Unassociated Document
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
  (Mark one)

x QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2009
Or
¨ TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to _________
 Commission file number: 000-33123
 
China Automotive Systems, Inc.
(Exact name of registrant as specified in its charter)

Delaware
33-0885775
(State or other jurisdiction of incorporation or
organization)
(I.R.S. employer identification number)

No. 1 Henglong Road, Yu Qiao Development Zone, Shashi District,
Jing Zhou City, Hubei Province, People’s Republic of China

(Address of principal executive offices)
 
Issuer’s telephone number: (86) 716- 832- 9196
 Issuer’s fax number: (86) 716-832-9298

Not Applicable
(Former name, former address and former fiscal year, if changed since last report.)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No ¨  

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

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

Large accelerated filer ¨  
Accelerated filer ¨  
Non-accelerated filer ¨  (Do not check if a smaller reporting company)
Smaller reporting company x

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

As of June 30, 2009, the Company had 26,983,244 shares of common stock issued and outstanding.

 
 

CHINA AUTOMOTIVE SYSTEMS, INC.
INDEX

   
Page
Part I — Financial Information
    
     
Item 1.  Financial Statements
  
   
Condensed Consolidated Statements of Operations (Unaudited) for the Three Months and Six Months Ended June 30, 2009 and 2008
  
3
Condensed Consolidated Statements of Comprehensive Income  (Unaudited) for the Three Months and Six Months Ended June 30, 2009 and 2008
  
5
Condensed Consolidated Balance Sheets at June 30, 2009 (Unaudited) and December 31, 2008
  
7
Consolidated Statements of Stockholders’ Equity for the Six Months Ended June 30, 2009 (Unaudited) and December 31, 2008
  
8
Condensed Consolidated Statements of Cash Flows (Unaudited) for the Six Months Ended June 30, 2009 and 2008 
  
9
Notes to Condensed Consolidated Financial Statements (Unaudited) for the Six Months Ended June 30, 2009 and 2008
  
11
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
  
38
Item 3.  Quantitative and Qualitative Disclosures About Market Risk
  
59
Item 4T.  Controls and Procedures
  
59
     
Part II — Other Information
  
 
Item 1.  Legal Proceedings
  
60
Item 1A.  Risk Factors
  
60
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
  
67
Item 3.  Defaults Upon Senior Securities
  
68
Item 4.  Submission of Matters to a Vote of Security Holders
  
68
Item 5.  Other Information
  
68
Item 6.  Exhibits
  
68
Signatures
  
70

 
2
 

PART 1 — FINANCIAL INFORMATION
 
Item 1. Financial Statements
 
China Automotive Systems, Inc.
Condensed Consolidated Statements of Operations (Unaudited)

   
Three Months Ended June 30,
  
   
2009
    
2008
  
Net product sales, including $1,314,247 and $747,405 to related parties for the three months ended June 30, 2009 and 2008
  
$
62,484,279
    
$
46,508,340
  
Cost of product sold, including $2,812,741 and $2,651,000 purchased from related parties for the three months ended June 30, 2009 and 2008
    
43,982,547
      
32,045,336
  
Gross profit
    
18,501,732
      
14,463,004
  
Add: Gain on other sales
    
172,747
      
117,710
  
Less: Operating expenses-
                
Selling expenses
    
3,816,301
      
2,936,835
  
General and administrative expenses
    
2,246,330
      
4,151,633
  
R&D expenses
    
444,226
      
563,295
  
Depreciation and amortization
    
507,341
      
1,451,064
  
Total Operating expenses
    
7,014,198
      
9,102,827
  
Income from operations
    
11,660,281
      
5,477,887
  
Add: Other income, net (note 22)
    
-
      
-
  
Financial income (expenses) net (note 23)
    
(478,228
)
    
(459,140
)
Gain (loss) on change in fair value of derivative (note 24)
    
(977,435
)
    
995,153
  
Income before income taxes
    
10,204,618
      
6,013,900
  
Less: Income taxes (note 25)
    
1,474,618
      
(415,458
)
Net income
  
$
8,730,000
    
$
6,429,358
  
Net income attributable to noncontrolling interests
    
2,653,651
      
1,685,003
  
Net income attributable to common shareholders
  
$
6,076,349
    
$
4,744,355
  
Net income per common share-
                
Basic
  
$
0.23
    
$
0.19
  
Diluted (note 2)
  
$
0.21
    
$
0.18
  
Weighted average number of common shares outstanding –
                
Basic
    
26,983,244
      
24,880,071
  
Diluted
    
31,466,402
      
28,834,380
  

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 
3

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

   
Six Months Ended June 30,
  
   
2009
    
2008
  
Net product sales, including $1,873,258 and $2,798,487 to related parties for the six months ended June 30, 2009 and 2008
  
$
107,181,725
    
$
87,975,383
  
Cost of product sold, including $4,986,222 and $4,603,390 purchased from related parties for the six months ended June 30, 2009 and 2008
    
76,482,162
      
61,300,009
  
Gross profit
    
30,699,563
      
26,675,374
  
Add: Gain on other sales
    
239,626
      
251,900
  
Less: Operating expenses-
                
Selling expenses
    
6,175,467
      
5,412,176
  
General and administrative expenses
    
4,048,032
      
5,767,783
  
R&D expenses
    
884,148
      
738,973
  
Depreciation and amortization
    
1,078,754
      
2,745,791
  
Total Operating expenses
    
12,186,401
      
14,664,723
  
Income from operations
    
18,752,788
      
12,262,551
  
Add: Other income, net (note 22)
    
-
      
199,459
  
Financial income (expenses) net (note 23)
    
(917,708
)
    
(438,447
)
Gain (loss) on change in fair value of derivative (note 24)
    
(2,538,283
)
    
995,153
  
Income before income taxes
    
15,296,797
      
13,018,716
  
Less: Income taxes (note 25)
    
2,924,288
      
408,937
  
Net income
  
$
12,372,509
    
$
12,609,779
  
Net income attributable to noncontrolling interests
    
4,037,348
      
3,435,250
  
Net income attributable to common shareholders
  
$
8,335,161
    
$
9,174,529
  
Net income per common share-
                
Basic
  
$
0.31
    
$
0.37
  
Diluted (note 2)
  
$
0.29
    
$
0.36
  
Weighted average number of common shares outstanding –
                
Basic
    
26,983,244
      
24,422,429
  
Diluted
    
31,719,477
      
27,394,392
  

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 
4
 
China Automotive Systems, Inc.
Condensed Consolidated Statements of Comprehensive Income (Unaudited)

   
Three Months Ended June 30,
  
   
2009
    
2008
  
Net income
  
$
8,730,000
    
$
6,429,358
  
Other comprehensive income:
                
Foreign currency translation gain (loss)
    
(187,750
)
    
2,785,709
  
Comprehensive income
  
$
8,542,250
    
$
9,215,067
  
Comprehensive income attributable to non-controlling interests
    
2,667,188
      
2,119,778
  
Comprehensive income attributable to common shareholders
  
$
5,875,062
    
$
7,095,289
  

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 
 
5
 
China Automotive Systems, Inc.
Condensed Consolidated Statements of Comprehensive Income (Unaudited)

   
Six Months Ended June 30,
  
   
2009
    
2008
  
Net income
  
$
12,372,509
    
$
12,609,779
  
Other comprehensive income:
                
Foreign currency translation gain (loss)
    
(202,329
)
    
6,097,038
  
Comprehensive income
  
$
12,170,180
    
$
18,706,817
  
Comprehensive income attributable to non-controlling interests
    
4,046,468
      
4,797,468
  
Comprehensive income attributable to common shareholders
  
$
8,123,712
    
$
13,909,349
  

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 
6
 
China Automotive Systems, Inc.
Condensed Consolidated Balance Sheets

   
June 30, 2009
    
December 31, 2008
  
   
(Unaudited)
        
