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SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549
   FORM 20-F o
    
    REGISTRATION STATEMENT PURSUANT TO
SECTION 12(b) OR 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934ORþ
    
    ANNUAL REPORT PURSUANT TO SECTION
13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31, 2003ORo
    
    TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from  to
 For the fiscal year ended December 31, 2003
    
    Commission file number 1-13522
 China Yuchai International Limited  N/A
    
    Bermuda(Translation of Registrants Name Into English)
    
    (Jurisdiction of Incorporation or Organization)
   16 Raffles Quay #26-00
Hong Leong Building
Singapore 048581
65-6220-8411
(Address and Telephone Number of Principal Executive Offices)   Securities registered or to be registered pursuant to Section 12(b) of the Act: Name of Each ExchangeTitle of Each Class
    
    on Which RegisteredCommon Stock, par value US$0.10 per share
    
    The New York Stock Exchange
 Securities registered or to be registered pursuant to Section 12(g) of the Act:
None
(Title of Class) Securities for which there
is a reporting obligation pursuant to Section 15(d) of the Act:
None
(Title of Class) Indicate the number of outstanding shares of each of the issuers classes
of capital or common stock as of the close of the period covered by the annual
report. As of December 31, 2003, 35,340,000 shares of common stock, par value
US$0.10 per share, and one special share, par value US$0.10 per share, were
issued and outstanding. 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  þ                    No  o Indicate by check mark which financial statement item the registrant has
elected to follow. Item 17  o                    Item 18  þ




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TABLE OF CONTENTS CHINA YUCHAI INTERNATIONAL LIMITED Certain Definitions and Supplemental Information
    
    
    3Cautionary Statements with respect to Forward-Looking Statements
    
    
    3Incorporation by Reference
    
    
    4Part IItem 1.  Identity of Directors, Senior Management and Advisers
    
    
    4Item 2.  Offer Statistics and Expected Timetable
    
    
    4Item 3.  Key Information
    
    
    4Item 4.  Information on the Company
    
    
    15Item 5.  Operating and Financial Review and Prospects
    
    
    30Item 6.  Directors, Senior Management and Employees
    
    
    38Item 7.  Major Shareholders and Related Party Transactions
    
    
    45Item 8.  Financial Information
    
    
    49Item 9.  The Offer and Listing
    
    
    51Item 10.  Additional Information
    
    
    52Item 11.  Quantitative and Qualitative Disclosure about Market Risk
    
    
    65Item 12.  Description of Securities other than Equity Securities
    
    
    65Part IIItem 13.  Defaults, Dividend Arrearages and Delinquencies
    
    
    65Item 14.  Material Modifications to the Rights of Security Holders and Use of Proceeds
    
    
    65Item 15.  Controls and Procedures
    
    
    66Item 16A.  Audit Committee Financial Expert
    
    
    66Item 16B.  Code of Ethics
    
    
    66Item 16C.  Principal Accountants Fees and Services
    
    
    66Item 16D.  Exemption from the Listing Standards for Audit Committees
    
    
    67Item 16E.  Purchases of Equity Securities by the Issuer and Affiliated Purchasers
    
    
    67Part IIIItem 17.  Financial Statements
    
    
    67Item 18.  Financial Statements
    
    
    68Item 19.  Exhibits
    
    
    68Signatures
    
    
    70Employment Agreement, dated September 5, 2003Form of Indemnification AgreementAgreement dated July 19, 2003Subsidiaries of the RegistrantCertification Pursuant to Section 302Certification Pursuant to Section 906Consent of Independent Reg. Public Acctg Firm
  2




