2003, respectively $ 43,682,280 $ 36,923,748
Cost of sales, including $1,168,748
and $1,663,483 purchased from
related parties in 2004 and
2003, respectively 26,667,088 20,378,268
------------ ------------
Gross profit 17,015,191 16,545,480
------------ ------------
Costs and expenses:
Selling 1,935,483 1,151,754
General and administrative 6,062,232 5,029,546
Depreciation and amortization 402,767 256,940
Stock-based compensation -- 1,300,000
------------ ------------
Total costs and expenses 8,400,482 7,738,240
------------ ------------
Income from operations 8,614,709 8,807,240
------------ ------------
Other income (expense):
Other non-operating income 668,735 446,776
Financial expenses (557,740) (225,165)
------------ ------------
Other income, net 110,995 221,611
------------ ------------
Income before income taxes 8,725,704 9,028,851
Income taxes 1,142,118 942,520
------------ ------------
Income before minority interest 7,583,586 8,086,331
Minority interests 2,734,841 4,655,939
------------ ------------
Net income $ 4,848,745 $ 3,430,392
============ ============
Net income per common share -
Basic $ 0.21 $ 0.16
Diluted $ 0.21 $ 0.16
Weighted average number of
common shares outstanding
Basic 22,574,542 21,773,149
Diluted 22,574,907 22,075,006
See accompanying notes to condensed consolidated financial statements.
6
China Automotive Systems, Inc. and Subsidiaries
Condensed Consolidated Statements of Comprehensive Income (Loss) (Unaudited)
Three Months Ended September 30,
--------------------------------
2004 2003
---------- ----------
(Restated -
Note 12)
Net income $2,029,598 $1,954,138
Other comprehensive income (loss):
Foreign currency translation gain -- --
---------- ----------
Comprehensive income $2,029,598 $1,954,138
========== ==========
7
China Automotive Systems, Inc. and Subsidiaries
Condensed Consolidated Statements of Comprehensive Income (Loss) (Unaudited)
Nine Months Ended September 30,
-------------------------------
2004 2003
---------- ----------
(Restated -
Note 12)
Net income $4,848,745 $3,430,392
Other comprehensive income (loss):
Foreign currency translation gain 7,119 --
---------- ----------
Comprehensive income $4,855,864 $3,430,392
========== ==========
See accompanying notes to condensed consolidated financial statements.
8
China Automotive Systems, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited)
Nine Months Ended September 30,
-------------------------------
2004 2003
------------ ------------
(Restated -
Note 12)
Cash flows from operating activities:
Net income $ 4,848,745 $ 3,430,392
Adjustments to reconcile net income to net
cash provided by operating activities:
Minority interests 2,734,841 4,655,939
Issuance of warrants to consultants -- 1,300,000
Depreciation and amortization 2,040,149 1,531,303
Other operating adjustments (1,006,401) (67,805)
Changes in operating assets and
liabilities:
(Increase) decrease in:
Pledged deposits (427,428) (1,952,003)
Accounts receivable 4,865,812 (7,796,292)
Advance payments 76,648 (783,900)
Inventories (4,465,424) (1,094,807)
Increase (decrease) in:
Accounts and notes payable 4,746,432 4,516,119
Customer deposits (471,878) (269,524)
Accrued payroll and related
costs 781,083 (141,439)
Accrued expenses and other
payables 631,626 (1,088,317)
Accrued pension costs 687,234 598,746
Taxes payable (1,504,828) (162,558)
------------ ------------
Net cash provided by operating activities 13,536,611 2,675,854
------------ ------------
Cash flows from investing activities:
(Increase) decrease in other receivables (1,498,369) 5,605,023
(Increase) decrease in long-term investments (239,399) 1,189,157
Cash paid to acquire fixed assets (6,669,027) (4,062,479)
------------ ------------
Net cash provided by (used in)
investing activities (8,406,795) 2,731,701
------------ ------------
9
China Automotive Systems, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited) (continued)
Nine Months Ended September 30,
-------------------------------
2004 2003
------------ ------------
(Restated -
Note 12)
Cash flows from financing activities:
Proceeds from bank loans,net $ 3,614,458 $ 2,409,638
Dividends paid (4,469,379) (6,187,309)
Decrease in amounts due to
shareholders/directors (4,630,537) (1,726,752)
Contributions to capital by minority
interest holders 1,841,772 159,000
Decrease in liability related to
acquisition of joint venture assets (1,204,819) --
------------ ------------
Net cash used in financing activities (4,848,505) (5,345,423)
------------ ------------
Cash and cash equivalents:
Net increase 281,311 62,132
At beginning of period 10,730,882 --
Adjustment as a result of change
to consolidation accounting
from equity accounting
effective January 1, 2003 -- 5,618,436
------------ ------------
At end of period $ 11,012,193 $ 5,680,568
============ ============
Supplemental Disclosure of Non-Cash
Investing and Financing Activities:
Cancellation of dividends
previously declared -- 17,167,000
Shares of common stock
retained by public
shareholders in March
2003 recapitalization -- 110
Dividends declared (2,295,394)
Advances from shareholders in
connection with dividends declared 2,295,394
Deemed distribution to shareholders (279,863)
Issuance of warrants to consultants -- 1,300,000
Decrease in minority interests as a
result of Jingzhou transaction 1,493,188 --
See accompanying notes to condensed consolidated financial statements.
10
China Automotive Systems, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
Three Months and Nine Months Ended September 30, 2004 and 2003
1. Organization and Basis of Presentation
Organization - Effective March 5, 2003, Visions-In-Glass, Inc., a United States
public company incorporated in the State of Delaware ("Visions"), entered into a
Share Exchange Agreement to acquire 100% of the shareholder interest in Great
Genesis Holding Limited, a company incorporated on January 3, 2003 under the
Companies Ordinance in Hong Kong as a limited liability company ("Great
Genesis"), as a result of which Great Genesis became a wholly-owned subsidiary
of Visions. At the closing, the former directors and officers of Visions
resigned, and new directors and officers were appointed. Visions subsequently
changed its name to China Automotive Systems, Inc.
China Automotive Systems, Inc., 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, through
its Sino-foreign joint ventures described below, is engaged in the manufacture
and sale of automotive systems and components in the People's Republic of China
(the "PRC" or "China") as described below.
Ji Long Enterprise Investment Limited was incorporated on October 8, 1992 under
the Companies Ordinance in Hong Kong as a limited liability company ("Ji Long").
Ji Long is an investment holding company. Effective March 4, 2003, all of the
shareholders of Ji Long exchanged their 100% shareholder interest for a 100%
shareholder interest in Great Genesis, as a result of which Ji Long became a
wholly-owned subsidiary of Great Genesis.
In exchange for the acquisition of 100% of the shareholder interest in Great
Genesis, the shareholders of Great Genesis were issued 20,914,250 shares of
common stock of Visions. In addition, the shareholders of Great Genesis paid
$250,000 to the former officer, director and controlling shareholder of Visions
for the cancellation of 17,424,750 shares of common stock, and have agreed to
pay an additional $70,000, subject to certain conditions.
The acquisition of Great Genesis by the Company was accounted for as a
recapitalization of Great Genesis, pursuant to which the accounting basis of
Great Genesis remained unchanged subsequent to the transaction date.
Accordingly, the pre-transaction financial statements of Great Genesis are the
historical financial statements of the Company.
11
Ji Long owns the following aggregate net interests in four Sino-foreign joint
ventures organized in the PRC as of September 30, 2004:
Name of Entity Percentage Interest
--------------------------- -------------------
Jingzhou Henglong Automotive Parts
Co. Limited ("Henglong") 44.5%
Shashi Jiulong Power Steering Co.
Limited ("Jiulong") 81.0%
Shenyang Jinbei Henglong Automotive
Steering System Co. Limited ("Shenyang") 70.0%
Zhejiang Henglong & Vie Pump-Manu Co.
Limited ("Zhejiang") 51.0%
The Company accounted for the above joint ventures on a consolidated basis
since January 1, 2003 because the Company exercised sufficient control over the
management and operations.
