China Automotive Systems, Inc. Annual Report 2011

Plain-text annual report

Based in Hubei Province, People’s Republic of China, China Automotive Systems, Inc. is a leading supplier of power steering components and systems to the Chinese automotive industry and is exporting into the North American market. The company operates through nine Sino-foreign joint ventures in China and three wholly-owned subsidiaries in China and America. o Henglong USA Corporation o Great Genesis Holdings Limited • • Shenyang Jinbei Henglong Automotive Steering System Co., Ltd. Jingzhou Hengsheng Automotive System Co., Ltd. o Shashi Jiulong Power Steering Co. Jingzhou Henglong Automotive Parts Co. o o Wuhu Henglong Electric Power Steering Co., Ltd. o Wuhan Jielong Steering System Co., Ltd. Universal Sensor Application, Inc. o o Beijing Henglong Automotive System Co., Ltd. • Jingzhou Henglong Automotive Technology (Testing) Centre Dear Shar D reholders, We ach difficult and d C China. In 2011 d declined by 5.4 b by 6.3% in C argest supplie l of China’s larg o by the perform b The eco n 2009 and in automotive inc a G Government t g growth mainly argeted real t policies reduc p tr rucks with he with 2010. w hieved a solid challenging 1, domestic br 4% and comm China, compar er of safety-rel gest vehicle O mance of both m nomic stimulu 2010 weake centives expir o adopt new y through a re estate and co ed demand fo eavy-duty truc d performanc automotive randed passen mercial vehicle red with 2010 lated steering EMs, our sale markets. us that propell ened in 201 ed. Inflation policies to r estrictive mon onstruction ac or automobile ck sales down Our 201 o $348.0 mil t e electric powe e exports to Chry ower unit sal l China. Sales C s superior to com commanding h c To incre utilized joint v u e expenditures a d developed a j produce steerin p units to our ca u v venture with S n new steering p and we will a capacity. We f c e establish our p m market in Sou South Americ S 1 annual net s llion as we a er steering (“ ysler in North les of our tra of new prod mpetitors’ lead higher sale pri ease our pen ventures to red as we add pro joint venture ng systems an apacity. In ear Shanghai Auto products for ou add another further develop presence in B uth America. can market a sales increased achieved high “EPS”) units h America incr aditional steer ducts increase ding to market ces. netration of k duce our risk a duction capac with Beijing nd add approx rly 2012, we d o-IVECO Hon ur partner’s he 200,000 unit ped a joint ve Brazil, the lar We are optim s some of o e in 2011 in environment ger vehicle sa e sales decreas 0 sales. As systems to ma es were impac n a in ales sed the any ted led rapid grow 1 just as m n led the Chine reduce econom etary policy t ctivities. The es and especia n 25% compar wth most ese mic that ese ally red d by $2.1 milli her sales of o in China a reased, offsetti ring products ed as they w t share gains a ion our and ing in ere and key markets, and share capi city. In 2010, g Auto that w ximately 500,0 developed a jo ngyan to devel eavy-duty truc ts of producti enture in 2011 rgest automot mistic about our key Chine we ital we will 000 oint lop cks ion 1 to tive the ese entering this ion of our p automotive O custom mers are also e the va alue propositi ed by local a receive nies as well. compan D During 2011, er Group LLC Chrysle increased th as we g products fro steering RAM® 250 Dodge contrac ct follows CAA er Award from Supplie now a Nort we are g gears for o steering division. We a parts d new vehicle with n h our effectiv through ement maintai manage ent high produ consiste We continued W ped our EPS t develop product for th growth roducts to take new pr veness of ou effectiv ts generating 2 product T The Chinese a h so far. We sluggish of diversified needs o nal lucrative addition position in C market ts with higher product ke our safe to mak titive and to ge compet we expanded C for their pro e vehicle mo om the Jeep W 00 and 3500 AS being awa m Chrysler’s th American a ne SUV as p are able to ex models and ve product de ining unit cos uct quality. to invest in o technology as he future as w e market shar ur R&D is 20.5% of total automotive m e remain com markets in Ch foreign mark China, we con r quality and ety-related ste enerate free ca market and w products will OEMs and a we believe l be well ftermarket d our relation ducts in North odels using o Wrangler® to th pick-up truc arded the 2011 China office. aftermarket su part of a glob xpand our rel penetratenew evelopment, p sts and ability nship with h America our power he popular cks. This Excellent Further, upplier of bal OEM's lationships w markets production y to ensure we further t will be a ping other etitors.The d by new our R&D as w we believe it well as develop e from compe demonstrated l sales in 2011 . market in 201 2 remains eeting the mmitted to me nding into hina and expa ur leading kets. With ou us on new ntinue to focu improved pe rformance ucts more eering produ ash flow。 Sincere Qizhou China A May 23 ely, u Wu - CEO & Automotive Sy 3, 2012 & Director ystems, Inc. (This page intentionally left blank) CHINA AUTOMOTIVE SYSTEMS, INC. INDEX Page(s) 0PART I .................................................................................................................................................................................. 1 11 1ITEM 1 BUSINESS ............................................................................................................................................... 1 2ITEM 2 PROPERTIES ........................................................................................................................................ 2 3ITEM 3 LEGAL PROCEEDINGS ...................................................................................................................... 2 21 212 213 4PART II .............................................................................................................................................................................. 2 214 5ITEM 4 MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES ....................................................................................... 2 6ITEM 5 SELECTED FINANCIAL DATA ......................................................................................................... 2 7ITEM 6 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. .................................................................................................................................. 2 8ITEM 7 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ...................................................... 2 9ITEM 8 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE ..................................................................................................................................... 2 214 215 217 239 240 1PART III ............................................................................................................................................................................. 2 242 1ITEM 9 DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE ............................... 2 1ITEM 10 EXECUTIVE COMPENSATION ......................................................................................................... 3 1ITEM 11 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS ................................................................................................................ 3 1ITEM 12 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE ...................................................................................................................................................... 3 1ITEM 13 PRINCIPAL ACCOUNTING FEES AND SERVICES ........................................................................ 3 342 346 349 349 350 1PART IV ............................................................................................................................................................................. 3 350 1ITEM 14 FINANCIAL STATEMENTS ............................................................................................................... 3 350 0 1 2 3 4 5 6 7 8 9 1 1 1 1 1 1 1 1 (This page intentionally left blank) CAUTIONARY STATEMENT This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. These statements relate to future events or the Company’s future financial performance. The Company has attempted to identify forward-looking statements by terminology including “anticipates,” “believes,” “expects,” “can,” “continues,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “should” or “will” or the negative of these terms or other comparable terminology. Such statements are subject to certain risks and uncertainties, including the matters set forth in this Annual 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. Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, the Company cannot guarantee future results, levels of activity, performance or achievements. Undue reliance should not be placed on these forward-looking statements which speak only as of the date hereof. The Company’s expectations are as of the date this Form 10-K is filed, and the Company does not intend to update any of the forward-looking statements after the date this Annual Report on Form 10-K is filed to confirm these statements to actual results, unless required by law. PART I ITEM 1 BUSINESS COMPANY HISTORY China Automotive Systems, Inc., “China Automotive” or the “Company,” was incorporated in the State of Delaware on June 29, 1999 under the name Visions-In-Glass, Inc. On or around March 5, 2003, the Company acquired all of the issued and outstanding equity interests of Great Genesis Holdings Limited, “Genesis,” a corporation organized under the laws of the Hong Kong Special Administrative Region, China, by issuance of 20,914,250 shares of common stock to certain sellers. After the acquisition, the Company continued the operations of Genesis. On May 19, 2003, the Company changed its name from Visions-In-Glass, Inc. to China Automotive Systems, Inc. Presently, Genesis directly and indirectly owns interests in eight Sino-joint ventures and a wholly owned subsidiary in the People’s Republic of China, “China” or the “PRC,” which manufacture power steering systems and/or related products for different segments of the automobile industry. Unless the context indicates otherwise, the Company uses the terms “the Company,” “we,” “our” and “us” to refer to Genesis and China Automotive collectively on a consolidated basis. BUSINESS OVERVIEW The Company is a holding company and has no significant business operations or assets other than its interest in Genesis. All operations are conducted through Genesis and Henglong USA, its wholly owned subsidiaries (the abbreviated names of subsidiaries and joint ventures are defined in the organization chart below), as well as through eight Sino-foreign joint ventures in China, Henglong, Jiulong, Shenyang, Zhejiang, USAI, Wuhu, Jielong and Testing Center and a wholly owned subsidiary in China, Hengsheng. Seven non-wholly owned joint ventures (Henglong, Jiulong, Shenyang, Zhejiang, USAI, Wuhu and Jielong) are under the Company’s control, whereas the Testing Center is a wholly owned subsidiary of Henglong. Beijing Henglong is a joint venture formed by Hengsheng, which is jointly controlled by the Company and another investor. Set forth below is an organizational chart as at December 31, 2011. 1 China Automotive Systems, Inc. [NASDAQ:CAAS] ↓100% Great Genesis Holdings Limited ↓ ↓70% Shenyang Jinbei Henglong Automotive Steering System Co., Ltd. ↓51% Zhejiang Henglong & Vie Pump-Manu Co., Ltd. ↓81% Shashi Jiulong Power Steering Gears Co., Ltd. ↓83.34% Universal Sensor Application, Inc. “Jiulong” 2 “Shenyang” 3 “Zhejiang” 4 “USAI” 5 ↓100% Henglong USA Corporation ↓77.33% Wuhu Henglon g Automotive Steering System Co., Ltd. “Wuhu” 6 ↓85% Wuhan Jielong Electric Power Steering Co., Ltd. “Jielong” 7 ↓100.00% Jingzhou Hengsheng Automotive System Co., Ltd. “Hengsheng” 8 ↓ 50.00% Beijing Henglong Automotive System Co., Ltd. “Beijing Henglong” 10 ↓80% Jingzhou Henglong Automotive Parts Co., Ltd. “Henglong” 1 ↓80.00% Jingzhou Henglong Automotive Technology (Testing) Center “Testing Center” 9 1. Henglong was established in 1997 and is mainly engaged in the production of rack and pinion power steering gear 2. for cars and light duty vehicles. Jiulong was established in 1993 and is mainly engaged in the production of integral power steering gear for heavy-duty vehicles. 3. Shenyang was established in 2002 and focuses on power steering parts for light duty vehicles. 4. Zhejiang was established in 2002 to focus on power steering pumps. 5. USAI was established in 2005 and is mainly engaged in the production and sales of sensor modules. 6. Wuhu was established in 2006 and is mainly engaged in the production and sales of automobile steering systems. 7. Jielong was established in 2006 and is mainly engaged in the production and sales of electric power steering gear, “EPS.” 8. On March 7, 2007, Genesis established Hengsheng, its wholly owned subsidiary, to engage in the production and sales of automotive steering systems. The registered capital of Hengsheng at the time of establishment was $10,000,000. On February 10, 2010, the registered capital of Hengsheng was increased to $16,000,000. On October 12, 2011, the board of directors of the Company approved a reorganization of the Company’s subsidiaries operating in China. As a result of the reorganization, all of Genesis’s equity interests of its subsidiaries operating in China, except for Shenyang and Zhejiang, were transferred to Hengsheng, the Company’s new China-based holding company. The reorganization was completed on January 19, 2012, and after that, the registered capital of Hengsheng increased to $39,000,000. In December 2009, Henglong, a subsidiary of Genesis, formed the Testing Center, which is mainly engaged in the research and development of new products. The registered capital of the Testing Center was RMB 30,000,000, equivalent to approximately $4,393,544. 9. 10. On January 24, 2010, Genesis entered into a joint venture contract with Beijing Hainachuan Auto Parts Co., Ltd., to establish Beijing Henglong as a joint venture company to design, develop and manufacture both hydraulic and electric power steering systems and parts. On September 16, 2010, with Beijing Hainachuan’s agreement, Genesis transferred its interest in the joint venture to Hengsheng, and left the other terms of the joint venture contract unchanged. According to the joint venture agreement, the Company does not have voting control of Beijing Henglong. Therefore, the Company’s consolidated financial statements do not include Beijing Henglong, and such investment is accounted for by the equity method. On October 12, 2011, the board of directors of the Company approved a reorganization of the Company’s subsidiaries operating in China. This reorganization is intended to improve the Company’s marketing of its products in China by presenting a more unified structure under one PRC-based holding company and to improve the administration and control of the various China-based subsidiaries. As a result of the reorganization, all of Genesis’s equity interests in its subsidiaries operating in China, except for Shenyang and Zhejiang, were transferred to Hengsheng (the Company’s 2 new China-based holding company). As the reorganized entities were under common control of the Company, the reorganization will not have a material impact on the Company’s consolidated financial position or results of operations and should not impact the tax treatment of the Company or its subsidiaries in any material respect. The reorganization was completed on January 19, 2012. Set forth below is the organizational chart after the reorganization. China Automotive Systems, Inc. [NASDAQ:CAAS] ↓100% Henglong USA Corporation ↓100% Great Genesis Holdings Limited ↓ ↓100.00% Jingzhou Hengsheng Automotive System Co., Ltd. “Hengsheng” ↓ ↓70% Shenyang Jinbei Henglong Automotive Steering System Co., Ltd. “Shenyang” ↓81% Shashi Jiulong Power Steering Gears Co., Ltd. ↓83.34% Universal Sensor Application, Inc. ↓77.33% Wuhu Henglong Automotive Steering System Co., Ltd. ↓85% Wuhan Jielong Electric Power Steering Co., Ltd. “Jiulong” “USAI” “Wuhu” 6 “Jielong” ↓80% Jingzhou Henglong Automotive Parts Co., Ltd. “Henglong” ↓80.00% Jingzhou Henglong Automotive Technology (Testing) Center “Testing Center” ↓51% Zhejiang Henglong & Vie Pump-Manu Co., Ltd. “Zhejiang” ↓50.00% Beijing Henglong Automotive System Co., Ltd., “Beijing Henglong” The Company has business relationships with more than sixty vehicle manufacturers, including FAW Group and Dongfeng Auto Group, two of the five largest automobile manufacturers in China; Shenyang Brilliance Jinbei Co., Ltd., the largest light vehicle manufacturer in China; Chery Automobile Co., Ltd, the largest state owned car manufacturer in China, and BYD Auto Co., Ltd and Zhejiang Geely Automobile Co., Ltd., the largest privately owned car manufacturers in China. From 2008, the Company has supplied power steering pumps and power steering gear to the Sino-Foreign joint ventures established by General Motors (GM), Citroen and Volkswagen. Since 2009, the Company has also supplied power steering gears to Chrysler North America. INTELLECTUAL PROPERTY RIGHTS Intellectual Property rights, “IP,” are important in helping the Company maintain its competitive position. Currently, the Company owns IP rights, including two trademarks covering automobile parts, “HL” and “JL,” and more than eighty five patents registered in China covering power steering technology. The Company is in the process of integrating new advanced technologies such as electronic chips in power steering systems into its current production line and is pursuing aggressive strategies in technology to maintain a competitive edge within the automobile industry. In 2006, the Company signed a five-year licensing agreement with Bishop Steering Technology Limited, a leader in automotive steering gear technology innovation which offers advanced technology for steering valves within the contract period. On December 20, 2011, the Company extended that agreement for one year. Before expiration, the Company plans to negotiate with Bishop Steering Technology Limited to renew the agreement. The Company does not anticipate that there will be a significant adverse impact if the Company fails to renew as the Company has already developed independent R&D capabilities in steering valves. In 2003, the Company signed a Technology Transfer Agreement with Nanyang Ind. Co. Ltd., a leading steering column maker, for the technology necessary for electronic power steering (EPS) systems. In addition, the Company established with Tsinghua University a steering systems 3 research institute designed to develop EPS and Electronic Hydraulic Power Steering Systems (EHPS). In December 2009, the Company, through Henglong, a subsidiary of Genesis, formed Henglong Testing Center to engage in the research and development of new products, such as EPS, integral rack and pinion power steering and high pressure power steering, to optimize current products design and to develop new, cost-saving manufacturing processes. CUSTOMERS The Company’s ten largest customers represented 72.0% of the Company’s total sales for the year ended December 31, 2011. The following table sets forth information regarding the Company’s ten largest customers. Name of Major Customers Chery Automobile Co., Ltd Dongfeng Auto Group Co., Ltd Zhejiang Geely Holding Co., Ltd China FAW Group Corporation Beiqi Foton Motor Co., Ltd. Brilliance China Automotive Holdings Limited Great Wall Motor Company Limited BYD Auto Co., Ltd Chrysler Group LLC Xiamen Joylon Co., Ltd., Total Percentage of Total Revenue in 2011 11.7% 9.7% 7.8% 6.9% 6.6% 6.4% 6.1% 6.0% 5.9% 4.9% 72.0% The Company primarily sells its products to the above-mentioned original equipment manufacturing, “OEM,” customers; it also has excellent relationships with them, including serving as their first-rank supplier and developer for product development for new models. While the Company intends to continue to focus on retaining and winning this business, it cannot ensure that it will succeed in doing so. It is difficult to keep these contracts as a result of severe price competition and customers’ diversification of their supply base. The Company’s business would be materially and adversely affected if it loses one or more of these major customers. SALES AND MARKETING The Company’s sales and marketing team has 103 sales persons, which are divided into an OEM team, a sales service team and a working group dedicated to international business. These sales and marketing teams provide a constant interface with the Company’s key customers. They are located in all major vehicle producing regions to represent more effectively the Company’s customers’ interests within the Company’s organization, to promote their programs and to coordinate their strategies with the goal of enhancing overall service and satisfaction. The Company’s ability to support its customers is further enhanced by its broad presence in terms of sales offices, manufacturing facilities, engineering technology centers and joint ventures. The Company’s sales and marketing organization and activities are designed to create overall awareness and consideration of, and therefore to increase sales of, the Company’s modular systems and components. To achieve that objective, the Company organized delegations to visit the United States, Korea, India and Japan and has supplied power steering gear to Chrysler North America. Through these activities, the Company has generated potential business interest as a strong base for future development. DISTRIBUTION The Company’s distribution system covers all of China. The Company has established sales and service offices with certain significant customers to deal with matters related to such customers in a timely fashion. The Company also established distribution warehouses close to major customers to ensure timely deliveries. The Company maintains strict control over inventories. Each of these sales and service offices sends back to the Company through e-mail or fax 4 information related to the inventory and customers’ needs. The Company guarantees product delivery in 8 hours for those customers who are located within 200 km from the Company’s distribution warehouses, and 24 hours for customers who are located outside of 200 km from the Company’s distribution warehouses. Delivery time is a very important competitive factor in terms of customer decision making, together with quality, pricing and long-term relationships. EMPLOYEES AND FACILITIES As of December 31, 2011, the Company employed approximately 3,746 persons, including approximately 2,131 by Henglong and Jiulong, approximately 290 by Shenyang, approximately 347 by Zhejiang, approximately 38 by USAI, approximately 207 by Wuhu, approximately 370 by Jielong, approximately 353 by Hengsheng, and 10 by Henglong USA. As of December 31, 2011, each of Henglong and Jiulong, Shenyang, Zhejiang, Wuhu, Jielong, and Hengsheng has a manufacturing and administration area of 278,092 square meters, 35,354 square meters, 32,000 square meters, 83,700 square meters, 99,580 square meters, and 170,520 square meters, respectively. Hubei Province, which is home to Dongfeng, one of the largest automakers in China, provides an ample supply of inexpensive but skilled labor to automotive-related industries. The annual production of the Company’s main product, power steering gear, was approximately 3,400,000 units and 3,100,000 units in 2011 and 2010, respectively. Although the production process continues to rely heavily on manual labor, the Company has invested substantially in high-level production machinery to improve capacity and production quality. Approximately $61 million was spent over the last three years to purchase professional-grade equipment and extend workshops—approximately 80% of which has been used in the production process as of December 31, 2011. RAW MATERIALS The Company purchases various manufactured components and raw materials for use in its manufacturing processes. The principal components and raw materials the Company purchases include castings, finished sub-components, aluminum, steel, fabricated metal electronic parts and molded plastic parts. The most important raw material is steel. The Company enters into purchase agreements with local suppliers. The annual purchase plans are determined at the beginning of the calendar year but are subject to revision every three months as a result of customers’ orders. A purchase order is made according to monthly production plans. This protects the Company from building up inventory when the orders from customers change. The Company’s purchases from its ten largest suppliers represented in the aggregate 28.6% of all components and raw materials it purchased for the year ended December 31, 2011, and none of them provided more than 10% of total purchases. All components and raw materials are available from numerous sources. The Company has not, in recent years, experienced any significant shortages of manufactured components or raw materials and normally does not carry inventories of these items in excess of what is reasonably required to meet its production and shipping schedules. RESEARCH AND DEVELOPMENT In 2006, the Company signed a five year consulting and licensing agreement with Bishop Steering Technology Ltd, one of the leading design firms in power steering systems. Bishop’s technology in power steering systems is currently used by carmakers such as BMW and Mercedes Benz. Pursuant to the agreement, the Company has implemented the Bishop steering valve technology into the Henglong brand R&P power steering gear. On December 20, 2011, the Company signed a one-year extension of a licensing agreement with Bishop Steering Technology Limited for steering valves technology. Before expiration, the Company plans to negotiate with Bishop Steering Technology Limited to renew the agreement. The Company does not anticipate that there will be a significant adverse impact if the Company fails to renew as the Company has already developed independent R&D capabilities in steering valves. 5 The Company owns the Testing Center, a Hubei Provincial-Level technical center, which has been approved by the Hubei Economic Commission. The center has a staff of about 295, including 26 senior engineers, 3 foreign experts and 205 engineers, primarily focusing on steering system R&D, tests, production process improvement and new material and production methodology application. In addition, the Company has partnered with Tsinghua University to establish a steering system research center, called Tsinghua Henglong Automobile Steering Research Institute, for the purposes of R&D and experimentation for EPS. The Company believes that its engineering and technical expertise, together with its emphasis on continuing research and development, allow it to use the latest technologies, materials and processes to solve problems for its customers and to bring new, innovative products to market. The Company believes that continued research and development activities, including engineering, are critical to maintaining its pipeline of technologically advanced products. The Company has aggressively managed costs in other portions of its business in order to increase its total expenditures for research and development activities, including engineering, at approximately $10,010,000, $7,990,000, and $2,560,000 for the years ended December 31, 2011, 2010, and 2009, respectively. The significant increase in 2011 is mainly due to the large expenditure in EPS R&D, because the Company believes demands for new EPS products will increase significantly in the future. In 2011, the sales of newly developed products accounted for about 20.5% of total sales. As the Company sold newly developed products in 2011, the Company’s sales of steering gear for passenger vehicles increased by 7.3%, compared with the year 2010. By way of comparison, the sales of passenger vehicles in the China market only increased by 4.23%, compared with the year 2010. CHINESE AUTOMOBILE INDUSTRY The Company is a supplier of automotive parts and most of its operations are located in China. An increase or decrease in the output and sales of Chinese vehicles could result in an increase or decrease of the Company’s results of operations. According to the latest statistics from the China Association of Automobile Manufacturers (“CAAM”), in 2011, the output and sales volume of vehicles in China have reached 18.24 million and 18.51 million units, respectively, an increase of 0.84% and 2.5% compared to 2010. The output and sales volume of passenger vehicles have reached 14.49 million and 14.47 million units respectively, with an increase of 4.23% and 5.19% compared to 2010. The output and sales volume of commercial vehicles have reached 3.93 million and 4.03 million units, respectively, a decrease of 9.94% and 6.31% compared to 2010. Accordingly, in 2011, the Company’s sales of steering gear for passenger vehicles increased by 7.3% compared with the year 2010, steering gear and steering pumps for commercial vehicles decreased by 13.0% and 24.2%, respectively, compared with the year 2010. Industry analysts expect market growth to slow in 2012 as the incentive policies, such as subsidies to rural area consumers, fuel-efficient car buyers and reduced purchase taxes, have expired. In addition, some PRC cities, like Beijing, have policies to limit the number of cars purchased each month to deal with gridlocked streets, which the Company expects to have a longer-term impact on the development of the automobile industry in China. Despite these challenges, management believes that the continuing development of the highway system will have a significant positive long-term impact on the manufacture and sale of private automobiles in the PRC. Statistics from the Ministry of Transport show that 71,000 kilometers of highway and 11,000 kilometers of expressway were built in 2011. Total highways and expressways in the PRC now amount to 4,055,000 kilometers and 85,000 kilometers, respectively. FINANCIAL INFORMATION AND GEOGRAPHIC AREAS Financial information about sales and long-term assets by major geographic region can be found in Note 32, “Segment Information” to the consolidated financial statements. The following table summarizes the percentage of sales and total assets by major geographic regions: 6 Net Sales Year Ended December 31 2010 2011 2009 Long-term Assets As of December 31 2010 2011 Geographic region: United States China Total ITEM 1A RISK FACTORS 6.4% 93.6 100% 5.0% 95.0 100% 2.4% 97.6 100% 0.03% 99.97 100% 0.02% 99.98 100% Any investment in the Company’s securities involves a high degree of risk. You should carefully consider the risks described below, together with the information contained elsewhere in this Annual Report, before you make a decision to invest in the Company. The Company’s business, 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 any forward-looking statements. Factors that might cause such differences include, among others, the following: RISKS RELATED TO THE COMPANY’S BUSINESS AND INDUSTRY 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 and the price and availability of gasoline. They also can be affected by labor relations issues, regulatory requirements and other factors. In the last two years, the price of automobiles in China has generally declined. Additionally, the volume of automotive production in China has fluctuated from year to year, which gives rise to fluctuations in the demand for the Company’s products. Therefore, any significant economic decline could result in a reduction in automotive production and sales by the Company’s customers and could have a material adverse effect on the Company’s 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 the Company’s operating costs and adversely affect its profit margins and profitability. 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 almost has no operations independent of those of Genesis and its subsidiaries, and the Company’s principal assets are its investments in Genesis and its subsidiaries and affiliates. As a result, the Company is dependent upon the performance of Genesis and its subsidiaries and will be subject to the financial, business and other factors affecting 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, the Company 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 the Company’s 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, its assets and 7 those of its subsidiaries will be available to satisfy the claims of the Company’s stockholders only after all of its and its subsidiaries’ liabilities and obligations have been paid in full. The convertible notes are the Company’s unsecured obligations, but are not obligations of its subsidiaries. In addition, the subsidiaries’ secured bank loans and notes payable are senior to the convertible notes. 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: system and product performance; reliability and timeliness of delivery; - quality; - price/cost competitiveness; - - - new product and technology development capability; - - degree of global and local presence; - - overall management capability. excellence and flexibility in operations; effectiveness of customer service; and The Company’s competitors include independent suppliers of parts, as well as suppliers formed by spin-offs from the Company’s 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 it could lose market share, any of which could materially harm the Company’s business, results of operations 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. 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. The Company’s business, revenues and profitability would be materially and adversely affected if it loses any of its large customers. For the year ended December 31, 2011, approximately 11.7% of the Company’s sales were to Chery Automobile Co., Ltd, approximately 9.7% were to Dongfeng Auto Group Co., Ltd, approximately 7.8% were to Zhejiang Geely Holding Co., Ltd, and approximately 6.9% were to China FAW Group Corporation, the Company’s four largest customers. In total, these four largest customers accounted for 36.1% of the total sales in 2011. For the year ended December 31, 2010, approximately 12.3% of the Company’s sales were to Chery Automobile Co., Ltd, approximately 11.0% were to BYD Automobile Co., Ltd, approximately 8.8% were to Dongfeng Auto Group Co., Ltd and approximately 8.5% were to Zhejiang Geely Holding Co., Ltd, the Company’s four largest customers. In total, these 8 four largest customers accounted for 40.6% of the total sales in 2010. 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 not be able to collect receivables incurred by customers. Although the Company currently sells its products on credit, the Company’s ability to receive payment for its products depends on the continued creditworthiness of its customers. The Company’s customer base may change if its sales increase because of the Company’s expanded capacity. If the Company is not able to collect its receivables, its profitability will be adversely affected. 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 some of 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 of about 2%–6% of the total amount of parts supplied. Accordingly, the Company has experienced and will 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 its results of operations. 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 requirements. 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 fail to perform, and it 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 staff, particularly engineers and other employees with mechanics and electronics expertise, and managerial, finance and marketing personnel. The Company does not maintain a key person life insurance policy on Mr. Hanlin Chen or Mr. Qizhou Wu. 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. The Company’s management controls approximately 71.31% of its outstanding common stock and may have conflicts of interest with the Company’s minority stockholders. 9 As of December 31, 2011, members of the Company’s management beneficially own approximately 71.31% of the outstanding shares of the Company’s common stock. As a result, except for the related party transactions that require approval of the audit committee of the board of directors of the Company, these majority stockholders have control over decisions to enter into any corporate transaction, which could result in the approval of transactions that might not maximize overall 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. The Company regularly engages in transactions with entities controlled by one or more of its officers and directors, including those controlled by Mr. Hanlin Chen, the chairman of the board of directors of the Company and its controlling stockholder. Covenants contained in the Securities Purchase Agreement and the convertible notes restrict the Company’s operating flexibility. In connection with the convertible notes, the Company entered into a series of binding covenants and contractual provisions that limits the Company’s operating flexibility. For example, the Securities Purchase Agreement prohibits the Company from paying cash dividends on common stock without the approval of the holders of the convertible notes. Also, if the Weighted Average Price (WAP) for twenty (20) consecutive trading days is less than $3.187, the convertible notes holders shall have the right, in their sole discretion, to require that the Company redeem all or any portion of the convertible notes. The portion of this convertible notes subject to redemption in connection with the share price change of the underlying common stock will be redeemed by the Company in cash at a price equal to the sum of the conversion amount being redeemed and the Other Make Whole Amount as mentioned in Note 12 to the consolidated financial statements. Also, upon the consummation of a change of control as defined in the convertible notes agreements, the convertible notes holders may require the Company to redeem all or any portion of the convertible notes. These binding covenants and contractual provisions limit the Company’s ability to declare or pay dividends, issue other notes or debt, issue certain types of securities engage in certain types of intercompany loans or enter into other types of fundamental transactions. These restrictions could limit the Company’s ability to operate and may harm the equity interest of stockholders. There is a limited public float of the Company’s common stock, which can result in the Company’s stock price being volatile and prevent the realization of a profit on resale of the Company’s common stock or derivative securities. There is a limited public float of the Company’s common stock. As of December 31, 2011, approximately 28.69% of the Company’s outstanding common stock is considered part of the public float. The term “public float” refers to shares freely and actively tradable on the NASDAQ Capital 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 and the limited trading volume on some days, the market price of the Company’s common stock can be volatile, and relatively small changes in the demand for or supply of the Company’s common stock can have a disproportionate effect on the market price for its common stock. This stock price volatility could prevent a security holder seeking to sell the Company’s common stock or derivative securities from being able to sell them at or above the price at which the stock or derivative securities were bought, or at a price which a fully liquid market would report. 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 it 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. Litigation arising from the need to restate certain previously issued historical financial statements of the Company could have a material adverse effect on the Company’s business, financial condition, results of operations or liquidity. 