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Certain Definitions and Supplemental Information All references to China, PRC and the State in this Annual Report are
references to the Peoples Republic of China. Unless otherwise specified, all
references in this Annual Report to U.S. dollars, dollars, US$ or $ are
to United States dollars; all references to Renminbi or Rmb are to
Renminbi, the legal tender currency of China. Unless otherwise specified,
translation of amounts from Renminbi to U.S. dollars for the convenience of the
reader has been made in this Annual Report at the rate of Rmb 8.2767 = US$1.00,
the rate quoted by the Peoples Bank of China on December 31, 2003. No
representation is made that the Renminbi amounts could have been, or could be,
converted into U.S. dollars at that rate or at any other rate. The consolidated financial statements of China Yuchai International
Limited and its subsidiaries are presented in Renminbi. All consolidated
financial statements of the Company presented herein have been prepared in
conformity with accounting principles generally accepted in the United States
of America (US GAAP). Totals presented in this Annual Report may not
correctly total due to rounding of numbers. As used in this Annual Report, unless the context otherwise requires, the
term the Company refers to China Yuchai International Limited and its
consolidated subsidiaries. All references herein to Yuchai are to Guangxi
Yuchai Machinery Company Limited and its consolidated subsidiaries and, prior
to its incorporation in July 1992, to the machinery business of its
predecessor, Guangxi Yulin Diesel Engine Factory (Yulin Diesel), which was
founded in 1951 and became a state-owned enterprise in 1959. In the
restructuring of Yulin Diesel in July 1992, its other businesses were
transferred to Guangxi Yuchai Machinery Holdings Company, also sometimes
referred to as Guangxi Yuchai Machinery Group Company Limited (the State
Holding Company), which became a shareholder of Yuchai. 
 Cautionary Statements with Respect to Forward-Looking Statements The Company wishes to caution readers that the forward-looking statements
contained in this Annual Report, which include all statements which, at the
time made, address future results of operations, are based upon the Companys
interpretation of factors affecting the business and operations of the Company
and its subsidiaries. The Company believes the following important factors,
among others, in some cases have affected, and in the future could affect, the
Companys actual consolidated results and could cause the Companys actual
consolidated results for 2004, and beyond, to differ materially from those
described in any forward-looking statements made by, or on behalf of, the
Company:  
    
    political, economic and social conditions in China, including the Chinese
governments specific policies with respect to foreign investment, economic
growth, inflation and the availability of credit, particularly to the extent
such current or future conditions and policies affect the truck and diesel
engine industries and markets in China, the Companys diesel engine customers,
the demand, sales volume and sales prices for the Companys diesel engines and
the Companys levels of accounts receivable;
    
    the effects of competition in the diesel engine market on the demand, sales
volume and sales prices for the Companys diesel engines;
    
    the Companys ability to collect and control its levels of accounts receivable;
    
    the Companys dependence on the Dongfeng Automobile Company and other major
diesel truck manufacturers controlled by or affiliated with the Dongfeng
Automobile Company;
    
    the Companys ability to successfully manufacture and sell its 4108, 4110,
4110Q, 4110ZQ, 4112, 6105, 6108, 6112 and new 6113 diesel engines and any new
products;
    
    the Companys ability to finance its working capital and capital expenditure
requirements, including obtaining any required external debt or other
financing; 3




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
    
    the effects of inflation on the Companys financial condition and
results of operations, including the effects on Yuchais costs of raw
materials and parts and labor costs;
    
    the Companys ability to successfully implement the agreement which it
entered into with Yuchai on July 19, 2003 with respect to the
Companys investment in Yuchai (the July 2003 Agreement);
    
    the effects of Chinas political, economic and social conditions on
the Companys business, financial condition and results of operations;
    
    the effects of uncertainties in the Chinese legal system, which could
limit the legal protections available to foreign investors, including
with respect to the enforcement of foreign judgments in China; and
    
    the impact on the Companys business and results of operations as a
result of Chinas membership with the World Trade Organization
(WTO). 
 Incorporation by Reference This Annual Report on Form 20-F shall be deemed to be incorporated by
reference in the Prospectus, dated March 24, 2004, included in the Registration
Statement (File No. 333-111106) on Form F-3 of the Company and to be a part
thereof from the date on which this Annual Report is filed, to the extent
it is not superseded by documents or reports subsequently filed or furnished. 
 PART I 
 ITEM 1.  IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS. Not Applicable. 
 ITEM 2.  OFFER STATISTICS AND EXPECTED TIMETABLE. Not Applicable. 
 ITEM 3.  KEY INFORMATION. Selected Financial Data The selected financial information set forth below should be read in
conjunction with, and is qualified in its entirety by reference to, Item 5.
Operating and Financial Review and Prospects and the Companys audited
consolidated financial statements and the related notes for the three-year
period ended December 31, 2003 included in this Annual Report. The consolidated
financial statements of the Company are prepared in conformity with US GAAP. The Companys sole operating asset is its 76.4% ownership interest in
Yuchai. As a result, the Companys financial condition and results of
operations depend entirely upon Yuchais financial condition and results of
operations, and the implementation of the July 2003 Agreement with respect to
the Companys investment in Yuchai, described elsewhere herein (see Item 8.
Financial Information  Legal Proceedings). The selected balance sheet data as of December 31, 2002 and 2003 and the
statement of income data and cash flow statement data of the Company set forth
below for the years ended December 31, 2001, 2002 and 2003 are derived from the
consolidated financial statements of the Company included in this Annual
Report, which have been audited by KPMG, Certified Public Accountants (the
Consolidated Financial Statements). The selected balance 4