Henglong and Jiulong are mainly engaged in the production of rack and pinion
power steering gears and integral ball and nut power steering gears for cars,
light and heavy-duty vehicles. Shenyang and Zhejiang were established in 2002
and are focused on power steering parts and power steering pumps. Jingzhou
Henglong Fulida Textile Co., Ltd ("Jingzhou") was formed in 2003 to produce
environmental textiles and raw materials. At present, Henglong, Jiulong,
Shenyang and Zhejiang are the main revenue-generating entities.
Prior to December 31, 2002, the investors in Shenyang were Ji Long, Henglong,
Shengyang Automotive Industry Investment Corporation and Shenyang Jinbei
Automotive Industry Co., Ltd. The Company owned 25% of Shenyang directly and
12.6% of Shenyang indirectly through its ownership in Henglong, for a combined
ownership of 37.6%. On December 31, 2002, according to an equity transfer
agreement, 30% of the stock rights in Shenyang held by Henglong were to be
transferred to Ji Long, and 17% of the stock rights in Shenyang held by Shenyang
Automotive Industry Investment Corporation were to be transferred to Shenyang
Jinbei Automotive Industry Co., Ltd. This transfer has been approved by the
applicable PRC authorities. As a result, the Company has owned 55% of Shenyang
directly. The Company accounted this increase in ownership in Shenyang from
January 1, 2003, with an appropriate adjustment of minority interest. On April
8, 2004, the board of directors approved an increase in Shenyang's registered
capital and total capital from $5,421,687 (RMB45,000,000) to $8,132,530
(RMB67,500,000); the Chinese investor was changed from Shenyang Jinbei
Automotive Industry Co., Ltd. to Shenyang Jinbei Automotive Company Limited. The
shareholder transfer and capital increase, along with the newly signed Joint
Venture Agreement and Articles of Incorporation, have been approved by the
applicable PRC authorities. Accordingly, Shenyang's registered capital is now
$8,132,530 (RMB67,500,000), including $5,692,771 (RMB47,250,000) from the
Company, which is 70% of the total registered capital, and $2,439,759
(RMB20,250,000) from Shenyang Jinbei Automotive Company Limited, which is 30% of
the total registered capital. The increase in capital of $2,710,843
(RMB22,500,000) has been injected into Shenyang.
12
Jingzhou was formed in February 2003 to produce environmental textiles and raw
materials, and was owned 51% by Ji Long and 49% by Cixi City Fulida Synthetic
Fibre Co., Ltd. As the minority interest partner has the right to participate in
management, the Company accounted for its interest in this Sino-foreign joint
venture under the equity method of accounting through September 30, 2003. As a
result of the execution of an "Act in Concert" Agreement for Jingzhou during the
three months ended December 31, 2003, the Company consolidated Jingzhou as of
December 31, 2003 and for the year then ended.
Effective September 1, 2004, in order to concentrate on its main products,
namely steering and automotive parts, the Company disposed of its 51% interest
in Jingzhou by entering into an equity exchange agreement (the "Exchange
Agreement") with Hubei Wanlong Investment Co., Ltd ("Hubei Wanlong"), which is
controlled by Mr. Chen Hanlin, the Chairman of the Company. Pursuant to the
Exchange Agreement, the 51% equity interest in Jingzhou owned by Ji Long was
exchanged for 2.5% of Hubei Wanlong's equity interests in Henglong based on
their respective fair market values as determined by an independent appraisal
firm. The difference between the fair value and the book value resulting from
the disposition of the joint venture interest in Jingzhou was debited to
additional paid-in capital. With respect to consideration paid by the Company in
excess of the Chairman's basis in his investment, such excess has been charged
to additional paid-in capital as a distribution to the Chairman, resulting in
the acquired 2.5% equity interests in Henglong being recorded by the Company at
the Chairman's original cost basis. The Company paid approximately $90,000 to
Hubei Wanlong in conjunction with this transaction.
Jingzhou was consolidated with the Company's operations through August 31,
2004. Accordingly, for the three months and nine months ended September 30,
2004, the Company's unaudited condensed consolidated results of operations
included revenues from Jingzhou of $379,878 and $2,746,389, respectively, and a
net loss of $24,432 and $42,337, respectively. Jingzhou was in the initial
development stage during 2003, generating revenues of $510,654 and a net loss
of $86,661 for the nine months ended September 30, 2003.
Basis of Presentation - The accompanying condensed consolidated financial
statements include the accounts of the Company and its majority-owned
subsidiaries and Sino-foreign joint ventures for the three months and nine
months ended September 30, 2004 and 2003. All significant inter-company accounts
and transactions have been eliminated in consolidation. The condensed
consolidated financial statements have been prepared in accordance with
generally accepted accounting principles in the United States of America.
13
During early 2003, the Directors of the Company and the other joint venturers in
the Company's Sino-foreign joint ventures (except for Jingzhou) executed "Act in
Concert" agreements, resulting in the Company having voting control in such
Sino-foreign joint ventures. The Company is in the process of making application
to the relevant PRC authorities for their approval to effect this change through
amendments to the respective joint venture agreements. Consequently, effective
January 1, 2003, the Company changed from equity accounting to consolidation
accounting for its investments in Sino-foreign joint ventures (except for
Jingzhou). Prior to January 1, 2003, the Company accounted for its investments
in Sino-foreign joint ventures under the equity method. As a result of the Board
structures of the Company's joint ventures, each of the minority partners of
Zhejiang, Henglong, Jiulong and Shenyang had the right to approve major
operational decisions of their respective joint ventures because the Company's
representatives on the Boards of Directors of the Joint Ventures did not account
for the requisite 67% of voting control required to approve various operating
matters, which allowed the minority partners to participate in the operations of
the management of the respective Joint Ventures. As such, prior to January 1,
2003, the Company used the equity method to account for its interest in Jingzhou
pursuant to Emerging Issues Task Force Issue No. 96-16, which states that if a
minority joint venture partner has the right to participate in management, the
majority joint venture partner is required to account for its interest in the
joint venture under the equity method of accounting.
In May 2003, Henglong outsourced to Jiulong the production of an integral power
steering system. Jiulong sells the related finished product to Henglong, which
then sells the product to third parties. All intercompany profit is eliminated
on consolidation. The transferred profit due to this transaction has been
recorded in the interest account of minority shareholders according to their
investment ratios since that date.
Foreign Currencies - The Company maintains its books and records in Renminbi
("RMB"), the currency of the PRC, its functional currency. Translation of
amounts into United States dollars ("US$") has been made at the rate of RMB8.30
to US$1.00.
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 (loss) for the
period.
14
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.
The RMB is not readily convertible into United States dollars or other foreign
currencies. The foreign exchange rate between the United States dollar and the
RMB has been stable at approximately 1RMB to US$0.1205 for the last few years.
No representation is made that the RMB amounts could have been, or could be,
converted into United States dollars at that rate or at any other rate.
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 at September 30, 2004, the results of operations
for the three months and nine months ended September 30, 2004 and 2003, and cash
flows for the nine months ended September 30, 2004 and 2003. The consolidated
balance sheet as of December 31, 2003 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 management of
the Company 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 Annual Report on Form 10-KSBA, as filed
with the Securities and Exchange Commission.
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.
The results of operations for the three months and nine months ended September
30, 2004 are not necessarily indicative of the results of operations to be
expected for the full fiscal year ending December 31, 2004.
15
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 assuming the issuance of common shares,
if dilutive, resulting from the exercise of stock options and warrants. Income
per common share calculations for the nine months ended September 30, 2003
reflected the retroactive restatement of the shareholders' equity section to
reflect the March 2003 recapitalization. As of September 30, 2003, the Company
had potentially dilutive securities consisting of warrants to purchase 550,375
shares of common stock exercisable at $1.20 per share. As of September 30, 2004,
the Company had potentially dilutive consisting of stock options to purchase
22,500 shares of common stock exercisable at $4.50 per share.
The Company effected a 3.5 to 1 forward split of its outstanding shares of
common stock during March 2003, prior to the transaction with Great Genesis
described above. Unless otherwise indicated, all share and per share amounts
presented herein have been adjusted to reflect the forward stock split.
Stock-Based Compensation - The Company may periodically issue shares of common
stock for services rendered or for financing costs. Such shares are valued based
on the market price on the transaction date.
The Company may periodically issue stock options and warrants to employees and
non-employees in non-capital raising transactions for services and for financing
costs.
16
The Company has adopted Statement of Financial Accounting Standards ("SFAS") No.
