UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION
 WASHINGTON, D.C.
20549
  FORM
10-K
  (Mark
One)
  x
              ANNUAL
      REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF
      1934.
  For
the fiscal year ended December 31, 2008
  or
   ̈
              TRANSITION REPORT PURSUANT TO
      SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF
      1934.
  For
the transition period from ____________ to ____________
  Commission
File Number 000-33123
  CHINA
AUTOMOTIVE SYSTEMS, INC.
 (Exact
name of Registrant as specified in its charter)
  Delaware
                    
                    33-0885775(State
      or Other Jurisdiction
                      of
      Incorporation or Organization)
                    
                    (I.R.S.
      Employer
                      Identification
      No.)
 
 No.
      1 Henglong Road, Yu Qiao Development Zone
                      Shashi
      District, Jing Zhou City Hubei Province, China
                    
                    434000(Address
      of Principal Executive Offices)
                    
                    (Zip
      Code)
  (Registrant’s Telephone Number,
Including Area Code)(86) 716-8329196
  Securities
registered pursuant to Section 12(b) of the Act:
 Common
Stock, $0.0001 par value
 Securities
registered pursuant to Section 12(g) of the Act:
 None
  
  Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.  Yes   ̈  No  x
  Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Act.
 Yes ̈Nox
 
 Indicate
by check mark whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.  Yes  x   No   ̈
 
 Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not
be contained, to the best of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.  x
  Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
definition of “accelerated filer”, “large accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
  Large Accelerated Filer ̈Accelerated Filer ̈Non-Accelerated
Filer ̈Smaller Reporting
Company  x
  Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
 Yes  ̈  No  x
  Aggregate
market value of voting and non-voting common equity held by non-affiliates of
the registrant as of June 30, 2008, based upon the closing price of the common
stock as reported on the NASDAQ Stock Market under the symbol “CAAS” on such
date, was approximately $27,945,022.
  The
Company has 26,983,244 shares of Common Stock outstanding as of February 27,
2009.
  
  CHINA
AUTOMOTIVE SYSTEMS, INC.
  FORM
10-K
  INDEX
  PagePART
      I
                          
                          4Item
      1. Description of Business
                          
                          4Item
      1A. Risk Factors
                          
                          13Item
      1B. Unresolved Staff Comments
                          
                          20Item
      2. Description of Property
                          
                          20Item
      3. Legal Proceedings
                          
                          21Item
      4. Submission of Matters of a Vote of Security Holders
                          
                          21PART
      II
                          
                          21Item
      5. Market for Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
                          
                          21Item
      6. Selected Financial Data
                          
                          22Item
      7. Management’s Discussion and Analysis of Financial Condition and Results
      of Operations
                          
                          23Item
      8. Financial Statements and Supplementary Data
                          
                          40Item
      9. Changes in and Disagreements with Accountants on Accounting and
      Financial Disclosure
                          
                          41Item
      9A. Controls and Procedures
                          
                          41Item
      9B Other Information
                          
                          42PART
      III
                          
                          42Item
      10. Directors and Executive Officers, Corporate Governance and Board
      Independence
                          
                          42Item
      11. Executive Compensation
                          
                          46Item
      12. Security Ownership of Certain Beneficial Owners and Management and
      Related Stockholder Matters
                          
                          49Item
      13. Certain Relationships and Related Transactions
                          
                          50Item
      14. Principal Accountant Fees and Services
                          
                          50PART
      IV
                          
                          51Item
      15. Exhibits and Financial Statement Schedules
                          
                          51Signatures
                          
                          53Financial
      Statements
                          
                          55
 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,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,”
“plans,” “potential,” “predict,” “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 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.
  3
  PART
I
  ITEM 1.
 DESCRIPTION OF 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. Presently, Genesis owns interests in eight Sino-joint ventures,
which manufacture power steering systems and/or related products for different
segments of the automobile industry in China.
  On May
19, 2003, the Company changed its name from Visions-In-Glass, Inc. to China
Automotive Systems, Inc.
  Since
September 5, 2007, Hanlin Chen, Qizhou Wu, Robert Tung, Haimian Cai, and William
E. Thomson began serving their terms as members of the Company’s Board of
Directors. The directors appointed Hanlin Chen as the chairman of the Board,
Qizhou Wu as the Chief Executive Officer of the Board of Directors, and Jie Li
as Chief Financial Officer.
  BUSINESS
OVERVIEW
  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. The Company is a holding company and has no significant
business operations or assets other than its interest in Genesis. Through
Genesis, the Company manufactures power steering systems and other component
parts for automobiles. All operations are conducted through eight Sino-foreign
joint ventures in China and a wholly-owned subsidiary in the U.S. set forth
below is an organizational chart as at December 31, 2008.
  4
  China Automotive Systems, Inc. [NASDAQ:CAAS]↓100%
                                                            
                                                            
                                                            
                                                            ↓100%Great Genesis Holdings Limited
                                                            
                                                            
                                                            
                                                            Henglong USA Corporation↓↓80%
                                                            
                                                            ↓81%
                                                            
                                                            ↓70%
                                                            
                                                            ↓51%
                                                            
                                                            ↓83.34%
                                                            
                                                            ↓77.33%
                                                            
                                                            ↓85%
                                                            
                                                            ↓100.00%Jingzhou
                                                              Henglong
                                                              Automotive
                                                              Parts Co.,
                                                              Ltd.
                                                            
                                                            Shashi
                                                              Jiulong
                                                              Power
                                                              Steering
                                                              Gears
                                                              Co., Ltd.
                                                            
                                                            Shenyang Jinbei
                                                              Henglong
                                                              Automotive
                                                              Steering System
                                                              Co., Ltd.
                                                            
                                                            Zhejiang
                                                              Henglong &
                                                              Vie
                                                              Pump-Manu
                                                              Co., Ltd.
                                                            
                                                            Universal
                                                              Sensor
                                                              Application,
                                                              Inc.
                                                            
                                                            Wuhu
                                                              Henglong
                                                              Automotive
                                                              Steering
                                                              System Co.,
                                                              Ltd.
                                                            
                                                            Wuhan
                                                              Jielong
                                                              Electric
                                                              Power
                                                              Steering Co.,
                                                              Ltd
                                                            
                                                            Jingzhou
                                                              Hengsheng
                                                              Automotive
                                                              System
                                                              Co., Ltd.“Henglong”
                                                            
                                                            “Jiulong”
                                                            
                                                            “Shenyang”
                                                            
                                                            “Zhejiang”
                                                            
                                                            “USAI”
                                                            
                                                            “Wuhu”
                                                            
                                                            “Jielong”
                                                            
                                                            “Hengsheng”
 
 Jiulong
was established in 1993 and mainly engaged in the production of integral power
steering gear for heavy-duty vehicles.
 
 Henglong
was established in 1997 and mainly engaged in the production of rack and pinion
power steering gear for cars and light duty vehicles.
 
 On March
31, 2008, the Company’s wholly-owned subsidiary, Genesis, and Wiselink Holdings
Limited, “Wiselink”, both controlled by Hanlin Chen and his family, entered into
an equity transfer agreement, the “Henglong Agreement”, pursuant to which
Wiselink agreed to transfer and assign its 35.5% equity interest in Henglong,
one of the Company’s currently consolidated subsidiaries, to Genesis for a total
consideration of $32,090,000. The Company now holds an 80% equity interest in
Jingzhou Henglong.
  Under the
terms of the Henglong Agreement, Genesis is deemed to be the owner of Jingzhou
Henglong commencing from January 1, 2008. The Henglong acquisition is considered
as a business combination of companies under common control and is being
accounted for in a manner of pooling of interests.
 
 Shenyang
was established in 2002 and focuses on power steering parts for light duty
vehicles.
 
 Zhejiang
was established in 2002 to focus on power steering pumps.
 
 USAI was
established in 2005 and mainly engaged in the production and sales of sensor
modulars.
  In 2008,
Genesis and Shanghai Hongxi Investment Inc., “Hongxi”, the other shareholder of
USAI, agreed to increase USAI’s capital to $2,600,000 from $1,800,000. The
increased capital was wholly funded by Genesis. Therefore, the capital
contributed by Genesis in USAI increased to $2,166,900 from $1,366,900,
accounting for 83.34% of the total capital; while the capital contributed by
Hongxi remained unchanged, accounting for 16.66% of the total
capital.
 
 Wuhu was
established in 2006 and mainly engaged in the production and sales of automobile
steering systems.
 
 Jielong
was established in 2006 and mainly engaged in the production and sales of
electric power steering gears, “EPS”.
 
 On March
7, 2007, Genesis established a wholly-owned subsidiary, Jingzhou Hengsheng
Automotive System Co., Ltd, “Hengsheng”, to engage in production and sales of
automotive steering systems. The registered capital of Hengsheng is
$10,000,000.
  5
  The
Company has business relations 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
minivan manufacturer in China; Cherry Automobile Co., Ltd, the largest state
owned car manufacturer in China, and Zhejiang Geely Automobile Co., Ltd., the
largest private owned car manufacturer. In 2007 and 2008, the Company has
supplied power steering pumps and power steering gears for the Sino-Foreign
joint ventures established by General Motors (GM) and Volkswagen.
  The
Company currently owns two trademarks covering automobile parts and twelve
Chinese patents 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 2001, the Company signed a Ten-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. 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 research
institute designed to develop Electronic Power Steering (EPS) and Electronic
Hydraulic Steering Systems (EHPS).
  STRATEGIC
PLAN
  The
Company’s short to medium term strategic plan is to focus on both domestic and
international market expansion. To achieve this goal and higher profitability,
the Company focuses on brand recognition, quality control, decreasing costs,
research and development and strategic acquisitions. Set forth below are the
Company’s programs:
  - Brand
Recognition. Under the Henglong and Jiulong brands, the Company offers four
separate series of power steering sets and 310 models of power steering sets,
steering columns, steering oil pumps and steering hoses.
  -Quality
Control. The Henglong and Jiulong manufacturing facilities passed the ISO/TS
16949 System Certification in January 2004, a well-recognized quality control
system in the auto industry developed by TUVRheindland of Germany.
  -
Decrease Cost. By improving the Company’s production ability and enhancing
equipment management, optimizing the process and products structure, perfecting
the supplier system and cutting production cost, the Company’s goal is to
achieve a more competitive profit margin.
  -
Research and Development. By partnering with Bishop Steering Technology Limited,
Nanyang Ind. Co. Ltd. and Tsinghua University for the development of advanced
steering systems, the Company’s objective is to gain increased market share in
China.
  -
International Expansion. The Company has entered into agreements with several
international vehicle manufacturers and auto parts modules suppliers and carried
on preliminary negotiations regarding future development projects.
  -
Acquisitions. The Company is exploring opportunities to create long-term growth
through new ventures or acquisitions of other auto component manufacturers. The
Company will seek acquisition targets that fulfill the following criteria:
·
  -
              companies
      that can be easily integrated into product manufacturing and corporate
      management;
  -
              companies
      that have strong joint venture partners that would become major customers;
      and
  6
  -
              companies
      involved with power steering systems, oil pump or engine-cooling
      systems.
  CUSTOMERS
  The
Company’s ten largest customers represent 78.6% of the Company’s total sales for
the year ended December 31, 2008. The following table sets forth information
regarding the Company’s ten largest customers.
  Name of Major Customers
                  
                  Percentage of Total
                    Revenue in 2008Chery
      Automobile Co., Ltd
                  
                  
                  15.1
                  %Brilliance
      China Automotive Holdings Limited
                  
                  
                  12.0
                  %Xi’an
      BYD Electric Car Co., Ltd
                  
                  
                  11.4
                  %Beiqi
      Foton Motor Co., Ltd.
                  
                  
                  10.7
                  %Zhejiang
      Geely Holding Co., Ltd
                  
                  
                  9.7
                  %China
      FAW Group Corporation
                  
                  
                  6.5
                  %Dongfeng
      Auto Group Co., Ltd
                  
                  
                  5.6
                  %Shanxi
      Heavy Auto Co., Ltd
                  
                  
                  2.9
                  %Great
      Wall Motor Company Limited
                  
                  
                  2.5
                  %Huainan
      Haonaite Machinery Co., Ltd.
                  
                  
                  2.2
                  %Total
                  
                  
                  78.6
                  %
  The
Company primarily sells its products to the above-mentioned customers; it also
has excellent relationships with them, including as their first-ranking supplier
and developer for new 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 102 sales persons, which are divided into
an original equipment manufacturing, “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 more effectively represent 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 met
with potential customers. Through these activities, the Company has generated
potential business interests as a strong base for future
development.
  7
  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
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, 2008, the Company employed approximately 2,487 persons,
including approximately 1,631 by Henglong and Jiulong, approximately 261 by
Shengyan, approximately 283 by Zhejiang, approximately 43 by USAI, approximately
130 by Wuhu, and approximately 139 for Hengsheng.
  As of
December 31, 2008, each of Henglong and Jiulong, Shenyang, Zhejiang, Wuhu and
Hengsheng has a manufacturing and administration area of 278,092 square meters,
35,354 square meters, 100,000 square meters, 83,700 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
gears, was approximately 1,290,000 units and 1,070,000 units in 2008 and 2007
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 $33.6
million was spent over the last three years on professional-grade equipment and
workshops — approximately 81% of which has used in the production process as of
December 31, 2008.
  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, electronic parts, molded plastic parts,
finished sub-components, fabricated metal, aluminum and steel. 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 represent in the aggregate
26.8% of all components and raw materials it purchased for the year ended
December 31, 2008, and none of them providing more than 10% of total
purchases.
  8
  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
  The
Company has a ten-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.
  The
Company owns a Hubei Provincial-Level Technical Center, which is approved by the
Hubei Economic Commission. The center has a staff of 140, including 12 senior
engineers, 2 foreign experts and 85 engineers, primarily focused 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
Electronic Power Steering, “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
maintain its total expenditures for research and development activities,
including engineering, at approximately $2,260,000, $1,700,000, and $1,100,000
for the years ended December 31, 2008, 2007 and 2006, respectively. In
2008, the sales of newly developed products accounted for about 9.8% of total
sales.
  COMPETITION
  The
automotive components industry is extremely competitive. Criteria for the
Company’s customers include quality, price/cost competitiveness, system and
product performance, reliability and timeliness of delivery, new product and
technology development capability, excellence and flexibility in operations,
degree of global and local presence, effectiveness of customer service and
overall management capability. The power steering system market is fragmented in
China, and the Company has seven major competitors. Of these competitors, two
are Sino-foreign joint ventures while the other five are state-owned. Like many
competitive industries, there is downward pressure on selling
prices.
  The
Company’s major competitors, including Shanghai ZF and FKS, are component
suppliers to specific automobile manufacturers. Shanghai ZF is the joint venture
of SAIC and ZF Germany, which is an exclusive supplier to SAIC-Volkswagen and
SAIC-GM. First Auto FKS is a joint venture between First Auto Group and Japan’s
Koyo Company and its main customer is FAW-Volkswagen Company.
  While the
Chinese Government limits foreign ownership of auto assemblers to 50%, there is
no analogous limitation in the automotive components industry. Thus,
opportunities exist for foreign component suppliers to set up factories in
China. These overseas competitors employ technology that may be more advanced
and may have existing relationships with global automobile assemblers, but they
are generally not as competitive as the Company in China in terms of production
cost and flexibility in meeting client requirements.
  9
  CHINESE
AUTOMOBILE INDUSTRY
  The
Company is a supplier of automotive parts and all 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 2008, the output and sales volume of passenger
vehicles have reached 9,345,000 and 9,381,000 units respectively, with only a
single-digit growth rate of 5.2% and 6.7% for the first time in at least 10
years as consumer confidence waned in a slowing economy. The output and
sales volume of passenger vehicles have reached 6,738,000 and 6,756,000 units
respectively with an increase of 5.6% and 7.3% compared with the year 2007. The
output and sales volume of commercial vehicles have reached 2,607,000 and
2,625,000 units respectively with an increase of 4.2% and 5.3% over last
year. Accordingly, the Company’s sales of steering gears and steering pumps
for passenger vehicles in 2008 increased by 27.8% and 9.2% compared with the
year 2007. The sales of steering gears for commercial vehicles in 2008 increased
13.1% compared with the year 2007.
  To
bolster auto demand in China, the government implemented a series of stimulus
measures in the early 2009, including halving the purchase taxes on smaller
cars, scrapping some road fees and granting subsidies for farmers who trade in
their polluting vehicles for more fuel-efficient ones.
  Based on
the effects of these measures, management believes that the auto industry in
China will grow faster and the Company’s net sales in 2009 will increase by 10%
to 15% compared with 2008.
  CHINESE
ECONOMY
  Management
believes that the most important factor in understanding the Chinese automobile
industry is the country’s rapid economic growth. During 2008, Chinese economic
growth still maintained a relatively high level, although it suffered from the
global financial crisis since the third quarter of 2008. According to data
from the State Statistical Bureau, Chinese economic growth reached 9.0% in 2008.
With the pulling function of great government investment, the investment by
Chinese enterprises and consumption by Chinese residents will continue to
increase relatively rapid in 2009.
  Management
believes that the continued investment and consumption growth will have a
favorable effect on the sales of commercial vehicles and passenger
vehicles.
  HIGHWAY
DEVELOPMENT
  Management
believes that the continuing development of the highway system will have a
significant positive impact on the manufacture and sale of private automobiles.
Statistics from the Ministry of Communications show that 100,000 kilometers of
highway and 6,433 kilometers of expressway were developed in 2008. Total
highways and expressways now amount to 3,673,000 kilometers and 60,300
kilometers, respectively.
  10
  DOING
BUSINESS IN CHINA
  CHINESE
LEGAL SYSTEM
  The
practical effect of the Chinese legal system on the Company’s business
operations in China can be viewed from two separate but intertwined
considerations. First, as a matter of substantive law, the Foreign Invested
Enterprise Laws provide significant protection from government interference. In
addition, these laws guarantee the full enjoyment of the benefits of corporate
articles and contracts to Foreign Invested Enterprise participants. These laws,
however, do impose standards concerning corporate formation and governance,
which are not qualitatively different from the general corporation laws of other
countries. Similarly, the Chinese accounting laws mandate accounting practices,
which are not consistent with US Generally Accepted Accounting Principles. The
Chinese accounting laws require that an annual “statutory audit” be performed in
accordance with Chinese accounting standards and that the books of account of
Foreign Invested Enterprises be maintained in accordance with Chinese accounting
laws. Article 14 of the People’s Republic of China Wholly Foreign-Owned
Enterprise Law requires a Wholly Foreign-Owned Enterprise to submit certain
periodic fiscal reports and statements to designated financial and tax
authorities. Otherwise, there is risk that its business license will be
revoked.
  Second,
while the enforcement of substantive rights may appear less clear than those in
the United States, the Foreign Invested Enterprises and Wholly Foreign-Owned
Enterprises are Chinese registered companies which enjoy the same status as
other Chinese registered companies in business dispute resolution. Because the
terms of the Company’s various Articles of Association provide that all business
disputes pertaining to Foreign Invested Enterprises will be resolved by the
Arbitration Institute of the Stockholm Chamber of Commerce in Stockholm, Sweden
applying Chinese substantive law, the Chinese minority partner in the Company’s
joint venture companies will not assume any advantageous position regarding such
disputes. Any award rendered by this arbitration tribunal is, by the express
terms of the various Articles of Association, enforceable in accordance with the
“United Nations Convention on the Recognition and Enforcement of Foreign
Arbitral Awards (1958).” Therefore, as a practical matter, although no
assurances can be given, the Chinese legal infrastructure, while different from
its United States counterpart, should not present any significant impediment to
the operation of Foreign Invested Enterprises.
  ECONOMIC
REFORM ISSUES
  Although
the Chinese Government owns the majority of productive assets in China, in the
past several years the Government has implemented economic reform measures that
emphasize decentralization and encourage private economic activity. Because
these economic reform measures may be inconsistent or ineffectual, there is no
assurance that:
  -
              The
      Company will be able to capitalize on economic
  reforms;
 -
              The
      Chinese Government will continue its pursuit of economic reform
      policies;
 -
              The
      economic policies, even if pursued, will be
  successful;
 -
              Economic
      policies will not be significantly altered from time to time;
      and
 -
              Business
      operations in China will not become subject to the risk of
      nationalization.
  Negative
impact resulting from economic reform policies or nationalization could result
in a total investment loss in the Company’s common stock.
  Since
1979, the Chinese Government has reformed its economic system. Because many
reforms are unprecedented or experimental, they are expected to be refined and
readjusted. Other political, economic and social factors, such as political
changes, changes in the rates of economic growth, unemployment or inflation, or
disparities in per capita wealth between regions within China, could lead to
further readjustment of the reform measures. This refining and readjustment
process may negatively affect the Company’s operations.
  11
  Over the
last few years, China’s economy has registered a high growth rate. Recently,
there have been indications that the rate of inflation has increased. In
response, the Chinese Government recently has taken measures to curb the
excessively expansive economy. These measures included implementation of a
unitary and well-managed floating exchange rate system based on market supply
and demand for the exchange rates of Renminbi, restrictions on the availability
of domestic credit, reduction of the purchasing capability of its citizens, and
centralization of the approval process for purchases of certain limited foreign
products. These austerity measures alone may not succeed in slowing down the
economy’s excessive expansion or control inflation, and may result in severe
dislocations in the Chinese economy. The Chinese Government may adopt additional
measures to further combat inflation, including the establishment of freezes or
restraints on certain projects or markets.
  To date
reforms to China’s economic system have not adversely affected the Company’s
operations and are not expected to adversely affect the Company’s operations in
the foreseeable future; however, there can be no assurance that reforms to
China’s economic system will continue or that the Company will not be adversely
affected by changes in China’s political, economic, and social conditions and by
changes in policies of the Chinese Government, such as changes in laws and
regulations, measures which may be introduced to control inflation, changes in
the rate or method of taxation, imposition of additional restrictions on
currency conversion and remittance abroad, reduction in tariff protection and
other import restrictions.
  ENVIRONMENTAL
COMPLIANCE
 
 The
Company is subject to the requirements of U.S. federal, state, local and
non-U.S. environmental and occupational safety and health laws and regulations.
These include laws regulating air emissions, water discharge and waste
management. The Company has an environmental management structure designed to
facilitate and support its compliance with these requirements globally. Although
it is the Company’s intent to comply with all such requirements and regulations,
it cannot provide assurance that it is at all times in compliance. The Company
has made and will continue to make capital and other expenditures to comply with
environmental requirements, although such expenditures were not material during
the past two years. Environmental requirements are complex, change frequently
and have tended to become more stringent over time. Accordingly, the Company
cannot assure that environmental requirements will not change or become more
stringent over time or that its eventual environmental cleanup costs and
liabilities will not be material.
 
 During
2008, the Company did not make any material capital expenditures relating to
environmental compliance.
 
 WEB SITE
ACCESS TO SEC FILINGS
 
 The
Company files electronically with the SEC its annual reports on Form 10-K,
quarterly reports on Form 10-Q and current reports on Form 8-K pursuant to
Section 13(a) of the Securities Exchange Act of 1934.  The SEC
maintains an Internet site that contains reports, proxy information and
information statements, and other information regarding issuers that file
electronically with the SEC.  The address of that website is
http://www.sec.gov.  The materials are also available at the SEC’s
Public Reference Room, located at 100 F Street, Washington, D.C.
20549.  The public may obtain information through the public reference
room by calling the SEC at 1-800-SEC-0330.
  12
  ITEM
1A.      RISK FACTORS
  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 prospectus, 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
  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.  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 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
Senior Convertible Notes are the Company’s unsecured obligations, but are not
obligations of its subsidiaries. In addition, the Company’s secured commercial
debt is senior to the Senior 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:
  •
              Quality;
 •
              Price/cost
      competitiveness;
 •
              System
      and product performance;
 •
              Reliability
      and timeliness of delivery;
 •
              New
      product and technology development
capability;
 •
              Excellence
      and flexibility in operations;
 •
              Degree
      of global and local presence;
 •
              Effectiveness
      of customer service; and
 •
              Overall
      management capability.
  The
Company’s competitors include independent suppliers of parts, as well as
suppliers formed by spin-offs from 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.
  13
 
 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.
  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 addition, in the
last two years, the price of automobiles in China has generally declined. 
As a result, the volume of automotive production in China has fluctuated from
year to year, which gives rise to fluctuations in the demand for the Company’s
products.  Any significant economic decline that results in a reduction in
automotive production and sales by the Company’s customers would have a material
adverse effect on 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.
  Pricing
pressure by automobile manufacturers on their suppliers may adversely affect the
Company’s business and results of operations.
  Recently,
pricing pressure from automobile manufacturers has been prevalent in the
automotive parts industry in China.  Virtually all vehicle manufacturers
seek price reductions each year, including requiring suppliers to pay a “3-R
Guarantees” service charge for repair, replacement and refund in an amount equal
to one percent of the total amount of parts supplied.  Although the Company
has tried to reduce costs and resist price reductions, these reductions have
impacted the Company’s sales and profit margins.  If the Company cannot
offset continued price reductions through improved operating efficiencies and
reduced expenditures, price reductions will have a material adverse effect on
the Company's results of operations.
  14
  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, 2008, approximately 15.1% of the Company’s sales were to
Chery Automobile Co., Ltd, approximately 12.0% were to Brilliance China
Automotive Holdings Limited, approximately 11.4% were to Xi’an BYD Electric Car
Co., Ltd, and approximately 10.7% were to Beiqi Foton Motor Co., Ltd, the
Company’s four largest customers. The loss of, or significant reduction in
purchases by, one or more of these major customers could adversely affect the
Company’s business.
  The
Company may be subject to product liability and warranty and recall claims,
which may increase the costs of doing business and adversely affect the
Company’s financial condition and liquidity.
  The
Company may be exposed to product liability and warranty claims if its products
actually or allegedly fail to perform as expected or the use of its products
results, or is alleged to result, in bodily injury and/or property damage. 
The Company started to pay 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 equal to one percent 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
operation.
  The
Company is subject to the requirements of environmental and occupational safety
and health laws and regulations in China.  The Company cannot provide
assurance that it has been or will be at all times in full compliance with all
of these requirements, or that it will not incur material costs or liabilities
in connection with these 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 failed 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.
  15
  The
Company’s management controls approximately 82.9% of its outstanding common
stock and may have conflicts of interest with the Company’s minority
stockholders.
  Members
of the Company’s management beneficially own approximately 82.9% of the
outstanding shares of the Company’s common stock.  As a result, these
majority stockholders have control over decisions to enter into any corporate
transaction and have the ability to prevent any transaction that requires the
approval of stockholders, which could result in the approval of transactions
that might not maximize stockholders’ value.  Additionally, these
stockholders control the election of members of the Company’s board, have the
ability to appoint new members to the Company’s management team and control the
outcome of matters submitted to a vote of the holders of the Company’s
common stock.  The interests of these majority stockholders may at times
conflict with the interests of the Company’s other stockholders.  The
Henglong Transaction was a transaction involving the Company and a counterparty
controlled by Mr. Hanlin Chen, the Company’s Chairman and controlling
stockholder.  The Company regularly engages in transactions with
entities controlled by one or more of its officers and directors.
 