ASSETS
  
      
 
  
Current assets:
            
Cash and cash equivalents
  
$
39,555,309
    
$
37,113,375
  
Pledged cash deposits (note 3)
    
8,280,299
      
6,739,980
  
Accounts and notes receivable, net, including $2,108,230 and $1,285,110 from related parties at June 30, 2009 and December 31, 2008 (note 4)
    
121,466,435
      
96,424,856
  
Advance payments and other, including $400,890 and $9,374 to related parties at June 30, 2009 and December 31, 2008
    
2,256,519
      
1,442,614
  
Inventories (note 6)
    
26,754,416
      
26,571,755
  
Total current assets
  
$
198,312,978
    
$
168,292,580
  
Long-term Assets:
                
Property, plant and equipment, net (note 7)
  
$
56,116,786
    
$
51,978,905
  
Intangible assets, net (note 8)
    
723,244
      
504,339
  
Other receivables, net, including $998,447 and $903,674 from related parties at June 30, 2009 and December 31, 2008 (note 5)
    
1,369,831
      
1,349,527
  
Advance payments for property, plant and equipment, including $3,651,235 and $2,473,320 to related parties at June 30, 2009 and December 31, 2008
    
4,368,370
      
6,459,510
  
Long-term investments
    
79,041
      
79,010
  
Deferred income tax assets (note 9)
    
2,637,462
      
2,383,065
  
Total assets
  
$
263,607,712
    
$
231,046 ,936
  
LIABILITIES AND STOCKHOLDERS' EQUITY
                
Current liabilities:
                
Bank loans (note 10)
  
$
8,782,330
    
$
7,315,717
  
Accounts and notes payable, including $1,803,688 and $1,097,642 to related parties at June 30, 2009 and December 31, 2008 (note 11)
    
78,913,062
      
59,246,043
  
Convertible notes payable (note 12)
    
28,429,062
      
32,922,077
  
Derivative liabilities (note 13)
    
4,042,857
      
1,502,597
  
Customer deposits
    
258,020
      
236,018
  
Accrued payroll and related costs
    
2,886,378
      
2,715,116
  
Accrued expenses and other payables(note 14)
    
13,312,169
      
12,460,784
  
Accrued pension costs (note 15)
    
3,794,216
      
3,806,519
  
Taxes payable (note 16)
    
8,623,760
      
5,717,438
  
Amounts due to shareholders/directors (note 17)
    
564,290
      
337,370
  
Total current liabilities
  
$
149,606,144
    
$
126,259,679
  
Long-term liabilities:
                
Advances payable (note 18)
    
233,815
      
234,041
  
Total liabilities
  
$
149,839,959
    
$
126,493,720
  
Related Party Transactions and balances (note 27)
                
Commitments and contingencies (note 28)
    
  
      
  
  
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 - 26,983,244 shares at June 30, 2009 and December 31, 2008 (note 19)
    
2,698
      
2,698
  
Additional paid-in capital (note 19)
    
27,148,206
      
27,148,206
  
Retained earnings-
                
Appropriated
    
8,324,533
      
7,525,777
  
Unappropriated
    
43,562,921
      
36,026,516
  
Deferred stock compensation (note 20)
  
(375,039
) 
    
(500,052
)
Accumulated other comprehensive income
    
10,916,056
      
11,127,505
  
Non-controlling interests (note 21)
    
24,188,378
      
23,222,566
  
Total stockholders' equity
  
$
113,767,753
    
$
104,553,216
  
Total liabilities and stockholders' equity
  
$
263,607,712
    
$
231,046,936
  

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

 
7
 

China Automotive Systems, Inc. and Subsidiaries
Consolidated Statements of Stockholders’ Equity
Period Ended June 30, 2009 (unaudited) and December 31, 2008
 
   
Common Stock
    
Additional
    
Retained Earnings
    
Deferred
    
Accumulated
Other
    
 
       
   
Shares
    
Par
Value
    
Paid-in
Capital
    
Appropriated
    
Unappropriated
    
stock
Compensation
    
Comprehensive
Income (Loss)
    
Non-controlling
interests
    
Total
  
Balance at January 1, 2008
     23,959,702     $ 2,396     $ 30,125,951     $ 7,525,777     $ 23,591,275     $ -     $ 5,989,463     $ 23,166,270     $ 90,401,132  
Net income for the year ended December 31, 2008
     -       -       -       -       12,435,241       -       -       5,071,408       17,506,649  
Foreign currency translation gain
     -       -       -       -       -       -       5,138,042       1,432,977       6,571,019  
Capital contribution
     -       -       -       -       -       -       -       745,723       745,723  
Issuance of common stock
     3,023,542       302       22,089,698       -       -       -       -       -       22,090,000  
Issuance of stock options to independent directors and management
     -       -       845,478       -       -       (500,052 )     -       -       345,426  
Payment for acquisition of 35.5% Henglong’s equity
     -       -       (25,912,921 )     -       -       -       -       (6,177,079 )     (32,090,000 )
Dividend distribution
     -       -       -       -       -       -       -       (1,016,733 )     (1,016,733 )
Balance at December 31, 2008
     26,983,244     $ 2,698     $ 27,148,206     $ 7,525,777     $ 36,026,516     $ (500,052 )   $ 11,127,505     $ 23,222,566     $ 104,553,216  
Net income for the six months ended June 30, 2009
     -       -       -       -       8,335,161       -       -       4,037,348       12,372,509  
Foreign currency translation gain (loss)
     -       -       -       -       -       -       (211,449 )     9,120       (202,329 )
Amortization for stock-based compensation
     -       -       -       -       -       125,013       -       -       125,013  
Dividend distribution
     -       -       -       798,756       (798,756 )     -       -       (3,080,656 )     (3,080,656 )
Balance at June 30, 2009
     26,983,244     $ 2,698     $ 27,148,206     $ 8,324,533     $ 43,562,921     $ (375,039 )   $ 10,916,056     $ 24,188,378     $ 113,767,753  

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

 
8
 

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

   
Six Months Ended June 30,
  
   
2009
    
2008
  
Cash flows from operating activities:
            
Net income
  
$
12,372,509
    
$
12,609,779
  
Adjustments to reconcile net income from continuing operations to net cash provided by operating activities:
                
Stock-based compensation
    
125,013
      
95,400
  
Depreciation and amortization
    
3,886,332
      
4,766,575
  
Allowance for doubtful accounts (Recovered)
    
(1,117,881
)
    
218,515
  
Deferred income taxes assets
    
(253,521
)
    
(398,551
)
Amortization for discount of convertible note payable
    
506,985
      
181,328
  
(Gain) loss on change in fair value of derivative
    
2,538,283
      
(995,153
)
Other operating adjustments
    
(227,474
)
    
(4,203
)
Changes in operating assets and liabilities:
                
(Increase) decrease in:
                
Pledged deposits
    
(1,537,010
)
    
602,009
  
Accounts and notes receivable
    
(23,776,920
)
    
(16,249,120
)
Advance payments and other
    
(813,196
)
    
(1,447,803
)
Inventories
    
(171,352
)
    
(4,680,059
)
Accounts and notes payable
    
19,639,466
      
9,349,207
  
Customer deposits
    
21,744
      
456,276
  
Accrued payroll and related costs
    
170,135
      
(13,849
)
Accrued expenses and other payables
    
1,512,206
      
699,033
  
Accrued pension costs
    
(13,754
)
    