10 On March 17, 2011, the Company announced that it had identified historical accounting errors relating to the accounting treatment of the Company’s convertible notes issued on February 15, 2008. The accounting errors resulted in the misstatement of certain charges since the first quarter of 2009. The Company undertook a review to determine the total amount of the errors and the accounting periods in which the errors occurred. The Company’s review was overseen by the audit committee of the board of directors of the Company, the “Audit Committee”, with the assistance of management and accounting consultants engaged by management. The Audit Committee concluded on March 12, 2011 that the Company’s previously issued audited consolidated financial statements as of and for the year ended December 31, 2009, and related auditors’ report, and unaudited interim consolidated financial statements as of and for the quarterly periods ended March 31, June 30 and September 30, 2010 should no longer be relied upon because of these errors in the financial statements. The Company’s board of directors agreed with the Audit Committee’s conclusions. After analyzing the size and timing of the errors, the Company determined that, in the aggregate, the errors were material and would require the Company to restate certain of its previously issued financial statements. On October 25, 2011, a purported securities class action was filed in the United States District Court for the Southern District of New York on behalf of all purchasers of the Company’s securities between March 25, 2010 and March 17, 2011. On February 24, 2012, the plaintiffs filed an amended complaint, changing the purported class period from May 12, 2010 through March 17, 2011. The amended complaint alleges that the Company, certain of its present officers and directors and the Company’s former auditor violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and the rules promulgated thereunder, and seeks unspecified damages. On December 23, 2011, a purported shareholder derivative action was filed in the Court of Chancery of the State of Delaware (the “Court of Chancery”) on behalf of the Company. The complaint alleges that certain of the Company’s current officers and directors breached their fiduciary duties to the Company in relation to the Company’s accounting of convertible notes issued in February 2008. On January 25, 2012, a second purported shareholder derivative action was filed in the Court of Chancery on behalf of the Company. On February 3, 2012 the Court of Chancery consolidated the two cases. The shareholder suits have been stayed pending the outcome of any motion to dismiss in the securities class action. The Company has not yet been required to respond formally to these lawsuits. In addition, the complaints do not specify an amount of damages that plaintiffs seek. Because these matters are in very early stages, the Company cannot determine whether or not an adverse outcome is probable, nor can it provide a reasonable estimate of potential losses related to these matters. An adverse outcome in one or more of these matters could have a material adverse effect on the Company’s business, financial condition, results of operations or liquidity. The Company may also be subject to additional lawsuits as a result of the restatement, which could have a material adverse effect on the Company’s business, financial condition, results of operations or liquidity. Failure to achieve and maintain effective internal control over financial reporting could have a material adverse effect on the Company’s business, results of operations and the trading price of its shares. The Company is subject to reporting obligations under the U.S. securities laws. The Securities and Exchange Commission, the “SEC,” as required by Section 404 of the Sarbanes-Oxley Act of 2002, has adopted rules requiring public companies to include a report of management in its annual report that contains an assessment by management of the effectiveness of such company’s internal control over financial reporting. In addition, beginning with the year ended December 31, 2007, an independent registered public accounting firm for an accelerated filer must attest to and report on the effectiveness of the company’s internal control over financial reporting. The Company’s management has conducted an evaluation of the effectiveness of its internal control over financial reporting and concluded that the Company’s internal control over financial reporting was not effective as of December 31, 2011, and a material weakness was noted because the Company did not have sufficient personnel with appropriate levels of accounting knowledge and experience to address complex U.S. GAAP accounting issues, and to prepare and review financial statements and related disclosures under U.S. GAAP. If the Company fails to maintain the effectiveness or fails to remediate the deficiencies of its internal control over financial reporting, the Company may not be able to conclude on an ongoing basis that it has effective internal control over financial reporting in accordance with the Sarbanes-Oxley Act. 11 Effective internal controls are necessary for the Company to produce reliable financial reports. For the deficiencies identified in this fiscal year, the Company’s management team is evaluating remediation measures that can be undertaken to address this material weakness and will continue such evaluation so that it may institute a comprehensive remediation plan in order to maintain effective internal control over financial reporting. Any failure to achieve and maintain effective internal control over financial reporting could result in the loss of investor confidence in the reliability of the Company’s financial statements, which in turn could negatively impact the trading price of the Company’s shares. Furthermore, the Company may need to incur additional costs and use additional management and other resources in an effort to comply with Section 404 of the Sarbanes-Oxley Act and other requirements going forward. The Company does not pay cash dividends on its common stock. The Company has never paid common stock cash dividends and does not anticipate doing so in the foreseeable future. In addition, the Securities Purchase Agreement prohibits the Company from paying cash dividends on common stock without the approval of the holders of the convertible notes. Techniques employed by short sellers may drive down the market price of the Company’s common stock. Short selling is the practice of selling securities that the seller does not own but rather has borrowed from a third party with the intention of buying identical securities back at a later date to return to the lender. The short seller hopes to profit from a decline in the value of the securities between the sale of the borrowed securities and the purchase of the replacement shares, as the short seller expects to pay less in that purchase than it received in the sale. As it is in the short seller’s best interests for the price of the stock to decline, many short sellers publish, or arrange for the publication of, negative opinions regarding the relevant issuer and its business prospects in order to create negative market momentum and generate profits for themselves after selling a stock short. These short attacks have, in the past, led to selling of shares in the market. Recently, public companies that have substantially all of their operations in China have been the subject of short selling. Much of the scrutiny and negative publicity has centered around allegations of a lack of effective internal control over financial reporting resulting in financial and accounting irregularities and mistakes, inadequate corporate governance policies or a lack of adherence thereto and, in many cases, allegations of fraud. As a result, many of these companies are now conducting internal and external investigations into the allegations and, in the interim, are subject to shareholder lawsuits and/or SEC enforcement actions. It is not clear what effect such negative publicity would have on the Company, if any. If the Company were to become the subject of any unfavorable allegations, whether such allegations are proven to be true or untrue, the Company could have to expend a significant amount of resources to investigate such allegations and/or defend itself. While the Company would strongly defend against any such short seller attacks, the Company may be constrained in the manner in which it can proceed against the relevant short seller by principles of freedom of speech, applicable state law or issues of commercial confidentiality. Such a situation could be costly and time-consuming, and could distract the Company’s management from growing the Company. Even if such allegations are ultimately proven to be groundless, allegations against the Company could severely impact its business operations and stockholders equity, and any investment in the Company’s stock could be greatly reduced or rendered worthless. ITEM 2 PROPERTIES The Company’s headquarters are located at No. 1 Henglong Road, Yu Qiao Development Zone, Shashi District, Jing Zhou City Hubei Province, the PRC. Set forth below are the manufacturing facilities operated by each joint venture. The Company has forty-five to fifty years long-term rights to use the lands and buildings. 12 Name of Entity Product Total Area (M2) Building Area (M2) Original Cost of Equipment Site Henglong Automotive Parts 225,221 20,226 $ 35,710,000 Jingzhou City, Hubei Province Jiulong Shenyang Power Steering Gear Automotive Steering Gear 13,393 39,478 23,728 $ 31,880,000 13,707 $ - Wuhan City, Hubei Province 35,354 5,625 $ 5,480,000 Jingzhou City, Hubei Province Shenyang City, Liaoning Province Zhuji City, Zhejiang Province Zhejiang Steering Pumps 32,000 20,000 $ 10,610,000 Jielong USAI Hengsheng Wuhu Total Electric Power Steering Sensor Modular Automotive Steering Gear Automotive Steering Gear 99,580 - - $ - $ 170,520 26,000 $ 6,090,000 Wuhan City, Hubei Province 900,000 Wuhan City, Hubei Province Jingzhou City, Hubei Province 12,490,000 83,700 12,600 $ 4,160,000 Wuhu City, Anhui Province 699,246 121,886 $ 107,320,000 The Company is not involved in investments in (i) real estate or interests in real estate, (ii) real estate mortgages, and (iii) securities of or interests in persons primarily engaged in real estate activities, as all of its land rights are used for production purposes. ITEM 3 LEGAL PROCEEDINGS On October 25, 2011, a purported securities class action was filed in the United States District Court for the Southern District of New York on behalf of all purchasers of the Company’s securities between March 25, 2010 and March 17, 2011. On February 24, 2012, the plaintiffs filed an amended complaint, changing the purported class period from May 12, 2010 through March 17, 2011. The amended complaint alleges that the Company, certain of its present officers and directors and the Company’s former auditor violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and the rules promulgated thereunder, and seeks unspecified damages. The Company has not yet responded to the amended complaint, but believes the allegations in the complaint are without merit. The Company intends to defend itself vigorously against the claims. On December 23, 2011, a purported shareholder derivative action was filed in the Court of Chancery of the State of Delaware (the “Court of Chancery”) on behalf of the Company. The complaint alleges that certain of the Company’s current officers and directors breached their fiduciary duties to the Company in relation to the Company’s accounting of convertible notes issued in February, 2008. On January 25, 2012, a second purported shareholder derivative action was filed in the Court of Chancery on behalf of the Company. On February 3, 2012 the Court of Chancery consolidated the two cases. The shareholder suits have been stayed pending the outcome of any motion to dismiss in the securities class action. The Company believes the allegations in the shareholder suits are without merit, and intends to defend itself vigorously against the claims. The Company has not yet been required to respond formally to these lawsuits. In addition, the complaints do not specify an amount of damages that plaintiffs seek. Because these matters are in very early stages, the Company cannot determine whether or not an adverse outcome is probable, nor can it provide a reasonable estimate of potential losses related to these matters. While the Company believes that it has meritorious defenses to each of these actions and intends to defend them vigorously, an adverse outcome in one or more of these matters could have a material adverse effect on the Company’s business, financial condition, results of operations or liquidity. 13 Other than the above, the Company is not a party to any pending or, to the best of the Company’s knowledge, any threatened legal proceedings. In addition, no director, officer or affiliate of the Company, or owner of record of more than five percent of the securities of the Company, or any associate of any such director, officer or security holder is a party adverse to the Company or has a material interest adverse to the Company in reference to pending litigation. PART II ITEM 4 MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES MARKET PRICES OF COMMON STOCK` The Company’s common stock has been traded on the NASDAQ Capital Market under the symbol “CAAS.” The high and low bid intra-day prices of the common stock in 2011 and 2010 were reported on NASDAQ for the time periods indicated on the table below. Accordingly, the table below contains the high and low bid closing prices of the common stock as reported on the NASDAQ for the time periods indicated. Price Range 2011 2010 High Low High Low $ $ $ $ 15.02 $ 11.59 $ 9.29 $ 5.65 $ 7.40 $ 6.30 $ 4.03 $ 3.23 $ 27.17 $ 25.15 $ 20.70 $ 17.98 $ 14.18 14.60 13.60 13.10 First Quarter Second Quarter Third Quarter Fourth Quarter STOCKHOLDERS The Company’s common shares are issued in registered form. Securities Transfer Corporation in Frisco, Texas is the registrar and transfer agent for the Company’s common stock. As of December 31, 2011, there were 28,260,302 shares of the Company’s common stock outstanding and the Company had approximately 59 stockholders of record. DIVIDENDS The Company has never declared or paid any cash dividends on its common stock and it does not anticipate paying any cash dividends in the foreseeable future. The Company currently intends to retain future earnings, if any, to finance operations and the expansion of its business. Any future determination to pay cash dividends will be at the discretion of the Board of Directors and will be based upon the Company’s financial condition, operating results, capital requirements, plans for expansion, restrictions imposed by any financing arrangements and any other factors that the Board of Directors deems relevant. SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS The securities authorized for issuance under equity compensation plans at December 31, 2011 are as follows: Plan category Equity compensation plans approved by security holders Number of securities to be issued upon exercise of outstanding options Weighted average exercise price of outstanding options Number of securities remaining available for future issuance 2,200,000 $ 9.72 1,721,150 14 The stock option plan was approved at the 2004 Annual Meeting of Stockholders, and the maximum common shares for issuance under this plan are 2,200,000 with a term of 10 years. PERFORMANCE GRAPH Company Stock Performance The information contained below shall not be deemed incorporated by reference in any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, the “Exchange Act,” whether made before or after the date hereof and irrespective of any general incorporation language in any such filing (except to the extent that the Company specifically incorporates this information by reference) and shall not otherwise be deemed “soliciting material” or “filed” with the Securities and Exchange Commission or subject to Regulation 14A or 14C, or to the liabilities of Section 18 of the Exchange Act (except to the extent that the Company specifically requests that this information be treated as soliciting material or specifically incorporate this information by reference). The following graph shows a five-year comparison of the cumulative total stockholder return on the Company’s common stock as compared to the cumulative total return of two other indexes: a custom composite index (“Peer Group”), and the Standard & Poor’s 500 Composite Stock Price Index. The companies included in the Peer Group are: SORL Auto Parts, Inc., China Yuchai International Limited, Standard Motor Products Inc. and Dorman Products, Inc. These comparisons assume an initial investment of $100 and the reinvestment of dividends. CAAS S&P 500 1 Peer Group Peer + CAAS $ $ $ $ 2006 100 $ 100 $ 100 $ 100 $ Data Source: Standard & Poor's Fiscal Years End December 31, 2009 2008 2007 65 $ 105 $ 101 $ 92 $ 28 $ 66 $ 54 $ 47 $ 156 $ 84 $ 129 $ 136 $ 2010 114 $ 97 $ 255 $ 219 $ 2011 28 99 187 147 The graph and other information furnished in the section titled “Share Performance” under this Part II, Item 5 of this Form 10-K shall not be deemed to be “soliciting” material or to be “filed” with the Securities and Exchange Commission or subject to Regulation 14A or 14C, or to the liabilities of Section 18 of the Securities Exchange Act of 1934, as amended. ITEM 5 SELECTED FINANCIAL DATA The selected consolidated statement of income (loss) and cash flows data for the years ended December 31, 2011, 2010 and 2009 and the selected balance sheet data as of December 31, 2011 and 2010 are derived from the Company’s audited consolidated financial statements included elsewhere in this Annual Report. The selected consolidated financial data for the years ended December 31, 2008 and 2007, and the selected balance sheet data as of 15 December 31, 2009, 2008 and 2007, are derived from the Company’s audited consolidated financial statements not included in this Annual Report. The following selected historical financial information should be read in conjunction with the Company’s consolidated financial statements and related notes and the information contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. 2007 Year Ended December 31, 2009 2010 2008 2011 Statement of income (loss) data: Net sales Gross profit Operating expenses Income from operations Net income (loss) attributable to parent company Earnings (loss) per share attributable to parent company — basic — diluted Statement of cash flows data: Net cash flows provided by operating activities Net cash flows used in investing activities (1) Net cash flows provided by/(used in) financing activities (2) $133,597,003 $163,179,286 $255,597,553 $ 345,925,182 $347,974,754 45,323,048 41,470,073 61,742,626 80,302,710 68,098,997 24,611,397 25,207,560 25,648,736 27,384,338 36,201,809 20,737,277 16,996,576 36,932,395 54,047,404 33,378,496 $ 8,859,906 $ 10,244,130 $ (26,440,871) $ 51,738,113 $ 40,791,987 $ $ 0.37 $ 0.37 $ 0.35 $ 0.35 $ (0.98) $ (0.98) $ 1.65 $ 1.10 $ 1.30 0.69 $ 11,324,473 $ 16,373,966 $ 34,956,534 $ 38,552,161 $ 34,063,290 $ (13,159,277) $ (22,356,060) $ (17,335,687) $ (32,596,741) $ (14,402,403) $ (7,429,025) $ 21,981,953 $ (11,290,625) $ (1,394,578) $ 871,936 $ Balance sheet data: Cash and cash equivalents Total assets Long-term debt obligation and accrued make-whole (2) Total liabilities (2) Total stockholders’equity $ 2007 2008 2009 2010 2011 Year Ended December 31, 19,487,159 $ 182,984,687 37,113,375 $ 231,888,141 43,480,176 $ 314,382,572 49,424,979 $ 405,527,665 72,960,500 466,447,120 - 92,583,555 90,401,132 $ - 129,252,311 102,635,830 $ - 232,529,179 81,853,393 $ - 257,287,874 148,239,791 $ 31,187,138 250,289,944 216,157,176 (1) In January 2010, the Company invested $3.1 million to establish a joint venture company with another stockholder, Beijing Henglong. Please see Note 6 to the Consolidated Financial Statements under Item 15 of this Annual Report for more details. (2) In February 2008, the Company issued convertible notes in the amount of $35 million, of which $5.0 million and $6.4 million were redeemed and converted into common shares in April 2009 and March 2011, respectively. As of December 31, 2011, 2010, and 2009, the accrued make-whole interests were $ 7.6 million, $6.6 million and $4.8 million, respectively. Upon expiration of the mandatory redemption period of the convertible notes in February 2011, the outstanding balance of the convertible notes and accrued make-whole interests were reclassified as long-term obligations. Please see Notes 12 and 15 to the Consolidated Financial Statements under Item 15 of this Annual Report for more details. 16 ITEM 6 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with the Company’s consolidated financial statements and the related notes thereto and other financial information contained elsewhere in this Form 10-K. GENERAL OVERVIEW China Automotive Systems, Inc., including, when the context so requires, its subsidiaries and the subsidiaries’ interests in the Sino-foreign joint ventures described below, is referred to herein as the “Company.” The Company, through its Sino-foreign joint ventures, engages in the manufacture and sales of automotive systems and components in the People’s Republic of China, the “PRC” or “China.” Genesis, a company incorporated on January 3, 2003 under The Companies Ordinance in Hong Kong as a limited liability company, is a wholly owned subsidiary of the Company. Henglong USA Corporation, “HLUSA,” which was incorporated on January 8, 2007 in Troy, Michigan, is a wholly owned subsidiary of the Company, and mainly engages in marketing of automotive parts in North America, and provides after sales service and research and development support accordingly. Furthermore, the Company owns the following aggregate net interests in the following wholly owned subsidiaries and joint ventures organized in the PRC as of December 31, 2011, 2010, and 2009. Name of Entity Jingzhou Henglong Automotive Parts Co., Ltd., “Henglong” Shashi Jiulong Power Steering Gears Co., Ltd., “Jiulong” Shenyang Jinbei Henglong Automotive Steering System Co., Ltd., “Shenyang” Zhejiang Henglong & Vie Pump-Manu Co., Ltd., “Zhejiang” Universal Sensor Application Inc., “USAI” Wuhu HengLong Auto Steering System Co., Ltd., “Wuhu” Wuhan Jielong Electric Power Steering Co., Ltd., “Jielong” Jingzhou Hengsheng Automotive System Co., Ltd, “Hengsheng” Jingzhou Henglong Automotive Technology (Testing) Center, “Testing Center” Beijing Hainachuan HengLong Automotive Steering System Co., Ltd, “Beijing HengLong” Aggregate Net Interest 2010 2011 2009 80.00% 81.00% 70.00% 51.00% 83.34% 77.33% 85.00% 100.00% 80.00% 81.00% 70.00% 51.00% 83.34% 77.33% 85.00% 100.00% 80.00% 81.00% 70.00% 51.00% 83.34% 77.33% 85.00% 100.00% 80.00% 80.00% 80.00% 50.00% 50.00% — RESULTS OF OPERATIONS Net Sales and Cost of Sales 2011 Versus 2010 Comparative For the years ended December 31, 2011 and 2010, net sales and cost of sales are summarized as follows: Net Sales 2011 2010 $ 196,296,846 $ 197,226,807 $ 92,095,265 39,691,553 26,193,095 33,057,878 13,092,659 69,517,738 30,290,139 20,269,837 35,271,488 22,313,422 43,357,605 (69,342,321) 32,707,067 (88,139,142) $ 347,974,754 $ 345,925,182 $ Henglong Jiulong Shenyang Zhejiang Wuhu Hengsheng 1 Other Sectors 1 Eliminations Total 2011 Cost of sales 2010 Change (929,961) (22,577,527) -24.5 (9,401,414) -23.7 (5,923,258) -22.6 2,213,610 6.7 9,220,763 70.4 -0.5% $ 154,856,218 $ 150,622,578 $ 80,664,101 33,644,820 18,630,742 31,330,114 10,650,920 60,387,004 26,239,369 15,555,120 33,531,226 17,655,987 Change 4,233,640 2.8% (20,277,097) -25.1 (7,405,451) -22.0 (3,075,622) -16.5 2,201,112 7.0 7,005,067 65.8 10,650,538 32.6 18,796,821 -21.3 2,049,572 41,729,969 (70,079,136) 29,204,686 (89,125,489) 12,525,283 42.9 19,046,353 -21.4 0.6% $ 279,875,757 $ 265,622,472 $ 14,253,285 5.4% 17 1. Hengsheng was previously included in “Other Sectors.” The Company is now reporting Hengsheng as a separate sector, as it has recently become a principal profit maker. As such, a reclassification has been made to all periods presented to conform to the current period presentation. Such reclassifications had no effect on previously reported results of operations. Net Sales Net sales were $347,974,754 for the year ended December 31, 2011, compared with $345,925,182 for the year ended December 31, 2010, an increase of $2,049,572, or 0.6%. Historically, more than 90% of the Company’s business was derived from China and denominated in RMB, and the increase in net sales results from the appreciation of the RMB against the U.S. dollar. The growth rate of the Company’s net sales in 2011 was lower than the prior year’s as China’s auto market demand slowed, as a result of the expiration of government incentive policies (such as subsidies to rural-area consumers, fuel-efficient car buyers and reduced purchase taxes) and tightened auto industry financing. The decrease in sales volume led to a sales decrease of $18,817,548, a decrease in the average selling price led to a sales decrease of $406,716 and the appreciation of the RMB against the U.S. dollar led to a sales increase of $21,273,836 compared with the same period of 2010. Further analysis is as follows: - Net sales for Henglong was $196,296,846 for the year ended December 31, 2011, compared with $197,226,807 for the year ended December 31, 2010, representing a decrease of $929,961, or 0.5%. Decrease in sales was mainly due to decrease in sale volumes with a sales decrease of $4,788,983, decrease in selling price with a sales decrease of $5,715,008 and the effect of foreign currency translation of the RMB against the U.S. dollar with a sales increase of $9,574,030. - Net sales for Jiulong was $69,517,738 for the year ended December 31, 2011, compared with $92,095,265 for the year ended December 31, 2010, representing a decrease of $22,577,527, or 24.5%. Excluding the net sales of $9,497,104 to Chrysler during the nine months ended September 30, 2010, net sales decrease was $13,080,423, or 15.8% in 2011. Prior to October 1, 2010, sales of Hengsheng’s product to Chrysler were made through Jiulong. Subsequent to that date, Hengsheng directly sells its products to Chrysler. The net sales decrease was mainly due to decrease in sales volumes with a sales decrease of $16,441,619, increase in selling prices resulting from newly developed steering gear models which have higher selling prices than those of old models with a sales increase of $734,771 and the effect of foreign currency translation of the RMB against the U.S. dollar with a sales increase of $2,626,425. - Net sales for Shenyang was $30,290,139 for the year ended December 31, 2011, compared with $39,691,553 for the year ended December 31, 2010, representing a decrease of $9,401,414, or 23.7%. Net sales decrease was mainly due to a decrease in sale volumes with a sales decrease of $11,662,345, an increase in selling prices resulting from newly developed steering gear models that have higher selling prices than those of older models with a sales increase of $ 318,036 and the effect of foreign currency translation of the RMB against the U.S. dollar with a sales increase of $1,942,895. - Net sales for Zhejiang was $20,269,837 for the year ended December 31, 2011, compared with $26,193,095 for the year ended December 31, 2010, representing a decrease of $5,923,258, or 22.6%. Net sales decrease was mainly due to a decreased sale volume with a sales decrease of $5,682,237, a decrease in selling price with a sales decrease of $1,521,246 and the effect of foreign currency translation of the RMB against the U.S. dollar with a sales increase of $1,280,225. - Net sales for Wuhu was $35,271,488 for the year ended December 31, 2011, compared with $33,057,878 for the year ended December 31, 2010, representing an increase of $2,213,610, or 6.7%. Net sales increase was mainly due to a decrease in sale volumes with a sales decrease of $1,752,322, an increase in selling prices resulting from newly developed steering gear models which have higher selling prices than that of older models with a sales increase of $ 2,331,516 and the effect of foreign currency translation of the RMB against the U.S. dollar with a sales increase of $1,634,416. 18 - Net sales for Hengsheng was $22,313,422 for the year ended December 31, 2011, compared with $13,092,659 for the year ended December 31, 2010, representing an increase of $9,220,763, or 70.4%. Net sales increase was mainly due to an increase in automobile consumption in the United States as a result of its economic recovery. Hengsheng’s products were all sold to United States. Increase in sale volumes lead to a sales increase of $10,083,605, a decrease in selling price led to a sales decrease of $1,497,148 and the appreciation of the RMB against the U.S. dollar led to a sales increase of $634,306. - Net sales for Other Sectors was $43,357,605 for the year ended December 31, 2011, compared with $32,707,067 for the year ended December 31, 2010, representing an increase of $10,650,538 or 32.6%. Net sales increase was mainly due to an increase in the market demand for newly developed EPS products. Increase in sale volumes led to a sales increase of $4,567,049, increase in selling prices resulting from newly developed steering gear models that have higher selling prices than those of older models led to a sales increase of $ 4,408,880 and the appreciation of the RMB against the U.S. dollar led to a sales increase of $1,674,609. Cost of Sales For the year ended December 31, 2011, the cost of sales was $279,875,757, compared with $265,622,472 for the same period of 2010, an increase of $14,253,285, or 5.4%. Increase in cost of sales was mainly due to the net effect of decrease in sale volumes with a cost of sales decrease of $15,326,980, increase in unit cost with a cost of sales increase of $12,175,705, and the appreciation of the RMB against the U.S. dollar with a cost of sales increase of $17,404,560. The increase in the unit cost of sales was primarily due to an increase in the cost of raw materials, such as steel. Further analysis is as follows: - Cost of sales for Henglong was $154,856,218 for the year ended December 31, 2011, compared with $150,622,578 for the year ended December 31, 2010, representing an increase of $4,233,640, or 2.8%. Increase in cost of sales was mainly due to a decrease in sales volumes with a cost of sales decrease of $6,878,103, an increase in unit cost with a cost of sales increase of $3,775,578 and the effect of foreign currency translation of the RMB against the U.S. dollar with a cost of sales increase of $7,336,165. - Cost of sales for Jiulong was $60,387,004 for the year ended December 31, 2011, compared with $80,664,101 for the year ended December 31, 2010, representing a decrease of $20,277,097, or 25.1%. Excluding the cost of sales of $7,430,534 to Chrysler during the nine months ended September 30, 2010, cost of sales decrease was $12,846,563, or 17.5%. Prior to October 1, 2010, the sales of Hengsheng’s products to Chrysler were made through Jiulong. Subsequent to that date, Hengsheng directly sells its products to Chrysler. Decrease in cost of sales was mainly due to a decrease in sales volumes with a cost of sales decrease of $ 16,301,757, an increase in unit cost with a cost of sales increase of $ 932,206 and the effect of foreign currency translation of the RMB against the U.S. dollar with a cost of sales increase of $ 2,522,988. - Cost of sales for Shenyang was $26,239,369 for the year ended December 31, 2011, compared with $33,644,820 for the year ended December 31, 2010, representing a decrease of $7,405,451, or 22.0%. Decrease in cost of sales was mainly due to a decrease in sales volumes with a cost of sales decrease of $10,121,205, an increase in unit cost with a cost of sales increase of $1,071,712 and the effect of foreign currency translation of the RMB against the U.S. dollar with a cost increase of $1,644,042. - Cost of sales for Zhejiang was $15,555,120 for the year ended December 31, 2011, compared with $18,630,742 for the year ended December 31, 2010, representing a decrease of $3,075,622, or 16.5%. Decrease in cost of sales was mainly due to a decrease in sales volumes with a cost of sales decrease of $4,101,041, an increase in unit cost with a cost of sales increase of $113,424 and the effect of foreign currency translation of the RMB against the U.S. dollar with a cost increase of $911,995. - Cost of sales for Wuhu was $33,531,226 for the year ended December 31, 2011, compared with $31,330,114 for the year ended December 31, 2010, representing an increase of $2,201,112, or 7.0%. Increase in cost of sales was mainly due to a decrease in sales volumes with a cost of sales decrease of $1,647,723, an increase in unit cost with 19 a cost of sales increase of $2,336,653 and the effect of foreign currency translation of the RMB against the U.S. dollar with a cost increase of $1,512,182. - Cost of sales for Hengsheng was $17,655,987 for the year ended December 31, 2011, compared with $10,650,920 for the year ended December 31, 2010, representing an increase of $7,005,067, or 65.8%. Increase in cost of sales increase was mainly due to an increase in automobile consumption in the United States as a result of its economic recovery. The increase in sales volumes led to a cost of sales increase of $8,561,925, a decrease in unit cost as a result of increase in purchases led to a cost of sales decrease of $2,074,006 and the appreciation of the RMB against U.S. dollar led to a cost of sales increase of $517,148. - Cost of sales for Other Sectors was $41,729,969 for the year ended December 31, 2011, compared with $29,204,686 for the year ended December 31, 2010, representing an increase of $12,525,283, or 42.9%. Increase in net cost of sales was mainly due to an increase in market demand of newly developed EPS, which resulted in an increase in sales volumes. The increase in sales volumes led to a cost of sales increase of $5,543,612. Given that the Company’s market share of EPS in the China market is relatively low, and yet to reach a production level with economies of scale, the Company could not purchase relevant materials from suppliers for a lower price. Furthermore certain suppliers increased their selling prices as a result of inflation, which resulted in an increase in costs of sales of $5,480,944. The appreciation of the RMB against the U.S. dollar led to a cost of sales increase of $1,500,727. Gross margin was 19.6% for the year ended December 31, 2011, representing a 3.6 percentage point decrease from 23.2% for the same period of 2010, which was primarily due to a decrease of selling price and an increase of unit cost. Gain on Other Sales Gain on other sales mainly consisted of net amount retained from sales of materials and other assets. For the year ended December 31, 2011, gain on other sales amounted to $1,481,308, while it amounted to $1,129,032 for the year ended December 31, 2010. The increase of $352,276, or 31.2%, was mainly due to an increase in sales of materials. Selling Expenses For the years ended December 31, 2011 and 2010, selling expenses are summarized as follows: Salaries and wages Office expense Transportation expense Rent expense Other expense Total 2011 2,337,901 $ 1,509,413 4,634,306 1,277,140 213,075 9,971,835 $ $ $ Year Ended December 31 2010 2,247,519 $ 1,129,348 4,690,313 1,085,128 211,567 9,363,875 $ Increase/(Decrease) Percentage 90,382 380,065 (56,007 ) 192,012 1,508 607,960 4.0% 33.7 -1.2 17.7 0.1 6.5% Selling expenses were $9,971,835 for the year ended December 31, 2011. As compared to $9,363,875 for the year ended December 31, 2010, there was an increase of $607,960, or 6.5%, which was mainly due to an: • • increase in office expenses (including office supplies, travel expenses and meeting expenses), as a result of an increase in marketing activities; and increase in rent expense due to expansion of commercial networks, which led to increases in product warehouses rental. 20 General and Administrative Expenses For the years ended December 31, 2011 and 2010, general and administrative expenses are summarized as follows: Year Ended December 31, Increase/ (Decrease) Salaries and wages Labor insurance expenses Maintenance and repair expenses Property and other taxes Provision/(recovery) for bad debts Office expense Depreciation and amortization expense Listing expenses 1 Others expenses Total 2011 5,401,098 $ 2,988,187 1,112,250 1,479,122 (75,486) 1,642,180 919,682 2,370,880 386,456 16,224,369 $ $ $ 2010 4,681,335 $ 2,086,319 679,858 1,179,092 (2,558,818) 958,542 691,721 1,939,774 371,388 10,029,211 $ Percentage 719,763 901,868 432,392 300,030 2,483,332 683,638 227,961 431,106 15,068 6,195,158 15.4% 43.2 63.6 25.4 -97.0 71.3 33.0 22.2 4.1 61.8% 1. Listing expenses consisted of the costs associated with legal, accounting and auditing fees for operating a public company. The expenses also included share-based compensation expense for options granted to members of the audit committee. General and administrative expenses were $16,224,369 for the year ended December 31, 2011. As compared to $10,029,211 for the year ended December 31, 2010, there was an increase of $6,195,158, or 61.8%. The analysis of expense items with significant fluctuation is as follows: - - - Increases in salaries and wages and labor insurance expenses were mainly due to an overall increase in labor cost and additional endowment insurance for employees. Increase of maintenance and repair expenses was mainly due to repair and maintenance projects on certain office facilities in 2011, thus the costs of maintenance of office facilities and repair increased in 2011. Increase in property and other taxes paid to government were mainly due to acquisition of new land use rights and development of new properties in 2011. - The Company recorded provision for bad debts based on specific identification methods. Decrease in provision for bad debts in 2011 was mainly due to further improvement of OEMs’ financial positions as a result of the continuing growth of China's economy. Compared with bad debt recovery of $2.6 million in 2010, in 2011, the Company collected less aged accounts receivable that was previously considered uncollectible and for which the Company made provisions. Accordingly, there was less of a reversal of the provision for bad debts. - The increase in office expense was mainly due to expansion of operations. - The increase of depreciation and amortization expense was mainly due to the increase in the number of land and buildings, office equipment and software as a result of operation expansion. - The increase in listing expenses was mainly due to the increase of auditing expenses, accounting consulting expenses and attorney service expenses. The increase in professional fees was mainly due to increased cost in the requirement of compliance as a publicly listed entity, the restatement of certain of the Company’s previously reported financial statements and the need to evaluate the Company’s internal control over financial reporting. 