CHINA AUTOMOTIVE SYSTEMS INC - Quarter Report: 2007 March (Form 10-Q)
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-Q
(Mark
One)
x
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
|
For
the
quarterly period ended March 31, 2007
Or
o
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
|
For
the transition period from ________ to _________
Commission
file number: 000-33123
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 No.)
|
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)
Registrant’s
telephone number, including Area Code: (86) 716-832-9196
|
Registrant’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 Securities Exchange Act of 1934 during
the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements
for
the past 90 days.
Yes
x No
o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
one):
Large
accelerated filer o
|
Accelerated
filer o
|
Non-accelerated
filer x
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
Yes
o No
x
As
of
March 31, 2007, the Company had 23,959,702 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 Ended March 31, 2007 and 2006
|
2
|
|
Condensed
Consolidated Statements of Comprehensive Income (Unaudited)
for
the Three Months Ended March 31, 2007 and 2006
|
3
|
|
Condensed
Consolidated Balance Sheets at March
31, 2007 (Unaudited)
and December 31, 2006
|
4
|
|
Condensed
Consolidated Statements of Cash Flows (Unaudited) for the Three Months
Ended March 31, 2007 and 2006
|
6
|
Notes
to Condensed
Consolidated Financial Statements (Unaudited) for the Three Months
Ended
March 31, 2007 and 2006
|
8
|
|
Item
2.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
22
|
Item
3.
|
Quantitative
and Qualitative Disclosures About Market Risk
|
33
|
Item
4
|
Controls
and Procedures
|
33
|
|
||
|
Part
II — Other Information
|
|
|
||
Item
1.
|
Legal
Proceedings
|
34
|
Item
1A.
|
Risk
Factors
|
34
|
Item
2.
|
Unregistered
Sales of Equity Securities and Use of Proceeds.
|
41
|
Item
3.
|
Defaults
Upon Senior Securities.
|
41
|
Item
4.
|
Submission
of matters to a Vote of Security Holders.
|
41
|
Item
5.
|
Other
Information.
|
41
|
Item
6.
|
Exhibits
|
41
|
Signature
|
|
PART
1 —
FINANCIAL INFORMATION
Item
1. Financial Statements
China
Automotive Systems, Inc.
Condensed
Consolidated Statements of Operations (Unaudited)
Three
Months Ended March 31,
|
|||||||
2007
|
2006
|
||||||
Net
product sales, including $902,584 and $583,539 to related parties
at
March
31, 2007 and 2006
|
$
|
28,383,392
|
$
|
20,964,452
|
|||
Cost
of product sold, including $1,051,480 and $655,995 purchased from
related
parties at March
31,2007 and 2006
|
19,191,486
|
14,019,255
|
|||||
Gross
profit
|
9,191,906
|
6,945,197
|
|||||
Add:
Gain on other sales
|
112,094
|
82,715
|
|||||
Less:
Operating expenses-
|
|||||||
Selling
expenses
|
1,593,646
|
1,492,488
|
|||||
General
and administrative expenses
|
1,509,027
|
2,037,537
|
|||||
R&D
expenses
|
119,465
|
189,747
|
|||||
Depreciation
and amortization
|
893,251
|
688,490
|
|||||
Total
Operating
expenses
|
4,115,389
|
4,408,262
|
|||||
Income
from operations
|
5,188,611
|
2,619,650
|
|||||
Add:
Other income, net
|
38,462
|
624
|
|||||
Financial
(expenses)
|
(394,997
|
)
|
(334,386
|
)
|
|||
Income
before income taxes
|
4,832,076
|
2,285,888
|
|||||
Less:
Income taxes
|
1,294,080
|
200,711
|
|||||
Income
before minority interests
|
3,537,996
|
2,085,177
|
|||||
Less:
Minority
interests
|
1,894,895
|
990,779
|
|||||
Net
income
|
$
|
1,643,101
|
$
|
1,094,398
|
|||
Net
income per common share
|
|||||||
Basic
and diluted
|
$
|
0.07
|
$
|
0.05
|
|||
Weighted
average number of common shares outstanding
|
|||||||
Basic
|
23,938,078
|
22,680,813
|
|||||
Diluted
|
23,949,809
|
22,704,753
|
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
2
China
Automotive Systems, Inc.
Condensed
Consolidated Statements of Comprehensive Income (Unaudited)
Three
Months Ended March 31,
|
|||||||
2007
|
2006
|
||||||
Net
income
|
$
|
1,643,101
|
$
|
1,094,398
|
|||
Other
comprehensive income:
|
|||||||
Foreign
currency translation gain
|
—
|
601,399
|
|||||
Comprehensive
income
|
$
|
1,643,101
|
$
|
1,695,797
|
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
3
China
Automotive Systems, Inc.
Condensed
Consolidated Balance Sheets
March
31, 2007
|
December
31, 2006
|
||||||
(Unaudited)
|
|||||||
ASSETS
|
|||||||
Current
assets:
|
|||||||
Cash
and cash equivalents
|
$
|
17,362,082
|
$
|
27,418,500
|
|||
Pledged
cash deposits
|
2,984,344
|
3,484,335
|
|||||
Accounts
and notes receivable, net, including $2,090,888 and $1,770,933 from
related parties at March 31, 2007 and December 31, 2006, net of an
allowance for doubtful accounts of $4,208,453 and $4,086,218 at March
31,
2007 and December 31, 2006.
|
60,477,292
|
57,234,383
|
|||||
Advance
payments and other, including $181,590 and $487,333 to related
parties at March 31, 2007 and December 31, 2006.
|
920,857
|
837,014
|
|||||
Inventories
|
18,051,757
|
15,464,571
|
|||||
Total
current assets
|
$
|
99,796,332
|
$
|
104,438,803
|
|||
Long-term
Assets:
|
|||||||
Property,
plant and equipment, net
|
$
|
40,535,608
|
$
|
40,848,046
|
|||
Intangible
assets, net
|
433,388
|
3,140,548
|
|||||
Other
receivables, net, including $664,016 and $738,510 from related parties
at
March 31, 2007 and December 31, 2006, net of an allowance for doubtful
accounts of $697,472 and $898,203 at March 31, 2007 and December
31,
2006.
|
1,432,340
|
966,715
|
|||||
Advance
payment for property, plant and equipment, including $1,159,667 and
$488,873 to related parties at March 31, 2007 and December 31,
2006.
|
3,705,310
|
2,640,708
|
|||||
Long-term
investments
|
70,513
|
73,718
|
|||||
Total
assets
|
$
|
145,973,491
|
$
|
152,108,538
|
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
China
Automotive Systems, Inc.
Condensed
Consolidated Balance Sheets
March
31, 2007
|
December
31, 2006
|
||||||
(Unaudited)
|
|||||||
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
|||||||
Current
liabilities:
|
|||||||
Bank
loans
|
$
|
8,333,333
|
$
|
15,384,615
|
|||
Accounts
and notes payable, including $893,901 and $640,405 to related parties
at
March 31, 2007 and December 31, 2006.
|
38,542,305
|
37,647,913
|
|||||
Customer
deposits
|
134,917
|
146,171
|
|||||
Accrued
payroll and related costs
|
1,610,700
|
1,506,251
|
Accrued
expenses and other payables
|
8,298,907
|
11,078,186
|
|||||
Accrued
pension costs
|
3,276,133
|
3,266,867
|
|||||
Taxes
payable
|
7,114,338
|
5,914,362
|
|||||
Amounts
due to shareholders/directors
|
318,065
|
358,065
|
|||||
Total
current liabilities
|
$
|
67,628,698
|
$
|
75,302,430
|
|||
Long-term
liabilities:
|
|||||||
Advances
payable
|
313,151
|
313,151
|
|||||
Total
liabilities
|
$
|
67,941,849
|
$
|
75,615,581
|
|||
Minority
interests
|
$
|
21,665,326
|
$
|
23,112,667
|
|||
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 - 23,959,702 shares and 23,851,581 shares
at March
31, 2007 and December 31, 2006, respectively
|
2,396
|
2,385
|
|||||
Additional
paid-in capital
|
29,994,873
|
28,651,959
|
|||||
Retained
earnings-
|
|||||||
Appropriated
|
6,209,909
|
6,209,909
|
|||||
Unappropriated
|
17,690,338
|
16,047,237
|
|||||
Accumulated
other comprehensive income
|
2,468,800
|
2,468,800
|
|||||
Total
stockholders' equity
|
$
|
56,366,316
|
$
|
53,380,290
|
|||
Total
liabilities and stockholders' equity
|
$
|
145,973,491
|
$
|
152,108,538
|
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
5
China
Automotive Systems, Inc.
Condensed
Consolidated Statements of Cash Flows (Unaudited)
Three
Months Ended March 31,
|
|||||||
2007
|
2006
|
||||||
Cash
flows from operating activities:
|
|||||||
Net
income
|
$
|
1,643,101
|
$
|
1,094,398
|
|||
Adjustments
to reconcile net income from continuing operations to net cash provided
by
operating activities:
|
|||||||
Minority
interests
|
1,894,895
|
990,779
|
|||||
Depreciation
and amortization
|
1,827,792
|
1,453,473
|
|||||
Allowance
for doubtful accounts (Recovered)
|
(78,495
|
)
|
686,568
|
||||
Other
operating adjustments
|
8,972
|
—
|
|||||
Changes
in operating assets and liabilities:
|
|||||||
(Increase)
decrease in:
|
|||||||
Pledged
deposits
|
|
499,991
|
(2,341,003
|
)
|
|||
Accounts
and notes receivable
|
(3,365,144
|
)
|
(5,074,395
|
)
|
|||
Advance
payments and other
|
(83,843
|
)
|
(157,173
|
)
|
|||
Inventories
|
(2,587,186
|
)
|
(1,208,496
|
)
|
|||
Increase
(decrease) in:
|
|||||||
Accounts
and notes payable
|
894,392
|
9,748,793
|
|||||
Customer
deposits
|
(11,254
|
)
|
58,717
|
||||
Accrued
payroll and related costs
|
104,449
|
132,544
|
|||||
Accrued
expenses and other payables
|
(151,316
|
)
|
1,334,919
|
||||
Accrued
pension costs
|
9,266
|
115,564
|
|||||
Taxes
payable
|
1,199,976
|
874,994
|
|||||
Net
cash provided by operating activities
|
$
|
1,805,596
|
$
|
7,709,682
|
|||
Cash
flows from investing activities:
|
|||||||
(Increase)
in other receivables
|
(264,895
|
)
|
(1,401,564
|
)
|
|||
Cash
received from equipment sales
|
66,737
|
—
|
|||||
Cash
paid to acquire property, plant and equipment
|
(2,533,099
|
)
|
(652,784
|
)
|
|||
Cash
paid to acquire intangible assets
|
(12,404
|
)
|
(138,238
|
)
|
|||
Net
cash (used in) investing activities
|
$
|
(2,743,661
|
)
|
$
|
(2,192,586
|
)
|
|
Cash
flows from financing activities:
|
|||||||
(Decrease)
in proceeds from bank loans
|
(7,051,282
|
)
|
(1,081,981
|
)
|
|||
Dividends
paid to the minority interest holders of Joint-venture
companies
|
(3,172,571
|
)
|
(124,844
|
)
|
|||
(Decrease)
in amounts due to shareholders/directors
|
(40,000
|
)
|
(86,018
|
)
|
|||
Proceeds
from issuance of common stock
|
1,145,500
|
4,940,000
|
|||||
Net
cash provided by (used in) financing activities
|
$
|
(9,118,353
|
)
|
$
|
3,647,157
|
||
Cash
and cash equivalents effected by foreign currency
|
$
|
—
|
$
|
601,399
|
|||
Net
(decrease) increase in cash and cash equivalents
|
(10,056,418
|
)
|
9,765,652
|
||||
Cash
and cash equivalents at beginning of period
|
27,418,500
|
12,374,944
|
|||||
Cash
and cash equivalents at end of period
|
$
|
17,362,082
|
$
|
22,140,596
|
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
6
China
Automotive Systems, Inc. and Subsidiaries
Condensed
Consolidated Statements of Cash Flows (Unaudited)
(continued)
SUPPLEMENTAL
DISCLOSURE OF CASH FLOW INFORMATION:
Three
Months Ended March 31,
|
|||||||
2007
|
2006
|
||||||
Cash
paid for interest
|
$
|
192,557
|
$
|
193,099
|
|||
Cash
paid for income taxes
|
$
|
159,059
|
$
|
130,715
|
SUPPLEMENTAL
DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Three
Months Ended March 31,
|
|||||||
2007
|
2006
|
||||||
Issuance
of common shares on a non-cash basis
|
$
|
—
|
$
|
4
|
|||
Financing
services fee related to issuance of common shares
|
—
|
(4
|
)
|
||||
Increase
in capital by minority shareholders of Joint-venture companies on
a
non-cash basis
|
—
|
921,785
|
|||||
Dividends
payable to minority shareholders of Joint-venture companies being
converted into capital
|
—
|
(921,785
|
)
|
||||
Decrease
in minority interests as a result of minority shareholder’s withdrawal
from Joint-venture.
|
(2,830,545
|
)
|
—
|
||||
Withdrawal
of invested intangible assets by minority shareholder of
Joint-venture.
|
2,600,204
|
—
|
|||||
Increase
in equity in connection with minority shareholder’s withdrawal from
Joint-venture.
|
$
|
230,341
|
$
|
—
|
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
7
China
Automotive Systems, Inc. and Subsidiaries
Notes
to Condensed Consolidated Financial Statements (Unaudited)
Three
Months Ended March 31, 2007 and 2006
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, through its Sino-foreign joint
ventures described below, is primarily 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.