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sheet data of the Company set forth below as of December 31, 1999, 2000 and
2001 and the statement of income data and cash flow statement data for the
years ended December 31, 1999 and 2000 are derived from the consolidated
financial statements of the Company, which have been audited by KPMG, but which
are not included in this Annual Report. As of and for the Year Ended December 31,1999
    
    2000
    
    2001
    
    2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    Rmb
    
    Rmb
    
    Rmb
    
    US$(5)(in thousands)Statement of Income Data:Net sales
    
    
    1,270,337
    
    
    
    1,414,527
    
    
    
    1,783,329
    
    
    
    3,513,047
    
    
    
    4,569,950
    
    
    
    552,146Cost of goods sold
    
    
    828,865
    
    
    
    960,079
    
    
    
    1,183,403
    
    
    
    2,371,080
    
    
    
    3,192,794
    
    
    
    385,756Gross profit
    
    
    441,472
    
    
    
    454,448
    
    
    
    599,926
    
    
    
    1,141,967
    
    
    
    1,377,156
    
    
    
    166,390Research and development costs
    
    
    11,328
    
    
    
    49,011
    
    
    
    44,721
    
    
    
    75,532
    
    
    
    94,594
    
    
    
    11,429Selling, general and administrative
expenses
    
    
    298,667
    
    
    
    298,361
    
    
    
    243,231
    
    
    
    426,128
    
    
    
    561,151
    
    
    
    67,800Amortization of goodwill(1)
    
    
    16,859
    
    
    
    16,859
    
    
    
    16,859
    
    
    
    
    
    
    
    
    
    
    
    Operating income
    
    
    114,618
    
    
    
    90,217
    
    
    
    295,115
    
    
    
    640,307
    
    
    
    721,411
    
    
    
    87,161Interest expense
    
    
    36,602
    
    
    
    27,886
    
    
    
    29,784
    
    
    
    25,144
    
    
    
    23,624
    
    
    
    2,854Other expenses/(income), net
    
    
    4,449
    
    
    
    (1,685
    )
    
    
    (3,858
    )
    
    
    (10,287
    )
    
    
    881
    
    
    
    106Income before income taxes and
minority interests
    
    
    73,567
    
    
    
    64,016
    
    
    
    269,189
    
    
    
    625,450
    
    
    
    696,906
    
    
    
    84,201Income tax expense/(benefit)
    
    
    11,217
    
    
    
    10,682
    
    
    
    (63,584
    )
    
    
    83,242
    
    
    
    112,924
    
    
    
    13,644Income before minority interests
    
    
    62,350
    
    
    
    53,334
    
    
    
    332,773
    
    
    
    542,208
    
    
    
    583,982
    
    
    
    70,557Minority interests in income of
consolidated subsidiaries
    
    
    18,650
    
    
    
    16,256
    
    
    
    82,386
    
    
    
    129,775
    
    
    
    145,800
    
    
    
    17,615Net income
    
    
    43,700
    
    
    
    37,078
    
    
    
    250,387
    
    
    
    412,433
    
    
    
    438,182
    
    
    
    52,942Basic and diluted earnings per share
    
    
    1.24
    
    
    
    1.05
    
    
    
    7.09
    
    
    
    11.67
    
    
    
    12.40
    
    
    
    1.50Weighted average number of shares
outstanding
    
    
    35,340
    
    
    
    35,340
    
    
    
    35,340
    
    
    
    35,340
    
    
    
    35,340
    
    
    
    35,340Balance Sheet Data (at period end):Working capital(2)
    
    
    539,567
    
    
    
    804,725
    
    
    
    1,100,462
    
    
    
    1,340,832
    
    
    
    962,804
    
    
    
    116,327Goodwill(1)
    
    
    246,353
    
    
    
    229,495
    
    
    
    212,636
    
    
    
    212,636
    
    
    
    212,636
    
    
    
    25,691Total assets
    
    
    2,600,306
    
    
    
    2,770,242
    
    
    
    3,262,868
    
    
    
    3,985,459
    
    
    
    4,033,632
    
    
    