155,338
  
Taxes payable
    
2,901,849
      
(2,591,573
)
Net cash provided by operating activities
  
$
15,763,414
    
$
2,753,149
  
Cash flows from investing activities:
                
(Increase) decrease in other receivables
    
(55,386
)
    
(408,139
)
Cash received from equipment sales
    
458,950
      
96,317
  
Cash paid to acquire property, plant and equipment
    
(6,341,035
)
    
(7,573,715
)
Cash paid to acquire intangible assets
    
(321,671
)
    
(101,601
)
Cash paid for the acquisition of 35.5% of Henglong
    
-
      
(10,000,000
)
Net cash (used in) investing activities
  
$
(6,259,142
)
  
$
(17,987,138
)
Cash flows from financing activities:
                
Proceeds from repayment of bank loans
    
1,465,006
      
(7,564,564
)
Dividends paid to the non-controlling interest holders of Joint-venture companies
    
(3,768,668
)
    
(4,697,780
)
(Decrease) in amounts due to shareholders/directors
    
226,717
      
(82,610
)
Proceeds on issuance of convertible note payable
    
-
      
35,000,000
  
Repayment of convertible note payable
    
(5,000,000
)
    
-
  
Net cash provided by (used in) financing activities
  
$
(7,076,945
)
  
$
22,655,046
  
Cash and cash equivalents effected by foreign currency
  
$
14,607
    
$
1,522,990
  
Net increase in cash and cash equivalents
    
2,441,934
      
8,944,047
  
Cash and cash equivalents at beginning of period
    
37,113,375
      
19,487,159
  
Cash and cash equivalents at end of period
  
$
39,555,309
    
$
28,431,206
  

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

 
9
 

China Automotive Systems, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited) (continued)
 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
 
   
Six Months Ended June 30,
  
   
2009
    
2008
  
Cash paid for interest
  
$
989,247
    
$
501,138
  
Cash paid for income taxes
  
$
1,403,715
    
$
2,019,073
  

SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
 
   
Six Months Ended June 30,
  
   
2009
    
2008
  
             
Acquisition of 35.5% of Henglong from the minority shareholder on a cashless basis
  
$
-
    
$
(22,090,000
)
Liability result from issuance of common stock to acquire 35.5% of Henglong's equity
    
-
      
22,090,000
  
Issuance of a warrants to purchase common stock
    
-
      
798,626
  
Derivative liabilities
    
-
      
1,703,962
  
Warrants and derivative liabilities for issuance of Convertible Debt are considered as discount of Convertible Debt.
  
$
-
    
$ 
(2,502,588
)
 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 
10
 
China Automotive Systems, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
Three Months and Six Months Ended June 30, 2009 and 2008

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

Great Genesis Holdings Limited, a company incorporated on January 3, 2003 under The Companies Ordinance in Hong Kong as a limited liability company, “Genesis”, is a wholly-owned subsidiary of the Company.

Henglong USA Corporation, “HLUSA”, incorporated on January 8, 2007 in Troy, Michigan, is a wholly-owned subsidiary of the Company, and mainly engages in marketing of automotive parts in North America, and provides after sales service and research and development support accordingly.

 The Company owns the following aggregate net interests in eight Sino-foreign joint ventures organized in the PRC as of June 30, 2009 and 2008.
 
11
 
   
Percentage Interest
  
Name of Entity
  
June 30, 2009
    
June 30, 2008
  
Shashi Jiulong Power Steering Gears Co., Ltd., “Jiulong”
    
81.00
%   
    
81.00
%
Jingzhou Henglong Automotive Parts Co., Ltd.,  “Henglong”
    
80.00
%
    
80.00
%
Shenyang Jinbei Henglong Automotive Steering System Co., Ltd., “Shenyang”
    
70.00
%
    
70.00
%
Zhejiang Henglong & Vie Pump-Manu Co., Ltd., “Zhejiang”
    
51.00
%
    
51.00
%
Universal Sensor Application Inc., “USAI”
    
83.34
%
    
75.90
%
Wuhan Jielong Electric Power Steering Co., Ltd., “Jielong”
    
85.00
%
    
85.00
%
Wuhu HengLong Automotive Steering System Co., Ltd., “Wuhu”
    
77.33
%
    
77.33
%
Jingzhou Hengsheng Automotive System Co., Ltd., “Hengsheng”
    
100.00
%
    
100.00
%

Jiulong was established in 1993 and mainly engages in the production of integral power steering gear for heavy-duty vehicles.

Henglong was established in 1997 and mainly engages in the production of rack and pinion power steering gear for cars and light duty vehicles.

On March 31, 2008, the Company’s wholly-owned subsidiary, Genesis, and Wiselink Holdings Limited, “Wiselink”, both controlled by Hanlin Chen and his family, entered into an equity transfer agreement, the “Henglong Agreement”, pursuant to which Wiselink transferred and assigned its 35.5% equity interest in Jingzhou Henglong, one of the Company’s currently consolidated subsidiaries, to Genesis for a total consideration of US$32,090,000. The Company now holds an 80% equity interest in Jingzhou Henglong.

Under the terms of the Henglong Agreement, Genesis is deemed to be the owner of Jingzhou Henglong commencing from January 1, 2008. The Henglong Acquisition is considered as a business combination of companies under common control and is being accounted for in a manner of pooling of interests.

Shenyang was established in 2002 and focuses on power steering parts for light duty vehicles. 
 
Zhejiang was established in 2002 to focus on power steering pumps.
 
USAI was established in 2005 and mainly engages in production and sales of sensor modulars. In 2008, Genesis and Shanghai Hongxi Investment Inc., “Hongxi”, the other shareholder of USAI, agreed to increase USAI’s capital to $2,600,000 from $1,800,000. The increased capital was wholly funded by Genesis. Therefore, the capital contributed by Genesis in USAI increased to $2,166,900 from $1,366,900, accounting for 83.34% of the total capital; while the capital contributed by Hongxi remained unchanged, accounting for 16.66% of the total capital.

Jielong was established in 2006 and mainly engages in production and sales of electric power steering, “EPS”.

Wuhu was established in 2006 and mainly engages in production and sales of automobile steering systems.
 
12
 
Hengsheng was established in 2007 and mainly engages in production and sales of automobile steering systems.
 
2. Basis of Presentation and Significant Accounting Policies
 
Basis of Presentation - For the three months and six months ended June 30, 2009 and 2008, the accompanying unaudited consolidated financial statements include the accounts of the Company and its subsidiaries. The subsidiaries include eight Sino-foreign Joint-ventures mentioned in Note 1. Significant inter-company balances and transactions have been eliminated upon consolidation. The unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America.

Foreign Currencies - The Company maintains its books and records in Renminbi, “RMB”, the currency of the PRC, its functional currency. Foreign currency transactions in RMB are reflected using the temporal method. Under this method, all monetary items are translated into the functional currency at the rate of exchange prevailing at the balance sheet date. Non-monetary items are translated at historical rates. Income and expenses are translated at the rate in effect on the transaction dates. Transaction gains and losses, if any, are included in the determination of net income for the period.

 In translating the financial statements of the Company from its functional currency into its reporting currency in United States dollars, balance sheet accounts are translated using the closing exchange rate in effect at the balance sheet date and income and expense accounts are translated using an average exchange rate prevailing during the reporting period. Adjustments resulting from the translation, if any, are included in cumulative other comprehensive income (loss) in stockholders’ equity.

Income Per Share - Basic income per share is calculated by dividing net income by the weighted average number of common shares outstanding during the period. Diluted income per share is calculated based on the treasury stock method, assuming the issuance of common shares, if dilutive, resulting from the exercise of warrants. The dilutive effect of convertible securities is reflected in diluted earnings per share by application of the “if converted” method.