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”, is a wholly-owned subsidiary of the Company. 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.
The
Company owns the following aggregate net interests in seven Sino-foreign joint
ventures organized in the PRC as of March 31, 2007 and 2006.
|
Percentage
Interest
|
||||||
Name
of Entity
|
March
31, 2007
|
March
31, 2006
|
|||||
Shashi
Jiulong Power Steering Gears Co., Ltd., "Jiulong"
|
81.00
|
%
|
81.00
|
%
|
|||
Jingzhou
Henglong Automotive Parts Co., Ltd., "Henglong"
|
44.50
|
%
|
44.50
|
%
|
|||
Shenyang
Jinbei Henglong Automotive Steering System Co., Ltd.,
”Shenyang"
|
70.00
|
%
|
70.00
|
%
|
|||
Zhejiang
Henglong & Vie Pump-Manu Co., Ltd., "Zhejiang"
|
51.00
|
%
|
51.00
|
%
|
|||
Universal
Sensor Application Inc., “USAI”
|
85.71
|
%
|
60.00
|
%
|
|||
Wuhan
Jielong Electric Power Steering Co., Ltd., “Jielong”
|
85.00
|
%
|
—
|
||||
Wuhu
HengLong Automotive Steering System Co., Ltd., “Wuhu”
|
77.33
|
%
|
—
|
Jiulong
was established in 1993 and mainly engaged in the production of integral power
steering gears for heavy-duty vehicles.
Henglong
was established in 1997 and mainly engaged in the production of rack and pinion
power steering gears for cars and light duty vehicles.
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.
On
April
12, 2005, Great Genesis entered into a Joint-venture agreement with Shanghai
Hongxi Investment Inc., “Hongxi”, a company controlled by Mr. Hanlin Chen, the
Company’s Chairman, and Sensor System Solution Inc., “Sensor”, to establish a
joint venture, Universal Sensor Application Inc., “USAI”, in the Wuhan East Lake
development zone to engage in production and sales of sensor modulars. The
registered capital of the Joint-venture is $10 million. Great Genesis and Hongxi
intended to invest $6 million and $1 million, respectively, including cash
and
land and building, which would account for 60% and 10% of the total registered
capital, respectively. Sensor would invest $3 million in technology, accounting
for 30% of the total registered capital. As of March 20, 2007, the three parties
of USAI, Great Genesis, Hongxi, Sensor, entered into an agreement, which led
to
Sensor's withdrawal from USAI and abandonment all its rights and interests
in
USAI. The registered capital of the Joint-venture has changed to $7,000,000,
with 85.71% owned by the Company, 14.29% owned by Hongxi. Since the withdrawal
of intangible assets, another technology supplier is being sought.
8
On
April
14, 2006, Great Genesis entered into a Joint-venture agreement with Hong Kong
Tongda, “Tongda”, to establish a joint venture, Wuhan Jielong Electric Power
Steering Co., Ltd., “Jielong”, in the Wuhan East Lake development zone. Jielong
is mainly engaged in the production and sales of electric power steering, “EPS”.
The registered capital of the Joint-venture is $6 million. Great Genesis and
Tongda will invest $5,100,000 and $900,000, respectively, amounting to 85%
and
15% of the total registered capital, respectively.
On
March
31, 2006, as amended on May 2, 2006, Great Genesis, entered into a Joint-venture
agreement with Wuhu Chery Technology Co., Ltd., “Chery Technology”, to establish
a Joint-venture, Wuhu Henglong Automotive Steering System Co., Ltd., “Wuhu”, in
the Wuhu Technological Development Zone. Wuhu is mainly engaged in the
production and sales of automobile steering system. The registered capital
of
the Joint-venture is $3,750,387, the equivalent of RMB 30,000,000. Great Genesis
and Chery Technology invested $2,900,300, the equivalent of RMB 23,200,000,
and
$848,938, the equivalent of RMB 6,800,000, respectively, which accounts for
77.33% and 22.67% of the total registered capital, respectively.
2.
Basis
of Presentation and Significant Accounting Policies
Basis
of
Presentation - For the three months ended March 31, 2007 and 2006, the
accompanying consolidated financial statements include the accounts of the
Company and its subsidiaries. The subsidiaries include seven Sino-foreign
Joint-ventures mentioned in Note 1. Significant inter-company balances and
transactions have been eliminated upon consolidation. The 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 (loss) 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.
9
Actual
weighted average shares outstanding used in calculating basic and diluted income
per share were:
Three
Months Ended March 31,
|
|||||||
2007
|
2006
|
||||||
Weighted
average shares outstanding
|
23,938,078
|
22,680,813
|
|||||
Effect
of dilutive securities
|
11,731
|
23,940
|
|||||
Diluted
shares outstanding
|
23,949,809
|
22,704,753
|
The
156,250 shares underlying warrants issued to Cornell Capital Partners, LP on
March 20, 2006 has not been included in the computation of diluted income per
share because such inclusion would have had an anti-dilutive effect:
Three
Months Ended March 31,
|
|||||||
2007
|
2006
|
||||||
Anti-dilutive
securities
|
94,023
|
67,104
|
Stock-Based
Compensation - The Company may periodically issue shares of common stock for
services rendered or for financing costs. Such shares will be valued based
on
the market price on the transaction date. The Company may periodically issue
stock options to employees and stock options or warrants to non-employees in
non-capital raising transactions for services and for financing costs.
In
July
2004, the Company adopted a stock incentive plan. The maximum number of common
shares for issuance under this plan is 2,200,000 with a period of 10 years.
The
stock incentive plan provides for the issuance, to the Company’s officers,
directors, management and employees, of options to purchase shares of the
Company’s common stock. As of March 31, 2007, the Company has issued 67,500
stock options under this plan and there remain 2,132,500 stock options issuable
in future.
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 at the grant date based on the fair value. The fair
value is determined using the Black-Scholes option pricing model. The resulting
amount is charged to expense on the straight-line basis over the period in
which
the Company expects to receive benefit, which is generally the vesting period.
Comprehensive
Income - The Company has adopted the provisions of Statement of Financial
Accounting Standards No. 130, “Reporting Comprehensive Income” (“SFAS No. 130”).
SFAS No. 130 establishes standards for the reporting and display of
comprehensive income, its components and accumulated balances in a full set
of
general purpose financial statements. SFAS No. 130 defines comprehensive income
to include all changes in equity except those resulting from investments by
owners and distributions to owners, including adjustments to minimum pension
liabilities, accumulated foreign currency translation, and unrealized gains
or
losses on marketable securities.
Estimates
- 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.
Reclassifications
- Certain comparative amounts have been reclassified to conform to the current
year’s presentation.
Comments
- The accompanying interim condensed consolidated financial statements are
unaudited, but in the opinion of management of the Company, contain all
adjustments, which include normal recurring adjustments, necessary to present
fairly the financial position, the results of operations and cash flows for
the
three months ended March 31, 2007 and 2006.
The
consolidated balance sheet as of December 31, 2006 is derived from the Company’s
audited financial statements.
10
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 2006 Annual Report on Form 10-K, as filed with the Securities and
Exchange Commission.
The
results of operations for the three months ended March 31, 2007 are not
necessarily indicative of the results of operations to be expected for the
full
fiscal year ending December 31, 2007.
3.
ACCOUNTS AND NOTES RECEIVABLE
The
Company’s accounts receivable at March 31, 2007 (unaudited) and December 31,
2006 are summarized as follows:
March
31, 2007
|
December
31, 2006
|
||||||
Accounts
receivable
|
$
|
45,491,760
|
$
|
41,174,404
|
|||
Notes
receivable
|
19,193,985
|
20,146,197
|
|||||
Less:
allowance for doubtful accounts
|
(4,208,453
|
)
|
(4,086,218
|
)
|
|||
Balance
at the end of the period
|
$
|
60,477,292
|
$
|
57,234,383
|
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 three
months ended March 31, 2007 (unaudited) and the years ended December 31, 2006
are summarized as follows:
March
31, 2007
|
|
December
31, 2006
|
|||||
Balance
at beginning of period
|
$
|
4,086,218
|
$
|
2,856,025
|
|||
Add:
amounts provided during the period
|
122,235
|
1,099,092
|
|||||
Add:
foreign currency translation
|
—
|
131,101
|
|||||
Balance
at the end of the period
|
$
|
4,208,453
|
$
|
4,086,218
|
4.
OTHER
RECEIVABLES
The
Company’s other receivables at March 31, 2007 (unaudited) and December 31, 2006
are summarized as follows:
|
March
31, 2007
|
December
31, 2006
|
|||||
Other
receivables
|
$
|
2,129,812
|
$
|
1,864,918
|
|||
Less:
allowance for doubtful accounts
|
(697,472
|
)
|
(898,203
|
)
|
|||
Balance
at the end of the period
|
$
|
1,432,340
|
$
|
966,715
|
The
activity in the Company’s allowance for doubtful accounts of other receivable
during the three months ended March 31, 2007 (unaudited) and the years ended
December 31, 2006 are summarized as follows:
March
31, 2007
|
December
31, 2006
|
||||||
Balance
at beginning of the period
|
$
|
898,203
|
$
|
1,040,169
|
|||
Less:
recovered amounts during the period
|
(200,731
|
)
|
(210,861
|
)
|
|||
Add:
foreign currency translation
|
—
|
68,895
|
|||||
Balance
at the end of the period
|
$
|
697,472
|
$
|
898,203
|
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.
5.
INVENTORIES
The
Company’s
inventories at March 31, 2007 (Unaudited) and December 31, 2006 consisted of
the
following:
March
31, 2007
|
December
31, 2006
|
||||||
Raw
materials
|
$
|
5,778,366
|
$
|
5,381,372
|
|||
Work
in process
|
3,741,975
|
3,253,192
|
|||||
Finished
goods
|
9,267,813
|
7,548,218
|
|||||
18,788,154
|
16,182,782
|
||||||
Less:
provision for loss
|
(736,397
|
)
|
(718,211
|
)
|
|||
Balance
at the end of the period
|
$
|
18,051,757
|
$
|
15,464,571
|
11
6.
PROPERTY, PLANT AND EQUIPMENT
The
Company’s property, plant and equipment at March 31, 2007 (unaudited) and
December 31, 2006 are summarized as follows:
March
31, 2007
|
December
31, 2006
|
||||||
Land
use rights and buildings
|
$
|
18,256,372
|
$
|
17,384,534
|
|||
Machinery
and equipment
|
34,143,895
|
33,466,198
|
|||||
Electronic
equipment
|
3,006,758
|
2,945,454
|
|||||
Motor
vehicles
|
2,066,034
|
2,095,169
|
|||||
Construction
in progress
|
2,810,292
|
3,280,279
|
|||||
60,283,351
|
59,171,634
|
||||||
Less:
Accumulated depreciation
|
(19,747,743
|
)
|
(18,323,588
|
)
|
|||
Balance
at the end of the period
|
$
|
40,535,608
|
$
|
40,848,046
|
Depreciation
charge for the three months ended March 31, 2007 and the year ended December
31,
2006 are $1,708,431 and $5,816,922 respectively.
7.
INTANGIBLE ASSETS
The
activities in the Company’s intangible asset account at March 31, 2007
(unaudited) and December 31, 2006 are summarized as follows:
March
31, 2007
|
December
31, 2006
|
||||||
Balance
at beginning of period
|
$
|
3,140,548
|
$
|
3,503,217
|
|||
Add:
additions during the period-
|
|||||||
Patent
technology
|
—
|
109,073
|
|||||
Management
software license
|
12,404
|
65,852
|
|||||
Foreign
currency translation
|
—
|
121,698
|
|||||
Less:
decrease during the period-
|
|||||||
Patent
technology
|
(2,600,204
|
)
|
—
|
||||
552,748
|
3,799,840
|
||||||
Less:
Amortization for the period
|
(119,360
|
)
|
(659,292
|
)
|
|||
Balance
at the end of the period
|
$
|
433,388
|
$
|
3,140,548
|
When
USAI
was established in 2005, Sensor contributed $3,000,000 as capital, being the
fair market value of the intangible assets, namely the sensor product and the
technology for sensor production, as well as the Joint-venture’s technical
personnel training. As of March 20, 2007 Sensor withdrew from USAI, abandoned
all its right and interest in the Joint-venture, and repossessed the rights
to
the intangible assets at the carrying value of the intangible assets was
$2,600,204. Please see Note 1 and Note 14.
8.
BANK
LOANS
At
March
31, 2007,
the
Company, through its Sino-foreign joint ventures, had outstanding fixed-rate
short-term bank loans of $8,333,333, with weighted average interest rate at
5.99% per annum. These loans are secured with some of the property and equipment
of the Company and are repayable within one year.
12
At
December 31, 2006, the Company, through its Sino-foreign joint ventures, had
outstanding fixed-rate short-term bank loans of $15,384,615, with weighted
average interest rate at 5.90% per annum. These loans are secured with some
of
the property and equipment of the Company, and are repayable within one year.
9.
ACCOUNTS AND NOTES PAYABLE
The
Company’s accounts and notes payable at March 31, 2007 (unaudited) and December
31, 2006 are summarized as follows:
March
31, 2007
|
December
31, 2006
|
||||||
Accounts
payable
|
$
|
27,079,756
|
$
|
22,517,260
|
|||
Notes
payable
|
11,462,549
|
15,130,653
|
|||||
Balance
at the end of the period
|
$
|
38,542,305
|
$
|
37,647,913
|
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.
10.