 Covenants
contained in the Securities Purchase Agreement and the Senior Convertible Notes
restrict the Company’s operating flexibility.
  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. Of the Company’s
outstanding common stock, approximately 17.1% 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.
  The
Company may face early redemption from Convertible Note Holders and if it is not
able to raise capital quickly to redeem, it may result in a material adverse
effect on the Company’s liquidity, capital resources, business, results of
operations or financial condition.
 In
February 2008, the Company sold to two accredited institutional investors,
Lehman Brothers Commercial Corporation Asia Limited and YA Global Investments,
L.P., $35 million of convertible debt, the “Convertible Notes”, with a scheduled
maturity date of February 15, 2013. Pursuant to the terms of the Convertible
Notes, among others, 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”, the Convertible Note holders , at their
sole discretion, can require the Company redeem all or any portion of their
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. As a result of the recent worldwide financial turmoil, 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 the
WAP Default notice to the Convertible Note holders.  Since the Company
has not received any notice from YA Global Investments, L.P. as of March
24, 2009, its redemption rights under such WAP Default has lapsed. On
March 23, 2009, the Company received a letter from the joint and several
provisional liquidator acting on behalf of Lehman Brothers Commercial
Corporation Asia Limited, “LBCCA Liquidator”, requesting that it be granted an
extension of time until April 24, 2009 to obtain legal advice and to consider
its rights under the Convertible Notes. The Company has granted an
extension to April 15, 2009. Although the LBCCA Liquidator has
not given the Company any notice of redemption yet, it may exercise
its discretionary right of early redemption on any date that is no earlier
than ninety (90) days after it delivers the written redemption notice to
the Company, so long as it delivers such notice on or before April
15, 2009.
  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 its control. It is uncertain
whether the Company can raise sufficient capital to redeem via borrowing or
issuance of additional stock as the world economic and financial conditions
remain unsettled. 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 failure to redeem
would result in a material adverse effect on its liquidity, capital resources,
business, results of operations or financial condition.
  16
  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.
  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 Senior Convertible Notes.
 
 Risks Related to Doing
Business in China and Other Countries Besides the United
States
  Because
the Company’s operations are all located outside of the United States and are
subject to Chinese laws, any change of Chinese laws may adversely affect its
business.
  All of
the Company’s operations are outside the United States and in China, which
exposes it to risks, such as exchange controls and currency restrictions,
currency fluctuations and devaluations, changes in local economic conditions,
changes in Chinese laws and regulations, exposure to possible expropriation or
other Chinese government actions, and unsettled political conditions. 
These factors may have a material adverse effect on the Company’s operations or
on its business, results of operations and financial condition.
  The
Company’s international expansion plans subject it to risks inherent in doing
business internationally.
  The
Company’s long-term business strategy relies on the expansion of its
international sales outside China by targeting markets, such as the United
States.  Risks affecting the Company’s international expansion include
challenges caused by distance, language and cultural differences, conflicting
and changing laws and regulations, foreign laws, international import and export
legislation, trading and investment policies, foreign currency fluctuations, the
burdens of complying with a wide variety of laws and regulations, protectionist
laws and business practices that favor local businesses in some countries,
foreign tax consequences, higher costs associated with doing business
internationally, restrictions on the export or import of technology,
difficulties in staffing and managing international operations, trade and tariff
restrictions, and variations in tariffs, quotas, taxes and other market
barriers.  These risks could harm the Company’s international expansion
efforts, which could in turn materially and adversely affect its business,
operating results and financial condition.
  17
 
 The
Company faces risks associated with currency exchange rate fluctuations; any
adverse fluctuation may adversely affect tits operating margins.
 
 Although
he Company is incorporated in the United States, “Delaware”, the majority of its
current revenues are in Chinese currency.  Conducting business in
currencies other than US dollars subjects the Company to fluctuations in
currency exchange rates that could have a negative impact on its reported
operating results.  Fluctuations in the value of the US dollar relative to
other currencies impact the Company’s revenues, cost of revenues and operating
margins and result in foreign currency translation gains and losses. 
Historically, the Company has not engaged in exchange rate hedging activities.
Although the Company may implement hedging strategies to mitigate this risk,
these strategies may not eliminate its exposure to foreign exchange rate
fluctuations and involve costs and risks of their own, such as ongoing
management time and expertise requirements, external costs to implement the
strategy and potential accounting implications.
  If
relations between the United States and China worsen ,the Company’s stock price
may decrease and the Company may have difficulty accessing the U.S. capital
markets.
  At
various times during recent years, the United States and China have had
disagreements over political and economic issues.  Controversies may arise
in the future between these two countries.  Any political or trade
controversies between the United States and China could adversely affect the
market price of the Company’s common stock and its ability to access US capital
markets.
  The
Chinese Government could change its policies toward private enterprise, which
could adversely affect the Company’s business.
  The
Company’s business is subject to political and economic uncertainties in China
and may be adversely affected by China’s political, economic and social
developments.  Over the past several years, the Chinese Government has
pursued economic reform policies including the encouragement of private economic
activity and greater economic decentralization.  The Chinese Government may
not continue to pursue these policies or may alter them to the Company’s
detriment from time to time.  Changes in policies, laws and regulations, or
in their interpretation or the imposition of confiscatory taxation, restrictions
on currency conversion, restrictions or prohibitions on dividend payments to
stockholders, devaluations of currency or the nationalization or other
expropriation of private enterprises could have a material adverse effect on the
Company’s business.  Nationalization or expropriation could result in the
total loss of the Company’s investment in China.
  The
economic, political and social conditions in China could affect the Company’s
business.
  All of
the Company’s business, assets and operations are located in China.  The
economy of China differs from the economies of most developed countries in many
respects, including government involvement, level of development, growth rate,
control of foreign exchange, and allocation of resources.  The economy of
China has been transitioning from a planned economy to a more market-oriented
economy.  Although the Chinese Government has implemented measures recently
emphasizing the utilization of market forces for economic reform, the reduction
of state ownership of productive assets and the establishment of sound corporate
governance in business enterprises, a substantial portion of productive assets
in China is still owned by the Chinese Government.  In addition, the
Chinese Government continues to play a significant role in regulating industry
by imposing industrial policies.  It also exercises significant control
over China’s economic growth through the allocation of resources, controlling
payment of foreign currency-denominated obligations, setting monetary policy and
providing preferential treatment to particular industries or companies. 
Therefore, the Chinese Government’s involvement in the economy could adversely
affect the Company’s business operations, results of operations and/or financial
condition.
  18
  The
Chinese Government’s macroeconomic policies could have a negative effect on the
Company’s business and results of operations
  The
Chinese Government has implemented various measures from time to time to control
the rate of economic growth. Some of these measures benefit the overall
economy of China, but may have a negative effect on the Company.
  Government control of currency
conversion and future movements in exchange rates may adversely affect the
Company’soperations and financial
results.
  The
Company receives substantially all of its revenues in Renminbi, the currency of
China.  A portion of such revenues will be converted into other currencies
to meet the Company’s foreign currency obligations.  Foreign exchange
transactions under the Company’s capital account, including principal payments
in respect of foreign currency-denominated obligations, continue to be subject
to significant foreign exchange controls and require the approval of the State
Administration of Foreign Exchange in China.  These limitations could
affect the Company’s ability to obtain foreign exchange through debt or equity
financing, or to obtain foreign exchange for capital expenditures.
 
 The
Chinese Government controls its foreign currency reserves through restrictions
on imports and conversion of Renminbi into foreign currency. In July 2005,
the Chinese Government has adjusted its exchange rate policy from “Fixed
Rate” to “Floating Rate”. During July 2005 to July 2008, the exchange rate
between RMB and US dollars has experienced a big fluctuation, for RMB
1.00 to US$0.1205 and RMB 1.00 to US$0.1462, respectively. Since August 2008,
the exchange rate has maintained stable, and was approximately at RMB 1.00
to US$0.1462. There can be no assurance that the exchange rate will
remain stable. The Renminbi could devalue against the US dollar. The
Company’s financial condition and results of operations may also be affected by
changes in the value of certain currencies other than the Renminbi in which its
earnings and obligations are denominated. In particular, a devaluation of
the Renminbi is likely to increase the portion of the Company’s cash flow
required to satisfy its foreign currency-denominated obligations.
  Because
the Chinese legal system is not fully developed, the Company and its
securityholders’ legal protections may be limited.
  The
Chinese legal system is based on written statutes and their interpretation by
the Supreme People’s Court. Although the Chinese government introduced new laws
and regulations to modernize its business, securities and tax systems on January
1, 1994, China does not yet possess a comprehensive body of business
law. Because Chinese laws and regulations are relatively new,
interpretation, implementation and enforcement of these laws and regulations
involve uncertainties and inconsistencies and it may be difficult to enforce
contracts. In addition, as the Chinese legal system develops, changes in
such laws and regulations, their interpretation or their enforcement may have a
material adverse effect on the Company’s business operations. Moreover,
interpretative case law does not have the same precedential value in China as in
the United States, so legal compliance in China may be more difficult or
expensive.
  19
  It
may be difficult to serve the Company with legal process or enforce judgments
against its management or the Company.
  All of
the Company’s assets are located in China and three of its directors and
officers are non-residents of the United States, and all or substantial portions
of the assets of such non-residents are located outside the United
States. As a result, it may not be possible to effect service of process
within the United States upon such persons to originate an action in the United
States. Moreover, there is uncertainty that the courts of China would
enforce judgments of U.S. courts against the Company, its directors or officers
based on the civil liability provisions of the securities laws of the United
States or any state, or an original action brought in China based upon the
securities laws of the United States or any state.
  ITEM 1B.
 UNRESOLVED STAFF COMMENTS.
  Not
Applicable.
  ITEM 2.
 DESCRIPTION OF PROPERTY.
  The
Company’s headquarters are located at No. 1 Henglong Road, Yu Qiao Development
Zone Shashi District, Jing Zhou City Hubei Province, PRC. Set forth below are
the manufacturing facilities operated by each joint venture. The Company has
forty to fifty years long-term rights to use the lands and
buildings.
  Name of
                                                                                  Entity
                                                                                
                                                                                Product
                                                                                
                                                                                Total Area
                                                                                  (M2)
                                                                                
                                                                                
                                                                                Building Area
                                                                                  (M2)
                                                                                
                                                                                
                                                                                Original Cost of
                                                                                  Equipment
                                                                                
                                                                                SiteHenglong
                                                                                
                                                                                Automotive
      Parts
                                                                                
                                                                                
                                                                                225,221
                                                                                
                                                                                
                                                                                
                                                                                20,226
                                                                                
                                                                                
                                                                                $
                                                                                28,637,306
                                                                                
                                                                                Jingzhou
      City, Hubei Province13,393
                                                                                
                                                                                
                                                                                
                                                                                13,707
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                Wuhan
      City, Hubei ProvinceJiulong
                                                                                
                                                                                Power
      Steering Gears
                                                                                
                                                                                
                                                                                39,478
                                                                                
                                                                                
                                                                                
                                                                                23,728
                                                                                
                                                                                
                                                                                
                                                                                17,618,189
                                                                                
                                                                                Jingzhou
      City, Hubei ProvinceShenyang
                                                                                
                                                                                Automotive
      Steering Gears
                                                                                
                                                                                
                                                                                35,354
                                                                                
                                                                                
                                                                                
                                                                                5,625
                                                                                
                                                                                
                                                                                
                                                                                3,817,590
                                                                                
                                                                                Shenyang
      City, Liaoning ProvinceZhejiang
                                                                                
                                                                                Steering
      Pumps
                                                                                
                                                                                
                                                                                100,000
                                                                                
                                                                                
                                                                                
                                                                                32,000
                                                                                
                                                                                
                                                                                
                                                                                6,408,334
                                                                                
                                                                                Zhuji
      City, Zhejiang ProvinceUSAI
                                                                                
                                                                                Sensor
      Modular
                                                                                
                                                                                
                                                                                —
                                                                                
                                                                                
                                                                                
                                                                                —
                                                                                
                                                                                
                                                                                
                                                                                706,307
                                                                                
                                                                                Wuhan
      City, Hubei ProvinceWuhu
                                                                                
                                                                                Automotive
      Steering Gears
                                                                                
                                                                                
                                                                                83,700
                                                                                
                                                                                
                                                                                
                                                                                12,600
                                                                                
                                                                                
                                                                                
                                                                                1,745,373
                                                                                
                                                                                Wuhu
      City, Anhue ProvinceJielong
                                                                                
                                                                                Electric
      PowerSteering
                                                                                
                                                                                
                                                                                —
                                                                                
                                                                                
                                                                                
                                                                                —
                                                                                
                                                                                
                                                                                
                                                                                301,823
                                                                                
                                                                                Wuhan
      City, Hubei ProvinceHengsheng
                                                                                
                                                                                Automotive
      Steering Gears
                                                                                
                                                                                
                                                                                170,520
                                                                                
                                                                                
                                                                                
                                                                                26,000
                                                                                
                                                                                
                                                                                
                                                                                1,706,416
                                                                                
                                                                                Jingzhou
      City, Hubei ProvinceTotal
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                667,666
                                                                                
                                                                                
                                                                                
                                                                                133,886
                                                                                
                                                                                
                                                                                $
                                                                                60,941,338
  20
  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.
  The
Company is not a party to any pending or to the best of the Company’s knowledge,
any threatened legal proceedings. No director, officer or affiliate of the
Company, or owner of record of more than five percent, 5%, 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.
  ITEM 4.
 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  On June
25 2008, the Company held a shareholder meeting at which the shareholders
elected 5 directors and approved the engagement of Schwartz Levitsky Feldman LLP
as independent auditor.
  PART
II
  ITEM 5.
 MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES
OF EQUITY SECURITIES.
  (a)
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 2008
and 2007 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 Range2008
                    
                    
                    2007High
                    
                    
                    Low
                    
                    
                    High
                    
                    
                    LowFirst
      Quarter
                    
                    $
                    7.98
                    
                    
                    $
                    4.40
                    
                    
                    $
                    11.97
                    
                    
                    $
                    7.83Second
      Quarter
                    
                    
                    7.45
                    
                    
                    
                    4.85
                    
                    
                    
                    8.90
                    
                    
                    
                    7.00Third
      Quarter
                    
                    
                    6.69
                    
                    
                    
                    3.88
                    
                    
                    
                    8.76
                    
                    
                    
                    6.19Fourth
      Quarter
                    
                    $
                    4.20
                    
                    
                    $
                    2.01
                    
                    
                    $
                    9.39
                    
                    
                    $
                    6.40
  21
  (b)
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 February 27, 2009, there were 26,983,244 shares of
the Company’s common stock outstanding and the Company had approximately 76
stockholders of record.
  (c)
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.
  (d)
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
  The
securities authorized for issuance under equity compensation plans at December
31, 2008 are as follows:
  Plan category
                    
                    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 issuanceEquity
      compensation plans approved by security holders
                    
                    
                    2,200,000
                    
                    
                    $
                    3.84
                    
                    
                    
                    1,788,650
  The stock
option plan was approved in 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.
  ITEM
6.  SELECTED FINANCIAL DATA
 
 Not
applicable.
  22
  ITEM 7.
 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION.
  The
following is management’s discussion and analysis of certain significant factors
which have affected the Company’s financial position and operating results
during the periods included in the accompanying consolidated financial
statements, as well as information relating to the plans of its current
management. This report includes forward-looking statements. 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,” “continue,” “could,”
“estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predict,”
“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 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 undertakes no obligation to update these
forward-looking statements. 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.
  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”, as described below.
  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.
  The
Company owns the following aggregate net interests in eight Sino-foreign joint
ventures organized in the PRC as of December 31, 2008 and 2007.
  Percentage InterestName of Entity
                  
                  2008
                  
                  
                  2007Jingzhou
      Henglong Automotive Parts Co., Ltd., “Henglong”
                  
                  
                  80.00
                  %
                  
                  
                  44.50
                  %Shashi
      Jiulong Power Steering Gears Co., Ltd., “Jiulong”
                  
                  
                  81.00
                  %
                  
                  
                  81.00
                  %Shenyang
      Jinbei Henglong Automotive Steering System Co., Ltd.,
      “Shenyang”
                  
                  
                  70.00
                  %
                  
                  
                  70.00
                  %Zhejiang
      Henglong & Vie Pump-Manu Co., Ltd., “Zhejiang”
                  
                  
                  51.00
                  %
                  
                  
                  51.00
                  %Universal
      Sensor Application Inc., “USAI”
                  
                  
                  83.34
                  %
                  
                  
                  75.90
                  %Wuhan
      Jielong Electric Power Steering Co., Ltd., “Jielong”
                  
                  
                  85.00
                  %
                  
                  
                  85.00
                  %Wuhu
      HengLong Auto Steering System Co., Ltd., “Wuhu”
                  
                  
                  77.33
                  %
                  
                  
                  77.33
                  %Jingzhou
      Hengsheng Automotive System Co., Ltd, “Hengsheng”
                  
                  
                  100.00
                  %
                  
                  
                  100.00
                  %
  23
  Jiulong
was established in 1993 and mainly engaged in the production of integral power
steering gears for heavy-duty vehicles.
  Henglong
was established in 1997 and mainly engaged in the production of rack and pinion
power steering gear for cars and light duty vehicles.
  On March
31, 2008, the Company’s wholly-owned subsidiary, Genesis, and Wiselink, both
controlled by Hanlin Chen and his family, entered into an equity transfer
agreement, the “Henglong Agreement”, pursuant to which Wiselink transferred and
assigned its 35.5% equity interest in Henglong, one of the Company’s currently
consolidated subsidiaries, to Genesis for a total consideration of $32,090,000.
The Company now holds an 80% equity interest in Jingzhou Henglong.
  Under the
terms of the Henglong Agreement, Genesis is deemed to be the owner of Henglong
commencing from January 1, 2008. The Henglong Acquisition is considered as a
business combination of companies under common control and is being accounted
for in a manner of pooling of interests.
  Shenyang
was established in 2002 and focuses on power steering parts for light duty
vehicles.
  Zhejiang
was established in 2002 to focus on power steering pumps.
  USAI was
established in 2005 and mainly engaged in production and sales of sensor
modulars.
  In 2008,
Genesis and Shanghai Hongxi Investment Inc., “Hongxi”, the other shareholder of
USAI, agreed to increase USAI’s capital to $2,600,000 from $1,800,000. The
increased capital was wholly funded by Genesis. Therefore, the capital
contributed by Genesis in USAI increased to $2,166,900 from $1,366,900,
accounting for 83.34% of the total capital; while the capital contributed by
Hongxi remained unchanged, accounting for 16.66% of the total
capital.
  Wuhu was
established in 2006 and mainly engaged in production and sales of automobile
steering systems.
  Jielong
was established in 2006 and mainly engaged in production and sales of electric
power steering, “EPS”.
  Hengsheng
was established in 2007 and mainly engaged in production and sales of automobile
steering systems.
  RESULTS
OF OPERATIONS
  The
following table sets forth for the periods indicated certain items from the
Company's Consolidated Statements of Income expressed as a percentage of net
sales and the percentage change in the dollar amount of each such item from that
in the indicated previous year.
  24
  Percentage on net sales
                    
                    
                    Change in percentageYear Ended December 31
                    
                    
                    Year Ended December 312008
                    
                    
                    2007
                    
                    
                    2008 vs 2007Net
      sales
                    
                    
                    100.00
                    %
                    
                    
                    100.00
                    %
                    
                    
                    22.1
                    %Cost
      of sales
                    
                    
                    71.0
                    
                    
                    
                    66.1
                    
                    
                    
                    31.3Gross
      profit
                    
                    
                    29.0
                    
                    
                    
                    33.9
                    
                    
                    
                    4.3Gain
      on other sales
                    
                    
                    0.4
                    
                    
                    
                    0.4
                    
                    
                    
                    32.5Less:
      operating expensesSelling
      expenses
                    
                    
                    6.7
                    
                    
                    
                    7.2
                    
                    
                    
                    12.4General
      and administrative expenses
                    
                    
                    7.4
                    
                    
                    
                    6.8
                    
                    
                    
                    34.0R
      & D expenses
                    
                    
                    1.4
                    
                    
                    
                    1.2
                    
                    
                    
                    35.4Depreciation
      and amortization
                    
                    
                    3.6
                    
                    
                    
                    3.2
                    
                    
                    
                    37.8Total
      operating expenses
                    
                    
                    19.1
                    
                    
                    
                    18.4
                    
                    
                    
                    26.2Operating
      income
                    
                    
                    10.3
                    
                    
                    
                    15.9
                    
                    
                    
                    (20.4
                    )Other
      income
                    
                    
                    0.7
                    
                    
                    
                    0.0
                    
                    
                    
                    -Financial
      expenses
                    
                    
                    (0.8
                    )
                    
                    
                    (0.4
                    )
                    
                    
                    128.6Gain
      (loss) on change in fair value of derivative
                    
                    
                    0.6
                    
                    
                    
                    -
                    
                    
                    
                    -Income
      before income tax
                    
                    
                    10.8
                    
                    
                    
                    15.5
                    
                    
                    
                    (14.7
                    )Income
      tax
                    
                    
                    0.1
                    
                    
                    
                    1.7
                    
                    
                    
                    (91.7
                    )Income
      before minority interests
                    
                    
                    10.7
                    
                    
                    
                    13.8
                    
                    
                    
                    (5.4
                    )Minority
      interests
                    
                    
                    3.1
                    
                    
                    
                    7.2
                    
                    
                    
                    (47.4
                    )Net
      income
                    
                    
                    7.6
                    %
                    
                    
                    6.6
                    %
                    
                    
                    40.4
                    %
  RESULTS
OF OPERATIONS: 2008 VERSUS 2007
  NET
SALES
  The
increase in net product sales of the Company is summarized as
follows:
  Years Ended December 312008
                  
                  
                  2007
                  
                  
                  Increase (Decrease)
                  
                  
                  PercentageSteering
      gear for commercial vehicles
                  
                  $
                  40,457,552
                  
                  
                  $
                  35,774,012
                  
                  
                  $
                  4,683,540
                  
                  
                  
                  13.1
                  %Steering
      gear for passenger vehicles
                  
                  
                  107,219,598
                  
                  
                  
                  83,895,652
                  
                  
                  
                  23,323,946
                  
                  
                  
                  27.8Steering
      pumps
                  
                  
                  15,094,357
                  
                  
                  
                  13,828,252
                  
                  
                  
                  1,266,105
                  
                  
                  
                  9.2Sensor
      modular
                  
                  
                  407,779
                  
                  
                  
                  99,087
                  
                  
                  
                  308,692
                  
                  
                  
                  311.5Total
                  
                  $
                  163,179,286
                  
                  
                  $
                  133,597,003
                  
                  
                  $
                  29,582,283
                  
                  
                  
                  22.1
                  %
  For the
year ended December 31, 2008, net product sales were $163,179,286, as compared
to $133,597,003 for the year ended December 31, 2007, an increase of
$29,582,283, or 22.1%. The increase in net sales in 2008 as compared to 2007 was
a result of several factors.
  25
  (1)
Increases in the income of Chinese residents and the growth of consumption led
to an increase in the sales of passenger vehicles, which led to the increase in
the Company’s sales of steering gears and pumps. During 2008, the output and
sales volume of passenger vehicles in China have reached 6,737,700 and 6,755,600
units respectively, with an increase of 5.6% and 7.3% compared with last year.
As a result, sales of steering gear and pumps for domestic passenger vehicles
for the year ended December 31, 2008 increased 27.8% and 9.2% over 2007,
respectively.
 
 (2)
Increased national economic investments in China led to an increase in sales of
commercial vehicles, which led to the increase in the Company’s sales of
steering gears for commercial vehicles. The output and sales volume of
commercial vehicles have reached 2,607,400 and 2,624,900 units respectively with
an increase of 4.2% and 5.3% over last year. For the year ended December 31,
2008, sales of steering gears and accessories for commercial vehicles increased
by 13.1% as compared to 2007.
 
 (3) The
Company has raised the technological contents in, and production efficiency of,
its products as a result of technological improvement to its production lines,
allowing the Company to reduce its costs and, correspondingly, its sales prices
which led to increased sales volumes.
  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, 2008, gain on other sales were $734,063,
as compared to $554,150 for the year ended December 31, 2007, an increase of
$179,913, or 32.5%, due to increased sales of materials.
 