The calculations of diluted income per share were:  

   
Three Months Ended June 30,
  
   
2009
    
2008
  
Numerator:
            
Net income attributable to common shareholders
  
$
6,076,349
    
$
4,744,355
  
Add: interest expenses of convertible notes payable
    
262,500
      
262,500
  
Add: Amortization for discount of convertible notes payable
    
384,638
      
81,879
  
   
$
6,723,487
    
$
5,088,734
  
Denominator:
                
Weighted average shares outstanding
    
26,983,244
      
24,880,071
  
Effect of dilutive securities
    
4,483,158
      
3,954,309
  
     
31,466,402
      
28,834,380
  
Net income per common share- diluted
  
$
0.21
    
$
0.18
  
 
13
 
   
Six Months Ended June 30,
  
   
2009
    
2008
  
Numerator:
            
Net income attributable to common shareholders
  
$
8,335,161
    
$
9,174,529
  
Add: interest expenses of convertible notes payable
    
546,875
      
393,750
  
Add: Amortization for discount of convertible notes payable
    
506,985
      
181,328
  
   
$
9,389,021
    
$
9,749,607
  
Denominator:
                
Weighted average shares outstanding
    
26,983,244
      
24,422,429
  
Effect of dilutive securities
    
4,736,233
      
2,971,963
  
     
31,719,477
      
27,394,392
  
Net income per common share- diluted
  
$
0.29
    
$
0.36
  

During the three months and six months ended June 30, 2009, the options and warrants outstanding have not been included in the computation of diluted income per share, except the 298,850 options issued on December 10, 2008, because such inclusion would have had an anti-dilutive effect. The shares issuable upon conversion of Convertible Notes have been included in the computation.

Stock-Based Compensation - The Company may periodically issue shares of common stock for services rendered or for financing costs. Such shares will be valued based on the market price on the transaction date. The Company may periodically issue stock options to employees and stock options or warrants to non-employees in non-capital raising transactions for services and for financing costs.

 In July 2004, the Company adopted a stock incentive plan. The maximum number of common shares for issuance under this plan is 2,200,000 with a period of 10 years. The stock incentive plan provides for the issuance, to the Company’s officers, directors, management and employees, of options to purchase shares of the Company’s common stock. Since the adoption of the stock incentive plan, the Company has issued 411,350 stock options under this plan, and there remain 1,788,650 stock options issuable in the future. As of June 30, 2009, the Company had 388,850 stock options outstanding.

The Company has adopted Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Accounting for Stock-Based Compensation”, which establishes a fair value method of accounting for stock-based compensation plans. In accordance with SFAS No. 123R, the cost of stock options and warrants issued to employees and non-employees is measured on the grant date based on the fair value. The fair value is determined using the Black-Scholes option pricing model. The resulting amount is charged to expense on the straight-line basis over the period in which the Company expects to receive benefit, which is generally the vesting period.
 
14
 
Comprehensive Income - The Company has adopted the provisions of Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income” (“SFAS No. 130”). SFAS No. 130 establishes standards for the reporting and display of comprehensive income, its components and accumulated balances in a full set of general purpose financial statements. SFAS No. 130 defines comprehensive income to include all changes in equity except those resulting from investments by owners and distributions to owners, including adjustments to minimum pension liabilities, accumulated foreign currency translation, and unrealized gains or losses on marketable securities.

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

Financial instruments - Derivative financial instruments, as defined in Financial Accounting Standard No. 133, Accounting for Derivative Financial Instruments and Hedging Activities (FAS 133), consist of financial instruments or other contracts that contain a notional amount and one or more underlying, e.g. interest rate, security price or other variable, require no initial net investment and permit net settlement. Derivative financial instruments may be free-standing or embedded in other financial instruments. Further, derivative financial instruments are initially, and subsequently, measured at fair value and recorded as liabilities or, in rare instances, assets.

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

 Registration Payment Arrangements - The Company has entered into registration payment arrangements with certain investors that provide for the payment of damages for failures to register common shares underlying the investor’s financial instruments. FASB Staff Position 00-19-2, Accounting for Registration Payment Arrangements, provides for the exclusion of registration payments, such as the liquidated damages, from the consideration of classification of financial instruments. Rather, such registration payments would be accounted for pursuant to Financial Accounting Standard No. 5 Accounting for Contingencies, which is the Company’s current accounting practice. That is, all registration payments will require recognition when they are both probable and reasonably estimable. The Company does not currently believe that damages are probable.

Fair Value Measurements - Effective January 1, 2008, the Company adopted the provisions of FAS 157, Fair Value Measurements , except as it applies to those nonfinancial assets and nonfinancial liabilities as noted in proposed FSP FAS 157-b. The partial adoption of FAS 157 did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This statement does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information. In February 2008, the FASB issued FASB Staff Position (“FSP”) 157-2, Effective Date of FASB Statement No.157, which delays the effective date of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually).
 
15
 
Noncontrolling Interests in Consolidated Financial Statements - In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements-reported in equity", which was effective for the fiscal year beginning on or after December 15, 2008. The objective of SFAS No. 160 is to improve the relevance, comparability and transparency of the financial information that a reporting entity provides in its consolidated financial statements by establishing additional accounting and reporting standards. Effective January 1, 2009, the Company adopted the provisions of SFAS No. 160, the noncontrolling interests are reported in the equity currently.

Comments - The accompanying interim condensed consolidated financial statements are unaudited, but in the opinion of the Company’s management, contain all adjustments, which include normal recurring adjustments, necessary to present fairly the financial position, the results of operations and cash flows for the six months ended June 30, 2009 and 2008 respectively.

The consolidated balance sheet as of December 31, 2008 is derived from the Company’s audited financial statements.

Certain information and footnote disclosures normally included in financial statements that have been prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission, although the Company’s management believes that the disclosures contained in these financial statements are adequate to make the information presented therein not misleading. For further information, refer to the financial statements and the notes thereto included in the Company’s 2008 Annual Report on Form 10-K, as filed with the Securities and Exchange Commission.

 The results of operations for the six months ended June 30, 2009 are not necessarily indicative of the results of operations to be expected for the full fiscal year ending December 31, 2009.

3. Pledged cash deposits 

Pledged as guarantee for its notes payable, the Company regularly pays some of its suppliers by bank notes. The Company has to deposit a cash deposit, equivalent to 10%- 40% of the face value of the relevant bank note, at a bank in order to obtain the bank note.

4. Accounts and notes receivable

The Company’s accounts receivable at June 30, 2009 (unaudited) and December 31, 2008 are summarized as follows:
 
16
 
   
June 30, 2009
    
December 31, 2008
  
Accounts receivable
  
$
84,268,008
    
$
60,345,494
  
Notes receivable
    
40,888,091
      
40,989,840
  
     
125,156,099
      
101,335,334
  
Less: allowance for doubtful accounts
    
(3,689,664
)
    
(4,910,478
)
Balance at the end of the period
  
$
121,466,435
    
$
96,424,856
  
  
Notes receivable represent accounts receivable in the form of bills of exchange whose acceptances and settlements are handled by banks.