ACCRUED EXPENSES AND OTHER PAYABLES
The
Company’s accrued expenses and other payables at March 31, 2007 (unaudited) and
December 31, 2006 are summarized as follows:
March
31, 2007
|
December
31, 2006
|
||||||
Accrued
expenses
|
$
|
1,498,532
|
$
|
1,695,188
|
|||
Other
payables
|
1,527,918
|
1,987,540
|
|||||
Warranty
reserves
|
3,459,288
|
2,954,326
|
|||||
Dividend
payable to minority interested shareholders of Joint-ventures
|
1,813,169
|
4,441,132
|
|||||
Balance
at the end of the period
|
$
|
8,298,907
|
$
|
11,078,186
|
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 products. Estimates
will be adjusted on the basis of actual claims and circumstances.
13
For
the
three months ended March 31, 2007 (unaudited) and the year ended December 31,
2006, the warranties activities were as follows:
March
31, 2007
|
December
31, 2006
|
||||||
Balance
at the beginning of period
|
$
|
2,954,326
|
$
|
1,787,869
|
|||
Additions
during the reporting period
|
917,265
|
3,956,521
|
|||||
Settlement
within reporting period, by cash or actual material
|
(412,303
|
)
|
(2,858,829
|
)
|
|||
Foreign
currency translation
|
—
|
68,765
|
|||||
Accrual
balance at end of period
|
$
|
3,459,288
|
$
|
2,954,326
|
The
Company has recorded $3,459,288 and $ 2,954,326 product warranty reserves for
the three months ended March 31, 2007 (unaudited) and the year ended December
31, 2006, which were included in the accrued
expenses and other payables
in the
accompanying consolidated financial statements.
11.
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 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 three months ended March
31, 2007 (unaudited) and the year ended December 31, 2006 are summarized as
follows:
March
31, 2007
|
December
31, 2006
|
||||||
Balance
at beginning of the period
|
$
|
3,266,867
|
$
|
2,653,064
|
|||
Amounts
provided during the period
|
296,925
|
1,287,609
|
|||||
Settlement
during the period
|
(287,659
|
)
|
(789,265
|
)
|
|||
Foreign
currency translation
|
--
|
115,459
|
|||||
Balance
at end of period
|
$
|
3,276,133
|
$
|
3,266,867
|
12.
TAXES
PAYABLE
The
Company’s taxes payable at March 31, 2007 (unaudited) and December 31, 2006 are
summarized as follows:
March
31, 2007
|
December
31, 2006
|
||||||
Value-added
tax payable
|
$
|
6,339,081
|
$
|
6,274,698
|
|||
Income
tax payable
|
772,754
|
(362,267
|
)
|
||||
other
tax payable
|
2,503
|
1,931
|
|||||
Balance
at the end of the period
|
$
|
7,114,338
|
$
|
5,914,362
|
14
The
Company’s
subsidiaries registered in the PRC are subject to state and local income taxes
within the PRC at the applicable tax rate on the taxable income as reported
in
their PRC statutory financial statements in accordance with the relevant income
tax laws applicable to foreign invested enterprise. The Company’s PRC
subsidiaries are generally subject to enterprise income tax at a statutory
rate
of 33%, which comprises 30% national income tax and 3% local income
tax.
On
January 1, 1996, one of the subsidiaries of the Company, Jiulong, was granted
an
enterprise income tax holiday of a 100% enterprise income tax exemption for
two
years commencing from 1996, and a 50% enterprise national income tax deduction
and a 100% local income tax deduction for the next nine years thereafter, from
1998 to 2006, for income tax purpose. In 2007, Jiulong continued to be granted
a
100% local income tax deduction.
On
January 1, 1999, one of the subsidiaries of the Company, Henglong, was granted
an enterprise income tax holiday of a 100% enterprise income tax exemption
for
two years commencing from 1999, and a 50% enterprise national income tax
deduction and a 100% local income tax deduction for the next nine years
thereafter, from 2001 to 2009, for income tax purpose.
On
January 1, 2003, one of the subsidiaries of the Company, Shenyang, was granted
an enterprise income tax holiday of a 100% enterprise income tax exemption
for
two years commencing from 2003, and a 75% enterprise national income tax
deduction and a 100% local income tax deduction for the next three years
thereafter, from 2005 to 2007, for income tax purpose.
On
January 1, 2004, one of the subsidiaries of the Company, Zhejiang, was granted
an enterprise income tax holiday of a 100% enterprise income tax exemption
for
two years commencing from 2004, and a 50% enterprise national income tax
deduction and a 50% local income tax deduction for the next three years
thereafter, from 2006 to 2008, for income tax purpose.
USAI,
Wuhu and Jielong are at their start up stage and accordingly, there is no
assessable profit for the period ended March 31, 2007 subject to PRC enterprise
income tax.
No
provision for Hong Kong tax is made as Jilong and Great
Genesis
are both investment holding companies, and have no assessable income in Hong
Kong for the three months ended March 31, 2007 and the year ended December
31,2006.
No
provision for US tax is made as the Company has no assessable income in US
for
the three months ended March 31, 2007 and the year ended December 31,2006.
The
Company’s activities of income taxes at March 31, 2007 (unaudited) and December
31, 2006 are summarized as follows:
March
31,2007
|
December
31, 2006
|
||||||
Tax
rate
|
7.5%-30.0%
|
|
7.5%-16.5%
|
|
|||
Balance
at beginning of the period(a)
|
$ |
(362,267
|
)
|
$ |
(624,707
|
)
|
|
Add:
additions during the period-
|
|||||||
Accrual
taxation
|
1,294,080
|
2,597,189
|
|||||
Less:
decrease during the period-
|
|||||||
Income
tax refund (b)
|
—
|
(928,108
|
)
|
||||
Settlement
during the period
|
(159,059
|
)
|
(1,382,614
|
)
|
|||
Foreign
currency translation
|
—
|
(24,027
|
)
|
||||
Balance
at the end of the period
|
$ |
772,754
|
$ |
(362,267
|
)
|
15
(a)At
the
end of the fiscal year, the Company must deliver income tax in advance, and
the
government will liquidate with the Company within the three months after the
end
of the fiscal year.
(b)Two
of
the Company’s Sino-foreign joint ventures, Henglong and Jiulong, received an
income tax benefit of $928,108 in 2006 for purchase of domestic equipment,
which
has been reflected as a reduction to income tax expense in the Company’s
consolidated statements of operations for the year ended December 31, 2006.
The
2007 income tax refund is in application.
13.
AMOUNTS DUE TO SHAREHOLDERS/DIRECTORS
The
activities in the amounts due to shareholders/directors at March 31, 2007
(unaudited) and December 31, 2006 are summarized as follows:
March
31, 2007
|
December
31, 2006
|
||||||
Balance
at the beginning of period
|
$
|
358,065
|
$
|
766,642
|
|||
Decrease
during the reporting period
|
(40,000
|
)
|
(429,061
|
)
|
|||
Foreign
currency translation
|
—
|
20,484
|
|||||
Balance
at end of period
|
$
|
318,065
|
$
|
358,065
|
The
amounts due to shareholders/directors were unsecured, interest-free and
repayable on demand.
14.
MINORITY INTERESTS
The
Company’s activities in respect of the amounts of the minority interests’ equity
at March 31, 2007 (unaudited) and December 31, 2006 are summarized as
follows:
March
31, 2007
|
December
31, 2006
|
||||||
Balance
at beginning of the period
|
$
|
23,112,667
|
$
|
21,751,043
|
|||
Add: Additions during the period- | |||||||
Contribution
by minority shareholders
|
—
|
2,332,470
|
|||||
Minority
interest’s income
|
1,894,895
|
5,545,350
|
|||||
Increase
in connection with minority shareholders’ abandonment of all its right and
interest in Joint-venture.
|
32,916
|
—
|
|||||
Foreign
currency translation
|
—
|
1,468,787
|
|||||
Less:
decrease during the period-
|
|||||||
dividends
declared to the minority interest holders of Joint-venture
companies
|
(544,607
|
)
|
(7,984,983
|
)
|
|||
Decrease
in minority interests as a result of minority shareholder, Sensor’s
withdrawal from Joint-venture
|
(2,830,545
|
)
|
—
|
||||
Balance
at end of period
|
$
|
21,665,326
|
$
|
23,112,667
|
16
As
of
March 20, 2007, Great Genesis, Hongxi and Sensor entered into an agreement,
which led to Sensor’s
withdrawal from USAI, its withdrawal of intangible assets, and abandonment
of
all its right and interest in USAI. Please see Note 1.
The
calculation of the withdrawal of Sensor is summarized as follows:
Equity
of
USAI
|
|||||||||||||||||||
(before
|
Sensor’s
|
Additional
paid-in capital
|
|||||||||||||||||
Sensor’s
withdrawal
|
Withdrawal
|
Carrying
value of
|
|||||||||||||||||
at
March 20,
|
of
equity in
|
intangible
assets
|
Abandoned
|
The
|
|||||||||||||||
2007)
|
USAI
|
withdrawn
|
interest
|
Company’s
|
Hongxi’s
|
||||||||||||||
a
|
b
|
c
|
d=b-c
|
e=d*85.71%
|
f=d*14.29%
|
||||||||||||||
Additional
paid-in capital
|
$
|
4,337,291
|
$
|
3,000,000
|
$
|
2,600,204
|
$
|
399,796
|
$
|
342,665
|
$
|
57,131
|
|||||||
Foreign
currency translation
|
219,927
|
183,923
|
—
|
183,923
|
157,641
|
26,283
|
|||||||||||||
Stockholders'
deficit
|
(1,177,928
|
)
|
(353,378
|
)
|
—
|
(353,378
|
)
|
(302,881
|
)
|
(50,498
|
)
|
||||||||
Equity
|
$
|
3,379,290
|
$
|
2,830,545
|
$
|
2,600,204
|
$
|
230,341
|
$
|
197,425
|
$
|
32,916
|
Sensor’s
withdrawal from USAI, its withdrawal of intangible assets, and abandonment
of
all its right and interest in USAI, was debited into minority interests of
$2,830,545, and credited into intangible assets of $2,600,204. The abandoned
interest of $230,341, recognized as additional paid-in capital of USAI, was
credited into additional paid-in capital and minority interests of $197,425
and
$32,916,
respectively.
17
15.
SHARE
CAPITAL
The
Company’s activities in its share capital account during the three months ended
March 31, 2007 (unaudited) and the year ended December 31, 2006 are summarized
as follows:
March
31, 2007
|
December
31, 2006
|
||||||||||||
Common
Stock
|
Par
Value
|
Common
Stock
|
Par
Value
|
||||||||||
Balance
at beginning of the period
|
23,851,581
|
$
|
2,385
|
22,574,543
|
$
|
2,257
|
|||||||
Add:
Additions during the period
|
|||||||||||||
Issuance
of common stock for cash in accordance with the standby equity
distribution agreement with Cornell Capital Partners, LP
|
108,121
|
11
|
1,216,675
|
122
|
|||||||||
Exercise
of stock option by independent directors
|
—
|
—
|
22,500
|
2
|
|||||||||
Pay
commissions and placement agent fee in accordance with the standby
equity
distribution agreement with Cornell Capital Partners, LP
|
—
|
—
|
37,863
|
4
|
|||||||||
Balance
at end of period
|
23,959,702
|
$
|
2,396
|
23,851,581
|
$
|
2,385
|
On
January 17, 2007, the Company raised gross amounts of $1,200,000 in a private
placement (PIPE) to Cornell Capital Partners, LP (“Investor”)
by issuing 108,121 shares of common stock.
16.
ADDITIONAL PAID-IN CAPITAL
The
Company’s activities in the Company’s additional paid-in capital account during
the three months ended March 31, 2007 (unaudited) and the year ended December
31, 2006 are summarized as follows:
March
31, 2007
|
|
December
31, 2006
|
|
||||
Balance
at beginning of the period
|
$
|
28,651,959
|
$
|
18,146,722
|
|||
Add:
Additions during the period-
|
|||||||
Issuance
of common stock for cash in accordance with the standby equity
distribution agreement with Cornell Capital Partners, LP. Please
see Note
15.
|
1,199,989
|
10,899,872
|
|||||
Exercise
of stock option by independent directors
|
—
|
101,248
|
|||||
Issuance
of stock options to independent directors
|
—
|
131,625
|
|||||
Issuance
of common stock in accordance with the standby equity distribution
agreement with Cornell Capital Partners, LP
|
—
|
449,996
|
|||||
Issuance
of common stock warrants in accordance with the standby equity
distribution agreement with Cornell Capital Partners, LP
|
—
|
832,639
|
|||||
Increase
in connection with minority shareholders’ abandonment
of all its right and interest in Joint-venture. (Please see Note
14.)
|
197,425
|
—
|
|||||
Less:
decrease during the period-
|
|||||||
Payment
of commissions and placement agent fee by issuance of common stock
in
accordance with the standby equity distribution agreement with Cornell
Capital Partners, LP
|
—
|
(449,996
|
)
|
||||
Payment
of commissions and placement agent fee by issuance of common stock
warrants in accordance with the standby equity distribution agreement
with
Cornell Capital Partners, LP
|
—
|
(832,639
|
)
|
||||
Cash
paid for retaining fee, commissions
and placement agent fee in connection with offering. (Please see
Note
15.)
|
(54,500
|
)
|
(627,504
|
)
|
|||
Payment
of commissions and placement agent fee by issuance of common stock
in
accordance with the standby equity distribution agreement with Cornell
Capital Partners, LP
|
—
|
(4
|
)
|
||||
Balance
at end of period
|
$
|
29,994,873
|
$
|
28,651,959
|
18
17.