    487,348Long-term debt, excluding current
installments
    
    
    60,000
    
    
    
    170,000
    
    
    
    180,000
    
    
    
    50,000
    
    
    
    
    
    
    
    Minority interests
    
    
    354,926
    
    
    
    360,311
    
    
    
    420,545
    
    
    
    487,491
    
    
    
    544,526
    
    
    
    65,790Net assets
    
    
    1,526,355
    
    
    
    1,560,508
    
    
    
    1,805,045
    
    
    
    2,161,903
    
    
    
    1,991,687
    
    
    
    240,638Capital stock
    
    
    30,349
    
    
    
    30,349
    
    
    
    30,349
    
    
    
    30,349
    
    
    
    30,349
    
    
    
    3,667Stockholders equity
    
    
    1,526,355
    
    
    
    1,560,508
    
    
    
    1,805,045
    
    
    
    2,161,903
    
    
    
    1,991,687
    
    
    
    240,638Statement of Cash Flow Data:Capital expenditures(3)
    
    
    32,663
    
    
    
    14,958
    
    
    
    43,043
    
    
    
    174,850
    
    
    
    372,775
    
    
    
    45,039Depreciation(4)
    
    
    127,892
    
    
    
    125,981
    
    
    
    113,680
    
    
    
    118,872
    
    
    
    125,519
    
    
    
    15,165
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(1)
    
    Goodwill represents the difference between the price the Company paid for
common shares of Yuchai and the estimated fair value of its corresponding
share of Yuchais underlying net assets. The Company adopted the
provisions of Statement of Financial Accounting Standards (SFAS) No.
142, Goodwill and Other Intangible Assets, as of January 1, 2002.
Goodwill acquired in a business combination and intangibles determined to
have an indefinite useful life are not amortized, but instead are tested
for impairment at least annually in accordance with the provisions of SFAS
No. 142. Prior to the adoption of SFAS No. 142, goodwill was amortized
over 20 years on a straight line basis. For a discussion of goodwill, see
Note 3(n) of the Notes to the Consolidated Financial Statements.(2)
    
    Current assets (including cash) less current liabilities.(3)
    
    Purchase of property, plant and equipment, lease prepayment and payment for construction in
progress.(4)
    
    Depreciation of property, plant and equipment and
amortization of lease prepayments.(5)
    
    The Companys functional and reporting
currency is Renminbi, and the
translation of amounts from Renminbi to U.S. dollars is solely for the
convenience of the reader. Translation of amounts from Renminbi to U.S.
dollars has been made at the rate of Rmb 8.2767 = US$1.00, the rate quoted
by the Peoples Bank of China at the close of business on December 31,
2003. No representation is made that the Renminbi amounts could have
been, or could be, converted into U.S. dollars at that rate or at any
other rate prevailing on December 31, 2003 or any other date. Dividends The following table sets forth a five-year summary of dividends paid by
the Company to its shareholders and by Yuchai to the Company, respectively: Dividend paid bythe Company to
    
    Dividend Paid by Yuchaiits shareholders
    
    to the Company(1)Period
    
    (per share)
    
    (in thousands)1999
    
    
    
    
    
    Rmb 72,282 (US$8,712)2000
    
    
    US$0.01
    
    
    Rmb 72,284 (US$8,732)2001
    
    
    US$0.02
    
    
    Rmb 72,284 (US$8,720)2002
    
    
    US$0.19
    
    
    Rmb 245,766 (US$29,694)(2)2003
    
    
    US$2.08
    
    
    Rmb 61,433 (US$7,422)
   (1)
    
    Dividends paid by Yuchai to the Company, as well as to other shareholders
of Yuchai, were declared in Renminbi and paid in U.S. dollars (as shown in
the parentheses) based on the exchange rates at local designated foreign
exchange banks on the respective payment dates. For dividends paid for
1999, 2000, 2001 and 2002, the exchange rate used was Rmb 8.2973 =
US$1.00, Rmb 8.2781 = US$1.00, Rmb 8.2894 = US$1.00 and Rmb 8.2767 =
US$1.00, respectively.(2)
    
    The dividends declared for 2002 by Yuchai were paid to the Company in
2003 following execution of the July 2003 Agreement. Historical Exchange Rate Information On
June 25, 2004, the noon buying rate was Rmb 8.2767 = US$1.00. The following tables set forth certain information concerning exchange
rates between Renminbi and U.S. dollars for the periods indicated: 6