The activity in the Company’s allowance for doubtful accounts during the six months ended June 30, 2009 (unaudited) and the year ended December 31, 2008 are summarized as follows:

   
June 30, 2009
    
December 31, 2008
  
Balance at beginning of period
  
$
4,910,478
    
$
3,827,838
  
Amounts provided (recovered) during the period
    
(1,222,297
)
    
841,078
  
Foreign currency translation gain
    
1,483
      
241,562
  
Balance at the end of the period
  
$
3,689,664
    
$
4,910,478
  

 5. Other receivables

The Company’s other receivables at June 30, 2009 (unaudited) and December 31, 2008 are summarized as follows:

   
June 30, 2009
    
December 31, 2008
  
Other receivables
  
$
2,065,635
    
$
2,009,364
  
Less: allowance for doubtful accounts
    
(695,804
)
    
(659,837
)
Balance at the end of the period
  
$
1,369,831
    
$
1,349,527
  
 
Other receivables consist of amounts advanced to both related and unrelated parties, primarily as unsecured demand loans, with no stated interest rate or due date.
 
The activity in the Company’s allowance for doubtful accounts of other receivable during the six months ended June 30, 2009 (unaudited) and the year ended December 31, 2008 are summarized as follows:
 
17
 
   
June 30, 2009
    
December 31, 2008
  
Balance at beginning of the period
  
$
659,837
    
$
652,484
  
Amounts provided (recovered) during the period
    
35,694
      
(41,264
)
Foreign currency translation gain
    
273
      
48,617
  
Balance at the end of the period
  
$
695,804
    
$
659,837
  
  
6. Inventories

The Company’s inventories at June 30, 2009 (Unaudited) and December 31, 2008 consisted of the following:

   
June 30, 2009
    
December 31, 2008
  
Raw materials
  
$
8,204,420
    
$
8,354,397
  
Work in process
    
5,329,680
      
4,466,720
  
Finished goods
    
14,667,682
      
14,826,961
  
     
28,201,782
      
27,648,078
  
Less: provision for loss
    
(1,447,366
)
    
(1,076,323
)
Balance at the end of the period
  
$
26,754,416
    
$
26,571,755
  

7. Property, plant and equipment

The Company’s property, plant and equipment at June 30, 2009 (unaudited) and December 31, 2008 are summarized as follows:

   
June 30, 2009
    
December 31, 2008
  
Land use rights and buildings
  
$
28,715,292
    
$
27,416,977
  
Machinery and equipment
    
60,235,951
      
54,405,700
  
Electronic equipment
    
4,789,687
      
4,356,475
  
Motor vehicles
    
2,434,181
      
2,641,378
  
Construction in progress
    
1,043,089
      
1,007,415
  
     
97,218,200
      
89,647,945
  
Less: Accumulated depreciation
    
(41,101,414
)
    
(37,669,040
)
Balance at the end of the period
  
$
56,116,786
    
$
51,978,905
  

 Depreciation charge for the six months ended June 30, 2009 and the year ended December 31, 2008 are $3,783,224 and $9,672,948 respectively.
 
18
 
8. Intangible assets
 
The activities in the Company’s intangible asset account at June 30, 2009 (unaudited) and December 31, 2008 are summarized as follows:

   
June 30, 2009
    
December 31, 2008
  
Balance at beginning of period
  
$
504,339
    
$
589,713
  
Add: additions during the period–
                
Patent technology
    
292,573
      
-
  
Management software license
    
29,098
      
125,550
  
Foreign currency translation gain
    
342
      
41,120
  
     
826,352
      
756,383
  
Less: Amortization at end of the period
    
(103,108
)
    
(252,044
)
Balance at the end of the period
  
$
723,244
    
$
504,339
  
 
9. Deferred Income Tax Assets

Deferred income taxes are provided for temporary differences between amounts of assets and liabilities for financial reporting purposes and the basis of such assets and liabilities as measured by tax laws and regulations, as well as net operating loss, tax credit and other carryforwards. Additionally, deferred taxes have been provided for the purpose of repatriating earnings from consolidated foreign subsidiaries. Statement of Financial Accounting Standards No. 109 (“SFAS 109”), “Accounting for Income Taxes,” requires that deferred tax assets be reduced by a valuation allowance if, based on all available evidence, it is considered more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods.

The components of estimated deferred income tax assets at June 30, 2009 (unaudited) and December 31, 2008 were as follows:

   
June 30, 2009
    
December 31, 2008
  
Losses carryforward (U.S.)
  
$
3,843,496
    
$
2,300,322
  
Losses carryforward (PRC)
    
430,488
      
287,285
  
Product warranties and other reserves
    
1,932,607
      
1,737,052
  
Property, plant and equipment
    
2,533,978
      
2,471,716
  
Bonus accrual
    
199,048
      
297,208
  
Other
    
249,987
      
154,348
  
     
9,189,604
      
7,247,931
  
Valuation allowance *
    
(6,552,142
)
    
(4,864,866
)
Total deferred tax assets
  
$
2,637,462
    
$
2,383,065
  
 
19
 
*As of June 30, 2009, valuation allowance was $6,552,142, including $3,843,496 and $2,708,646 allowance for the Company’s deferred tax assets in the U.S. and allowance for the Company’s non-U.S. deferred tax assets. As of December 31, 2008, valuation allowance was $4,864,866, including $2,300,322 allowance for the Company’s deferred tax assets in the U.S. and $2,564,544 allowance for the Company’s non-U.S. deferred tax assets. Based on the Company’s current operations in the U.S., the management believes that the deferred tax assets in the U.S. are not likely to be realized in the future. For the non-U.S. deferred tax assets, pursuant to certain tax laws and regulations in China, the management believes such amount will not be utilized to offset future taxable income.

10. Bank loans

At June 30, 2009, the Company, through its Sino-foreign joint ventures, had outstanding fixed-rate short-term bank loans of $8,782,330, with weighted average interest rate at 5.64% per annum. These loans are secured with some of the property and equipment of the Company, and are repayable within one year.

At December 31, 2008, the Company, through its Sino-foreign joint ventures, had outstanding fixed-rate short-term bank loans of $7,315,717, with weighted average interest rate at 6.17% per annum. These loans are secured with some of the property and equipment of the Company and are repayable within one year.

11. Accounts and notes payable

The Company’s accounts and notes payable at June 30, 2009 (unaudited) and December 31, 2008 are summarized as follows:

   
June 30, 2009
    
December 31, 2008
  
Accounts payable
  
$
54,780,624
    
$
38,595,446
  
Notes payable
    
24,132,438
      
20,650,597
  
Balance at the end of the period
  
$
78,913,062
    
$
59,246,043
  

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

The Company has pledged cash deposits, notes receivable and certain property plant and machinery to secure trade financing granted by banks.
 
20
 
12. Convertible notes payable

In February 2008, the Company sold to two accredited institutional investors $35 million of convertible notes, the "Convertible Notes", with a scheduled maturity date of February 15, 2013. The Convertible Notes, including any accrued but unpaid interest, are convertible into common shares of the Company at a conversion price of $8.8527 per share, subject to adjustment upon the occurrence of certain events.

The Convertible Notes bear annual interest rates of 3%, 3.5%, 4%, 4.5% and 5% for each year of 2008, 2009, 2010, 2011 and 2012. The interest on the Convertible Notes shall be computed commencing from the issuance date and will be payable in cash in arrears semi-annually on January 15, and July 15 of each year with the first interest payable date being July 15, 2008. From and after the occurrence and during the continuance of an Event of Default defined in the relevant Convertible Note agreements, the interest rate then in effect shall be increased by two percent (2%) until the event of default is remedied.

The holders of the Convertible Notes will be entitled to convert any portion of the conversion amount into shares of common stock at the conversion price at any time or times on or after the thirtieth (30th) day after the issuance date and prior to the thirtieth (30th) Business Day prior to the expiry date of the Convertible Notes. A damage penalty will be paid if share certificates are not delivered timely after any conversion.