21 Research and Development Expenses Research and development expenses, “R & D” expenses, were $10,005,605 for the year ended December 31, 2011. As compared to $7,991,252 for the year ended December 31, 2010, there was an increase of $2,014,353, or 25.2%. The global automotive parts industry is highly competitive; winning and maintaining new business requires suppliers to rapidly produce new and innovative products on a cost-competitive basis. In 2011, foreign OEMs significantly increased their demand for EPS, but the related technology in China is still in the research and development and testing stage. In order to expand into the market for EPS, the Company increased its investment in the research and development of EPS in 2011, including assigning the Company’s senior technicians and advanced manufacturing equipment to EPS, establishing the EPS trail-production department, introducing technology expectations and purchasing advanced technology and test equipment. At present, the Company has developed several types of EPSs suitable for small-engine cars, and has sold certain quantities of EPS. Income from Operations Income from operations was $33,378,496 for the year ended December 31, 2011. As compared to $54,047,404 for the year ended December 31, 2010, there was a decrease of $20,668,908, or 38.2%, which mainly consisted of a decrease of $12,203,713, or 15.2%, in gross profit, an increase of $352,276, or 31.2%, in gain on other sales (such as raw materials) and an increase in operating expenses of $8,817,471, or 32.2%. Other Income, Net Other income was $168,749 for the year ended December 31, 2011. As compared to $558,058 for the year ended December 31, 2010, there was a decrease of $389,309, or 69.8%, primarily as a result of fewer government subsidies being recognized in 2011. The Company’s government subsidies consisted of an interest subsidy and an investment subsidy. Interest subsidies are refunds of bank interest charges offered by the Chinese government. Investment subsidies are subsidies for encouraging foreign investors to set up technologically advanced enterprises in China. For the year ended December 31, 2011, the Company received interest subsidy of $168,749. For the year ended December 31, 2010, the Company received interest subsidy of $311,291, and investment subsidy of $231,951, as Henglong was qualified as an advanced enterprise. Financial Expenses Financial expenses were $3,983,817 for the year ended December 31, 2011. As compared to financial expenses of $3,360,837 for 2010, there was an increase of $622,980, or 18.5%, primarily as a result of an: (a) increase in the average balance of borrowings increased to $8.6 million in 2011 from $6.0 million in 2010; (b) increase in the average borrowing interest rate to 6.29% in 2011 from 5.25% in 2010; and (c) increase in foreign currency losses, as the Company’s PRC based subsidiaries and Genesis maintain their books and records in the RMB (their functional currency) and Hengsheng, which is also based in the PRC, settles its external sales in U.S. dollars. During 2011, the RMB appreciated approximately by 5% against the U.S. dollar. Gain (Loss) on Change in Fair Value of Derivatives During the year ended December 31, 2011, the gain on change in fair value of the derivatives embedded in the convertible notes was $20,971,087. As compared to $20,171,698 for the year ended December 31, 2010, there was an increase of $799,389. The derivative liability was marked to market each period. Compared with the fair value of compound derivative liabilities as of December 31, 2010, the fair value of compound derivative liabilities decreased $24,712,660, including: (a) on March 1, 2011, an investor converted 22 $6,428,571 of the principal amount of the convertible notes and, correspondingly, the derivative liabilities decreased $3,741,573; and (b) during the year ended December 31, 2011, the Company’s common stock market price dropped to $3.30 from $13.62 at the beginning of year, which significantly decreased fair value of $20,971,087 for the embedded conversion option of the convertible notes. See Note 13 to the Consolidated Financial Statements under Item 15 of this Annual Report for more details. During the year ended December 31, 2010, the Company’s common stock market price dropped to $13.62 from $18.71 at the beginning of the year, which significantly decreased the intrinsic value of the embedded conversion option of the convertible notes. As a result, the fair value of compound derivative liabilities decreased significantly and, correspondingly, the gain on change in fair value of derivatives increased. The increase of gain on change in fair value of derivatives as compared with 2010 was primarily due to greater stock price decreases with lower compound derivative liabilities in 2011. Gain on Convertible Notes Conversion During the year ended December 31, 2011, the Company recognized a gain of $1,564,418 for convertible notes conversion which occurred in March 2011 whereas there was no convertible note converted in 2010. On March 1, 2011, an investor converted $6,428,571 principal amount of the convertible notes at a conversion price of $7.0822 per share and the Company issued 907,708 shares of its common stock to the investor. On the conversion date, the market price of the common shares issued was $10,111,869 ($11.14 per share) and the value of the conversion consideration was $11,676,287, including $6,428,571 of principal, $1,506,143 of coupon interest and make-whole amount payable and $3,741,573 of derivative liabilities under such principal. The Company recorded a gain on convertible notes conversion of $1,564,418, which is the difference between the market price of the common stock and the conversion consideration. Income before Income Tax Expenses and Equity in Earnings of Affiliated Companies Income before income tax expenses and equity in earnings of affiliated companies was $52,098,933 for the year ended December 31 , 2011, compared with $71,416,323 for the year ended December 31, 2010, a decrease of $19,317,390, or 27.0%, including a decrease in income from operations of $20,668,908, a decrease in gain on other income of $389,309, an increase in financial expense of $622,980, an increase in gain on change in fair value of derivative of $799,389 and an increase in gain on convertible notes conversion of $1,564,418. Income Taxes Income tax expense was $4,353,702 for the year ended December 31, 2011, compared to $8,484,205 for the year ended December 31, 2010, a decrease of $4,130,503, mainly because of: (1) a decrease in income before income tax; and (2) certain joint ventures of the Company based in the PRC that were qualified as an “Advanced Technology Enterprises” in 2011 need to have their qualification re-assessed in 2012. Thus, for these entities, their current tax rates of 12.5% and 15% need further government assessment. If such approval is not given, these entities will be subject to a tax rate of 25% in 2012. Therefore, the Company has calculated deferred income tax for these joint ventures based on a rate of 25% in 2011, while preferential rates were applied previously. As a result, additional deferred tax assets of $929,795 were recognized, which offset the current income tax expense. See Note 25 to the Consolidated Financial Statements under Item 15 of this Annual Report. For a full reconciliation of the Company’s effective tax rate to the U.S. federal statutory rate of 35%, and further explanation of the Company’s provision for taxes, see Note 27 to the consolidated financial statements in Item 15. Net Income Net income was $47,903,481 for the year ended December 31, 2011. As compared with $62,917,302 for the year ended December 31, 2010, there was a decrease of $15,013,821 or 23.9%, representing a decrease in income before income tax expenses and equity in earnings of affiliated companies of $19,317,390, or 27.0%, a decrease in income tax expenses of $4,130,503, or 48.7%, and an increase in equity in earnings of affiliated companies of $173,066. 23 Net Income Attributable to Noncontrolling Interests The Company recorded net income attributable to noncontrolling interests of $7,111,494 for the year ended December 31, 2011, compared to $11,179,189 for the year ended December 31, 2010, a decrease of $4,067,695, or 36.4%. The Company owns different equity interests in nine joint ventures, through which it conducts its operations. The operating results of eight entities were consolidated in the Company’s financial statements for the years ended December 31, 2011, 2010 and 2009. The Company records the net income attributable to noncontrolling interests of the respective entities for each period. In 2011, net income attributable to noncontrolling interests decreased as compared to that of 2010, primarily resulting from a decrease in net income of joint ventures. Net Income Attributable to Parent Company Net income attributable to parent company was $40,791,987 for the year ended December 31, 2011. As compared to $51,738,113 for the year ended December 31, 2010, there was a decrease of $10,946,126, consisting of a decrease in net income of $15,013,821, and a decrease in net income attributable to noncontrolling interests of $4,067,695. 2010 Versus 2009 Comparative Net Sales and Cost of Sales For the years ended December 31, 2010 and 2009, net sales and cost of sales are summarized as follows: Net Sales 2010 2009 Change 2010 Cost of sales 2009 Change $197,226,807 $ 153,459,876 $ 43,766,931 28.5% $150,622,578 $112,141,910 $ 38,480,668 34.3% Henglong 92,095,265 61,613,116 30,482,149 49.5 Jiulong 39,691,553 32,492,844 7,198,709 22.2 Shenyang 26,193,095 24,193,366 1,999,729 8.3 Zhejiang 33,057,878 26,496,148 6,561,730 24.8 Wuhu Hengsheng 1 13,092,659 10,209,668 2,882,991 28.2 Other Sectors 1 596,865 32,110,202 5379.8 Eliminations (88,139,142 ) (53,464,330) (34,674,812) 64.9 Total 80,664,101 53,368,639 27,295,462 51.1 33,644,820 27,051,979 6,592,841 24.4 18,630,742 18,926,080 -1.6 31,330,114 25,769,456 5,560,658 21.6 47 10,650,920 29,204,686 710,971 28,493,715 4007.7 (89,125,489) (51,358,895) (37,766,594) 73.5 $345,925,182 $ 255,597,553 $ 90,327,629 35.3% $265,622,472 $193,854,927 $ 71,767,545 37.0% 7,244,787 3,406,133 32,707,067 (295,338) 1. Hengsheng was previously included in “Other Sectors.” The Company is now reporting Hengsheng as a separate sector in 2011, as it has recently become a principal profit maker. As such, a reclassification has been made to all periods presented to conform to the current period presentation. Such reclassifications had no effect on previously reported results of operations. Net Sales Net sales were $345,925,182 for the year ended December 31, 2010, compared with $255,597,553 for the year ended December 31, 2009, an increase of $90,327,629, or 35.3%, mainly due to the increases in the income of Chinese residents and significant government investment, including incentives to buyers, leading to an increase in demand of passenger vehicles and commercial vehicles, and the resultant increase in the Company’s sales of steering gear and pumps. Further analysis is as follows: 24 - Net sales for Henglong was $197,226,807 for the year ended December 31, 2010, compared with $153,469,876 for the year ended December 31, 2009, representing an increase of $43,766,931, or 28.5%. Net sales increase was mainly due to increased sale volumes with a sales increase of $56,708,725, the impact from the decrease in sales price of $15,532,900 and the effect of foreign currency translation with a sales increase of $2,591,106. - Net sales for Jiulong was $92,095,265 for the year ended December 31, 2010, compared with $61,613,116 for the year ended December 31, 2009, representing an increase of $30,482,149, or 49.5%. The net sales increase was mainly due to increased sale volumes with a sales increase of $25,273,955, the impact from the increase in sales price of $4,159,962 and the effect of foreign currency translation with a sales increase of $1,048,232. - Net sales for Shenyang was $39,691,553 for the year ended December 31, 2010, compared with $32,492,844 for the year ended December 31, 2009, representing an increase of $7,198,709, or 22.2%. The net sales increase was mainly due to increased sale volumes with a sales increase of $8,770,764, the impact from the decrease in sales price of $2,077,612, and the effect of foreign currency translation with a sales increase of $505,557. - Net sales for Zhejiang was $26,193,095 for the year ended December 31, 2010, compared with $24,193,366 for the year ended December 31, 2009, representing an increase of $1,999,729, or 8.3%. The net sales increase was mainly due to decreased sale volumes with a sales decrease of $233,616, the impact from the increase in sales price of $1,875,753 and the effect of foreign currency translation with a sales increase of $357,592. - Net sales for Wuhu was $33,057,878 for the year ended December 31, 2010, compared with $26,496,148 for the year ended December 31, 2009, representing an increase of $6,561,730, or 24.8%. The net sales increase was mainly due to increased sale volumes with a sales increase of $7,006,394, the impact from the decrease in sales price of $878,314 and the effect of foreign currency translation with a sales increase of $433,650. - Net sales for Other Sectors was $45,799,726 for the year ended December 31, 2010, compared with $10,806,533 for the year ended December 31, 2009, representing an increase of $34,993,193 or 323.8%. The net sales increased mainly due to the development of new market, such as the U.S. market and EPS market. For the U.S. market, net sales were $16,950,000 in 2010, compared with $6,430,000 in 2009, representing an increase of $10,520,000. For the new products in the China market, net sales were $28,850,000 in 2010, compared with $4,380,000 in 2009, representing an increase of $24,470,000. Cost of Sales For the year ended December 31, 2010, the cost of sales was $265,622,472, compared with $193,854,927 for the same period of 2009, an increase of $71,767,545, or 37.0%, mainly due to the increase of sales. Further analysis is as follows: - Cost of sales for Henglong was $150,622,578 for the year ended December 31, 2010, compared with $112,141,910 for the year ended December 31, 2009, representing an increase of $38,480,668, or 34.3%. The cost of sales increase was mainly due to increased sale volumes with a cost of sales increase of $40,349,480, decreased unit price with a cost of sales decrease of $3,808,979, and the effect of foreign currency translation with a cost increase of $1,940,167. - Cost of sales for Jiulong was $80,664,101 for the year ended December 31, 2010, compared with $53,368,639 for the year ended December 31, 2009, representing an increase of $27,295,462, or 51.1%. The cost of sales increase was mainly due to increased sales volumes with a cost of sales increase of $21,512,660, increased unit price with a cost of sales increase of $4,859,034, and the effect of foreign currency translation with a cost increase of $923,768. - Cost of sales for Shenyang was $33,644,820 for the year ended December 31, 2010, compared with $27,051,979 for the year ended December 31, 2009, representing an increase of $6,592,841, or 24.4%. The cost of sales increase was mainly due to increased sales volumes with a cost of sales increase of $7,257,738, decreased unit 25 price with a cost of sales decrease of $1,086,994, and the effect of foreign currency translation with a cost increase of $422,097. - Cost of sales for Zhejiang was $18,630,742 for the year ended December 31, 2010, compared with $18,926,080 for the year ended December 31, 2009, representing a decrease of $295,338, or 1.6%. The cost of sales decrease was mainly due to decreased sales volumes with a cost of sales decrease of $188,586, decreased unit price with a cost of sales decrease of $394,748, and the effect of foreign currency translation with a cost increase of $287,996. - Cost of sales for Wuhu was $31,330,114 for the year ended December 31, 2010, compared with $25,769,456 for the year ended December 31, 2009, representing an increase of $5,560,658, or 21.6%. The cost of sales increase was mainly due to increased sales volumes with a cost of sales increase of $6,846,269, decreased unit price with a cost of sales decrease of $1,718,865, and the effect of foreign currency translation with a cost increase of $433,254. - Cost of sales for Other Sectors was $39,855,606 for the year ended December 31, 2010, compared with $7,955,758 for the year ended December 31, 2009, representing an increase of $31,899,848, or 401.0%, mainly due to the sales volume increase. Gross margin was 23.2% for the year ended December 31, 2010, a 1 percentage point decrease from 24.2% for the same period of 2009, primarily due to declines in sales price in excess of unit cost reductions. Gain on Other Sales Gain on other sales consisted of net amount retained from sales of materials and other assets. For the year ended December 31, 2010, gain on other sales were $1,129,032, compared to $838,505 for the year ended December 31, 2009, an increase of $290,527, or 34.6%, due to increased sales of materials. Selling Expenses For the years ended December 31, 2010 and 2009, selling expenses are summarized as follows: Salaries and wages Office expense Transportation expense Rent expense Other expense Total 2010 2,247,519 $ 1,129,348 4,690,313 1,085,128 211,567 9,363,875 $ $ $ Year Ended December 31 2009 2,563,384 $ 841,748 3,703,818 699,206 84,384 7,892,540 $ Increase(Decrease) Percentage (315,865) 287,600 986,495 385,922 127,183 1,471,335 -12.3% 34.2 26.6 55.2 150.7 18.6% Selling expenses were $9,363,875 for the year ended December 31, 2010, compared to $7,892,540 for 2009, an increase of $1,471,335, or 18.6%. Items that increased in 2010 compared to 2009 were office expenses, transportation expense, rent expenses, and other expense. The major item that decreased was salaries and wages. The increase in office expenses was due to increased sales, which led to increases in office supplies, travel expenses and meeting expenses. 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. The increase in rent expense was due to increased sale volumes, which led to increases in the area of product warehouses in different places. 26 The salaries of salesmen, including bonuses for meeting sales target, were indexed with their sales performance. During 2010, revenue increased by 35.3% over the last year, compared with the increase of 56.6% in 2009, a decrease of 21.3 percentage points. As the salesmen did not meet their target, correspondingly their salaries decreased. General and Administrative Expenses For the years ended December 31, 2010 and 2009, general and administrative expenses are summarized as follows: Year Ended December 31 Increase (Decrease) Salaries and wages Labor insurance expenses Maintenance and repair expenses Taxes Provision/(income) for bad debts Office expense Depreciation and amortization expense Listing expenses 1 Others expenses Total 2010 4,681,335 $ 2,086,319 679,858 1,179,092 (2,558,818) 958,542 691,721 1,939,774 371,388 10,029,211 $ $ $ 2009 4,623,631 $ 2,123,071 1,214,160 1,120,948 120,483 1,189,475 2,955,159 1,589,236 258,863 15,195,026 $ Percentage 57,704 (36,752) (534,302) 58,144 (2,679,301) (230,933) (2,263,438) 350,538 112,525 (5,165,815) 1.2% -1.7 -44.0 5.2 -2223.8 -19.4 -76.6 22.1 43.5 -34.0% 1. Listing expenses consisted of the costs associated with legal, accounting and auditing fees for operating a public company. The expenses also included share-based compensation expense for options granted to members of the audit committee. General and administrative expenses were $10,029,211 for the year ended December 31, 2010, compared to $15,195,026 for the year ended December 31, 2009, a decrease of $5,165,815, or 34.0%. The expense items that significantly increased in 2010 compared to 2009 were listing expenses and other expenses. The expense items that significantly decreased in 2010 compared to 2009 were provision for bad debt expenses, maintenance and repair expenses, office expenses and depreciation and amortization expense. The increase of listing expenses was mainly due to the increase of auditing expenses. The increase in professional fees was mainly due to increased cost in the requirement of compliance with being a publicly listed entity and the need to evaluate the Company’s internal control over financial reporting. The increase of other expenses was primarily due to expansion of the scale of operation, and increases of the costs associated with legal, insurance, and accounting service. The Company recorded provision for bad debts based on specific identification methods. The decrease in provision for bad debts in 2010 was mainly due to further improvement of OEMs’ financial positions resulting from the Chinese government’s continuous stimulation measures on the automobile industry, such as subsidies to rural area consumers and fuel efficient car buyers and reduction in purchase taxes. As a result, the Company collected about $2,600,000 of accounts receivable in 2010, which was not expected to be collectible in prior years and bad debts provision has been provided for. As a result, the provision for bad debts was negative. The decrease of maintenance and repair expenses was mainly due to certain office facilities having maintenance and repair last year and none this year, thus the maintenance of office facilities and repair were reduced in 2010. The decrease of depreciation and amortization expense was mainly due to certain fixed assets of the Company not needing to be depreciated in 2010 as they have been fully depreciated. 27 Research and Development Expenses Research and development expenses, “R&D” expenses, were $7,991,252 for the year ended December 31, 2010, compared to $2,561,170 for the year ended December 31, 2009, an increase of $5,430,084, or 212.0%. The global automotive parts industry is highly competitive; winning and maintaining new business requires suppliers to rapidly produce new and innovative products on a cost-competitive basis. In 2010, foreign OEMs significantly increased their demand for EPS, but the related technology in China is still in the research and development and testing stage. In order to market “EPS” quickly, the Company invested more in the R&D of “EPS” in 2010, including focusing the Company’s senior technicians and advanced manufacture equipment on “EPS” establishing the “EPS” trail-production department, introducing technology expectations and purchasing advanced technology and test equipment. Income from Operations Income from operations was $54,047,404 for the year ended December 31, 2010, compared to $36,932,395 for the year ended December 31, 2009, an increase of $17,115,009, or 46.3%, mainly consisting of an increase of $18,560,084, or 30.1%, in gross profit, an increase of $290,527, or 34.6%, in gain on other sales, such as raw materials, and an increase of operating expenses of $1,735,602, or 6.8%. Other Income, Net Other income was $558,058 for the year ended December 31, 2010, compared to $94,534 for the year ended December 31, 2009, an increase of $463,524, or 490.3%, primarily as a result of increased government subsidies. The Company’s government subsidies consisted of interest subsidy and investment subsidy. Interest subsidy is the refund by the Chinese government of interest charged by banks to companies which are entitled to such subsidies. Investment subsidy is subsidy to encourage foreign investors to set up technologically advanced enterprises in China. During the year ended December 31, 2009, the Company received $94,534 for interest subsidy, and no investment subsidy. During the year ended December 31, 2010, the Company’s received $311,291 for interest subsidy, and $231,951 for investment subsidy. Interest subsidies apply only to loan interest related to production facilities expansion. During 2008 and 2009, the Company had used the special loans to improve different products’ production lines technologically in order to enlarge production capability and enhance quality. The expansion projects were completed and new facilities were put into use at the end of 2009 and 2010, respectively. The Chinese government also provided incentives to foreign investors for setting up technologically advanced enterprises in China. Henglong, a subsidiary of the Company, has received $231,951 of government subsidies because it is a technologically advanced enterprise. Financial Expenses Financial expenses were $3,360,837 for the year ended December 31, 2010, compared to financial expenses of $7,883,714 for 2009, a decrease of $4,522,877, or 57.4%, primarily as a result of a decrease in interest expense related to the convertible notes. Convertible notes holders are entitled to require the Company to redeem all or any portion of the convertible notes in cash, if the weighted average price, “WAP,” is less than $3.187 for twenty (20) consecutive trading days at any time following February 15, 2009. In March 2009, due to a default on the WAP under the aforesaid contractual provision, the “WAP Default,” the Company accreted $3,900,000 of the remaining discount on the convertible notes immediately and accrued an additional $520,000 of interest expenses for WAP Default. Please see Note 13 to the Consolidated Financial Statements under Item 15 of this Annual Report for more details. 28 Gain (Loss) on Change in Fair Value of Derivatives During the year ended December 31, 2010, the gain on change in fair value of the derivatives embedded in the convertible notes was $20,171,698, as compared to a loss of $43,074,327 for the year ended December 31, 2009, an increase of $63,246,025. The derivative liability was marked to market each period. During the year ended December 31, 2009, the increase of loss on change in fair value of derivatives was primarily due to the increase in the intrinsic value of the embedded conversion feature in the convertible notes as a result of the increase in the market price of the Company’s common stock which rose from $3.39 at the beginning of 2009 to $18.71 at December 31, 2009. Upon the adoption of ASC 815-10 on January 1, 2009, the Company is required to bifurcate the embedded conversion feature of the convertible note payable as a derivative liability. During the year ended December 31, 2010, the Company’s common stock market price dropped to $13.62 from $18.71 at the beginning of the year, which significantly decreased the intrinsic value of the embedded conversion option of the convertible notes. As a result, the fair value of compound derivative liabilities decreased significantly and correspondingly, the gain on change in fair value of derivatives increased. Please see Note 14 to the Consolidated Financial Statements under Item 15 of this Annual Report for more details. Income (Loss) before Income Taxes Income before income taxes was $71,416,323 for the year ended December 31, 2010, compared to a loss of $13,931,112 for the year ended December 31, 2009, an increase of $85,347,435, consisting of increased income from operations of $17,115,009, increased other income of $463,524, decreased finance expenses of $4,522,877, and increased gain on change in fair value of derivative of $63,246,025. Income taxes Income tax expense was $8,484,205 for the year ended December 31, 2010, compared to $4,720,013 for the year ended December 31, 2009, an increase of $3,764,192, mainly because of: (1) an increase in income before income tax in the PRC market that was not offset by losses before income tax in the U.S. market and the Company made a provision for deferred income tax assets in the United States (see Note 9); (2) while there was a gain before income tax in the United States for the year ended December 31, 2010 (and loss for the year ended December 31, 2009) mainly due to a change in the fair value of convertible notes, the Company cannot recognize such gain as a deferred income tax as if it was a permanent change; and (3) a decrease of foreign government tax return. For a full reconciliation of the Company’s effective tax rate to the U.S. federal statutory rate of 35% and further explanation of the Company’s provision for taxes, see Note 27 to the consolidated financial statements in Item 15. Net income Net income was $62,917,302 for the year ended December 31, 2010, compared to a loss of $18,651,125 for the year ended December 31, 2009, an increase of $81,568,427, consisting of increased income before income taxes of $85,332,619, and an increase of income tax expenses of $3,764,192. Net Income Attributable to Noncontrolling Interests The Company recorded net income attributable to noncontrolling interests of $11,179,189 for the year ended December 31, 2010, compared to $7,789,746 for the year ended December 31, 2009, an increase of $3,389,443, or 43.5%. The Company owns different equity interests in eight Sino-foreign joint ventures, through which it conducts its operations. All the operating results of these eight Foreign Investment Enterprises were consolidated in the Company’s financial statements as of December 31, 2010 and 2009. The Company records the net income attributable to noncontrolling interests of the respective Sino-foreign joint ventures for each period. In 2010, net income attributable to noncontrolling interests increased compared to 2009, primarily resulting from increased net income of joint ventures. 29 Net Income Attributable to Parent Company Net income attributable to parent company was $51,738,113 for the year ended December 31, 2010, compared to a loss attributable to parent company of $26,440,871 for the year ended December 31, 2009, an increase of $78,178,984, consisting of increased net income of $81,568,427, and an increased net income attributable to noncontrolling interests of $3,389,443. 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 December 31, 2011, the Company had cash and cash equivalents of $72,960,500. As compared to $49,424,979 and $43,480,176 as of December 31, 2010 and 2009, there was an increase of $23,535,521 and $29,480,324, respectively. The Company had working capital of $147,819,863 as of December 31, 2011. As compared with $54,191,797 as of December 31, 2010, there was an increase of $93,628,066, or 172.8%, which mainly includes: (a) according to the terms of the convertible notes, convertible notes payable, compound derivative liabilities and accrued make-whole redemption interest expense for convertible notes were recorded as current liabilities before February 15, 2011 (which was the last annual redemption date), and thereafter reclassified to and recorded as non-current liabilities as the convertible notes will mature on February 15, 2013 (refer to Note 15 to the Consolidated Financial Statements); (b) on March 1, 2011, an investor converted $6,428,571 of the principal amount of the convertible notes and, correspondingly, decreased the principal amount and compound derivative liabilities (refer to Note 13); and (c) the net income realized in the current year. The Company intends to indefinitely reinvest the funds in subsidiaries incorporated in China. Capital Source The Company’s capital source is multifaceted, such as bank loans and banker’s acceptance bill facilities. In financing activities and operating activities, the Company’s banks require the Company to sign lines of credit agreement and 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, such one year facilities can be extended for another year. The Company had bank loans maturing in less than one year of $10,315,987 (Note 10) and bankers’ acceptances of $57,307,445 (Note 11) as of December 31, 2011. 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 (See the table of Bank Arrangements below). 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. Owing to depreciation, the value of the mortgages securing the above-mentioned bank loans and bankers’ acceptance bills will be devalued by approximately $14,799,392. If the Company wishes to obtain the same amount of bank loans and bankers’ acceptance bills, it will have to provide $14,799,392 additional mortgages as of the maturity date of such agreements (See the table in section (a) Bank loan). The Company still can obtain a reduced line of credit with a reduction of $8,137,184, which is 54.98% (the mortgage rates) of $14,799,392, if it cannot provide additional mortgages. The Company expects that the reduction of bank loans will not have a material adverse effect on its liquidity. On February 15, 2008, the Company issued $35,000,000 of convertible notes to Lehman Brothers Commercial Corporation Asia Limited, “LBCCA”, and YA Global Investments, L.P., “YA Global”, maturing in 5 years. According to the terms of the convertible notes (as described in Note 12), convertible notes may be required to be repaid in cash 30 on or prior to their maturity. For example, convertible note holders are entitled to require the Company to redeem all or any portion of the convertible notes in cash, if the Weighted Average Price (WAP) for twenty (20) consecutive trading days is less than $3.187 at any time following February 15, 2009, the “WAP Default,” by delivering written redemption notice to the Company within five (5) business days after the receipt of the Company’s notice of the WAP Default. As a result of the worldwide financial crisis in 2009, the Company’s stock’s WAP for twenty (20) consecutive trading days ended on March 16, 2009 was below $3.187. On March 17, 2009, the Company delivered two WAP Default notices to the convertible note holders. On March 27, 2009, the Company received a letter dated March 26, 2009 from YA Global, one of the convertible note holders, electing to require the Company to redeem all the three convertible notes it held in the total principal amount of $5,000,000, together with interest, late charges, if any, and the Other Make Whole Amount as defined in Section 5(d) of the convertible notes. After negotiation, on April 15, 2009, the Company paid YA Global $5,041,667 for the total principal amount ($5,000,000), together with interest and late charges, if any. YA Global has waived its entitlement to the Other Make Whole Amount. Following the WAP Default notices, the Company received a letter from the provisional liquidator acting on behalf of LBCCA, the “LBCCA Liquidator,” requesting that it be granted an extension until April 24, 2009 to consider its rights under the convertible notes. The Company granted an extension to April 15, 2009. The LBCCA Liquidator further requested another extension to April 24, 2009. On April 24, 2009, LBCCA’s lawyers sent three Holder Redemption Notices electing to redeem the entire outstanding principal of $30,000,000, together with interest, late charges, if any, and the Other Make Whole Amount, to be paid on July 23, 2009. The Company discussed settlement with the LBCCA Liquidator, and on or about July 22, 2009, the Company and the LBCCA Liquidator agreed to extend the applicable holder mandatory redemption date for two months to September 23, 2009 to give more time to the Company and the LBCCA Liquidator to pursue settlement discussion. The Company received a letter dated September 22, 2009 from the LBCCA Liquidator stating that upon the Company’s acceptance of the revocation, all holder redemption notices dated April 24, 2009 shall be immediately revoked as if they were never issued, and the letter and the revocation did not purport to amend, restate or supplement any other terms and conditions under the three Notes and Securities Purchase Agreements dated 1 February 2008 between the Company and the LBCCA Liquidator. The Company accepted such revocation on September 23, 2009. On March 1, 2011, LBCCA Liquidator converted $6,428,571 of the principal amount of the convertible notes at a conversion price of $7.0822 per share and the Company issued 907,708 shares of its common stock to the investor. No additional consideration was paid for the conversion of the convertible notes into common stock. For the years ended December 31, 2011 and 2010, the Company’s stock’s WAP for any twenty consecutive trading days was above $3.187. The Company’s ability to redeem the convertible notes and meet its payment obligations depends on its cash position and its ability to refinance or generate significant cash flow, which is subject to general economic, financial and competition factors and other factors beyond the Company’s control. The Company cannot assure you that it has sufficient funds available or will be able to obtain sufficient funds to meet its payment obligations under the convertible notes, and the Company’s redemption of the convertible notes would result in a material adverse effect on its liquidity and capital resources, business, results of operations or financial condition. Bank Arrangements As of December 31, 2011, the principal outstanding under the Company’s credit facilities and lines of credit was as follows: 1.Comprehensive credit facilities (1) 2.Comprehensive credit facilities 3.Comprehensive credit facilities Bank Bank of China Jingzhou Commercial Bank China Construction Due Date Amount Available Amount Used Mortgage Value Jan-12 (2) $ 22,377,756 $ 4,761,225 $ 6,879,208 Apr-12 31,741,497 14,519,624 71,066,736 Oct-12 12,696,599 3,174,150 32,125,934 31 4.Comprehensive credit facilities (1) 5.Comprehensive credit facilities 6.Comprehensive credit facilities 7.Comprehensive credit facilities (1) 8.Comprehensive credit facilities Total Bank Shanghai Pudong Development Bank China CITIC Bank Industrial and Commercial Bank of China China Hua Xia Bank China EverbrightBank Dec-13 15,870,749 9,890,314 12,866,860 Sep-12 16,505,579 14,848,990 14,767,732 May-12 16,188,164 8,710,660 4,119,761 Jan-12 (2) 25,393,198 3,676,459 33,033,938 Aug-14 4,761,225 6,900,903 (3) 8,126,522 $145,534,767 $ 66,482,325 (4) $ 182,986,691 (1) Henglong’s comprehensive credit facility with China CITIC Bank, Henglong and Jielong's comprehensive credit facility with Shanghai Pudong Development Bank, and Henglong's comprehensive credit facility with Hua Xia Bank, also need to be guaranteed by Jiulong, another subsidiary of the Company, in addition to the above pledges. (2) As at the date of this Annual Report, the comprehensive credit line arrangements with the Bank of China and China Hua Xia Bank have expired. The Company plans to negotiate with these lenders to renew the agreements. The Company does not anticipate that there will be any material adverse impact if the Company fails to renew as the Company has obtained sufficient comprehensive credit lines from other banks. (3) The amount available for use was increased to the amount of assets pledged with the bank. (4) Total amount used includes bank loans of $10,315,987 and notes payable of $56,166,338 as of December 31, 2011. Please see Notes 10 and 11 to the Consolidated Financial Statements under Item 15 of this Annual Report for more details. The Company may request the 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 2011 at annual interest rates of 5.31% to 7.87 %, and maturity terms of twelve months. Pursuant to the comprehensive credit line arrangement the Company pledged: (1) land use rights with an assessed value of $6.9 million as security for its comprehensive credit facility with the Bank of China; (2) land use rights and equipment with an assessed value of approximately $71.1 million as security for its revolving comprehensive credit facility with Jingzhou Commercial Bank; (3) equipment, land use rights and buildings with an assessed value of approximately $32.1 million as security for its comprehensive credit facility with China Construction Bank; (4) land use rights and buildings with an assessed value of approximately $12.9 million as security for its comprehensive credit facility with Shanghai Pudong Development Bank; (5) land use rights and buildings with an assessed value of approximately $14.8 million as security for its comprehensive credit facility with China CITIC Bank; (6) land use rights and buildings with an assessed value of approximately $4.1 million as security for its comprehensive credit facility with Industrial and Commercial Bank of China; (7) accounts receivable with an assessed value of approximately $33.0 million as security for its comprehensive credit facility with China Hua Xia Bank; and (8) land use rights and buildings with an assessed value of approximately $8.1 million as security for its comprehensive credit facility with China Everbright Bank. 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, which are less than three months. 32 Short-term bank loan including interest payable Notes payable 2 Convertible notes payable Convertible notes interest Other contractual purchase commitments, including service agreements Total Total Less than 1 year 1-3 years 3-5 years More than 5 Years Payment Due Dates $10,315,987 $10,315,987 $ — $ — $ — 57,307,445 23,571,429 12,982,849 57,307,445 — 1,572,968 23,571,429 11,409,881 12,037,323 7,159,582 4,877,741 $116,215,033 $76,355,982 $39,859,051 — — — — — — — — — — 1. Including accrued make-whole redemption interest expense of $7,615,709, accrued coupon interest of $625,447 and interest and make-whole obligation of $4,870,615 to be accrued. 2. Notes payable do not bear interest. Short-term Bank Loans The following table summarizes the contract information of short-term borrowings between the banks and the Company as of December 31, 2011. Bank China Construction Bank Bank of China China CITIC Bank Total Purpose Working Capital Working Capital Working Capital Borrowing Date 29-Jun-11 30-Sep-11 6-Jul-11 Borrowing Term (Year) Annual Percentage Rate Date of Interest Payment Due Date Amount Payable on Due Date 1 1 1 6.56% Pay monthly 28-Jun-12 $ 3,174,150 6.56% Pay monthly 29-Sep-12 4,761,225 7.87% Pay monthly 5-Jul-12 2,380,612 $10,315,987 The Company must use the loans for the purpose described in the table. If the Company fails to do so, it will be charged a penalty interest at 100% of the specified loan rate listed in the table above. The Company has to pay interest at 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 in the above table. 