 GROSS
PROFIT FROM PRODUCT SALES
  For the
year ended December 31, 2008, the gross profit was $47,258,701, as compared to
$45,323,048 for the year ended December 31, 2007, an increase of $1,935,653, or
4.3%, as a result of following factors:
  The
increased income of sales contributed to an increase of $16,908,063 in gross
profit, while the increase in unit cost resulted in a decrease of $14,972,410 in
gross profit.
  Gross
margin was 29.0% for the year ended December 31, 2008, a decrease of 4.9% from
33.9% for the same period of 2007, primarily due to an increase in materials
price and unit cost. The Company took the following measures in 2008 to increase
gross profit levels.
  1. Reduce
manufacturing costs by optimizing product design and production techniques.
During 2008, the Company’s technical personnel improved product design and
production techniques to reduce wastage in the production process and improve
manufacturing efficiency, thus reducing costs.
  2. Raise
the selling price of commercial vehicles steering gear. During the twelve months
ended December 31, 2008, the unit cost of commercial vehicles steering gear
increased, due to the sharp rise of the price of steel, its main raw material.
In order to meet the gross margin target, the Company has raised the selling
price of commercial vehicles steering gear after negotiation with the
OEMs.
  SELLING
EXPENSES
  For the
years ended December 31, 2008 and 2007, selling expenses are summarized as
follows:
  26
  Years Ended December 312008
                  
                  
                  2007
                  
                  
                  Increase (Decrease)
                  
                  
                  PercentageSalaries
      and wages
                  
                  $
                  1,413,708
                  
                  
                  $
                  1,516,436
                  
                  
                  $
                  (102,728
                  )
                  
                  
                  (6.8
                  %)Supplies
      expense
                  
                  
                  138,489
                  
                  
                  
                  76,448
                  
                  
                  
                  62,041
                  
                  
                  
                  81.2Travel
      expense
                  
                  
                  489,872
                  
                  
                  
                  328,095
                  
                  
                  
                  161,777
                  
                  
                  
                  49.3Transportation
      expense
                  
                  
                  2,158,793
                  
                  
                  
                  1,868,245
                  
                  
                  
                  290,548
                  
                  
                  
                  15.6After
      sales service expense
                  
                  
                  5,861,783
                  
                  
                  
                  5,251,382
                  
                  
                  
                  610,401
                  
                  
                  
                  11.6Rent
      expense
                  
                  
                  384,167
                  
                  
                  
                  265,908
                  
                  
                  
                  118,259
                  
                  
                  
                  44.5Office
      expense
                  
                  
                  152,179
                  
                  
                  
                  114,105
                  
                  
                  
                  38,074
                  
                  
                  
                  33.4Advertising
      expense
                  
                  
                  10,009
                  
                  
                  
                  14,168
                  
                  
                  
                  (4,159
                  )
                  
                  
                  (29.4
                  )Business
      entertainment expense
                  
                  
                  219,787
                  
                  
                  
                  222,200
                  
                  
                  
                  (2,413
                  )
                  
                  
                  (1.1
                  )Insurance
      expense
                  
                  
                  16,917
                  
                  
                  
                  15,431
                  
                  
                  
                  1,486
                  
                  
                  
                  9.6Other
      expense
                  
                  
                  23,957
                  
                  
                  
                  2,058
                  
                  
                  
                  21,899
                  
                  
                  
                  1,063.6Total
                  
                  $
                  10,869,661
                  
                  
                  $
                  9,674,476
                  
                  
                  $
                  1,195,185
                  
                  
                  
                  12.4
                  %
  Selling
expenses were $10,869,661 for the year ended December 31, 2008, as compared to
$9,674,476 for 2007, an increase of $1,195,185, or
12.4%. Major items that increased by more than $100,000 in 2008 as compared
to 2007 were travel expenses, transportation expense, after sales service
expense, and rent expenses.
  The
increase in travel expense was due to increased sales and marketing activities,
which led to increases in business travel.
  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.
  After
sales service expense for the year ended December 31, 2008 increased by
$610,401, or 11.6%, as compared with the last year, mainly due to the increased
product sales.
  The
increase in rent expense was due to increased marketing areas, which led to
increases in product warehouses and offices.
  GENERAL
AND ADMINISTRATIVE EXPENSES
  For the
years ended December 31, 2008 and 2007, general and administrative expenses are
summarized as follows:
  27
  Years Ended December 312008
                  
                  
                  2007
                  
                  
                  Increase (Decrease)
                  
                  
                  PercentageSalaries
      and wages
                  
                  $
                  3,929,989
                  
                  
                  $
                  3,921,572
                  
                  
                  $
                  8,417
                  
                  
                  
                  0.2
                  %Travel
      expenses
                  
                  
                  487,690
                  
                  
                  
                  491,422
                  
                  
                  
                  (3,732
                  )
                  
                  
                  (0.8
                  )Office
      expenses
                  
                  
                  551,760
                  
                  
                  
                  473,796
                  
                  
                  
                  77,964
                  
                  
                  
                  16.5Supplies
      expenses
                  
                  
                  611,169
                  
                  
                  
                  609,895
                  
                  
                  
                  1,274
                  
                  
                  
                  0.2Repairs
      expenses
                  
                  
                  656,886
                  
                  
                  
                  564,284
                  
                  
                  
                  92,602
                  
                  
                  
                  16.4Business
      entertainment expenses
                  
                  
                  363,791
                  
                  
                  
                  206,677
                  
                  
                  
                  157,114
                  
                  
                  
                  76.0Labor
      insurance expenses
                  
                  
                  1,667,287
                  
                  
                  
                  1,017,072
                  
                  
                  
                  650,215
                  
                  
                  
                  63.9Labor
      union dues expenses
                  
                  
                  108,704
                  
                  
                  
                  65,200
                  
                  
                  
                  43,504
                  
                  
                  
                  66.7Board
      of directors expense
                  
                  
                  66,920
                  
                  
                  
                  63,677
                  
                  
                  
                  3,243
                  
                  
                  
                  5.1Taxes
                  
                  
                  690,918
                  
                  
                  
                  476,765
                  
                  
                  
                  214,153
                  
                  
                  
                  44.9Provision
      for bad debts
                  
                  
                  989,584
                  
                  
                  
                  (649,512
                  )
                  
                  
                  1,639,096
                  
                  
                  
                  -Training
      expenses
                  
                  
                  194,954
                  
                  
                  
                  128,032
                  
                  
                  
                  66,922
                  
                  
                  
                  52.3Listing
      expenses
                  
                  
                  1,624,161
                  
                  
                  
                  1,203,104
                  
                  
                  
                  421,057
                  
                  
                  
                  35.0Others
      expenses
                  
                  
                  153,687
                  
                  
                  
                  454,733
                  
                  
                  
                  (301,046
                  )
                  
                  
                  (66.2
                  )Total
                  
                  $
                  12,097,500
                  
                  
                  $
                  9,026,717
                  
                  
                  $
                  3,070,783
                  
                  
                  
                  34.0
                  %
  General
and administrative expenses were $12,097,500 for the year ended December 31,
2008, as compared to $9,026,717 for the year ended December 31, 2007, an
increase of $3,070,783, or 34.0%.
  The
expense items that increased more than $100,000 in 2008 as compared to 2007 were
business entertainment expenses, labor insurance expenses, taxes expenses,
provision for bad debts expenses and listing expenses. Listing expenses
consisted of the costs associated with legal, accounting and auditing fees for
operating a public company.
  The
increase in business entertainment expense was due to reception of Government
staff to inspect and direct the Company’s management in 2008.
  The increase in labor insurance
expenses was mainly due to an increase of housing fund expenses at Henglong and
Jiulong for 2008.
  The
increase in tax expense was due to the increased assets of the Company, which
led to increased property taxes.
  The
increase in provision for bad debts was mainly due to certain accounts
receivable and advance payment for equipment which had remained outstanding
after the credit period. The Company believes that an additional provision for
bad debts is required.
  The
increase in listing expenses was due to increased costs associated with
auditing, legal, consulting and accounting fees for issuance of convertible
notes, and acquisition of 35.5% equity of Henglong, one of the Company’s
Joint-venture.
  RESEARCH
AND DEVELOPMENT EXPENSES
  Research
and development expenses were $2,255,892 for the year ended December 31, 2008,
as compared to $1,666,274 for the year ended December 31, 2007, an increase of
$589,618, or 35.4%.
  The
global automotive parts industry is highly competitive; winning and maintaining
new businesses require suppliers to rapidly produce new and innovative products
on a cost-competitive basis. In order to maintain the Company’s competitiveness,
the Company needs to invest more R & D expenses. In 2008, the Company not
only developed new products for foreign OEMs, but also increased R & D
expenses of power steering gears for domestic OEMs.
  28
  DEPRECIATION
AND AMORTIZATION EXPENSE
  For the
year ended December 31, 2008, depreciation and amortization expenses excluded
from that recorded under cost of sales were $5,846,290, as compared to
$4,243,930 for the year ended December 31, 2007, an increase of $1,602,360, or
37.8%, as a result of the Company’s increasing its fixed assets.
  INCOME
FROM OPERATIONS
  Income
from operations was $16,923,421 for the year ended December 31, 2008, as
compared to $21,265,801 for the year ended December 31, 2007, a decrease of
$4,342,380, or 20.4%, mainly consisting of an increase of $1,935,653, or 4.3%
from gross profit; an increase of $179,913, or 32.5% from net sales from
materials and others, and a decrease of operating income of $6,457,946, or
26.2%, as a result of increased operating expenses.
  OTHER
INCOME
  Other
income was $1,067,309 for the year ended December 31, 2008, as compared to
$38,462 for the year ended December 31, 2007, an increase of $1,028,847,
primarily as a result of increased government subsidies.
  Government
subsidies including interest subsidies, are the refunds by the Chinese
Government of interest charged by banks to companies which are entitled to such
subsidies, and subsidies for encouraging foreign investors to set up
technologically advanced enterprises in China.
  Interest
subsidies apply only to loan interest related to production facilities
expansion. During 2005 and 2006, the Company had used this special loan to
improve technologically its production line in order to enlarge capability and
enhance quality. The expansion project was completed and new facilities were put
into use at the end of 2006 and 2007, respectively.
  During
2007 and 2008, the experts sent by the Chinese Government reviewed and assessed
the actual usage of technologically improved production facilities on site in
order to confirm whether the improvement has achieved its expected goal of
production expansion and quality enhancement. Whether or not a company can
receive interest subsidies from the Chinese Government depends on the company’s
achieving the two goals set forth above after the technological
improvement.
  Chinese
government also provided incentives to foreign investors for setting up
technologically advanced enterprises in China. During 2008, Genesis, as a
foreign investor, has received $802,331 for re-investment in Jiulong and
Henglong with their profit distribution, and those entities were
technologically advanced enterprises and entitled to such
subsidies.
  Since
such government subsidy is similar to an investment income, the Company has
recorded it as other income.
  FINANCIAL
EXPENSES
  Financial
expenses were $1,296,218 for the year ended December 31, 2008, as compared to
financial expenses of $566,986 for the year of 2007, an increase of $729,232, or
128.6%, primarily as a result of an increase in interest expense of
$678,992, an increase in convertible notes discount amortization of $424,665 and
an increase in bank service fee of $36,210, as well as an increase of foreign
currency exchange gain of $210,081 and an increase in notes discount gain of
$200,554.
  GAIN ON
CHANGE IN FAIR VALUE OF DERIVATIVE
  Gain on
change in fair value of the derivatives embedded in the convertible
notes was $998,014 for the year ended December 31, 2008.
  29
 
 INCOME
BEFORE INCOME TAXES
  Income
before income taxes was $17,692,526 for the year ended December 31, 2008, as
compared to $20,737,277 for the year ended December 31, 2007, a decrease of
$3,044,751, or 14.7%, consisting of decreased income from operations of
$4,342,380, increased other income of $1,028,847, increased finance expenses of
$729,232, and increased gain on change in fair value of derivative of
$998,014.
  INCOME
TAXES
  Income
tax expense was $185,877 for the year ended December 31, 2008, as compared to
$2,231,032 for the year ended December 31, 2007, a decrease of $2,045,155, or
91.7%, mainly because of:
  1.
Decreased income from taxable income resulted in decreased income tax of
$325,105.
  2. The
Company has received an income tax refund of $2,762,823 for domestic equipment
purchased during the year ended December 31, 2008, as compared to $2,085,180 for
the year of 2007, leading to a decrease of income tax of $677,643.
 
 3. The
income tax rate for Jiulong, one of the Company’s Sino-foreign joint ventures in
2008, decreased to 25% from previous year’s 30%. This decrease in income tax
rate led to a decreased income tax expenses of $68,023.
 
 4. An
increase in deferred income taxes assets led to a decreased income tax expenses
of $974,383.
  INCOME
BEFORE MINORITY INTEREST
  Income
before minority shareholders' was $17,506,649 for the year ended December 31,
2008, as compared to $18,506,245 for the year ended December 31, 2007, a
decrease of $999,596, or 5.4%, consisting of decreased income before income
taxes of $3,044,751, or 14.7%, and an increase of $2,045,155, or 91.7% due to
decreased income tax expenses.
  MINORITY
INTEREST
  The
Company recorded minority shareholders’ share in the
earnings of the Sino-foreign joint ventures aggregating $5,071,408 for the year
ended December 31, 2008, and compared to $9,646,339 for the year ended December
31, 2007, a decrease of $4,574,931, or 47.4%.
  The
Company owns different equity interest in eight Sino-foreign joint ventures,
through which it conducts its operations. All the operating results of these
eight Sino-foreign joint ventures were consolidated in the Company’s financial
statements as of December 31, 2008 and 2007. The Company records the minority
shareholders' share in the earnings of the respective Sino-foreign joint
ventures for each period.
  In 2008,
minority interest decreased significantly as compared to 2007,
primarily because the minority shareholders' equity interest in Henglong
decreased by 35.5%. In early 2008, the Company acquired such equity
interest.
  30





NET
INCOME




Net
income was $12,435,241 for the year ended December 31, 2008, as compared to
$8,859,906 for the year ended December 31, 2007, an increase of $3,575,335, or
40.4%, consisting of decreased income before minority interest of $999,596, or
5.4%, and a decreased minority interest of $4,574,931, or 47.4%, which increased
net income.




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, 2008, the Company had cash and cash equivalents of $37,113,375, as
compared to $19,487,159 as of December 31, 2007, an increase of $17,626,216, or
90.5%.




The
Company had working capital of $42,032,901 as of December 31, 2008, as compared
to $35,022,355 as of December 31, 2007, an increase of $7,010,546, or
20.0%.




Financing
activities:





For the
Company’s bank loans and banker’s acceptance bill facilities, the Company’s
banks require the Company to sign documents to repay such facilities within one
year. On the condition that the Company can provide adequate mortgage security
and has not violated the terms of the line of credit agreement, such one year
facilities can be extended for another year.





The
Company had bank loans maturing in less than one year of $7,315,717 and bankers’
acceptances of $20,650,596 as of December 31, 2008.





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 in
section (a) Bank loan). 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 banker's acceptance bills will be devalued by
approximately $7,449,616. If the Company wishes to obtain the same amount of
bank loans and banker's acceptance bills, it will have to provide
$7,449,616 additional mortgages as of the mature 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 $2,205,537, which is 30% (the mortgage rates) of
$7,449,616, 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, and YA Global Investments, L.P.,
maturing in 5 years. According to the terms of the Senior Convertible Notes (as
described in Note 13), convertible notes may be required to be repaid in cash on
or prior to their maturity.  For example, Convertible Note holders are
entitled to require the Company 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 recent worldwide financial turmoil, 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 the
WAP Default notice to the Convertible Note holders.  Since the Company
has not received any notice from YA Global Investments, L.P. as of March
24, 2009, its redemption rights under such WAP Default has lapsed. On
March 23, 2009, the Company received a letter from the joint and several
provisional liquidator acting on behalf of Lehman Brothers Commercial
Corporation Asia Limited, “LBCCA Liquidator”, requesting that it be granted an
extension of time until April 24, 2009 to obtain legal advice and to consider
its rights under the Convertible Notes. The Company has granted an extension to
April 15, 2009. Although the LBCCA Liquidator has not given the
Company any notice of redemption yet, it may exercise its discretionary right of
early redemption on any date that is no earlier than ninety (90) days after it
delivers the written redemption notice to the Company, so long as it
delivers such notice on or before April 15, 2009.




The
Company’s ability to redeem the Convertible Notes and meet the Company’s payment
obligations depends on the Company’s cash position and the Company’s 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 failure
to redeem would result in a material adverse effect on its liquidity and capital
resources, business, results of operations or financial
condition.


31





(a) Bank
loans




As of
December 31, 2008, the principal outstanding under the Company’s credit
facilities and lines of credit was as follows:




Bank
                          
                          Due
      Date
                          
                          Amount
                            available
                          
                          
                          Amount
                            borrowedComprehensive
      credit facilities
                          
                          Bank
      of China
                          
                          Dec-09
                          
                          $
                          8,924,809
                          
                          
                          $
                          7,070,641Comprehensive
      credit facilities
                          
                          China
      Construction Bank
                          
                          Oct-09
                          
                          
                          8,984,988
                          
                          
                          
                          3,613,379Comprehensive
      credit facilities
                          
                          CITIC
      Industrial Bank
                          
                          Jul-09
                          
                          
                          6,804,559
                          
                          
                          
                          4,096,802Comprehensive
      credit facilities
                          
                          Shanghai
      Pudong Development Bank
                          
                          Oct-09
                          
                          
                          7,350,740
                          
                          
                          
                          2,936,383Comprehensive
      credit facilities
                          
                          Jingzhou
      Commercial Bank
                          
                          Oct-09
                          
                          
                          9,972,786
                          
                          
                          
                          1,155,883Comprehensive
      credit facilities
                          
                          Industrial
      and Commercial Bank of China
                          
                          Sep-09
                          
                          
                          2,926,287
                          
                          
                          
                          1,593,363Comprehensive
      credit facilities
                          
                          Bank
      of Communications Co., Ltd
                          
                          Sep-09
                          
                          
                          3,335,967
                          
                          
                          
                          1,360,723Comprehensive
      credit facilities
                          
                          China
      Merchants Bank Co. Ltd
                          
                          Sep-09
                          
                          
                          2,194,715
                          
                          
                          
                          2,194,715Total
                          
                          
                          
                          
                          
                          $
                          50,494,851
                          
                          
                          $
                          24,021,889







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 early 2008 at annual interest
rates of 5.31% to 6.83%, and for terms of six to twelve months. Pursuant to the
refinancing arrangement, the Company pledged $30,567,846 of equipment,
$5,334,489 of land use rights and $3,177,816 of buildings as security for its
comprehensive credit facility with the Bank of China; pledged $2,105,054 of land
use rights and $11,392,532 of buildings as security for its comprehensive credit
facility with Shanghai Pudong Development Bank; pledged $5,863,884 of land use
rights and $7,455,433 of equipment as security for its revolving comprehensive
credit facility with Jingzhou Commercial Bank; pledged $1,575,707 of land use
rights and $1,064,522 of buildings as security for its comprehensive credit
facility with Industrial and Commercial Bank of China; pledged $1,463,143 of
accounts receivable, $7,034,062 of land use rights and $3,660,990 of buildings
as security for its comprehensive credit facility with China Construction Bank;
pledged $2,985,764 of land use rights and $4,252,217 of buildings as security
for its comprehensive credit facility with China CITIC Bank; pledged $3,465,792
of land use rights and $1,920,101 of buildings as security for its comprehensive
credit facility with China Merchants Bank; pledged $4,151,801 of land use rights
and $2,341,907 of buildings as security for its comprehensive credit facility
with Bank of Communications Co., Ltd.


32





(b) Financing
from investors:





On
February 15, 2008, the Company sold $30,000,000 and $5,000,000 convertible notes
to Lehman Brothers Commercial Corporation Asia Limited, and YA Global
Investments, L.P., respectively, with a scheduled maturity date of February 15,
2013 and an initial conversion price for conversion into the Company’s common
stock of $8.8527 per share. 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.





According
to the terms of the Senior Convertible Notes (as described in Note 13),
convertible notes may be required to be repaid in cash on or prior to their
maturity.  For example, Convertible Note holders are entitled to
require the Company 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 recent worldwide financial turmoil, 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 the
WAP Default notice to the Convertible Note holders.  Since the Company
has not received any notice from YA Global Investments, L.P. as of March
24, 2009, its redemption rights under such WAP Default has lapsed. On
March 23, 2009, the Company received a letter from the joint and several
provisional liquidator acting on behalf of Lehman Brothers Commercial
Corporation Asia Limited, “LBCCA Liquidator”, requesting that it be granted an
extension of time until April 24, 2009 to obtain legal advice and to consider
its rights under the Convertible Notes. The Company has granted an extension to
April 15, 2009. Although the LBCCA Liquidator has not given the
Company any notice of redemption yet, it may exercise its discretionary right of
early redemption on any date that is no earlier than ninety (90) days after it
delivers the written redemption notice to the Company, so long as it
delivers such notice on or before April 15, 2009.




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. If the
aforementioned convertible notes must be repaid in cash at or before scheduled
maturity, and if at that time the Company cannot issue new notes or stock to
refinance, or acquire enough bank loans, or cannot extend the maturity dates of
such notes, the Company’s liquidity and capital resources will be adversely
affected.




Cash
Requirements:




The
following table summarizes the Company’s expected cash outflows resulting from
financial contracts and commitments. The Company has not included information on
its recurring purchases of materials for use in its manufacturing operations.
These amounts are generally consistent from year to year, closely reflecting the
Company’s levels of production, and are not long-term in nature, which are less
than three months.





Payment Due DatesTotal
                  
                  
                  Less
      than 1
                    year
                  
                  
                  1-3
      years
                  
                  
                  3-5
      years
                  
                  
                  More
      than 5
                    yearsShort-term
      bank loan
                  
                  $
                  7,315,717
                  
                  
                  $
                  7,315,717
                  
                  
                  $
                  —
                  
                  
                  $
                  —
                  
                  
                  $
                  —Notes
      payable
                  
                  
                  20,650,596
                  
                  
                  
                  20,650,596
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Convertible
      notes payable
                  
                  
                  35,000,000
                  
                  
                  
                  35,000,000
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Other
      contractual purchase commitments, including information
      technology
                  
                  
                  7,103,327
                  
                  
                  
                  5,971,113
                  
                  
                  
                  1,132,214
                  
                  
                  
                  —
                  
                  
                  
                  —Total
                  
                  $
                  70,069,640
                  
                  
                  $
                  68,937,426
                  
                  
                  $
                  1,132,214
                  
                  
                  $
                  —
                  
                  
                  $
                  —





33





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, 2008




Bank
                                
                                Purpose
                                
                                Borrowing
                                  Date
                                
                                Borrowing
                                  Term
                                  (Year)
                                
                                
                                Annual
                                  Percentage
                                  Rate
                                
                                Date
      of
                                  Interest
                                  Payment
                                Date
      of
                                  payment
                                
                                Amount
                                  Payable
      on
                                  Due
      DateBank
      of China
                                
                                Working
      Capital
                                
                                31-Oct-08
                                
                                
                                1
                                
                                
                                
                                6.66
                                %
                                Pay
      monthly
                                31-Oct-09
                                
                                
                                2,194,715China
      Construction Bank
                                
                                Working
      Capital
                                
                                29-Dec-08
                                
                                
                                1
                                
                                
                                
                                5.31
                                %
                                Pay
      monthly
                                29-Dec-09
                                
                                
                                2,926,287China
      Construction Bank
                                
                                Working
      Capital
                                
                                28-Sep-08
                                
                                
                                0.5
                                
                                
                                
                                6.83
                                %
                                Pay
      monthly
                                19-Mar-09
                                
                                
                                2,194,715Total
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                7,315,717




The
Company must use the loans for the purpose described in the table. If the
Company fails, it will be charged a penalty interest at 100% of the specified
loan rate. The Company has to pay interest 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. 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, 2008, and will continue to comply with them.




The
following table summarizes the contract information of issuing notes payable
between the banks and the Company as of December 31, 2008:




Purpose
                        
                        Term
      (Month)
                        
                        Due
      Date
                        
                        Amount
      Payable on Due
                          DateWorking
      Capital
                        
                        
                        3-6
                        
                        Jan-09
                        
                        $
                        2,500,975Working
      Capital
                        
                        
                        3-6
                        
                        Feb-09
                        
                        
                        4,150,806Working
      Capital
                        
                        
                        3-6
                        
                        Mar-09
                        
                        
                        4,042,958Working
      Capital
                        
                        
                        3-6
                        
                        Apr-09
                        
                        
                        4,892,752Working
      Capital
                        
                        
                        3-6
                        
                        May-09
                        
                        
                        594,329Working
      Capital
                        
                        
                        3-6
                        
                        Jun-09
                        
                        
                        4,468,777Total
                        
                        
                        
                        
                        
                        
                        $
                        20,650,597


34




The
Company must use the loan for the purpose described in the table. If it fails,
the banks will no longer issue the notes payable, and it may have an adverse
effect on the Company’s liquidity and capital resources. The Company has to
deposit sufficient cash in the designated account of the bank on the due date of
notes payable for payment to the suppliers. If the bank has advanced payment for
the Company, it will be charged a penalty interest at 150% of the specified loan
rate. Management believes that the Company had complied with such financial
covenants as of December 31, 2008, and will continue to comply with
them.




The
Company had approximately $7,103,327 of capital commitment as of December 31,
2008, arising from equipment purchases for expanding production capacity. The
Company intends to pay $5,971,113 in 2009 using its working capital. Management
believes that it will not have a material adverse effect on the Company’s
liquidity.




Cash
flows:





(a) Operating
activities




Net cash
generated from operations during the year ended December 31, 2008 was
$16,373,966, compared with $11,324,473 for the year of 2007, an increase of
$5,049,493, primarily due to increased net income.




During
the year ended December 31, 2008, the most important factor of cash outflow of
operation activities is increased accounts receivables, notes receivables, and
inventories, the same as the year ended December 31, 2007.




First,
cash outflow caused by the increased accounts receivables was about
$12,080,000, mainly due to increased sales in 2008 than in 2007. The credit
terms on sale of goods between customers and the Company generally range from 3
- 4 months, which resulted in increased accounts receivable as sales increased.
This is a normal capital circulation and the Company believes that it will not
have a material adverse effect on future cash flows. Second, cash
outflow caused by increased notes receivable was about $2,160,000,
mainly due to the Company having sufficient working capital, thus having less
notes receivable discounted during this period. Since the notes receivable were
based on bank credit standing, they may turn into cash any time the Company
elects. Therefore, the increase of notes receivable will not have a material
adverse effect on the Company’s future operating activities. Third, increased
inventories led to cash outflow of $4,960,000, mainly due to the Company’s
intention to produce sufficient inventories to meet huge demands in the first
quarter of 2009.




(b) Investing
activities:




The
Company expended net cash of $22,356,060 in investment activities during the
year ended December 31, 2008, as compared to $13,159,277 during the year of
2007, an increase of $9,196,783.




There
were two major investment activities in 2008:




First, as
in 2007, the Company invested cash for equipment purchases and building facility
to expand production to meet market needs. Cash used for equipment purchases and
building facility in 2008 and 2007 were $12,245,383 and $13,982,490,
respectively.