123, "Accounting for Stock-Based Compensation", which establishes a fair value
method of accounting for stock-based compensation plans.
The provisions of SFAS No. 123 allow companies to either record an expense in
the financial statements to reflect the estimated fair value of stock options or
warrants to employees, or to continue to follow the intrinsic value method set
forth in Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees", but to disclose on an annual basis the pro forma effect on
net income (loss) and net income (loss) per common share had the fair value of
the stock options and warrants been recorded in the financial statements. SFAS
No. 123 was amended by SFAS No. 148, which now requires companies to disclose in
interim financial statements the pro forma effect on net income (loss) and net
income (loss) per common share of the estimated fair market value of stock
options or warrants issued to employees. The Company has elected to continue to
account for stock-based compensation plans utilizing the intrinsic value method.
Accordingly, compensation cost for stock options and warrants is measured as the
excess, if any, of the fair market price of the Company's common stock at the
date of grant above the amount an employee must pay to acquire the common stock.
In accordance with SFAS No. 123, the cost of stock options and warrants issued
to non-employees is measured at the grant date based on the fair value of the
award. The fair value of the stock-based award 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.
Pro Forma Financial Disclosure - The fair value of stock options issued to
directors in July 2004 has been estimated on the grant date using the
Black-Scholes option-pricing model. Had such stock options been accounted for
pursuant to SFAS No. 123, the effect on the Company's results of operations
would have been as follows:
For the three months ended September 30, 2004 and 2003, the Company would have
recorded $55,125 and $0 additional compensation expense, resulting in net income
of $1,974,473 and $1,954,138, respectively, and net income per common share of
$0.09 and $0.09, respectively.
For the nine months ended September 30, 2004 and 2003, the Company would have
recorded $55,125 and $0 as additional compensation expense, resulting in net
income of $4,793,620 and $3,430,392, respectively, and net income per common
share of $0.21 and $0.16, respectively.
17
Comprehensive Income (Loss) - 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 (loss) 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.
The Company's only component of other comprehensive income (loss) is foreign
currency translation gain of $7,119 for the nine months ended September 30,
2004. This amount has been recorded as a separate component of stockholders'
equity.
Reclassifications - Certain reclassifications have been made to the 2003
financial statements to conform to the 2004 presentation.
2. Certain Significant Risks and Uncertainties
The Company is subject to the consideration and risks of operating in the PRC.
These include risks associated with the political and economic environment,
foreign currency exchange and the legal system in the PRC.
The economy of the PRC differs significantly from the economies of the "western"
industrialized nations in such respects as structure, level of development,
gross national product, growth rate, capital reinvestment, resource allocation,
self-sufficiency, rate of inflation and balance of payments position, among
others. Only recently has the PRC government encouraged substantial private
economic activities. The Chinese economy has experienced significant growth in
the past several years, but such growth has been uneven among various sectors of
the economy and geographic regions. Actions by the PRC government to control
inflation have significantly restrained economic expansion in the recent past.
Similar actions by the PRC government in the future could have a significant
adverse effect on economic conditions in PRC.
Many laws and regulations dealing with economic matters in general and foreign
investment in particular have been enacted in the PRC. However, the PRC still
does not have a comprehensive system of laws, and enforcement of existing laws
may be uncertain and sporadic.
18
The Company's operating assets and primary sources of income and cash flows are
the interests of its subsidiaries in Sino-foreign joint ventures in the PRC. The
PRC economy has, for many years, been a centrally-planned economy, operating on
the basis of annual, five-year and ten-year state plans adopted by central PRC
governmental authorities, which set out national production and development
targets. The PRC government has been pursuing economic reforms since it first
adopted its "open-door" policy in 1978. There is no assurance that the PRC
government will continue to pursue economic reforms or that there will not be
any significant change in its economic or other policies, particularly in the
event of any change in the political leadership of, or the political, economic
or social conditions in, the PRC. There is also no assurance that the Company
will not be adversely affected by any such change in governmental policies or
any unfavorable change in the political, economic or social conditions, the laws
or regulations, or the rate or method of taxation in the PRC.
As many of the economic reforms, which have been or are being implemented by the
PRC government are unprecedented or experimental, they may be subject to
adjustment or refinement, which may have adverse effects on the Company.
Further, through state plans and other economic and fiscal measures such as the
level of exchange rate, it remains possible for the PRC government to exert
significant influence on the PRC economy.
The Company's financial instruments that are exposed to concentration of credit
risk consist primarily of cash and cash equivalents, and accounts receivable
from customers. Cash and cash equivalents are maintained with major banks in the
PRC. The Company's business activity is with customers in the PRC. The Company
periodically performs credit analysis and monitors the financial condition of
its clients in order to minimize credit risk.
Any devaluation of the Renminbi (RMB) against the United States dollar would
consequently have adverse effects on the Company's financial performance and
asset values when measured in terms of the United States dollar. Should the RMB
significantly devalue against the United States dollar, such devaluation could
have a material adverse effect on the Company's earnings and the foreign
currency equivalent of such earnings. The Company does not hedge its RMB -
United States dollar exchange rate exposure.
On January 1, 1994, the PRC government introduced a single rate of exchange as
quoted daily by the People's Bank of China (the "Unified Exchange Rate"). No
representation is made that the RMB amounts have been, or could be, converted
into US$ at that rate. This quotation of exchange rates does not imply free
convertibility of RMB to other foreign currencies. All foreign exchange
transactions continue to take place either through the Bank of China or other
banks authorized to buy and sell foreign currencies at the exchange rate quoted
by the People's Bank of China. Approval of foreign currency payments by the
People's Bank of China or other institutions requires submission of a payment
application form together with suppliers' invoices, shipping documents and
signed contracts.
19
3. Recent Accounting Pronouncements
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations". SFAS No. 143 addresses the diverse accounting practices for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. The Company adopted SFAS No. 143, effective
January 1, 2003. The adoption of SFAS No. 143 did not have a significant effect
on the Company's financial statement presentation or disclosures.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections".
SFAS No. 145 rescinds the provisions of SFAS No. 4 that requires companies to
classify certain gains and losses from debt extinguishments as extraordinary
items, eliminates the provisions of SFAS No. 44 regarding transition to the
Motor Carrier Act of 1980 and amends the provisions of SFAS No. 13 to require
that certain lease modifications be treated as sale leaseback transactions. The
provisions of SFAS No. 145 related to classification of debt extinguishments are
effective for fiscal years beginning after May 15, 2002. The adoption of SFAS
No. 145 did not have a significant effect on the Company's financial statement
presentation or disclosures.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities", which requires companies to recognize costs
associated with exit or disposal activities when they are incurred rather than
at the date of a commitment to an exit or disposal plan. Such costs covered by
SFAS No. 146 include lease termination costs and certain employee severance
costs that are associated with a restructuring, discontinued operation, plant
closing, or other exit or disposal activity. SFAS No. 146 replaces the previous
accounting guidance provided by the EITF No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)". SFAS No. 146 is to be
applied prospectively to exit or disposal activities initiated after December
31, 2002. The adoption of SFAS No. 146 did not have a significant effect on the
Company's financial statement presentation or disclosures.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation -Transition and Disclosure". SFAS No. 148 amends SFAS No. 123,
"Accounting for Stock-Based Compensation", to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, SFAS No. 148 amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. SFAS No. 148 is effective for fiscal years beginning after December 15,
2002. The interim disclosure provisions are effective for financial reports
containing financial statements for interim periods beginning after December 15,
2002. The adoption of SFAS No. 148 did not have a significant effect on the
Company's financial statement presentation or disclosures.
20
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities". SFAS No. 149 amends and
clarifies under what circumstances a contract with initial investments meets the
characteristics of a derivative and when a derivative contains a financing
component. SFAS No. 149 is effective for contracts entered into or modified
after June 30, 2003. The adoption of SFAS No. 149 did not have a significant
effect on the Company's financial statement presentation or disclosures.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity". SFAS No. 150
establishes standards for how an issuer classifies and measures in its statement
of financial position certain financial instruments with characteristics of both
liabilities and equity. SFAS No. 150 requires that an issuer classify a
financial instrument that is within its scope as a liability (or an asset in
some circumstances) because that financial instrument embodies an obligation of
the issuer. SFAS No. 150 is effective for financial instruments entered into or
modified after May 31, 2003 and otherwise is effective at the beginning of the
first interim period beginning after June 15, 2003. SFAS No. 150 is to be
implemented by reporting the cumulative effect of a change in accounting
principles for financial instruments created before the issuance date of SFAS
No. 150 and still existing at the beginning of the interim period of adoption.