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 December 31, 2011, and will continue to comply with them. Notes Payable The following table summarizes the contract information of issuing notes payable between the banks and the Company as of December 31, 2011: Purpose Working Capital 1 Working Capital 1 Working Capital Working Capital Working Capital Working Capital 33 Term (Month) Due Date Jan-12 $ Feb-12 Mar-12 Apr-12 May-12 Jun-12 3-6 3-6 3-6 3-6 3-6 3-6 Amount Payable on Due Date 7,321,970 7,858,782 12,768,906 11,748,839 8,355,092 9,254,056 Total $ 57,307,445 1. The notes payable were settled in January and February 2012, respectively. The Company must use notes payable 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 loan rate that is published by the People’s Bank of China in the same period. Management believes that the Company had complied with such financial covenants as of December 31, 2011, and will continue to comply with them. Cash flows (a) Operating activities Compared with the net cash generated from operations during the year ended December 31, 2010 and 2009 of $38,552,161 and $34,956,534, respectively, net cash generated from operations during the year ended December 31, 2011 was $34,063,290. Net cash generated from operations in 2011 decreased by $4,488,872 from 2010, whereas net cash generated from operations in 2010 increased by $3,595,628 from 2009. The decrease in net cash generated from operations in 2011 was mainly due to decreases in gross profit and in accounts and notes payable, and increases in accounts and notes receivable and inventory compared with those of 2010. As compared with 2009, in 2010, the primary factors for the increase in net cash generated from operations were the increase in gross profit and accounts and notes payable. For the years ended December 31, 2011, 2010 and 2009, changes in the balances of accounts and notes payable used cash flow of $15,013,604, $36,821,221, and $48,178,260, respectively, and cash flow decreased in the amount of $21,807,617, $11,357,039, and increased in $39,858,788 year on year. For the years ended December 31, 2011, 2010 and 2009, changes in the balances of accounts receivable generated cash flow of $6,294,797, and used cash flow of $14,450,692 and $43,700,826, respectively. For the years ended December 31, 2011, 2010 and 2009, changes in the balances of notes receivable used cash flow of $12,495,349, $18,605,172, and $15,034,485, respectively. The settlements of notes receivable are guaranteed by issuing banks, and may be converted into cash whenever the Company factors them. Therefore, the increase in notes receivable does not have any material adverse effect on the Company’s operations. During the year ended December 31, 2011, the inventory turnover rate of the Company decreased as a result of a slowdown in the growth of China’s automobile industry. Accordingly, an increase in year-end inventory balances used cash flow of $12,458,644. The increasing in cash used in inventory in 2011 was primarily due to inventories stocked up for seasonal sales during Chinese New Year in January 2012 and new models of inventories built for a customer based in North America. For the years ended December 31, 2010 and 2009, an increase in inventory balances used cash flow of $8,679,749 and $1,849,579, respectively. As the Company stocks up based on customers’ orders and market demand, increase in inventory does not have any material adverse effect on the Company’s operations. The Company may adjust its inventory level based on market demand. (b) Investing activities The Company expended $14,042,403 in investment activities during the year ended December 31, 2011, as compared to $32,596,741 and $17,335,687 during the years ended December 31, 2010 and 2009. 34 During the years ended December 31, 2011, 2010, and 2009, the Company invested in manufacturing facilities to expand production to meet market needs. Cash used for equipment purchases and building facilities in 2011, 2010 and 2009 were $14,857,364, $28,024,638 and $17,498,957, respectively. For the year ended December 31, 2010, the Company invested $3,095,414 in Beijing to set up a jointly operated company, Beijing Henglong, with Beijing Hainachuan to expand the market share of the Company. Beijing Henglong was established to design, develop and manufacture both hydraulic and electric power steering systems and parts. (c) Financing activities During the year ended December 31, 2011, the Company received $871,936 provided by financing activities, during the years ended December 2010 and 2009; the Company used $1,394,578 and $11,290,625 in financing activities, respectively. During the years ended December 31, 2011 and 2010, the Company borrowed net cash of $3,204,631 and $1,420,279 from the banks. For the year ended December 31, 2009, the Company repaid bank loans of $2,196,367. During the years ended December 31, 2011, 2010, and 2009, the Company’s subsidiaries in China paid dividends of $2,822,432, $3,614,252 and $4,176,583 to their noncontrolling interest holders. During the year ended December 31, 2009, the Company repaid YA Global $5,000,000 for its redemption of convertible notes. OFF-BALANCE SHEET ARRANGEMENTS At December 31, 2011, 2010, and 2009, 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 December 31, 2011: Obligations for service agreements Obligations for purchasing agreements Interest and make-whole on convertible notes Total 2012 2013 2014 2015 Thereafter Total Payment Obligations by Period $ — $ 206,320 $ — $ — $ — $ 206,320 7,159,582 4,671,421 1,075,022 3,794,172 — — — — — — 11,831,003 4,869,194 $ 8,234,604 $ 8,671,913 $ — $ — $ — $ 16,906,517 SUBSEQUENT EVENTS On December 1, 2011, Hengsheng entered into a Sino-foreign equity joint venture contract with SAIC-IVECO Hongyan Company to establish a Sino-foreign joint venture company, Chongqing Henglong Hongyan Power Steering Systems Co. Ltd. ("Chongqing Henglong") to design, develop and manufacture both hydraulic and electric power steering systems and parts. The new joint venture will be located in Chongqing City and have a registered capital of RMB60 million (of which RMB 42 million, or 70%, will be invested by Hengsheng). Under PRC law, the establishment of Chongqing Henglong and the effectiveness of the equity joint venture contract are subject to approval by the local Ministry of Commerce and the registration of the same with the local Administration of Industries and Commerce in Chongqing. As of the date of this Annual Report, such approval has not been obtained. On January 19, 2012, the Company completed its reorganization as discussed in Item 1–BUSINESS. 35 INFLATION AND CURRENCY MATTERS China’s economy has experienced rapid growth recently, mostly through the issuance of debt. Debt-induced economic growth can lead to growth in the money supply and rising inflation. If prices for the Company’s products rise at a rate that is insufficient to compensate for the rise in the cost of supplies, it may harm the Company’s profitability. In order to control inflation in the past, the Chinese government has imposed controls on bank credit, limits on loans for fixed assets and restrictions on state bank lending. Such policies can lead to a slowing of economic growth. Rises in interest rates by the central bank would likely slow economic activity in China which could, in turn, materially increase the Company’s costs and also reduce demand for the Company’s products. Foreign operations are subject to certain risks inherent in conducting business abroad, including price and currency exchange controls, and fluctuations in the relative value of currencies. During 2011, the Company supplied products to North America and settled in cash in U.S. dollars. As a result, appreciation or currency fluctuation of the RMB against the U.S. dollar would increase the cost of export products, and adversely affect the Company’s financial performance. In July 2005, the Chinese government adjusted its exchange rate policy from “Fixed Rate” to “Floating Rate.” During July 2005 to December 2011, the exchange rate between RMB and U.S. dollar appreciated from RMB 1.00 to US$0.1205 to RMB 1.00 to US$0.1587. This significant appreciation of the RMB may continue for in the near term, as the Chinese government attempts to slow the rate of inflation in the PRC. Significant appreciation of the RMB is likely to decrease the income of export products, thus decreasing the Company’s cash flow. RECENT ACCOUNTING PRONOUNCEMENTS In May 2011, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” (ASU 2011-04). This newly issued accounting standard clarifies the application of certain existing fair value measurement guidance and expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. This ASU is effective on a prospective basis for annual and interim reporting periods beginning on or after December 15, 2011, which for the Company means January 1, 2012. The adoption of this standard is not expected to have a material impact on the Company’s financial position or results of operations. In June 2011, the FASB issued ASU No. 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income” (ASU 2011-05). This newly issued accounting standard: (1) eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity; (2) requires the consecutive presentation of the statement of net income and other comprehensive income; and (3) requires an entity to present reclassification adjustments on the face of the financial statements from other comprehensive income to net income. The amendments in this ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income nor do the amendments affect how earnings per share is calculated or presented. In December 2011, the FASB issued ASU No. 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05 , which defers the requirement within ASU 2011-05 to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented. During the deferral, entities should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect prior to the issuance of ASU 2011-05. These ASUs are required to be applied retrospectively and are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, which for the Company means January 1, 2012. As these accounting standards do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income, the adoption of these standards is not expected to have an impact on our financial position or results of operations. In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities (ASU 2011-11). This newly issued accounting standard requires an entity to disclose both gross 36 and net information about instruments and transactions eligible for offset in the statement of financial position as well as instruments and transactions executed under a master netting or similar arrangement and was issued to enable users of financial statements to understand the effects or potential effects of those arrangements on its financial position. This ASU is required to be applied retrospectively and is effective for fiscal years, and interim periods within those years, beginning on or after January 1, 2013. As this accounting standard only requires enhanced disclosure, the adoption of this standard is not expected to have an impact on our financial position or results of operations. SIGNIFICANT ACCOUNTING POLICIES AND CRITICAL ACCOUNTING ESTIMATES The Company prepares its 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 dates of the financial statements and the reported amount of revenues and expenses during the reporting periods. 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 consolidated financial statements. The Company considers an accounting estimate to be critical if: • It requires the Company to make assumptions about matters that were uncertain at the time it was making the estimate, and • Changes in the estimate or different estimates that the Company could have selected would have had a material impact on the Company’s financial condition or results of operations. The table below presents information about the nature and rationale for the Company’s critical accounting estimates: Balance Sheet Caption Accrued liabilities and other long-term liabilities Critical Estimate Item Warranty obligations Property, plant and equipment, intangible assets and other long-term assets Valuation of long- lived assets and investments Accounts and notes receivables Provision for doubtful accounts and notes receivable Nature of Estimates Required Estimating warranty requires the Company to forecast the resolution of existing claims and expected future claims on products sold. VMs (Vehicle Manufacturer) are increasingly seeking to hold suppliers responsible for product warranties, which may impact the Company’s exposure to these costs. Assumptions/Approaches Used The Company bases its estimate on historical trends of units sold and payment amounts, combined with its current understanding of the status of existing claims and discussions with its customers. Key Factors • VM sourcing • VM policy decisions regarding warranty claims The Company is required from time-to-time to review the recoverability of certain of its assets based on projections of anticipated future cash flows, including future profitability assessments of various product lines. The Company estimates 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 Estimating the provision for doubtful accounts and notes receivable requires 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 impact the Company’s expense disclosure and results of operations if such estimate is 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 records provision for bad debts based on specific identification methods. •Customers’ credit standing and financial condition Deferred income Recoverability The Company is required to estimate The Company uses historical and • Tax law 37 taxes of deferred tax assets whether recoverability of its deferred tax assets is more likely than not based on forecasts of taxable earnings in the related tax jurisdiction. projected future operating results, based upon approved business plans, including a review of the eligible carry forward period, tax planning opportunities and other relevant considerations. changes • Variances in future projected profitability, including by taxing entity Convertible notes payable, warrant liabilities, compound derivative liabilities Warrant liabilities and compound derivative liabilities The Company is required to estimate the fair value of warrant liabilities and compound derivative liabilities at conception and completion of each reporting period. The Company uses Black-Scholes option pricing model to determine fair value of warrant; uses Monte Carlo simulation (“MCS”) valuation techniques to determine fair value of compound derivative liabilities. • Expected volatility • Risk-free rate •interest market risk •Credit risk • Redemption activities before maturity Uncertain Tax Uncertain Tax Positions The Company is required to determine and assess all material positions, including all significant uncertain positions in all tax years that are still subject to assessment or challenge under relevant tax statutes. The Company applies a more likely than not threshold and a two-step approach for tax position measurement and financial statement recognition. For the two-step approach, the first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely to be realized upon settlement. • An allocation or a shift of income between jurisdictions • The characterization of income or a decision to exclude reporting taxable income in a tax return •A decision to classify a transaction, entity, or other position in a tax return as tax exempt In addition, there are other items within the Company’s 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 the Company’s consolidated financial statements. ITEM 6A QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK The Company is exposed to market risk from changes in interest rates and foreign currency exchange rates. For purposes of specific risk analysis, the Company uses sensitivity analysis to determine the effects that market risk exposures may have. FOREIGN CURRENCY RISK The Company’s reporting currency is the U.S. dollar and the majority of its revenues will be settled in RMB and U.S. dollars. The Company’s currency exchange rate risks come primarily from the sales of products to international customers. Most of the Company’s assets are denominated in RMB except for part of cash and accounts receivable. As a result, the Company is exposed to foreign exchange risk as its revenues and results of operations may be affected by fluctuations in the exchange rate between the U.S. dollar and the RMB. The value of the RMB fluctuates and is affected by, among other things, changes in China's political and economic conditions. In addition, the RMB is not readily convertible into U.S. dollars or other foreign currencies. All foreign exchange transactions continue to take place either through the Bank of China or other banks authorized to buy and sell foreign currencies at the exchange rate quoted by the People’s Bank of China. The conversion of RMB into foreign currencies such as the U.S. dollar has been generally based on rates set by the People's Bank of China, which 38 are set daily based on the previous day's interbank foreign exchange market rates and current exchange rates on the world financial markets. On December 31, 2011 and 2010, the exchange rates of RMB against U.S. dollar were RMB1.00 to US$0.1587 and RMB1.00 to US$0.1510, respectively. This floating exchange rate, and any appreciation of the RMB that may result from such rate, could have various adverse effects on the Company’s business. If the RMB appreciates against foreign currencies, it will make the Company’s sales income increase. In order to mitigate the currency exchange rate risk, the Company has inserted a currency exchange rate fluctuation compensation provision in its sales contracts with its international customers to the effect that both parties will bear 50% of such loss when the fluctuation is over 8% within that contract year. CREDIT RISK Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of trade accounts receivable. The Company does not require collateral or other security to support client receivables since most of its customers are large, well-established companies. The Company's credit risk is also mitigated because its customers are all selected enterprises supported by the local government. One customer, Chery Automobile Co. Ltd, accounted for more than 10% (11.7%) of the Company’s consolidated revenues in 2011. The Company maintains an allowance for doubtful accounts for any potential credit losses related to its trade receivables. The Company does not use foreign exchange contracts to hedge the risk in receivables denominated in foreign currencies and the Company does not hold or issue derivative financial instruments for trading or speculative purposes. ITEM 7 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA FINANCIAL STATEMENTS The following financial statements are set forth at the end of this Annual Report. 1. Report of Registered Public Accounting Firm, PricewatershouseCoopers Zhong Tian CPAs Limited Company 2. Report of Registered Public Accounting Firm, Schwartz Levitsky Feldman LLP 3. Consolidated Balance Sheets as of December 31, 2011 and 2010 4. Consolidated Statements of Income/(Loss) for the years ended December 31, 2011, 2010 and 2009 5. Consolidated Statements of Comprehensive Income/(Loss) for the years ended December 31, 2011, 2010 and 2009 6. Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2011, 2010 and 2009 7. Consolidated Statements of Cash Flows for the years ended December 31, 2011, 2010 and 2009 8. Notes to Consolidated Financial Statements 9. Financial Statement Schedule I – Condensed Financial Information of Registrant SELECTED QUARTERLY FINANCIAL DATA Selected quarterly financial data for the past two years are summarized in the following table. First Quarterly Results of Operations Second Third Fourth 2011 2010 2011 2010 2011 2010 2011 2010 $ 91,014,170 $ 84,232,689 $ 82,505,886 $ 85,081,138 $ 75,002,717 $ 76,102,844 $ 99,451,981 $ 100,508,511 19,984,908 22,535,017 14,800,670 19,810,260 13,786,743 18,173,560 19,526,676 19,783,873 5,959,211 12,171,373 8,047,270 12,272,586 11,731,250 15,890,489 7,640,765 13,712,956 5,764,192 30,418,967 11,491,500 18,285,666 8,567,551 15,252,777 22,080,238 (1,040,108) 2,438,256 3,066,343 19,641,982 (4,106,451) 1,420,234 2,811,362 1,382,653 2,350,280 1,870,351 2,951,204 4,343,958 27,607,605 10,108,847 15,935,386 6,697,200 12,301,573 Net sales Gross profit Operating income Net income/(loss) Net income attributable to noncontrolling interest Net income /(loss) attributable to parent company Earnings/(loss) per share attributable to parent company Basic Diluted $ $ 0.63 $ 0.23 $ (0.15) $ (0.15) $ 0.14 $ 0.14 $ 0.88 $ 0.28 $ 0.32 $ 0.10 $ 0.51 $ 0.26 $ 0.21 $ 0.19 $ 0.39 0.22 39 ITEM 8 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 8A CONTROLS AND PROCEDURES (A) DISCLOSURE CONTROLS AND PROCEDURES The Company’s management, under the supervision and with the participation of its chief executive officer and chief financial officer, Messrs. Wu Qizhou and Li Jie, respectively, evaluated the effectiveness of the Company’s disclosure controls and procedures as of December 31, 2011, the end of the period covered by this Report. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports, such as this Form 10-K, that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. Based on that evaluation, Messrs. Wu and Li concluded that the Company’s disclosure controls and procedures were not effective as of December 31, 2011. The Company’s disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that the objectives of its disclosure control system are met. Because of inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected. (B) MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) promulgated under the Exchange Act, is a process designed by, or under the supervision of, the chief executive officer and chief financial officer and effected by the board of directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements for external reporting purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that: a. pertain to the maintenance of records that, in reasonable detail accurately and fairly reflect the transactions and dispositions of the Company’s assets; b. provide reasonable assurance that transactions are recorded as necessary to permit preparation of the consolidated financial statements in accordance with generally accepted accounting principles, and that the Company’s receipts and expenditures are being made only in accordance with appropriate authorization of the Company’s management and board of directors; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the consolidated financial statements. c. In making its assessment of internal control over financial reporting, management, under the supervision and with the participation of the chief executive officer and chief financial officer, used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in “Internal Control—Integrated Framework.” 40 Management has assessed the effectiveness of internal control over financial reporting as of December 31, 2011 and determined that the following material weakness in internal control over financial reporting existed as of December 31, 2011. The Company did not have sufficient personnel with appropriate levels of accounting knowledge and experience to address complex U.S. GAAP accounting issues and to prepare and review financial statements and related disclosures under U.S. GAAP. Specifically, the Company's controls did not operate effectively to ensure the appropriate and timely analysis of and accounting for unusual and non-routine transactions and certain financial statement accounts, including, but not limited to, accounting and disclosure for the convertible notes and accounting for deferred taxes. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company's annual or interim financial statements will not be prevented or detected on a timely basis. The above material weakness could result in misstatements of accounting for unusual and non-routine transactions and certain financial statement accounts, including, but not limited to the aforementioned accounts and disclosures that would result in a material misstatement in the Company’s annual or interim consolidated financial statements that would not be prevented or detected in a timely manner. The effectiveness of the Company’s internal control over financial reporting as of December 31, 2011 has been audited by PricewaterhouseCoopers Zhong Tian CPAs Limited Company, an independent registered public accounting firm, as stated in their report which is included in Item 15 of this Annual Report. Remediation of Previously Identified Material Weakness As of December 31, 2011, the Company believes it has effectively remediated a material weakness in internal control over financial reporting that was included in “Management’s Annual Report on Internal Control over Financial Reporting” in “Item 9A — Controls and Procedures” contained in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2010. During 2011, the Company was actively engaged in the implementation of remediation efforts to address the material weaknesses in controls over financial reporting that were in existence at December 31, 2010. As it relates to the material weakness identified by which the Company did not have formalized closing procedures and adequate period-end review procedures to ensure a) proper preparation of the period-end financial statement closing entries and b) consistency of application of accounting policies and completeness and accuracy of the financial statement disclosures, the Company: 1. 2. 3. 4. engaged an external consulting firm in the area of accounting advisory to assist it in reviewing the accounting treatment of the convertible notes and other complex transactions and to enhance the Company’s knowledge of U.S. GAAP and disclosure requirements for SEC registrants in preparing year-end financial statements and Form 10-K; appointed a new financial manager at its headquarters, and redefined the responsibilities, roles and review matrix clearly among the financial manager, chief accounting officer and chief financial officer in the process of preparation and review of consolidated financial statements for its periodic reports; established and developed comprehensive financial period-end closing procedures to ensure the proper preparation of quarterly and annual consolidated financial statements, disclosure notes and related information in compliance with accounting standards and guidance; established a procedure for additional review of period-end closing procedures by conducting a detailed and extensive review of non-routine and complex transactions and agreements, and carried out more comprehensive accounting reconciliation processes; 5. provided more training on U.S. GAAP to accounting and other relevant personnel; 6. required members of the finance team to perform extensive research to enhance knowledge of the relevant U.S. GAAP interpretations and their application, including, but not limited to, accounting and disclosure for the convertible notes and accounting for deferred taxes; and 41 7. engaged the external consulting firm to review the draft Annual Report on Form 10-K before filing. The Company’s remediation efforts were under the direction of its chief executive officer, chief financial officer and chief accountant. The status of the remediation was reviewed by the audit committee of the board of directors of the Company, who were advised of issues encountered and key decisions reached by the management. Remediation of Existing Material Weakness In order to address the material weakness identified as of December 31, 2011, the Company plans to: 1. hire additional key individuals in the corporate accounting function with in-depth knowledge and experience in U.S. GAAP; 2. provide further comprehensive training on U.S. GAAP to accounting and other relevant personnel; and 3. require the finance team to perform extensive research to enhance their knowledge of the relevant U.S. GAAP interpretations and their application. Management believes that the measures described above will satisfactorily address the referenced material weakness. Under the direction of the Audit Committee, management will continue to review and make necessary changes to the system of internal controls and the control environment, as well as policies and procedures to improve the overall effectiveness of internal control over financial reporting. (C) CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING Other than as described above, there have been no changes in the Company’s internal control over financial reporting during the fourth quarter of the year ended December 31, 2011 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. PART III ITEM 9 DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE The following table and text set forth the names and ages of all directors and executive officers of the Company as of December 31, 2011. The Board of Directors is comprised of only one class. All of the directors will serve until the next annual meeting of stockholders and until their successors are elected and qualified, or until their earlier death, retirement, resignation or removal. Also provided herein are brief descriptions of the business experience of each director and executive officer during the past five years and an indication of directorships held by each director in other companies subject to the reporting requirements under the federal securities laws. Name Hanlin Chen Robert Tung Guangxun Xu Bruce C. Richardson Qizhou Wu Jie Li Andy Tse Shengbin Yu Shaobo Wang Yijun Xia Daming Hu Haimian Cai Position(s) Chairman of the Board Director Director Director Chief Executive Officer and Director Chief Financial Officer Senior Vice President Senior Vice President Senior Vice President Vice President Chief Accounting Officer Vice President Age 54 55 61 54 47 42 41 58 49 49 53 48 42 BIOGRAPHIES OF DIRECTORS AND EXECUTIVE OFFICERS Directors Hanlin Chen has served as the chairman of the board of directors and an executive officer since March 2003. Mr. Chen is a standing board member of Political Consulting Committee of Jingzhou City and vice president of Foreign Investors Association of Hubei Province. He was the general manager of Shashi Jiulong Power Steering Gears Co., Ltd. from 1993 to 1997. Since 1997, he has been the Chairman of the Board of Henglong Automotive Parts, Ltd. Mr. Hanlin Chen is the brother-in-law of the Company’s Senior Vice President, Mr. Andy Tse. Qizhou Wu has served as a director and an executive officer since September 2003, and the chief executive officer since September 2007. Prior to that position he served as the Chief Operating Officer since March 2003. He was the Executive General Manager of Jiulong from 1993 to 1999 and general manager of Henglong Automotive Parts, Ltd. from 1999 to 2002. Mr. Wu graduated from Tsinghua University in Beijing with a Master’s degree in Automobile Engineering. Robert Tung has been an independent director of the Company since September 2003 and a member of the Company’s Audit, Compensation and Nominating Committees. Mr. Tung is currently the president of Multi-Media Communications, Inc., and vice president of Herbal Blends International, LLC. Mr. Tung holds a M.S. in Chemical Engineering from the University of Virginia. Since 2003, Mr. Tung has been actively developing business in China. Currently, Mr. Tung is the China Operation Vice President of Iraq Development Company of Canada, a leading North American corporation engaging in oil field and infrastructure development in the Republic of Iraq. In addition, Mr. Tung holds the Grand China sales representative position of TRI Products, Inc., a well known North American iron ores and scrap metals supplier. Mr. Tung is also actively involved in minerals, iron ore and petroleum derivatives purchase and trading. Guangxun Xu has served as an independent director of the Company since December 2009. Mr. Xu has also been an independent director of iNet School, a Korean company. Prior to that, he has been the Chief Representative of NASDAQ in China in the past two years and was a managing director with the NASDAQ Stock Market International, Asia for over 10 years. With a professional career in the finance field spanning over 25 years, Mr. Xu’s practice focuses on providing package services on U.S. and U.K. listings, advising on and arranging for Private Placements, PIPEs and IPOs, pre-IPO restructuring, M&A, Corporate and Project Finance, corporate governance, post-IPOIR compliance, Risk Control, etc. He holds an MBA from Middlesex University, London. He is also on the Audit Committee. Bruce C. Richardson joined the Company as an independent director in December 2009. In November, 2010 Mr. Richardson joined Corin Group, a UK orthopedics firm, as China Managing Director. Prior to joining Corin Group, Mr. Richardson served as a manager with Redwood Capital from July 2009. Prior to joining Redwood Capital, he served as chief financial officer and company secretary of Dalian RINO Environmental Engineering from October 2007 until September 2008, and as a Managing Director of Xinhua Finance in Shanghai from April 2006 until September 2007. He began his career with Arthur Andersen in New York, where he worked from 1989 to 1994 before returning to China. Mr. Richardson earned a BA in Classics from the University of Notre Dame in 1980, and graduated with an MA in International Management from the University of Texas at Dallas in 1986. He was awarded a graduate study grant by the U.S. National Academy of Sciences in 1987 and completed a year of post-graduate research on PRC accounting at People’s University in 1988. He is also the Chairman of the Audit Committee. Executive Officers Jie Li has served as the chief financial officer since September 2007. Prior to that position he served as the corporate secretary from December 2004. Prior to joining the Company in September 2003, Mr. Li was the assistant president of Jingzhou Jiulong Industrial Inc. from 1999 to 2003 and the general manger of Jingzhou Tianxin Investment Management Co. Ltd. from 2002 to 2003. Mr. Li has a Bachelor's degree from the University of Science and Technology of China. He also completed his graduate studies in economics and business management at the Hubei Administration Institute. 43 Andy Tse has served as a senior vice president of the Company since March 2003. He has also served as chairman of the board of Shenyang. He was the vice GM of Jiulong from 1993 to 1997 and the vice GM of Henglong. Mr. Tse has over 10 years of experience in automotive parts sales and strategic development. Mr. Tse has an MBA from the China People University. He is brother in-law to Hanlin Chen Shengbin Yu has served as a senior vice president of the Company and had overall charge of the production since March 2003. Mr. Yu was the Vice-G.M. of Jiulong from 1993 to 1996 and Executive Vice-G.M. of Henglong from 1997 to 2003. Shaobo Wang has served as a senior vice president of the Company and had overall charge of the technology since March 2003. He was the Vice-G.M. of Jiulong from 1993 to 2003. Mr. Wang graduated from Tsinghua University in Beijing with a bachelor degree in Automobile Engineering. Yijun Xia has served as a vice president of the Company since December 2009. He has also served as the general manager of Henglong since April 2005. Prior to that position he served as the Vice-G.M. of Henglong from December 2002. Mr. Xia graduated from Wuhan University of Water Transportation Engineering with a bachelor degree in Metal Material and Heat Treatment. Haimian Cai was an independent director of the Company from September 2003 to December 2009, and also a member of the Company’s Audit, Compensation and Nominating Committees. Dr. Cai is a technical specialist in the automotive industry. Prior to that, Dr. Cai was a staff engineer in ITT Automotive Inc. Dr. Cai has written more than fifteen technical papers and co-authored a technical book regarding the Powder Metallurgy industry for automotive application. Dr. Cai has more than ten patents including pending patents. Dr. Cai holds a B.S. Degree in Automotive Engineering from Tsinghua University and a M.S. and Ph. D. in manufacturing engineering from Worcester Polytechnic Institute. Since December 2009, Mr. Cai has not served as independent director and a member of the Company’s Audit Committee, Compensation and Nominating Committees, because he was nominated as vice president of the Company. Daming Hu has served as the chief accounting officer since September 2007 and had overall charge of the financial report. During March 2003 to August 2007, he served as Chief Financial Officer of the Company. Mr. Hu was the Finance Manager of Jiulong from 1996 to 1999 and Finance Manager of Henglong from 1999 to 2002. Mr. Hu graduated from Zhongnan University of Economics and Law with bachelor’s degree in accounting. BOARD COMPOSITION AND COMMITTEES Audit Committee and Independent Directors The Company has a standing Audit Committee of the Board of Directors established in accordance with Section 3(a)(58)(A) of the Exchange Act, as amended. The Audit Committee is operated under a written charter. The Audit Committee consists of the following individuals, all of whom the Company considers to be independent, as defined under the SEC’s rules and regulations and the Nasdaq’s definition of independence: Robert Tung, Guangxun Xu and Bruce C. Richardson. Bruce C. Richardson is the Chairman of the Audit Committee. The Board has determined that Mr. Bruce C. Richardson is the audit committee financial expert, as defined in Item 407(d) (5) of Regulation S-K, serving on the Company’s audit committee. Compensation Committee The Company has a standing Compensation Committee of the Board of Directors. The Compensation Committee is responsible for determining compensation for the Company’s executive officers. Three of the Company’s independent directors, as defined under the SEC’s rules and regulations and the Nasdaq’s definition of independence, Robert Tung, Guangxun Xu and Bruce C. Richardson serve on the Compensation Committee. Since July 8, 2010, Mr. Robert Tung has been the Chairman of the Compensation Committee. The Board has determined that all members of the Compensation Committee are independent directors under the rules of the Nasdaq Stock Market, as applicable. The Compensation Committee administers the Company’s benefit plans, reviews and administers all compensation arrangements for executive officers, and establishes and reviews general policies relating to the compensation and 44 benefits of the Company’s officers and employees. The Compensation Committee operates under a written charter that is made available on the Company’s website, www.caasauto.com. The Company’s Compensation Committee is empowered to review and approve the annual compensation and compensation procedures for the executive officers of the Company. The primary goals of the Compensation Committee of the Company’s Board of Directors with respect to executive compensation are to attract and retain the most talented and dedicated executives possible and to align executives’ incentives with stockholder value creation. The Compensation Committee evaluates individual executive performance with a goal of setting compensation at levels the committee believes are comparable with executives in other companies of similar size and stage of development operating in similar industry while taking into account the Company’s relative performance and its strategic goals. The Company has not retained a compensation consultant to review its policies and procedures with respect to executive compensation. The Company conducts an annual review of the aggregate level of its executive compensation, as well as the mix of elements used to compensate its executive officers. The Company compares compensation levels with amounts currently being paid to executives in its industry and most importantly with local practices in China. The Company is satisfied that its compensation levels are competitive with local conditions. Nominating Committee The Company has a standing Nominating Committee of the Board of Directors. Director candidates are nominated by the Nominating Committee. The Nominating Committee will consider candidates based upon their business and financial experience, personal characteristics, and expertise that are complementary to the background and experience of other Board members, willingness to devote the required amount of time to carry out the duties and responsibilities of Board membership, willingness to objectively appraise management performance, and any such other qualifications the Nominating Committee deems necessary to ascertain the candidates’ ability to serve on the Board. The Nominating Committee will not consider nominee recommendations from security holders, other than the recommendations received from a security holder or group of security holders that beneficially owned more than five (5) percent of the Company’s outstanding common stock for at least one year as of the date the recommendation is made. Three of the Company’s independent directors, as defined under the SEC’s rules and regulations and the NASDAQ’s definition of independence, Robert Tung, Guangxun Xu and Bruce C. Richardson, serve on the Nominating Committee. Since December 17, 2009, Mr. Guangxun Xu has been the Chairman of the Nominating Committee. Stockholder Communications Stockholders interested in communicating directly with the Board of Directors, or individual directors, may email the Company’s independent director Mr. Bruce C. Richardson at bcrichardson@hotmail.com. Mr. Richardson will review all such correspondence and will regularly forward to the board of directors of the Company copies of all such correspondence that deals with the functions of the Board or committees thereof or that he otherwise determines requires their attention. Directors may at any time review all of the correspondence received that is addressed to members