Second,
the Company acquired 35.5% equity interest in Henglong, one of the Company’s
Joint-Ventures.


35




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




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




(c) Financing
activities




During
the year ended December 31, 2008, the Company obtained net cash of $21,981,953
in financing activities, as compared to expending net cash of $7,429,025 through
financing activities for the same period of 2007, an increase of $29,410,978 as
a result of the following factors:





During
the year ended December 31, 2008, the Company sold $30,000,000 and $5,000,000 of
convertible notes to Lehman Brothers Commercial Corporation Asia Limited, and YA
Global Investments, L.P., respectively. During the same period in 2007, the
Company issued 108,121 shares of common stock and raised
$1,145,500.





The
Company also repaid bank loans of $7,567,697 during the year ended December 31,
2008, to decrease bank loan interest.





OFF-BALANCE
SHEET ARRANGEMENTS





At December 31, 2008 and 2007, 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,
2008:




Payment
      Obligations by Period2009
                    
                    
                    2010
                    
                    
                    2011
                    
                    
                    2012
                    
                    
                    Thereafter
                    
                    
                    TotalObligations
      for service agreements
                    
                    $
                    110,000
                    
                    
                    $
                    110,000
                    
                    
                    $
                    110,000
                    
                    
                    $
                    —
                    
                    
                    $
                    —
                    
                    
                    $
                    330,000Obligations
      for purchasing agreements
                    
                    
                    5,861,113
                    
                    
                    
                    912,214
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    6,773,327Total
                    
                    $
                    5,971,113
                    
                    
                    $
                    1,022,214
                    
                    
                    $
                    110,000
                    
                    
                    $
                    —
                    
                    
                    $
                    —
                    
                    
                    $
                    7,103,327




36




SUBSEQUENT
EVENTS




Since the
Company’s stock Weighted Average Price for twenty (20) consecutive trading days
ended on March 16, 2009 was below $3.187, which is less than 45% of the
Conversion Price in effect of the Issuance Date, as adjusted, the “WAP Default”,
the Convertible Debt holder shall have the right, at its sole discretion, to
require that the Company redeem all or any portion of the Convertible Debt 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 the WAP Default notice to the Convertible Debt
holders.  Since the Company has not received any notice from YA Global
Investments, L.P. as of March 24, 2009, its redemption rights under such WAP
Default has lapsed. On March 23, 2009, the Company received a letter from the
joint and several provisional liquidator acting on behalf of Lehman Brothers
Commercial Corporation Asia Limited, “LBCCA Liquidator”, requesting that it be
granted an extension of time until April 24, 2009 to obtain legal advice and to
consider its rights under the Convertible Debt. The Company has granted an
extension to April 15, 2009. Although the LBCCA Liquidator has not given the
Company any notice of redemption yet, it may exercise its discretionary right of
early redemption on any date that is no earlier than ninety (90) days after it
delivers the written redemption notice to the Company, so long as it delivers
such notice on or before April 15, 2009.




INFLATION
AND CURRENCY MATTERS




In the
most recent decade, the Chinese economy has experienced periods of rapid
economic growth as well as relatively high rates of inflation, which in turn has
resulted in the periodic adoption by the Chinese Government of various
corrective measures designed to regulate growth and contain
inflation.




Foreign
operations are subject to certain risks inherent in conducting business abroad,
including price and currency exchange controls, and fluctuations in the relative
value of currencies. The Company conducts virtually all of its business in China
and, accordingly, the sale of its products is settled primarily in RMB. As a
result, devaluation or currency fluctuation of the RMB against the US$ would
adversely affect the Company’s financial performance when measured in US
dollars.




In July
2005, the Chinese Government adjusted its exchange rate policy from “Fixed Rate”
to “Floating Rate”. During July 2005 to July 2008, the exchange rate between RMB
and US dollars experienced a big fluctuation, for RMB 1.00 to US$0.1205 and RMB
1.00 to US$0.1462, respectively. Since August 2008, the exchange rate has
maintained stable, and was approximately at RMB 1.00 to US$0.1462. There
can be no assurance that the exchange rate will remain stable.  The
Renminbi could devalue against the US dollar.  The Company’s financial
condition and results of operations may also be affected by changes in the value
of certain currencies other than the Renminbi in which the Company’s earnings
and obligations are denominated.  In particular, a devaluation of the
Renminbi is likely to increase the portion of the Company’s cash flow required
to satisfy the Company’s foreign currency-denominated obligations.




RECENT
ACCOUNTING PRONOUNCEMENTS




In
February 2007, FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities Including an Amendment of FASB Statement No.
115 (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial
instruments and certain other items at fair values. SFAS 159 is effective for
fiscal years after November 15, 2007. The Company has adopted the provisions of
this statement since January 1, 2008.





In
December 2007, the FASB issued SFAS No. 141 (Revised 2007), Business
Combinations. SFAS 141(R) retains the fundamental requirements of the original
pronouncement requiring that the purchase method be used for all business
combinations. SFAS 141(R) defines the acquirer as the entity that obtains
control of one or more businesses in the business combination, establishes the
acquisition date as the date that the acquirer achieves control and requires the
acquirer to recognize the assets acquired, liabilities assumed and any
noncontrolling interest at their fair values as of the acquisition date. In
addition, SFAS 141(R) requires expensing of acquisition-related and
restructure-related costs, remeasurement of earn out provisions at fair value,
measurement of equity securities issued for purchase at the date of close of the
transaction and non-expensing of in-process research and development related
intangibles. 141R is effective for financial statements issued for fiscal years
beginning after December 15, 2008, and interim periods within those fiscal
years. The Company is required to and plans to adopt the provisions of SFAS 141R
beginning in the first quarter of 2009. The Company is currently evaluating the
impact of the implementation of SFAS No. 141(R) on its consolidated financial
position, results of operations and cash flows.


37





In
December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in
Consolidated Financial Statements-an amendment of ARB No. 51." The objective of
SFAS No. 160 is to improve the relevance, comparability and transparency of the
financial information that a reporting entity provides in its consolidated
financial statements by establishing additional accounting and reporting
standards. SFAS No. 160 is effective for fiscal years beginning on or after
December 15, 2008. Early adoption of this statement is prohibited. By adopting
SFAS No. 160, the noncontrolling interests will be reported as equity while the
noncontrolling interests are reported in the mezzanine section between
liabilities and equity currently. The Company is currently assessing the impact
of adopting SFAS No. 160 on its consolidated financial
statements.





In March
2008, the Financial Accounting Standards Board (FASB) issued FASB Statement No.
161, Disclosures about Derivative Instruments and Hedging Activities. The new
standard is intended to improve financial reporting about derivative instruments
and hedging activities by requiring enhanced disclosures to enable investors to
better understand their effects on an entity’s financial position, financial
performance, and cash flows. It is effective for financial statements issued for
fiscal years and interim periods beginning after November 15, 2008, with early
application encouraged. The Company is currently evaluating the impact of
adopting SFAS No. 161 on its consolidated financial
statements.





In May
2008, the FASB issued Financial Accounting Standard No. 162, "The Hierarchy of
Generally Accepted Accounting Principles" ("SFAS No. 162"). The statement is
intended to improve financial reporting by identifying a consistent hierarchy
for selecting accounting principles to be used in preparing financial statements
that are prepared in conformance with GAAP. Unlike SAS No. 69, "The Meaning of
Present in Conformity With GAAP," SFAS No. 162 is directed to the entity rather
than the auditor. The statement is effective 60 days following the SEC's
approval of the Public Company Accounting Oversight Board amendments to AU
Section 411, "The Meaning of Present Fairly in Conformity with GAAP." The
Company is currently assessing the impact of this statement, but believes it
will not have a material impact on its financial position, results of
operations, or cash flows upon adoption.





In May
2008, the FASB issued SFAS No. 163, “Accounting for Financial Guarantee
Insurance Contracts-an interpretation of FASB Statement No. 60.” Diversity
exists in practice in accounting for financial guarantee insurance contracts by
insurance enterprises under FASB Statement No. 60, Accounting and Reporting by
Insurance Enterprises. This results in inconsistencies in the recognition and
measurement of claim liabilities. This Statement requires that an insurance
enterprise recognize a claim liability prior to an event of default (insured
event) when there is evidence that credit deterioration has occurred in an
insured financial obligation. This Statement requires expanded disclosures about
financial guarantee insurance contracts. The accounting and disclosure
requirements of the Statement will improve the quality of information provided
to users of financial statements. The adoption of FASB 163 is not expected to
have a material impact on the Company’s financial position.


In May
2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff
Position (“FSP”) APB 14-1, Accounting for Convertible Debt Instruments That May
be Settled in Cash upon Conversion (Including Partial Cash Settlement). FSP
APB14-1 clarifies that convertible debt  instruments that may be
settled in cash upon either mandatory or optional conversion (including Partial
Cash Settlement) are not addressed by paragraph 12 of APB Opinion No.14,
Accounting for Convertible Debt and Debt issued with Stock Purchase Warrants.
Additionally, FSP APB14-1 specifies that issuers of such instruments should
separately account for the liability and equity components in a manner that will
reflect the entity’s non-convertible debt borrowing rate when interest cost is
recognized in subsequent periods. FSP APB14-1 is effective for financial
statements issued for fiscal years beginning after December 15, 2008, and
interim periods within those fiscal years. The Company has adopted FSP APB14-1
beginning January 1, 2009, and this standard must be applied on a retrospective
basis. The Company is evaluating the  impact the adoption of FSP
APB14-1 will have on its consolidated financial position and results of
operations.


In June
2008, the FASB ratified the consensus reached on EITF Issue No. 07-05,
Determining Whether an Instrument (or Embedded Feature) Is Indexed to an
Entity's Own Stock. EITF Issue No. 07-05 clarifies the determination of whether
an instrument (or an embedded feature) is indexed to an entity's own stock,
which would qualify as a scope exception under SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities. EITF Issue No. 07-05 is effective
for financial statements issued for fiscal years beginning after December 15,
2008. Early adoption for an existing instrument is not permitted. The Company is
currently evaluating the impact of adopting EITF Issue No. 07-05 on its
consolidated financial statements.
  On June
16, 2008, the FASB issued final Staff Position (FSP) No. EITF03-6-1,
“Determining Whether Instruments Granted in Share-Based Payment Transaction Are
Participating Securities,” to address the question of whether instrument granted
in share-based payment transaction are participating securities prior to
vesting. The FSP determines that unvested share-based payment awards that
contain rights to dividend payments should be  included in earnings
per share calculations. The guidance will be effective for fiscal years
beginning after December 15, 2008. The Company is currently evaluating the
requirement of (FSP) No. EITF03-6-1 as well as the impact of the adoption on its
consolidated financial statements.
 
 In
December 2008, the FASB issued FSP FAS 140-4 and FIN 46(R)-8, “Disclosures by
Public Entities (Enterprises) about Transfers of Financial Assets and Interests
in Variable Interest Entities” (“FSP FAS 140-4 and FIN 46 (R)-8”). FSP FAS140-4
and FIN 46(R)-8 amends FAS140 and FIN 46(R) to require additional disclosures
regarding transfers of financial assets and interest in variable interest
entities. FSP FAS 140-4 and FIN 46 (R)-8 is effective for interim or annual
reporting periods ending after December 15, 2008. The Company is currently
evaluating the impact of the adoption of FSP FAS140-4 and FIN 46(R)-8 will have
on its consolidated financial position and results of
operations.


38


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 date of the financial
statements and the reported amount of revenues and expenses during the reporting
period. Management periodically evaluates the estimates and judgments made.
Management bases its estimates and judgments on historical experience and on
various factors that are believed to be reasonable under the circumstances.
Actual results may differ from these estimates as a result of different
assumptions or conditions. The following critical accounting policies affect the
more significant judgments and estimates used in the preparation of the
Company’s 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
critical accounting estimates:





Balance
      Sheet
                                Caption
                              
                              Critical
      Estimate
                                Item
                              
                              Nature
      of Estimates Required
                              
                              Assumptions/Approaches
                                Used
                              
                              Key
      FactorsAccrued
      liabilities and other long-term liabilities
                              
                              Warranty
      obligations
                              
                              Estimating
      warranty requires the Company to forecast the resolution of existing
      claims and expected future claims on products sold. VMs are increasingly
      seeking to hold suppliers responsible for product warranties, which may
      impact the Company’s exposure to these costs.
                              
                              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.
                              
                              • VM
      (Vehicle Manufacturer)
      sourcing
                                • VM
      policy decisions regarding warranty claims
                                ·VMsProperty,
      plant and equipment, intangible assets and other long-term
      assets
                              
                              Valuation
      of long- lived assets and investments
                              
                              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




39





Accounts
      and notes receivables
              
              Provision
      for doubtful accounts and notes receivable
              
              Estimating
      the provision for doubtful accounts and notes receivable require the
      Company to analyze and monitor each customer’s credit standing and
      financial condition regularly. The Company grants credit to its customers,
      generally on an open account basis. It will have material adverse effect
      on the Company’s cost disclosure if such assessment were
      improper.
              
              The
      Company grants credit to its customers for three to four months based on
      each customer’s current credit standing and financial data. The Company
      assesses allowance on an individual customer basis, under normal
      circumstances; the Company
      does not record any provision for doubtful accounts for those accounts
      receivable amounts which were in credit terms.  For those
      receivables out of credit terms, certain proportional provision, namely
      25% to 100%, will be recorded based on respective overdue
      terms.
              
              •Customers’  credit
      standing and financial conditionDeferred
      income taxes
              
              Recoverability
      of deferred tax assets
              
              The
      Company is required to estimate whether recoverability of its deferred tax
      assets is more likely than not based on forecasts of taxable earnings in
      the related
      tax               jurisdiction.
              
              The
      Company uses historical and projected future operating results, based
      upon approved business plans, including a review of the eligible
      carryforward period, tax planning opportunities and other relevant
      considerations.
              
              • Tax
      law
      changes
                • Variances
      in future    projected profitability,
         including by taxing
   entity




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
8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.




(a) FINANCIAL
STATEMENTS




The
following financial statements are set forth at the end hereof.




40




1.   Report
of Independent Auditors




2.   Consolidated
Balance Sheets as of December 31, 2008 and 2007




3.   Consolidated
Statements of Earnings for the years ended December 31, 2008 and
2007




4.   Consolidated
Statements of Comprehensive Income (Loss) for the years ended December 31, 2008
and 2007




5.   Consolidated
Statements of Changes in Stockholders’ Equity for the years ended December 31,
2008 and 2007




6.   Consolidated
Statements of Cash Flows for the years ended December 31, 2008 and
2007




7.   Notes
to Consolidated Financial Statements





(b) Selected
quarterly financial data for the past two years appears in the following
table:





Quarterly Results of
      OperationsFirst
                                    
                                    
                                    Second
                                    
                                    
                                    Third
                                    
                                    
                                    Fourth2008
                                    
                                    
                                    2007
                                    
                                    
                                    2008
                                    
                                    
                                    2007
                                    
                                    
                                    2008
                                    
                                    
                                    2007
                                    
                                    
                                    2008
                                    
                                    
                                    2007Net
      Sales
                                    
                                    $
                                    41,467,043
                                    
                                    
                                    $
                                    28,383,392
                                    
                                    
                                    $
                                    46,508,340
                                    
                                    
                                    $
                                    36,312,338
                                    
                                    
                                    $
                                    36,936,755
                                    
                                    
                                    $
                                    31,202,731
                                    
                                    
                                    $
                                    38,267,148
                                    
                                    
                                    $
                                    37,698,542Gross
      Profit
                                    
                                    
                                    12,212,370
                                    
                                    
                                    
                                    9,191,906
                                    
                                    
                                    
                                    14,463,004
                                    
                                    
                                    
                                    12,093,806
                                    
                                    
                                    
                                    9,878,223
                                    
                                    
                                    
                                    11,362,751
                                    
                                    
                                    
                                    10,705,104
                                    
                                    
                                    
                                    12,674,585OperatingIncome
                                    
                                    
                                    6,784,664
                                    
                                    
                                    
                                    5,188,611
                                    
                                    
                                    
                                    5,477,887
                                    
                                    
                                    
                                    5,944,365
                                    
                                    
                                    
                                    3,697,416
                                    
                                    
                                    
                                    6,630,432
                                    
                                    
                                    
                                    963,454
                                    
                                    
                                    
                                    3,502,393Net
      Income
                                    
                                    
                                    4,430,174
                                    
                                    
                                    
                                    1,643,101
                                    
                                    
                                    
                                    4,744,355
                                    
                                    
                                    
                                    2,455,154
                                    
                                    
                                    
                                    2,758,779
                                    
                                    
                                    
                                    2,574,418
                                    
                                    
                                    
                                    501,933
                                    
                                    
                                    
                                    2,187,233Earnings
      Per Share
                                    
                                    $
                                    0.18
                                    
                                    
                                    $
                                    0.07
                                    
                                    
                                    $
                                    0.19
                                    
                                    
                                    $
                                    0.10
                                    
                                    
                                    $
                                    0.10
                                    
                                    
                                    $
                                    0.11
                                    
                                    
                                    $
                                    0.01
                                    
                                    
                                    $
                                    0.09





ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.





Not
applicable.





ITEM
9A.  CONTROLS AND PROCEDURES.





Disclosure
Controls and Procedures




The
Company maintains disclosure controls and procedures that are designed to ensure
that information required to be disclosed in periodic reports filed with the SEC
under the Securities Exchange Act of 1934 is recorded, processed, summarized,
and reported within the time periods specified in the SEC’s rules and forms, and
that such information 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.




41




As of
December 31, 2008, an evaluation was performed under the supervision and
with the participation of the Company’s management, including its Chief
Executive officer and Chief Financial Officer, of the effectiveness of the
design and operation of disclosure controls and procedures. Based on that
evaluation, the Chief Executive Officer and the Chief Financial
Officer concluded that the Company’s disclosure controls and procedures were
effective as of December 31, 2008.




Internal
Control over Financial Reporting





The
Company’s management is responsible for establishing and maintaining adequate
internal control over financial reporting, as such term is defined in Exchange
Act Rules 13a-15(f). Under the supervision and with the participation of
the Company’s management, including its principal executive officer and its
principal financial officer, the Company conducted an evaluation of the
effectiveness of its internal control over financial reporting, based on the
framework in Internal Control—Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission, the Company’s management
concluded that its internal control over financial reporting was effective as of
December 31, 2008.





Changes
in Internal Control over Financial Reporting


Management
identified material weaknesses in the Company’s internal control over financial
reporting for the twelve months ended December 31, 2006 in its 10K for 2006,
including inadequate reclassification adjustments and inadequate presentation of
other income and warranties.


Commencing
October 1, 2006, the Company has taken remediation measures to improve its
internal control and performed testing of those remediation measures to ensure
improvement of its internal control.  For example, the Company has
provided its in-house accountants training of accounting policy to follow the
provision of GAAP in order to ensure the financial reports are prepared under
the provision of GAAP and has employed experienced
accountants.


Management
believes, based on testing performed, that the material weakness in the
Company’s internal control over financial reporting had been
remediated.


ITEM 9B.
OTHER INFORMATION.




None.




PART
III




ITEM 10.
DIRECTORS AND EXECUTIVE OFFICERS, CORPORATE GOVERNANCE AND BOARD
INDEPENDENCE.




The
following table and text set forth the names and ages of all directors and
executive officers of the Company as of December 31, 2008. 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.


42




Name
                  
                  Age
                  
                  Position(s)Hanlin
      Chen
                  
                  51
                  
                  Chairman
      of the BoardQizhou
      Wu
                  
                  44
                  
                  Chief
      Executive Officer and DirectorJie
      Li
                  
                  39
                  
                  Chief
      Financial OfficerTse,
      Yiu Wong Andy
                  
                  38
                  
                  Sr.
      VPShengbin
      Yu
                  
                  55
                  
                  Sr.
      VPShaobo
      Wang
                  
                  46
                  
                  Sr.
      VPDaming
      Hu
                  
                  50
                  
                  Chief Accounting
      OfficerRobert
      Tung
                  
                  52
                  
                  DirectorDr.
      Haimian Cai
                  
                  45
                  
                  DirectorWilliam
      E. Thomson
                  
                  67
                  
                  Director




(a) BIOGRAPHIES
OF DIRECTORS AND EXECUTIVE OFFICERS:




Hanlin
Chen has served as Chairman of the board and CEO since September 2007. Mr. Chen
is a standing board member of the Political Consulting Committee of Jingzhou
city and vice president of Foreign Investors Association of Hubei Province. He
was the general manager of Jiulong from 1993 to 1997. Since 1997, he has been
the Chairman of the Board of Henglong.




Qizhou Wu
has served as 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 Vice General Manager of Jiulong from 1993 to 1999 and GM of Henglong
from 1999 to 2002. Mr. Wu graduated from Tsinghua University in Beijing with a
Masters degree in Automobile Engineering.




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.




Tse, Yiu
Wong Andy has served as Sr. VP of the Company since March 2003. He has also
served as the general manager of the Henglong and Jiulong joint ventures and the
chairman of the board of Shenyang since 2003. 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.


43




Shengbin
Yu has served as Sr. VP 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 Sr. VP 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.




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 Heng Long from 1999 to
2002.Mr. Hu
graduated from Zhongnan University of Economics and Law as an accountant
bachelor.




Robert
Tung has been a 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 and B.S. degrees in Computer Science and Chemical
Engineering from the University of Maryland and National Taiwan University,
respectively. Since 2003, Mr. Tung has been actively developing the business in
China. Currently, Mr. Tung is the China Operation General Manager of Ulamatic
Inc., a leading North American automated equipment design house and
manufacturer. In addition, Mr. Tung holds grand China sales representative
position of TRI Products, Inc., a well known North American iron ores and scrap
metals supplier.




Haimian Cai
has been a Director since September 2003 and 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.




William
E. Thomson, CA, has been a Director of the Company since September 2003 and is a
member of the Company’s Audit, Compensation and Nominating Committees. Mr.
Thomson has been the president of Thomson Associates, Inc., a leading merchant
banking and crisis management company, since 1978. Mr. Thomson’s current
additional directorships include: Nasdaq-Maxus Technology Inc. (eWaste
Management Solutions); Asia Bio Chem (Agriculture); TSX-Score Media Inc.
(Media); Electrical Contacts Ltd. (Industrial), Open EC Technologies Inc.(IT
Financing), Wright Environmental Management Inc. (Waste Management Solutions),
YTW Growth Capital Management Corporation (CPC facilitation), Redpearl Funding
Corp. (Financial), Han Wind Energy (BVI) (Sustainable Energy), Summit Energy
Management (Oil and Gas), Paradox Financial Solutions Inc. (Supply Chain
Financing), and Pure Med Laser (Healthcare).




BOARD
COMPOSITION AND COMMITTEES




(b) 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 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, Haimian Cai, and
William Thomson. Mr. William Thomson is the Chairman of the Audit Committee. The
Board has determined that Mr. William Thomson is the Audit Committee financial
expert, as defined in Item 407(d)(5) of Regulation S-K, serving on the Company’s
audit committee.


44




(c) 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, Haimian Cai and William Thomson, serve on the
Compensation Committee. Dr. Haimian Cai is the Chairman of the Compensation
Committee.




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.




(d) 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,
William Thomson and Haimian Cai, serve on the Nominating Committee. Mr. Robert
Tung is the Chairman of the Nominating Committee.




(e) STOCKHOLDER
COMMUNICATIONS




Stockholders
interested in communicating directly with the Board of Directors, or individual
directors, may email the Company’s independent director William Thomson at
Bill.Thomson@chl.com.cn. Mr. Thomson will review all such correspondence and
will regularly forward to the Board 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
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.


45




(f) FAMILY
RELATIONSHIPS




Mr.
Hanlin Chen and Mr. Tse, Yiu Wong Andy are brothers-in-law.




(g) 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 is
filed as an exhibit to this Form 10-K, which incorporates it by reference from
the Form 10-KSB for year ended December 31, 2003.




(h) SECTION
16(a) BENEFICIAL OWNERSHIP COMPLIANCE




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 11.
EXECUTIVE COMPENSATION




Compensation
Committee




The
Company has a standing Compensation Committee of the Board of Directors as
described under Item 10(c) above.  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,
Haimian Cai and William Thomson, serve on the Compensation Committee. Dr.
Haimian Cai is the Chairman of the Compensation Committee.




Executive
compensation consists of salary, stock option awards, and performance bonus in
cash.





Salary





The
Company’s Board of Directors and Compensation Committee have approved the
current salaries for executives: $150,000 for the Chairman, $100,000 for the
CEO, and $60,000 for other officers in 2008.


46





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 shareholder 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
option granted for management in 2008 was as follows, which was approved by the
Board of Directors and 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 09, 2008
 c.
              Date
      of Grant: December 10, 2008
 d.
              Expiration
      Date: on or before December 9, 2011
 e.
              Vesting
      Schedule
 (i)
              On
      December 10, 2008, 1/3 of the granted stock option shall be vested and
      become exercisable
 (ii)
              On
      December 10, 2009, another 1/3 of the granted stock option shall be vested
      and become exercisable
 (iii)
              On
      December 10, 2010, remaining 1/3 of the granted stock option shall be
      vested and become exercisable




In
accordance with SFAS No. 123R, 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 21.




The
compensation that executive officers received for their services for fiscal year
2008 and 2007 were as follows:




Name
      and
                                    principal
                                    position
                                  
                                  Year
                                  
                                  Salary
                                  
                                  
                                  Bonus
                                  
                                  
                                  Stock
                                    awards
                                  
                                  
                                  Option
      awards
                                  
                                  
                                  Non-equity
                                    incentive
      plan
                                    compensation
                                  
                                  
                                  Change
      in
                                    pension
      value
                                    and
                                    non-qualified
                                    deferred
                                    compensation
                                    earnings
                                  
                                  
                                  All
      other
                                    compensation
                                  
                                  
                                  TotalHanlin
      Chen
                                  
                                  2008
                                  
                                  $
                                  150,000
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  150,000(Chairman)
                                  
                                  2007
                                  
                                  $
                                  116,667
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  116,667Qizhou
      Wu
                                  
                                  2008
                                  
                                  $
                                  100,000
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  100,000(CEO)
                                  
                                  2007
                                  
                                  $
                                  86,667
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  86,667Jie
      Li
                                  
                                  2008
                                  
                                  $
                                  60,000
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  
                                  
                                  
                                  $
                                  38,654
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  98,654(CFO)
                                  
                                  2007
                                  
                                  $
                                  35,000
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  35,000




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 and net profits for 2008 must
      exceed 10%; and (ii) the average growth rate of the foregoing indicators
      must exceed that of the whole industry in
2008;
 c.
              Bonus:
      50% of each officer’s annual salary in
2008.