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

0-6 months:   125%
6-12 months:  125%
12-18 months: 135%
18-24 months: 135%
24-30 months: 145%
30-36 months: 145%
36-42 months: 155%
42-48 months: 155%

On each six month anniversary of the issuance date beginning August 15, 2008, the conversion price will be adjusted downward to the Reset Reference Price, as defined below, if the weighted average price for the twenty (20) consecutive trading days immediately prior to the applicable six month anniversary, the “Reset Reference Price”, is less than 95% of the conversion price in effect as of such applicable six month anniversary date. The foregoing notwithstanding, the conversion price will not be reduced via such reset provision to less than $7.0822. The conversion price is also subject to weighted-average antidilution adjustments, but in no event will the conversion price be reduced to less than $6.7417. If and whenever on or after the issuance date, the Company issues or sells its shares of Common Stock or other convertible securities, except for certain defined exempt issuances, for a consideration per share less than a price equal to the conversion price in effect on the issuance date immediately prior to such issue or sale, the original conversion price then in effect shall be adjusted by a weighted-average antidilution formula, but in no event to a new conversion price less than $6.4717.
 
21
 
The Company will not effect any conversion of the Convertible Notes, and each holder of the Convertible Notes will not have the right to convert any portion of the Convertible Notes to the extent that after giving effect to such conversion, such holders would beneficially own in excess of 4.99% of the number of shares of Common Stock outstanding immediately after giving effect to such conversion.

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

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

Upon the consummation of a change of control as defined in the Convertible Note agreements, the Convertible Note holder may require the Company to redeem all or any portion of the Convertible Notes. The portion of the Convertible Notes subject to redemption shall be redeemed by the Company in cash at a price equal to the sum of the conversion amount of being redeemed and the Other Make Whole Amount as defined above.

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

In the event that the Company has not completed the necessary filings to list the conversion shares on its principal market by the date that is ninety (90) days after the issuance date or has not so listed the conversion shares by the date that is ninety (90) days after the issuance date or the shares of the Company’s common stock are terminated from registration under the Securities Act of 1933, the Convertible Note holders will have the right, in its sole discretion, to require that the Company redeem all or any portion of the Convertible Notes. The portion of the Convertible Notes subject to redemption in connection with this listing default will be redeemed by the Company in cash at a price equal to the sum of the conversion amount being redeemed and the Other Make Whole Amount as mentioned above.
 
22
 
At any time following February 15, 2009, if the Weighted Average Price (WAP) for twenty (20) consecutive trading days is less than 45% of the Conversion Price in effect on the Issuance Date, as adjusted, namely $3.187, the Convertible Note holder shall have the right, in its sole discretion, to require that the Company redeem all or any portion of the Convertible Notes. The portion of this Convertible Note subject to redemption in connection with the share price change of the underlying common stock will be redeemed by the Company in cash at a price equal to the sum of the conversion amount being redeemed and the Other Make Whole Amount as mentioned above.

Since the Company’s stock Weighted Average Price for twenty (20) consecutive trading days ended on March 16, 2009 was below $3.187, which is less than 45% of the Conversion Price in effect of the Issuance Date, as adjusted, the “ WAP Default” , each Convertible Note holder shall have the right, at its sole discretion, to require that the Company redeem all or any portion of the Convertible Notes by delivering written redemption notice to the Company within five (5) business days after the receipt of the Company ’ s notice of the WAP Default.  

On March 17, 2009, the Company delivered two WAP Default notices to the Convertible Note holders.  On March 27, 2009, the Company received a letter from YA Global, one of the Convertible Note holders, electing to require the Company to redeem all the three Convertible Notes it held in the total principal amount of $5,000,000, together with interest, late charges, if any, and the Other Make Whole Amount as defined in Section 5(d) of the Convertible Notes. After negotiation, the Company and YA Global reached a settlement agreement on April 8, 2009 whereby the Company would pay a redemption amount of $5,041,667 to YA Global and YA Global waived its entitlement to the Other Make Whole Amount. Under the terms of the settlement agreement, on April 15, 2009, the Company paid YA Global $5,041,667 for the total principal amount, together with interest and late charges, if any. YA Global has waived its entitlement to the Other Make Whole Amount.

 Following the WAP Default notices, the Company received a letter from the provisional liquidator acting on behalf of Lehman Brothers Commercial Corporation Asia Limited, the “LBCCA Liquidator”, the other Convertible Note holder, requesting that it be granted an extension of time until April 24, 2009 to consider its rights under the Convertible Notes. The Company has granted an extension to April 15, 2009. The LBCCA Liquidator further requested another extension to April 24, 2009.  On April 24, 2009, LBCCA’s lawyers sent three Holder Redemption Notices via fax electing to redeem the entire outstanding principal of $30,000,000, together with interest, late charges, if any, and the Other Make Whole Amount, to be paid on July 23, 2009. The Company has discussed settlement with the LBCCA Liquidator, and on or about July 22, 2009, the Company and the LBCCA Liquidator reached an agreement to extend the applicable holder mandatory redemption date for two months from July 23, 2009 to September 23, 2009 in order to give more time to the Company and the LBCCA Liquidator to pursue settlement discussion.

In connection with the Convertible Notes, the Company issued 1,317,864 detachable warrants, the “Warrants,” to purchase from the Company shares of common stock of the Company at the exercise price of $8.8527 per share. The Warrants are exercisable immediately and expired on February 15, 2009. The Warrants require net cash settlement in the event that there is a fundamental transaction, contractually defined as a merger, sale of substantially all assets, tender offer or share exchange. Due to this contingent redemption provision, the warrants require liability classification under SFAS 150 and must be recorded at fair value each reporting period. As of the issuance date, i.e., February 15, 2008, the fair value of warrants was $798,626, which was determined using the Black-Scholes option pricing model.
 
23
 
The Company has evaluated the convertible notes for terms and conditions that are not clearly and closely associated with the risks of the debt-type host instrument. Generally, such features require separation from the host contract and treatment as derivative financial instruments. Certain features, such as the conversion option, were found to be exempt. Other features, such as puts and redemption features, were found to require bifurcation and recognition as derivative liabilities. These derivative liabilities are recognized initially at fair value, using forward cash-flow valuation techniques. As of February 15, 2008, the compound derivative value amounted to $1,703,962. This derivative will be adjusted to its estimated fair value at the completion of each reporting period until the debt arrangement is ultimately settled, converted or paid.

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

 As indicated above, according to the terms of the convertible notes, the conversion price was reset to $7.0822 as of August 15, 2008 based on the weighted average price of the stock on that date.  In accordance with EITF 00-27, a contingency feature that cannot be measured at inception of the instrument, should be recorded when the contingent event occurs.  Therefore, on the date of the reset, the difference in the number of indexed shares prior to the reset was compared to the indexed shares subsequent to the reset and this incremental number of shares was multiplied by the commitment date stock price to determine the incremental intrinsic value that resulted from the adjustment to the conversion price.  This difference was recorded in equity as a beneficial conversion feature (“BCF”) and the related discount reduced the carrying value of the note and is being amortized over the remaining life of the instrument.

The Financing Agreements embody a contingent conversion feature (reset conversion price). EITF 98-5 provides that the beneficial conversion feature, if any, embodied in a convertible debt instrument requires recognition and reclassification to stockholders' equity in an amount "not to exceed" the financing basis. For purposes of calculating the beneficial conversion feature, EITF 00-27, provides that the contractual conversion rate should give effect to the allocation of proceeds to other financial instruments, as required by APB 14.  Accordingly, the "effective" conversion rate is calculated as the basis allocated to the debt instruments divided by the number of indexed shares. The reset conversion price was a contingent conversion price that was not known at inception of the agreement. Under the guidance of EITF 98-5, the beneficial conversion feature should be recalculated once the contingent conversion feature is known.  The reset conversion feature was determined to be $7.0822 on August 15, 2008.  The BCF was then calculated as if the reset amount was known at inception of the agreement in order to determine what the APB 14 allocation would have been using a conversion price of $7.0822.