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Noon Buying Rate(1)(Rmb per US$)Period
    
    High
    
    LowDecember 2003
    
    
    8.2772
    
    
    
    8.2765January 2004
    
    
    8.2772
    
    
    
    8.2767February 2004
    
    
    8.2773
    
    
    
    8.2769March 2004
    
    
    8.2774
    
    
    
    8.2767April 2004
    
    
    8.2772
    
    
    
    8.2768May 2004
    
    
    8.2773
    
    
    
    8.2768June 2004
    
    
    8.2768
    
    
    
    8.2765
 Noon Buying Rate(1)Period
    
    Period End
    
    Average(2)
    
    High
    
    Low(Rmb per US$)1999
    
    
    8.2795
    
    
    
    8.2785
    
    
    
    8.2800
    
    
    
    8.22762000
    
    
    8.2774
    
    
    
    8.2784
    
    
    
    8.2799
    
    
    
    8.27682001
    
    
    8.2766
    
    
    
    8.2772
    
    
    
    8.2786
    
    
    
    8.27632002
    
    
    8.2775
    
    
    
    8.2770
    
    
    
    8.2775
    
    
    
    8.27652003
    
    
    8.2767
    
    
    
    8.2771
    
    
    
    8.2800
    
    
    
    8.27652004
(through June 25)
    
    
    8.2767
    
    
    
    8.2770
    
    
    
    8.2776
    
    
    
    8.2766
   (1)
    
    The noon buying rate in New York for cable transfers payable in foreign
currencies as certified for customs purposes by the Federal Reserve Bank
of New York. Since April 1994, the noon buying rate has been based on the
rate quoted by the Peoples Bank of China. As a result, since April 1994,
the noon buying rate and the Peoples Bank of China rate have been
substantially similar. The Peoples Bank of China rate at the end of 2003
was Rmb 8.2767, compared with Rmb 8.2771 for the noon buying rate
(average).(2)
    
    Determined by averaging the rates on the last business day of each month
during the relevant period. Risk Factors The disclosure set forth in this section was prepared pursuant to the
Plain English Rules adopted by the Securities and Exchange Commission.
References to we, us, our and our company in this section are to China
Yuchai International Limited and its consolidated subsidiaries. Risks relating to our Company and our business In 2003, we initiated and upon execution of the July 2003 Agreement
subsequently discontinued various legal and arbitration proceedings against our
sole operating subsidiary Yuchai, as well as against Yuchais principal Chinese
shareholder, and Yuchais Chairman and legal representative. Our business,
financial condition and results of operations may be adversely affected if we
are unable to implement the July 2003 Agreement. Our sole operating asset is our ownership interest in Yuchai, and our only
sources of cash flow are our share of the dividends, if any, paid by Yuchai and
investment interest thereon. In response to difficulties with respect to our
investment in Yuchai, in May 2003 we initiated legal proceedings in New York
and arbitration proceedings in London and Singapore. We subsequently
discontinued our claims and these proceedings as a result of the agreement 7