47




Outstanding
Equity Awards at Fiscal Year-End:




Not
Applicable.




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,
2008.






The
compensation that directors received for serving on the Board of Directors for
fiscal year 2008 was as follows:




Name
                      
                      Fees
                        earned
      or
                        paid
      in
                        cash
                      
                      
                      Stock
                        awards
                      
                      
                      Option
                        awards*
                      
                      
                      Non-equity
                        incentive
                        plan
                        compensation
                      
                      
                      Change
      in
                        pension
      value
                        and
                        nonqualified
                        deferred
                        compensation
                        earnings
                      
                      
                      All
      other
                        compensation**
                      
                      
                      TotalHaimian
      Cai
                      
                      $
                      40,000
                      
                      
                      $
                      -
                      
                      
                      $
                      31,800
                      
                      
                      $
                      -
                      
                      
                      $
                      -
                      
                      
                      $
                      101,200
                      
                      
                      $
                      173,000William
      E. Thomson
                      
                      $
                      45,500
                      
                      
                      $
                      -
                      
                      
                      $
                      31,800
                      
                      
                      $
                      -
                      
                      
                      $
                      -
                      
                      
                      $
                      15,600
                      
                      
                      $
                      92,900Robert
      Tung
                      
                      $
                      40,000
                      
                      
                      $
                      -
                      
                      
                      $
                      31,800
                      
                      
                      $
                      -
                      
                      
                      $
                      -
                      
                      
                      $
                      9,200
                      
                      
                      $
                      81,000





* 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 SFAS No. 123R, 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 21.




**The cost of the above mentioned
compensation paid to directors was measured based on investment, operating,
technology, and consulting services they provided.




During
the year 2008, Mr. Haimian Cai provided additional investment and technology
consulting services. Mr. Thomson and Robert Tung provided additional investment
consulting services.




All other
directors did not receive compensation for their service on the Board of
Directors.




48




ITEM 12.
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
26,983,244 shares of common stock outstanding at February 27, 2009.




Name/Title
                
                Total Number of Shares
                
                
                Percentage OwnershipHanlin
      Chen,  Chairman (1)
                
                
                15,659,826
                
                
                
                58.03
                %Qizhou
      Wu, CEO, President and Director
                
                
                2,157,296
                
                
                
                7.99
                %Jie
      Li, CFO
                
                
                11,247
                
                
                
                0.04
                %Li
      Ping Xie(2)
                
                
                15,659,826
                
                
                
                58.03
                %Tse,
      Yiu Wong Andy, Sr. VP, Director
                
                
                899,426
                
                
                
                3.33
                %Shaobo
      Wang, Sr. VP
                
                
                425,104
                
                
                
                1.58
                %Shengbin
      Yu, Sr. VP
                
                
                476,429
                
                
                
                1.77
                %Daming
      Hu,CAO
                
                
                9,000
                
                
                
                0.03
                %Robert
      Tung, Director
                
                
                7,500
                
                
                
                0.02
                %Dr.
      Haimian Cai, Director
                
                
                7,500
                
                
                
                0.02
                %William
      E. Thomson, Director
                
                
                —
                
                
                
                —Wiselink
      Holdings Limited (3)
                
                
                3,023,542
                
                
                
                11.21
                %All
      Directors and Executive Officers (10 persons) (4)
                
                
                22,374,516
                
                
                
                82.92
                %




(1)Includes 2,011,425 shares of common stock beneficially owned by Mr.
Chen’s wife, Ms. Xie and 302,354 shares indirectly held in Wiselink Holdings
Limited.




(2)Includes 13,648,401 shares of common stock beneficially owned by Ms.
Xie’s husband, Mr. Chen.





(3)Wiselink Holdings Limited is a company controlled by Mr. Chen and other
executive officers.





(4)
Excludes 302,354 shares indirectly held by Mr. Chen in Wiselink Holdings
Limited




In July
2004, the Company adopted a stock option plan subject to shareholders approval,
which was approved at the Company’s annual general meeting on June 28, 2005. The
stock option 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.


49




ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.




For the
information required by Item 13 please refer to Consolidated Financial
Statements notes 3 and 23 “Certain Relationships And
Related Transactions” and
“Related Party Transactions” in theAnnual Report
on Form 10-K for the year ended December 31, 2008.




ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES.




The
following table sets forth the aggregate fees for professional audit services
rendered by Schwartz Levitsky Feldman LLP for the audit of the Company’s annual
financial statements, and fees billed for other services for the fiscal years
2008 and 2007. The Audit Committee has approved all of the following
fees.




Fiscal Year Ended2008
                    
                    
                    2007Audit
      Fees
                    
                    $
                    285,000
                    
                    
                    $
                    280,000Audit-Related
      Fees(1)
                    
                    
                    24,100
                    
                    
                    
                    -Tax
      Fees (2)
                    
                    
                    8,400
                    
                    
                    
                    8,000Total
      Fees Paid
                    
                    $
                    317,500
                    
                    
                    $
                    288,000




(1)
Includes accounting and reporting consultations related to financing and
internal control procedures.




(2) Includes fees for service related
to tax compliance services, preparation and filing of tax returns and tax
consulting services.




Audit
Committee’s Pre-Approval Policy




During fiscal years ended December 31,
2008 and 2007, 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.


50




PART
IV




ITEM
15.  EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.




(a)
List of Financial
Statements/Schedules




1.   Report
of Independent Auditors




2.   Consolidated
Balance Sheets as of December 31, 2008 and 2007




3.   Consolidated
Statements of Earnings for the years ended December 31, 2008 and
2007




4.   Consolidated
Statements of Comprehensive Income (Loss) for the years ended December 31, 2008
and 2007




5.   Consolidated
Statements of Changes in Stockholders’ Equity for the years ended December 31,
2008 and 2007




6.   Consolidated
Statements of Cash Flows for the years ended December 31, 2008 and
2007




7.   Notes
to Consolidated Financial Statements




(b)
EXHIBITS




The
following is a list of exhibits filed as part of this Annual Report on Form
10-K. Where so indicated by footnote, exhibits that were previously filed are
incorporated by reference.




Exhibit
                  Number
                
                Description3.1(i)
                
                Certificate
      of Incorporation (incorporated by reference from the filing on Form 10KSB
      File No. 000-33123.)3.1(ii)
                
                Bylaws
      (incorporated by reference from the Form 10KSB for the year ended December
      31, 2002.)10.1
                
                Registration
      Rights Agreement dated March 20, 2006 between the Company and Cornell
      Capital Partners, LP (incorporated by reference to the Company’s Form S-3
      Registration Statement (File No. 333 - 133331) filed on April 17,
      2006)10.2
                
                Investor
      Registration Rights Agreement dated March 20, 2006 between the Company and
      Cornell Capital Partners, LP. (incorporated by reference to the Company’s
      Form S-3 Registration Statement (File No. 333 - 133331) filed on April 17,
      2006)10.3
                
                Warrant
      to purchase 86,806 shares of common stock at $14.40 per share, issued to
      Cornell Capital Partners, LP. (incorporated by reference to the Company’s
      Form S-3 Registration Statement (File No. 333 - 133331) filed on April 17,
      2006 )10.4
                
                Warrant
      to purchase 69,444 shares of common stock at $18.00 per share, issued to
      Cornell Capital Partners, LP. (incorporated by reference to the Company’s
      Form S-3 Registration Statement (File No. 333 - 133331) filed on April 17,
      2006 )10.5
                
                Joint-venture
      Agreement, dated March 31, 2006, as amended on May 2, 2006, between Great
      Genesis Holdings Limited and Wuhu Chery Technology Co., Ltd. (incorporated
      by reference to the exhibit 10.8 to the Company’s Form 10Q Quarterly
      Report on May 10, 2006
)




51





10.6
                                    
                                    Securities
      Purchase Agreement dated February 1, 2008 among us, Lehman Brothers
      Commercial Corporation Asia Limited, and YA Global Investments, L.P.
      (incorporated by reference to the Company’s Form 10-K for the year ended
      December 31, 2007.)10.7
                                    
                                    Securities
      Purchase Agreement dated February 15, 2008 between the Company and the
      investors. (incorporated by reference to the Company’s Form 10-K for the
      year ended December 31, 2007.)10.8
                                    
                                    Escrow
      Agreement dated February 15, 2008 among us, U.S. Bank National
      Association, Lehman Brothers Commercial Corporation Asia Limited, and YA
      Global Investments, L.P. (incorporated by reference to the Company’s Form
      10-K for the year ended December 31, 2007.10.9
                                    
                                    Registration
      Rights Agreement dated February 15, 2008 among us, Lehman Brothers
      Commercial Corporation Asia Limited, and YA Global Investments, L.P.
      (incorporated by reference to the Company’s Form 10-K for the year ended
      December 31, 2007.)10.10
                                    
                                    Senior
      Convertible Note dated February 15, 2008 in the original principal
      amount of $8,571,429 issued by the Company in favor of TFINN & CO. as
      nominee for Lehman Brothers Commercial Corporation Asia Limited.
      (incorporated by reference to the Company’s Form 10-K for the year ended
      December 31, 2007.)10.11
                                    
                                    Senior
      Convertible Note dated February 15, 2008 in the original principal
      amount of $6,428,571 issued by the Company in favor of TFINN & CO. as
      nominee for Lehman Brothers Commercial Corporation Asia Limited.
      (incorporated by reference to the Company’s Form 10-K for the year ended
      December 31,
2007.)
  10.12
                          
                          Senior
      Convertible Note dated February 15, 2008 in the original principal
      amount of $15,000,000 issued by the Company in favor of TFINN & CO. as
      nominee for Lehman Brothers Commercial Corporation Asia Limited.
      (incorporated by reference to the Company’s Form 10-K for the year ended
      December 31, 2007.)10.13
                          
                          Closing
      Warrant to purchase 564,799 shares of common stock at $8.8527 per share,
      dated February 15, 2008, issued by the Company in favor of TFINN
      & CO. as nominee for Lehman Brothers Commercial Corporation Asia
      Limited. (incorporated by reference to the Company’s Form 10-K for the
      year ended December 31, 2007.)10.14
                          
                          Escrow
      Warrant to purchase 564,799 shares of common stock at $8.8527 per share,
      dated February 15, 2008, issued by the Company in favor of TFINN
      & CO. as nominee for Lehman Brothers Commercial Corporation Asia
      Limited. (incorporated by reference to the Company’s Form 10-K for the
      year ended December 31, 2007.)10.15
                          
                          Senior
      Convertible Note dated February 15, 2008 in the original principal
      amount of $1,428,571 issued by the Company in favor of YA Global
      Investments, L.P. (incorporated by reference to the Company’s Form 10-K
      for the year ended December 31, 2007.)10.16
                          
                          Senior
      Convertible Note dated February 15, 2008 in the original principal
      amount of $1,071,429 issued by the Company in favor of YA Global
      Investments, L.P. (incorporated by reference to the Company’s Form 10-K
      for the year ended December 31,
2007.)
 
 52


10.17
              
              Senior
      Convertible Note dated February 15, 2008 in the original principal
      amount of $2,500,000 issued by the Company in favor of YA Global
      Investments, L.P. (incorporated by reference to the Company’s Form 10-K
      for the year ended December 31, 2007.)10.18
              
              Closing
      Warrant to purchase 94,133 shares of common stock at $8.8527 per share,
      dated February 15, 2008, issued by the Company in favor of YA Global
      Investments, L.P. (incorporated by reference to the Company’s Form 10-K
      for the year ended December 31, 2007.)10.19
              
              Escrow
      Warrant to purchase 94,133 shares of common stock at $8.8527 per share,
      dated February 15, 2008, issued by the Company in favor of YA Global
      Investments, L.P. (incorporated by reference to the Company’s Form 10-K
      for the year ended December 31, 2007.)10.20
              
              Translation
      of the Equity Transfer Agreement dated March 31, 2008 in English
      (incorporated by reference to exhibit 99.1 of the Company’s Form 8-K filed
      on April 2, 2008)21
              
              Schedule
      of Subsidiaries*23
              
              Consent
      of Schwartz Levitsky Feldman LLP., Independent Registered Public
      Accountant Firm*31.1
              
              Rule
      13a-14(a) Certification*31.2
              
              Rule
      13a-14(a) Certification*32.1
              
              Section
      1350 Certification*32.2
              
              Section
      1350 Certification*





* Filed
herewith




SIGNATURES




In
accordance with Section 13 or 15(d) of the Exchange Act, the Company caused this
report to be signed on its behalf by the undersigned, thereunto duly
authorized.




CHINA
      AUTOMOTIVE SYSTEMS, INC.Dated:
      March 26, 2009
                    
                    /s/
      Qizhou WuName:
                    Qizhou
      WuTitle:
                    Chief
      Executive Director and
President




In
accordance with the Securities Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the Company and in the capacities
and on the dates indicated.


53




Dated:
      March 26, 2009
                        
                        /s/
      Hanlin ChenName:
                        Hanlin
      ChenTitle:
                        ChairmanDated:
      March 26, 2009
                        
                        /s/
      Qizhou WuName:
                        Qizhou
      WuTitle:
                        Chief
      Executive Director, President and
Director





Dated:
      March 26, 2009
                                
                                /s/
      Jie LiName:
                                Jie
      LiTitle:
                                Chief
      Financial OfficerDated:
      March 26, 2009
                                
                                /s/
      Daming HuName:
                                Daming
      HuTitle
                                Chief
      Accounting OfficerDated:
      March 26, 2009
                                
                                /s/
      Robert TungName:
                                Robert
      TungTitle:
                                Director





Dated:
      March 26, 2009
                      
                      /s/
      Dr. Haimian CaiName:
                      Name:
      Dr. Haimian CaiTitle:
                      DirectorDated:
      March 26, 2009
                      
                      /s/
      William E. ThomsonName:
                      William
      E. ThomsonTitle:
                      Director


54




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 sheets of China Automotive
Systems, Inc. and Subsidiaries as at December 31, 2008 and 2007 and the related
consolidated statements of earnings, and comprehensive income, cash flows and
changes in stockholders’ equity for the years ended December 31, 2008 and 2007.
These consolidated financial statements are the responsibility of the management
of China Automotive Systems, Inc. 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 audits
procedures that we 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 China Automotive
Systems, Inc. and Subsidiaries as of December 31, 2008 and 2007 and the results
of its earnings and its cash flows for the years ended December 31, 2008 and
2007 in conformity with generally accepted accounting principles in the United
States of America.




Toronto,
Ontario, Canada




March 16,
2009




/s/ Schwartz Levitsky Feldman
  LLPSchwartz
      Levitsky Feldman LLPChartered
      AccountantsLicensed Public
Accountant


55




China
Automotive Systems, Inc. and Subsidiaries


Consolidated
Balance Sheets


December
31, 2008 and 2007




December 31,2008
                                                          
                                                          
                                                          2007ASSETSCurrent
      assets:Cash
      and cash equivalents
                                                          
                                                          $
                                                          37,113,375
                                                          
                                                          
                                                          $
                                                          19,487,159Pledged
      cash deposits (note 4)
                                                          
                                                          
                                                          6,739,980
                                                          
                                                          
                                                          
                                                          4,645,644Accounts
      and notes receivable, net, including $1,285,110 and $1,869,480 from
      related parties at December 31, 2008 and 2007, net of an allowance for
      doubtful accounts of $4,910,478 and $3,827,838 at December 31, 2008 and
      2007 (note 5)
                                                          
                                                          
                                                          96,424,856
                                                          
                                                          
                                                          
                                                          82,022,643Advance
      payments and others, including $9,374 and $55,323 to related parties
      at December 31, 2008 and 2007
                                                          
                                                          
                                                          1,442,614
                                                          
                                                          
                                                          
                                                          922,578Inventories
      (note 7)
                                                          
                                                          
                                                          26,571,755
                                                          
                                                          
                                                          
                                                          20,193,286Total
      current assets
                                                          
                                                          $
                                                          168,292,580
                                                          
                                                          
                                                          $
                                                          127,271,310Long-term
      Assets:Property,
      plant and equipment, net (note 8)
                                                          
                                                          $
                                                          51,978,905
                                                          
                                                          
                                                          $
                                                          46,585,041Intangible
      assets, net (note 9)
                                                          
                                                          
                                                          504,339
                                                          
                                                          
                                                          
                                                          589,713Other
      receivables, net, including $903,674 and $638,826 from related parties at
      December 31, 2008 and 2007, net of an allowance for doubtful accounts of
      $659,837 and $652,484 at December 31, 2008 and 2007 (note
    6)
                                                          
                                                          
                                                          1,349,527
                                                          
                                                          
                                                          
                                                          888,697Advance
      payment for property, plant and equipment, including $2,473,320 and
      $1,560,378 to related parties at December 31, 2008 and
2007
                                                          
                                                          
                                                          6,459,510
                                                          
                                                          
                                                          
                                                          6,260,443Long-term
      investments
                                                          
                                                          
                                                          79,010
                                                          
                                                          
                                                          
                                                          73,973Deferred
      income tax assets (note 10)
                                                          
                                                          
                                                          2,383,065
                                                          
                                                          
                                                          
                                                          1,315,510Total
      assets
                                                          
                                                          $
                                                          231,046,936
                                                          
                                                          
                                                          $
                                                          182,984,687LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      liabilities:Bank
      loans (note 11)
                                                          
                                                          $
                                                          7,315,717
                                                          
                                                          
                                                          $
                                                          13,972,603Accounts
      and notes payable, including $1,097,641 and $1,134,817 to related parties
      at December 31, 2008 and 2007(note 12)
                                                          
                                                          
                                                          59,246,043
                                                          
                                                          
                                                          
                                                          47,530,383Convertible
      notes payable, net, including $2,077,923 for discount of convertible
      note payable at December 31, 2008.(note 13)
                                                          
                                                          
                                                          32,922,077
                                                          
                                                          
                                                          
                                                          -Derivative
      liabilities (note 14)
                                                          
                                                          
                                                          1,502,597
                                                          
                                                          
                                                          
                                                          -Customer
      deposits
                                                          
                                                          
                                                          236,018
                                                          
                                                          
                                                          
                                                          135,627Accrued
      payroll and related costs
                                                          
                                                          
                                                          2,715,116
                                                          
                                                          
                                                          
                                                          2,664,464Accrued
      expenses and other payables (note 15)
                                                          
                                                          
                                                          12,460,784
                                                          
                                                          
                                                          
                                                          14,938,055Accrued
      pension costs (note 16)
                                                          
                                                          
                                                          3,806,519
                                                          
                                                          
                                                          
                                                          3,622,729Taxes
      payable (note 17)
                                                          
                                                          
                                                          5,717,438
                                                          
                                                          
                                                          
                                                          9,080,493Amounts
      due to shareholders/directors (note 18)
                                                          
                                                          
                                                          337,370
                                                          
                                                          
                                                          
                                                          304,601Total
      current liabilities
                                                          
                                                          $
                                                          126,259,679
                                                          
                                                          
                                                          $
                                                          92,248,955Long-term
      liabilities:Advances
      payable (note 19)
                                                          
                                                          
                                                          234,041
                                                          
                                                          
                                                          
                                                          334,600Total
      liabilities
                                                          
                                                          $
                                                          126,493,720
                                                          
                                                          
                                                          $
                                                          92,583,555Minority
      interests (note 20)
                                                          
                                                          $
                                                          23,222,566
                                                          
                                                          
                                                          $
                                                          23,166,270Related
      Party Transactions (note 30)Commitments
      and contingencies (note 31)Stockholders'
      equity:Preferred
      stock, $0.0001 par value - Authorized - 20,000,000
                                                            shares
      Issued and Outstanding – None
                                                          
                                                          $
                                                          —
                                                          
                                                          
                                                          $
                                                          —Common
      stock, $0.0001 par value - Authorized - 80,000,000
                                                            shares
      Issued and Outstanding – 26,983,244 shares and 23,959,702 shares at
      December 31, 2008 and 2007, respectively (note 21)
                                                          
                                                          
                                                          2,698
                                                          
                                                          
                                                          
                                                          2,396Additional
      paid-in capital (note 21))
                                                          
                                                          
                                                          27,148,206
                                                          
                                                          
                                                          
                                                          30,125,951Retained
      earnings-(note
      22)Appropriated
                                                          
                                                          
                                                          7,525,777
                                                          
                                                          
                                                          
                                                          7,525,777Unappropriated
                                                          
                                                          
                                                          36,026,516
                                                          
                                                          
                                                          
                                                          23,591,275Deferred
      stock compensation (note 23)
                                                          
                                                          
                                                          (500,052
                                                          )
                                                          
                                                          
                                                          —Accumulated
      other comprehensive income
                                                          
                                                          
                                                          11,127,505
                                                          
                                                          
                                                          
                                                          5,989,463Total
      stockholders' equity
                                                          
                                                          $
                                                          81,330,650
                                                          
                                                          
                                                          $
                                                          67,234,862Total
      liabilities and stockholders' equity
                                                          
                                                          $
                                                          231,046,936
                                                          
                                                          
                                                          $
                                                          182,984,687




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


56




China
Automotive Systems, Inc. and Subsidiaries


Consolidated
Statements of Earnings


Years
Ended December 31, 2008 and 2007





Years Ended December 312008
                
                
                2007Net
      product sales, including $4,675,410 and $5,472,509 to related parties
      for Years Ended December 31, 2008 and 2007
                
                $
                163,179,286
                
                
                $
                133,597,003Cost
      of product sold, including $7,901,944 and $5,472,595 purchased from
      related parties at Years Ended December 31, 2008 and 2007
                
                
                115,920,585
                
                
                
                88,273,955Gross
      profit
                
                $
                47,258,701
                
                
                $
                45,323,048Add:
      Gain on other sales
                
                
                734,063
                
                
                
                554,150Less:
      Operating expensesSelling
      expenses
                
                
                10,869,661
                
                
                
                9,674,476General
      and administrative expenses
                
                
                12,097,500
                
                
                
                9,026,717R&D
      expenses
                
                
                2,255,892
                
                
                
                1,666,274Depreciation
      and amortization
                
                
                5,846,290
                
                
                
                4,243,930Total
      Operating expenses
                
                
                31,069,343
                
                
                
                24,611,397Income
      from operations
                
                $
                16,923,421
                
                
                $
                21,265,801Add:
      Other income, net (note 24)
                
                
                1,067,309
                
                
                
                38,462Financial
      income (expenses) (note 25)
                
                
                (1,296,218
                )
                
                
                (566,986
                )Gain
      (loss) on change in fair value of derivative (note 26)
                
                
                998,014
                
                
                
                —Income
      before income taxes
                
                
                17,692,526
                
                
                
                20,737,277Less:
      Income taxes (note 27)
                
                
                185,877
                
                
                
                2,231,032Income
      before minority interests
                
                
                17,506,649
                
                
                
                18,506,245Less:
      Minority interests
                
                
                5,071,408
                
                
                
                9,646,339Net
      income
                
                $
                12,435,241
                
                
                $
                8,859,906Net
      income per common share–Basic
                
                $
                0.48
                
                
                $
                0.37Diluted
      (note 28)
                
                $
                0.46
                
                
                $
                0.37Weighted
      average number of common shares outstanding –Basic
                
                
                25,706,364
                
                
                
                23,954,370Diluted
                
                
                29,668,726
                
                
                
                23,958,705




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


57




China
Automotive Systems, Inc. and Subsidiaries


Consolidated
Statements of Comprehensive Income


Years
Ended December 31, 2008 and 2007





Years
      Ended December 312008
                
                
                2007Net
      income
                
                $
                12,435,241
                
                
                $
                8,859,906Other
      comprehensive income:Foreign
      currency translation gain
                
                
                5,138,042
                
                
                
                3,520,663Comprehensive
      income
                
                $
                17,573,283
                
                
                $
                12,380,569




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


58




China
Automotive Systems, Inc. and Subsidiaries


Consolidated
Statements of Stockholders’ Equity


Years
Ended December 31, 2008 and 2007




AccumulatedAdditional
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    Deferred
                                                    
                                                    
                                                    OtherCommon
      Stock
                                                    
                                                    
                                                    Paid-in
                                                    
                                                    
                                                    Retained
      Earnings
                                                    
                                                    
                                                    stock
                                                    
                                                    
                                                    ComprehensiveShares
                                                    
                                                    
                                                    Par
      value
                                                    
                                                    
                                                    Capital
                                                    
                                                    
                                                    Appropriated
                                                    
                                                    
                                                    Unappropriated
                                                    
                                                    
                                                    compensation
                                                    
                                                    
                                                    Income
      (Loss)
                                                    
                                                    
                                                    TotalBalance
      at January 1, 2007
                                                    
                                                    
                                                    23,851,581
                                                    
                                                    
                                                    $
                                                    2,385
                                                    
                                                    
                                                    $
                                                    28,651,959
                                                    
                                                    
                                                    $
                                                    6,209,909
                                                    
                                                    
                                                    $
                                                    16,047,237
                                                    
                                                    
                                                    $
                                                    –
                                                    
                                                    
                                                    $
                                                    2,468,800
                                                    
                                                    
                                                    $
                                                    53,380,290Foreign
      currency translation gain
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    3,520,663
                                                    
                                                    
                                                    
                                                    3,520,663Sale
      of common stock
                                                    
                                                    
                                                    108,121
                                                    
                                                    
                                                    
                                                    11
                                                    
                                                    
                                                    
                                                    1,199,989
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    1,200,000Cash
      paid for retaining fee, commissions and placement agent fee in connection
      with offering
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    (54,500
                                                    )
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    (54,500
                                                    )Increase
      in connection with minority shareholders’ abandonment of all its
      right and interest in Joint-venture
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    174,828
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    174,828Issuance
      of stock options to independent directors
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    153,675
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    153,675Net
      income for the year ended December 31, 2007
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    8,859,906
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    8,859,906Appropriation
      of retained earnings
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    1,315,868
                                                    
                                                    
                                                    