SIGNIFICANT CONCENTRATIONS
The
Company grants credit to its customers, generally on an open account
basis. The Company’s customers are all located in the PRC.
During
the three months ended March 31, 2007 (unaudited), the Company’s ten largest
customers accounted for 75.5% of the Company’s consolidated net sales, with each
of four customers individually accounting for more than 10% of consolidated
net
sales, i.e. 15.7%, 13.0%, 11.7% and 11.4% individually, or an aggregate of
51.8%. At March 31, 2007, approximately 34.0% of accounts receivable were
from trade transactions with the aforementioned four customers.
During
the three months ended March 31, 2006 (unaudited), the Company’s ten largest
customers accounted for 64.2% of the Company’s consolidated net sales, with each
of four customers individually accounting for more than 10% of consolidated
net
sales, i.e. 13.8%, 13.0%, 11.9% and 11.2% individually, or an aggregate of
49.9%. At March 31, 2006, approximately 36.2% of accounts receivable were
from trade transactions with the aforementioned four customers.
18.
RELATED PARTY TRANSACTIONS AND BALANCES
Related
party transactions with companies with common directors are as
follows:
Related
sales:
Three
Months Ended March 31,
|
|||||||
2007
|
2006
|
||||||
Merchandise
Sold to Related Parties (unaudited)
|
$
|
902,584
|
$
|
583,539
|
Related
purchases (unaudited):
Three
Months Ended March 31,
|
|||||||
2007
|
2006
|
||||||
Materials
Purchased from Related Parties
|
$
|
1,051,480
|
$
|
655,995
|
|||
Technology
Purchased from Related Parties
|
64,103
|
188,640
|
|||||
Equipment
Purchased from Related Parties
|
181,218
|
109,788
|
|||||
Total
|
$
|
1,296,801
|
$
|
954,423
|
19
Related
receivables
(March
31, 2007 unaudited):
March
31,2007
|
December
31, 2006
|
||||||
Accounts
receivable
|
$
|
2,090,888
|
$
|
1,770,933
|
|||
Other
receivables
|
664,016
|
738,510
|
|||||
Total
|
$
|
2,754,904
|
$
|
2,509,443
|
Related
advances
(March
31, 2007 unaudited):
March
31,2007
|
December
31, 2006
|
||||||
Advanced
Equipment Payment to Related Parties
|
$
|
1,159,667
|
$
|
488,873
|
|||
Advanced
Expenses and Others to Related Parties
|
181,590
|
487,333
|
|||||
Total
|
$
|
1,341,257
|
$
|
976,206
|
Related
payables
March
31,2007
|
December
31, 2006
|
||||||
Accounts
payable
(March 31, 2007 unaudited)
|
$
|
893,901
|
$
|
640,405
|
These
transactions were consummated under similar terms as those with the Company's
customers and suppliers.
19.
COMMITMENTS AND CONTINGENCIES:
Legal
Proceedings - The Company is not currently a party to any threatened or pending
legal proceedings, other than incidental litigation arising in the ordinary
course of business. In the opinion of management, the ultimate disposition
of
these matters will not have a material adverse effect on the Company's
consolidated financial position, results of operations or cash flows.
20
The
following table summarizes the Company‘s major contractual payment obligations
and commitments as of March 31, 2007 (unaudited):
Payment
Obligations by Period
|
|||||||||||||||||||
2007(a)
|
2008
|
2009
|
2010
|
Thereafter
|
Total
|
||||||||||||||
Obligations
for service agreements
|
$
|
110,000
|
$
|
110,000
|
$
|
110,000
|
$
|
110,000
|
$
|
110,000
|
$
|
550,000
|
|||||||
Obligations
for purchasing agreements
|
3,215,525
|
1,395,451
|
—
|
—
|
—
|
4,610,976
|
|||||||||||||
Total
|
$
|
3,325,525
|
$
|
1,505,451
|
$
|
110,000
|
$
|
110,000
|
$
|
110,000
|
$
|
5,160,976
|
(a)
Remaining 9 months in 2007
20.
OFF-BALANCE SHEET ARRANGEMENTS
At
March
31, 2007 and 2006, the Company did not have any transactions, obligations or
relationships that could be considered off-balance sheet
arrangements.
21.
SEGMENT REPORTING
The
accounting policies of the product sectors are the same as those described
in
the summary of significant accounting policies except that the disaggregated
financial results for the product sectors have been prepared using a management
approach, which is consistent with the basis and manner in which management
internally disaggregates financial information for the purposes of assisting
them in making internal operating decisions. Generally, the Company evaluates
performance based on stand-alone product sector operating income and accounts
for inter segment sales and transfers as if the sales or transfers were to
third
parties, at current market prices.
During
the three months ended March 31, 2007 (unaudited), the Company had seven product
sectors, five of them were principal profit makers, which were reported as
separate sectors which engaged in the production and sales of power steering
(Henglong), power steering (Jiulong), power steering (Shenyang), power pumps
(Zhejiang), and power steering (Wuhu). The other two sectors which were
established in 2005 and 2006 respectively, engaged in the production and sales
of sensor modular (USAI), and electronic power steering (Jielong).Since the
revenues, net income and net assets of these two sectors are less than 10%
of
its segment in the consolidated statement, the Company incorporated these three
sectors into “other sectors”.
During
the three months ended March 31, 2006 (unaudited), the Company had seven product
sectors, four of them were principal profit makers, which were reported as
separate sectors which engaged in the production and sales of power steering
for
cars (Henglong), power steering for trucks (Jiulong), power steering for light
duty vehicles (Shenyang), and power pumps (Zhejiang). To conform with the year
2007, power steering (Wuhu) was reported separately. The other two sectors
which
were established in 2005 and 2006 respectively, engaged in the production and
sales of sensor modular (USAI), and electronic power steering (Jielong).Since
the revenues, net income and net assets of these two sectors are less than
10%
of its segment in the consolidated statement, the Company incorporated these
three sectors into “other sectors”
21
The
Company’s product
sectors information is as follows:
Henglong
|
Jiulong
|
Shenyang
|
Zhejiang
|
Wuhu
|
Other
sector
|
Other
(1)
|
Total
|
||||||||||||||||||
For
the Three Months Ended:
|
|
||||||||||||||||||||||||
March
31,2007
|
|||||||||||||||||||||||||
Revenue
|
|||||||||||||||||||||||||
Net
product sales - external
|
$
|
10,545,718
|
$
|
7,421,381
|
$
|
3,317,584
|
$
|
3,257,331
|
$
|
3,829,849
|
$
|
11,529
|
$
|
—
|
$
|
28,383,392
|
|||||||||
Net
product sales - internal
|
6,379,077
|
1,094,395
|
603,268
|
8,729
|
—
|
—
|
(8,085,469
|
)
|
—
|
||||||||||||||||
Gain
on other sales and other income - external
|
114,177
|
32,050
|
8,193
|
(2,546
|
)
|
—
|
—
|
(1,318
|
)
|
150,556
|
|||||||||||||||
Total
revenue
|
$
|
17,038,972
|
$
|
8,547,826
|
$
|
3,929,045
|
$
|
3,263,514
|
$
|
3,829,849
|
$
|
11,529
|
$
|
(8,086,787
|
)
|
$
|
28,533,948
|
||||||||
Net
income
|
$
|
1,450,313
|
$
|
772,381
|
$
|
358,006
|
$
|
279,858
|
$
|
(305,945
|
)
|
$
|
(70,067
|
)
|
$
|
(841,445
|
)
|
$
|
1,643,101
|
||||||
March
31,2006
|
|||||||||||||||||||||||||
Revenue
|
|||||||||||||||||||||||||
Net
product sales - external
|
$
|
10,417,337
|
$
|
5,368,643
|
$
|
3,444,778
|
$
|
1,733,231
|
$
|
—
|
$
|
463
|
$
|
—
|
$
|
20,964,452
|
|||||||||
Net
product sales - internal
|
1,097,048
|
252,204
|
94,763
|
294,458
|
—
|
—
|
(1,738,473
|
)
|
—
|
||||||||||||||||
Gain
on other sales and other income - external
|
52,667
|
22,418
|
7,934
|
1,241
|
—
|
—
|
(921
|
)
|
83,339
|
||||||||||||||||
Total
revenue
|
$
|
11,567,052
|
$
|
5,643,265
|
$
|
3,547,475
|
$
|
2,028,930
|
$
|
—
|
$
|
463
|
$
|
(1,739,394
|
)
|
$
|
21,047,791
|
||||||||
Net
income
|
$
|
522,795
|
$
|
449,944
|
$
|
159,244
|
$
|
108,165
|
$
|
—
|
$
|
(58,864
|
)
|
$
|
(86,886
|
)
|
$
|
1,094,398
|
(1)
Other
includes activity not allocated to the product sectors and elimination of
inter-sector transactions.
22.
SUBSEQUENT EVENTS
None
ITEM
2.
|
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
|
Cautionary
Statement Pursuant to Safe Harbor Provisions of the Private Securities
Litigation Reform Act of 1995:
This
Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2007
contains “forward-looking statements” within the meaning of Section 27A of the
Securities Act of 1933, as amended and Section 21E of the Securities Exchange
Act of 1934, as amended. Generally, the words “believes”, “anticipates,”
“may,” “will,” “should,” “expect,” “intend,” “estimate,” “continue,” and similar
expressions or the negative thereof or comparable terminology are intended
to
identify forward-looking statements which 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. Such statements are subject to certain risks and uncertainties,
including the matters set forth in this Quarterly Report or other reports or
documents the Company files with the Securities and Exchange Commission from
time to time, which could cause actual results or outcomes to differ materially
from those projected. Undue reliance should not be placed on these
forward-looking statements which speak only as of the date hereof. The
Company undertakes no obligation to update these forward-looking
statements. In addition, the forward-looking statements in this Quarterly
Report on Form 10-Q for the quarterly period ended March 31, 2007 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. Please see the discussion on risk factors in Item 1A of Part II of
this quarterly report on Form 10-Q.
22
GENERAL
OVERVIEW:
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, through its
Sino-foreign joint ventures described below, is primarily 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.
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”, is a wholly-owned subsidiary of the Company. 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.
The
Company owns the following aggregate net interests in seven Sino-foreign joint
ventures organized in the PRC as of March 31, 2007 and 2006 (unaudited).
Percentage
Interest
|
|||||||
Name
of Entity
|
March
31, 2007
|
March
31, 2006
|
|||||
Shashi
Jiulong Power Steering Gears Co., Ltd., "Jiulong"
|
81.00
|
%
|
81.00
|
%
|
|||
Jingzhou
Henglong Automotive Parts Co., Ltd., "Henglong"
|
44.50
|
%
|
44.50
|
%
|
|||
Shenyang
Jinbei Henglong Automotive Steering System Co., Ltd.,
”Shenyang”
|
70.00
|
%
|
70.00
|
%
|
|||
Zhejiang
Henglong & Vie Pump-Manu Co., Ltd., "Zhejiang"
|
51.00
|
%
|
51.00
|
%
|
|||
Universal
Sensor Application Inc., “USAI”
|
85.71
|
%
|
60.00
|
%
|
|||
Wuhan
Jielong Electric Power Steering Co., Ltd., “Jielong”
|
85.00
|
%
|
—
|
||||
Wuhu
HengLong Automotive Steering System Co., Ltd., “Wuhu”
|
77.33
|
%
|
—
|
Jiulong
was established in 1993 and mainly engaged in the production of integral power
steering gears for heavy-duty vehicles.
Henglong
was established in 1997 and mainly engaged in the production of rack and pinion
power steering gears for cars and light duty vehicles.
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.
On
April
12, 2005, Great Genesis entered into a Joint-venture agreement with Shanghai
Hongxi Investment Inc., “Hongxi”, a company controlled by Mr. Hanlin Chen, the
Company’s Chairman, and Sensor System Solution Inc., “Sensor”, to establish a
joint venture, Universal Sensor Application Inc., “USAI”, in the Wuhan East Lake
development zone to engage in production and sales of sensor modulars. The
registered capital of the Joint-venture is $10 million. Great Genesis and Hongxi
intended to invest $6 million and $1 million, respectively, including cash
and
land and building, which would account for 60% and 10% of the total registered
capital, respectively. Sensor would invest $3 million in technology, accounting
for 30% of the total registered capital. As of March 20, 2007, the three parties
of USAI, Great Genesis, Hongxi, Sensor, entered into an agreement, which led
to
Sensor’s withdrawal from USAI and abandonment of all its rights and interests in
USAI. The registered capital of the Joint-venture has changed to $7,000,000,
with 85.71% owned by the Company, 14.29% owned by Hongxi. Since the withdrawal
of intangible assets, another technology supplier is being sought.
23
On
April
14, 2006, Great Genesis entered into a Joint-venture agreement with Hong Kong
Tongda, “Tongda”, to establish a joint venture, Wuhan Jielong Electric Power
Steering Co., Ltd., “Jielong”, in the Wuhan East Lake development zone. Jielong
is mainly engaged in the production and sales of electric power steering, “EPS”.
The registered capital of the Joint-venture is $6 million. Great Genesis and
Tongda will invest $5,100,000 and $900,000, respectively, amounting to 85%
and
15% of the total registered capital, respectively.
On
March
31, 2006, as amended on May 2, 2006, Great Genesis, entered into a Joint-venture
agreement with Wuhu Chery Technology Co., Ltd., “Chery Technology”, to establish
a Joint-venture, Wuhu Henglong Automotive Steering System Co., Ltd., “Wuhu”, in
the Wuhu Technological Development Zone. Wuhu is mainly engaged in the
production and sales of automobile steering system. The registered capital
of
the Joint-venture is $3,750,387,
the
equivalent of RMB 30,000,000. Great Genesis and Chery Technology invested
$2,900,300, the equivalent of RMB 23,200,000, and $848,938, the equivalent
of
RMB 6,800,000, respectively, which accounts for 77.33% and 22.67% of the total
registered capital, respectively.