of the board of directors of the Company and request copies of such correspondence. Concerns relating to accounting, internal controls or auditing matters will immediately be brought to the attention of the Audit Committee and handled in accordance with procedures established by the Audit Committee with respect to such matters. Family Relationships Mr. Hanlin Chen and Mr. Yiu Wong Andy Tse are brothers-in-law. Code of Ethics and Conduct The Board of Directors has adopted a Code of Ethics and Conduct which is applicable to all officers, directors and employees. The Code of Ethics and Conduct was filed as an exhibit to the Form 10-K for the year ended December 31, 2009, which was filed with the Securities and Exchange Commission on March 25, 2010. Section 16(a) Beneficial Ownership Compliance 45 Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the Company’s executive officers and directors and persons who own more than 10% of a registered class of the Company’s equity securities to file with the Securities and Exchange Commission initial statements of beneficial ownership, reports of changes in ownership and annual reports concerning their ownership of common stock and other of the Company’s equity securities, on Forms 3, 4 and 5 respectively. Executive officers, directors and greater than 10% stockholders are required by Commission regulations to furnish the Company with copies of all Section 16(a) reports they file. To the best of the Company’s knowledge, based solely upon a review of the Form 3, 4 and 5 filed, no officer, director or 10% beneficial shareholder failed to file on a timely basis any reports required by Section 16(a) of the Securities Exchange Act of 1934, as amended. ITEM 10 EXECUTIVE COMPENSATION COMPENSATION DISCUSSION AND ANALYSIS In 2003, the Board of Directors established a Compensation Committee consisting only of independent Board members, which is responsible for setting the Company’s policies regarding compensation and benefits and administering the Company’s benefit plans. At the end of fiscal year 2011, the Compensation Committee consisted of Robert Tung, Guangxun Xu and Bruce C. Richardson. The members of the Compensation Committee approved the amount and form of compensation paid to executive officers of the Company and set the Company’s compensation policies and procedures during these periods. The primary goals of the Company’s compensation committee with respect to executive compensation are to attract and retain highly talented and dedicated executives and to align executives’ incentives with stockholder value creation. The Compensation Committee will conduct an annual review of the aggregate level of the Company’s executive compensation, as well as the mix of elements used to compensate the Company’s executive officers. The Company compares compensation levels with amounts currently being paid to executives at similar companies in the same area and the same industry. Most importantly, the Company compares compensation levels with local practices in China. The Company believes that its compensation levels are competitive with local conditions. Elements of compensation The Company’s executive compensation consists of the following elements: Base Salary Base salaries for the Company’s executives are established to be amounts of compensation that are similar to those paid by other companies to executives in similar positions and with similar responsibilities. Base salaries are adjusted from time to time to realign salaries with market levels after taking into account individual responsibilities, performance and experience. The Compensation Committee established a salary structure to determine base salaries and is responsible for initially setting executive officer compensation in employment arrangements with each individual. The base salary amounts are intended to reflect the Company’s philosophy that the base salary should attract experienced individuals who will contribute to the success of the Company’s business goals and represent cash compensation that is commensurate with the compensation of individuals at similarly situated companies. The Company’s Board of Directors and Compensation Committee have approved the current salaries for executives: $165,000 for the Chairman, $110,000 for the CEO, and $66,000 for other officers in 2011. Performance Bonus a. Grantees: Hanlin Chen, Qizhou Wu, Shengbin Yu, Shaobo Wang, Andy Tse, Jie Li, and Daming Hu; b. Conditions: (i) based on the Company’s consolidated financial statements, the year over year growth rates of net sales, net profits and earnings per share for 2011 must exceed 20%; and (ii) the average growth rate of the 46 foregoing indicators must exceed that of China auto industry in 2010 published by China Association Of Auto Manufacturers, “CAAM”; c. Bonus: 50% of each officer’s annual salary in 2011. There are no accrued performance bonuses in 2011 as the Company did not reach either of the above conditions for awarding performance bonuses. Stock Option Awards The stock options plan proposed by management, which aims to incentivize and retain core employees, to meet employees’ benefits, the Company’s long term operating goals and stockholder benefits, was approved at the 2004 Annual Meeting of Stockholders, and the maximum common shares for issuance under this plan is 2,200,000 with a period of 10 years. The stock options granted to management in 2008 were as follows, which were approved by the Board of Directors and the Compensation Committee. a. Total Number of Options Granted: 298,850 b. Exercise Price Per Option: $2.93, the closing price of the common shares of the Company on December 9, 2008 c. Date of Grant: December 10, 2008 d. Expiration Date: on or before December 9, 2011, management has exercised all options before their expiration date e. Vesting Schedule • On December 10, 2008, 1/3 of the granted stock option vested and became exercisable • On December 10, 2009, 1/3 of the granted stock option vested and became exercisable • On December 10, 2010, 1/3 of the granted stock option vested and became exercisable Other Compensation Other than the base salary for the Company’s executive officers, the performance bonus and the stock option awards referred to above, the Company does not have any other benefits and perquisites for its executive officers. However, the Compensation Committee in its discretion may provide benefits and perquisites to these executive officers if it deems advisable to do so. Compensation Committee Report The Compensation Committee of the Board of Directors of the Company has reviewed and discussed the Compensation Discussion and Analysis contained in this Annual Report on Form 10-K with management. Based on the Company’s Compensation Committee’s review of and the discussions with management with respect to the Compensation Discussion and Analysis, the Company’s Compensation Committee recommended to the Board of Directors that the Compensation Discussion and Analysis be included in this Annual Report on Form 10-K for filing with the SEC. The foregoing report is provided by the following directors, who constitute the Compensation Committee: Robert Tung, Guangxun Xu and Bruce C. Richardson. Compensation Committee Interlocks and Insider Participation None of the Company’s executive officers has served as a member of a compensation committee, or other committee serving an equivalent function, of any other entity whose executive officers serve as a director of the Company or member of the Company’s compensation committee. 47 Compensation Tables Executive Officers The compensation that executive officers received for their services for fiscal years ended 2011, 2010 and 2009 were as follows: Name and principal position Hanlin Chen (Chairman) Qizhou Wu (CEO) Jie Li (CFO) Haimian Cai (Vice President) Shengbin Yu (Senior Vice President) Option Awards 3 Total Year 2011 2010 2009 Salary 1 Bonus 2 $ 165,000 $ $ 150,000 $ $ 150,000 $ — $ 75,000 $ 75,000 $ 2011 2010 2009 $ 110,000 $ $ 100,000 $ $ 100,000 $ — $ 50,000 $ 50,000 $ 66,000 $ 60,000 $ 60,000 $ — $ 30,000 $ 30,000 $ — $ 165,000 — $ 225,000 — $ 225,000 — $ 110,000 — $ 150,000 — $ 150,000 — $ — $ — $ 66,000 90,000 90,000 96,000 $ 96,000 $ 40,000 $ — $ — $ 96,000 $ — $ — $ 96,000 96,000 65,550 $ 201,550 33,000 $ 60,000 $ 60,000 $ — $ 30,000 $ 30,000 $ — $ — $ — $ 33,000 90,000 90,000 2011 2010 2009 2011 2010 2009 2011 2010 2009 $ $ $ $ $ $ $ $ $ 1. Salary – Please refer to Base Salary disclosed under “Elements of compensation” section above for further details 2. Bonus – Please refer to Performance Bonus disclosed under “Elements of compensation” section above for further details. 3. Option Awards – Please refer to Stock Option Awards disclosed under “Elements of compensation” section above for further details. For detailed information on option exercises and stock vested, please see Note 20 to the Consolidated Financial Statements under Item 15 of this Annual Report. Compensation for Directors Based on the number of the board of directors’ service years, workload and performance, the Company decides on their pay. The management believes that the pay for the members of the Board of Directors was appropriate as of December 31, 2011. The compensation that directors received for serving on the Board of Directors for fiscal year 2011 was as follows: Name Robert Tung Guangxun Xu Bruce C. Richardson Fees earned or paid in cash Option awards 1 33,525 $ $ 33,525 $ $ 33,525 $ $ 44,000 $ 32,000 $ 38,000 $ Total 77,525 65,525 71,525 1. Other than the cash payment based on the number of a director’s service years, workload and performance, the Company grants 7,500 option awards to each director every year. In accordance with ASC Topic 718, the cost of the above mentioned stock options issued to directors was measured on the grant date based on their fair value. The fair value is determined using the Black-Scholes option pricing model and certain assumptions. Please see Note 24 to the Consolidated Financial Statements under Item 15 of this Annual Report for more details. 48 The cost of the above-mentioned compensation paid to directors was measured based on investment, operating, technology, and consulting services they provided. All other directors did not receive compensation for their service on the Board of Directors. ITEM 11 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS As used in this section, the term beneficial ownership with respect to a security is defined by Rule 13d-3 under the Securities Exchange Act of 1934, as amended, as consisting of sole or shared voting power, including the power to vote or direct the vote, and/or sole or shared investment power, including the power to dispose of or direct the disposition of, with respect to the security through any contract, arrangement, understanding, relationship or otherwise, subject to community property laws where applicable. The percentage ownership is based on 28,260,302 shares of common stock outstanding at December 31, 2011. Name/Title Total Number of Shares Percentage Ownership Hanlin Chen, Chairman 1 Qizhou Wu, CEO and Director Jie Li, CFO Li Ping Xie 2 Tse, Yiu Wong Andy, Sr. VP, Director Shaobo Wang, Sr. VP Shengbin Yu, Sr. VP Yijun Xia, VP Daming Hu, CAO Robert Tung, Director Haimian Cai, Director Wiselink Holdings Limited 3 All Directors and Executive Officers (12 persons) 17,849,014 1,445,136 33,403 17,849,014 377,204 165,104 226,429 17,200 26,400 7,500 3,750 17,849,014 20,151,140 63.16% 5.11% 0.12% 63.16% 1.33% 0.58% 0.80% 0.06% 0.09% 0.03% 0.01% 63.16% 71.31% 1. 2. Includes 1,502,925 shares of common stock beneficially owned by Mr. Chen’s wife, Ms. Xie, and 3,023,542 shares beneficially held through Wiselink Holdings Limited. Includes 13,322,547 shares of common stock beneficially owned by Ms. Xie’s husband, Mr. Chen and 3,023,542 beneficially held in Wiselink Holdings Limited. 3. Wiselink Holdings Limited is a company controlled by Mr. Chen. Includes 13,322,457 shares of common stock beneficially owned by Mr. Chen and 1,502,925 shares of common stock beneficially owned by Mr. Chen’s wife, Ms. Xie. ITEM 12 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE For the information required by Item 13 please refer to Consolidated Financial Statements Note 2 (Basis of Presentation and Significant Accounting Policies–Certain Relationships and Related Transactions) and Note 28 (Related Party Transactions). The Company’s Audit Committee’s charter provides that one of its responsibilities is to review and approve related party transactions defined as those transactions required to be disclosed under Item 404 of Regulation S-K of the rules and regulations under the Exchange Act. Although the Company does not currently have a formal written set of policies and procedures for the review, approval or ratification of related person transactions, the Company does have written procedures in place to identify related party transactions that may require Audit Committee approval. These procedures include submission of a forecast summary of transactions with related parties annually. Where a related party transaction is identified, the Audit Committee reviews and, where appropriate, approves the transaction 49 based on whether it believes that the transaction is at arm’s length and contains terms that are no less favorable than what the Company could have obtained from an unaffiliated third party. ITEM 13 PRINCIPAL ACCOUNTING FEES AND SERVICES The following table sets rendered by PricewaterhouseCoopers Zhong Tian CPAs Limited Company for the audit of the Company’s annual financial statements, and fees billed for other services for the fiscal years 2011 and 2010. The Audit Committee has approved all of the following fees. for professional audit services the aggregate forth fees Audit Fees Audit-Related Fees Tax Fees Total Fees Paid Fiscal Year Ended 2010 2011 823,000 870,000 $ — — — — 823,000 870,000 $ $ $ AUDIT COMMITTEE’S PRE-APPROVAL POLICY During the fiscal years ended December 31, 2011, 2010 and 2009, the Audit Committee of the Board of Directors adopted policies and procedures for the pre-approval of all audit and non-audit services to be provided by the Company’s independent auditor and for the prohibition of certain services from being provided by the independent auditor. The Company may not engage the Company’s independent auditor to render any audit or non-audit service unless the service is approved in advance by the Audit Committee or the engagement to render the service is entered into pursuant to the Audit Committee’s pre-approval policies and procedures. On an annual basis, the Audit Committee may pre-approve services that are expected to be provided to the Company by the independent auditor during the fiscal year. At the time such pre-approval is granted, the Audit Committee specifies the pre-approved services and establishes a monetary limit with respect to each particular pre-approved service, which limit may not be exceeded without obtaining further pre-approval under the policy. For any pre-approval, the Audit Committee considers whether such services are consistent with the rules of the Securities and Exchange Commission on auditor independence. ITEM 14 FINANCIAL STATEMENTS PART IV 1. Report of Independent Registered Public Accounting Firm, PricewatershouseCoopers Zhong Tian CPAs Limited Company 2. Report of Registered Public Accounting Firm, Schwartz Levitsky Feldman LLP 3. Consolidated Balance Sheets as of December 31, 2011 and 2010 4. Consolidated Statements of Income (Loss) for the years ended December 31, 2011, 2010 and 2009 5. Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2011, 2010 and 2009 6. Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2011, 2010 and 2009 7. Consolidated Statements of Cash Flows for the years ended December 31, 2011, 2010 and 2009 8. Notes to Consolidated Financial Statements 50 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF CHINA AUTOMOTIVE SYSTEMS, INC.: In our opinion, the consolidated balance sheets as of December 31, 2011 and 2010 and the related consolidated statements of income (loss), comprehensive income (loss), changes in stockholders' equity and cash flows for the years then ended present fairly, in all material respects, the financial position of China Automotive Systems, Inc. and its subsidiaries (“the Company”) at December 31, 2011 and 2010, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule as of December 31, 2011 and 2010 and for the years ended December 31, 2011 and 2010 listed in the index appearing under Item 8 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company did not maintain, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") because a material weakness in internal control over financial reporting related to insufficient personnel with appropriate levels of accounting knowledge and experience to address complex U.S. GAAP accounting issues and to prepare and review financial statements and related disclosures under U.S. GAAP existed as of that date. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. The material weakness referred to above is described in Management's Report on Internal Control over Financial Reporting appearing under Item 9A. We considered this material weakness in determining the nature, timing, and extent of audit tests applied in our audit of the 2011 consolidated financial statements, and our opinion regarding the effectiveness of the Company's internal control over financial reporting does not affect our opinion on those consolidated financial statements. The Company's management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in management's report referred to above. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls 51 may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. We do not express an opinion or any other form of assurance on management's statements referring to the management’s actions and plans of remediation of previously identified material weakness and the actions and plans to remediate the existing material weakness included in the Management’s Report on Internal Control Over Financial Reporting. /s/ PricewaterhouseCoopers Zhong Tian CPAs Limited Company PricewaterhouseCoopers Zhong Tian CPAs Limited Company Shanghai, People’s Republic of China March 9, 2012 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of China Automotive Systems, Inc. and Subsidiaries We have audited the accompanying consolidated balance sheet of China Automotive Systems, Inc. and subsidiaries (the “Company”) as at December 31, 2009 and the related consolidated statements of operations, comprehensive loss, cash flows and changes in stockholders’ equity for the year ended December 31, 2009. These consolidated financial statements are the responsibility of the management of the Company. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. The Company is not required to have nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal controls over financing reporting. Accordingly, we express no such opinion. In our opinion, these consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2009 and the results of its operations and its cash flows for the year ended December 31, 2009 in conformity with generally accepted accounting principles in the United States of America. Toronto, Ontario, Canada March 16, 2010 except for note 2 to the consolidated financial statements appearing on the Company’s 2010 Form 10-K, which was as of June 23, 2011 “SCHWARTZ LEVITSKY FELDMAN LLP” Chartered Accountants Licensed Public Accountants 52 China Automotive Systems, Inc. and Subsidiaries Consolidated Balance Sheets ASSETS Current assets: Cash and cash equivalents Pledged cash deposits Accounts and notes receivable, net - unrelated parties Accounts and notes receivable, net - related parties Advance payments and others - unrelated parties Advance payments and others - related parties Inventories Current deferred tax assets Total current assets Non-current assets: Property, plant and equipment, net Intangible assets, net Other receivables, net - unrelated parties Other receivables, net - related parties Advance payment for property, plant and equipment - unrelated parties Advance payment for property, plant and equipment - related parties Long-term investments Non-current deferred tax assets Total assets LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Bank loans Accounts and notes payable - unrelated parties Accounts and notes payable - related parties Convertible notes payable Compound derivative liabilities Customer deposits Accrued payroll and related costs Accrued expenses and other payables Accrued pension costs Taxes payable Amounts due to shareholders/directors Deferred tax liabilities Total current liabilities Long-term liabilities: Convertible notes payable Compound derivative liabilities Accrued make-whole redemption interest expense of convertible notes Advances payable Total liabilities Commitments and Contingencies Stockholders’ Equity Common stock, $0.0001 par value - Authorized - 80,000,000 shares Issued and Outstanding – 28,260,302 and 27,175,826 shares at December 31, 2011 and 2010, respectively Additional paid-in capital Retained earnings- 53 December 31, 2011 2010 $ 72,960,500 $ 49,424,979 21,820,890 20,983,891 206,333,110 190,392,146 5,466,842 6,126,148 2,892,068 2,215,240 1,334,069 629,741 51,607,193 36,870,272 3,686,713 3,511,421 365,379,535 310,875,688 84,843,250 75,380,747 662,089 837,075 2,450,970 1,876,953 350,464 499,652 1,839,537 1,472,442 7,534,440 3,712,121 3,162,136 3,485,118 4,340,974 3,271,594 $466,447,120 $405,527,665 $ 10,315,987 $ 6,794,812 169,456,482 146,649,497 1,867,926 2,052,897 - 30,000,000 - 25,271,808 720,883 1,181,401 5,177,140 4,927,200 22,617,667 29,072,710 3,851,988 4,067,399 6,860,946 2,029,215 353,817 351,817 312,304 309,667 217,559,672 256,683,891 23,571,429 559,148 7,615,709 983,986 - - - 603,983 250,289,944 257,287,874 2,717 39,295,419 28,565,153 2,826 Appropriated Unappropriated Accumulated other comprehensive income Total parent company stockholders' equity Non-controlling interests Total stockholders' equity Total liabilities and stockholders' equity 9,026,240 8,767,797 99,513,395 58,979,851 25,291,231 15,957,500 173,129,111 112,273,018 43,028,065 35,966,773 216,157,176 148,239,791 $466,447,120 $405,527,665 The accompanying notes are an integral part of these consolidated financial statements. China Automotive Systems, Inc. and Subsidiaries Consolidated Statements of Income/(Loss) Net product sales Unrelated parties Related parties (Note 28) Cost of product sold Unrelated parties Related parties(Note 28) Year Ended December 31 2010 2009 2011 $328,043,323 $334,264,680 $249,705,389 19,931,431 11,660,502 5,892,164 347,974,754 345,925,182 255,597,553 259,096,894 246,369,792 179,856,225 20,778,863 19,252,680 13,998,702 279,875,757 265,622,472 193,854,927 68,098,997 80,302,710 61,742,626 838,505 1,129,032 9,363,875 9,971,835 1,481,308 Gross profit Net gain on other sales Operating expenses: Selling expenses General and administrative expenses R&D expenses Total operating expenses Operating income Other income, net Financial expenses, net Gain (loss) on change in fair value of derivative Gain on convertible notes conversion Income (loss) before income tax expenses and equity in earnings of affiliated companies 4,720,013 Less: Income taxes - Add: Equity in earnings of affiliated companies 47,903,481 62,917,302 (18,651,125) Net income (loss) 7,789,746 Net income attributable to noncontrolling interest $ 40,791,987 $ 51,738,113 $ (26,440,871) Net income (loss) attributable to parent company Allocation to convertible notes holders - Net income (loss) attributable to parent company’s common shareholders 36,273,149 44,743,807 (26,440,871) 7,892,540 16,224,369 10,029,211 15,195,026 10,005,605 2,561,170 36,201,809 27,384,338 25,648,736 33,378,496 54,047,404 36,932,395 94,534 (7,883,714) 20,971,087 20,171,698 (43,074,327) - 52,098,933 4,353,702 158,250 168,749 (3,983,817) 558,058 (3,360,837) 7,111,494 11,179,189 8,484,205 (14,816) (4,518,838) (6,994,306) (13,931,112) 1,564,418 7,991,252 71,416,323 - Net income (loss) attributable to parent company’s common shareholders per share – Basic Diluted Weighted average number of common shares outstanding – $ $ 1.30 $ 0.69 $ 1.65 $ 1.10 $ (0.98) (0.98) 54 Basic Diluted 27,930,668 27,098,258 26,990,649 31,511,685 31,565,422 26,990,649 The accompanying notes are an integral part of these consolidated financial statements. China Automotive Systems, Inc. and Subsidiaries Consolidated Statements of Comprehensive Income/(Loss) Net income (loss) Other comprehensive income: Foreign currency translation gain, net of tax Comprehensive income (loss) Comprehensive income attributable to noncontrolling interest Comprehensive income (loss) attributable to parent company Year Ended December 31 2010 $ 47,903,481 $ 62,917,302 $(18,651,125) 2011 2009 82,638 11,284,880 5,707,902 59,188,361 68,625,204 (18,568,487) 7,812,156 $ 50,125,718 $ 56,507,880 $(26,380,643) 9,062,643 12,117,324 The accompanying notes are an integral part of these consolidated financial statements. China Automotive Systems, Inc. and Subsidiaries Consolidated Statements of Changes in Stockholders’ Equity Common Stock Balance at January 1 Issuance of common shares for the conversion of convertible notes Exercise of stock option Balance at December 31 Additional paid-in capital Balance at January 1 Issuance of common shares for the conversion of convertible notes Issuance of stock options Exercise of stock option Balance at December 31 Retained earnings— Appropriated Balance at January 1 Appropriation of retained earnings Balance at December 31 Unappropriated Balance at January 1 – as previously reported Accumulated effect of adopted ASC815-15 Balance at January 1 Net income (loss) attributable to parent company Appropriation of retained earnings Balance at December 31 55 2011 2010 2009 $ $ 2,717 $ 91 18 2,826 $ 2,704 $ — 13 2,717 $ 2,698 — 6 2,704 $ 28,565,153 $ 27,515,064 $ 26,648,154 — 446,676 420,234 $ 39,295,419 $ 28,565,153 $ 27,515,064 10,111,778 100,575 517,913 — 595,402 454,687 $ 8,767,797 $ 8,324,533 $ 7,525,777 798,756 $ 9,026,240 $ 8,767,797 $ 8,324,533 258,443 443,264 — 58,979,851 40,791,987 (258,443) $ 58,979,851 $ 7,685,002 $ 34,060,876 863,753 34,924,629 (26,440,871) (798,756) $ 99,513,395 $ 58,979,851 $ 7,685,002 — 7,685,002 51,738,113 (443,264) Accumulated Other Comprehensive Income Balance at January 1 Net foreign currency translation adjustment attributable to parent company Balance at December 31 Total parent company stockholders' equity $ 15,957,500 11,187,733 $ 11,127,505 9,333,731 4,769,767 60,228 $ 25,291,231 $ 15,957,500 $ 11,187,733 $173,129,111 $112,273,018 $ 54,715,036 Non-controlling interest Balance at January 1 Net foreign currency translation adjustment attributable to non-controlling interest Net income attributable to non-controlling interest Distribution of retained earnings Balance at December 31 Total stockholders' equity $ 35,966,773 $ 27,138,357 $ 23,270,820 1,951,149 938,135 22,410 7,111,494 (2,001,351) 11,179,189 (3,288,908) 7,789,746 (3,944,619) $ 43,028,065 $ 35,966,773 $ 27,138,357 $216,157,176 $148,239,791 $ 81,853,393 The accompanying notes are an integral part of these consolidated financial statements. China Automotive Systems, Inc. and Subsidiaries Consolidated Statements of Cash Flows Year Ended December 31 2010 2011 2009 Cash flows from operating activities: Net income (loss) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Stock-based compensation Depreciation and amortization Deferred income tax assets and liabilities Inventory write downs Provision (reversal) for doubtful accounts Amortization for discount of convertible notes payable Equity in earnings of affiliated companies Gain on convertible notes conversion (Gain) loss on change in fair value of derivative Loss on disposal of fixed assets Other operating adjustments Changes in operating assets and liabilities: (Increase) decrease in: Pledged cash deposits Accounts and notes receivable Advance payments and other Inventories Increase (decrease) in: Accounts and notes payable Customer deposits Accrued payroll and related costs Accrued expenses and other payables Accrued pension costs Taxes payable 56 $ 47,903,481 $ 62,917,302 $(18,651,125) 100,575 595,402 13,501,091 9,497,618 620,880 (914,886 ) (23,054 ) 431,652 (75,486 ) (2,373,520 ) — 14,816 - 446,676 8,684,169 (1,676,731) 1,031,751 901,680 3,891,148 - - (20,971,087 ) (20,171,698 ) 43,074,327 22,970 (235,076) — (158,250 ) (1,564,418 ) 104,849 - 690,256 (6 ) 181,608 (7,656,455 ) (5,994,298) (6,200,552 ) (33,055,864 ) (58,735,311) (968,719) 1,576,777 (1,721,067 ) (1,849,579) (12,458,644 ) (8,679,749 ) 19,903 15,013,604 36,821,221 48,178,260 1,682,384 1,055,134 8,375,518 (31,847) 5,755,520 409,036 (1,232,590 ) 206,373 2,355,538 6,295,860 (45,692 ) (5,107,984 ) (4,963,593 ) 25,566 Advances payable Net cash provided by operating activities Cash flows from investing activities: (Increase) decrease in other receivables Cash received from equipment sales Cash paid to acquire property, plant and equipment Cash paid to acquire intangible assets Equity investment Net cash used in investing activities Cash flows from financing activities: Bank loans borrowed Repayment of bank loans Dividends paid to the non-controlling interest holders of joint-venture companies Increase (decrease) in amounts due to shareholders/directors Exercise of stock option Redemption of convertible notes Net cash provided by (used in) financing activities Cash and cash equivalents affected by foreign currency Net increase in cash and cash equivalents Cash and equivalents at beginning of year Cash and equivalents at end of year 345,623 (317) 34,063,290 38,552,161 34,956,534 361,015 563,649 (1,695,321 ) 383,924 574,775 207,014 280,270 (14,857,364 ) (28,024,638 ) (17,498,957) (324,014) (165,292 ) — - (3,095,414 ) (14,042,403 ) (32,596,741 ) (17,335,687) (323,463 ) 10,199,951 8,215,091 (6,995,320 ) (6,794,812 ) 6,590,317 (8,786,684) (28,194 ) 517,931 — (2,822,432 ) (3,614,252 ) 344,695 454,700 — (4,176,583) (337,915) 420,240 (5,000,000) 871,936 (1,394,578 ) (11,290,625) 36,579 2,642,698 1,383,961 23,535,521 5,944,803 6,366,801 49,424,979 43,480,176 37,113,375 $ 72,960,500 $ 49,424,979 $ 43,480,176 The accompanying notes are an integral part of these consolidated financial statements. China Automotive Systems, Inc. and Subsidiaries Consolidated Statements of Cash Flows (continued) SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for interest Cash paid for income taxes $1,972,601 $2,044,713 $8,271,564 $6,685,443 SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES: Year Ended December 31 2010 2011 2009 $1,475,307 $4,048,120 Year Ended December 31 2010 2011 2009 Issuance of common shares for the conversion of convertible notes Advance payments for acquiring property, plant and equipment Dividend Payable to non-controlling interest shareholders of joint-ventures $10,111,869 $- $5,184,563 $9,373,977 $- $6,369,043 $807,970 1,530,445 1,761,339 The accompanying notes are an integral part of these consolidated financial statements. 57 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS China Automotive Systems, Inc. and Subsidiaries Notes to Consolidated Financial Statements 1. Organization and Business China Automotive Systems, Inc., “ China Automotive,” was incorporated in the State of Delaware on June 29, 1999 under the name of Visions-In-Glass, Inc. China Automotive, including, when the context so requires, its subsidiaries and the subsidiaries’ interests in the Sino-foreign joint ventures described below, is referred to herein as the “Company.” The Company is primarily engaged in the manufacture and sale of automotive systems and components, as described below. Great Genesis Holdings Limited, a company incorporated on January 3, 2003 under The Companies Ordinance in Hong Kong as a limited liability company, “Genesis,” is a wholly-owned subsidiary of the Company. Henglong USA Corporation, “HLUSA,” which was incorporated on January 8, 2007 in Troy, Michigan, is a wholly-owned subsidiary of the Company, and mainly engages in marketing of automotive parts in North America, and provides after-sales service and research and development support accordingly. The Company owns the following aggregate net interests in the following Sino-foreign joint ventures, wholly-owned subsidiary and joint ventures organized in the PRC as of December 31, 2011, 2010, and 2009. Name of Entity Jingzhou Henglong Automotive Parts Co., Ltd., “Henglong” 1 Shashi Jiulong Power Steering Gears Co., Ltd., “Jiulong” 2 Shenyang Jinbei Henglong Automotive Steering System Co., Ltd., “Shenyang” 3 Zhejiang Henglong & Vie Pump-Manu Co., Ltd., “Zhejiang” 4 Universal Sensor Application Inc., “USAI” 5 Wuhu HengLong Auto Steering System Co., Ltd., “Wuhu” 6 Wuhan Jielong Electric Power Steering Co., Ltd., “Jielong” 7 Jingzhou Hengsheng Automotive System Co., Ltd, “Hengsheng” 8 Jingzhou Henglong Automotive Technology (Testing) Center, “Testing Center” 9 Beijing Hainachuan HengLong Automotive Steering System Co., Ltd, “Beijing HengLong” 10 2009 Aggregate Net Interest 2011 2010 80.00% 80.00% 80.00% 81.00% 81.00% 81.00% 70.00% 70.00% 70.00% 51.00% 51.00% 51.00% 83.34% 83.34% 83.34% 77.33% 77.33% 77.33% 85.00% 85.00% 85.00% 100.00% 100.00% 100.00% 80.00% 80.00% 80.00% 50.00% 50.00% - 1. Henglong was established in 1997 and is mainly engaged in the production of rack and pinion power steering gear 2. for cars and light duty vehicles. Jiulong was established in 1993 and is mainly engaged in the production of integral power steering gear for heavy-duty vehicles. 3. Shenyang was established in 2002 and focuses on power steering parts for light duty vehicles. 4. Zhejiang was established in 2002 to focus on power steering pumps. 5. USAI was established in 2005 and is mainly engaged in the production and sales of sensor modules. 6. Wuhu was established in 2006 and is mainly engaged in the production and sales of automobile steering systems. 7. Jielong was established in 2006 and is mainly engaged in the production and sales of electric power steering gear, “EPS.” 8. On March 7, 2007, Genesis established Hengsheng, its wholly-owned subsidiary, to engage in the production and sales of automotive steering systems. The registered capital of Hengsheng at the time of establishment was $10,000,000. On February 10, 2010, the registered capital of Hengsheng was increased to $16,000,000. On October 12, 2011, the board of directors of the Company approved a reorganization of the Company’s subsidiaries operating in China. As a result of the reorganization, all of Genesis’s equity interests of its subsidiaries operating in China, except for Shenyang and Zhejiang, were transferred to Hengsheng, the Company’s new China-based 58 9. holding company. The reorganization was completed on January 19, 2012 and, after that, the registered capital of Hengsheng was increased to $39,000,000. In December 2009, Henglong, a subsidiary of Genesis, formed the Testing Center, which is mainly engaged in the research and development of new products. The registered capital of the Testing Center was RMB 30,000,000, equivalent to approximately $4,393,544. 10. On January 24, 2010, Genesis entered into a joint venture contract with Beijing Hainachuan Auto Parts Co., Ltd., to establish Beijing Henglong as a joint venture company to design, develop and manufacture both hydraulic and electric power steering systems and parts. On September 16, 2010, with Beijing Hainachuan’s agreement, Genesis transferred its interest in the joint venture to Hengsheng, and left the other terms of the joint venture contract unchanged. According to the joint venture agreement, the Company does not have voting control of Beijing Henglong. Therefore, the Company’s consolidated financial statements do not include Beijing Henglong, and such investment is accounted for by the equity method. On October 12, 2011, the board of directors of the Company approved a reorganization of the group companies operating as subsidiaries in China. The reorganization is intended to improve the Company’s marketing of its products in China by presenting a more unified structure under one PRC-based holding company and to improve the administration and control of the various China-based subsidiaries. As a result of the reorganization, all of Genesis’ equity interests in its subsidiaries operating in China, except for Shenyang and Zhejiang, were transferred to Hengsheng (the Company’s new China-based holding company). As the reorganization was under common control of the Company, it will not have a material impact on the Company’s consolidated financial position or results of operations and should not impact the tax treatment of the Company or its subsidiaries in any material respect. The reorganization was completed on January 19, 2012. Set forth below is an organizational chart after reorganization. 