                                                    (1,315,868
                                                    )
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –Balance
      at December 31, 2007
                                                    
                                                    
                                                    23,959,702
                                                    
                                                    
                                                    $
                                                    2,396
                                                    
                                                    
                                                    $
                                                    30,125,951
                                                    
                                                    
                                                    $
                                                    7,525,777
                                                    
                                                    
                                                    $
                                                    23,591,275
                                                    
                                                    
                                                    $
                                                    –
                                                    
                                                    
                                                    $
                                                    5,989,463
                                                    
                                                    
                                                    $
                                                    67,234,862Foreign
      currency translation gain
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    5,138,042
                                                    
                                                    
                                                    
                                                    5,138,042Difference
      between the book value of and Consideration paid for the 35.5% equity
      interest of Henglong
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    (25,912,921
                                                    )
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    (25,912,921
                                                    )Issuance
      of common stock
                                                    
                                                    
                                                    3,023,542
                                                    
                                                    
                                                    
                                                    302
                                                    
                                                    
                                                    
                                                    22,089,698
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    22,090,000Issuance
      of stock options to independent directors and management
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    845,478
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    845,478Net
      income for the year ended December 31, 2008
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    12,435,241
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    12,435,241Issuance
      of stock options to management
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    (500,052
                                                    )
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    (500,052
                                                    )Balance
      at December 31, 2008
                                                    
                                                    
                                                    26,983,244
                                                    
                                                    
                                                    $
                                                    2,698
                                                    
                                                    
                                                    $
                                                    27,148,206
                                                    
                                                    
                                                    $
                                                    7,525,777
                                                    
                                                    
                                                    $
                                                    36,026,516
                                                    
                                                    
                                                    $
                                                    (500,052
                                                    )
                                                    
                                                    $
                                                    11,127,505
                                                    
                                                    
                                                    $
                                                    81,330,650




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


59


China
Automotive Systems, Inc. and Subsidiaries


Consolidated
Statements of Cash Flows


Years
Ended December 31, 2008 and 2007





Years
      Ended December 312008
                                                
                                                
                                                2007Cash
      flows from operating activities:Net
      income
                                                
                                                $
                                                12,435,241
                                                
                                                
                                                $
                                                8,859,906Adjustments
      to reconcile net income from continuing operations to net cash provided by
      operating activities:Minority
      interests
                                                
                                                
                                                5,071,408
                                                
                                                
                                                
                                                9,646,339Stock-based
      compensation
                                                
                                                
                                                345,426
                                                
                                                
                                                
                                                153,675Depreciation
      and amortization
                                                
                                                
                                                9,924,992
                                                
                                                
                                                
                                                7,349,546Deferred
      income taxes
                                                
                                                
                                                (974,383
                                                )
                                                
                                                
                                                (1,315,510
                                                )Allowance
      for doubtful accounts (Recovered)
                                                
                                                
                                                1,030,738
                                                
                                                
                                                
                                                (881,423
                                                )Amortization
      for discount of convertible note payable
                                                
                                                
                                                424,665
                                                
                                                
                                                
                                                -(Gain)
      loss on change in fair value of derivative
                                                
                                                
                                                (998,014
                                                )
                                                
                                                
                                                -Other
      operating adjustments
                                                
                                                
                                                2,533
                                                
                                                
                                                
                                                92,401Changes
      in operating assets and liabilities:(Increase)
      decrease in:Pledged
      cash deposits
                                                
                                                
                                                (1,776,424
                                                )
                                                
                                                
                                                (981,519
                                                )Accounts
      and notes receivable
                                                
                                                
                                                (9,335,776
                                                )
                                                
                                                
                                                (19,748,023
                                                )Advance
      payments and other
                                                
                                                
                                                (417,973
                                                )
                                                
                                                
                                                41,648Inventories
                                                
                                                
                                                (4,955,085
                                                )
                                                
                                                
                                                (3,454,479
                                                )Increase
      (decrease) in:Accounts
      and notes payable
                                                
                                                
                                                8,319,472
                                                
                                                
                                                
                                                7,120,821Customer
      deposits
                                                
                                                
                                                89,046
                                                
                                                
                                                
                                                (20,924
                                                )Accrued
      payroll and related costs
                                                
                                                
                                                (128,344
                                                )
                                                
                                                
                                                1,032,723Accrued
      expenses and other payables
                                                
                                                
                                                1,487,900
                                                
                                                
                                                
                                                627,192Accrued
      pension costs
                                                
                                                
                                                (69,998
                                                )
                                                
                                                
                                                128,136Taxes
      payable
                                                
                                                
                                                (3,974,905
                                                )
                                                
                                                
                                                2,673,964Advances
      payable
                                                
                                                
                                                (126,553
                                                )
                                                
                                                
                                                —Net
      cash provided by operating activities
                                                
                                                $
                                                16,373,966
                                                
                                                
                                                $
                                                11,324,473Cash
      flows from investing activities:(Increase)
      decrease in other receivables
                                                
                                                
                                                (353,834
                                                )
                                                
                                                
                                                481,042Cash
      received from equipment sales
                                                
                                                
                                                368,707
                                                
                                                
                                                
                                                629,918Cash
      paid to acquire property, plant and equipment
                                                
                                                
                                                (12,245,383
                                                )
                                                
                                                
                                                (13,982,490
                                                )Cash
      paid to acquire intangible assets
                                                
                                                
                                                (125,550
                                                )
                                                
                                                
                                                (287,747
                                                )Cash
      paid for the acquisition of 35.5% of Henglong equity
                                                
                                                
                                                (10,000,000
                                                )
                                                
                                                
                                                -Net
      cash (used in) investing activities
                                                
                                                $
                                                (22,356,060
                                                )
                                                
                                                $
                                                (13,159,277
                                                )Cash
      flows from financing activities::Repayment
      of bank loans
                                                
                                                $
                                                (7,567,697
                                                )
                                                
                                                $
                                                (2,182,860
                                                )Dividends
      paid to the minority interest holders of Joint-venture
      companies
                                                
                                                
                                                (6,198,489
                                                )
                                                
                                                
                                                (6,307,189
                                                )Increase
      (decrease) in amounts due to shareholders/directors
                                                
                                                
                                                2,416
                                                
                                                
                                                
                                                (84,476
                                                )Proceeds
      from issuance of common stock
                                                
                                                
                                                -
                                                
                                                
                                                
                                                1,145,500Capital
      Contribution from the minority interest holders of Joint-venture
      companies
                                                
                                                
                                                745,723
                                                
                                                
                                                
                                                —Proceeds
      from issuance of convertible note payable
                                                
                                                
                                                35,000,000
                                                
                                                
                                                
                                                -Net
      cash provided by (used in) financing activities
                                                
                                                $
                                                21,981,953
                                                
                                                
                                                $
                                                (7,429,025
                                                )Cash
      and cash equivalents effected by foreign currency
                                                
                                                $
                                                1,626,357
                                                
                                                
                                                $
                                                1,332,488Net
      change in cash and cash equivalentsNet
      increase (decrease) in cash and cash equivalents
                                                
                                                $
                                                17,626,216
                                                
                                                
                                                $
                                                (7,931,341
                                                )Cash
      and cash equivalents, at the beginning of year
                                                
                                                
                                                19,487,159
                                                
                                                
                                                
                                                27,418,500Cash
      and cash equivalents, at the end of year
                                                
                                                $
                                                37,113,375
                                                
                                                
                                                $
                                                19,487,159




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


60




China
Automotive Systems, Inc. and Subsidiaries


Consolidated
Statements of Cash Flows (continued)


Years
Ended December 31, 2008 and 2007




SUPPLEMENTAL
DISCLOSURE OF CASH FLOW INFORMATION:




Years
      Ended December 312008
                        
                        
                        2007Cash
      paid for interest
                        
                        $
                        1,266,204
                        
                        
                        $
                        895,491Cash
      paid for income taxes
                        
                        $
                        4,126,048
                        
                        
                        $
                        1,970,544




SUPPLEMENTAL
DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:




Years
      Ended December 312008
                
                
                2007Acquisition
      of 35.5% of Henglong equity from the minority shareholder on a cashless
      basis
                
                $
                (22,090,000
                )
                
                $
                —Liability
      result from issuance of common stock to acquire 35.5% of Henglong's
      equity
                
                
                22,090,000
                
                
                
                —Decrease
      in minority interests as a result of minority shareholder’s withdrawal
      from Joint-venture
                
                
                -
                
                
                
                (2,830,545
                )Withdrawal
      of invested intangible assets by minority shareholder of
      Joint-venture
                
                
                -
                
                
                
                2,600,204Increase
      in equity in connection with minority shareholder’s withdrawal from
      Joint-venture
                
                $
                -
                
                
                $
                230,341




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


61




China
Automotive Systems, Inc. and Subsidiaries


Notes to
Consolidated Financial Statements


Years
Ended December 31, 2008 and 2007




1. Organization
and Business




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




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




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




The
Company owns the following aggregate net interests in eight Sino-foreign joint
ventures organized in the PRC as of December 31, 2008 and 2007.




Percentage InterestName of Entity
                            
                            2008
                            
                            
                            2007Jingzhou
      Henglong Automotive Parts Co., Ltd., “Henglong”
                            
                            
                            80.00
                            %
                            
                            
                            44.50
                            %Shashi
      Jiulong Power Steering Gears Co., Ltd., “Jiulong”
                            
                            
                            81.00
                            %
                            
                            
                            81.00
                            %Shenyang
      Jinbei Henglong Automotive Steering System Co.,
      Ltd.,“Shenyang”
                            
                            
                            70.00
                            %
                            
                            
                            70.00
                            %Zhejiang
      Henglong & Vie Pump-Manu Co., Ltd., “Zhejiang”
                            
                            
                            51.00
                            %
                            
                            
                            51.00
                            %Universal
      Sensor Application Inc., “USAI”
                            
                            
                            83.34
                            %
                            
                            
                            75.90
                            %Wuhan
      Jielong Electric Power Steering Co., Ltd., “Jielong”
                            
                            
                            85.00
                            %
                            
                            
                            85.00
                            %Wuhu
      HengLong Auto Steering System Co., Ltd., “Wuhu”
                            
                            
                            77.33
                            %
                            
                            
                            77.33
                            %Jingzhou
      Hengsheng Automotive System Co., Ltd., “Hengsheng”
                            
                            
                            100.00
                            %
                            
                            
                            100.00
                            %




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


62




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




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




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




Shenyang
was established in 2002 and focuses on power steering parts for light duty
vehicles.




Zhejiang
was established in 2002 to focus on power steering pumps.




USAI was
established in 2005 and mainly engaged in the production and sales of sensor
modulars.




In 2008,
Genesis and Shanghai Hongxi Investment Inc., “Hongxi”, the other shareholder of
USAI, agreed to increase USAI’s capital to $2,600,000 from $1,800,000. The
increased capital was wholly funded by Genesis. Therefore, the capital
contributed by Genesis in USAI increased to $2,166,900 from $1,366,900,
accounting for 83.34% of the total capital; while the capital contributed by
Hongxi remained unchanged, accounting for 16.66% of the total
capital.


Wuhu was
established in 2006 and mainly engaged in the production and sales of automobile
steering systems.





Jielong
was established in 2006 and mainly engaged in the production and sales of
electric power steering gears (“EPS”).




On March
7, 2007, Genesis established a wholly-owned subsidiary, Jingzhou Hengsheng
Automotive System Co., Ltd, “Hengsheng”, to engage in production and sales of
automotive steering systems. The registered capital of Hengsheng is
$10,000,000.




2. Basis
of Presentation and Significant Accounting Policies




Basis of
Presentation - For the year ended December 31, 2008 and 2007, the accompanying
consolidated financial statements include the accounts of the Company and its
two 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.




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 having 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 Emerging Issues
Task Force Issue No. 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% 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. Because of the Company’s control over the operation and
assets of Henglong, the minority shareholders of Henglong have no right to
select, terminate and set the compensation of management responsible for
implementing the enterprise’s policies and procedures, nor do they have any
right to establish operating and capital decisions of Henglong.


63




Jiulong
was formed in 1993, with 81% owned by the Company, 10% owned by Jingzhou Jiulong
Machinery and Electronic Manufacturing Co., Ltd., “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%, are 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 is appointed by the Company.




Shenyang
was formed in 2002, with 70% owned by the Company, 30% owned by Shengyang
Automotive Industry Investment Corporation, “JB Investment”. 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 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.
The general manager is appointed by the Company.




Zhejiang
was formed in 2002, with 51% owned by Genesis 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. The Chairman of the Board of Directors
is appointed by ZVG. The general manager is appointed by the
Company.




USAI was
formed in 2005. As at December 31, 2008, 83.34% was owned by the Company. 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 is appointed by the Company.




Jielong
was formed in April 2006, with 85% owned by the Company, 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, 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 is appointed by the
Company.




Wuhu was
formed in May 2006, with 77.33% owned by the Company, 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, 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 the other joint venture partner of Wuhu executed
“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 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.




64




Use of
Estimates - The preparation of 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
date of the financial statements, and the reported amounts of revenues and
expenses during the reporting periods. The Company is of an opinion that the
significant items were warranty reserves, long term assets and investment, the
realizable value of accounts receivable and inventories, useful lives of
property, plant and equipment, 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 - The Company has pledged cash deposits to secure trade financing
provided by banks.




Accounts
Receivable - In order to determine the value of the Company’s accounts
receivable, the Company records a provision for doubtful accounts to cover
estimated credit losses. Management reviews and adjusts this allowance
periodically based on historical experience and its evaluation of the
collectibility of outstanding accounts receivable. The Company evaluates the
credit risk of its customers utilizing historical data and estimates of future
performance.




Inventories
- Inventories are stated at the lower of cost and net realizable value. Cost is
calculated on the moving-average basis and includes all costs to acquire and
other costs incurred in 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 or prepayments to acquire various
assets to be utilized in the future in the Company’s normal business operations.
Such amounts are paid according to their respective contract terms and are
classified as a current asset 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 provided on the
straight-line method over the estimated useful lives of the respective assets as
follows:




Category
                
                Estimated Useful Life
    (Years)Land
      use rights and buildings:Land
      use rights
                
                45-50Buildings
                
                25Machinery
      and equipment
                
                6Electronic
      equipment
                
                4Motor
      vehicles
                
                6




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 financeassets 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.


65




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 operations
on the date of disposal.




Interest
Costs Capitalized - Interest costs incurred in connection with specific
borrowings for the acquisition, construction or installation of property, plant
and equipment are capitalized and depreciated as part of the asset’s total cost
when the respective asset is placed into service.




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 Statement of Financial
Accounting Standards No. 144, “Accounting for the Impairment or Disposal of
Long-Lived Assets”. Property, plant and equipment and intangible assets are
reviewed periodically for impairment losses 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
January 2002, the Company adopted SFAS No. 142, “Goodwill and Other Intangible
Assets”. The Company did not have any goodwill at December 31, 2008 and
2007.




The
Company’s long-lived assets are reviewed annually for impairment or whenever
events or changes in circumstances indicated that the carrying amount of an
asset might not be recoverable. An impairment is recognized when the carrying
amount of an asset to be held and used exceeds the projected undiscounted future
net cash flows expected from its use and disposal and is measured as the amount
by which the carrying amount of asset exceeds its fair value.




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
realizability.




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 value added tax laws have been complied with, and
collectibility is probable. The Company recognizes product sales generally at
the time the product is shipped. Concurrent with the recognition of revenue, the
Company reduces revenue for estimated product returns. Shipping and handling
costs are included in cost of goods sold. Revenue is presented net of any sales
tax and value added tax.




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 operations in
accordance with EITF 99-19.





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 sales amount less cost of the assets. The Company has classified such
revenue from materials and other asset sales into gain on other sales in its
consolidated statement of operations.


66


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
operations.




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.




Pension -
The Company’s operations are all located in China, all the employees are located
in China. The Company records pension costs and various employment benefits in
accordance with the relevant Chinese social security laws, which is
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 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 collectibility of outstanding accounts
receivable.




Interest
Rate Risk- Bank loans 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. Statement of Financial Accounting Standards No. 109
(“SFAS 109”), “Accounting for Income Taxes,” requires that deferred tax
assets be reduced by a valuation allowance if, based on all available evidence,
it is considered more likely than not that some portion or all of the recorded
deferred tax assets will not be realized in future periods. 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.




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




Comprehensive
Income - The Company has adopted the provisions of Statement of Financial
Accounting Standards No. 130, “Reporting Comprehensive Income” (“SFAS No. 130”).
SFAS No. 130 establishes standards for the reporting and display of
comprehensive income, its components and accumulated balances in a full set of
general purpose financial statements. SFAS No. 130 defines comprehensive income
to include all changes in equity except those resulting from investments by
owners and distributions to owners, including adjustments to minimum pension
liabilities, accumulated foreign currency translation, and unrealized gains or
losses on marketable securities.


67




Fair
Value of Financial Instruments - The Company believes that the carrying value of
its cash and cash equivalents, accounts receivable, accounts payable and accrued
liabilities as of December 31, 2008 approximates their respective fair values
due to the short-term nature of those instruments. The fair values of other
long-term receivables and advances payable, discounted at 5.90%, would be
approximately $1,740,000 and $220,000 respectively as of December 31,
2008.




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 411,350 stock options under this plan and there remain
1,788,650 stock options issuable in future. As of December 31, 2008, the Company
had 388,850 stock options outstanding.




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




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




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




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




68




Fair
Value Measurements-Effective January 1, 2008, the Company adopted the provisions
of FAS 157, Fair Value Measurements, except as it applies to those
nonfinancial assets and nonfinancial liabilities as noted in proposed FSP FAS
157-b. The partial adoption of FAS 157 did not have a material impact on the
Company’s consolidated financial position, results of operations or cash flows.
SFAS No. 157 defines fair value, establishes a framework for measuring fair
value in generally accepted accounting principles, and expands disclosures about
fair value measurements. This statement does not require any new fair value
measurements, but provides guidance on how to measure fair value by providing a
fair value hierarchy used to classify the source of the information. In February
2008, the FASB issued FASB Staff Position (“FSP”) 157-2, Effective Date of FASB
Statement No. 157, which delays the effective date of SFAS No. 157 for all
nonfinancial assets and nonfinancial liabilities, except for items that are
recognized or disclosed at fair value in the financial statements on a recurring
basis (at least annually).




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




In
translating the financial statements of the Company from its functional currency
into its 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”)




69




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 transaction with related parties are
as follows:




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
purchases from related parities – The Company purchased materials from related
parties at fair market prices, and also received 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,
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.




3. Recent
Accounting Pronouncements





In
February 2007, FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities Including an Amendment of FASB Statement No.
115 (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial
instruments and certain other items at fair values. SFAS 159 is effective for
fiscal years after November 15, 2007. The Company has adopted the provisions of
this statement since January 1, 2008.





In
December 2007, the FASB issued SFAS No. 141 (Revised 2007), Business
Combinations. SFAS 141(R) retains the fundamental requirements of the original
pronouncement requiring that the purchase method be used for all business
combinations. SFAS 141(R) defines the acquirer as the entity that obtains
control of one or more businesses in the business combination, establishes the
acquisition date as the date that the acquirer achieves control and requires the
acquirer to recognize the assets acquired, liabilities assumed and any
noncontrolling interest at their fair values as of the acquisition date. In
addition, SFAS 141(R) requires expensing of acquisition-related and
restructure-related costs, remeasurement of earn out provisions at fair value,
measurement of equity securities issued for purchase at the date of close of the
transaction and non-expensing of in-process research and development related
intangibles. 141R is effective for financial statements issued for fiscal years
beginning after December 15, 2008, and interim periods within those fiscal
years. The Company is required to and plans to adopt the provisions of SFAS 141R
beginning in the first quarter of 2009. The Company is currently evaluating the
impact of the implementation of SFAS No. 141(R) on its consolidated financial
position, results of operations and cash flows.


70





In
December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in
Consolidated Financial Statements-an amendment of ARB No. 51." The objective of
SFAS No. 160 is to improve the relevance, comparability and transparency of the
financial information that a reporting entity provides in its consolidated
financial statements by establishing additional accounting and reporting
standards. SFAS No. 160 is effective for fiscal years beginning on or after
December 15, 2008. Early adoption of this statement is prohibited. By adopting
SFAS No. 160, the noncontrolling interests will be reported as equity while the
noncontrolling interests are reported in the mezzanine section between
liabilities and equity currently. The Company is currently assessing the impact
of adopting SFAS No. 160 on its consolidated financial
statements.





In March
2008, the Financial Accounting Standards Board (FASB) issued FASB Statement No.
161, Disclosures about
Derivative Instruments and Hedging Activities. The new standard is
intended to improve financial reporting about derivative instruments and hedging
activities by requiring enhanced disclosures to enable investors to better
understand their effects on an entity’s financial position, financial
performance, and cash flows. It is effective for financial statements issued for
fiscal years and interim periods beginning after November 15, 2008, with early
application encouraged. The Company is currently evaluating the impact of
adopting SFAS No. 161 on its consolidated financial
statements.





In May
2008, the FASB issued Financial Accounting Standard No. 162, "The Hierarchy of
Generally Accepted Accounting Principles" ("SFAS No. 162"). The statement is
intended to improve financial reporting by identifying a consistent hierarchy
for selecting accounting principles to be used in preparing financial statements
that are prepared in conformance with GAAP. Unlike SAS No. 69, "The Meaning of
Present in Conformity With GAAP," SFAS No. 162 is directed to the entity rather
than the auditor. The statement is effective 60 days following the SEC's
approval of the Public Company Accounting Oversight Board amendments to AU
Section 411, "The Meaning of Present Fairly in Conformity with GAAP." The
Company is currently assessing the impact of this statement, but believes it
will not have a material impact on its financial position, results of
operations, or cash flows upon adoption.





In May
2008, the FASB issued SFAS No. 163, “Accounting for Financial Guarantee
Insurance Contracts-an interpretation of FASB Statement No. 60.” Diversity
exists in practice in accounting for financial guarantee insurance contracts by
insurance enterprises under FASB Statement No. 60, Accounting and Reporting by
Insurance Enterprises. This results in inconsistencies in the recognition and
measurement of claim liabilities. This Statement requires that an insurance
enterprise recognize a claim liability prior to an event of default (insured
event) when there is evidence that credit deterioration has occurred in an
insured financial obligation. This Statement requires expanded disclosures about
financial guarantee insurance contracts. The accounting and disclosure
requirements of the Statement will improve the quality of information provided
to users of financial statements. The adoption of FASB 163 is not expected to
have a material impact on the Company’s financial position.


In May
2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff
Position (“FSP”) APB 14-1, Accounting for Convertible Debt Instruments That May
be Settled in Cash upon Conversion (Including Partial Cash Settlement). FSP
APB14-1 clarifies that convertible debt  instruments that may be
settled in cash upon either mandatory or optional conversion (including Partial
Cash Settlement) are not addressed by paragraph 12 of APB Opinion No.14,
Accounting for Convertible Debt and Debt issued with Stock Purchase Warrants.
Additionally, FSP APB14-1 specifies that issuers of such instruments should
separately account for the liability and equity components in a manner that will
reflect the entity’s non-convertible debt borrowing rate when interest cost is
recognized in subsequent periods. FSP APB14-1 is effective for financial
statements issued for fiscal years beginning after December 15, 2008, and
interim periods within those fiscal years. The Company has adopted FSP APB14-1
beginning January 1, 2009, and this standard must be applied on a retrospective
basis. The Company is evaluating the  impact the adoption of FSP
APB14-1 will have on its consolidated financial position and results of
operations.


In June
2008, the FASB ratified the consensus reached on EITF Issue No. 07-05,
Determining Whether an Instrument (or Embedded Feature) Is Indexed to an
Entity's Own Stock. EITF Issue No. 07-05 clarifies the determination of whether
an instrument (or an embedded feature) is indexed to an entity's own stock,
which would qualify as a scope exception under SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities. EITF Issue No. 07-05 is effective
for financial statements issued for fiscal years beginning after December 15,
2008. Early adoption for an existing instrument is not permitted. The Company is
currently evaluating the impact of adopting EITF Issue No. 07-05 on its
consolidated financial statements.
  On June
16, 2008, the FASB issued final Staff Position (FSP) No. EITF03-6-1,
“Determining Whether Instruments Granted in Share-Based Payment Transaction Are
Participating Securities,” to address the question of whether instrument granted
in share-based payment transaction are participating securities prior to
vesting. The FSP determines that unvested share-based payment awards that
contain rights to dividend payments should be  included in earnings
per share calculations. The guidance will be effective for fiscal years
beginning after December 15, 2008. The Company is currently evaluating the
requirement of (FSP) No. EITF03-6-1 as well as the impact of the adoption on its
consolidated financial statements.
 
 In
December 2008, the FASB issued FSP FAS 140-4 and FIN 46(R)-8, “Disclosures by
Public Entities (Enterprises) about Transfers of Financial Assets and Interests
in Variable Interest Entities” (“FSP FAS 140-4 and FIN 46 (R)-8”). FSP FAS140-4
and FIN 46(R)-8 amends FAS140 and FIN 46(R) to require additional disclosures
regarding transfers of financial assets and interest in variable interest
entities. FSP FAS 140-4 and FIN 46 (R)-8 is effective for interim or annual
reporting periods ending after December 15, 2008. The Company is currently
evaluating the impact of the adoption of FSP FAS140-4 and FIN 46(R)-8 will have
on its consolidated financial position and results of
operations.