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. The following critical accounting policies affect
the
more significant judgments and estimates used in the preparation of the
Company’s condensed consolidated financial statements.
We
consider an accounting estimate to be critical if:
• It
requires us to make assumptions about matters that were uncertain at the time
we
were making the estimate, and
• Changes
in the estimate or different estimates that we could have selected would have
had a material impact on our financial condition or results of operations.
24
The
table
below presents information about the nature and rationale for the Company
critical accounting estimates:
Balance
Sheet Caption
|
Critical
Estimate Item
|
Nature
of Estimates
Required
|
Assumptions/Approaches
Used
|
Key
Factors
|
||||
Accrued
liabilities and other long-term liabilities
|
Warranty
obligations
|
Estimating
warranty requires us to forecast the resolution of existing claims
and
expected future claims on products sold. VMs are increasingly seeking
to
hold suppliers responsible for product warranties, which may impact
our
exposure to these costs.
|
We
base our estimate on historical trends of units sold and payment
amounts,
combined with our current understanding of the status of existing
claims
and discussions with our customers.
|
• VM
(Vehicle Manufacturer) sourcing
• VM
policy decisions regarding warranty claims
|
||||
Property,
plant and equipment, intangible assets and other long-term
assets
|
Valuation
of long- lived assets and investments
|
We
are required from time-to-time to review the recoverability of certain
of
our assets based on projections of anticipated future cash flows,
including future profitability assessments of various product lines.
|
We
estimate cash flows using internal budgets based on recent sales
data,
independent automotive production volume estimates and customer
commitments.
|
• Future
production estimates
• Customer
preferences and decisions
|
||||
Accounts
and notes receivables
|
Provision
for doubtful accounts and notes receivable
|
Estimating
the provision for doubtful accounts and notes receivable require
the
Company to analyze and monitor each customer’s credit standing and
financial condition regularly. The Company grants credit to its customers,
generally on an open account basis. It will material adverse effect
the
Company’s cost disclosure if such assessment were
improper.
|
The
Company grants credit to its customers for three to four months based
on
each customer’s current credit standing and financial data. The Company
assesses allowance on an individual customer basis, under normal
circumstances, the Company does not record any provision for doubtful
accounts for those accounts receivable amounts which were in credit
terms.
For those receivables out of credit terms, certain proportional provision,
namely 25% to 100%, will be recorded based on respective overdue
terms.
|
• Customers’
credit standing and financial
condition
|
In
addition, there are other items within our financial statements that require
estimation, but are not as critical as those discussed above. These include
the
allowance for reserves for excess and obsolete inventory. Although not
significant in recent years, changes in estimates used in these and other items
could have a significant effect on our consolidated financial statements.
RESULTS
OF OPERATIONS——THREE MONTHS ENDED MARCH 31, 2007 AND 2006:
The
following table sets forth for the periods indicated certain items from the
Company's Consolidated Statements of Income expressed as a percentage of net
sales and the percentage change in the dollar amount of each such item from
that
in the indicated previous year.
Percentage
on net sales
|
Change
in percentage
|
|||||||||
2007
|
2006
|
2006
to 2007
|
||||||||
Net
sales
|
100.0
|
%
|
100.0
|
%
|
35.4
|
%
|
||||
Cost
of sales
|
67.6
|
66.9
|
36.9
|
|||||||
Gross
profit
|
32.4
|
33.1
|
32.3
|
|||||||
Gain
on other sales (a)
|
0.4
|
0.4
|
35.5
|
|||||||
Less:
operating expenses –
|
||||||||||
Selling
expenses (a)
|
5.6
|
7.1
|
6.8
|
|||||||
General
and administrative expenses (a)
|
5.3
|
9.7
|
(25.9
|
)
|
||||||
R
& D expenses
|
0.4
|
0.9
|
(37.0
|
)
|
||||||
Depreciation
and amortization
|
3.1
|
3.3
|
29.7
|
|||||||
Total
operating expenses
|
14.4
|
21.0
|
(6.6
|
)
|
||||||
Operating
income
|
18.4
|
12.5
|
98.1
|
|||||||
Other
income (a)
|
0.1
|
0.0
|
--
|
|||||||
Financial
expenses
|
(1.4
|
)
|
(1.6
|
)
|
18.1
|
|||||
Income
before income tax
|
17.1
|
10.9
|
111.4
|
|||||||
Income
tax
|
4.6
|
1.0
|
544.7
|
|||||||
Income
before minority interests
|
12.5
|
9.9
|
69.7
|
|||||||
Minority
interests
|
6.7
|
4.7
|
91.3
|
|||||||
Net
income
|
5.8
|
%
|
5.2
|
%
|
50.1
|
%
|
(a)
For
the convenience of comparability, the Company has reclassified warranty expenses
from general and administrative expenses into after-sales service under selling
expenses, and part of non-operating income which was attributable to operating
income into Gain on other sales, to be consistent with the presentation of
its
financial statement for the three months ended March 31, 2007.
NET
SALES:
Net
sales
were $28,383,392 for the three months ended March 31, 2007, as compared to
$20,964,452 for the three months ended March 31, 2006, an increase of $7,418,940
or 35.4%. The increase in net sales in 2007 as compared to 2006 was a
result of the following factors:
(1)
Increases in the income of Chinese residents and the growth of consumption
led
to an increase in the sales of passenger vehicles and an increase in the
Company’s sales of steering gear and pumps. As a result, sales of steering gear
and pumps for domestic passenger vehicles for the three months ended March
31,
2007 increased 27.6% and 87.9% over the same period of 2006,
respectively.
(2)
Increased investments and business activities in China led to an increase in
sales of commercial vehicles. For the three months ended March 31, 2007, sales
of steering gears and accessories for commercial vehicles increased by 38.2%
as
compared to the same period of 2006.
25
(3)
The
Company has raised the technological contents in and production efficiency
of
its products as a result of technological improvement to its production lines,
allowing the Company to reduce its costs and, correspondingly, its sales prices
which led to increased sales volumes.
GROSS
PROFIT
For
the
three months ended March 31, 2007, gross profit was $9,191,906, as compared
to
$6,945,197 for the three months ended March 31, 2006, an increase of $2,246,709
or 32.3%.
The
increase in sales contributed to an increase of $2,638,952 in gross profit,
a
decrease in unit cost resulted in an increase of $75,944 in gross profit, which
was partially offset by a decrease in selling prices which resulted in a
decrease of $468,187 in gross profit.
Gross
margin was 32.4% for the three months ended March 31, 2007, a decrease of 0.7%
from 33.1% for the same period of 2006. The decrease reflects a decrease
in selling prices which was partially offset by a cost decrease. The
decrease in gross profit was consistent with the Company’s expectation that the
sales price of automotive parts would fall approximately by 5%-7% during 2007
as
compared to 2006. The Company plans to take the following measures in the
remaining nine months of 2007 to reduce costs and to meet its yearly gross
margin target of not less than 30%:
1.
Reduce
manufacturing costs by optimizing product design and production techniques.
During 2007, the Company’s technical personnel will improve product design and
production techniques to reduce wastage in the production process and improve
manufacturing efficiency, thus reducing costs. The Company estimates the
manufacturing costs will be reduced by 1.5% as compared to 2006 as a result
of
the optimized product design and production techniques.
2.
Reduce
the cost of raw materials. In 2007, the Company plans to continue controlling
the costs of raw materials in two ways: Firstly, volume purchase of major raw
materials will be made through a bidding process, and for purchases of other
smaller quantities of non major materials, “target prices” will be set to guide
such purchases. Secondly, to set “target profit” to further control purchase
cost of raw materials. The Company estimated that material cost will be reduced
by 1.6% as a result of these measures.
GAIN
ON
OTHER SALES
Gain
on
other sales consisted of net amount retained from sales of materials and other
assets. For the three months ended March 31, 2007, gain on other sales were
$112,094, as compared to $82,715 for the same period of 2006, an increase of
$29,379 or 35.5%, mainly due to increased sales of materials.
SELLING
EXPENSES
Selling
expenses were $1,593,646 for the three months ended March 31, 2007, as compared
to $1,492,488 for the same period of 2006, an increase of 101,158 or
6.8%. Material increased items were salaries and wages expense, and
transportation expense.
The
increase in salaries and wages expense was due to an increase of 35.4% in net
sales for the three months ended March 31, 2007 as compared to the same period
of 2006, so that bonuses, as a percentage of net sales, paid to sales staff
also
increased accordingly.
The
increase in transportation expense was due to increased sales and a rise in
the
price of oil, which led to increases in domestic transportation
prices.
26
GENERAL
AND ADMINISTRATIVE EXPENSES
General
and administrative expenses were $1,509,027 for the three months ended March
31,
2007, as compared to $2,037,537 for the same period of 2006, a decrease of
$528,510 or 25.9%.
There
was
a material decrease in the provision for doubtful accounts. The
Company grants credit to its customers, generally on an open account basis.
Credit terms, based on each customer’s historical credit standing, is three to
four months. In normal circumstance, the Company does not record any provision
for doubtful accounts for those accounts receivable amounts which were in
credit. For those receivables in excess of normal credit terms a provision
has
been recorded accordingly. For those receivables in excess of credit terms,
a
provision has been recorded accordingly. During the three months ended March
31,
2007, the Company further tightened
its credit control, leading to a decreased
accounts receivable balance, thus recovering part of the provision for doubtful
accounts recorded in prior years.
RESEARCH
AND DEVELOPMENT EXPENSES
Research
and development expenses were $119,465 for the three months ended March 31,
2007, as compared to $189,747 for the three months ended March 31, 2006, a
decrease of $70,282 or 37.0%, as a result of the Company’s R&D department
focusing on applications of prior purchased versus organic
technologies.
DEPRECIATION
AND AMORTIZATION EXPENSE
For
the
three months ended March 31, 2007, the depreciation and amortization expenses
excluding those recorded in cost of sales were $893,251, as compared to $688,490
for the three months ended March 31, 2006, an increase of $204,761 or 29.7%,
as
a result of increased property, plant and equipment.
INCOME
FROM OPERATIONS
Income
from operations was $5,188,611 for the three months ended March 31, 2007, as
compared to $2,619,650 for the three months ended March 31, 2006, an increase
of
$2,568,961 or 98.1%, as a result of an increase of $2,246,709 or 32.3% in gross
profit, an increase of $29,379 or 35.5% in gain on other sales, and a decrease
of $292,873 or 6.6% in operating expenses.
OTHER
INCOME
Other
income was $38,462 for the three months ended March 31, 2007, as compared to
$624 for the same period of 2006, an increase of $37,838, primarily as a result
of increased government subsidy.
Interest
subsidy means the refunds by the Chinese Government of interest charged by
banks
to companies which are entitled to such subsidy. This kind of subsidy applies
only to loan interest related to production facilities expansion.
Whether
or not a company can receive interest subsidies from the Chinese Government
depends on whether the company’s technological improvement has achieved its
expected goal of production expansion and quality enhancement.
FINANCIAL
EXPENSES
Financial
expenses were $394,997 for the three months ended March 31, 2007, as compared
to
$334,386 for the three months ended March 31, 2006, an increase of $60,611
or
18.1%, primarily result of an increase in weighted average interest rates from
5.91% for the three months ended March 31, 2006 to 5.99% for the three months
ended March 31, 2007.
27
INCOME
BEFORE INCOME TAXES
Income
before income taxes was $4,832,076 for the three months ended March 31, 2007,
as
compared to $2,285,888 for the three months ended March 31, 2006, an increase
of
$2,546,188 or 111.4%, as a result of an increase in income from operations
of
$2,568,961 or 98.1%, an increase in gain on other sales of $37,838, and an
increase in financial expenses of $60,611 or 18.1%.
INCOME
TAXES
Income
taxes expense was $1,294,080 for the three months ended March 31, 2007, as
compared to $200,711 for the three months ended March 31, 2006, an increase
of
$1,093,369 or 544.7%, mainly because of:
1.
Increased income before income taxes resulted in increased income tax of
$472,555.
2.
The
Company has received an income tax refund of $365,793 for domestic equipment
purchased during the three months ended March 31, 2006. In 2007, the Company
did
not receive any income tax refund. In accordance with the relevant regulations
of income taxes stipulated by the Ministry of Finance and Administration of
Taxation, 40% of domestic equipment purchases can be refundable from increased
income taxes for the purchasing year over those of the previous year.
The
2007
income tax refund is in application.
3.
One of
the Company’s Sino-foreign joint ventures, Jiulong, has finished its 50% state
tax exemption by December 31, 2006. During the three months ended March 31,
2007, Jiulong was subject to an increased tax rate of 30% from 15%, which led
to
an increased income tax of $255,021.
INCOME
BEFORE MINORITY INTERESTS
Income
before minority interests was $3,537,996 for the three months ended March 31,
2007, as compared to $2,085,177 for the three months ended March 31, 2006,
an
increase of $1,452,819 or 69.7%, as a result of an increase in income before
income taxes of $2,546,188 or 111.4%, and an increase in income taxes of
$1,093,369 or 544.7%.
MINORITY
INTERESTS
Minority
interests in the earnings of the Sino-foreign Joint-ventures amount to
$1,894,895 for the three months ended March 31, 2007, as compared to $990,779
for the three months ended March 31, 2006, an increase of $904,116 or
91.3%.