2. Basis of Presentation and Significant Accounting Policies Basis of Presentation - For the years ended December 31, 2011, 2010, and 2009, the accompanying consolidated financial statements include the accounts of the Company and its three wholly-owned subsidiaries and eight joint ventures, which are described 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. The Company has no voting control in Beijing Henglong, thus such investment was accounted for using the equity method. During early 2003, the Directors of the Company and the other joint venture partners in the Company’s Sino-foreign joint ventures executed “Act in Concert” agreements, resulting in the Company’s ownership of voting control in such Sino-foreign joint ventures. Consequently, effective January 1, 2003, the Company changed from equity accounting to consolidation accounting for its investments in Sino-foreign joint ventures for the year ended December 31, 2003. Prior to January 1, 2003, the Company used the equity method pursuant to the provision in ASC Topic 810 (formerly EITF 96-16), as described as follows. Henglong was formed in 1997. The Company increased its shareholdings from 44.5% to 80% in 2008 and the remaining 20% is owned by Jingzhou Jiulong Machinery and Electronic Manufacturing Co., Ltd., “JLME.” The highest authority of the joint venture is the Board of Directors, which is comprised of five directors, four of which, 80%, are appointed by the Company, and one of which, 20%, is appointed by JLME. As for day-to-day operating matters, approval by more than two-thirds of the members of the Board of Directors, 67%, is required. Both the Chairman of the Board of Directors and general manager of Henglong are appointed by the Company. Jiulong was formed in 1993, with 81% owned and controlled by the Company, 10% owned by JLME, and 9% owned by Jingzhou Tianxin Investment Consulting Co., Ltd., “Tianxin.” The highest authority of the joint venture is the Board of Directors, which is comprised of five directors, four of which, 80%, are appointed by the Company, and one of whom, 20%, is appointed by JLME. As for day-to-day operating matters, approval by more than two-thirds of the members of the Board of Directors, 67%, is required. The Chairman of the Board of Directors is appointed by JLME. The general manager of Jiulong is appointed by the Company. Shenyang was formed in 2002, with 70% owned and controlled by the Company, and 30% owned by Shenyang Automotive Industry Investment Corporation, “JB Investment.” The highest authority of the joint venture is the Board 59 of Directors, which is comprised of seven directors, four of whom, 57%, are appointed by the Company, and three of whom, 43%, are appointed by JB Investment. As for day-to-day operating matters, approval by more than two-thirds of the members of the Board of Directors, 67%, is required. The Chairman of the Board of Directors is appointed by the Company. In March 2003, the Company and Jinbei entered into an act-in-concert agreement, under which the directors appointed by Jinbei agree to act in concert with the directors appointed by the Company. As a result, the Company obtained control of Shenyang in March 2003. The general manager of Shenyang is appointed by the Company. Zhejiang was formed in 2002, with 51% owned by Genesis, which is wholly-owned and controlled by the Company, and 49% owned by Zhejiang Vie Group, “ZVG.” The highest authority of the joint venture is the Board of Directors, which is comprised of seven directors, four of whom, 57%, are appointed by the Company and three of whom, 43%, are appointed by ZVG. As for day-to-day operating matters, approval by more than two-thirds of the members of the Board of Directors, 67%, is required. In March 2003, the Company and ZVG entered into an act-in-concert agreement, under which the directors appointed by ZVG agree to act in concert with the directors appointed by the Company. As a result, the Company obtained control of Zhejiang in March 2003. The Chairman of the Board of Directors is appointed by ZVG. The general manager of Zhejiang is appointed by the Company. USAI was formed in 2005. As at December 31, 2008, 83.34% was owned by the Company and 16.66% owned by Shanghai Hongxi Investment Inc., “Hongxi”. The highest authority of the joint venture is the Board of Directors, which is comprised of three directors, two of whom, 67%, are appointed by the Company, one of whom, 33%, is appointed by Hongxi. As for day-to-day operating matters, approval by more than two-thirds of the members of the Board of Directors, 67%, is required. The Chairman of the Board of Directors is appointed by the Company. The general manager of USAI is appointed by the Company. Jielong was formed in April 2006, with 85% owned by the Company, and 15% owned by Hong Kong Tongda, “Tongda.” The highest authority of the joint venture is the Board of Directors, which is comprised of three directors, two of whom, 67%, are appointed by the Company, and one of whom, 33%, is appointed by Tongda. As for day-to-day operating matters, approval by more than two-thirds of the members of the Board of Directors, 67%, is required. The Chairman of the Board of Directors is appointed by the Company. The general manager of Jielong is appointed by the Company. Wuhu was formed in May 2006, with 77.33% owned by the Company, and 22.67% owned by Wuhu Chery Technology Co., Ltd., “Chery Technology.” The highest authority of the joint venture is the Board of Directors, which is comprised of five directors, three of whom, 60%, are appointed by the Company, and two of whom, 40%, are appointed by Chery Technology. As for day-to-day operating matters, approval by more than two-thirds of the members of the Board of Directors, 67%, is required. The directors of the Company and Chery Technology executed an “Act in Concert” agreement, resulting in the Company having voting control in the joint venture. The Chairman of the Board of Directors is appointed by the Company. The general manager of Wuhu is appointed by the Company. Testing Center was formed in December 2009, as a wholly-owned subsidiary of Henglong. The highest authority of the entity is the Board of Directors, which is comprised of three directors, all of them are appointed by the Company. Beijing Henglong was formed in 2010, with 50% owned by the Company and 50% owned by Beijing Hainachuan Auto Parts Co. Ltd., "Hainachuan.” The highest authority of the joint venture is the Board of Directors, which is comprised of seven directors, four of whom, 57%, are appointed by the Company, and three of whom, 43%, are appointed by Hainachuan. As for day-to-day operating matters, approval by more than two-thirds of the members of the Board of Directors, 67%, is required. The Chairman of the Board of Directors is appointed by Hainachuan. The general manager of Beijing Henglong is appointed by the Company. The minority partners of each of the joint ventures are all private companies not controlled, directly or indirectly, by any PRC municipal government or other similar government entity. Use of Estimates - The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the dates of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. The Company is of an 60 opinion that the significant estimates related to impairment of long term assets and investment, the realizable value of accounts receivable and inventories, useful lives of property, plant and equipment, and the amounts of accruals, warranty liabilities and deferred tax assets. Actual results could differ from those estimates. Cash and Cash Equivalents - Cash and cash equivalents include all highly-liquid investments with an original maturity of three months or less at the date of purchase. Pledged Cash Deposits - Pledged as guarantee for the Company's notes payable and restricted to use. The Company regularly pays some of its suppliers by bank notes. The Company (the drawer) has to deposit a cash deposit, equivalent to 30%- 40% of the face value of the relevant bank note, in a bank (the drawer) in order to obtain the bank note. Allowance for Doubtful Accounts-In order to determine the value of the Company’s accounts receivable, the Company records a provision for doubtful accounts to cover estimated credit losses. Management reviews and adjusts this allowance periodically based on historical experience and its evaluation of the collectability of outstanding accounts receivable. The Company evaluates the credit risk of its customers utilizing historical data and estimates of future performance. Inventories - Inventories are stated at the lower of cost and net realizable value. Cost is calculated on the moving-average basis and includes all costs to acquire and other costs to bring the inventories to their present location and condition. The Company evaluates the net realizable value of its inventories on a regular basis and records a provision for loss to reduce the computed moving-average cost if it exceeds the net realizable value. Advance Payments - These amounts represent advances to acquire various assets to be utilized in the future in the Company’s normal business operations, such as machine equipment, raw materials and technology. Such amounts are paid according to their respective contract terms. Advance payment for machinery and equipment is classified as advance payment for property, plant and equipment in the consolidated balance sheet and advance payment of raw materials and technology are classified as advance payments and others in the consolidated balance sheet. Property, Plant and Equipment – Property, plant and equipment are stated at cost. Major renewals and improvements are capitalized; minor replacements and maintenance and repairs are charged to operations. Depreciation is calculated on the straight-line method over the estimated useful lives of the respective assets as follows: Category Land use rights and buildings: Land use rights Buildings Machinery and equipment Electronic equipment Motor vehicles Estimated Useful Life (Years) 45-50 25 6 4 8 Assets under construction - represent buildings under construction and plant and equipment pending installation— are stated at cost. Cost includes construction and acquisitions, and interest charges arising from borrowings used to finance assets during the period of construction or installation and testing. No provision for depreciation is made on assets under construction until such time as the relevant assets are completed and ready for their intended commercial use. Gains or losses on disposal of property, plant and equipment are determined as the difference between the net disposal proceeds and the carrying amount of the relevant asset, and are recognized in the consolidated statements of income/(loss) on the date of disposal. Gains or losses on disposal of property, plant and equipment has not been material for the years ended December 31, 2011, 2010 and 2009. 61 Interest Costs Capitalized - Interest costs incurred in connection with specific borrowings for the acquisition, construction or installation of property, plant and equipment are capitalized (if significant) and depreciated as part of the asset’s total cost when the respective asset is placed into service. However, for the fiscal year ended December 31, 2011, 2010 and 2009, interest costs which were incurred before achieving the expected usage as result of using such specific borrowings for the acquisition, construction or installation of property, plant and equipment were not significant, so the Company did not capitalize interest costs. Intangible Assets - Intangible assets, representing patents and technical know-how acquired, are stated at cost less accumulated amortization and impairment losses. Amortization is calculated on the straight-line method over the estimated useful life of 5 to 15 years. Long-Lived Assets - The Company has adopted the provisions of ASC Topic 360 (formerly SFAS No.144), “Accounting for the Impairment or Disposal of Long-Lived Assets.” Property, plant and equipment and definite life intangible assets are reviewed periodically for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. If required, an impairment loss is recognized as the difference between the carrying value and the fair value of the assets. In assessing long-lived assets for impairment, management considered the Company’s product line portfolio, customers and related commercial agreements, labor agreements and other factors in grouping assets and liabilities at the lowest level for which identifiable cash flows are largely independent. The Company considers projected future undiscounted cash flows, trends and other factors in its assessment of whether impairment conditions exist. Whilst the Company believes that its estimates of future cash flows are reasonable, different assumptions regarding such factors as future automotive production volumes, customer pricing, economics and productivity and cost saving initiatives, could significantly affect its estimates. In determining fair value of long-lived assets, management uses appraisals, management estimates or discounted cash flow calculations. Long-Term Investments - Investments in which the Company owns less than 20% of the investee company and does not have the ability to exert significant influence are stated at cost, and are reviewed periodically for realization. Investments in which the Company owns 20% - 50% of the investee company and does have the ability to exert significant influence are accounted for using the equity method. In 2010, the Company set up a joint venture with Beijing Hainachuan, Beijing Henglong. Beijing Henglong is an entity over which the Company has significant influence, but which it does not control. Investment in Beijing Henglong is accounted for by the equity method of accounting. Under this method, the Company’s income (loss) from investment in Beijing Henglong is recognized in the consolidated statements of income/ (loss). Unrealized gains on transactions between the Company and Beijing Henglong are eliminated to the extent of the Company’s interest in Beijing Henglong, if any; unrealized losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred. When the Company’s share of losses in Beijing Henglong equals or exceeds its interest in Beijing Henglong, the Company does not recognize further losses, unless the Company has incurred obligations or made payments on behalf of Beijing Henglong. The Company continually reviews its investment in Beijing Henglong to determine whether a decline in fair value below the carrying value is other than temporary. The primary factors the Company considers in its determination are the length of time that the fair value of the investment is below the Company’s carrying value and the financial condition, operating performance and near term prospects of the investee. In addition, the Company considers the reason for the decline in fair value, including general market conditions, industry-specific or investee-specific reasons, and changes in valuation subsequent to the balance sheet date and the Company’s intent and ability to hold the investment for a period of time sufficient to allow for a recovery in fair value. If the decline in fair value is deemed to be other than temporary, the carrying value of the security is written down to fair value. There was no impairment losses for its long-term investment in the three years ended December 31, 2011. Revenue from Product Sales Recognition - The Company recognizes revenue when the significant risks and rewards of ownership have been transferred to the customer pursuant to PRC law, including factors such as when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, sales and 62 value added tax laws have been complied with, and collectability is probable. The Company recognizes product sales generally at the time the product is installed on OEMs’ production line, and a small number of product sales is recognized at the time the product is shipped. Concurrent with the recognition of revenue, the Company reduces revenue for estimated product returns. Revenue is presented net of any sales tax and value added tax. Revenue from Materials and Other Assets Sales Recognition – Normally, the Company purchases materials only for its production. Occasionally, some materials will be sold to other suppliers in case of temporary inventory overage of such materials and to make a profit on any price difference. The Company is essentially the agent in these transactions because it does not have any risk of product return. When there is any quality or quantity loss, the suppliers are obligated to restitution. Income generated from selling materials is recorded as the net amount retained, that is, the amount billed to the customers less the amount paid to suppliers, in the consolidated statement of income (loss) in accordance with the provisions of ASC Topic 350. Revenue from other asset sales represents gains or losses from other assets, for example, used equipment. Income generated from selling other assets is recorded as the net sales amount less the carrying value of the assets. The Company has classified such revenue from materials and other asset sales into gain on other sales in its consolidated statements of income/ (loss). Sales Taxes - The Company is subject to value added tax, “VAT.” The applicable VAT tax rate is 17% for products sold in the PRC. The amount of VAT liability is determined by applying the applicable tax rate to the invoiced amount of goods sold less VAT paid on purchases made with the relevant supporting invoices. VAT is collected from customers by the Company on behalf of the PRC tax authorities and is therefore not charged to the consolidated statements of income/ (loss). Uncertain Tax Positions - In order to assess uncertain tax positions, the Company applies a more likely than not threshold and a two-step approach for tax position measurement and financial statement recognition. For the two-step approach, the first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely to be realized upon settlement. Product Warranties - The Company provides for the estimated cost of product warranties when the products are sold. Such estimates of product warranties were based on, among other things, historical experience, product changes, material expenses, service and transportation expenses arising from the manufactured product. Estimates will be adjusted on the basis of actual claims and circumstances. For the years ended December 31, 2011, 2010 and 2009, the warranties activities were as follows: Balance at the beginning of year Additions during the year Settlement within the year Foreign currency translation Balance at end of year 2011 2009 Year Ended December 31 2010 $ 13,944,392 $ 9,092,464 $ 6,335,613 11,484,592 13,285,612 10,192,749 (7,442,982) 7,084 $ 16,808,787 $ 13,944,392 $ 9,092,464 (9,332,366) (8,715,820 ) 282,136 712,169 Pension - Most of the operations and employees of the Company are located in China. The Company records pension costs and various employment benefits in accordance with the relevant Chinese social security laws, which is approximately at a total of 31% of salary as required by local governments. Base salary levels are the average salary determined by the local governments. Concentration of Credit Risk - Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of trade accounts receivable. The Company performs ongoing credit 63 evaluations with respect to the financial condition of its debtors, but does not require collateral. In order to determine the value of the Company’s accounts receivable, the Company records a provision for doubtful accounts to cover probable credit losses. Management reviews and adjusts this allowance periodically based on historical experience and its evaluation of the collectability of outstanding accounts receivable. Interest Rate Risk- Bank loans and convertible notes payable are charged at fixed interest rates. Income Taxes - The Company accounts for income taxes using the liability method whereby deferred income taxes are recognized for the tax consequences of temporary differences by applying statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of certain assets and liabilities, changes in deferred tax assets and liabilities, if any, include the impact of any tax rate changes enacted during the year. ASC Topic 350, “Accounting for Income Taxes,” requires that deferred tax assets be reduced by a valuation allowance if, based on all available evidence, it is considered more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. Additionally, the Company accounts for uncertainty in income taxes using a two-step approach to recognize and measure uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement. The Company classifies the liability for unrecognized tax benefits as current to the extent that the Company anticipates payment (or receipt) of cash within one year. Interest and penalties related to uncertain tax positions are recognized in the provision for income taxes. If the amount of the Company’s taxable income or income tax liability is a determinant of the amount of a grant, the grant is treated as a reduction of the income tax provision in the year the grant is realized. Research and Development Costs - Research and development costs are expensed as incurred. Advertising, Shipping and Handling Costs - Advertising, shipping and handling costs are expensed as incurred and recorded in selling expenses. Shipping and handling costs relating to sales of $4,632,840, $4,690,313 and $3,867,125 were included in selling expenses for the years ended December 31, 2011, 2010 and 2009, respectively. Income Per Share - Basic income per share is computed by dividing net income attributable to ordinary shareholders by the weighted average number of ordinary shares outstanding during the period using the two-class method. Under the two-class method, net income is allocated between ordinary shares and other participating securities (convertible note holders) based on their participating rights. Diluted income per share is calculated by dividing net income attributable to ordinary shareholders, as adjusted for the effects on income of participating securities as if they were dilutive ordinary shares, if any, by the weighted average number of ordinary and dilutive ordinary equivalent shares outstanding during the period. Ordinary equivalent shares consist of ordinary shares issuable upon the conversion of the convertible notes using the if-converted method, and shares issuable upon the exercise of stock options and warrants for the purchase of ordinary shares using the treasury stock method. Ordinary equivalent shares are not included in the denominator of the diluted earnings per share calculation when inclusion of such shares would be antidilutive. Comprehensive Income - ASC Topic 220 establishes standards for the reporting and display of comprehensive income, its components and accumulated balances in a full set of general purpose financial statements. ASC Topic 220 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. Financial Instruments – Financial instruments consist of cash, evidence of ownership in an entity, and contracts that both (i) impose on one entity a contractual obligation to deliver cash or another financial instrument to a second entity, or to exchange other financial instruments on potentially unfavorable terms with the second entity, and (ii) conveys to that second entity a contractual right (a) to receive cash or another financial instrument from the first entity, or (b) to exchange other financial instruments on potentially favorable terms with the first entity. Inputs to the valuation methodology for Level 1 are quoted prices (unadjusted) for identical assets or liabilities in active markets. Inputs to the 64 valuation methodology for Level 2 include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the assets or liability, either directly or indirectly, for substantially the full term of the financial instruments. Inputs to the valuation methodology for Level 3 are unobservable and significant to the fair value. Consideration is also given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model. Effective on January 1, 2009, the Company adopted the provisions of ASC 815 Derivatives and Hedging Activities that address the determination of whether an instrument meets the definition of a derivative being indexed to a company’s own stock for purposes of applying the scope exception as provided for in accordance with ASC 815-15. Upon adoption of the standard on the effective date, the embedded conversion option that is embedded in the Company’s convertible notes payable no longer met the definition of being indexed to its own stock because it embodied certain anti-dilution protections that are not based on input to the fair value of a fixed-for-fixed option. As a result, the embedded conversion feature required bifurcation, classification in liabilities and measurement at fair value at each reporting period, with changes reflected in earnings, until the convertible notes are settled. The Company has accounted for this change in accounting principle by reflecting the cumulative effect as an adjustment to its beginning retained earnings during the year ended December 31, 2009. The cumulative effect adjustment that the Company made is the difference between the amounts that it has recognized on the convertible notes Payable prior to the adoption of ASC 815-40 and the amounts that would have been recognized if the amended guidance had been effective on the issuance date of the convertible notes payable, which was February 15, 2008. The following table illustrates the differences that comprise the cumulative effect: Financial Instrument: Convertible notes payable Derivative liabilities Total (Effective Date January 1, 2009) As As Recorded Adjusted $ 34,339,807 $ 31,108,852 $ 3,230,955 (2,367,202) 863,753 $ 34,339,807 $ 33,476,054 $ Cumulative 2,367,202 Effect — The following table illustrates the reallocation as if the amended provisions of ASC 815 had been in effect on the financing date: Financial Instrument: Convertible notes payable Derivative liabilities Warrants Total (Financing Date February 15, 2008) Amended Original Allocation Allocation Difference $ 34,201,374 $ 28,379,704 $ 5,821,670 (5,821,670) — — $ 35,000,000 $ 35,000,000 $ 5,821,670 798,626 798,626 — The cumulative effect of the change in accounting principle on the effective date reflects (i) the difference in the financing date allocation of proceeds, (ii) the resulting change in the amortization of the debt discount that results from the revised allocation, and (iii) the changes in the fair values of the derivative liabilities that would have been recorded had the amended standard been in effect since the financing date. Fair Value Measurements – For purposes of fair value measurements, the Company applies the applicable provisions of ASC 820 “Fair Value Measurements and Disclosures”. Accordingly, fair value for the Company’s financial accounting and reporting purposes represents the estimated price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the designated measurement date. With an objective to increase consistency and comparability in fair value measurements and related disclosures, the Financial Accounting Standard Board established the fair value hierarchy which prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. 65 Level 1 Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. An active market for the asset or liability is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available. As at December 31, 2011 and 2010, the Company did not have any fair value assets and liabilities classified as Level 1. Level 2 Inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. If the asset or liability has a specified (contractual) term, a Level 2 input must be observable for substantially the full term of the asset or liability. As at December 31, 2011 and 2010, the Company did not have any fair value assets and liabilities classified as Level 2. Level 3 Inputs are unobservable inputs for the asset or liability. Unobservable inputs are used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date. However, the fair value measurement objective remains the same, that is, an exit price from the perspective of a market participant that holds the asset or owes the liability. Therefore, unobservable inputs shall reflect the reporting entity’s own assumptions about the assumptions that market participants would use in pricing the asset or liability (including assumptions about risk). Accordingly, the compound derivative liabilities are classified as Level 3 as the inputs reflected management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. The following table presents information about the Company’s financial liabilities classified as Level 3 as of December 31, 2011 and December 31, 2010. Derivative liability, non-current $ 559,148 $ Level 1 Level 2 - $ Level 3 - $ 559 ,148 Balance as of December 31, 2011 Carrying Value Fair Value Measurements Using Fair Value Hierarchy Balance as of December 31, 2010 Carrying Value Fair Value Measurements Using Fair Value Hierarchy Derivative liability, current $ 25,271,808 $ Level 1 Level 2 - $ Level 3 - $25,271,808 For a summary of changes in Level 3 derivative liabilities for the years ended December 31, 2011, 2010 and 2009, please see Note 13 Stock-Based Compensation - The Company may issue stock options to employees and stock options or warrants to non-employees in non-capital raising transactions for services and for financing costs. In July 2004, the Company adopted a stock incentive plan. The maximum number of common shares for issuance under this plan is 2,200,000 with a period of 10 years. The stock incentive plan provides for the issuance, to the Company’s officers, directors, management and employees, of options to purchase shares of the Company’s common stock. Since the adoption of the stock incentive plan, the Company has issued 478,850 stock options and 1,721,150 stock options remain to be issuable in the future. As of December 31, 2011, the Company had 67,500 stock options outstanding. The Company has adopted ASC Topic 718, “Accounting for Stock-Based Compensation,” which establishes a fair value based method of accounting for stock-based compensation plans. In accordance with ASC Topic 718, the cost of stock options and warrants issued to employees and non-employees is measured on the grant date based on the fair value. The fair value is determined using the Black-Scholes option pricing model. The resulting amount is charged 66 to expense on the straight-line basis over the period in which the Company expects to receive the benefit, which is generally the vesting period. Registration Payment Arrangements - The Company has entered into registration payment arrangements with certain investors that provide for the payment of damages for failures to register common shares underlying the investor’s financial instruments. ASC Topic 825, Accounting for Registration Payment Arrangements, provides for the exclusion of registration payments, such as the liquidated damages, from the consideration of classification of financial instruments. Rather, such registration payments would be accounted for pursuant to ASC Topic 450, “Accounting for Contingencies,” which is the Company’s current accounting practice. That is, all registration payments will require recognition when they are both probable and reasonably estimable. The Company does not currently believe that damages are probable. As the investors may sell the convertible notes and underlying shares freely pursuant to Rule 144, there are no liquidated damages. Foreign Currencies - The Company’s subsidiaries based in PRC and Genesis maintain their books and records in Renminbi, their functional currency. In accordance with ASC Topic 830, 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, including shareholders’ equity, are translated at historical rates. Income and expenses are translated at the rate in effect on the transaction dates. Transaction gains and losses, if any, are included in the determination of net income for the period. The parent company (CAAS) and Henglong USA Corporation (HLUSA) maintain their books and records in U.S. dollars, “USD,” the currency of U.S.A., their functional currency. In translating the financial statements of the Company’s China subsidiaries and Genesis from their functional currency into the Company's reporting currency of 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. Certain Relationships and Related Transactions The following related parties are related through common ownership with the major shareholders of the Company: Jingzhou Henglong Fulida Textile Co., Ltd., “Jingzhou” Xiamen Joylon Co., Ltd., “Xiamen Joylon” Shanghai Tianxiang Automotive Parts Co., Ltd., “Shanghai Tianxiang” Shanghai Fenglong Materials Co., Ltd., “Shanghai Fenglong” Changchun Hualong Automotive Technology Co., Ltd., “Changchun Hualong” Jiangling Tongchuang Machining Co., Ltd., “Jiangling Tongchuang” Beijing Hualong Century Digital S&T Development Co., Ltd., “Beijing Hualong” Jingzhou Jiulong Material Co., Ltd., “Jiulong Material” Shanghai Hongxi Investment Inc., “Hongxi” Hubei Wiselink Equipment Manufacturing Co., Ltd., “Hubei Wiselink” Jingzhou Tongyi Special Parts Co., Ltd., “Jingzhou Tongyi” Jingzhou Derun Agricultural S&T Development Co., Ltd., “Jingzhou Derun” Jingzhou Tongying Alloys Materials Co., Ltd., “Jingzhou Tongying” Wuhan Dida Information S&T Development Co., Ltd., “Wuhan Dida” Hubei Wanlong Investment Co., Ltd., “Hubei Wanlong” Jiangling Yude Machining Co., Ltd., “Jiangling Yude” Wiselink Holdings Limited, “Wiselink” Principal policies of the Company in connection with transactions with related parties are as follows: 67 Products sold to related parties – The Company sold products to related parties at fair market prices, and also granted them credit of three to four months on an open account basis. These transactions were consummated under similar terms as the Company's other customers. Materials purchased from related parties – The Company purchased materials from related parties at fair market prices, and also received from them credit of three to four months on an open account basis. These transactions were consummated under similar terms as the Company's other suppliers. Equipment and production technology purchased from related parties - The Company purchased equipment and production technology from related parties at fair market prices, or reasonable cost plus pricing if fair market prices are not available and was required to pay in advance based on the purchase agreement between the two parties, because such equipment manufacturing and technology development was required for a long period. These transactions were consummated under similar terms as the Company's other suppliers. Recent Accounting Pronouncements In May 2011, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” (ASU 2011-04). This newly issued accounting standard clarifies the application of certain existing fair value measurement guidance and expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. This ASU is effective on a prospective basis for annual and interim reporting periods beginning on or after December 15, 2011, which for the Company means January 1, 2012. The adoption of this standard is not expected to have a material impact on the Company’s financial position or results of operations. In June 2011, the FASB issued ASU No. 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income” (ASU 2011-05). This newly issued accounting standard (1) eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity; (2) requires the consecutive presentation of the statement of net income and other comprehensive income; and (3) requires an entity to present reclassification adjustments on the face of the financial statements from other comprehensive income to net income. The amendments in this ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income nor do the amendments affect how earnings per share is calculated or presented. In December 2011, the FASB issued ASU No. 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05, which defers the requirement within ASU 2011-05 to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented. During the deferral, entities should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect prior to the issuance of ASU 2011-05. These ASUs are required to be applied retrospectively and are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, which for the Company means January 1, 2012. As these accounting standards do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income, the adoption of these standards is not expected to have an impact on the Company’s financial position or results of operations. In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities (ASU 2011-11). This newly issued accounting standard requires an entity to disclose both gross and net information about instruments and transactions eligible for offset in the statements of financial position as well as instruments and transactions executed under a master netting or similar arrangement and was issued to enable users of financial statements to understand the effects or potential effects of those arrangements on their financial position. This ASU is required to be applied retrospectively and is effective for fiscal years, and interim periods within those years, beginning on or after January 1, 2013. As this accounting standard only requires enhanced disclosure, the adoption of this standard is not expected to have an impact on the Company’s financial position or results of operations. 68 3. Accounts and Notes Receivable The Company’s accounts receivable at December 31, 2011 and 2010 are summarized as follows: Accounts receivable Notes receivable Less: allowance for doubtful accounts Balance at end of year December 31, 2011 2010 $120,845,295 $122,379,968 92,805,163 76,407,523 213,650,458 198,787,491 (2,928,503) (1,191,200) $212,459,258 $195,858,988 Notes receivable represents accounts receivable in the form of bills of exchange whose acceptances and settlements are handled by banks. As of December 31, 2011, the Company has pledged $33,033,938 of accounts receivable as security for its comprehensive credit facility with the banks in China. The activity in the Company’s allowance for doubtful accounts of accounts receivable during the years ended December 31, 2011, 2010 and 2009 are summarized as follows: Balance at beginning of year Amounts provided for during the year Amounts reversed of collection during the year Written off during the year Foreign currency translation Balance at end of year 4. Other Receivables 2009 2011 10,258 Year Ended December 31 2010 $ 2,928,503 $ 5,320,378 $ 4,910,478 1,171,429 (765,201) - 3,672 $ 1,191,200 $ 2,928,503 $ 5,320,378 25,729 (168,008) (2,582,693) - 165,089 (1,729,116) 149,563 The Company’s other receivables at December 31, 2011 and 2010 are summarized as follows: Other receivables Less: allowance for doubtful accounts Balance at end of year December 31, 2011 2010 $ 3,073,860 $ 3,501,967 (700,533) $ 2,376,605 $ 2,801,434 (697,255) Other receivables consist of amounts advanced to both related and unrelated parties, primarily as unsecured demand loans, with no stated interest rate or due date. The activity in the Company’s allowance for doubtful accounts of other receivable during the years ended December 31, 2011, 2010 and 2009 are summarized as follows: Balance at beginning of year Amounts provided for during the year Amounts reversed of collection during the year Foreign currency translation Balance at end of year $ $ 69 Year Ended December 31, 2010 740,110 $ 102,522 (165,066) 22,967 700,533 $ 2011 700,533 $ 57,849 (96,903) 35,776 697,255 $ 2009 659,837 113,905 (34,287) 655 740,110 5. Inventories The Company’s inventories at December 31, 2011 and 2010 consisted of the following: Raw materials Work in process Finished goods Balance at end of year December 31, 2011 2010 $ 15,603,801 $ 11,394,670 7,344,342 7,537,766 28,659,050 17,937,836 $ 51,607,193 $ 36,870,272 Provision for inventories valuation amounted to $0.02million, $0.4 million and $1 million for the years ended December 31, 2011, 2010 and 2009, respectively. 6. Long-term Investments On December 31, 2011 and 2010, the Company’s balance of long-term investment was $3,485,118 and $3,162,136, respectively. As discussed in note 2, for the long-term investments that the Company has no voting control, such investments were accounted for using the equity method or the cost method. On January 24, 2010, the Company invested $ 3,095,414 to establish a joint venture company with the other shareholder, Beijing Hainachuan Henglong Steering System Co., Ltd., “Beijing Henglong,” in which the Company owns 50% equity, as discussed in Note 2. The Company accounted for its operation results with the equity method. On December 31, 2011 and 2010, the Company had $3,399,416 and $3,080,598, respectively, of net equity in Beijing Henglong, respectively. Summarized statement of balance sheet data of Beijing Henglong as of December 31 is as follows: Current assets Other assets Total assets Current liabilities Other liabilities Shareholders’ equity Total liabilities and shareholders’ equity December 31, 2011 2010 $ 10,114,458 $ 4,462,788 4,860,562 4,530,395 $ 14,975,020 $ 8,993,183 586,678 $ 5,690,939 $ 2,245,308 2,485,248 6,161,197 6,798,833 $ 14,975,020 $ 8,993,183 Summarized statement of operations data for the years ended December 31 is as follows: Net Sales Gross Margin Net Income(Loss) Beijing Henglong 2011 2010 2009 $ 25,051,883 $ — $ — $733,591 $ — $ — $316,500 $ (29,631) $ — 2010 2009 2011 2010 2009 2011 The Company’s share of net assets and net income is reported in the consolidated financial statements as “long-term investments” on the consolidated balance sheets and “equity in earnings of affiliated companies” on the consolidated statements of income/(loss) . The Company’s consolidated financial statement contains the net income and net loss of non-consolidated affiliates of $158,250 and $14,816 at December 31, 2011 and 2010, respectively. 7. Property, Plant and Equipment The Company’s property, plant and equipment at December 31, 2011 and 2010 are summarized as follows: 70 Costs: Land use rights and buildings Machinery and equipment Electronic equipment Motor vehicles Construction in progress Less: Accumulated depreciation Balance at end of year December 31, 2011 2010 6,353,939 2,956,235 6,546,981 $ 39,527,681 $ 36,983,940 100,327,278 81,905,845 5,840,308 2,902,738 4,686,699 155,712,114 132,319,530 (70,868,864) (56,938,783) $ 84,843,250 $ 75,380,747 Depreciation charges for the years ended December 31, 2011, 2010 and 2009 were $13,320,752, $9,416,451 and $8,429,863, respectively. As of December 31, 2011, the Company has pledged approximately $83,000,000 of property, plant and equipment as security for its comprehensive credit facilities with the banks in China. 8. Intangible Assets The Company’s intangible asset at December 31, 2011 and 2010 are summarized as follows: Costs: Patent technology Management software license Less: Accumulated amortization Balance at end of the year December 31, 2011 2010 $ 1,896,013 $ 1,536,268 509,221 2,045,489 (1,383,400) 662,089 578,754 2,474,767 (1,637,692) 837,075 $ $ For the years ended 2011, 2010 and 2009, amortization expenses were $180,339, $81,167 and $254,306, respectively. The estimated aggregated amortization expense for the five succeeding years is $820,000 with $164,000 for each year. 9. Deferred Income Tax Assets In accordance with the provisions of ASC Topic 740 “Income Taxes”, the Company assesses, on a quarterly basis, its ability to realize its deferred tax assets. Based on the more likely than not standard in the guidance and the weight of available evidence, the Company believes a valuation allowance against its deferred tax assets is necessary. In determining the need for a valuation allowance, the Company considered the following significant factors: an assessment of recent years’ profitability and losses by taxing authorities; the Company’s expectation of profits based on margins and volumes expected to be realized (which are based on current pricing and volume trends); the long period in all significant operating jurisdictions before the expiry of net operating losses, noting further that a portion of the deferred tax asset is composed of deductible temporary differences that are subject to an expiry period until realized under tax law. The Company will continue to evaluate the provision of valuation allowance in future periods. 