71


4. Pledged
cash deposits





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





5. Accounts
Receivable and Notes Receivable





The
Company’s accounts receivable at December 31, 2008 and 2007 are summarized as
follows:





December 31,2008
                
                
                2007Accounts
      receivable
                
                $
                60,345,494
                
                
                $
                49,605,411Notes
      receivable
                
                
                40,989,840
                
                
                
                36,245,070101,335,334
                
                
                
                85,850,481Less:
      allowance for doubtful accounts
                
                
                (4,910,478
                )
                
                
                (3,827,838
                )Balance
      at end of year
                
                $
                96,424,856
                
                
                $
                82,022,643




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




The
activity in the Company’s allowance for doubtful accounts of accounts receivable
during the year ended December 31, 2008 and 2007 are summarized as
follows:





December 31,2008
                
                
                2007Balance
      at beginning of year
                
                $
                3,827,838
                
                
                $
                4,086,218Amounts
      provided for (recovered) during the year
                
                
                841,078
                
                
                
                (532,392
                )Add:
      foreign currency translation
                
                
                241,562
                
                
                
                274,012Balance
      at end of year
                
                $
                4,910,478
                
                
                $
                3,827,838





72





6.
 Other Receivables





The
Company’s other receivables at December 31, 2008 and 2007 are summarized as
follows:





December 31,2008
                      
                      
                      2007Other
      receivables
                      
                      $
                      2,009,364
                      
                      
                      $
                      1,541,181Less:
      allowance for doubtful accounts
                      
                      
                      (659,837
                      )
                      
                      
                      (652,484
                      )Balance
      at end of the year
                      
                      $
                      1,349,527
                      
                      
                      $
                      888,697




Other receivables consist of amounts
advanced to both related and unrelated parties, primarily as unsecured demand
loans, with no stated interest rate or due date.




The
activity in the Company’s allowance for doubtful accounts of other receivable
during the year ended December 31, 2008 and 2007 are summarized as
follows:





December 31,2008
                
                
                2007Balance
      at beginning of the year
                
                $
                652,484
                
                
                $
                898,203Add:
      amounts provided (recovered) during the year
                
                
                (41,264
                )
                
                
                (297,870
                )Add:
      foreign currency translation
                
                
                48,617
                
                
                
                52,151Balance
      at end of the year
                
                $
                659,837
                
                
                $
                652,484




7. Inventories




The
Company’s inventories at December 31, 2008 and 2007 consisted of the
following:





December 31,2008
                
                
                2007Raw
      materials
                
                $
                8,354,397
                
                
                $
                7,904,167Work
      in process
                
                
                4,466,720
                
                
                
                4,181,248Finished
      goods
                
                
                14,826,961
                
                
                
                9,586,70927,648,078
                
                
                
                21,672,124Less:
      provision for loss
                
                
                (1,076,323
                )
                
                
                (1,478,838
                )Balance
      at end of the year
                
                $
                26,571,755
                
                
                $
                20,193,286




73




8.   Property,
Plant and Equipment




The
Company’s property, plant and equipment at December 31, 2008 and 2007 are
summarized as follows:





December 31,2008
                
                
                2007Land
      use rights and buildings
                
                $
                27,416,977
                
                
                $
                23,101,634Machinery
      and equipment
                
                
                54,405,700
                
                
                
                42,512,900Electronic
      equipment
                
                
                4,356,475
                
                
                
                3,480,008Motor
      vehicles
                
                
                2,461,378
                
                
                
                2,427,375Construction
      in progress
                
                
                1,007,415
                
                
                
                1,542,86589,647,945
                
                
                
                73,064,782Less:
      Accumulated depreciation
                
                
                (37,669,040
                )
                
                
                (26,479,741
                )Balance
      at end of the year
                
                $
                51,978,905
                
                
                $
                46,585,041




Depreciation
charge for the years ended December 31, 2008 and 2007 are $9,672,948 and
$7,079,313 respectively.




9.   Intangible
Assets




The
activity in the Company’s intangible asset account during the years ended
December 31, 2008 and 2007 are summarized as follows:




December 31,2008
                
                
                2007Balance
      at beginning of year
                
                $
                589,713
                
                
                $
                3,140,548Patent
      technology
                
                
                —
                
                
                
                144,390Management
      software license
                
                
                125,550
                
                
                
                143,356Patent
      technology
                
                
                -
                
                
                
                (2,600,204
                )Foreign
      currency translation
                
                
                41,120
                
                
                
                31,856756,383
                
                
                
                859,946Less:
      Amortization for the year
                
                
                (252,044
                )
                
                
                (270,233
                )Balance
      at end of year
                
                $
                504,339
                
                
                $
                589,713




The
estimated aggregated amortization expense for each of the five succeeding years
is $198,734, $126,596, $95,358, $68,874, and $23,958
respectively.


74




10. 
Deferred Income Tax Assets




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





The
components of deferred income tax assets at December 31, 2008 and 2007 were as
follows:




December
      31,2008
                          
                          
                          2007Losses
      carryforward (U.S.)
                          
                          $
                          2,300,322
                          
                          
                          $
                          1,646,531Losses
      carryforward (PRC)
                          
                          
                          287,285
                          
                          
                          
                          275,422Product
      warranties and other reserves
                          
                          $
                          1,737,052
                          
                          
                          $
                          1,258,559Property,
      plant and equipment
                          
                          
                          2,471,716
                          
                          
                          
                          1,573,787Bonus
      accrual
                          
                          
                          297,208
                          
                          
                          
                          347,089All
      other
                          
                          
                          154,348
                          
                          
                          
                          161,1217,247,931
                          
                          
                          
                          5,262,509Valuation
      allowance *
                          
                          
                          (4,864,866
                          )
                          
                          
                          (3,946,999
                          )Total
      deferred tax assets
                          
                          $
                          2,383,065
                          
                          
                          $
                          1,315,510





*As of
December 31, 2008, valuation allowance was $4,864,866, including $2,300,322
allowance for the Company’s deferred tax assets in the U.S. and $2,564,544
allowance for the Company’s non-U.S. deferred tax assets. Based on the Company’s
current operations in the U.S., the management believes that the deferred tax
assets in the U.S are not likely to be realized in the future. For the non-U.S.
deferred tax assets, pursuant to certain tax laws and regulations in China, the
management believes such amount will not be utilized to offset future taxable
income.




The
estimated losses available to reduce taxable income in future years will expire
as follows:





Years
      ending December 31,2028
                    
                    $
                    2,179,3052027
                    
                    
                    779,3882026
                    
                    
                    1,044,3632025
                    
                    
                    471,6232024
                    
                    
                    933,3082023
                    
                    
                    2,259,7532013
                    
                    
                    161,0202012
                    
                    
                    1,284,9382011
                    
                    
                    918,439Total
                    
                    $
                    10,032,137




75


11. 
Bank Loans




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




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




12. 
Accounts and notes payable




The
Company’s accounts and notes payable at December 31, 2008 and 2007 are
summarized as follows:





December 31,2008
                
                2007Accounts
      payable
                
                $
                38,595,446
                
                
                $
                32,511,812Notes
      payable
                
                
                20,650,597
                
                
                
                15,018,571Balance
      at end of year
                
                $
                59,246,043
                
                
                $
                47,530,383




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




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




13. 
Convertible notes payable




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





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


76





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





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





0-6
months:   125%


6-12
months:  125%


12-18
months: 135%


18-24
months: 135%


24-30
months: 145%


30-36
months: 145%


36-42
months: 155%


42-48
months: 155%




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





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





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


77





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





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





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





In the
event that the Company has not completed the necessary filings to list the
conversion shares on its principal market by the date that is ninety (90) days
after the issuance date or has not so listed the conversion shares by the date
that is ninety (90) days after the issuance date or the shares of the Company’s
common stock are terminated from registration under the Securities Act of 1933,
the Convertible Debt holders will have the right, in its sole discretion, to
require that the Company redeem all or any portion of the Convertible Debt. The
portion of the Convertible Debt subject to redemption in connection with this
listing default will be redeemed by the Company in cash at a price equal to the
sum of the conversion amount being redeemed and the Other Make Whole Amount as
mentioned above.





At 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 Debt
holder shall have the right, in its sole discretion, to require that the Company
redeem all or any portion of the Convertible Debt. The portion of this
Convertible Debt subject to redemption in connection with the share price change
of the underlying common stock will be redeemed by the Company in cash at a
price equal to the sum of the conversion amount being redeemed and the Other
Make Whole Amount as mentioned above.





Since the
Company’s stock Weighted Average Price for twenty (20) consecutive trading days
ended on March 16, 2009 was below $3.187, which is less than 45% of the
Conversion Price in effect of the Issuance Date, as adjusted, the “WAP Default”,
the Convertible Debt holder shall have the right, at its sole discretion, to
require that the Company redeem all or any portion of the Convertible Debt 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 the WAP Default notice to the Convertible Debt
holders.  Since the Company has not received any notice from YA Global
Investments, L.P. as of March 24, 2009, its redemption rights under such WAP
Default has lapsed. On March 23, 2009, the Company received a letter from the
joint and several provisional liquidator acting on behalf of Lehman Brothers
Commercial Corporation Asia Limited, “LBCCA Liquidator”, requesting that it be
granted an extension of time until April 24, 2009 to obtain legal advice and to
consider its rights under the Convertible Debt. The Company has granted an
extension to April 15, 2009. Although the LBCCA Liquidator has not given the
Company any notice of redemption yet, it may exercise its discretionary right of
early redemption on any date that is no earlier than ninety (90) days after it
delivers the written redemption notice to the Company, so long as it delivers
such notice on or before April 15, 2009. The Convertible Debt and related
Derivative liabilities have been recorded as short-term
liabilities.


78





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





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





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





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





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


79




Issue 7
(EITF 00-27) states that "the number of shares that would be received upon
conversion based on the adjusted conversion price would be compared to the
number that would have been received prior to the occurrence of the contingent
event. The excess number of shares multiplied by the commitment date stock price
equals the incremental intrinsic value that results from the resolution of the
contingency and the corresponding adjustment to the conversion price." The
guidance in Issue 7 does not specify whether the contingent BCF should only be
calculated if the contingent conversion feature is below the market price of the
stock and would have intrinsic value. The Company is of an opinion that the
Issue 7 approach was not intended to override the intrinsic value method
addressed in EITF Topic D-60, EITF 98-5 and EITF 00-27, and that the BCF should
be calculated as the intrinsic spread between the adjusted effective conversion
price and the market price at the commitment date.





As of
August 15, 2008, the number of indexed shares was 3,953,596 and 4,941,967 at the
inception conversion price and reset conversion price, respectively. At the
commitment date, the stock price was $6.09, and the “effective” conversion price
was $6.93. Accordingly, since the effective conversion price is higher than the
market value of the stock, the debt instruments are not considered "in the
money" and no beneficial conversion feature is present.





Allocation
of basis in the financing arrangement to the warrants and derivative liability
has resulted in an original issue discount to the face value of the convertible
notes in the amount of $2,502,588, which amount is subject to amortization over
the Convertible Debt’s term using the effective method. The Company recorded
amortization expense during 2008 of $424,665. If the convertible note becomes
callable, the unamortized discount on the convertible note will be written off
as expense at the earliest date of June 15, 2009.





14.
Derivative liabilities





The
Company has evaluated the convertible notes for terms and conditions that are
not clearly and closely associated with the risks of the debt-type host
instrument (see Note 13). Generally, such features require separation from the
host contract and treatment as derivative financial instruments. Certain
features, such as the conversion option, were found to be exempt. Other
features, such as puts and redemption features were found to require bifurcation
and recognition as derivative liabilities. These derivative liabilities are
recognized initially at fair value, using forward cash-flow valuation
techniques. As of February 15, 2008, the compound derivative value amounted to
$1,703,962. This derivative will be adjusted to its estimated fair value at the
completion of each reporting period until the debt arrangement is ultimately
settled, converted or paid. As of December 31, 2008, the compound derivative
value amounted to $1,502,597. The income from adjustment of fair value of
compound derivative has been recorded in the income statement as gain or loss on
change in fair value of derivative. (See note 13 and 26)




15.
Accrued expenses and other payables




The
Company’s accrued expenses and other payables at December 31, 2008 and 2007 are
summarized as follows:





December 31,2008
                
                
                2007Accrued
      expenses
                
                $
                2,441,352
                
                
                $
                1,957,146Other
      payables
                
                
                1,690,046
                
                
                
                1,340,442Warranty
      reserves*
                
                
                6,335,613
                
                
                
                4,919,491Dividend
      payable to minority interest shareholders of
Joint-ventures
                
                
                1,991,796
                
                
                
                6,720,976Liabilities
      in connection with warrants**
                
                
                1,977
                
                
                
                -Balance
      at end of year
                
                $
                12,460,784
                
                
                $
                14,938,055


80


*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
year ended December 31, 2008 and 2007, the warranties activities were as
follows:





December 31,2008
                
                
                2007Balance
      at the beginning of year
                
                $
                4,919,491
                
                
                $
                2,954,326Additions
      during the year
                
                
                5,861,782
                
                
                
                5,228,556Settlement
      within the year
                
                
                (4,797,457
                )
                
                
                (3,529,875
                )Foreign
      currency translation
                
                
                351,797
                
                
                
                266,484Balance
      at end of year
                
                $
                6,335,613
                
                
                $
                4,919,491





The
Company has recorded $6,335,613 and $ 4,919,491 product warranty reserves as at
December 31, 2008 and 2007, which were included in the accrued expenses and
other payables in the accompanying consolidated financial
statements.





**In
connection with the Convertible Debt, the Company issued 1,317,864 of detachable
warrants, “Warrants,” to purchase from the Company shares of common stock at the
exercise price of $ 8.8527 per share, subject to adjustments upon certain events
occurring. The Warrants are exercisable immediately and will expire on February
15, 2009.





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





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





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


81


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





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





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





As of
August 15, 2008, the Company valued the warrant using conversion price at
inception and reset respectively.  The fair value of the warrant is
$489,719 at the inception conversion price of $8.8527, and $551,131 at the reset
conversion price of $8.55, respectively. Such difference resulting from using
the reset conversion price has increased warrant liabilities by
$61,412.





As of
December 31, 2008, the fair value of warrants was $1,977, which was determined
using the Black-Scholes option pricing model. The income from adjustment of fair
value of liabilities in connection with warrants amount of gain has been
recorded in the income statement as gain or loss on change in fair value of
derivative. (See note 26)





16.
Accrued pension costs





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





The
activities in the Company’s pension account during the year ended December 31,
2008 and 2007 are summarized as follows:





December 31,2008
                
                
                2007Balance
      at beginning of the year
                
                $
                3,622,729
                
                
                $
                3,266,867Amounts
      provided during the year
                
                
                2,311,049
                
                
                
                1,286,566Settlement
      during the year
                
                
                (2,381,047
                )
                
                
                (1,154,462
                )Foreign
      currency translation
                
                
                253,788
                
                
                
                223,758Balance
      at end of year
                
                $
                3,806,519
                
                
                $
                3,622,729


82


17. Taxes
payable




The
Company’s taxes payable at December 31, 2008 and 2007 are summarized as
follows:





December 31,2008
                
                
                2007Value-added
      tax payable
                
                $
                6,279,089
                
                
                $
                7,052,682Income
      tax payable (recoverable)*
                
                
                (652,865
                )
                
                
                1,883,185Other
      tax payable
                
                
                91,214
                
                
                
                144,626Balance
      at end of year
                
                $
                5,717,438
                
                
                $
                9,080,493





*At the end of the fiscal year
of 2008, the Company paid income tax in advance, and the government will settle
with the Company during 2009.




18.
Amounts Due to Shareholders/Directors




The
activity in the amounts due to shareholders/directors during the years ended
December 31, 2008 and 2007 is summarized as follows:




December 31,2008
                
                
                2007Balance
      at beginning of the year
                
                $
                304,601
                
                
                $
                358,065Increase
      (decrease) during the year
                
                
                2,415
                
                
                
                (84,476
                )Foreign
      currency translation
                
                
                30,354
                
                
                
                31,012Balance
      at end of year
                
                $
                337,370
                
                
                $
                304,601




At
December 31, 2008 and 2007, the amounts due to shareholders/directors were
unsecured, interest free and repayable on demand.




19.
Advances payable




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




The
balances are unsecured, interest-free and will be repayable to the Chinese
government if the usage of such advance does not continue to qualify for the
subsidy (see notes 24 and 31).


83


20.
Minority Interests




The
Company’s activities in respect of the amounts of the minority interests’ equity
at December 31, 2008 and 2007 are summarized as follows:




December 31,2008
                
                
                2007Balance
      at beginning of the year
                
                $
                23,166,270
                
                
                $
                23,112,667Add:
      Additions during the year-Minority
      interest’s income
                
                
                5,071,408
                
                
                
                9,646,339Capital
      Contribution from the minority interest  holders of
      Joint-venture companies
                
                
                745,723
                
                
                
                55,512Less:
      decrease during the yearDividends
      declared to the minority interest holders of Joint-venture
      companies
                
                
                (1,016,733
                )
                
                
                (8,468,572
                )Transfer
      and assign equity interest in Henglong by minority interest holders of
      Joint-venture companies*
                
                
                (6,177,079
                )
                
                
                -Decrease
      in minority interests as a result of minority shareholders’ withdrawal
      form Joint-venture**
                
                
                -
                
                
                
                (2,830,545
                )Foreign
      currency translation
                
                
                1,432,977
                
                
                
                1,650,869Balance
      at end of year
                
                $
                23,222,566
                
                
                $
                23,166,270





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





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





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





**As of
March 20, 2007, Sensor withdrew from USAI, its withdrawal of intangible assets,
and abandonment of all its rights and interest in USAI, was charged to minority
interests of $2,830,545.




21. Share
Capital and Additional paid-in capital




The activities in the Company’s share
capital and Additional paid-in capital account during the years ended December
31, 2008 and 2007 are summarized as follows:


84




Share Capital
                  
                  
                  Additional paid-in
                    capitalShares
                  
                  
                  Par ValueBalance
      at January 1, 2007
                  
                  
                  23,851,581
                  
                  
                  
                  2,385
                  
                  
                  
                  28,651,959Cash
      from sale of common stock
                  
                  
                  108,121
                  
                  
                  
                  11
                  
                  
                  
                  1,199,989Cash
      paid for retaining fee, commissions and placement agent fee in connection
      with offering
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (54,500
                  )Increase
      in connection with minority shareholders’ abandonment of all its
      rights and interest in Joint-venture
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  174,828Issuance
      of stock options to independent directors
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  153,675Balance
      at December 31, 2007
                  
                  
                  23,959,702
                  
                  
                  
                  2,396
                  
                  
                  
                  30,125,951Issuance
      of common stock*
                  
                  
                  3,023,542
                  
                  
                  
                  302
                  
                  
                  
                  22,089,698Decrease
      in additional paid-in capital in connection with Henglong equity
      acquisition **
                  
                  -
                  
                  
                  -
                  
                  
                  
                  (25,912,921
                  )Issuance
      of stock options to independent directors and
management***
                  
                  -
                  
                  
                  -
                  
                  
                  
                  845,478Balance
      at December 31, 2008
                  
                  
                  26,983,244
                  
                  
                  
                  2,698
                  
                  
                  
                  27,148,206





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





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





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





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





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


85


***In
July 2004, the Company adopted a stock incentive plan. The maximum number of
common shares for issuance under this plan is 2,200,000 with a period of 10
years. The stock incentive plan provides for the issuance, to the Company’s
officers, directors, management and employees, of options to purchase shares of
the Company’s common stock. Since the adoption of the stock incentive plan, the
Company has issued 411,350 stock options under this plan, and there remain
1,788,650 stock options issuable in future. As of December 31, 2008, the Company
had 388,850 stock options outstanding.




The fair
value of the options at the grant date was $845,478 and $153,674, for the years
2008 and 2007, respectively, which was calculated based on Black-Scholes option
pricing model. The fair value was credited in additional paid-in capital,
debited in operating expenses using straight line method over the expected
beneficiary period. Difference was recorded as deferred stock compensation. For
the years ended December 31, 2008 and 2007, there was $345,426 and $153,674
recorded in operating expenses respectively.




The
weighted-average fair value of options granted during the periods 2008 and
2007 was $3.12 and $6.83, respectively. The fair value of each option granted
was estimated on the date of grant using the Black-Scholes option valuation
model and assumptions noted in the following table:




Issuance Date
                  
                  Expected volatility
                  
                  
                  Risk-free rate
                  
                  
                  Expected term (years)
                  
                  
                  Dividend yieldDecember
      10, 2008
                  
                  
                  134.39
                  %
                  
                  
                  1.21
                  %
                  
                  
                  3
                  
                  
                  
                  0.00
                  %June
      25, 2008
                  
                  
                  98.29
                  %
                  
                  
                  3.34
                  %
                  
                  
                  5
                  
                  
                  
                  0.00
                  %October
      1, 2007
                  
                  
                  118.53
                  %
                  
                  
                  3.00
                  %
                  
                  
                  4
                  
                  
                  
                  0.00
                  %





A summary
of option activities under the plans for the years ended December 31,
2008 and 2007 was as follows:




Shares
                          
                          
                          Weighted-Average
      Exercise Price
                          
                          
                          Weighted-Average
      Contractual Term (years)Outstanding
      - January 1, 2007
                          
                          
                          45,000
                          
                          
                          $
                          7.39
                          
                          
                          
                          5Granted
                          
                          
                          22,500
                          
                          
                          
                          7.01
                          
                          
                          
                          4Exercised
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —Cancelled
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —Outstanding
      - December 31, 2007
                          
                          
                          67,500
                          
                          
                          $
                          7.26
                          
                          
                          
                          4.7Granted
                          
                          
                          321,350
                          
                          
                          
                          3.12
                          
                          
                          
                          3.1Exercised
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —Cancelled
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —Outstanding
      - December 31, 2008
                          
                          
                          388,850
                          
                          
                          $
                          3.84
                          
                          
                          
                          3.4




86




The
following is a summary of warrants outstanding for the years ended December 31,
2008 and 2007:





Shares
                                
                                
                                Weighted-Average
      Exercise Price
                                
                                
                                Weighted-Average
      Contractual Term (years)Outstanding
      - January 1, 2007
                                
                                
                                156,250
                                
                                
                                $
                                16.00
                                
                                
                                
                                3Issued
                                
                                
                                —
                                
                                
                                
                                —
                                
                                
                                
                                —Exercised
                                
                                
                                —
                                
                                
                                
                                —
                                
                                
                                
                                —Cancelled
                                
                                
                                —
                                
                                
                                
                                —
                                
                                
                                
                                —Outstanding
      - December 31, 2007
                                
                                
                                156,250
                                
                                
                                $
                                16.00
                                
                                
                                
                                3Issued
                                
                                
                                1,317,864
                                
                                
                                
                                8.55
                                
                                
                                
                                1Exercised
                                
                                
                                —
                                
                                
                                
                                —
                                
                                
                                
                                —Cancelled
                                
                                
                                —
                                
                                
                                
                                —
                                
                                
                                
                                —Outstanding
      - December 31, 2008
                                
                                
                                1,474,114
                                
                                
                                $
                                9.34
                                
                                
                                
                                1.2





The
following is a summary of the range of exercise prices for stock options that
are outstanding and exercisable at December 31, 2008:





Range of Exercise Prices
                    
                    Outstanding Stock
                      Options
                    
                    
                    Weighted Average
                      Remaining Life
                    
                    
                    Weighted Average
                      Exercise Price
                    
                    
                    Number of Stock
                      Options Exercisable$2.00
      - $4.49
                    
                    
                    298,850
                    
                    
                    
                    2.94
                    
                    
                    $
                    2.93
                    
                    
                    
                    99,617$4.50
      - $10.00
                    
                    
                    90,000
                    
                    
                    
                    2.81
                    
                    
                    $
                    6.86
                    
                    
                    
                    90,000388,850
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    189,617





The
following is a summary of the range of exercise prices for warrants that are
outstanding and exercisable at December 31, 2008:





Range of Exercise Prices
                    
                    Issued Warrants
                    
                    
                    Weighted Average
                      Remaining Life
                    
                    
                    Weighted Average
                      Exercise Price
                    
                    
                    Number of Warrants
                      Exercisable$4.50
      - $9.99
                    
                    
                    1,317,864
                    
                    
                    
                    0.13
                    
                    
                    $
                    8.55
                    
                    
                    
                    1,317,864$10.01 - $20.00
                    
                    
                    156,250
                    
                    
                    
                    0.22
                    
                    
                    $
                    16.00
                    
                    
                    
                    156,2501,474,114
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    1,474,114


87




22. Retained earnings




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, 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%.




The
Company did not distribute the profit for the year 2008, therefore, there was no
statutory surplus recorded.




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 $10,000,000
respectively.




Net
income as reported in the US GAAP financial statements differs from that
reported in the PRC statutory financial statements. In accordance with relevant
laws and regulations in the PRC, profits available for distribution are based on
the statutory financial statements. If the Company has foreign currency
available after meeting its operational needs, the Company may make its profit
distributions in foreign currency to the extent foreign currency is available.
Otherwise, it is necessary to obtain approval and convert such distributions at
an authorized bank.




23.
Deferred stock compensation








24. Other
Income




During
2008 and 2007, the Company recorded other income, government subsidies, of
$1,067,309 and $38,462, respectively.




Government
subsidies including interest subsidies, which mean the refunds by the Chinese
Government of interest charged by banks to companies which are entitled to such
subsidies (see note 31), and subsidies for encouraging foreign investors to set
up technologically advanced enterprises in China .




Chinese
government also provided incentives to foreign investors for setting up
technologically advanced enterprises in China. During 2008, Genesis, as a
foreign investor, received $802,331 for re-investment in Jiulong and Henglong
with their profit distribution, and those entities were technologically
advanced enterprises and entitled to such subsidies.




Since
such government subsidy is similar to an investment income, the Company has
recorded it as other income.


88


25.
Financial income (expenses)





During
the year ended December 31, 2008 and 2007, the Company recorded financial income
(expenses) which was summarized as follows:





Years
      Ended December 31,2008
                
                
                2007Interest
      income(expenses),net
                
                $
                (1,238,764
                )
                
                $
                (559,773
                )Foreign
      exchange gain (loss), net
                
                
                305,578
                
                
                
                95,497Income
      (loss) of note discount, net
                
                
                150,654
                
                
                
                (49,900
                )Amortization
      for discount of convertible note payable
                
                
                (424,665
                )
                
                
                -Handling
      charge
                
                
                (89,021
                )
                
                
                (52,810
                )Total
                
                $
                (1,296,218
                )
                
                $
                (566,986
                )





26. Gain
(loss) on change in fair value of derivative





Years
      Ended December 31,2008
                
                2007Income
      from adjustment of fair value of liabilities in connection with
      warrants
                
                $
                796,649
                
                
                $
                -Income
      from adjustment of fair value of compound derivative
      liabilities
                
                
                201,365
                
                
                
                -Total
                
                $
                998,014
                
                
                $
                -





27.
Income Taxes





The
Company’s subsidiaries registered in the PRC are subject to state and local
income taxes within the PRC at the applicable tax rate on the taxable income as
reported in their PRC statutory financial statements in accordance with the
relevant income tax laws applicable to foreign invested enterprise. The
Company’s PRC subsidiaries which are in the stage of its enterprise income tax
exemption currently, are to remain subject to enterprise fixed income tax at a
statutory rate of 33%, which comprises 30% national income tax and 3% local
income tax.