Restatement is not permitted. The adoption of SFAS No. 150 did not have a
significant effect on the Company's financial statement presentation or
disclosures.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45"). FIN 45 elaborates on the existing disclosure
requirements for most guarantees, including loan guarantees such as standby
letters of credit. It also clarifies that at the time a company issues a
guarantee, the company must recognize an initial liability for the fair market
value of the obligations it assumes under that guarantee and must disclose that
information in its interim and annual financial statements. The initial
recognition and measurement provisions of FIN 45 apply on a prospective basis to
guarantees issued or modified after December 31, 2002. The Company implemented
the disclosure provisions of FIN 45 in its December 31, 2002 consolidated
financial statements, and the measurement and recording provisions of FIN 45
effective January 1, 2003.
21
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), which clarifies the application of
Accounting Research Bulletin No. 51, "Consolidated Financial Statements",
relating to consolidation of certain entities. In December 2003, the FASB issued
a revised version of FIN 46 ("FIN 46R") that replaced the original FIN 46. FIN
46R requires identification of a company's participation in variable interest
entities ("VIEs"), which are defined as entities with a level of invested equity
that is not sufficient to fund future activities to permit it to operate on a
stand alone basis. For entities identified as a VIE, FIN 46R sets forth a model
to evaluate potential consolidation based on an assessment of which party to the
VIE (if any) bears a majority of the exposure to its expected losses, or stands
to gain from a majority of its expected returns. FIN 46R also sets forth certain
disclosures regarding interests in VIEs that are deemed significant, even if
consolidation is not required. The Company is not currently participating in, or
invested in any VIEs, as defined in FIN 46R. The implementation of the
provisions of FIN 46R in 2003 did not have a significant effect on the Company's
consolidated financial statement presentation or disclosures.
4. Inventories
Inventories at September 30, 2004 and December 31, 2003 consisted of the
following:
September 30, December 31,
2004 2003
(Unaudited)
------------ ------------
Raw materials $ 4,697,787 $ 3,622,369
Work-in-process 2,234,655 2,110,612
Finished goods 7,745,477 4,808,434
------------ ------------
14,677,919 10,541,415
Less: provision for loss (269,928) (311,993)
------------ ------------
$ 14,407,991 $ 10,229,422
============ ============
22
5. Liability Related to Acquisition of Joint Venture Assets
In conjunction with the formation of the Jingzhou Sino-foreign joint venture in
February 2003, the Company purchased certain operating assets consisting of
production equipment from the local government and had a remaining liability
outstanding of $1,204,819 as of December 31, 2003. The obligation was interest
free and matured on February 28, 2004. The Company paid this liability in full
on a timely basis.
6. Amounts Due to Shareholders/Directors
The activity in the amounts due to shareholders/directors for the nine months
ended September 30, 2004 is as follows:
Balance, December 31, 2003 $ 5,229,281
Cash advances from shareholders 10,525,526
Cash disbursements to shareholders (15,156,063)
-----------
Balance, September 30, 2004 $ 598,744
===========
At September 30, 2004 and December 31, 2003, the amounts due to
shareholders/directors were unsecured, interest-free and repayable on demand.
During the three months ended March 31, 2003, amounts due to
shareholders/directors aggregating $17,167,000 were cancelled. This transaction
was accounted for as a contribution to capital.
7. Minority Interests
During the three months and nine months ended September 30, 2004, the minority
interest holders contributed $280,561 and $1,841,772, respectively, of capital
to the Company's Sino-foreign joint ventures, which has been shown as an
increase in the liability to minority interests in the accompanying balance
sheet as of September 30, 2004. On August 31, 2004, the equity exchange
involving Jingzhou and Henglong (see Note 1) resulted in a decrease of
$1,493,188 to minority interests in the accompanying balance sheet dated
September 30, 2004.
23
8. Stockholders' Equity
During March 2003, in conjunction with the transaction with Great Genesis
described at Note 1, the Company effected a 3.5 to 1 forward split of its
outstanding shares of common stock, thus increasing the 5,293,000 shares of
common stock outstanding at that time to 18,525,500 shares, of which 17,424,750
shares were then returned to the Company and cancelled.
During March 2003, in conjunction with the transaction with Great Genesis
described at Note 1, the Company issued common stock purchase warrants to three
consultants to acquire an aggregate of 550,375 shares of common stock,
exercisable for a period of one year at $1.20 per share. The aggregate fair
value of these warrants, calculated pursuant to the Black-Scholes option-pricing
model, was estimated to be $1,300,000, and was charged to operations during the
nine months ended September 30, 2003.
In July 2004, the Company proposed to adopt a stock incentive plan, which plan
is currently subject to shareholder approval. 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. On July
21, 2004, the Company issued options to purchase 7,500 shares of common stock to
each of its three independent directors. Such share options vest immediately
upon grant and are exercisable at $4.50 per share over a period of two years.
The exercise price represents a 11.11% premium from the fair market value as
based upon the grant date the stock options. After the stock incentive plan is
approved, the Company plans to register the common shares underlying the stock
incentive plan.
The following table sets forth stock options that would be granted to the
Directors:
Name of Director Number of Option Exercise Exercise Period
Shares Granted Price
---------------- --------------- -------- -------------------------------
Robert Tung 7,500 4.50 June 25, 2004 to June 24, 2006
Haimian Cai 7,500 4.50 June 25, 2004 to June 24, 2006
William Thomson 7,500 4.50 June 25, 2004 to June 24, 2006
9. Income Taxes
The Company's Sino-foreign joint ventures 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 enterprises.
Two of the Company's Sino-foreign joint ventures, Henglong and Jiulong, were
subject to a tax rate of 15% during 2003, and are also subject to a tax rate of
15% during 2004. Shenyang, was subject to a two-year tax holiday commencing with
its first profit-making year (2003), in accordance with the relevant income tax
laws for Sino-foreign joint ventures. Shenyang's second profit-making year is
2004. The tax rate for the Company's two other subsidiaries, Zhejiang and
Jingzhou, has not been ratified.
No provision for Hong Kong profits tax has been made as Ji Long and Great
Genesis are investment holding companies and did not have any assessable profits
in Hong Kong in 2003.
24
10. Significant Concentrations and Related Party Transactions
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 three months ended September 30, 2004, the Company's ten largest
customers accounted for 72.3% of the Company's consolidated net sales, with
three customers each accounting for in excess of 10% of consolidated net sales,
with 19%, 11.9% and 11.5% of consolidated net sales, or an aggregate of 42.4% of
consolidated net sales. As of September 30, 2004, approximately 33% of accounts
receivable were from trade transactions with the aforementioned three customers.
During the nine months ended September 30, 2004, the Company's ten largest
customers accounted for 65.7% of the Company's consolidated net sales, with two
customers each accounting for in excess of 10% of consolidated net sales, with
19.8% and 14.2% of consolidated sales, or an aggregate of 34% of consolidated
net sales. As of September 30, 2004, approximately 22% of accounts receivable
were from trade transactions with the aforementioned two customers.
During the three months ended September 30, 2003, the Company's ten largest
customers accounted for 77.6% of the Company's consolidated net sales, with
three customers each accounting for in excess of 10% of consolidated net sales,
with 27.2%, 12.2% and 11.2% of consolidated net sales, or an aggregate of 50.6%
of consolidated net sales. As of September 30, 2003, approximately 39% of
accounts receivable were from trade transactions with the aforementioned three
customers.
During the nine months ended September 30, 2003, the Company's ten largest
customers accounted for 77.3% of the Company's consolidated net sales, with
three customers each accounting for in excess of 10% of consolidated net sales,
with 27.1%, 10.7% and 10.1% of consolidated sales, or an aggregate of 47.9% of
consolidated net sales. As of September 30, 2003, approximately 39% of accounts
receivable were from trade transactions with the aforementioned two customers.
During the three months ended September 30, 2004 and 2003, sales to related
parties aggregated $488,083 and $651,000, respectively.
During the nine months ended September 30, 2004 and 2003, sales to related
parties aggregated $1,145,606 and $2,666,000, respectively.