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reached with Yuchai and its related parties in July 2003, as described under
Item 8. Financial Information  Legal Proceedings. Although the parties to
the agreement and their advisors have been actively seeking to agree on a
restructuring plan for CYI intended to be beneficial to CYIs shareholders, as
contemplated in the July 2003 Agreement, CYI believes that the parties may not
be able to implement a restructuring of CYI in the manner contemplated in the
July 2003 Agreement in the near future. As a result, CYI is unable to
determine at this point in time when such restructuring will likely be
completed and the form that it is likely to take. No assurance can be given
that CYI will be able to secure the agreement of the Chinese stakeholders to
any such restructuring arrangement, or that implementation of any such
restructuring will effectively resolve all of the difficulties faced by CYI
with respect to its investment in Yuchai. No assurance can be given that the
implementation of the July 2003 Agreement, including any restructuring
undertaken by CYI pursuant to the July 2003 Agreement, will be beneficial to
CYIs shareholders. We may not be able to fully exercise our controlling interest in Yuchai. Although we own 76.4% of Yuchais shares, we require the cooperation of
Yuchais Chinese shareholders in the daily management and operation of Yuchai
to fully exercise our controlling interest in Yuchai. We also need the
assistance and cooperation of the State Holding Company in dealing with various
matters, including the implementation of corporate governance procedures, the
payment of dividends, the holding of Yuchai board meetings and the resolution
of employee-related matters. From time to time we experience certain
problems in obtaining such cooperation, as for example described
under Item 4. Information on the Company  Business
Overview  Manufacturing, Item 6. Directors,
Senior Management and Employees  Directors and Senior
Management of the Company  Special Committee and
 Directors and Executive Officers of Yuchai,
Item 7. Major Shareholders and Related Party Transactions
 Related Party Transactions  Other Transactions and
Item 15. Controls and Procedures. Moreover, as further described under Item 8.
Financial Information  Legal Proceedings, in 2003 various Chinese government
agencies alleged that our share ownership in Yuchai may not be in conformity
with Chinese law. It appears that affiliates of the State Holding Company
initiated these allegations as a means to try to limit our rights to exercise
control over Yuchai. The July 2003 Agreement was intended to resolve the issues
raised by the various Chinese governmental agencies relating to our share
ownership in Yuchai. However, no assurance can be given that disagreements
with Yuchais Chinese shareholders will not recur, including with respect to
implementation of the July 2003 Agreement. We cannot assure you that we will
be able to fully exercise our controlling interest in Yuchai if such
disagreements recur, which could as a result have a material adverse effect on
our financial condition, results of operations, business or prospects,
including our inability to consolidate Yuchais financial statements. Our sales are concentrated among members of the Dongfeng Group. Any significant
decrease in sales to the Dongfeng Group may have a material adverse effect on
our business, financial condition and result of operations. Our sales are concentrated among the Dongfeng Group, which includes the
Dongfeng Automobile Company, one of the largest state-owned automobile
companies in China, and other major diesel truck manufacturers controlled by or
affiliated with the Dongfeng Automobile Company. In 2003, the Dongfeng Group
accounted for 31% of our gross sales and included our three largest customers:
Liuzhou Dongfeng Automobile, Hubei Dongfeng Automobile and Dongfeng Special
Automobile. Although we consider our relationships with the Dongfeng Group to
be good, the loss of one or more of the companies within the Dongfeng Group as
a customer would have a material adverse effect on our business, financial
condition and results of operations. The Dongfeng Group also competes with us in the diesel engine market in
China. Although we believe that the companies within the Dongfeng Group
generally make independent purchasing decisions based on end-user preferences,
we cannot assure you that truck manufacturers affiliated with the Dongfeng
Automobile Company will not preferentially purchase diesel engines manufactured
by companies within the Dongfeng Group over those manufactured by us. Competition in China from other diesel engine manufacturers may adversely
affect our business, financial condition and results of operations. The diesel engine industry in China is highly competitive. We compete with
many other domestic companies, most of which are state-owned enterprises. Some
of our competitors have formed joint ventures with or have technology
assistance relationships with foreign diesel engine manufacturers or foreign
engine design consulting firms and use foreign technology that is more advanced
than ours. We expect competition to intensify as a result of: 8




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
    
    improvements in competitors products;
    
    increased production capacity of competitors;
    