71 The components of deferred income tax assets at December 31, 2011 and 2010 were as follows: Losses carryforward (U.S.) ( 1) Losses carryforward (PRC) Product warranties and other reserves Property, plant and equipment Accrued make-whole interest expense for convertible notes Share-based compensation Bonus accrual Other accruals Others Total deferred tax assets Less: taxable temporary difference related to revenue recognition Total deferred tax assets, net Less: Valuation allowance Total deferred tax assets, net of valuation allowance (2) December 31, 2011 2010 $ 4,012,253 $ 2,422,312 804,147 1,351,498 2,871,844 3,512,683 3,271,594 4,094,824 2,320,938 2,665,498 366,464 213,098 182,970 206,035 943,373 790,664 314,795 136,660 16,983,213 13,498,437 (801,562) 16,166,072 12,696,875 (8,138,385) (5,913,860) $ 8,027,687 $ 6,783,015 (817,141) (1) The net operating loss carry forwards for the U.S. entity for income tax purposes are available to reduce future years' taxable income. These carry forwards will expire, if not utilized, in 20 years. Net operating loss carryforwards for non-U.S. entities can be carried forward for 5 years to offset taxable income. However, as of December 31, 2011, valuation allowance was $8,138,385, including $7,033,036 allowance for the Company’s deferred tax assets in the United States and $1,105,349 allowance for the Company’s non-U.S. deferred tax assets. Based on the Company’s current operations in the United States, management believes that the deferred tax assets in the United States are not likely to be realized in the future. For the non-U.S. deferred tax assets, pursuant to certain tax laws and regulations in China, the management believes such amount will not be used to offset future taxable income. (2) Approximately $4,340,974 and $3,271,594 of deferred income tax asset as of December 31, 2011 and 2010, respectively, is included in non-current deferred tax assets in the accompanying consolidated balance sheets. The remaining $3,686,713 and $3,511,421 of deferred income tax asset as of December 31, 2011 and 2010, respectively, is included in the current deferred tax assets. The activity in the Company’s valuation allowance for deferred tax assets during the year ended December 31, 2011, 2010 and 2009 are summarized as follows: Balance at beginning of year Amounts provided for during the year Amounts recovered during the year Foreign currency translation Balance at end of year 10. Bank Loans 2011 2009 Year Ended December 31 2010 $ 5,913,860 $ 4,821,210 $ 3,459,664 1,452,022 (91,037) 561 $ 8,138,385 $ 5,913,860 $ 4,821,210 2,336,821 1,269,127 (200,500) (153,367) 24,023 41,071 At December 31, 2011, the Company, through its Sino-foreign joint ventures, had outstanding fixed-rate short-term bank loans with a principal of $10,315,987 and a weighted average interest rate at 6.72 % per annum. Interest is to be paid on the twentieth day of each month and the principal repayment is at maturity. These loans are secured by some of the property and equipment of the Company and are repayable within one year. 72 1) On July 6, 2011, China CITIC Bank loaned $2,380,612 to the Company at an annual interest rate of 7.79%, and maturity term of twelve months. 2) On September 30, 2011, Bank of China loaned $4,761,225 to the Company at an annual interest rate of 6.56%, and maturity terms of twelve months. 3) On June 29, 2011, China Construction Bank loaned $3,174,150 to the Company at an annual interest rate of 6.56%, and maturity term of twelve months. At December 31, 2010, the Company, through its Sino-foreign joint ventures, had outstanding fixed-rate short-term bank loans with a principal of $6,794,812 and a weighted average interest rate at 5.25 % per annum. Interest is to be paid on the twentieth day of each month and the principal repayment is at maturity. These loans are secured by some of the property and equipment of the Company and are repayable within one year. The Company has repaid such loans at maturity dates in 2011. 11. Accounts and Notes Payable The Company’s accounts and notes payable at December 31, 2011 and 2010 are summarized as follows: Accounts payable Notes payable Balance at end of year December 31, 2011 2010 $114,201,934 $ 95,726,549 57,307,445 52,790,874 $171,509,379 $148,517,423 Included in notes payable, $56,166,338 were notes issued by the banks out of the Company’s banking facility lines, and $1,141,107 were notes issued by the banks in exchange of the notes received by the Company from customers for which no banking facility line was utilized. The Company has pledged cash deposits, accounts receivable and certain property plant and machinery as security for its comprehensive credit facility with the banks in China. 12. Convertible Notes Payable In February 2008, the Company sold to two accredited institutional investors $35 million of convertible notes, the "convertible notes,” with a scheduled maturity date of February 15, 2013. The convertible notes, including any accrued but unpaid interest, are convertible into common shares of the Company at a conversion price of $8.8527 per share, subject to adjustment upon the occurrence of certain events. The convertible notes bear annual interest rates of 3%, 3.5%, 4%, 4.5%, 5% and 5% for each year of 2008, 2009, 2010, 2011, 2012 and 2013, respectively. The interest on the convertible notes shall be computed commencing from the issuance date and will be payable in cash in arrears semi-annually on January 15, and July 15 of each year with the first interest payable date on July 15, 2008. From and after the occurrence and during the continuance of an Event of Default defined in the relevant convertible notes agreements, the interest rate then in effect shall be increased by two percent (2%) until the event of default is remedied. The holders of the convertible notes will be entitled to convert any portion of the conversion notes into shares of common stock at the conversion price at any time or times on or after the thirtieth (30th) day after the issuance date and prior to the thirtieth (30th) business day prior to the expiry date of the convertible notes. A penalty will be paid if share certificates are not delivered timely after any conversion. The Company will have the right to require the convertible notes holders to convert a portion of the conversion amount then remaining under the convertible notes obligation into shares of common stock, “ Mandatory Conversion,” if at any time during a six-month period, the beginning day of each such six-month period, a “Mandatory Conversion Period Start Date,” the arithmetic average of the weighted average price of the common stock for a period of at least 73 thirty (30) consecutive trading days following the Mandatory Conversion Period Start Date equals or exceeds the percentage set forth in the chart below multiplied by $8.8527 as applicable to the indicated six month period: 0-6 months: 6-12 months: 12-18 months: 18-24 months: 24-30 months: 30-36 months: 36-42 months: 42-48 months: 125% 125% 135% 135% 145% 145% 155% 155% The Company will not effect a Mandatory Conversion of more than twelve percent (12%) of the original principal amount of the convertible notes, with the applicable accrued but unpaid interest, in any six month period or twenty-four percent (24%) of the original principal amount of the convertible notes, with the applicable accrued but unpaid interest, in any twelve (12) month period. The Company will not effect any conversion of the convertible notes, and each holder of the convertible notes will not have the right to convert any portion of the convertible notes to the extent that after giving effect to such conversion, such holders would beneficially own in excess of 4.99% of the number of shares of Common Stock outstanding immediately after giving effect to such conversion. On each six month anniversary of the issuance date beginning August 15, 2008, the conversion price will be adjusted downward to the Reset Reference Price, as defined below, if the weighted average price for the twenty (20) consecutive trading days immediately prior to the applicable six month anniversary, the “Reset Reference Price”, is less than 95% of the conversion price in effect as of such applicable six month anniversary date. The foregoing notwithstanding, the conversion price will not be reduced via such reset provision to less than $7.0822. The conversion price is also subject to weighted-average antidilution adjustments, but in no event will the conversion price be reduced to less than $6.7417. If and whenever on or after the issuance date, the Company issues or sells its shares of Common Stock or other convertible securities, except for certain defined exempt issuances, for a consideration per share less than a price equal to the conversion price in effect on the issuance date immediately prior to such issue or sale, the original conversion price then in effect shall be adjusted by a weighted-average antidilution formula. According to the terms of the convertible notes, the conversion price was reset to $7.0822 as of August 15, 2008 based on the weighted average price of the stock on that date. In accordance with ASC Topic 470, a contingency feature that cannot be measured at inception of the instrument should be recorded when the contingent event occurs. Therefore, on the date of the reset, the difference in the number of indexed shares prior to the reset was compared to the indexed shares subsequent to the reset and this incremental number of shares was multiplied by the commitment date stock price to determine the incremental intrinsic value that resulted from the adjustment to the conversion price. At the commitment date, as the effective conversion price was higher than the market value of the stock, no beneficial conversion feature was present. As of August 15, 2008, based on the inception conversion price and reset conversion price, the convertible notes could be converted into 3,953,596 and 4,941,967 of common shares, respectively. At the commitment date, the stock price was $6.09, and the “effective” conversion price was $6.93. Accordingly, since the effective conversion price was higher than the market value of the stock, the debt instruments are not considered "in the money" and no beneficial conversion feature was present. Upon the occurrence of an event of default with respect to the convertible notes, the convertible note holders may require the Company to redeem all or any portion of the convertible notes. Each portion of the convertible notes subject to redemption by the Company will be redeemed by the Company at a price equal to the sum of (i) the conversion amount to be redeemed and (ii) the Other Make Whole Amount. The “Other Make Whole Amount” will mean a premium to the conversion amount such that the total amount received by the convertible notes holder upon redemption represents a gross yield to the convertible notes holders on the original principal amount as of the redemption date equal to thirteen percent (13%), with interest computed on the basis of actual number of days elapsed 74 over a 360-day year. The events of default include the Company’s failure to cure a conversion failure by delivery of the required number of shares of Common Stock, the Company’s failure to pay to the convertible notes holder any amount of principal, interest, late charges or other amounts when and as due under the convertible notes and other events as defined in the convertible notes agreements. Any amount of principal, interest or other amount due under the convertible notes which is not paid when due shall result in a late charge of 18% being incurred and payable by the Company until such amount has been paid. Upon the consummation of a change of control as defined in the convertible notes agreements, the convertible notes holder may require the Company to redeem all or any portion of the convertible notes. The portion of the convertible notes subject to redemption shall be redeemed by the Company in cash at a price equal to the sum of the conversion amount being redeemed and the Other Make Whole Amount as defined above. On each of February 15, 2010 and February 15, 2011, the convertible notes holders had the right, in their sole discretion, to require that the Company redeem the convertible notes in whole but not in part, by delivering written notice thereof to the Company. The portion of the convertible notes subject to redemption pursuant to this annual redemption right will be redeemed by the Company in cash at a price equal to the sum of the conversion amount being redeemed and the Annual Redemption Make Whole Amount. The “Annual Redemption Make Whole Amount” will mean a premium to the conversion amount such that the total amount received by the convertible notes holder upon any annual redemption represents a gross yield on the original principal amount of eleven percent (11%), with interest computed on the basis of actual number of days elapsed over a 360-day year. The convertible notes holders did not exercise their right on either of these dates. At any time following February 15, 2009, if the Weighted Average Price (WAP) for twenty (20) consecutive trading days is less than 45% of the Conversion Price in effect on the Issuance Date, as adjusted, namely $3.187, the convertible notes holder shall have the right, in its sole discretion, to require that the Company redeem all or any portion of the convertible notes. The portion of this convertible notes subject to redemption in connection with the share price change of the underlying common stock will be redeemed by the Company in cash at a price equal to the sum of the conversion amount being redeemed and the Other Make Whole Amount as mentioned above. Since the Company’s stock Weighted Average Price for twenty (20) consecutive trading days ended on March 16, 2009 was below $3.187, which is less than 45% of the Conversion Price in effect as of the Issuance Date, as adjusted, the “ WAP Default” , each convertible notes holder had the right, at its sole discretion, to require that the Company redeem all or any portion of the convertible notes by delivering written redemption notice to the Company within five (5) business days after the receipt of the Company’s notice of the WAP Default. On March 17, 2009, the Company delivered two WAP Default notices to the convertible notes holders. On March 27, 2009, the Company received a letter from YA Global, one of the convertible notes holders, electing to require the Company to redeem all the three convertible notes it held in the total principal amount of $5,000,000, together with interest, late charges, and the Other Make Whole Amount as defined in Section 5(d) of the convertible notes. After negotiation, the Company and YA Global reached a settlement agreement on April 8, 2009 and under the terms of the settlement agreement, the Company paid on April 15, 2009 a redemption amount of $5,041,667 to YA Global and YA Global waived its entitlement to the Other Make Whole Amount. The amount waived was accounted for as a gain on convertible notes conversion and recorded in interest expense. Following the WAP Default notices, the Company received a letter from the provisional liquidator acting on behalf of Lehman Brothers Commercial Corporation Asia Limited, the “LBCCA Liquidator,” the other convertible notes holder, requesting an extension until April 15, 2009 to consider its rights under the convertible notes. The Company granted an extension to April 15, 2009. The LBCCA Liquidator further requested another extension to April 24, 2009. On April 24, 2009, LBCCA’s lawyers sent three Holder Redemption Notices electing to redeem the entire outstanding principal of $30,000,000, together with interest, late charges, if any, and the Other Make Whole Amount, to be paid on July 23, 2009. The Company discussed settlement with the LBCCA Liquidator, and on July 22, 2009, the Company and the LBCCA Liquidator agreed to extend the applicable holder mandatory redemption date for two months to September 23, 2009 to give more time to pursue settlement discussions. The Company received a letter dated September 22, 2009 from the LBCCA Liquidator stating that upon the Company’s acceptance of the revocation, all holder redemption notices dated April 24, 2009 shall be immediately revoked as if they were never issued, and the letter and the revocation did not purport to amend, restate or supplement any other terms and conditions under the three 75 Notes and the Securities Purchase Agreement dated 1 February 2008 between the Company and LBCCA Liquidator. The Company accepted such revocation on September 23, 2009. In connection with the convertible notes, the Company issued 1,317,864 detachable warrants, the “Warrants,” to purchase from the Company shares of common stock of the Company at the exercise price of $8.8527 per share. On February 15, 2009, the warrants expired unexercised and the warrants were forfeited. On the issuance date, February 15, 2008, the Company has evaluated the convertible notes for terms and conditions that would be considered to be features of embedded derivatives. Generally, such features would be required to be separated from the host contract and accounted for as derivative financial instruments when certain conditions are met. Certain features, such as the conversion option, were found to be exempt; as they satisfied the conditions as set forth in ASC Topic 815 for instruments that are being (1) indexed to the Company’s own stock, and (2) classified as equity in the financial position statement. Other features, such as puts, were not required to be bifurcated from the debt host as they are clearly and closely associated with the risk of the debt-type host instrument. Upon the adoption of ASC 815-15 on January 1, 2009, the Company bifurcated the embedded conversion feature from the convertible notes and classified that financial instrument in liabilities at fair value. The Company has accounted for this change in accounting principle by reflecting the cumulative effect as an adjustment to its beginning retained earnings for the year ended December 31, 2009. The cumulative effect adjustment that the Company made is the difference between the amounts that it has recognized on the convertible notes payable (prior to the adoption of ASC 815-15 ) and the amounts that would have been recognized if the amended guidance had been effective on the issuance date of the convertible notes payable, which was February 15, 2008. The following table reflects the cumulative effect of the differences: Convertible notes payable Value allocated to debt Warrants (1) Compound embedded derivative (2) Face value of convertible notes payable Unamortized discount Unamortized value as of December 31, 2008 Unamortized value as of January 1, 2009 Allocation Original Allocation $34,201,374 798,626 - $35,000,000 660,193 $34,339,807 $- $ 28,379,704 798,626 5,821,670 35,000,000 3,891,148 - $ 31,108,852 1. The discount on original issuance reflects the fair value of the warrants of $798,626 at issuance date 2. Reflects the fair value of the embedded conversion feature of $5,821,670 As indicated above, on the date of the convertible note issuance, allocation of basis in the financing arrangement to the warrants has resulted in an original issue discount to the face value of the convertible notes in the amount of $798,626, of which the amount was accreted to its face value over the term of the convertible note using the effective method. As of December 31, 2008, the interest expense recorded by the Company was $138,433, and the unamortized discount was $660,193. On January 1, 2009, the Company adopted and applied the provision of ASC 815 Derivatives and Hedging Activities (effective on January 1, 2009). The accounting for the cumulative effect change in this accounting principle resulted in a discount of $6,620,296, including $798,626 discount resulting from Warrants and $5,821,670 from the embedded conversion feature of the original unamortized discount and the subsequent amortization using the effective interest method. On January 1, 2009, unamortized discount was $3,891,148. As indicated above, due to the Company’s WAP Default on March 17, 2009, the convertible notes holders had the option to elect to exercise their rights to require the Company to redeem the convertible notes. The remaining amount of $3,891,148 unamortized discount on the convertible notes was recorded to its full face value and the redemption make-whole amount of $520,000 was accrued. On April 8, 2009, the Company and YA Global reached a settlement agreement, whereby under the terms of the settlement agreement, the Company paid a redemption amount of $5,000,000 of principal and $41,667 of interest to YA Global, and accrual of $571,181 for make-whole redemption interest to YA Global was waived and accounted for as a gain on convertible notes conversion. On September 22, 2009, LBCCA Liquidator revoked the redemption notices that were sent on April 24, 2009, and continued to hold the 76 Company’s convertible notes, of which the face value was $30,000,000. The Company accepted such revocation on September 23, 2009. On March 1, 2011, LBCCA Liquidator converted $6,428,571 principal amount of the convertible notes at a conversion price of $7.0822 per share, and the Company issued 907,708 shares of its common stock to such investor. On the conversion date, the market price of the common shares issued was $10,111,869 ($11.14 per share) and the value of the conversion consideration was $11,676,287, including $6,428,571 of principal, $1,506,143 of coupon interest and make-whole amount payable and $3,741,573 of derivative liabilities under such principal. The amount of coupon interest, make-whole and derivative liabilities included in the value of the conversion consideration were determined by pro-rating the accrued coupon interest, accrued make-whole amount and the fair value of the derivative liabilities based on the principal amount of the convertible notes converted as a percentage of the outstanding balance prior to their conversion. The Company recorded a gain on convertible notes conversion of $1,564,418, which is the difference between the market price of the common stock and the conversion consideration. On December 31, 2011 and 2010, the carrying value of the Company’s convertible notes payable was $23,571,429 and $30,000,000, respectively. Upon expiration of the mandatory redemption date of the convertible notes on February 15, 2011, the outstanding convertible notes payable of $23, 571,429 were reclassified as long-term liabilities. 13. Compound Derivative Liabilities Effective January 1, 2009, the Company adopted the provisions of ASC 815 Derivatives and Hedging Activities that address the determination of whether an instrument meets the definition of a derivative being indexed to a company’s own stock for purposes of applying the scope exception as provided for in accordance with ASC 815-15. Upon adoption of the standard on the effective date, the embedded conversion option that is embedded in the Company’s convertible notes Payable (see Note 12) no longer met the definition because it embodied certain anti-dilution protections that are not based on input to the fair value of a fixed-for-fixed option. As a result, the embedded conversion feature required bifurcation, classification in liabilities and measurement at fair value at each reporting period, with changes reflected in earnings, until the convertible notes are settled. The Company’s derivative financial instruments (liabilities) consisted of a compound embedded derivative that originated in connection with the Company’s convertible note Payable and Warrant Financing Arrangement. Derivative liabilities are carried at fair value. The following table summarizes the compound derivative liabilities as of December 31, 2011 and 2010: Financial Instrument Derivative liability Common shares to which the derivative liability is linked December 31, 2011 2010 $ 3,328,264 559,148 $ 25,271,808 4,235,972 Changes in the fair value of derivative liabilities are recorded in gain (loss) on change in fair value of derivative in the income statement. The following tables summarize the components of gain (loss) on change in fair value of derivative arising from fair value adjustments during the years ended December 31, 2011, 2010 and 2009: Balances at January 1 Cumulative effect change in accounting principle Subtotal Decrease due to convertible notes conversion on March 1, 2011(see Note 12) (Decrease) increase in fair value adjustments 1 Balances at December 31 2011 25,271,808 $ $ 2010 45,443,506 $ — 25,271,808 — 45,443,506 2009 — 2,367,202 2,367,202 (3,741,573 ) (20,971,087) $ 559,148 $ - - (20,171,698) 43,076,304 25,271,808 $45,443,506 1. Recorded as gain on change in fair value of derivative in the statements of income. 77 Estimating fair values of derivative financial instruments requires the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors. In addition, option-based techniques are highly volatile and sensitive to changes in the trading market price of the Company’s common stock, which has a high estimated volatility. Since derivative financial instruments are initially and subsequently carried at fair values, the Company’s income will reflect the volatility in these estimate and assumption changes. The Company’s embedded conversion option derivative represents the conversion option, term-extending option, certain redemption and put features in the Company’s convertible notes payable. See Note 12 for additional information about the Company’s convertible notes payable. The features embedded in the convertible notes were combined into one compound embedded derivative that the Company measured at fair value using the Monte Carlo valuation technique. Monte Carlo was believed by the Company’s management to be the best available technique for this compound derivative because, in addition to providing for inputs such as trading market values, volatilities and risk free rates, Monte Carlo also embodies assumptions that provide for credit risk, interest risk and redemption behaviors(i.e., assumptions market participants exchanging debt-type instruments would also consider). Monte Carlo simulates multiple outcomes over the period to maturity using multiple assumption inputs also over the period to maturity. The following table sets forth (i) the range of inputs for each significant assumption and (ii) the equivalent, or averages, of each significant assumption as of December 31, 2011, 2010, and 2009, and January 1, 2009 (effective date of accounting principle change): December 31, 2011 Assumptions: Volatility Market adjusted interest rates Credit risk adjusted rates Implied expected life (years) December 31, 2010 Assumptions: Volatility Market adjusted interest rates Credit risk adjusted rates Implied expected life (years) December 31, 2009 Assumptions: Volatility Market adjusted interest rates Credit risk adjusted rates Implied expected life (years) January 1, 2009 Assumptions: Volatility Market adjusted interest rates Credit risk adjusted rates Implied expected life (years) Range Low High Equivalent 69.66% 21.87% 17.17% - 60.40% 18.52% 17.17% 1.13 51.63% 15.38% 17.17% - Range Low High Equivalent 76.00% 20.15% 15.82% — 63.00% 9.64% 15.11% 1.73 43.14% 5.14% 14.75% — Range Low High Equivalent 68.86% 6.40% 13.39% — Range 81.94% 7.87% 14.20% — 76.71% 7.05% 13.63% 1.96 Low High Equivalent 63.09% 4.14% 21.58% — 91.15% 17.01% 24.97% — 74.02% 7.15% 23.20% 4.27 The Monte Carlo technique requires the use of inputs that range across all levels in the fair value hierarchy. As a result, the technique is a Level 3 valuation technique in its entirety. The calculations of fair value utilized the Company’s trading market values on the calculation dates. The contractual conversion prices were adjusted to give effect to the value associated with the down-round, anti-dilution protection. Expected volatility for each interval in the Monte Carlo process was established based upon the Company’s historical volatility for historical periods consistent 78 with the term of each interval in the calculation. Market adjusted interest rates give effect to expected trends or changes in market interest rates by reference to historical trends in LIBOR. Credit risk adjusted rates, or yields were developed using bond curves, risk free rates, market and industry adjustment factors for companies with similar credit standings as the Company’s. Upon expiration of the mandatory redemption date of the convertible notes on February 15, 2011, the compound derivative liabilities of $559,148 were reclassified as long-term liabilities. 14. Accrued Expenses and Other Payables The Company’s accrued expenses and other payables at December 31, 2011 and 2010 are summarized as follows: Accrued expenses Accrued interest (1) Other payables Warranty reserves Dividend payable to non-controlling interest shareholders of joint-ventures Balance at end of year December 31, 2011 2010 $ 2,802,145 $ 3,627,768 7,143,751 625,447 1,573,318 2,826,354 16,808,787 13,944,392 1,530,445 $ 22,617,667 $ 29,072,710 807,970 (1) As of December 31, 2011, accrued interest of $625,447 represented coupon interest on convertible notes to be paid every six months, whereas, as of December 31, 2010, accrued interest of $ 7,143,751 included coupon interest and make-whole redemption interest of $512, 500 and $ 6,631,251, respectively. Upon expiration of the mandatory redemption period of the convertible notes on February 15, 2011, the entire make-whole redemption interest was reclassified as long-term liabilities (see Note 12 and 15). 15. Accrued Maturity and Make-whole Redemption Interest Expense for Convertible Notes In February 2008, the Company sold to two accredited institutional investors $35 million of convertible notes, the "convertible notes,” with a scheduled maturity date of February 15, 2013. Pursuant to the terms of the convertible notes, on each of February 15, 2010 and February 15, 2011, the convertible note holders had the right, in their sole discretion, to require that the Company redeem the convertible notes in whole but not in part, by delivering written notice thereof to the Company. The portion of the convertible note subject to redemption pursuant to this annual redemption right would have been redeemed by the Company in cash at a price equal to the sum of the conversion amount being redeemed and the Annual Redemption Make Whole Amount. The “Annual Redemption Make Whole Amount” means a premium to the conversion amount such that the total amount received by the convertible notes holder upon any annual redemption represents a gross yield on the original principal amount of eleven percent (11%), with interest computed on the basis of the actual number of days elapsed over a 360-day year. On February 15, 2011, the remaining convertible notes holder did not exercise its annual redemption right. Therefore, the next scheduled redemption date is the maturity date of February 15, 2013 and the make-whole provision accrued after February 15, 2011 was based on the “Maturity Make Whole Amount.” “Maturity Make Whole Amount” means a premium to the Conversion Amount such that the total amount received by the Holder at Maturity represents a gross yield to the Holder on the Original Principal Amount as of the Maturity Date equal to thirteen percent (13%), with interest computed on the basis of the actual number of days elapsed over a 360-day year. The make-whole redemption interest was recorded under accrued interest before February 15, 2011 due to its current liabilities feature and thereafter reclassified to and recorded as non-current liability. For the years ended December 31, 2011, 2010, and 2009, the accrued provision on maturity and make-whole redemption interest pursuant to the term of convertible notes were as follows: 79 Balance at beginning of year Amounts provided for during the year Amount waived during the year Decrease due to convertible notes conversion Balance at end of year 16. Warrants 2011 Year Ended December 31 2010 $ 6,631,251 $ 4,763,771 $ 2,038,729 3,296,223 (571,181) — $ 7,615,709 $ 6,631,251 $ 4,763,771 2,486,583 1,867,480 — — — (1,502,125) 2009 In connection with the convertible notes, the Company issued 1,317,864 detachable warrants to purchase from the Company shares of common stock at the exercise price of $8.8527 per share, subject to adjustments upon certain events occurring as defined in the debt agreement. The Warrants were exercisable immediately and expired on February 15, 2009. In accordance with ASC Topic 480, it appears that the warrants require liability classification due to the possible cash redemption upon the event of an all cash acquisition. This guidance clarifies that warrants that contain any redemption features, including contingent redemption features, must be recorded as liabilities and marked to fair value each reporting period. As of the issuance date, i.e., February 15, 2008, the fair value of warrants was $798,626. Such warrant liabilities were adjusted to their estimated fair values at the completion of each reporting period until the maturity of February 15, 2009. As of August 15, 2008, the Company valued the warrant using the conversion price at inception and reset the price respectively. The fair value of the warrant was $489,718 at the inception conversion price of $8.8527, and $551,131 at the reset conversion price of $8.55, respectively. On February 15, 2009, the warrants expired unexercised and the warrants were forfeited. Accordingly, the value of the warrants has been recorded in the income statement as gain or loss on change in fair value of derivative (see Note 24). As of the Issuance Date (February 15, 2008), the Reset date (August 15, 2008) and the end of each reporting period, the fair value of liabilities in connection with warrants was calculated using the Black-Scholes option pricing model and based on the following assumptions: Warrants indexed to common stock Trading market price Exercise price Exercise price adjustment Effective strike price for Black-Scholes model Term: Estimated Term (Year) Volatility Historical volatility for effective term Risk-free rate Dividend yield rates Fair value of warrants February 15, 2008 Issuance date 1,317,864 6.09 $ 8.8527 $ - August 15, 2008 Prior to reset 1,317,864 6.03 $ 8.8527 $ - August 15, February December 15, 2009 31, 2008 2008 Maturity Year end Subsequent to date date reset 1,317,864 1,317,864 1,317,864 3.30 $ 3.39 $ 6.03 8.8527 8.8527 8.8527 $ $ (0.3027) (0.3027) $ (0.3027) $ $ $ $ $ 8.8527 $ 8.8527 $ 8.5500 $ 8.5500 $ 8.5500 1.00 0.50 0.50 0.13 54.60% 2.02% 0.00% $ 798,626 64.00% 1.99% 0.00% $ 489,718 $ 64.00% 1.99% 0.00% $ 551,131 92.36% 0.11% 0.00% $ 1,977 — — — — — 80 17. Taxes Payable The Company’s taxes payable at December 31, 2011 and 2010 are summarized as follows: Value-added tax payable Income tax payable Other tax payable Balance at end of year 18. Amounts Due to Shareholders/Directors December 31, 2011 2010 $ 1,513,808 $ 3,203,808 3,273,776 383,362 $ 2,029,215 $ 6,860,946 423,586 91,821 The activity in the amounts due to shareholders/directors during the years ended December 31, 2011 and 2010 is summarized as follows: Balance at beginning of the year Increase (decrease) during the year Foreign currency translation Balance at end of year $ $ December 31, 2010 2011 353,817 $ (28,194) 26,194 351,817 $ — $ 344,695 9,122 353,817 $ 2009 337,370 (337,915) 545 — The amounts due to shareholders/directors were unsecured, interest-free and repayable on demand mainly resulting from expenses paid on behalf of the Company by shareholders/directors. 19. Advances Payable On December 31, 2011 and 2010, advances payable of the Company was $983,986 and $603,983, respectively. The amounts mainly represent advances made by the Chinese government to the Company as subsidy on interest on loans related to improvement of the production techniques and the quality of products. The balances are unsecured, interest-free and will be repayable to the Chinese government if the usage of such advance does not continue to qualify for the subsidy (see Note 22). 20. Stock Options 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 term of 10 years. The stock incentive plan provides for the issuance, to the Company’s officers, directors, management and employees who served over three years or have given outstanding performance, of options to purchase shares of the Company’s common stock. Since the adoption of the stock incentive plan, the Company has issued 478,850 stock options under this plan, and there remain 1,721,150 stock options issuable in the future as of December 31, 2011. Under the aforementioned plans, the stock options granted will have an exercise price equal to the closing price of the Company’s common stock traded on NASDAQ on the date of grant, and will expire two to five years after the grant date. Except for the 298,850 options granted to management on December 2008, which became exercisable on a ratable basis over the vesting period (3 years), the others were exercisable immediately on the grant date. Stock options will be settled in shares of the Company’s common stock upon exercise and are recorded in the Company’s consolidated balance sheets under the caption “Additional paid-in capital.” As of December 31, 2011, the Company has sufficient unissued registered common stock for settlement of the stock incentive plan mentioned above. 81 The fair value of stock options was determined at the date of grant using the Black-Scholes option pricing model. The Black-Scholes option model requires management to make various estimates and assumptions, including expected term, expected volatility, risk-free rate, and dividend yield. The expected term represents the period of time that stock-based compensation awards granted are expected to be outstanding and is estimated based on considerations including the vesting period, contractual term and anticipated employee exercise patterns. Expected volatility is based on the historical volatility of the Company’s stock. The risk-free rate is based on the U.S. Treasury yield curve in relation to the contractual life of stock-based compensation instruments. The dividend yield assumption is based on historical patterns and future expectations for the Company dividends. Assumptions used to estimate the fair value of stock options on the grant dates are as follows: Issuance Date Expected volatility Risk-free rate Expected term (years) Dividend yield October 12, 2011 July 8, 2010 September 10, 2009 157.0% 151.6% 153.6% 0.96% 1.79% 2.38% 5 5 5 0.00% 0.00% 0.00% The stock options granted during 2011, 2010 and 2009 were exercisable immediately and their fair value on the grant date using the Black-Scholes option pricing model was $100,575, $345,375 and $196,650, respectively. For the years ended December 31, 2011, 2010 and 2009, the Company recognized stock-based compensation of $100,575, $595,402 and $446,676, respectively. The activities of stock options are summarized as follows, including granted, exercised and forfeited. Outstanding - January 1, 2009 Granted Exercised Cancelled Outstanding - December 31, 2009 Granted Exercised Outstanding - December 31, 2010 Granted Exercised Cancelled Outstanding - December 31, 2011 Weighted-Average Contractual Term (years) Shares Exercise Price Weighted-Average 388,850 $ 22,500 (63,000) (4,500) 343,850 $ 22,500 (129,582) 236,768 $ 22,500 (176,768) (15,000) 67,500 $ 3.84 8.45 6.67 2.93 3.63 16.80 3.48 4.97 4.84 2.93 7.48 9.72 3.4 5 4.7 3 3.3 5 3.2 3.5 5 3 4.5 5 The following is a summary of the range of exercise prices for stock options that are outstanding and exercisable at December 31, 2011: Range of Exercise Prices $4.50 - $10.00 $10.01 - $18.00 Options Outstanding Stock Weighted Average Weighted Average Number of Stock Remaining Life Exercise Price 3.54 $ 3.52 $ 6.18 16.80 Options Exercisable 45,000 22,500 67,500 45,000 22,500 67,500 As of December 31, 2011, 2010, and 2009, the total intrinsic value of the Company’s stock options that were outstanding was $0, $2,119,510, and $5,171,504, respectively. 82 As of December 31, 2011, 2010, and 2009, the total intrinsic value of Company’s stock options that were exercisable was $0, $2,119,510, and $3,611,947, respectively. As of December 31, 2011, 2010, and 2009, the total intrinsic value of Company’s stock options that were exercised was $193,858, $749,400, and $637,725, respectively. As of December 31, 2011, 2010, and 2009, the weighted average fair value of the Company’s stock options that were granted was $4.47, $15.35, and $8.74, respectively. 21. Retained Earnings Appropriated Pursuant to the relevant PRC laws and regulations of Sino-foreign joint venture enterprises, the profits distribution of the Company’s Sino-foreign subsidiaries, which are based on their PRC statutory financial statements, other than the financial statement that was prepared in accordance with generally accepted accounting principles in the United States of America, are available for distribution in the form of cash dividends after these subsidiaries have paid all relevant PRC tax liabilities, provided for losses in previous years, and made appropriations to statutory surplus at 10%. When the statutory surplus reserve reaches 50% of the registered capital of a company, additional reserve is no longer required. However, the reserve cannot be distributed to joint venture partners. Based on the business licenses of the Sino-foreign joint ventures, the registered capital of Henglong, Jiulong, Shenyang, Zhejiang, USAI, Jielong, Wuhu, and Hengsheng are $10,000,000, $4,283,170 (RMB35,000,000), $8,132,530 (RMB67,500,000), $7,000,000, $2,600,000, $6,000,000, $3,750,387 (RMB30,000,000), and $16,000,000, respectively. The Company recorded $258,443, $443,264 and $798,756 statutory surplus reserve for the years ended 2011, 2010 and 2009, respectively. 