25
During the three months ended September 30, 2004 and 2003, purchases from
related parties aggregated $412,390 and $56,934, respectively.
During the nine months ended September 30, 2004 and 2003, purchases from related
parties aggregated $1,168,748 and $1,663,483, respectively.
11. Related Party Transactions
Effective August 2, 2003, the Company entered into a five-year License and
Technical Assistance Agreement (the "Agreement") with Sino-American, Inc.
("Sino-American"), a United States company controlled by the Company's Chairman
and controlling shareholder. The Agreement provided for total payments of
$6,000,000 to enable Sino-American to purchase technical assistance and
equipment for use in the Company's business operations in China. During November
2003, $2,000,000 was paid by the Company to Sino-American, which was classified
as advance payments in the consolidated balance sheets dated September 30, 2004
and December 31, 2003, net of amounts expended through such dates.
This agreement also allowed the Company to transfer funds from China to the
United States to fund normal corporate general and administrative expenses.
Through September 30, 2004, Sino-American had paid, on behalf of or for the
benefit of the Company, a total of $1,742,630, including a $250,000 initial
investment in a joint venture with an unrelated party, $255,000 for equipment
and $180,000 for software to unrelated third parties, $250,000 to the Company's
Chairman and controlling shareholder as reimbursement for costs incurred by him
related to the March 2003 recapitalization, and $807,630 for selling, general
and administrative expenses for the benefit of or on behalf of the Company. As
this Agreement was terminated effective April 1, 2004, the unexpended funds were
repaid to the Company subsequent to that date or continue to be used to pay
normal operating expenses on behalf of the Company. The $250,000 reimbursement
to the Chairman and controlling shareholder was recorded as a charge to
operations during the three months ended March 31, 2003.
26
During the three months and nine months ended September 30, 2004 and 2003, the
joint ventures entered into related party transactions with companies with
common directors as shown below:
Three Months Ended September 30,
--------------------------------
2004 2003
---------- ----------
Sales
- received $ -- $ --
- receivable 488,083 651,000
Purchases
- paid -- 3,934
- payable 412,390 53,000
Nine Months Ended September 30,
--------------------------------
2004 2003
---------- ----------
Sales
- received $ -- $1,512,000
- receivable 1,145,606 1,154,000
Purchases
- paid 541,223 1,610,483
- payable 627,525 53,000
These transactions were consummated under similar terms as those with the
Company's customers and suppliers.
27
12. Restatement
In conjunction with the Company's audit of its consolidated financial statements
for the year ended December 31, 2003, the Company conducted a review of its 2002
financial statements, as a result of which restated its balance sheet dated
December 31, 2002 and for the 2003 interim periods. A summary of the effect of
these adjustments with respect to the statement of operations for the three
months and nine months ended September 30, 2003 is as follows:
Three months ended September 30, 2003:
Net income, as reported $ 2,417,000
Less: Costs and expenses
not properly recorded on September 30, 2003, net (462,862)
-----------
Net income, as revised $ 1,954,138
===========
Net income per common share -
Basic and diluted - as reported $ 0.11
Less: Costs and expenses
not properly recorded on September 30, 2003, net (0.02)
-----------
Net income per common share -
Basic and diluted - as adjusted $ 0.09
===========
Weighted average common shares
outstanding -
Basic 22,023,281
Diluted 22,411,383
Nine months ended September 30, 2003:
Net income, as reported $ 3,235,000
Add: Costs and expenses
properly recorded in 2002, net 195,392
-----------
Net income, as revised $ 3,430,392
===========
Net income per common share -
Basic and diluted - as reported $ 0.15
Add: Costs and expenses
properly recorded in 2002, net 0.01
-----------
Net income per common share -
Basic and diluted - as adjusted $ 0.16
===========
Weighted average common shares
outstanding -
Basic 21,773,149
Diluted 22,075,006
28
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
This Quarterly Report on Form 10-QSB for the quarterly period ended September
30, 2004 contains "forward-looking statements" within the meaning of Section 27A
of the Securities Act of 1933, as amended, including statements that include the
words "believes", "expects", "anticipates", or similar expressions. These
forward-looking statements include, but are not limited to, statements
concerning the Company's expectations regarding its working capital
requirements, financing requirements, business prospects, and other statements
of expectations, beliefs, future plans and strategies, anticipated events or
trends, and similar expressions concerning matters that are not historical
facts. The forward-looking statements in this Quarterly Report on Form 10-QSB
for the quarterly period ended September 30, 2004 involve known and unknown
risks, uncertainties and other factors that could cause the actual results,
performance or achievements of the Company to differ materially from those
expressed in or implied by the forward-looking statements contained herein.
These other factors include, without limitation, risks related to the demand for
the Company's products, political climate of the PRC, doing business in the PRC,
unfavorable changes in the economic or social conditions of the PRC or in
countries where the Company sells its products, changes in the PRC laws or
regulations applicable to the Company's business, increase in tax rates,
currency fluctuations, competition, price fluctuations of raw materials, and
volatility of earnings.
General Overview:
The Company, through its wholly-owned subsidiary Great Genesis, wholly-owns Ji
Long. Ji Long owns the following aggregate net interests in four Sino-foreign
joint ventures organized in the PRC as of September 30, 2004:
Name of Entity Percentage
Interest
-------------------- ----------
Jingzhou Henglong Automotive Parts
Co. Limited ("Henglong") 44.5%
Shashi Jiulong Power Steering Co.
Limited ("Jiulong") 81.0%
Shenyang Jinbei Henglong Automotive
Steering System Co. Limited ("Shenyang") 70.0%
Zhejiang Henglong & Vie Pump-Manufacturing Co.
Limited ("Zhejiang") 51.0%
The Company has accounted for the above joint ventures on a consolidated basis
since January 1, 2003 because the Company has exercised sufficient control over
their management and operations.
29
The Company, through its Sino-foreign joint ventures, is engaged in the
manufacture and sale of automotive systems and components in the PRC. The
Company, through intermediary holding companies, own four Sino-foreign joint
ventures in the PRC. Henglong and Jiulong are mainly engaged in the production
of rack and pinion power steering gears and integral ball and nut power steering
gears for cars, light and heavy-duty vehicles. Shenyang and Zhejiang were
established in 2002 and are focused on power steering parts and power steering
pumps.
Critical Accounting Policies:
The Company prepares its condensed consolidated financial statements in
accordance with accounting principles generally accepted in the United States of
America. The preparation of these financial statements requires the use of
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amount of revenues and expenses
during the reporting period. Management periodically evaluates the estimates and
judgments made. Management bases its estimates and judgments on historical
experience and on various factors that are believed to be reasonable under the
circumstances. Actual results may differ from these estimates as a result of
different assumptions or conditions.
Minority interests refer to the percentage of the owner's equity of a subsidiary
owned by those investors other than the parent company. Minority interests in
the condensed consolidated financial statements means the percentage of the
Company's net assets owned by shareholders of the Company's Sino-foreign joint
ventures other than the Company, according to their respective investment
ratios.
The following critical accounting policies affect the more significant judgments
and estimates used in the preparation of the Company's consolidated financial
statements.
Revenues:
The Company recognizes revenue when the significant risks and rewards of
ownership have been transferred to the customer pursuant to PRC law, including
factors such as when persuasive evidence of an arrangement exists, delivery has
occurred, the sales price is fixed or determinable, sales and value added tax
laws have been complied with, and collectibility is probable. The Company
recognizes product sales generally at the time the product is shipped.
Concurrent with the recognition of revenue, the Company reduces revenue for
estimated product returns. Shipping and handling costs are included in cost of
goods sold. Revenue is presented net of any sales tax and value added tax.
30
Accounts Receivable:
In order to determine the value of the Company's accounts receivable, the
Company records a provision for doubtful accounts to cover estimated credit
losses. Management reviews and adjusts this allowance periodically based on
historical experience and its evaluation of the collectibility of outstanding
accounts receivable. The Company evaluates the credit risk of its customers
utilizing historical data and estimates of future performance.
Inventories:
Inventories are stated at the lower of cost or net realizable value. Cost is
calculated on the moving-average basis and includes all costs to acquire and
other costs incurred in bringing the inventories to their present location and
condition. The Company evaluates the net realizable value of its inventories on
a regular basis and records a provision for loss to reduce the computed
moving-average cost if it exceeds the net realizable value.