Issue 7 (EITF 00-27) states that "the number of shares that would be received upon conversion based on the adjusted conversion price would be compared to the number that would have been received prior to the occurrence of the contingent event. The excess number of shares multiplied by the commitment date stock price equals the incremental intrinsic value that results from the resolution of the contingency and the corresponding adjustment to the conversion price." The guidance in Issue 7 does not specify whether the contingent BCF should only be calculated if the contingent conversion feature is below the market price of the stock and would have intrinsic value. The Company is of an opinion that the Issue 7 approach was not intended to override the intrinsic value method addressed in EITF Topic D-60, EITF 98-5 and EITF 00-27, and that the BCF should be calculated as the intrinsic spread between the adjusted effective conversion price and the market price at the commitment date.
 
24
 
As of August 15, 2008, the number of indexed shares was 3,953,596 and 4,941,967 at the inception conversion price and reset conversion price, respectively. At the commitment date, the stock price was $6.09, and the “effective” conversion price was $6.93. Accordingly, since the effective conversion price is higher than the market value of the stock, the debt instruments are not considered "in the money" and no beneficial conversion feature is present.

On the date of inception, allocation of basis in the financing arrangement to the warrants and derivative liability has resulted in an original issue discount to the face value of the convertible notes in the amount of $2,502,588, which amount is subject to amortization over the Convertible Note’s term using the effective method. As of June 30, 2009, the amortization expense balance recorded by the Company was $931,650, including unamortized discount on the YA Global convertible note $276,448, which has been written off after its redemption. As the YA Global convertible note has been elected by its holder to be redeemed, the unamortized discount on the convertible note has been written off as expense on the redemption date.

 13. Derivative liabilities

The Company has evaluated the convertible notes for terms and conditions that are not clearly and closely associated with the risks of the debt-type host instrument (see Note 12). Generally, such features require separation from the host contract and treatment as derivative financial instruments. Certain features, such as the conversion option, were found to be exempt. Other features, such as puts and redemption features were found to require bifurcation and recognition as derivative liabilities. These derivative liabilities are recognized initially at fair value, using forward cash-flow valuation techniques. As of February 15, 2008, the compound derivative value amounted to $1,703,962. This derivative will be adjusted to its estimated fair value at the completion of each reporting period until the debt arrangement is ultimately settled, converted or paid. As of June 30, 2009, the compound derivative value amounted to $4,042,857. The income from adjustment of fair value of compound derivative has been recorded in the income statement as gain or loss on change in fair value of derivative. (See note 12 and 24)

14. Accrued expenses and other payables

The Company’s accrued expenses and other payables at June 30, 2009 (unaudited) and December 31, 2008 are summarized as follows:

   
June 30, 2009
    
December 31, 2008
  
Accrued expenses
  
$
2,866,016
    
$
2,441,352
  
Other payables
    
1,553,456
      
1,690,046
  
Warranty reserves*
    
7,588,165
      
6,335,613
  
Dividend payable to non-controlling interest shareholders of Joint-ventures
    
1,304,532
      
1,991,796
  
Liabilities in connection with warrants**
    
-
      
1,977
  
Balance at the end of the period
  
$
13,312,169
    
$
12,460,784
  

 
25
 
*The Company provides for the estimated cost of product warranties when the products are sold. Such estimates of product warranties were based on, among other things, historical experience, product changes, material expenses, service and transportation expenses arising from the manufactured product. Estimates will be adjusted on the basis of actual claims and circumstances.

For the six months ended June 30, 2009 (unaudited) and the year ended December 31, 2008, the warranties activities were as follows:

   
June 30, 2009
    
December 31, 2008
  
Balance at the beginning of period
  
$
6,335,613
    
$
4,919,491
  
Additions during the period-
    
3,490,290
      
5,861,782
  
Settlement within period, by cash or actual material
    
(2,240,620
)
    
(4,797,457
)
Foreign currency translation gain
    
2,882
      
351,797
  
Balance at end of period
  
$
7,588,165
    
$
6,335,613
  
 
**In connection with the Convertible Notes, the Company issued 1,317,864 of detachable warrants, “Warrants,” to purchase from the Company shares of common stock at the exercise price of $8.8527 per share, subject to adjustments upon certain events occurring. The Warrants are exercisable immediately and expired on February 15, 2009.

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

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

If and whenever on or after the issuance date, the Company issues or sells its shares of common stock or other convertible securities for a consideration per share less than a price equal to the exercise price of a Warrant in effect on the issuance date immediately prior to such issue or sale, the exercise price of such Warrant then in effect will be adjusted.

The warrants issued in connection with the financial arrangement were derivative instruments. The warrants require net cash settlement in the event that there is a fundamental transaction, contractually defined as a merger, sale of substantially all assets, tender offer or share exchange.
 
26

As a result of FASB Staff Position (FSP) FAS 150-5, it appears that the warrants require liability classification due to the possible cash redemption upon the event of an all cash acquisition. The FSP clarifies that warrants that contain any redemption features, including contingent redemption features, must be recorded as liabilities and marked to fair value each reporting period. As of the issuance date, i.e., February 15, 2008, the fair value of warrants was $798,626. Such warrant liabilities will be adjusted to its estimated fair value at the completion of each reporting period until the maturity of February 15, 2009.

The warrant agreements contain strike price adjustment provisions. In accordance with Section 8(iii), if the rate at which any Convertible Instruments are convertible into changes at any time, the warrant exercise price in effect at the time of the change will be adjusted based on the formula provided in Section 8(a) of the warrant agreement.  Accordingly, the warrants will be valued at the exercise price of $8.55 as of August 15, 2008 and thereafter.

As of August 15, 2008, the Company valued the warrant using conversion price at inception and reset respectively.  The fair value of the warrant is $489,719 at the inception conversion price of $8.8527, and $551,131 at the reset conversion price of $8.5500, respectively. Such difference resulting from using the reset conversion price has increased warrant liabilities by $61,412.

As of June 30, 2009, the fair value of warrant was $0 because it was not exercised on its expiration date, February 15, 2009. The income from adjustment of fair value of liabilities in connection with warrants amount of gain has been recorded in the income statement as gain or loss on change in fair value of derivative. (see note 24)

15. Accrued pension costs
 
Since the Company’s operations are all located in China, all the employees are located in China. The Company records pension costs and various employment benefits in accordance with the relevant Chinese social security laws, which is substantially based on a total of 31% of base salary as required by local governments. Base salary levels are the average salary determined by the local governments.

The activities in the Company’s pension account during the six months ended June 30, 2009 (unaudited) and the year ended December 31, 2008 are summarized as follows:

   
June 30,2009
    
December 31, 2008
  
Balance at beginning of the period
  
$
3,806,519
    
$
3,622,729
  
Amounts provided during the period
    
1,304,012
      
2,311,049
  
Settlement during the period
    
(1,317,767
)
    
(2,381,047
)
Foreign currency translation gain
    
1,452
      
253,788
  
Balance at end of period
  
$
3,794,216
    
$
3,806,519
  
 
27
 
 16. Taxes payable

The Company’s taxes payable at June 30, 2009 (unaudited) and December 31, 2008 are summarized as follows:

   
June 30,2009
    
December 31, 2008
  
Value-added tax payable
  
$
7,212,380
    
$
6,279,089
  
Income tax payable
    
1,325,852
      
(652,865
)
Other tax payable
    
85,528
      
91,214
  
Balance at end of the period
  
$
8,623,760
    
$
5,717,438
  

17. Amounts due to shareholders/ directors

The activities in the amounts due to shareholders/directors at June 30, 2009 (unaudited) and December 31, 2008 are summarized as follows:

   
June 30,2009
    
December 31, 2008
  
Balance at the beginning of period
  
$
337,370
    
$
304,601
  
Increase during the period
    
226,717
      
2,415
  
Foreign currency translation gain
    
203
      
30,354
  
Balance at end of period
  
$
564,290
    
$
337,370
  

The amounts due to shareholders/directors were unsecured, interest-free and repayable on demand.