The
Company owns different equity interests in seven Sino-foreign joint ventures,
through which it conducts its operations. All the operating results of these
seven Sino-foreign joint ventures were consolidated in the Company’s financial
statements of March 31, 2007 and 2006. The Company records the minority
interests' share in the earnings of the respective Sino-foreign joint ventures
for each period.
In
2007,
minority interest increased significantly as compared to 2006, primarily as
income from Henglong, one of the Company’s joint ventures, which was owned 55.5%
by minority interest holders increased significantly.
NET
INCOME
Net
income was $1,643,101 for the three months ended March 31, 2007, as compared
to
a net income of $1,094,398 for the three months ended March 31, 2006, an
increase of $548,703 or 50.1%, as a result of an increase in income before
minority interests of $1,452,819 or 69.7%, and an increase in minority interests
of $904,116 or 91.3%.
28
LIQUIDITY
AND CAPITAL RESOURCES
Capital
resources and use of cash
The
Company has historically financed its liquidity requirements from a variety
of
sources, including short-term borrowings under bank credit agreements, bankers’
acceptance, issuances of capital stock and internally generated cash. As of
March 31, 2007, the Company had cash and cash equivalents of $17,362,082, as
compared to $22,140,596 as of March 31, 2006, a decrease of $4,778,514 or
21.6%.
The
Company had working capital of $32,167,634 as of March 31, 2007, as compared
to
$29,136,373 as of March 31, 2006, an increase of $3,031,261 or
10.4%.
Financing
activities:
For
the
Company’s bank loans and banker’s acceptance bill facilities, the Company’s
banks will require the Company to sign documents to repay such facilities within
one year. On the condition that the Company can provide adequate mortgage
security and has not violated the terms of the line of credit agreement, it
can
extend such one year facilities for another year.
The
Company had bank loans maturing in less than one year of $8,333,333 and bankers’
acceptances of $11,462,549 as of March 31, 2007, including $581,175 which was
not a part of the line of credit and fully mortgaged by notes receivable.
The
Company currently expects to be able to obtain similar bank loans and bankers’
acceptance bills in
the
future if it can provide adequate mortgage security following the termination
of
the above mentioned agreements. If the Company is not able to do so, it will
have to refinance such debt as it becomes due or repay that debt to the extent
it has cash available from operations or from the proceeds of additional
issuances of capital stock. Due to depreciation, the value of the mortgages
securing the above-mentioned bank loans and banker's acceptance bills will
be
devalued by approximately $3,882,280. If the Company wishes to obtain the same
amount of bank loans and banker's acceptance bills, it will have to provide
$3,882,280 additional mortgages. The Company can obtain a reduced line of credit
with a reduction of $2,035,058, if it cannot provide additional mortgages,
$3,882,280 at 52% mortgage rates. The Company expects that the reduction of
bank
loans will not have a material adverse effect on its liquidity. As of March
31,
2007, the Company has adequate working capital, as well as $7,800,000 available
under a $15,000,000 equity line through a Standby Equity Distribution Agreement
with Cornell Capital Partners, LP. The Company views these capitals as providing
an ample available source of back-up liquidity in case of an
unanticipated event.
(a)
Bank
loans
As
of
March 31, 2007, the principal outstanding under the Company’s credit facilities
and lines of credit was as follows:
|
Bank
|
Amount
available
|
|
Amount
borrowed
|
||||||
Comprehensive
credit facilities
|
Bank of China |
$
|
9,487,179
|
$
|
8,623,438
|
|||||
Comprehensive
credit facilities
|
China Construction Bank |
2,564,103
|
—
|
|||||||
Comprehensive
credit facilities
|
CITIC Industrial Bank |
3,589,744
|
2,564,102
|
|||||||
Comprehensive
credit facilities
|
Shanghai Pudong Development Bank |
5,128,205
|
4,399,026
|
|||||||
Comprehensive
credit facilities
|
Jingzhou Commercial Bank |
6,410,256
|
2,373,718
|
|||||||
Comprehensive
credit facilities
|
Industrial and Commercial Bank of China |
1,410,256
|
1,254,423
|
|||||||
Total
|
$
|
28,589,743
|
$
|
19,214,707
|
29
The
Company may request banks to issue notes payable or bank loans within its credit
line using a 364-day revolving line.
The
Company refinanced its short-term debt during early 2007 at annual interest
rates of 5.580% to 7.254%, and for terms of six to twelve months. Pursuant
to
the refinancing arrangement, the Company pledged $18,918,617 of equipment,
$5,134,718 of land use rights and $3,706,462 of buildings as security for its
comprehensive credit facility with
Bank
of China; pledged $2,616,218 of land use rights and $3,725,923 of buildings
as
security for its comprehensive credit facility with CITIC Industrial Bank;
pledged $1,534,256 of land use rights and $6,656,397 of buildings as security
for its comprehensive credit facility with Shanghai Pudong Development Bank;
pledged $8,572,115 of land use rights as security for its comprehensive credit
facility with Jingzhou Commercial Bank; pledged $1,380,683 of land use rights
and $932,767 of buildings as security for its comprehensive credit facility
with
Industrial and Commercial Bank of China; and pledged $1,034,872 of land use
rights and $3,207,872 of buildings as security for its comprehensive credit
facility with China Construction Bank.
(b)
Financing from investors:
On
March
20, 2006, the Company entered into a Standby Equity Distribution Agreement
with
Cornell Capital Partners, LP for a total amount of $15 million. The Company
has
utilized $7,200,000 as of March 31, 2007. Under the agreement, Cornell Capital
Partners, LP has committed to provide funding to be drawn down over a stated
period at the Company’s discretion.
If
the
Company fails to obtain the same or similar terms for any debt or equity
refinancing to meet its debt obligations, or if the Company fails to obtain
extensions of the maturity dates of these obligations as they become due, its
overall liquidity and capital resources will be adversely affected.
Cash
Requirements:
The
following table summarizes the Company’s expected cash outflows resulting from
financial contracts and commitments. The Company has not included information
on
its recurring purchases of materials for use in its manufacturing operations.
These amounts are generally consistent from year to year, closely reflecting
the
Company’s levels of production, and are not long-term in nature being less than
three months.
Payment
Due Dates
|
||||||||||||||||
Total
|
Less
than 1 year
|
1-3
years
|
3-5
years
|
More
than 5 years
|
||||||||||||
Short-term
bank loan
|
$
|
8,333,333
|
$
|
8,333,333
|
$
|
—
|
$
|
—
|
$
|
—
|
||||||
Notes
payable
|
11,462,549
|
11,462,549
|
—
|
—
|
—
|
|||||||||||
Other
contractual purchase commitments, including information
technology
|
5,160,976
|
3,325,525
|
1,615,451
|
220,000
|
—
|
|||||||||||
Total
|
$
|
24,956,858
|
$
|
23,121,407
|
$
|
1,615,451
|
$
|
220,000
|
$
|
—
|
30
Short-term
bank loans:
The
following table summarizes the contract information of short-term borrowings
between the banks and the Company as of March 31, 2007:
Bank
|
Purpose
|
Borrowing
Date
|
Borrowing
Term (Year)
|
Annual
Percentage Rate
|
Date
of Interest Payment
|
Date
of payment
|
Amount
|
|||||||||||||||
Bank
of China
|
Working
Capital
|
16-May-06
|
1
|
5.58%
|
|
Pay
monthly
|
15-May-07
|
$
|
2,564,103
|
|||||||||||||
Bank
of China
|
Working
Capital
|
07-Mar-07
|
1
|
6.12%
|
|
Pay
monthly
|
07-Mar-08
|
641,024
|
||||||||||||||
CITIC
Industrial Bank
|
Working
Capital
|
15-Jun-06
|
1
|
5.85%
|
|
Pay
monthly
|
14-Jun-07
|
2,564,103
|
||||||||||||||
Shanghai
Pudong Development Bank
|
Working
Capital
|
14-Sep-06
|
1
|
6.12%
|
|
Pay
monthly
|
13-Sep-07
|
2,564,103
|
||||||||||||||
Total
|
$
|
8,333,333
|
The
Company must use the loans for the purpose described in the table. If the
Company fails, it will be charged a penalty interest at 100% of the specified
loan rate. The Company has to pay interest under the interest rate described
in
the table on the 20th of each month. If the Company fails, it will be charged
a
compounded interest at the specified rate. The Company has to repay the
principal outstanding on the specified date in the table. If it fails, it will
be charged a penalty interest at 50% of the specified loan rate. Management
believes that the Company had complied with such financial covenants as of
March
31, 2007, and will continue to comply with them.
The
following table summarizes the contract information of issuing notes payable
between the banks and the Company as of March 31, 2007:
Purpose
|
Term
(Month)
|
Due
Date
|
Amount
Payable
on
Due Date
|
|||||||
Working
Capital
|
3-6
|
Apr,
2007
|
$
|
2,061,483
|
||||||
Working
Capital
|
3-6
|
May,
2007
|
1,550,690
|
|||||||
Working
Capital
|
3-6
|
Jun,
2007
|
2,651,557
|
|||||||
Working
Capital
|
3-6
|
Jul,
2007
|
2,103,947
|
|||||||
Working
Capital
|
3-6
|
Sep,
2007
|
3,094,872
|
|||||||
Total
|
$
|
11,462,549
|
The
Company must use the loan for the purpose described in the table. If it fails,
the banks will no longer issue the notes payable, and it may have an adverse
effect on the Company’s liquidity and capital resources. The Company has to
deposit sufficient cash in the designated account of the bank on the due date
of
notes payable for payment to the suppliers. If the bank has advanced payment
for
the Company, it will be charged a penalty interest at 150% of the specified
loan
rate. Management believes that the Company had complied with such financial
covenants as of March 31, 2007, and will continue to comply with them.
31
The
Company had approximately $5,160,976 of capital commitment as of March 31,
2007,
arising from equipment purchases for expanding production capacity. The Company
intends to pay $3,325,525 in the remaining nine months of 2007 using its working
capital. Management believes that it will not have a material adverse effect
on
the Company’s liquidity.
Cash
flows:
(a)
Operating activities
The
Company’s operations provided cash of $1,805,596 for the three months ended
March 31, 2007, as compared to cash of $7,709,682 for the three months ended
March 31, 2006, a decrease of $5,904,086, reflecting a decreased notes payable
and an increased inventory. A decrease in notes payable contributed a $9,841,725
increase in cash outflow. Since the notes payable were required at different
time, maturing notes payable amount was greater than newly issued notes payable
amount as of March 31, 2007 while during the same period of 2006, maturing
notes
payable amount was lesser than newly issued notes payable amount. An increase
in
inventory contributed a $1,378,690 increase in cash outflow, mainly due to
the
Company’s intention to produce sufficient inventories to meet increasing demands
in the April of 2007, a peak time for the Company. In view of the 364-day
revolving notes payable, the increased inventories which will be turned into
cash in peak season, the Company anticipates that a decrease in notes payable
and an increase in inventory will not have a material adverse effect on its
future operating activates.
(b)
Investing activities
The
Company expended net cash of $2,743,661 in investment activities during the
three months ended March 31, 2007, and $2,192,586 during the same period of
2006.
Cash
used
in investment activities in 2007 increased by $551,075 compared to that in
2006,
primarily due to payment for a large amount of equipment during the three months
ended March 31, 2007 and for production facilities expansion.
(c)
Financing activities
During
the three months ended March
31,
2007, the Company expended net cash of $9,118,353 in financing activities,
as
compared to providing net cash of $3,647,157 for the three months ended March
31, 2006, a decrease of $12,765,510, as a result of following
factors:
During
the three months ended March 31, 2007, the Company expended an increased cash
of
$5,969,301 on bank loan repayment than that of the same period of 2006,
primarily due to decreased comprehensive credit lines from banks resulting
from
mortgages insufficiency. The Company expects that the reduction of bank credit
lines will not have a material adverse effect on its liquidity, for the Company
has adequate working capital as of March 31, 2007.
During
the three months ended March 31, 2007, the Company raised $1,145,500 of cash
by
issuing 108,121 shares of common stock to institutional investors. During the
same period of 2006, the Company raised $4,940,000 of cash by issuing 625,000
shares of common stock to institutional investors.
The
Company’s joint ventures paid minority shareholders of Sino-foreign joint
ventures higher dividends in the three months ended March 31, 2007 than in
the
same period of 2006. The amounts due to shareholders/directors were unsecured,
interest-free and repayable on demand.
32
OFF-BALANCE
SHEET ARRANGEMENTS
At
March
31, 2007 and 2006, the Company did not have any transactions, obligations or
relationships that could be considered off-balance sheet
arrangements.
COMMITMENTS
AND CONTINGENCIES
The
following table summarizes the Company’s contractual payment obligations and
commitments as of March 31, 2007:
Payment
Obligations by Period
|
|||||||||||||||||||
2007(a)
|
2008
|
2009
|
2010
|
Thereafter
|
Total
|
||||||||||||||
Obligations
for service agreements
|
$
|
110,000
|
$
|
110,000
|
$
|
110,000
|
$
|
110,000
|
$
|
110,000
|
$
|
550,000
|
|||||||
Obligations
for purchasing agreements
|
3,215,525
|
1,395,451
|
—
|
—
|
—
|
4,610,976
|
|||||||||||||
Total
|
$
|
3,325,525
|
$
|
1,505,451
|
$
|
110,000
|
$
|
110,000
|
$
|
110,000
|
$
|
5,160,976
|
(a)
Remaining 9 months in 2007.
SUBSEQUENT
EVENTS
None
ITEM
3
|
QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
|
There
have been no material changes to our exposures to market risk since
December 31, 2006.