    increased utilization of unused capacity by competitors; and
    
    price competition. In addition, if import restrictions on motor vehicles and motor vehicle
parts are reduced, foreign competition could increase significantly. See Risks
relating to Mainland China  The admission of China into the WTO could lead to increased foreign competition. In the medium-duty diesel engine market, our 6108 medium-duty engine,
introduced in 1997, has been able to compete effectively with the 6110
medium-duty engine offered by our competitors. We cannot assure you, however,
that we will be able to maintain or improve our current market share or develop
new markets for our medium-duty diesel engines. In the heavy-duty diesel engine market, we introduced the 6112 heavy-duty
engine in late 1999. Due to a delay in the commercial production of the 6112
engine, however, we were not able to benefit from the competitive advantages of
an early entry into the domestic market for heavy-duty engines. Moreover, the
market for heavy-duty diesel engines in China is price-sensitive, and customer
acceptance of the 6112 engines pricing structure requires considerable
marketing efforts by our company. As a result, we lowered our expectations for
future sales volume and profitability of the 6112 engine. In 2002, the sales
volume of the 6112 engine was in line with our expectations, and the sales in
2003 increased to 20,472 units. However, we cannot assure you that we will be
able to compete successfully in the heavy-duty diesel engine market in China
with the existing producers or any new entrants. We have commenced engine development work on the proposed new 6113
heavy-duty engine, which we anticipate will have a rated power in between 300
to 350 horsepower. Although, we expect initial production of this new 6113
engine to commence in 2004, we cannot assure you that we will be able to
commence production as expected, or that such engines will be able to compete
with other heavy-duty engines producers in China. In the light-duty diesel engine market, our 4108, 4110 and 4112 light-duty
engines introduced in 2000 were met with weak consumer demand due to strong
competition and a high pricing structure. Although there had been an increase
in sales of our 4-series engines in 2003, we cannot assure you that we will be
able to continue to improve our market share for light-duty diesel engines, and
we may, in the future, decide to cease production of one or more of the models
we are currently producing. Our long-term business prospects will depend largely upon our ability to
develop and introduce new or improved products at competitive prices. Our
competitors in the diesel engine markets may be able to introduce new or
improved engine models that are more favorably received by customers.
Competition in the end-use markets, mainly the truck market, may also lead to
technological improvement and advances that render our current products
obsolete at an earlier than expected date, in which case we may have to
depreciate or impair our production equipment more rapidly than planned.
Failure to introduce, or delays in the introduction of, new or improved
products at competitive prices could have a material adverse effect on our
business and prospects. Our exposure to the Dongfeng Group has had, and could continue to have, a
material adverse effect on our business, financial condition and results of
operation. We are highly dependent on the purchases made by the Dongfeng Group and
have significant exposure to their liquidity arising from the high level of
accounts receivable from them. We cannot assure you that the Dongfeng Group
will be able to repay all the money they owe to us. In addition, the Dongfeng
Group may not be able to continue purchasing the same volume of products from
our company, which would significantly reduce our overall sales volume. 9




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Our business, financial condition and results of operations may be adversely
affected to the extent we are unable to continue our sales growth or adequately
manage our growth. We have achieved consistent growth in net sales during the last two fiscal
years, with net sales increasing by 97.0% to Rmb 3,513.0 million in 2002 and by
30% to Rmb 4,570.0 million in 2003. We cannot assure you that we can continue
to increase our net sales or maintain our present level of net sales. In
particular, we may not be able to increase our net sales to levels more
appropriate for our levels of production capacity (production capacity was
estimated to be approximately 240,000 units at the end of 2003), fixed assets,
expenses (including factory overhead, direct labor, depreciation, selling,
general administrative and interest expenses) and capital expenditures.
Moreover, our future growth is dependent in large part on factors beyond our
control, such as continued economic growth in China. In addition, we cannot assure you that we will be able to properly manage
any future growth, including:  
    
    obtaining the necessary supplies;
    
    hiring and training skilled production workers and management personnel;
    
    manufacturing and delivering products for increased orders in a timely manner;
    
    maintaining quality standards and prices; and
    
    controlling production costs. Furthermore, we have acquired in the past, and may acquire in the future,
equity interests in engine parts suppliers. If we are unable to effectively
manage or assimilate these acquisitions, our business and prospects could be
adversely affected. See Item 4. Information on the Company  Business Overview
 Manufacturing. The diesel engine business in China is dependent in large part on the
performance of the Chinese economy, as well as Chinese government policy. As a
result, our business and prospects will be adversely affected by slowdowns in
the Chinese economy, as well as Chinese government policies that de-emphasize
the use of diesel engines. During periods of economic expansion, the demand for trucks, construction
machinery and other applications of diesel engines generally increases.
Conversely, during economic slowdowns the diesel engine industry is generally
adversely affected by a decline in demand. As a result, the performance of the
Chinese economy will affect, to a significant degree, our business and
prospects. For example, the various austerity measures taken by the Chinese
government from time to time to regulate economic growth and control inflation
have in prior periods significantly weakened demand for trucks in China, and
may have a similar effect in the future. In particular, austerity measures that
restrict access to credit and slow the rate of fixed investment (including
infrastructure development) adversely affect demand for, and production of,
trucks and other commercial vehicles. These adverse market conditions,
together with increased competition in the diesel engine market, result in
various degrees of financial and marketing difficulties for diesel engine
producers, including our company. The business and prospects for the diesel engine industry, and thus the
business and prospects of our company, may also be adversely affected by
Chinese government policy. For example, in 1998, the Chinese government
announced a major initiative to boost consumer demand through investments in
infrastructure projects and increased availability of bank credit. As a result,
demand for trucks and other commercial vehicles, and thus demand for diesel
engines, continued to increase from 2001 to 2003. However, we cannot assure you
that the Chinese government will not change its policy in the future to
de-emphasize the use of diesel engines, and any such change will adversely
affect our business, financial condition and results of operations. For
example, the Chinese government has recently announced measures to avoid
overheating in certain sectors of the economy, which may include tight bank
lending policies and increases in bank interest rates (see Risks relating to
Mainland China  Adverse changes in the 10