Income Taxes:
The Company records a tax provision to reflect the expected tax payable on
taxable income for the period, using tax rates enacted or substantially enacted
by the balance sheet date, and any adjustment to tax payable in respect of
previous periods.
Impairment of Long-Lived Assets:
The Company's long-lived assets consist of property and equipment and certain
intangible assets. In assessing the impairment of such assets, the Company
periodically makes assumptions regarding the estimated future cash flows and
other factors to determine the fair value of the respective assets. If these
estimates or the related assumptions indicate that the carrying amount may not
be recoverable, the Company records impairment charges for these assets at such
time.
Results of Operations:
Three Months Ended September 30, 2004 and 2003:
Net Sales. Net sales were $14,598,707 for the three months ended September 30,
2004, as compared to $13,087,884 for the three months ended September 30, 2003,
an increase of $1,510,823 or 11.5%. The increase in sales in 2004 as compared to
2003 was a result of several factors.
31
In the first half of 2003, the SARS virus spread throughout most of China, which
had a substantial negative impact on consumer spending and, in particular,
automobile sales in China during the nine months ended September 30, 2003. As an
automobile parts supplier to the automobile industry, the Company's sales were
also affected. As a result, during the three months ended September 30, 2003,
the sales of the Company's Henglong, Jiulong and Shenyang Sino-foreign joint
ventures were below expected levels.
During the latter part of 2003, the Company expanded its production lines, which
the Company believes contributed to sales increases during 2004 at its Jiulong
and Shenyang Sino-foreign joint ventures.
During the three months ended September 30, 2003, the Zhejiang and Jingzhou
Sino-foreign joint ventures were in the initial development stages, and were
primarily engaged in preparation to begin production. Sustained production and
sales commenced during the three months ended December 31, 2003. Incremental net
sales from these two joint ventures in 2004 as compared to 2003 were
approximately $860,000 or 6.6%, while net sales from the Henglong, Jiulong and
Shenyang Sino-foreign joint ventures increased by an aggregate of approximately
$650,000 or 4.9% as compared to 2003, resulting in a net increase in sales of
approximately $1,510,000 or 11.5% in 2004 as compared to 2003.
Gross Profit. Gross profit was $5,653,795 or 38.7% of net sales for the three
months ended September 30, 2004, which was 3.7% higher than the expected gross
profit margin of 35% of net sales for 2004. For the three months ended September
30, 2003, gross profit was $5,658,986 or 43.2% of net sales.
The decrease in the gross profit in 2004 was consistent with the Company's
expectations regarding the impact of rising raw material costs in the latter
part of 2003, which the Company anticipated would cause gross profit margins to
decrease by approximately 10% during 2004, to 35% of net sales. The reason that
the gross profit margin for the three months ended September 30, 2004 was 3.7%
higher than expected was a result of several factors, including the PRC
government enhancing macroeconomic adjustment controls beginning in April 2004
and the banks tightening the creation of new credit. As the PRC's overheated
economy cooled down, the prices of primary industrial raw materials fell, (for
example, the price of steel and iron fell 10% as compared with early 2004). In
addition, the caused gross profit margin in 2004 was positively influenced by
the following factors:
The Company has attempted to optimize product design and reduce the weight of
its parts, thus reducing the usage of raw materials. The Company formed a
special team to control costs in advance and/or during the manufacturing
process. The Company has installed certain advanced production equipment which
it anticipates will improve operating efficiencies.
32
Selling. Selling expenses were $648,127 for the three months ended September 30,
2004, as compared to $496,428 for the three months ended September 30, 2003, an
increase of $151,699 or 30.6%, primarily as a result of increased level of
operations in 2004 and increased transportation costs due to government imposed
limits on the amount of weight that automobiles can carry. The major components
of selling expenses are salaries and wages, supplies, travel, transportation,
sales service costs, rent, office expenses and advertising.
General and Administrative. General and administrative expenses were $1,396,212
for the three months ended September 30, 2004, as compared to $1,512,779 for the
three months ended September 30, 2003, a decrease of $116,567 or 7.7%, primarily
as a result of the implementation of effective cost controls. The major
components of general and administrative expenses are salaries and wages,
travel, office, supplies, repairs and labor-related costs.
Depreciation and Amortization. Depreciation and amortization, excluding
depreciation and amortization included in the cost of sales, was $152,152 for
the three months ended September 30, 2004, as compared to $91,645 for the three
months ended September 30, 2003, an increase of $60,507 or 66%,as a result of
increases to property, plant and equipment.
Income from Operations. Income from operations was $3,457,304 for the three
months ended September 30, 2004, as compared to $3,558,131 for the three months
ended September 30, 2003, a decrease of $100,827 or 2.8%, consisting primarily
of a decrease in gross profit of $5,188 or 0.1% and an increase in costs and
expenses of $95,639 or 4.6%.
Other Non-Operating Income. Other non-operating income was $223,302 for the
three months ended September 30, 2004, as compared to $98,855 for the three
months ended September 30, 2003, an increase of $124,447 or 125.9%, as a result
of the disposal of excess property, plant and equipment of Henglong and Jiulong.
Financial Expenses. Financial expenses were $212,138 for the three months ended
September 30, 2004, as compared to $102,506 for the three months ended September
30, 2003, an increase of $109,632 or 107.0%, as a result of increased
interest-bearing debt due to an increased level of business activity.
Income before Income Taxes. Income before income taxes was $3,468,468 for the
three months ended September 30, 2004, as compared to $3,554,480 for the three
months ended September 30, 2003, a decrease of $86,012 or 2.4%, consisting of a
decrease in income from operations of $100,827 or 2.8%, and an increase in other
non-operating income of $124,447 or 125.9%, and an increase in financial
expenses of $109,632 or 107.0%.
Income Taxes. Income tax expense was $376,730 for the three months ended
September 30, 2004, as compared to ($37,811) for the three months ended
September 30, 2003, an increase of $414,541, primarily as a result of two of the
Company's Sino-foreign joint ventures, Jiulong and Henglong, receiving an income
tax refund of $559,000 during September 2003 due to the purchase of domestic
equipment.
33
Income before Minority Interest. Income before minority interest was $3,091,738
for the three months ended September 30, 2004, as compared to $3,592,291 for the
three months ended September 30, 2003, a decrease of $500,553 or 13.9%,
consisting of a decrease in income before income taxes of $86,012 or 2.4%, and
an increase in income taxes of $500,553.
Minority Interests. The Company recorded minority interests' share in the
earnings of the Sino-foreign joint ventures aggregating $1,062,140 for the three
months ended September 30, 2004, as compared to $1,638,153 for the three months
ended September 30, 2003, a decrease of $576,013 or 35.2%.
The Company owns varying equity interests in five Sino-foreign joint ventures
through which it conducts its operations, all of which were consolidated in 2004
and 2003 (the equity interests in Jingzhou were effectively sold on August 31,
2004). The Company records the minority interests' share in the earnings of the
respective Sino-foreign joint ventures for each period. Since the Company does
not own the same equity interest in each Sino-foreign joint venture, a
comparison of the Company's consolidated results of operations for different
periods can be significantly affected by the performance mix of the individual
joint ventures. The minority interests' aggregate share in the earnings of the
Sino-foreign joint ventures decreased in 2004 as compared to 2003 primarily as a
result of a decrease in net income from Henglong, a 44.5%-owned Sino-foreign
joint venture, and an increase in net income from Jiulong, an 81%-owned
Sino-foreign joint venture.
Net Income. Net income was $2,029,598 for the three months ended September 30,
2004, as compared to a net income of $1,954,138 for the three months ended
September 30, 2003, an increase of $75,460 or 3.9%, consisting of a decrease in
income before minority interest of $500,553 or 13.9%, and a decrease in minority
interest of $576,013 or 35.2%.
Nine Months Ended September 30, 2004 and 2003:
Net sales. Net sales were $43,682,280 for the nine months ended September 30,
2004, as compared to $36,923,748 for the nine months ended September 30, 2003,
an increase of $6,758,532 or 18.3%, consisting of the sustained production level
of the Zhejiang and Jingzhou Sino-foreign joint ventures, and the increased
level of business activity of Henglong, Jiulong and Shenyang.