On
January 1, 2007, Jiulong has used up its enterprise income tax exemption. During
2007, Jiulong was subject to enterprise income tax at a rate of 30%, and 25% for
2008.





On
January 1, 1999, Henglong was granted an enterprise income tax holiday of a 100%
enterprise income tax exemption for two years commencing from 1999, and a 50%
enterprise national income tax deduction and a 100% local income tax deduction
for the next nine years thereafter, from 2001 to 2009, for income tax purposes.
Henglong is subject to enterprise national income tax at a rate of 15% for 2008
and 2009, and is subject to enterprise income tax at a rate of 25% commencing
from January 1, 2010.


89


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





On
January 1, 2004, Zhejiang was granted an enterprise income tax holiday of a 100%
enterprise income tax exemption for two years commencing from 2004, and a 50%
enterprise national income tax deduction, and a 50% local income tax deduction
for the next three years thereafter, from 2006 to 2008, for income tax purposes.
During 2008, Zhejiang is subject to enterprise income tax at a rate of 16.5%,
which comprises of 15% enterprise national income tax and 1.5% local income tax,
and is subject to enterprise income tax at a rate of 25% commencing from January
1, 2009.





USAI,
Wuhu, Jielong and Hengsheng are at their start up stage in 2008 and 2007,
accordingly, there is no assessable profit for the year ended December 31, 2008
and 2007 subject to PRC enterprise income tax. They have an enterprise income
tax exemption in 2008 and 2009, and are subject to enterprise income tax at a
rate of 16.5% for the next three years thereafter, from 2010 to 2012, and a 25%
enterprise national income tax for the years commencing from January 1,
2013.





No
provision for Hong Kong tax is made as Genesis is an investment holding company,
and has no assessable income in Hong Kong for the year ended December 31, 2008
and 2007. The enterprise income tax of Hong Kong is 17.5%.





No
provision for US tax is made as the Company has no assessable income in the US
for the year ended December 31, 2008 and 2007. The enterprise income tax of US
is 30%.





The
provision for income tax differs from the provision computed at statutory rates
as follows:




Years
      Ended December 31,2008
                                          
                                          
                                          2007Average
      tax rate
                                          
                                          14.17
                                          %
                                          
                                          
                                          17.95
                                          %Computed
      income tax provision
                                          
                                          
                                          2,507,295
                                          
                                          
                                          
                                          3,722,141Permanent
      DifferencesIncome
      tax refund*
                                          
                                          
                                          (2,762,823
                                          )
                                          
                                          
                                          (2,085,180
                                          )Other
      reconciling items
                                          
                                          
                                          441,405
                                          
                                          
                                          
                                          594,071Total
      current and deferred tax expense
                                          
                                          
                                          185,877
                                          
                                          
                                          
                                          2,231,032




*For the
years ended December 31, 2008 and 2007, the income tax refund mainly includes
the income tax benefit received by the Company's Sino-foreign joint ventures
for purchase of domestically manufactured equipments.


90





28.
Income Per Share




Basic
income per share is calculated by dividing net income by the weighted average
number of common shares outstanding during the period. Diluted income per share
is calculated based on the treasury stock method, assuming the issuance of
common shares, if dilutive, resulting from the exercise of
warrants.




The
calculations of diluted income per share were:





Years Ended December 31,2008
                
                
                2007Numerator:Net
      income
                
                $
                12,435,241
                
                
                $
                8,859,906Add:
      interest expenses of convertible notes payable
                
                
                918,750
                
                
                
                -Add:
      Amortization for discount of convertible notes payable
                
                
                424,665
                
                
                
                -$
                13,778,656
                
                
                $
                8,859,906Denominator:Weighted
      average shares outstanding
                
                
                25,706,364
                
                
                
                23,954,370Effect
      of dilutive securities
                
                
                3,962,362
                
                
                
                4,33529,668,726
                
                
                
                23,958,705Net
      income per common share- diluted
                
                $
                0.46
                
                
                $
                0.37





During
the year ended December 31, 2008, the options and warrants outstanding have not
been included in the computation of diluted income per share, except the options
issued on December 10, 2008, because such inclusion would have had an
anti-dilutive effect. The shares issuable upon conversion of Convertible Debt
have been included in the computation.




29.
Significant Concentrations




The
Company grants credit to its customers, generally on an open account basis. The
Company’s customers are all located in the PRC.




In 2008,
the Company’s ten largest customers accounted for 78.4% of the Company’s
consolidated sales, with four customers accounting for in excess of 10% of
consolidated sales, i.e. 15.1%, 11.9%, 11.4% and 10.6% of consolidated sales, or
an aggregate of 49.1% of consolidated sales.




In 2007,
the Company’s ten largest customers accounted for 73.9% of the Company’s
consolidated sales, with four customers accounting for in excess of 10% of
consolidated sales, i.e. 16.4%, 13.7%, 11.5% and 10.6% of consolidated sales, or
an aggregate of 52.2% of consolidated sales.




At
December 31, 2008 and 2007, approximately 34.2% and 38.1% of accounts receivable
were from trade transactions with the aforementioned
customers.


91


30.   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, 2008 and 2007, the joint-ventures entered into related
party transactions with companies with common directors as shown
below:




Merchandise
Sold to Related Parties





Years ended December 31,2008
                  
                  
                  2007Xiamen
      Joylon
                  
                  $
                  2,143,418
                  
                  
                  $
                  5,020,465Shanghai
      Fenglong
                  
                  
                  166,885
                  
                  
                  
                  452,044Jiangling
      Yude
                  
                  
                  2,365,107
                  
                  
                  
                  -Total
                  
                  $
                  4,675,410
                  
                  
                  $
                  5,472,509





Materials
Purchased from Related Parties





Years ended December 31,2008
                  
                  
                  2007Xiamen
      Joylon
                  
                  $
                  9,547
                  
                  
                  $
                  2,157Shanghai
      Fenglong
                  
                  
                  136,990
                  
                  
                  
                  144,333Jiangling
      Tongchuang
                  
                  
                  5,485,206
                  
                  
                  
                  4,032,771Jingzhou
      Tongyi
                  
                  
                  285,347
                  
                  
                  
                  225,451Jingzhou
      Tongying
                  
                  
                  1,984,854
                  
                  
                  
                  953,796Hubei
      Wiselink
                  
                  
                  -
                  
                  
                  
                  114,087Total
                  
                  $
                  7,901,944
                  
                  
                  $
                  5,472,595


92


Technology
Purchased from Related Parties





Years ended December 31,2008
                  
                  
                  2007Changchun
      Hualong
                  
                  $
                  321,892
                  
                  
                  $
                  479,452





Equipment
Purchased from Related Parties





Years ended December 31,2008
                  
                  
                  2007Hubei
      Wiselink
                  
                  $
                  3,031,072
                  
                  
                  $
                  1,015,493




Purchase
of 35.5% equity interest in Jinzhou Henglong (refer to note 20)




Related
receivables, advance payments and account payable: As at December 31, 2008 and
2007, accounts receivables, advance payments and account payable between the
Company and related parties are as shown below:




Due from
Related Parties




December
      31,2008
                                    
                                    
                                    2007Xiamen
      Joylon
                                    
                                    $
                                    1,077,659
                                    
                                    
                                    $
                                    1,704,571Shanghai
      Fenglong
                                    
                                    
                                    207,451
                                    
                                    
                                    
                                    164,909Total
                                    
                                    $
                                    1,285,110
                                    
                                    
                                    $
                                    1,869,480





Other
Receivables from Related Parties





December
      31,2008
                      
                      
                      2007Jiangling
      Tongchuang
                      
                      $
                      3,511
                      
                      
                      $
                      3,288Jingzhou
      Derun
                      
                      
                      -
                      
                      
                      
                      22,472WuHan
      Dida
                      
                      
                      141,560
                      
                      
                      
                      93,925Jiulong
      Material
                      
                      
                      534,369
                      
                      
                      
                      519,141Changchun
      Hualong
                      
                      
                      224,234
                      
                      
                      
                      —Total
                      
                      $
                      903,674
                      
                      
                      $
                      638,826


93


Other
receivables from related parties are primarily unsecured demand loans, with no
stated interest rate or due date.




On
December 31, 2008 and 2007, with the exception of the receivable from the
investee of Jiulong,Jiulong
Material,of
$534,309 and $519,141, which were fully recorded in the allowance for doubtful
accounts, the Company believes that all other receivables are collectible, as
the related parties are in good financial condition and are paying their
payables to Company pursuant to the terms of their respective
contracts.




Due to
Related Parties





December
      31,2008
                    
                    
                    2007Xiamen
      Joylon
                    
                    $
                    -
                    
                    
                    $
                    3,007Shanghai
      Tianxiang
                    
                    
                    609,675
                    
                    
                    
                    570,806Shanghai
      Fenglong
                    
                    
                    38,063
                    
                    
                    
                    1,007Jiangling
      Tongchuang
                    
                    
                    206,039
                    
                    
                    
                    287,292Hubei
      Wiselink
                    
                    
                    159,482
                    
                    
                    
                    146,658Jingzhou
      Tongyi
                    
                    
                    17,377
                    
                    
                    
                    33,859Jingzhou
      Tongying
                    
                    
                    67,006
                    
                    
                    
                    92,188Total
                    
                    $
                    1,097,642
                    
                    
                    $
                    1,134,817





Advanced
Equipment Payment to Related Parties





Years ended December 31,2008
                  
                  
                  2007Hubei
      Wiselink
                  
                  $
                  2,473,320
                  
                  
                  $
                  1,560,378





Advanced
Expenses and Others to Related Parties





Years ended December 31,2008
                  
                  
                  2007Jingzhou
      Tongyi
                  
                  $
                  -
                  
                  
                  $
                  54,799Jingzhou
      Tongying
                  
                  
                  9,374
                  
                  
                  
                  524Total
                  
                  $
                  9,374
                  
                  
                  $
                  55,323


94


31.
Commitments and Contingencies




Legal
Proceedings - The Company is not currently a party to any threatened or pending
legal proceedings, other than incidental litigation arising in the ordinary
course of business. In the opinion of management, the ultimate disposition of
these matters will not have a material adverse effect on the Company's
consolidated financial position, results of operations or cash
flows.




The
following table summarizes the Company‘s major contractual payment obligations
and commitments as of December 31, 2008:





Payment Obligations by year2009
                      
                      
                      2010
                      
                      
                      2011
                      
                      
                      2012
                      
                      
                      Thereafter
                      
                      
                      TotalObligations
      for service agreements
                      
                      $
                      110,000
                      
                      
                      $
                      110,000
                      
                      
                      $
                      110,000
                      
                      
                      $
                      -
                      
                      
                      $
                      —
                      
                      
                      $
                      330,000Obligations
      for purchasing agreements
                      
                      
                      5,861,113
                      
                      
                      
                      912,214
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      6,773,327Total
                      
                      $
                      5,971,113
                      
                      
                      $
                      1,022,214
                      
                      
                      $
                      110,000
                      
                      
                      $
                      -
                      
                      
                      $
                      —
                      
                      
                      $
                      7,103,327





Government
subsidies represent refunds by the Chinese Government of interest paid to banks
by companies entitled to such subsidies. This applies only to interest on loans
related to production facilities expansion, capability increase and quality
enhancement. Commencing in 2005 and 2006, the Company had used this type of
special loan to improve its production lines. The expansion was completed and
began to operate at the end of 2006 and 2007. During 2008 and 2007, the Chinese
Government sent experts to review and assess the Company’s usage of its improved
production facilities on site to confirm that the Company’s improvements had
achieved its goals and thereby qualify for the subsidy. The Company recorded the
refunded interest related to the achievement of its goals into Other income, and
refunded interest where goals were not achieved into advances
payable.





32.
Off-Balance Sheet Arrangements




At
December 31, 2008 and 2007, the Company did not have any transactions,
obligations or relationships that could be considered off-balance sheet
arrangements.


95


33.
Subsequent Events




Since the
Company’s stock Weighted Average Price for twenty (20) consecutive trading days
ended on March 16, 2009 was below $3.187, which is less than 45% of the
Conversion Price in effect of the Issuance Date, as adjusted, the “WAP Default”,
the Convertible Debt holder shall have the right, at its sole discretion, to
require that the Company redeem all or any portion of the Convertible Debt 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 the WAP Default notice to the Convertible Debt
holders.  Since the Company has not received any notice from YA Global
Investments, L.P. as of March 24, 2009, its redemption rights under such WAP
Default has lapsed. On March 23, 2009, the Company received a letter from the
joint and several provisional liquidator acting on behalf of Lehman Brothers
Commercial Corporation Asia Limited, “LBCCA Liquidator”, requesting that it be
granted an extension of time until April 24, 2009 to obtain legal advice and to
consider its rights under the Convertible Debt. The Company has granted an
extension to April 15, 2009. Although the LBCCA Liquidator has not given the
Company any notice of redemption yet, it may exercise its discretionary right of
early redemption on any date that is no earlier than ninety (90) days after it
delivers the written redemption notice to the Company, so long as it delivers
such notice on or before April 15, 2009.




34.
Segment reporting





The
accounting policies of the product sectors are the same as those described in
the summary of significant accounting policies except that the disaggregated
financial results for the product sectors have been prepared using a management
approach, which is consistent with the basis and manner in which management
internally disaggregates financial information for the purposes of assisting
them in making internal operating decisions. Generally, the Company evaluates
performance based on stand-alone product sector operating income and accounts
for inter segment sales and transfers as if the sales or transfers were to third
parties, at current market prices.





During
the year ended December 31, 2008 and 2007, the Company had nine product sectors,
five of them were principal profit makers, which were reported as separate
sectors which engaged in the production and sales of power steering (Henglong),
power steering (Jiulong), power steering (Shenyang), power pumps (Zhejiang), and
power steering (Wuhu). The other four sectors which were established in 2005,
2006 and 2007 respectively, engaged in the production and sales of sensor
modular (USAI), electronic power steering (Jielong), power steering (Hengsheng),
and provider of after sales and R&D services (HLUSA). Since the revenues,
net income and net assets of these four sectors are less than 10% of its segment
in the consolidated financial statements, the Company incorporated these four
sectors into “other sectors”.




The
Company’s product sectors information is as follows:





For the
year ended December 31, 2008


Henglong
                          
                          
                          Jiulong
                          
                          
                          Shenyang
                          
                          
                          Zhejiang
                          
                          
                          Wuhu
                          
                          
                          Other
      Sectors
                          
                          
                          Other
      (a)
                          
                          
                          TotalRevenueNet
      product sales – external
                          
                          $
                          65,903,560
                          
                          
                          $
                          40,457,552
                          
                          
                          $
                          21,360,581
                          
                          
                          $
                          15,094,357
                          
                          
                          $
                          19,953,632
                          
                          
                          $
                          409,604
                          
                          
                          $
                          —
                          
                          
                          $
                          163,179,286Net
      product sales – internal
                          
                          
                          27,088,095
                          
                          
                          
                          2,250,714
                          
                          
                          
                          3,646,916
                          
                          
                          
                          684,098
                          
                          
                          
                          -
                          
                          
                          
                          491,871
                          
                          
                          
                          (34,161,694
                          )
                          
                          
                          -Gain
      on other sales and other income – external
                          
                          
                          317,477
                          
                          
                          
                          73,819
                          
                          
                          
                          156,743
                          
                          
                          
                          33,930
                          
                          
                          
                          134,472
                          
                          
                          
                          21,217
                          
                          
                          
                          (3,595
                          )
                          
                          
                          734,063Total
      revenue
                          
                          $
                          93,309,132
                          
                          
                          $
                          42,782,085
                          
                          
                          $
                          25,164,240
                          
                          
                          $
                          15,812,385
                          
                          
                          $
                          20,088,104
                          
                          
                          $
                          922,692
                          
                          
                          $
                          (34,165,289
                          )
                          
                          $
                          163,913,349Depreciation
      and amortization
                          
                          
                          4,575,115
                          
                          
                          
                          2,569,716
                          
                          
                          
                          701,120
                          
                          
                          
                          1,147,517
                          
                          
                          
                          401,379
                          
                          
                          
                          416,957
                          
                          
                          
                          113,188
                          
                          
                          
                          9,924,992Net
      income(loss)
                          
                          
                          11,989,130
                          
                          
                          
                          286,376
                          
                          
                          
                          1,464,617
                          
                          
                          
                          1,394,015
                          
                          
                          
                          (369,090
                          )
                          
                          
                          (816,921
                          )
                          
                          
                          (1,512,886
                          )
                          
                          
                          12,435,241Total
      assets
                          
                          
                          107,998,822
                          
                          
                          
                          46,541,107
                          
                          
                          
                          23,460,621
                          
                          
                          
                          23,907,010
                          
                          
                          
                          10,068,515
                          
                          
                          
                          18,714,486
                          
                          
                          
                          856,427
                          
                          
                          
                          231,546,988Capital
      expenditures
                          
                          $
                          2,277,253
                          
                          
                          $
                          3,407,505
                          
                          
                          $
                          269,207
                          
                          
                          $
                          501,557
                          
                          
                          $
                          716,239
                          
                          
                          $
                          5,199,172
                          
                          
                          $
                          10,000,000
                          
                          
                          $
                          22,370,933
 96


For the
year ended December 31, 2007




Henglong
                
                
                Jiulong
                
                
                Shenyang
                
                
                Zhejiang
                
                
                Wuhu
                
                
                Other
      Sectors
                
                
                Other
      (a)
                
                
                TotalRevenueNet
      product sales – external
                
                $
                45,612,058
                
                
                $
                35,774,010
                
                
                $
                19,787,916
                
                
                $
                13,828,252
                
                
                $
                18,495,678
                
                
                $
                99,089
                
                
                $
                —
                
                
                $
                133,597,003Net
      product sales – internal
                
                
                30,487,995
                
                
                
                3,151,173
                
                
                
                3,696,888
                
                
                
                142,185
                
                
                
                -
                
                
                
                -
                
                
                
                (37,478,241
                )
                
                
                -Gain
      on other sales and other income – external
                
                
                419,814
                
                
                
                115,472
                
                
                
                70,879
                
                
                
                5,973
                
                
                
                5,595
                
                
                
                (18,831
                )
                
                
                (6,290
                )
                
                
                592,612Total
      revenue
                
                $
                76,519,867
                
                
                $
                39,040,655
                
                
                $
                23,555,683
                
                
                $
                13,976,410
                
                
                $
                18,501,273
                
                
                $
                80,258
                
                
                $
                (37,484,531
                )
                
                $
                134,189,615Depreciation
      and amortization
                
                
                3,594,199
                
                
                
                1,897,886
                
                
                
                531,033
                
                
                
                848,534
                
                
                
                176,952
                
                
                
                197,311
                
                
                
                103,631
                
                
                
                7,349,546Net
      income (loss)
                
                
                6,154,185
                
                
                
                3,105,196
                
                
                
                2,121,008
                
                
                
                1,415,060
                
                
                
                (942,270
                )
                
                
                (755,821
                )
                
                
                (2,237,452
                )
                
                
                8,859,906Total
      assets
                
                
                82,336,597
                
                
                
                43,072,284
                
                
                
                22,360,047
                
                
                
                19,432,066
                
                
                
                10,469,583
                
                
                
                7,279,420
                
                
                
                (1,965,310
                )
                
                
                182,984,687Capital
      expenditures
                
                $
                3,845,364
                
                
                $
                2,283,801
                
                
                $
                1,288,001
                
                
                $
                2,127,630
                
                
                $
                1,702,612
                
                
                $
                3,022,829
                
                
                $
                —
                
                
                $
                14,270,237





(a)
              Other
      includes activity at the corporate level, unrealized income between
      product companies (sectors), and elimination of inter-sector
      transactions.


97


EXHIBIT
INDEX





Exhibit
                    Number
                  
                  Description3.1(i)
                  
                  Certificate
      of Incorporation (incorporated by reference from the filing on Form 10KSB
      File No. 000-33123.)3.1(ii)
                  
                  Bylaws
      (incorporated by reference from the Form 10KSB for the year ended December
      31, 2002.)10.1
                  
                  Registration
      Rights Agreement dated March 20, 2006 between the Company and Cornell
      Capital Partners, LP (incorporated by reference to the Company’s Form S-3
      Registration Statement (File No. 333 - 133331) filed on April 17,
      2006)10.2
                  
                  Investor
      Registration Rights Agreement dated March 20, 2006 between the Company and
      Cornell Capital Partners, LP. (incorporated by reference to the Company’s
      Form S-3 Registration Statement (File No. 333 - 133331) filed on April 17,
      2006)10.3
                  
                  Warrant
      to purchase 86,806 shares of common stock at $14.40 per share, issued to
      Cornell Capital Partners, LP. (incorporated by reference to the Company’s
      Form S-3 Registration Statement (File No. 333 - 133331) filed on April 17,
      2006 )10.4
                  
                  Warrant
      to purchase 69,444 shares of common stock at $18.00 per share, issued to
      Cornell Capital Partners, LP. (incorporated by reference to the Company’s
      Form S-3 Registration Statement (File No. 333 - 133331) filed on April 17,
      2006 )10.5
                  
                  Joint-venture
      Agreement, dated March 31, 2006, as amended on May 2, 2006, between Great
      Genesis Holdings Limited and Wuhu Chery Technology Co., Ltd. (incorporated
      by reference to the exhibit 10.8 to the Company’s Form 10Q Quarterly
      Report on May 10, 2006 )10.6
                  
                  Securities
      Purchase Agreement dated February 1, 2008 among us, Lehman Brothers
      Commercial Corporation Asia Limited, and YA Global Investments, L.P.
      (incorporated by reference to the Company’s Form 10-K for the year ended
      December 31, 2007.)10.7
                  
                  Securities
      Purchase Agreement dated February 15, 2008 between the Company and the
      investors. (incorporated by reference to the Company’s Form 10-K for the
      year ended December 31, 2007.)10.8
                  
                  Escrow
      Agreement dated February 15, 2008 among us, U.S. Bank National
      Association, Lehman Brothers Commercial Corporation Asia Limited, and YA
      Global Investments, L.P. (incorporated by reference to the Company’s Form
      10-K for the year ended December 31, 2007.10.9
                  
                  Registration
      Rights Agreement dated February 15, 2008 among us, Lehman Brothers
      Commercial Corporation Asia Limited, and YA Global Investments, L.P.
      (incorporated by reference to the Company’s Form 10-K for the year ended
      December 31, 2007.)


98





10.10
              
              Senior
      Convertible Note dated February 15, 2008 in the original principal
      amount of $8,571,429 issued by the Company in favor of TFINN & CO. as
      nominee for Lehman Brothers Commercial Corporation Asia Limited.
      (incorporated by reference to the Company’s Form 10-K for the year ended
      December 31, 2007.)10.11
              
              Senior
      Convertible Note dated February 15, 2008 in the original principal
      amount of $6,428,571 issued by the Company in favor of TFINN & CO. as
      nominee for Lehman Brothers Commercial Corporation Asia Limited.
      (incorporated by reference to the Company’s Form 10-K for the year ended
      December 31, 2007.)10.12
              
              Senior
      Convertible Note dated February 15, 2008 in the original principal
      amount of $15,000,000 issued by the Company in favor of TFINN & CO. as
      nominee for Lehman Brothers Commercial Corporation Asia Limited.
      (incorporated by reference to the Company’s Form 10-K for the year ended
      December 31, 2007.)10.13
              
              Closing
      Warrant to purchase 564,799 shares of common stock at $8.8527 per share,
      dated February 15, 2008, issued by the Company in favor of TFINN
      & CO. as nominee for Lehman Brothers Commercial Corporation Asia
      Limited. (incorporated by reference to the Company’s Form 10-K for the
      year ended December 31, 2007.)10.14
              
              Escrow
      Warrant to purchase 564,799 shares of common stock at $8.8527 per share,
      dated February 15, 2008, issued by the Company in favor of TFINN
      & CO. as nominee for Lehman Brothers Commercial Corporation Asia
      Limited. (incorporated by reference to the Company’s Form 10-K for the
      year ended December 31, 2007.)10.15
              
              Senior
      Convertible Note dated February 15, 2008 in the original principal
      amount of $1,428,571 issued by the Company in favor of YA Global
      Investments, L.P. (incorporated by reference to the Company’s Form 10-K
      for the year ended December 31, 2007.)10.16
              
              Senior
      Convertible Note dated February 15, 2008 in the original principal
      amount of $1,071,429 issued by the Company in favor of YA Global
      Investments, L.P. (incorporated by reference to the Company’s Form 10-K
      for the year ended December 31, 2007.)10.17
              
              Senior
      Convertible Note dated February 15, 2008 in the original principal
      amount of $2,500,000 issued by the Company in favor of YA Global
      Investments, L.P. (incorporated by reference to the Company’s Form 10-K
      for the year ended December 31, 2007.)10.18
              
              Closing
      Warrant to purchase 94,133 shares of common stock at $8.8527 per share,
      dated February 15, 2008, issued by the Company in favor of YA Global
      Investments, L.P. (incorporated by reference to the Company’s Form 10-K
      for the year ended December 31, 2007.)10.19
              
              Escrow
      Warrant to purchase 94,133 shares of common stock at $8.8527 per share,
      dated February 15, 2008, issued by the Company in favor of YA Global
      Investments, L.P. (incorporated by reference to the Company’s Form 10-K
      for the year ended December 31, 2007.)10.20
              
              Translation
      of the Equity Transfer Agreement dated March 31, 2008 in English
      (incorporated by reference to exhibit 99.1 of the Company’s Form 8-K filed
      on April 2, 2008)21
              
              Schedule
      of Subsidiaries*23
              
              Consent
      of Schwartz Levitsky Feldman LLP., Independent Registered Public
      Accountant Firm*


99





31.1
              
              Rule
      13a-14(a) Certification*31.2
              
              Rule
      13a-14(a) Certification*32.1
              
              Section
      1350 Certification*32.2
              
              Section
      1350 Certification*


100