22. Other Income, Net The Company recorded government subsidies as other income. As of December 31, 2011, 2010, and 2009, the Company has received such subsidies in the amounts of $168,749, $558,058, and $94,534, respectively. The Company’s government subsidies consisted of interest subsidy and investment subsidy. Interest subsidy is the refund by the Chinese government of special loan interest charged by banks to companies which are entitled to such subsidies, such as the company improving its production capacity and product quality under the support of such loan. Investment subsidy is a subsidy to encourage foreign investors to set up technologically advanced enterprises in China. For the year ended December 31, 2011, 2010, and 2009, the Company received interest subsidies in the amounts of $168,749, $311,291, and $94,534, respectively, and investment subsidies of $0, $231,951, and $0, respectively. Interest subsidies apply to loan interest related to optimized production technology. During 2008, 2009, 2010 and 2011, the Company had used this special loan to improve its different products’ production line technologically in order to enlarge the production capability and enhance quality, and the Company has received government subsidies in these years. Some of these improvement projects were completed in 2009, 2010 and 2011, the remaining are still in progress. Improved production technologies were already produced benefits. Therefore, the Company recorded received government subsidies related to completed improvement program as other income, and received government subsidies related to uncompleted improvement program as advances payable. Chinese government also provided incentives to foreign investors for setting up technologically advanced enterprises in China. During 2010, the Company recognized $231,951 of investment subsidiary. Genesis, as a foreign investor, has received such subsidies for re-investment in Jiulong and Henglong with their profit distribution, and both entities were technologically advanced enterprises and entitled to such subsidies. 83 23. Financial (Income) Expenses During the years ended December 31, 2011, 2010, and 2009, the Company recorded financial (income) expenses which were summarized as follows: Year Ended December 31 2010 2011 2009 Accrual on maturity and make-whole redemption interest and coupon interest Interest expense Interest income Foreign exchange (gain) loss, net (Income) loss of note discount, net Amortization for discount of convertible notes payable (1) Bank fees Total $ 3,610,244 $ 3,048,730 $ 3,796,359 349,243 (726,926) 567,238 9,482 — 174,556 470,102 (455,035) (10,296) 82,757 3,891,148 108,679 $ 3,983,817 $ 3,360,837 $ 7,883,714 459,474 (587,640) 348,823 (70,308) — 161,758 (1) On March 17, 2009, due to the Company’s WAP Default, the remaining balance of $3,891,148 on the unamortized discount on the convertible notes was accreted to its full face value (see Note 12). 24. Gain (Loss) on Change in Fair Value of Derivative As of December 31, 2011, 2010, and 2009, following is the summary of Company’s recorded gain (loss) on change in fair value of derivatives: Year Ended December 31 2010 2009 2011 Income from changes in the fair value of warrant liabilities Income (loss) from changes in the fair value of compound derivative liabilities Total $ — $ — $ 1,977 20,971,087 20,171,698 (43,076,304) $ 20,971,087 $ 20,171,698 $(43,074,327) Gain on the change of the fair value of warrant liability and compound derivative liabilities mentioned above, see Notes 14 and 16. 25. Income Taxes The Company’s subsidiaries registered in the PRC are subject to state and local income taxes within the PRC at the applicable tax rate of 25% 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. If the enterprise meets certain preferential terms according to the China income tax law, such as assessment as an “Advanced Technology Enterprise” by the government, then, the enterprise will be subject to enterprise income tax at a rate of 15% or 12.5%. PRC withholding tax on undistributed dividends Pursuant to the New China Income Tax Law and the Implementing Rules (New CIT) which are effective as of January 1, 2008, dividends generated after January 1, 2008 and payable by a foreign-invested enterprise to its foreign investors will be subject to a 10% withholding tax if the foreign investors are considered as non-resident enterprises without any establishment or place within China or if the dividends payable have no connection with the establishment or place of the foreign investors within China, unless any such foreign investor’s jurisdiction of incorporation has a tax treaty with China that provides for a different withholding arrangement. 84 Genesis, the Company’s wholly owned subsidiary and the direct holder of the equity interests in the Company’s Joint Venture subsidiaries in China, is incorporated in Hong Kong. According to the Mainland and Hong Kong Taxation Arrangement, dividends paid by a foreign-invested enterprise in China to its direct holding company in Hong Kong will be subject to withholding tax at a rate of no more than 5% (if the foreign investor owns directly at least 25% of the shares of the foreign-invested enterprise). Under the New CIT Law and the Implementing Rules, if Genesis is regarded as a non-resident enterprise and therefore is required to pay a 5% withholding tax for any dividends payable to it from Joint Venture subsidiaries. The Company provides for deferred income taxes on the unremitted earnings of foreign subsidiaries unless such earnings are deemed to be permanently reinvested outside the United States. During the years ended December 31, 2011, 2010, and 2009, the Company has a gross U.S. deferred income taxes of $0.1 million, $0.2 million, and $0.2 million, respectively, on foreign earnings of $2.0 million, $4.0 million, and $3.7 million, respectively, that it consider not permanently reinvested outside the United States, respectively. As of December 31, 2011, the Company still has undistributed earnings of approximately $99 million from investment in foreign subsidiaries that are considered permanently reinvested. The determination of the amount of deferred taxes on these earnings is not practicable since the computation would depend on a number of factors that cannot be known until a decision to repatriate the earnings is made. During 2008, Jiulong was awarded the title of “Advanced Technology Enterprise”, based on the PRC income tax law; it was subject to enterprise income tax at a rate of 15% for 2008, 2009 and 2010. In 2011, the Company has passed re-assessment by the government, based on PRC income tax laws. Accordingly, it continues to be taxed at the 15% tax rate in 2011, 2012, and 2013. During 2008, Henglong was awarded the title of “Advanced Technology Enterprise”, based on the PRC income tax law, it was subject to enterprise income tax at a rate of 15% for 2008, 2009 and 2010. In 2011, the Company has passed re-assessment by the government, based on PRC income tax laws. Accordingly, it continues to be taxed at the 15% tax rate in 2011, 2012, and 2013. During 2009, Shenyang was awarded the title of “Advanced Technology Enterprise”, based on the PRC income tax law, and it was subject to enterprise income tax at a rate of 15% for 2009, 2010 and 2011. The government needs to re-assess whether Shenyang is entitled to “Advanced Technology Enterprise” status in 2012, and if approved, its term will be extended for another three years. If Shenyang fails to pass the re-assessment by the government, it would be subject to a tax rate of 25%. During 2009, Zhejiang was awarded the title of “Advanced Technology Enterprise”, based on the PRC income tax law, and it was subject to enterprise income tax at a rate of 15% for 2009, 2010 and 2011. The government needs to re-assess whether Zhejiang is entitled to “Advanced Technology Enterprise” status in 2012, and if approved, its term will be extended for another three years. If Shenyang fails to pass the re-assessment by the government, it would be subject to a tax rate of 25%. Wuhu, Jielong and Hengsheng had an enterprise income tax exemption in 2008 and 2009, and Wuhu is subject to income tax at a rate of 11%, 12%, and 12.5%, respectively, for 2010, 2011 and 2012; Jielong is subject to tax at a rate of 12.5% in 2010 and 2011, and 25% in 2012; and Hengsheng is subject to tax at a rate of 12.5% for the next three year thereafter, from 2010 to 2012. There is no assessable profit for USAI and the Testing Center in 2011, 2010, and 2009. Based on PRC income tax laws, they are exempted from income tax in 2009, subject to income tax at a rate of 12.5% in 2010 and 2011, and 25% in 2012 (if there is a taxable profit). No provision for Hong Kong tax is made as Genesis is an investment holding company, and has no assessable income in Hong Kong for the years 2011, 2010, and 2009. The enterprise income tax of Hong Kong is 16.5%. No provision for U.S. tax is made as the Company has no assessable income in the United States for the years ended December 31, 2011, 2010, and 2009. The enterprise income tax rate in the United States is 35%. 85 The provision for income taxes was calculated as follows: Tax rate Income (loss) before income taxes Federal tax (benefit) at statutory rate Fair value change in convertible bond Change of income tax rate Gain on convertible notes conversion Accumulated discount amortization Effect of differences in foreign tax rate Tax benefit from income tax return Provision on valuation allowance for deferred income tax – U.S. Provision on valuation allowance for deferred income tax – PRC Other differences Total income tax expense Year Ended December 31 2010 2009 2011 35% 35% 35% $ 71,416,323 $(13,931,112) $ 24,990,527 $ (4,875,889) (7,060,094) 13,866,951 $52,098,933 $18,234,627 (7,339,881) (929,795) (547,546) - - - (6,449,798) (10,901,349) (180,731) 1,062,704 29,946 543,202 - 2,268,652 (6,711,498) (1,053,092) 1,185,693 175,853 (136,657) $ 8,484,205 $ 4,720,013 - 1,923,322 260,132 (797,359) $ 4,353,702 The combined effects of the income tax exemption and reduction available to the Company are as follows: Tax holiday effect Basic net income per share effect Diluted net income per share effect 2011 Year Ended December 31, 2010 $ 6,449,798 $ 10,901,349 $ 6,711,498 0.25 0.25 0.23 0.20 0.40 0.35 2009 The Company is subject to examination in the United States and China. The Company's tax years for 2001 through 2011 are still open for examination in China. The Company's tax years for 2004 through 2011 are still open for examination in the United States. Uncertain Tax Positions The Company did not have any uncertain tax positions for the years ended December 31, 2011, 2010 and 2009. 26. Income (Loss) Per Share In periods when the Company generates income, the Company calculates basic earnings per share (“EPS”) using the two-class method, pursuant to ASC 260, “Earnings Per Share”. The two-class method is required as the Company’s convertible notes qualify as participating securities, having the right to receive dividends should dividends be declared on common stock. Under this method, earnings for the period are allocated on a pro-rata basis to the common stockholders and to the holders of convertible notes based on the weighted average number of common shares outstanding and the number of shares that could be converted. The Company does not use the two-class method in periods when it generates a loss as the holders of the convertible notes do not participate in losses. For diluted earnings per share, the Company uses the more dilutive of the if-converted method or the two-class method for convertible notes and the treasury stock method for options, assuming the issuance of common shares, if dilutive, resulting from the exercise of options and warrants. The calculations of diluted income per share attributable to parent company were: 86 Year Ended December 31 2010 2009 2011 Numerator: Net income (loss) attributable to parent company Allocation to convertible notes holders Net income (loss) attributable to parent company’s common shareholders – Basic Dilutive effect of: Add back allocation to convertible notes holders Interest expenses of convertible notes payable Gain on change in fair value of derivative Gain on convertible notes conversion Net income (loss) attributable to parent company’s common shareholders – Diluted Denominator: Weighted average ordinary shares outstanding – Basic Dilutive effects of stock options Dilutive effect of convertible notes Denominator for dilutive income/(loss) per share – Diluted Net income (loss) per share attributable to parent company’s common shareholders Basic Diluted $ 40,791,987 $ 51,738,113 $(26,440,871) - (4,518,838) (6,994,306) 36,273,149 44,743,807 (26,440,871) 4,518,838 6,994,306 3,610,244 3,048,730 (20,971,087) (20,171,698) - (1,564,418) — — — - $ 21,866,726 $ 34,615,145 $(26,440,871) 101,469 27,930,668 27,098,258 26,990,649 — — 31,511,685 31,565,422 26,990,649 231,192 3,479,548 4,235,972 1.30 0.69 1.65 1.10 (0.98) (0.98) The following table summarizes potential common shares outstanding excluded from the calculation of diluted income per share for the years ended December 31, 2011, 2010, and 2009 because such inclusion would have an anti-dilutive effect. Shares issuable under stock options Shares issuable upon conversion of convertible notes Total 67,500 - 67,500 - - - Year Ended December 31 2010 2011 2009 343,850 4,235,972 4,579,822 27. Significant Concentrations A significant portion of the Company’s business is conducted in China where the currency is the RMB. Regulations in China permit foreign owned entities to freely convert the RMB into foreign currency for transactions that fall under the "current account," which includes trade related receipts and payments, interest and dividends. Accordingly, the Company’s Chinese subsidiaries may use RMB to purchase foreign exchange for settlement of such "current account" transactions without pre-approval. However, pursuant to applicable regulations, foreign-invested enterprises in China may pay dividends only out of their accumulated profits, if any, determined in accordance with Chinese accounting standards and regulations. In calculating accumulated profits, foreign investment enterprises in China are required to allocate at least 10% of their accumulated profits each year, if any, to fund certain reserve funds, including mandated employee benefits funds, unless these reserves have reached 50% of the registered capital of the enterprises. China Automotive, the parent company, may depend on Genesis and HLUSA dividend payments, which are generated from their subsidiaries and their subsidiaries’ interests in the Sino-foreign joint ventures in China (“China-based Subsidiaries”) after they receive payments from the China-based Subsidiaries. Under PRC law China-based Subsidiaries are required to set aside at least 10% of their respective accumulated profits, up to 50% of their paid-in capital, to fund certain mandated reserve funds that are not payable or distributable as cash dividends. 87 The PRC government also imposes controls on the convertibility of RMB into foreign currencies and, in certain cases, the remittance of currencies out of China, the China-based Subsidiaries may experience difficulties in completing the administrative procedures necessary to obtain and remit foreign currencies. If China Automotive is unable to receive dividend payments from its subsidiaries and China-based subsidiaries, China Automotive may be unable to effectively finance its operations or pay dividends on its shares. Transactions other than those that fall under the "current account" and that involve conversion of RMB into foreign currency are classified as "capital account" transactions; examples of "capital account" transactions include repatriations of investment by or loans to foreign owners, or direct equity investments in a foreign entity by a China domiciled entity. "Capital account" transactions require prior approval from China's State Administration of Foreign Exchange, or SAFE, or its provincial branch to convert a remittance into a foreign currency, such as U.S. Dollars, and transmit the foreign currency outside of China. This system could be changed at any time and any such change may affect the ability of the Company or its subsidiaries in China to repatriate capital or profits, if any, outside China. Furthermore, SAFE has a significant degree of administrative discretion in implementing the laws and has used this discretion to limit convertibility of current account payments out of China. Whether as a result of a deterioration in the Chinese balance of payments, a shift in the Chinese macroeconomic prospects or any number of other reasons, China could impose additional restrictions on capital remittances abroad. As a result of these and other restrictions under the laws and regulations of the People's Republic of China, or the PRC, the Company’s China subsidiaries are restricted in their ability to transfer a portion of their net assets to the parent. The Company has no assurance that the relevant Chinese governmental authorities in the future will not limit further or eliminate the ability of the Company’s Chinese subsidiaries to purchase foreign currencies and transfer such funds to the Company to meet its liquidity or other business needs. Any inability to access funds in China, if and when needed for use by the Company outside of China, could have a material and adverse effect on the Company’s liquidity and its business. The Company grants credit to its customers including to Xiamen Joylon, Shanghai Fenglong and Jiangling Yude that are related parties of the Company. The Company’s customers are mostly located in the PRC. In 2011, the Company’s ten largest customers accounted for 72.0% of the Company’s consolidated sales, with 1 customer accounting for more than 10% of consolidated sales (as 11.7% of consolidated sales). In 2010, the Company’s ten largest customers accounted for 81.2% of the Company’s consolidated sales, with 2 customers each accounting for more than 10% of consolidated sales, i.e., 13.1% and 12.6% of consolidated sales, or an aggregate of 25.7% of consolidated sales. In 2009, the Company’s ten largest customers accounted for 80.2% of the Company’s consolidated sales, with four customers each accounting for more than 10% of consolidated sales, i.e., 14.8%, 12.0%, 10.4% and 10.0% of consolidated sales, or an aggregate of 47.2% of consolidated sales. At December 31, 2011, 2010 and 2009, approximately 7.1%, 15.1% and 31.9% of accounts receivable were from trade transactions with the aforementioned customers. 28. Related Party Transactions The Company’s related party transactions include product sales, material purchases and purchases of equipment and technology. These transactions were consummated under similar terms as those with the Company's customers and suppliers. On some occasions, the Company’s related party transactions also include purchase/sale of capital stock of the joint ventures and sale of property, plant and equipment. Related sales and purchases: During the years ended December 31, 2011, 2010, and 2009, the joint-ventures entered into related party transactions with companies with common directors as shown below: 88 Merchandise Sold to Related Parties Xiamen Joylon Shanghai Fenglong Hubei Wiselink Jiangling Yude Total Materials Purchased from Related Parties Honghu Changrun Shanghai Fenglong Jiangling Tongchuang Jingzhou Tongyi Jingzhou Tongying Hubei Wiselink Wuhan Tongkai Total 2009 2011 Year Ended December 31 2010 $ 16,981,268 $ 9,871,977 $ 4,850,977 400,001 - 641,186 $ 19,931,431 $ 11,660,502 $ 5,892,164 526,182 518,834 - 1,413,119 1,018,210 1,262,343 Year Ended December 31 2010 2009 2011 $ 1,104,102 $ — 81,266 $ — 8,912,337 9,187,392 785,649 9,152,847 9,198,373 — — — 17,273 7,078,698 489,116 6,216,739 196,876 — $ 20,778,863 $ 19,252,680 $ 13,998,702 958,513 650,947 117 Technology Purchased from Related Parties Changchun Hualong $ Year Ended December 31 2010 178,972 $ 2011 218,108 $ 2009 248,916 Equipment Purchased from Related Parties Hubei Wiselink Year Ended December 31 2010 $ 4,724,043 $ 1,873,898 $ 3,962,690 2011 2009 Related receivables, advance payments and account payable: As at December 31, 2011 and 2010, accounts receivables, advance payments and account payable between the Company and related parties are as shown below: Accounts receivables from Related Parties Xiamen Joylon Shanghai Fenglong Jiangling Yude Total Other Receivables from Related Parties WuHan Dida Jiulong Material Jiangling Yude Jingzhou Tongying Total 89 December 31, 2011 2010 $ 5,999,246 $ 5,046,397 212,658 207,787 $ 6,126,148 $ 5,466,842 104,442 22,460 December 31, 2011 2010 $ 63,608 $ 638,272 436,044 - 1,137,924 59,846 564,074 136,393 154,225 914,538 Less: provisions for bad debts Balance at end of year (638,272) 499,652 $ (564,074) 350,464 $ Other receivables from related parties are primarily unsecured demand loans, with no stated interest rate or due date. Accounts payable to Related Parties Shanghai Tianxiang Jiangling Tongchuang Hubei Wiselink Jingzhou Tongyi Jingzhou Tongying Honghu Changrun Total Advanced equipment payments to Related Parties Hubei Wiselink Advance payments to related parties and others Jiangling Tongchuang Jingzhou Tongyi Jingzhou Tongying Honghu Changrun Total $ December 31, 2011 661,316 $ 258,979 694,791 7,021 361,812 68,978 2010 629,183 263,246 509,898 51,561 414,038 $ 2,052,897 $ 1,867,926 December 31, 2011 2010 $ 3,712,121 $ 7,534,440 $ December 31, 2011 508,548 $ 1,817 71,907 47,469 2010 405,266 875,619 - 53,184 $ 629,741 $ 1,334,069 The Company’s related parties, such as Jingzhou Derun, and Wuhan Dida, pledged certain land use rights and buildings as security for the Company’s comprehensive credit facility. As of March 9, 2012, the date the Company issued the financial statements, Hanlin Chen, Chairman, owns 63.16% of the common stock of the Company and has the effective power to control the vote on substantially all significant matters without the approval of other stockholders. 29. Commitments and Contingencies Legal Proceedings – On October 25, 2011, a purported security class action was filed in the United States District Court for the Southern District of New York on behalf of all purchasers of the Company’s securities between March 25, 2010 and March 17, 2011. On February 24, 2012, the plaintiffs filed an amended complaint, changing the purported class period from May 12, 2010 through March 17, 2011. The amended complaint alleges that the Company, certain of its present officers and directors and the Company’s former auditor violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and the rules promulgated thereunder, and seeks unspecified damages. The Company has not yet responded to the amended complaint, but believes the allegations in the complaint are without merit. The Company intends to defend itself vigorously against the claims. On December 23, 2011, a purported shareholder derivative action was filed in the Court of Chancery of the State of Delaware (the “Court of Chancery”) on behalf of the Company. The complaint alleges that certain of the Company’s current officers and directors breached their fiduciary duties to the Company in relation to the Company’s accounting 90 of convertible notes issued in February, 2008. On January 25, 2012, a second purported shareholder derivative action was filed in the Court of Chancery on behalf of the Company. On February 3, 2012 the Court of Chancery consolidated the two cases. The shareholder suits have been stayed pending the outcome of any motion to dismiss in the securities class action. The Company believes the allegations in the shareholder suits are without merit, and intends to defend itself vigorously against the claims. The Company has not yet been required to respond formally to these lawsuits. In addition, the complaints do not specify an amount of damages that plaintiffs seek. Because these matters are in very early stages, the Company cannot determine whether or not an adverse outcome is probable, nor can it provide a reasonable estimate of potential losses related to these matters. While the Company believes that it has meritorious defenses to each of these actions and intends to defend them vigorously, an adverse outcome in one or more of these matters could have a material adverse effect on the Company’s business, financial condition, results of operations or liquidity. Other than the above, the Company is not a party to any pending or to the best of the Company’s knowledge, any threatened legal proceedings. In addition, no director, officer or affiliate of the Company, or owner of record of more than five percent of the securities of the Company, or any associate of any such director, officer or security holder is a party adverse to the Company or has a material interest adverse to the Company in reference to pending litigation. In addition to the convertible notes, bank loans, notes payables and the related interest, the following table summarizes the Company’s major commitments and contingencies as of December 31, 2011: Obligations for service agreements Obligations for purchasing agreements Interest and make-whole on convertible notes Total 2012 2013 2014 2015 Thereafter Total Payment Obligations by Period $ — $ 206,320 $ — $ — $ — $ 206,320 7,159,582 4,671,421 1,075,022 3,794,172 — — — — — — 11,831,003 4,869,194 $ 8,234,604 $ 8,671,913 $ — $ — $ — $ 16,906,517 30. Off-Balance Sheet Arrangements At December 31, 2011 and 2010, the Company did not have any transactions, obligations or relationships that could be considered off-balance sheet arrangements. 31. Subsequent Events On December 1, 2011, Hengsheng entered into a Sino-foreign equity joint venture contract with SAIC-IVECO Hongyan Company to establish a Sino-foreign joint venture company, Chongqing Henglong Hongyan Power Steering Systems Co. Ltd. ("Chongqing Henglong") to design, develop and manufacture both hydraulic and electric power steering systems and parts. The new joint venture will be located in Chongqing City and have a registered capital of RMB60 million (of which RMB 42 million, or 70%, will be invested by Hengsheng). Under PRC law, the establishment of Chongqing Henglong and the effectiveness of the equity joint venture contract are subject to approval by the local Ministry of Commerce and the registration of the same with the local Administration of Industries and Commerce in Chongqing. As of the date of this report, such approval has not been obtained. On January 19, 2012, the Company completed its reorganization as discussed in Note 1. 32. 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 91 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 years ended December 31, 2011, 2010, and 2009 the Company had ten product sectors, six 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), power steering (Wuhu), and power steering (Hengsheng). The other four sectors which were established in 2005, 2006 and 2007, respectively, engaged in the production and sales of sensor modular (USAI), EPS (Jielong), provider of after sales and R&D services (HLUSA), and the holding company (Genesis). Since the revenues, net income and net assets of these four sectors are less than 10% of its segment in the consolidated financial statements, the Company incorporated these four sectors into “other sectors.” Hengsheng was previously included in “Other Sectors.” The Company is now reporting Hengsheng as a separate sector, as it has recently become a principal profit maker. It is mainly engaged in manufacturing automobile power steering products for export to the U.S. market As such, a reclassification has been made to all periods presented in the summary above to conform to the current period presentation. Such reclassifications have no effect on previously reported results of operations. The Company’s product sectors information is as follows: Net Sales Year Ended December 31 2010 2009 2011 Net Income (Loss) Year Ended December 31 2010 2009 2011 Henglong Jiulong Shenyang Zhejiang Wuhu Hengsheng Other Sectors Eliminations Total Segments Corporate Total consolidated Henglong Jiulong Shenyang Zhejiang Wuhu Hengsheng Other Sectors Corporate Eliminations Total consolidated $196,296,846 $197,226,807 $153,459,876 $ 25,570,825 $ 30,563,088 $ 25,922,760 3,463,037 69,517,738 92,095,265 61,613,116 2,043,199 4,951,566 2,874,063 30,290,139 39,691,553 32,492,844 1,546,618 4,212,843 2,998,220 20,269,837 26,193,095 24,193,366 2,042,529 5,186,404 47,270 812,360 35,271,488 33,057,878 26,496,148 498,519 2,790,924 22,313,422 13,092,659 10,209,668 1,647,201 810,462 (1,487,820) 596,865 (2,101,341) 1,190,795 43,357,605 32,707,067 (69,342,321) (88,139,142) (53,464,330) (5,622,638) 1,000,819 (2,105,565) 347,974,754 345,925,182 255,597,553 25,624,912 48,728,337 34,502,889 — 22,278,569 14,188,965 (53,154,014) $347,974,754 345,925,182 255,597,553 $ 47,903,481 $ 62,917,302 $(18,651,125) — — Inventories As of December 31 2010 2011 2009 2011 Total Assets As of December 31 2010 2009 $ 14,277,098 $ 11,430,420 $ 13,686,928 $ 215,885,003 $ 188,019,911 $ 156,393,126 59,675,929 12,472,364 7,200,613 8,628,835 72,344,671 32,163,383 3,386,388 4,016,731 2,871,316 35,862,778 25,955,363 6,397,899 5,415,478 3,260,930 31,072,820 18,182,769 3,952,149 3,093,618 2,146,381 26,806,437 18,290,063 9,679,179 4,737,048 1,039,125 40,660,687 5,471,567 4,805,865 9,302,994 831,232 40,937,542 130,232,180 120,621,288 — — 189,518,582 (137,285,705) (126,202,343) (4,029,451) (3,829,501) (5,049,050) (186,641,400) $ 51,607,193 36,870,272 27,415,697 $ 466,447,120 $ 405,527,665 $ 314,382,572 71,193,527 36,496,737 30,208,969 26,702,478 29,190,456 30,769,112 — 92 Depreciation and Amortization Year Ended December 31 2010 2011 2009 Capital Expenditures Year Ended December 31 2010 2009 2011 Henglong Jiulong Shenyang Zhejiang Wuhu Hengsheng Other Sectors Eliminations Total Segments Corporate Total consolidated 573,991 523,160 2,069,851 $ 6,242,593 $ 3,302,493 $ 3,777,978 $ 8,458,999 $ 3,012,270 $ 5,378,814 1,671,141 4,874,238 2,219,799 218,297 521,475 2,486,501 1,461,982 1,031,155 150,212 359,472 3,527,192 944,802 4,390,814 875,315 1,099,082 - - (3,140,469) 8,613,332 15,180,827 31,285,344 17,822,971 13,480,661 9,478,278 — 19,340 $ 13,501,091 $ 9,497,618 $ 8,684,169 $ 15,180,827 $ 31,285,344 $ 17,822,971 6,970,742 9,736,642 1,868,528 1,223,395 948,602 1,287,999 1,118,148 1,586,144 599,309 6,763,8671(1) 1,012,542 7,675,027 - (5,796,043) 2,068,581 543,930 895,241 352,770 718,113 256,719 - 20,430 70,837 — — (1) Included in the balance, $3,095,414 was invested in Beijing Henglong by Hengsheng in 2010. Financial information segregated by geographic region is as follows: Net Sales Year Ended December 31 2010 2009 2011 Long-term assets As of December 31 2010 2011 Geographic region: United States China Total consolidated $ 22,313,426 $ 13,113,735 $ 18,787 325,661,328 332,811,447 249,391,737 96,701,841 91,361,596 $ 347,974,754 $345,925,182 $255,597,553 $ 96,726,611(1) $ 91,380,383(1) 6,205,816 $ 24,770 $ (1) Pursuant to ASC 280-10-50-41, the non-current deferred tax assets of $4,340,974 and $3,271,594 were excluding from the long-term assets as of December 31, 2011 and 2010, respectively. China Automotive Systems, Inc. (Unconsolidated – based on the parent company) Balance Sheets of Registrant December 31, 2011 and 2010 SCHEDULE I ASSETS Current assets: Cash and cash equivalents Total current assets Non-current assets: Other receivables — 3rd parties Other receivables — intercompany Long-term investments Total assets LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Convertible notes payable (Note 2) Compound derivative liabilities (Note 2) 93 December 31, 2011 2010 $ 129,810 $ 129,810 451,391 451,391 126,551 89,361 51,714,827 54,566,152 153,834,192 120,262,911 $205,805,380 $175,369,815 $ - $ 30,000,000 - 25,271,808 Accrued expenses and other payables (Note 3) Total current liabilities Long-term liabilities: Convertible notes payable (Note 2) Compound derivative liabilities (Note 2) Accrued make-whole redemption interest expense of convertible notes (Note 2) Total liabilities Commitments and Contingencies Stockholders' equity : Common stock-$0.0001 par value - Authorized-80,000,000 shares Issued and Outstanding – 28,260,302 shares and 27,175,826 at December 31, 2011 and 2010, respectively Additional paid-in capital Retained earnings- Appropriated Unappropriated Accumulated other comprehensive income Total stockholders' equity Total liabilities and stockholders' equity The accompanying notes are an integral part of these financial statements 929,983 7,824,989 929,983 63,096,797 - 23,571,429 - 559,148 - 7,615,709 32,676,269 63,096,797 2,717 39,295,419 28,565,153 2,826 9,026,240 8,767,797 99,513,395 58,979,851 25,291,231 15,957,500 173,129,111 112,273,018 $205,805,380 $175,369,815 China Automotive Systems, Inc. (Unconsolidated – based on the parent company) Statements of Income (Loss) of Registrant Year Ended December 31, 2011, 2010 and 2009 Year Ended December 31 2010 2009 2011 Operating expenses: General and administrative expenses (Note 4) Total Operating expenses Operating loss Financial expenses (Note 5) Gain (loss) on change in fair value of derivative (Note 5) Gain on convertible notes conversion Income (loss) before income taxes and equity in earnings of affiliated companies Equity in earnings of affiliated companies Income (loss) before income taxes Income tax Net income (loss) Allocation to convertible notes holders Net income (loss) attributable to common shareholders $ 2,370,880 $ 1,939,772 $ 1,452,118 1,452,118 (1,452,118) (7,687,507) 20,971,087 20,171,698 (43,074,327) 2,370,880 1,939,772 (2,370,880) (1,939,772) (3,610,189) (3,048,515) 1,564,418 16,554,436 15,183,411 (52,213,952) 24,237,551 36,554,702 25,773,081 40,791,987 51,738,113 (26,440,871) - 40,791,987 51,738,113 (26,440,871) - $ 36,273,149 $ 44,743,807 $(26,440,871) (4,518,838) (6,994,306) - - The accompanying notes are an integral part of these financial statements 94 China Automotive Systems, Inc. (Unconsolidated – based on the parent Company) Statements of Cash Flows of Registrant Year Ended December 31, 2011, 2010 and 2009 Year Ended December 31 2010 2011 2009 Cash flows from operating activities: Net income (loss) Adjustments to reconcile net income (loss) to net cash used in operating activities: Stock-based compensation Amortization for discount of convertible notes payable (Gain) loss on change in fair value of derivative (Gain) on convertible notes conversion Equity in earnings of affiliated companies Changes in operating assets and liabilities: Increases in accrued expenses and other payables Write-down of accrued interest upon conversion of convertible notes Net cash used in operating activities Cash flows from investing activities: Decrease in other receivables Net cash provided by investing activities Cash flows from financing activities: Exercise of stock option Redemption of convertible notes Net cash provided by (used in) financing activities Net change in cash and cash equivalents Net (decrease) increase in cash and cash equivalents Cash and equivalents at beginning of year Cash and equivalents at end of year $ 40,791,987 $ 51,738,113 $(26,440,871) 595,402 — 100,575 — 446,676 3,891,148 (20,971,087) (20,171,698) 43,074,327 - (24,237,551) (36,554,702) (25,773,081) (1,564,418) - 720,704 1,730,780 — 1,506,143 (3,653,647) (2,662,105) 3,462,462 — (1,339,339) 2,814,135 2,402,213 2,814,135 2,402,213 6,050,445 6,050,445 517,931 — 517,931 454,700 — 454,700 420,240 (5,000,000) (4,579,760) (321,581) 451,391 129,810 $ 194,808 256,583 451,391 $ 131,346 125,237 256,583 $ SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for interest Year Ended December 31 2010 $ 1,006,696 $ 1,656,034 $ 1,137,500 2009 2011 SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Year Ended December 31 2010 2011 2009 Issuance of common shares for the conversion of convertible notes $ 10,111,869 $ - $ - The accompanying notes are an integral part of these financial statements. 95 China Automotive Systems, Inc. Notes to Condensed Financial Statements NOTE 1 — Basis of Presentation China Automotive Systems, Inc., a Delaware corporation, is the direct or indirect parent company of all of China Automotive Systems, Inc.’s subsidiaries and joint ventures. The accompanying condensed financial statements reflect the financial position, results of operations and cash flows of China Automotive Systems, Inc. on a separate, parent company basis. All subsidiaries and joint ventures of China Automotive Systems, Inc. and its subsidiaries are reflected as investments accounted for using the equity method. For accounting policies and other information, see the Notes to Consolidated Financial Statements included elsewhere herein. NOTE 2 — Convertible Notes Payable and Compound Derivative Liabilities Convertible notes payable and compound derivative liabilities arose from the issuance of convertible notes in February 15, 2008. For detail information, see Notes 13 and 14 to the Consolidated Financial Statements included elsewhere herein. NOTE 3 — Accrued Expenses and Other Payables Accrued expenses and other payables at December 31, 2011 and 2010 are summarized as follows: Accrued interest (1) Other payables Balance at end of year December 31, 2010 2011 625,447 $ 7,143,751 304,536 681,238 929,983 $ 7,824,989 $ $ (1) As of December 31, 2011, accrued interest of $625,447 represented coupon interests on convertible notes to be paid every six months whereas, as of December 31, 2010, accrued interest of $ 7,143,751 included coupon interest and make-whole redemption interest of $512,500 and $ 6,631,251, respectively. Upon expiration of the mandatory redemption period of the convertible notes on February 15, 2011, the entire make-whole redemption interest was reclassified as long-term liabilities; see Notes 12 and 15 to the Consolidated Financial Statements included elsewhere herein. NOTE 4 — General and Administrative Expenses General and administrative expenses mainly consisted of the costs associated with legal, accounting and auditing fees for operating a public company. The expenses also included share-based compensation expense for options granted to the audit committee. NOTE 5 — Financial Income (Expenses) and Gain (Loss) on Change in Fair Value of Derivative Financial expenses and gain (loss) on change in fair value of derivative resulted from the issuance of the convertible notes in February 15, 2008. For detail information, see Notes 24 and 25 to the Consolidated Financial Statements included elsewhere herein. 96 Investor Information Annual Meeting The Annual Meeting of China Automotive Systems stockholders will be held on August 15, 2012 (Wednesday) at 10:00 am local time at the Grand Metropark Resort Sanya, Sanya, Hainan Province, China Independent Public Accountant PricewaterhouseCoopers Zhong Tian CPAs Ltd., Co. 11/F PricewaterhouseCoopers Center 2 Corporate Ave., 202 Hu Bin Road Luwan District, Shanghai www.pwccn.com Transfer Agent and Registrar Securities Transfer Corporation 2591 Dallas Parkway Ste102 Frisco, Texas 75034, USA Phone: 469-633-0101 www.stctransfer.com Investor Relations Grayling 405 Lexington Avenue, 7th Floor New York, New York 10174 T: +1-646-284-9400 www.grayling.com Corporate Headquarters China Automotive Systems, Inc. Henglong Building Optics Valley Software Park No. 1 Guanshan Avenue Wuhan City, Hubei Province People’s Republic of China Phone: (86) 27-8757-0027 www.caasauto.com Board of Directors Hanlin Chen Chairman Qizhou Wu Director, Chief Executive Officer Robert Tung Independent Non-executive Director Guangxun Xu Independent Non-executive Director Arthur Wong Independent Non-executive Director Executive Officers Qizhou Wu Chief Executive Officer Jie Li Chief Financial Officer Daming Hu Chief Accountant Tse Yiu Wong Andy Senior Vice President Shengbin Yu Senior Vice President Shaobo Wang Senior Vice President Yijun Xia Vice President Haimian Cai Vice President CHINA AUTO Henglong Bui No.1 Guansha Wuhan City, H T Tel:(86)27-875 http://www.c STEMS, INC. OMOTIVE SYS tics Valley Soft lding, D8 Opt ast Lake Hi-te an Avenue, E ce, 430073, PR Hubei Provinc 57-0027 Fax: (8 86)27-8757-008 m caasauto.com tware Park ech Zone of China 88

Continue reading text version or see original annual report in PDF format above