Gross Profit. Gross profit was $17,015,191 or 39.0% of net sales for the nine
months ended September 30, 2004, which was 4.0% higher than the expected gross
profit of 35% of net sales in 2004, as compared to $16,545,480 or 44.8% of net
sales for the nine months ended September 30, 2003.
34
The decrease in the gross profit in 2004 was consistent with the Company's
expectations regarding the impact of rising raw material costs in the latter
part of 2003, which the Company anticipated would cause gross profit margins to
decrease by approximately 10% during 2004, to 35% of net sales. The reason that
the gross profit margin for the three months ended September 30, 2004 was 3.7%
higher than expected was a result of several factors, including the PRC
government enhancing macroeconomic adjustment controls beginning in April 2004
and the banks tightening the creation of new credit. As the PRC's overheated
economy cooled down, the prices of primary industrial raw materials fell (for
example, the price of steel and iron fell 10% as compared with early 2004). In
addition, the gross profit margin in 2004 was positively influenced by the
following factors:
The Company has attempted to optimize product design and reduce the weight of
its parts, thus reducing the usage of raw materials. The Company formed a
special team to control costs in advance and/or during the manufacturing
process. The Company has installed certain advanced production equipment which
it anticipates will improve operating efficiencies.
Selling. Selling expenses were $1,935,483 for the nine months ended September
30, 2004, as compared to $1,151,754 for the nine months ended September 30,
2003, an increase of $783,729 or 68.0%. The increase in selling expenses was due
to increased sales and increased transportation cost. The major components of
selling expenses are salaries and wages, supplies, travel, transportation, sales
service costs, rent, office expenses and advertising.
General and Administrative. General and administrative expenses were $6,062,232
for the nine months ended September 30, 2004, as compared to $5,029,546 for the
nine months ended September 30, 2003, an increase of $1,032,686 or 20.5%,
primarily as a result of an increased level of business activity and the costs
of operating a public company. The major components of general and
administrative expenses are salaries and wages, travel, office, supplies,
repairs and labor-related costs.
Depreciation and Amortization. Depreciation and amortization, excluding
depreciation and amortization included in the cost of sales, was $402,767 for
the nine months ended September 30, 2004, as compared to $256,949 for the nine
months ended September 30, 2003, an increase of $145,827 or 56.8%, as a result
of increases to property, plant and equipment.
Stock-Based Compensation. During March 2003, in conjunction with the transaction
with Great Genesis described above, the Company issued common stock purchase
warrants to three consultants to acquire an aggregate of 550,375 shares of
common stock, exercisable for a period of one year at $1.20 per share. The
aggregated fair value of these warrants, calculated pursuant to the
Black-Scholes option-pricing model, was estimated to be $1,300,000, which was
charged to operations during the nine months ended September 30, 2003.
Income from Operations. Income from operations was $8,614,709 for the nine
months ended September 30, 2004, as compared to $8,807,240 for the nine months
ended September 30, 2003, a decrease of $192,531 or 2.2%, consisting of an
increase in gross profit of $469,711 or 2.8%, and an increase in cost and
expenses of $662,242 or 8.6%.
35
Other Non-Operating Income. Other non-operating income was $668,735 for the nine
months ended September 30, 2004, as compared to $446,776 for the nine months
ended September 30, 2003, an increase of $221,959 or 49.7%, as a result of the
disposal of excess property, plant and equipment and unsaleable inventory
produced in previous years.
Financial Expenses. Financial expenses were $557,740 for the nine months ended
September 30, 2004, as compared to $225,165 for the nine months ended September
30, 2003, an increase of $332,575 or 147.7%, as a result of increased
interest-bearing debt due to an increased level of business activity.
Income before Income Taxes. Income before income taxes was $8,725,704 for the
nine months ended September 30, 2004, as compared to $9,028,851 for the nine
months ended September 30, 2003, a decrease of $303,147 or 3.4%, consisting of a
decreased in income from operations of $192,531 or 2.2%, and a decrease in other
non-operating income of $110,616 or 49.9%.
Income Taxes. Income tax expense was $1,142,118 for the nine months ended
September 30, 2004, as compared to $942,520 for the nine months ended September
30, 2003, an increase of $199,598 or 21.2%, primarily as a result of two of the
Company's Sino-foreign joint ventures, Jiulong and Henglong, receiving an income
tax refund of $559,000 during September 2003 due to the purchase of domestic
equipment.
Income before Minority Interest. Income before minority interest was $7,583,586
for the nine months ended September 30, 2004, as compared to $8,086,331 for the
nine months ended September 30, 2003, a decrease of $502,745, primarily as a
result of a decrease in income before income taxes of $303,147 or 3.4%, and an
increase in income taxes of $199,598 or 21.2%.
Minority Interest. The Company recorded minority interests' share in the
earnings of the Sino-foreign joint ventures aggregating $2,734,841 for the nine
months ended September 30, 2004, as compared to $4,655,939 for the nine months
ended September 30, 2003, a decrease of $1,921,098 or 41.3%, primarily as a
result of decrease in net income of Henglong, a 44.5% owned Sino-foreign Joint
Venture, and increased net income of Jiulong, a 81% owned Sino-foreign Joint
Venture. The decrease in the minority interest percentage in Shenyang from 45%
to 30% also contributed to this decrease.
Net Income. Net income was $4,848,745 for the nine months ended September 30,
2004, as compared to a net income of $3,430,392 for the nine months ended
September 30, 2003, an increase of $1,418,353 or 41.3%, consisting of a decrease
in income before minority interests of $502,745 or 6.2% and a decrease in
minority interest of $1,921,098 or 41.3%.
36
Financial Condition - September 30, 2004:
Liquidity and Capital Resources:
The Company has relied primarily on cash flow from operations, bank loans and
advances and investments from its shareholders for its capital requirements
since inception.
Operating. The Company's operations provided net cash of $13,536,611 for the
nine months ended September 30, 2004, as compared to providing net cash of
$2,675,854 for the nine months ended September 30, 2003, an increase of
$10,860,757. The Company's operations provided increased cash in 2004 as
compared to 2003 primarily as a result of an increase in cash flow from the
collection of accounts receivable.
As of September 30, 2004, cash and cash equivalents were $11,012,194, as
compared to $10,730,882 at December 31, 2003. Working capital was $17,973,179 at
September 30, 2004, as compared to $19,944,120 at December 31, 2003, reflecting
current ratios of 1.34:1 and 1.39:1, respectively.
The Company anticipates that its working capital resources are adequate to fund
anticipated costs and expenditures for the remainder of 2004 and 2005.
Investing. During the nine months ended September 30, 2004, the Company expended
cash of $8,406,795 in investing activities, consisting of an increase in other
receivables of $1,498,369, a decrease in cash in conjunction with the
disposition of Jingzhou of $239,399, and payments to acquire fixed assets of
$6,669,027. During the nine months ended September 30, 2003, the Company
generated net cash from investing of $2,731,701, consisting of a decrease in
other receivables of $5,605,023, and a decrease in long-term investments of
$1,189,157, less payments to acquire fixed assets of $4,062,479.
Financing. During the nine months ended September 30, 2004, the Company expended
$4,848,505 in financing activities, consisting of the proceeds from bank loans
of $3,614,458 and contributions to capital by minority interest holders of
$1,841,772, less dividends paid of $4,469,379, a decrease in amount due to
shareholders/directors of $4,630,537 and a decrease in the liability related to
the acquisition of joint venture assets of $1,204,819. During the nine months
ended September 30, 2003, the Company generated $5,345,423 from financing
activities, consisting of proceeds from bank loans of $2,409,638 and
contributions to capital by minority interest holders of $159,000, less
dividends paid of $6,187,309, and a decrease in amount due to
shareholders/directors of $1,726,757.
During the nine months ended September 30, 2003, amounts due to
shareholders/directors aggregating $17,167,000 were cancelled. This transaction
was accounted for as a contribution to capital.
Advances from shareholders/directors have been used to fund the Company's
investments in joint ventures.
Off-Balance Sheet Arrangements:
At September 30, 2004, the Company did not have any transactions, obligations or
relationships that could be considered off-balance sheet arrangements.
37
Commitments and Contingencies:
The Company has the following material contractual obligations and capital
expenditure commitments:
Date Parties involved Description of Commitments and Contingencies
---------------- --------------------------- --------------------------------------------
October 29, 2001 Henglong Ten year license agreement for the design of
& power steering systems.