18. Advances payable

The amounts mainly represent advances made by the Chinese government to the Company as subsidy on interest on loans related to production facilities expansion. 

The balances are unsecured, interest-free and will be repayable to the Chinese government if the usage of such advance does not continue to qualify for the subsidy (see notes 22).
 
28

19. Share Capital and Additional paid-in capital

The activities in the Company’s share capital and additional paid-in capital account during the six months ended June 30, 2009 (unaudited) and the year ended December 31, 2008 are summarized as follows:
 
   
Share Capital
    
Additional paid-in capital
  
   
Shares
    
Par Value
      
Balance at January 1, 2008
    
23,959,702
    
$
2,396
    
$
30,125,951
  
Issuance of common stock*
    
3,023,542
      
302
      
22,089,698
  
Decrease in additional paid-in capital in connection with Henglong equity acquisition **
    
-
      
-
      
(25,912,921
)
Issuance of stock options to independent directors and management***
    
-
      
-
      
845,478
  
Balance at December 31, 2008 and June 30, 2009
    
26,983,244
    
$
2,698
    
$
27,148,206
  

* On March 31, 2008, Wiselink Holdings Limited, “Wiselink”, Great Genesis Holdings Limited, “Genesis”, a wholly-owned subsidiary of China Automotive Systems, Inc., “the Company” and other parties entered into an equity transfer transaction, the “Acquisition”, documented by an Equity Transfer Agreement, the “Agreement”, pursuant to which Wiselink agreed to transfer and assign a 35.5% equity interest in Jingzhou Henglong Automotive Parts Co. Ltd., “Henglong” to Genesis for a total consideration of $32,090,000, the “Consideration”.

Under the terms of the Agreement, the Consideration is to be paid as follows: $10,000,000 cash was paid by Genesis to Wiselink on April 30, 2008, and the balance of the purchase price ($22,090,000) was paid by issuance of 3,023,542 shares of common stock of the Registrant, in its capacity as the 100% parent company of Genesis.

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

On April 22 and June 30, 2008, the Company issued 1,170,000 and 1,853,542 shares of common stock, respectively, at an issuance price of $7.3060, par value of $0.0001. The difference between issuance price and par value was credited into additional paid-in capital.

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

*** In July 2004, the Company adopted a stock incentive plan. The maximum number of common shares for issuance under this plan is 2,200,000 with a period of 10 years. The stock incentive plan provides for the issuance, to the Company’s officers, directors, management and employees, of options to purchase shares of the Company’s common stock. Since the adoption of the stock incentive plan, the Company has issued 411,350 stock options under this plan, and there remain 1,788,650 stock options issuable in future. As of June 30, 2009, the Company had 388,850 stock options outstanding.
 
29
 
The Company issued 312,350 common stock options to independent directors and management, and the fair value of the options at the grant date was $845,478, for the year of 2008, which was calculated based on Black-Scholes option pricing model. The fair value was credited in additional paid-in capital, debited in operating expenses using straight line method over the expected beneficiary period. As of June 30, 2009, the Company has amortized $470,439 and the remaining 149,425 stock options, valued at $375,039, are reflected as deferred stock compensation under shareholders' equity in the balance sheet.

20. Deferred stock compensation
 
The Company issued 312,350 common stock options to independent directors and management, and the fair value of the options at the grant date was $845,478, for the year of 2008, which was calculated based on Black-Scholes option pricing model.  As of June 30, 2009, the Company has amortized $470,439 and the remaining 149,425 stock options, valued at $375,039, are reflected as deferred stock compensation under shareholders' equity in the balance sheet.

21. Non-controlling interests

The Company’s activities in respect of the amounts of the non-controlling interests’ equity at June 30, 2009 (unaudited) and December 31, 2008 are summarized as follows:

   
June 30,2009
    
December 31, 2008
  
Balance at beginning of the period
  
$
23,222,566
    
$
23,166,270
  
Add: Additions during the period –
                
Income attributable to non-controlling interests
    
4,037,348
      
5,071,408
  
Capital Contribution from the non-controlling interest  holders of Joint-venture companies
    
-
      
745,723
  
Less: Decreases during the period
                
Dividends declared to the non-controlling interest holders of Joint-venture companies
    
(3,080,656
)
    
(1,016,733
)
Transfer and assign equity interest in Henglong and USAI by non-controlling interest holders of Joint-venture companies*
    
-
      
(6,177,079
)
Foreign currency translation gain
    
9,120
      
1,432,977
  
Balance at end of period
  
$
24,188,378
    
$
23,222,566
  

 * On March 31, 2008, the Company’s wholly-owned subsidiary, Genesis and Wiselink, both controlled by Hanlin Chen and his family, entered into an equity transfer agreement, pursuant to which Wiselink agreed to transfer and assign its 35.5% equity interest in Jingzhou Henglong, one of the Company’s currently consolidated subsidiaries, to Genesis for a total consideration of $32,090,000.
 
30

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

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

22. Other Income

During the three months and six months ended June 30, 2009, there was no other income in the Company. During the three months and six months ended June 30, 2008, other income was $199,459, mainly from Government subsidies.

Government subsidies represent refunds by the Chinese Government of interest paid to banks by companies entitled to such subsidies. This applies only to interest on loans related to production facilities expansion. The Company recorded the refunded interest on projects which achieved their goals into Other income, and refunded interest on projects which have not achieved their goals into advances payable.

23. Financial income (expenses)

During the three months and six months ended June 30, 2009 (unaudited) and 2008, the Company recorded financial income (expenses) which is summarized as follows:

   
Three Months Ended June 30,
  
   
2009
    
2008
  
Interest income (expenses),net
  
$
(229,137
)
  
$
(394,615
)
Foreign exchange gain (loss), net
    
257,484
      
(30,522
)
Income (loss) of note discount, net
    
(94,545
)
    
74,009
  
Amortization for discount of convertible note payable
    
(384,638
)
    
(81,879
)
Handling charge
    
(27,392
)
    
(26,133
)
Total
  
$
(478,228
)
  
$
(459,140
)
 
31
 
   
Six Months Ended June 30,
  
   
2009
    
2008
  
Interest income (expenses),net
  
$
(517,417
)
  
$
(658,384
)
Foreign exchange gain , net
    
242,916
      
346,116
  
Income (loss) of note discount, net
    
(94,655
)
    
92,045
  
Amortization for discount of convertible note payable
    
(506,985
)
    
(181,328
)
Handling charge
    
(41,567
)
    
(36,896
)
Total
  
$
(917,708
)
  
$
(438,447
)
 
 24. Gain (loss) on change in fair value of derivative

During the three months and six months ended June 30, 2009 (unaudited) and 2008, the Company recorded gain (loss) on change in fair value of derivative is summarized as follows:

   
Three Months Ended June 30,
  
   
2009
    
2008
  
Income (loss) from adjustment of fair value of liabilities in connection with warrants
   $ -     $ (19,109 ) 
Income (loss) from adjustment of fair value of compound derivative liabilities
     (977,435 )     1,014,262  
Total
   $ (977,435 )    $ 995,153  

   
Six Months Ended June 30,
  
   
2009