ITEM
4
|
CONTROLS
AND PROCEDURES
|
(a) EVALUATION
OF DISCLOSURE CONTROLS AND PROCEDURES
As
of
March
31,
2007,
the end
of the period covered by this report, the Company’s chief executive officer and
its chief financial officer reviewed and evaluated the effectiveness of the
Company’s disclosure controls and procedures, as defined in Exchange Act Rule
13a-15(e) and 15d-15(e). As of the end of that period, based on that evaluation,
the Company’s chief executive officer and chief financial officer concluded that
from October 1, 2006 to date, the disclosure controls and procedures were
effective in ensuring that material information the Company must disclose in
the
reports that it files or submits under the Securities Exchange Act of 1934,
as
amended, the “Exchange Act”, is recorded, processed, summarized, and reported on
a timely basis, and that information required to be disclosed by the Company
in
reports that it files or submits under the Exchange Act is accumulated and
communicated to the Company’s chief executive officer and chief financial
officer as appropriate to allow timely decisions regarding required
disclosure.
33
(b) CHANGES
IN INTERNAL CONTROLS
There
was
no change in our internal control over financial reporting that occurred during
our last fiscal quarter that has materially affected, or is reasonably likely
to
materially affect, our internal control over financial reporting.
PART
II. OTHER INFORMATION
ITEM
1
|
LEGAL
PROCEEDINGS
|
The
Company is not currently a party to any threatened or pending legal proceedings,
other than incidental litigation arising in the ordinary course of
business. In the opinion of management, the ultimate disposition of these
matters will not have a material adverse effect on the Company’s consolidated
financial position, results of operations or cash flows.
ITEM
1A.
|
RISK
FACTORS
|
The
Company’s businesses, financial conditions and results of operations could be
materially and adversely affected by many risk factors. Because of these
risk factors, actual results might differ significantly from those projected
in
the forward-looking statements. Factors that might cause such differences
include, among others, the following:
Risks
Related to the Company’s Business and Industry
Because
the Company is a holding company with substantially all of its operations
conducted through its subsidiaries, its performance will be affected by the
performance of its subsidiaries.
The
Company has no operations independent of those of Great Genesis and its
subsidiaries, and its principal assets are its investments in Great Genesis
and
its subsidiaries. As a result, the Company is dependent upon the
performance of Great Genesis and its subsidiaries and will be subject to the
financial, business and other factors affecting Great Genesis as well as general
economic and financial conditions. As substantially all of the Company’s
operations are and will be conducted through its subsidiaries, it will be
dependent on the cash flow of its subsidiaries to meet its obligations.
Because
virtually all of the Company’s assets are and will be held by operating
subsidiaries, the claims of its stockholders will be structurally subordinate
to
all existing and future liabilities and obligations, and trade payables of
such
subsidiaries. In the event of the Company’s bankruptcy, liquidation or
reorganization, the Company’s assets and those of its subsidiaries will be
available to satisfy the claims of its stockholders only after all of the
Company’s and its subsidiaries’ liabilities and obligations have been paid in
full.
With
the automobile parts markets being highly competitive and many of the Company’s
competitors having greater resources than it does, the Company may not be able
to compete successfully.
|
The
automobile parts industry is a highly competitive business. Criteria
for the Company’s customers include:
|
|
|
•
|
Quality;
|
|
•
|
Price/cost
competitiveness;
|
|
•
|
System
and product performance;
|
|
•
|
Reliability
and timeliness of delivery;
|
34
|
•
|
New
product and technology development capability;
|
|
•
|
Excellence
and flexibility in operations;
|
|
•
|
Degree
of global and local presence;
|
|
•
|
Effectiveness
of customer service; and
|
|
•
|
Overall
management capability.
|
The
Company’s competitors include independent suppliers of parts, as well as
suppliers formed by spin-offs from its customers, who are becoming more
aggressive in selling parts to other vehicle manufacturers. Depending on
the particular product, the number of the Company’s competitors varies
significantly. Many of the Company’s competitors have substantially
greater revenues and financial resources than it does, as well as stronger
brand
names, consumer recognition, business relationships with vehicle manufacturers,
and geographic presence than it has. The Company may not be able to
compete favorably and increased competition may substantially harm its business,
business prospects and results of operations.
Internationally,
the Company faces different market dynamics and competition. The Company
may not be as successful as its competitors in generating revenues in
international markets due to the lack of recognition of its products or other
factors. Developing product recognition overseas is expensive and
time-consuming and the Company’s international expansion efforts may be more
costly and less profitable than it expects. If the Company is not
successful in its target markets, its sales could decline, its margins could
be
negatively impacted and the Company could lose market share, any of which could
materially harm the Company’s business, results of operations and profitability.
The
cyclical nature of automotive production and sales could result in a reduction
in automotive sales, which could adversely affect the Company’s business and
results of operations.
The
Company’s business relies on automotive vehicle production and sales by its
customers, which are highly cyclical and depend on general economic conditions
and other factors, including consumer spending and preferences. They also
can be affected by labor relations issues, regulatory requirements, and other
factors. In addition, in the last two years, the price of automobiles in
China has generally declined. As a result, the volume of automotive
production in China has fluctuated from year to year, which give rise to
fluctuations in the demand for the Company’s products. Any significant
economic decline that results in a reduction in automotive production and sales
by the Company’s customers would have a material adverse effect on its results
of operations. Moreover, if the prices of automobiles do not remain low, then
demand for automobile parts could fall and result in lower revenues and
profitability.
Increasing
costs for manufactured components and raw materials may adversely affect the
Company’s profitability.
The
Company uses a broad range of manufactured components and raw materials in
its
products, including castings, electronic components, finished sub-components,
molded plastic parts, fabricated metal, aluminum and steel, and resins.
Because it may be difficult to pass increased prices for these items on to
the
Company’s customers, a significant increase in the prices of the Company’s
components and materials could materially increase its operating costs and
adversely affect its profit margins and profitability.
Pricing
pressure by automobile manufacturers on their suppliers may adversely affect
the
Company’s business and results of operations.
Recently,
pricing pressure from automobile manufacturers has been prevalent in the
automotive parts industry in China. Virtually all vehicle manufacturers
seek price reductions each year, including requiring suppliers to pay a “3-R
Guarantees “ service charge for repair, replacement and refund in an amount
equal to one percent of the total amount of parts supplied. Although the
Company has tried to reduce costs and resist price reductions, these reductions
have impacted the Company’s sales and profit margins. If the Company
cannot offset continued price reductions through improved operating efficiencies
and reduced expenditures, price reductions will have a material adverse effect
on the Company’s results of operations.
35
The
Company’s business, revenues and profitability would be materially and adversely
affected if it loses any of its large customers.
For
the
three months ended March 31, 2007, approximately 11.4% of the Company’s sales
were to Brilliance China Automotive Holdings Limited, approximately 11.7% were
to Beiqi Foton Motor Co., Ltd., approximately 15.7% were to Cherry Automobile
Co., Ltd. and approximately 13.0% were to Zhejiang Geely Holding Co., Ltd.,
the
Company’s four largest customers. The loss of, or significant reduction in
purchases by, one or more of these major customers could adversely affect the
Company’s business.
The
Company may be subject to product liability and warranty and recall claims,
which may increase the costs of doing business and adversely affect the
Company’s financial condition and liquidity.
The
Company may be exposed to product liability and warranty claims if its products
actually or allegedly fail to perform as expected or the use of its products
results, or is alleged to result, in bodily injury and/or property damage.
The Company started to pay to its customers’ increased after-sales service
expenses due to consumer rights protection policies of “recall” issued by the
Chinese Government in 2004, such as the recalling flawed vehicles policy.
Beginning in 2004, automobile manufacturers unilaterally required their
suppliers to pay a “3-R Guarantees “ service charge (for repair, replacement and
refund) in an amount equal to one percent of the total amount of parts
supplied. Accordingly, the Company has experienced and shall continue to
experience higher after sales service expenses. Product liability,
warranty and recall costs may have a material adverse effect on the Company’s
financial condition.
The
Company is subject to environmental and safety regulations, which may increase
the Company’s compliance costs and may adversely affect the Company’s results of
operation.
The
Company is subject to the requirements of environmental and occupational safety
and health laws and regulations in China. The Company cannot provide
assurance that it has been or will be at all times in full compliance with
all
of these requirements, or that it will not incur material costs or liabilities
in connection with these requirement. Additionally, these regulations may
change in a manner that could have a material adverse effect on the Company’s
business, results of operations and financial condition. The capital
requirements and other expenditures that may be necessary to comply with
environmental requirements could increase and become a material expense of
doing
business.
Non-performance
by the Company’s suppliers may adversely affect its operations by delaying
delivery or causing delivery failures, which may negatively affect demand,
sales
and profitability.
The
Company purchases various types of equipment, raw materials and manufactured
component parts from its suppliers. The Company would be materially and
adversely affected by the failure of its suppliers to perform as expected.
The Company could experience delivery delays or failures caused by production
issues or delivery of non-conforming products if its suppliers failed to
perform, and the Company also faces these risks in the event any of its
suppliers becomes insolvent or bankrupt.
The
Company’s business and growth may suffer if it fails to attract and retain key
personnel.
The
Company’s ability to operate its business and implement its strategies
effectively depends on the efforts of its executive officers and other key
employees. The Company depends on the continued contributions of its
senior management and other key personnel. The Company’s future success
also depends on its ability to identify, attract and retain highly skilled
technical, particularly engineers and other employees with electronics
expertise, managerial, finance and marketing personnel. The Company does
not maintain a key person life insurance policy on Mr. Hanlin Chen. The
loss of the services of any of the Company’s key employees or the failure to
attract or retain other qualified personnel could substantially harm the
Company’s business.
36
The
Company’s management controls approximately 83.8% of its outstanding common
stock and may have conflicts of interest with its minority stockholders.
Members
of the Company’s management beneficially own approximately 83.8% of the
outstanding shares of the Company’s common stock. As a result, these
majority stockholders have control over decisions to enter into any corporate
transaction and have the ability to prevent any transaction that requires the
approval of stockholders, which could result in the approval of transactions
that might not maximize stockholders’ value. Additionally, these
stockholders control the election of members of the Company’s board, have the
ability to appoint new members to the Company’s management team and control the
outcome of matters submitted to a vote of the holders of the Company’s common
stock. The interests of these majority stockholders may at times conflict
with the interests of the Company’s other stockholders.
There
is a limited public float of the Company’s common stock, which can result in its
stock price being volatile and prevent the realization of a profit on resale
of
the Company’s common stock
There
is
a limited public float of the Company’s common stock. Of the Company’s
outstanding common stock, approximately 10% is considered part of the public
float. The term “public float” refers to shares freely and actively
tradable on the NASDAQ SmallCap Market and not owned by officers, directors
or
affiliates, as such term is defined under the Securities Act. As a result
of the limited public float, the market price of the Company’s common stock can
be volatile. This stock price volatility could prevent a stockholder seeking
to
sell Company common stock from being able to sell it at or above the price
at
which the stock was bought.
Provisions
in the Company’s certificate of incorporation and bylaws and the General
Corporation Law of Delaware may discourage a takeover attempt.
Provisions
in the Company’s certificate of incorporation and bylaws and the General
Corporation Law of Delaware, the state in which the Company is organized, could
make it difficult for a third party to acquire the Company, even if doing so
might be beneficial to the Company’s stockholders. Provisions of the
Company’s certificate of incorporation and bylaws impose various procedural and
other requirements, which could make it difficult for stockholders to effect
certain corporate actions and possibly prevent transactions that would maximize
stockholders’ value.
Risks
Related to Doing Business in China and other International
Countries
Because
the Company’s operations are all located outside of the United States and are
subject to Chinese laws, any change of Chinese laws may adversely affect the
Company’s business.
All
of
the Company’s operations are outside the United States and in China, which
exposes it to risks, such as exchange controls and currency restrictions,
currency fluctuations and devaluations, changes in local economic conditions,
changes in Chinese laws and regulations, exposure to possible expropriation
or
other Chinese government actions, and unsettled political conditions.
These factors may have a material adverse effect on the Company’s operations or
on the Company’s business, results of operations and financial condition.
The
Company’s international expansion plans subject it to risks inherent in doing
business internationally.
The
Company’s long-term business strategy relies on the expansion of the Company’s
international sales outside China by targeting markets, such as the United
States. Risks affecting the Company’s international expansion include
challenges caused by distance, language and cultural differences, conflicting
and changing laws and regulations, foreign laws, international import and export
legislation, trading and investment policies, foreign currency fluctuations,
the
burdens of complying with a wide variety of laws and regulations, protectionist
laws and business practices that favor local businesses in some countries,
foreign tax consequences, higher costs associated with doing business
internationally, restrictions on the export or import of technology,
difficulties in staffing and managing international operations, trade and tariff
restrictions, and variations in tariffs, quotas, taxes and other market
barriers. These risks could harm the Company’s international expansion
efforts, which could in turn materially and adversely affect the Company’s
business, operating results and financial condition.
37
The
Company faces risks associated with currency exchange rate fluctuations, any
adverse fluctuation may adversely affect the Company’s operating margins.
Although
the Company is incorporated in the United States, the majority of its current
revenues are in Chinese currency. Conducting business in currencies other
than US dollars subjects the Company to fluctuations in currency exchange rates
that could have a negative impact on the Company’s reported operating
results. Fluctuations in the value of the US dollar relative to other
currencies impact the Company’s revenues, cost of revenues and operating margins
and result in foreign currency translation gains and losses. Historically,
the Company has not engaged in exchange rate hedging activities. Although the
Company may implement hedging strategies to mitigate this risk, these strategies
may not eliminate the Company’s exposure to foreign exchange rate fluctuations
and involve costs and risks of their own, such as ongoing management time and
expertise, external costs to implement the strategy and potential accounting
implications.