Bishop Steering Technology
Limited ("Bishop"), an Henglong is obligated to pay Bishop a
Australian company technical assistance fee of approximately
$200,000 per year during the first two years
and $110,000 per year during the remaining
eight years of the agreement.
March 2003 Henglong Purchase and construction agreement to
& design and construct a software research and
Wuhan Huazhong Shuguang development facility.
Software Park Co., Ltd.
Total value $4,820,000.
The Company paid $2,421,300 during 2003. The
Company will pay an additional $952,900
during 2004 and pay off the remaining
$1,445,800 after it receives a license for
the right to use the land and a building
property certificate. During the nine months
ended September 30, 2004, the company has
paid $843,000 based on the construction
progress.
July 21, 2003 Henglong Five year license and technical assistance
& agreement. Henglong paid Namyang an initial
Namyang Industrial Co. Ltd. payment of $100,000 and is further obligated
("Namyang"), a Korean to pay a royalty of 3% of the sales price of
manufacturer of steering products sold, which includes the licensed
columns and universal joint technology.
assemblies for automobiles.
October 2003 Henglong Invest $10,000,000 to develop an industrial
& enterprise to carry out automobile component
Wuhu Science and Technology projects related to power steering systems.
Zone The agreement does not specify a time limit.
The Company plans to invest in phases over a
five year period. The Company plans to
invest approximately $870,000 in the first
phase to acquire land use rights. The
Company advanced approximately $435,000
during 2003 pursuant to the agreement under
the first phase. The second phase of
investment was put off because the local
Government did not complete their water and
electricity supply system on time. This new
plant is expected to service a large vehicle
manufacturer in Wuhu at reduced
transportation and storage costs.
October 5, 2003 Henglong Letter of intent for a joint venture to
& develop a sensor production facility.
Advanced Custom Sensors,
Henglong will be responsible for initial
loans and payments of $500,000, payable in
two installments of $250,000, to be used for
the development of related products, the
training of personnel, and other operating
costs. The first payment of $250,000 was
made on February 12, 2004. The Company
expects to make the second payment of
$250,000 during 2004.
October 20, 2003 Henglong Contract to purchase a land use right
relating to parcel of land for $3,680,000
and paid a $361,000 deposit. This
transaction is expected to close in 2004.
38
Inflation and Currency Matters:
In the most recent decade, the Chinese economy has experienced periods of rapid
economic growth as well as relatively high rates of inflation, which in turn has
resulted in the periodic adoption by the Chinese government of various
corrective measures designed to regulate growth and contain inflation. The
success of the Company depends in substantial part on the continued growth and
development of the Chinese economy.
Foreign operations are subject to certain risks inherent in conducting business
abroad, including price and currency exchange controls, and fluctuations in the
relative value of currencies. The Company conducts virtually all of its business
in China and, accordingly, the sale of its products is settled primarily in RMB.
As a result, devaluation or currency fluctuation of the RMB against the US
dollar would adversely affect the Company's financial performance when measured
in US dollar.
Although prior to 1994 the RMB experienced significant devaluation against the
US dollar, the RMB has remained fairly stable since then. The exchange rate was
approximately US$1.00 to RMB 8.30 at December 31, 2002 and 2003. In addition,
the RMB is not freely convertible into foreign currencies, and the ability to
convert the RMB is subject to the availability of foreign currencies. Effective
December 1, 1998, all foreign exchange transactions involving the RMB must take
place through authorized banks or financial institutions in China at the
prevailing exchange rates quoted by the People's Bank of China.
Since the PRC's admission as a member of the World Trade Organization, the
central government of China has been expected to adopt a more rigorous approach
to partially deregulate currency conversion restrictions, which may in turn
increase the exchange rate fluctuation of the RMB. Should there be any major
change in the central government's currency policies, the Company does not
believe that such an action would have a detrimental effect on the Company's
operations, since the Company conducts virtually all of its business in China,
and the sale of its products is settled in RMB.
Quantitative and Qualitative Disclosures about Market Risk:
The Company does not have any market risk with respect to such factors as
commodity prices, equity prices, and other market changes that affect market
risk sensitive investments. A 10 point basis change in the Company's average
debt interest rate would not have a material effect on the Company's results of
operations.
With respect to foreign currency exchange rates, the Company does not believe
hat a devaluation or fluctuation of the RMB against the US dollar would have a
detrimental effect on the Company's operations, since the Company conducts
virtually all of its business in China, and the sale of its products and the
purchase of raw materials and services are settled in RMB. The effect of a
devaluation or fluctuation of the RMB against the US$ would affect the Company's
results of operations, financial position and cash flows, when presented in US$
(based on a current exchange rate) as compared to RMB.
39
As the Company's debt obligations are primarily short-term in nature, with fixed
interest rates, the Company does not have any risk from an increase in market
interest rates. However, to the extent that the Company arranges new borrowings
in the future, an increase in market interest rates would cause a commensurate
increase in the interest expense related to such borrowings.
ITEM 3. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
Disclosure controls and procedures are designed to ensure that information
required to be disclosed in the reports filed or submitted under the Exchange
Act of 1934 is recorded, processed, summarized and reported, within the time
periods specified in the rules and forms of the Securities and Exchange
Commission. Disclosure controls and procedures include, without limitation,
controls and procedures designed to ensure that information required to be
disclosed in the reports filed under the Exchange Act of 1934 is accumulated and
communicated to management, including its principal executive and financial
officers, as appropriate, to allow timely decisions regarding required
disclosure.
The Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including its principal executive and
financial officers, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures as of the end of the period covered
by this report. Based upon and as of the date of that evaluation, the Company's
principal executive and financial officers concluded that the Company's
disclosure controls and procedures are effective to ensure that information
required to be disclosed in the reports the Company files and submits under the
Exchange Act of 1934 is recorded, processed, summarized and reported within the
time periods specified in the Securities and Exchange Commission's rules and
forms.
(b) Internal Controls
Effective internal controls are necessary for the Company to provide reliable
financial reports and effectively prevent fraud. Pursuant to Section 404 of the
Sarbanes-Oxley Act of 2002, the Company will be required, beginning with the
first fiscal year ending on or after July 15, 2005, to include in its annual
report an assessment of the effectiveness of the Company's internal control over
financial reporting and its audited financial statements as of the end of fiscal
year ending on or after July 15 2005. Furthermore, the Company's independent
registered public accounting firm Schwartz Levitsky Feldman (LLP) will be
required to attest to whether its assessment of the effectiveness of the
Company's internal control over financial reporting is fairly stated in all
material respects and separately report on whether it believes the Company
maintained, in all material respects, effective internal control over financial
reporting as of July 14, 2005. The Company has not yet completed its assessment
of the effectiveness of its internal controls. If the Company fails to timely
complete this assessment, or if the Company's independent registered public
accounting firm cannot timely attest to its assessment, the Company could be
subject to regulatory sanctions and a loss of public confidence in its internal
controls. In addition, any failure to implement required new or improved
controls, or difficulties encountered in their implementation, could harm the
Company's operating results or cause the Company to fail to timely meet its
regulatory reporting obligations. Any of these failures could have a negative
effect on the trading price of the Company's stock.
(c) Changes in Internal Controls
There were no changes in the Company's internal controls or in other factors
that could have significantly affected those controls subsequent to the date of
the Company's most recent evaluation.
40
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS
A list of exhibits required to be filed as part of this report is
set forth in the Index to Exhibits, which immediately precedes such
exhibits, and is incorporated herein by reference.
41
SIGNATURES
Pursuant to the requirements of the Exchange Act, the registrant caused this
report to be signed on its behalf by the undersigned, thereunto duly authorized.
CHINA AUTOMOTIVE SYSTEMS, INC.
------------------------------
(Registrant)
DATE: November 12, 2004 By: /s/ HANLIN CHEN
-----------------------------
Hanlin Chen
President and Chief
Executive Officer
DATE: November 12, 2004 By: /s/ DAMING HU
----------------------------
Daming Hu
Chief Financial Officer
42
INDEX TO EXHIBITS
Exhibit
Number Description of Document
------- ---------------------------------
31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002 - Hanlin Chen
31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002 - Daming Hu
32 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
43