If
relations between the United States and China worsen, the Company’s stock price
may decrease and the Company may have difficulty accessing the U.S. capital
markets.
At
various times during recent years, the United States and China have had
disagreements over political and economic issues. Controversies may arise
in the future between these two countries. Any political or trade
controversies between the United States and China could adversely affect the
market price of the Company’s common stock and the Company’s ability to access
US capital markets.
The
Chinese Government could change its policies toward private enterprises, which
could adversely affect the Company’s business.
The
Company’s business is subject to political and economic uncertainties in China
and may be adversely affected by its political, economic and social
developments. Over the past several years, the Chinese Government has
pursued economic reform policies including the encouragement of private economic
activity and greater economic decentralization. The Chinese Government may
not continue to pursue these policies or may alter them to the Company’s
detriment from time to time. Changes in policies, laws and regulations, or
in their interpretation or the imposition of confiscatory taxation, restrictions
on currency conversion, restrictions or prohibitions on dividend payments to
stockholders, devaluations of currency or the nationalization or other
expropriation of private enterprises could have a material adverse effect on
the
Company’s business. Nationalization or expropriation could result in the
total loss of the Company’s investment in China.
The
economic, political and social conditions in China could affect the Company’s
business.
All
of
the Company’s business, assets and operations are located in China. The
economy of China differs from the economies of most developed countries in
many
respects, including government involvement, level of development, growth rate,
control of foreign exchange, and allocation of resources. The economy of
China has been transitioning from a planned economy to a more market-oriented
economy. Although the Chinese Government has implemented measures recently
emphasizing the utilization of market forces for economic reform, the reduction
of state ownership of productive assets and the establishment of sound corporate
governance in business enterprises, a substantial portion of productive assets
in China is still owned by the Chinese Government. In addition, the
Chinese Government continues to play a significant role in regulating industry
by imposing industrial policies. It also exercises significant control
over China’s economic growth through the allocation of resources, controlling
payment of foreign currency-denominated obligations, setting monetary policy
and
providing preferential treatment to particular industries or companies.
Therefore, the Chinese Government’s involvement in the economy could adversely
affect the Company’s business operations, results of operations and/or the
financial condition.
38
The
significant but uneven growth in the economy of China in the past 20 years
could
have negative effect on the Company’s business and results of operations.
The
Chinese Government has implemented various measures from time to time to control
the rate of economic growth. Some of these measures benefit the overall
economy of China, but may have a negative effect on us.
Government
control of currency conversion and future movements in exchange rates may
adversely affect the Company’s operations and financial results.
The
Company receives substantially all of its revenues in Renminbi, the currency
of
China. A portion of such revenues will be converted into other currencies
to meet the Company’s foreign currency obligations. Foreign exchange
transactions under the Company’s capital account, including principal payments
in respect of foreign currency-denominated obligations, continue to be subject
to significant foreign exchange controls and require the approval of the State
Administration of Foreign Exchange in China. These limitations could
affect the Company’s ability to obtain foreign exchange through debt or equity
financing, or to obtain foreign exchange for capital expenditures.
The
Chinese Government controls its foreign currency reserves through restrictions
on imports and conversion of Renminbi into foreign currency. Although the
exchange rate of the Renminbi to the US dollar has been stable since January
1,
1994, and the Chinese Government has stated its intention to maintain the
stability of the value of Renminbi, there can be no assurance that exchange
rates will remain stable. The Renminbi could devalue against the US
dollar. The Company’s financial condition and results of operations may
also be affected by changes in the value of certain currencies other than the
Renminbi in which the Company’s earnings and obligations are denominated.
In particular, a devaluation of the Renminbi is likely to increase the portion
of the Company’s cash flow required to satisfy the Company’s foreign
currency-denominated obligations.
Because
the Chinese legal system is not fully developed, the Company’s legal protections
may be limited.
The
Chinese legal system is based on written statutes and their interpretation
by
the Supreme People’s Court. Although the Chinese government introduced new laws
and regulations to modernize its business, securities and tax systems on January
1, 1994, China does not yet possess a comprehensive body of business law.
Because Chinese laws and regulations are relatively new, interpretation,
implementation and enforcement of these laws and regulations involve
uncertainties and inconsistencies and it may be difficult to enforce
contracts. In addition, as the Chinese legal system develops, changes in
such laws and regulations, their interpretation or their enforcement may have
a
material adverse effect on the Company’s business operations. Moreover,
interpretative case law does not have the same precedential value in China
as in
the United States, so legal compliance in China may be more difficult or
expensive.
It
may be difficult to serve the Company with legal process or enforce judgments
against the Company’s management or the Company.
All
of
the Company’s assets are located in China and three out of the Company’s
directors and officers are non-residents of the United States, and all or
substantial portions of the assets of such non-residents are located outside
the
United States. As a result, it may not be possible to effect service of
process within the United States upon such persons to originate an action in
the
United States. Moreover, there is uncertainty that the courts of China
would enforce judgments of U.S. courts against the Company, its directors or
officers based on the civil liability provisions of the securities laws of
the
United States or any state, or an original action brought in China based upon
the securities laws of the United States or any state.
Risks
Related to the Standby Equity Distribution Agreement (“SEDA”)
Future
sales by our stockholders may adversely affect our stock price and our ability
to raise funds in new stock offerings.
39
Sales
of
our common stock in the public market following the SEDA could lower the market
price of our common stock. Sales may also make it more difficult for us to
sell equity securities or equity-related securities in the future at a time
and
price that our management deems acceptable, or at all. Of the 23,959,702
shares of common stock outstanding as of March 31, 2007, all such shares are,
or
will be, freely tradable without restriction, unless held by our
“affiliates.” Some of these shares may be resold under Rule 144.
Existing
stockholders could experience significant dilution from our sale of shares
under
the SEDA.
Our
financial needs will be partially provided from the SEDA. The issuance of
shares of our common stock under the SEDA, at below-market prices, will have
a
dilutive impact on our other stockholders and the issuance or even potential
issuance of such shares could have a negative effect on the market price of
our
common stock. As a result, our net income per share could decrease in future
periods, and the market price of our common stock could decline. In addition,
the lower our stock price, the more shares of common stock we will have to
issue
under the SEDA to draw down the full amount. If our stock price is lower, then
our existing stockholders would experience greater dilution.
Under
the SEDA, Cornell Capital Partners will pay less than the then-prevailing market
price of our common stock.
The
common stock to be issued under the SEDA will be issued at a 1.5% discount
to
the lowest daily VWAP of our common stock during the five consecutive trading
day period immediately following the date we notify Cornell Capital Partners
that we desire to access the SEDA; provided, that the price per share paid
by
Cornell Capital Partners will in no event be less than a minimum of 90% of
the
closing bid price for our common stock on the trading day immediately preceding
the date that we deliver an advance request. Further, Cornell Capital
Partners will retain 4.5% of each advance under the SEDA. Based on this
discount, Cornell Capital Partners will have an incentive to sell immediately
to
realize the gain on the 1.5% discount. These sales could cause the price
of our common stock to decline, based on increased selling of our common stock.
The
sale of our stock under the SEDA could encourage short sales by third parties,
which could contribute to the future decline of our stock price.
In
many
circumstances, the provisions of a SEDA have the potential to cause a
significant downward pressure on the price of a company’s common stock.
This is especially the case if the shares being placed into the market exceed
the market’s ability to take up the increased stock or if we have not performed
in such a manner to show that the equity funds raised will be used for
growth. Such an event could place further downward pressure on the price
of our common stock. We may request numerous drawdowns pursuant to the
terms of the SEDA. Even if we use the SEDA to invest in ways that are
materially beneficial to us, the opportunity exists for short sellers and others
to contribute to the future decline of our stock price. If there are
significant short sales of stock, the price decline that would result from
this
activity in turn may cause long holders of the stock to sell their shares
thereby contributing to sales of stock in the market. If there is an
imbalance on the sell side of the market for our common stock, the price will
decline.
It
is not
possible to predict those circumstances whereby short sales could materialize
or
the extent to which the stock price could drop. In some companies that
have been subjected to short sales the stock price has dropped
significantly. This could happen to our stock price.
Cornell
Capital Partners may sell shares of our common stock after we deliver an advance
notice during the pricing period, which could cause our stock price to decline.
Cornell
Capital Partners is deemed to beneficially own the shares of common stock
corresponding to a particular advance on the date that we deliver an advance
notice to Cornell Capital Partners, which is prior to the date the stock is
delivered to Cornell Capital Partners. Cornell Capital Partners may sell such
shares any time after we deliver an advance notice. Accordingly, Cornell Capital
Partners may sell such shares during the pricing period. Such sales may cause
our stock price to decline and if so would result in a lower VWAP during the
pricing period, which would result in us having to issue a larger number of
shares of common stock to Cornell Capital Partners in respect of the advance.
40
We
may not be able to obtain a cash advance under the SEDA if Cornell Capital
Partners holds more than 9.9% of our common stock.
In
the
event Cornell Capital Partners holds more than 9.9% of our then-outstanding
common stock, we will be unable to obtain a cash advance under the SEDA. A
possibility exists that Cornell Capital Partners may own more than 9.9% of
our
outstanding common stock at a time when we would otherwise plan to request
an
advance under the SEDA. In that event, if we are unable to obtain
additional external funding, we could fail to achieve the corporate objectives
that we had hoped to use the cash to achieve.
Risks
Related to the Non-compliance of NASD Rule
As
a
result of Mr. Guangxun Xu, an independent director's, resignation, the
Company
is not in compliance with NASD Rule 4350(c)(1) and there is a risk of delisting
if the non-compliance is not cured within the time period allowed by NASDAQ.
On
May
11, 2007, Mr. Guangxun Xu resigned from his position as a Director and
a member
of each of the Audit, Compensation and Nominating Committees of the Company
because of his recent appointment as co- chief representative in China
by The
NASDAQ Stock Market, Inc. As a result of Mr. Guangxun Xu's resignation,
the
Company is not in compliance with NASD Rule 4350(c)(1) because its board
of
directors no longer comprises of a majority of independent directors as
defined
by NASD Rule 4200(a)(15). Consequently, the Company is in the process of
searching for a new candidate to serve on its board to satisfy the NASD
Rules.
The Company is relying on the cure period set forth in NASD Rules 4350(c)(1),
which allow the Company to cure such non-compliance before its next annual
shareholders meeting. The Company has notified Nasdaq of such circumstances
are
required by NASD 4350(c)(1). If the Company cannot cure such non-compliance
before its next annual shareholders meeting, it faces the risk of being
delisted
from The NASDAQ Stock Market.
ITEM
2.
|
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS. |
None.
ITEM
3.
|
DEFAULTS
UPON SENIOR SECURITIES.
|
None.
ITEM
4.
|
SUBMISSION
OF MATTERS TO A VOTE OF SECURITY
HOLDERS.
|
None.
ITEM
5.
|
OTHER
INFORMATION.
|
None.
ITEM
6.
|
EXHIBITS
|
INDEX
TO EXHIBITS
Exhibit
Number
|
|
Description
of Document
|
3(i).1
|
|
Certificate
of Incorporation*
|
3(i).2
|
|
Certificate
of Amendment of Certificate of Incorporation**
|
3(ii).1
|
|
By
- laws***
|
10.1
|
|
Standby
Equity Distribution Agreement dated March 20, 2006 between us and
Cornell
Capital Partners, LP****
|
10.2
|
|
Placement
Agent Agreement dated March 20, 2006 between us and Newbridge Securities
Corporation****
|
10.3
|
|
Registration
Rights Agreement dated March 20, 2006 between us and Cornell Capital
Partners, LP****
|
10.4
|
|
Securities
Purchase Agreement dated March 20, 2006 between us and Cornell Capital
Partners, LP****
|
10.5
|
|
Investor
Registration Rights Agreement dated March 20, 2006 between us and
Cornell
Capital Partners, LP****
|
10.6
|
|
Warrant
to purchase 86,806 shares of common stock at $14.40 per share, issued
to
Cornell Capital Partners, LP****
|
10.7
|
|
Warrant
to purchase 69,444 shares of common stock at $18.00 per share, issued
to
Cornell Capital Partners, LP****
|
31.1
|
|
Rule
13a-14(a)/15d-14(a) Certification -Hanlin Chen*****
|
31.2
|
|
Rule
13a-14(a)/15d-14(a) Certification -Daming Hu*****
|
32.1
|
|
Section
1350 Certification -Hanlin Chen*****
|
32.2
|
|
Section
1350 Certification - Daming Hu*****
|
*
|
Incorporated
by reference to exhibit 3(i) to our Form 10SB Registration Statement
filed
on August 27, 2001.
|
**
|
Incorporated
by reference to Appendix A to our Schedule 14C Definitive Information
Statement filed on April 21, 2003.
|
41
***
|
Incorporated
by reference to exhibit 3(ii) to our Form 10SB Registration Statement
filed on August 27, 2001.
|
****
|
Incorporated
by reference to the exhibit of the same number to our Form S-3
Registration Statement (File No. 333 - 133331) filed on April 17,
2006.
|
*****
|
Filed
herewith
|
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: May 14, 2007 | By: | /s/ HANLIN CHEN |
Hanlin
Chen
President
and Chief Executive Officer
|
||
Date: May 14, 2007 |
By:
|
/s/ DAMING HU |
|
|
Daming
Hu
Chief
Financial Officer
|
42