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economic policies of the Chinese government could have a material adverse
effect on the overall economic growth of Mainland China, which could reduce the
demand for our products and adversely affect our competitive position). If we are not able to continuously improve our existing engine products and
develop new diesel engine products, we may become less competitive, and our
business and prospects will be adversely affected. As the Chinese automotive industry continues to develop, we will have to
continuously improve our existing engine products and develop new diesel engine
products in order to remain competitive. As a result, our long-term business
prospects will largely depend upon our ability to develop and introduce new or
improved products at competitive prices. Future products may utilize different
technologies and may require knowledge of markets that we do not currently
possess. Moreover, our competitors may be able to introduce new or improved
engine models that are more favorably received by customers than our products.
Any failure by our company to introduce, or any delays in the introduction of,
new or improved products at competitive prices could have a material adverse
effect on our business and prospects. We are dependent on our suppliers for most of the parts and components used to
produce our engines. To the extent we are unable to obtain an adequate supply
of high-quality parts and components on a timely basis, or at all, our
business, financial condition and results of operations will be adversely
affected. We are dependent on our suppliers for most of the parts and components
used to produce our engines, including connecting rods, starters, air
compressors, gear boxes and pistons. Although we manufacture a portion of the
engine blocks, cylinder heads, crankshafts and camshafts we require, have
acquired ownership interests in some of our suppliers and have established new
companies involved in the manufacture and sale of spare parts and components,
we continue to rely on third-party suppliers for a substantial portion of these
main components. As a result, the quality of our engines is dependent in part
upon our ability to control the quality of supplier parts and components. We
cannot assure you that we will be able to obtain an adequate supply of
high-quality parts and components on a timely basis or at all. Although we
generally purchase supplies from at least two sources, an interruption in
supplies from a major supplier could result in production delays while we seek
to obtain additional supplies from alternative sources. Our business, financial
condition and results of operations will be adversely affected to the extent we
are unable to obtain the necessary engine parts and components on a timely
basis or at all. See Item 4. Information on the Company  Business Overview 
Manufacturing. We may be unable to obtain sufficient financing to fund our capital
requirements, which could limit our growth potential. We believe that our cash from operations, together with any necessary
borrowings, will provide sufficient financial resources to meet our projected
capital and other expenditure requirements. If we have underestimated our
capital requirements or overestimated our future cash flows, additional
financing may be required. Financing may not be available to us on acceptable
terms or at all. Our ability to obtain external financing is subject to various
uncertainties, including our results of operations, financial condition and
cash flow, economic, political and other conditions in Mainland China, the
Chinese governments policies relating to foreign currency borrowings and the
condition of the Chinese and international capital markets. If adequate capital
is not available, our business and prospects could be adversely affected. Our controlling shareholders interests may differ from those of our other
shareholders. Our ultimate parent company is Hong Leong Asia Ltd., or HLA, which
indirectly owns 7,831,169, or 22.2%, of the outstanding shares of our common
stock, as well as a special share that entitles it to elect a majority of our
directors. HLA controls us through its wholly-owned subsidiary, Hong Leong
(China) Limited, or HLC, and through HL Technology Systems Pte Ltd, or HLT, a
wholly-owned subsidiary of HLC. HLT owns approximately 22.2% of the
outstanding shares of our common stock and is the registered holder of our
special share. HLA is a member of the Hong Leong group of companies. Prior to
August 2002, we were controlled by Diesel Machinery (BVI) Limited, or DML,
which, until its dissolution, was a holding company controlled by HLC and was
the prior 11




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owner of our special share. Through HLTs stock ownership and various
agreements among shareholders, HLA is able to effect most corporate
transactions without the concurrence of any of our other shareholders. See
Item 7. Major Shareholders and Related Party Transactions  Related Party
Transactions  Shareholders Agreement. In addition, our shareholders do not
have cumulative voting rights. We cannot assure you that HLAs actions will be
in the best interests of our other shareholders. See also Item 6. Directors,
Senior Management and Employees  Compensation  Yuchai. We may experience a change of control as a result of offerings of shares by our
controlling shareholders. As described above, HLT, a subsidiary of HLA, owns 7,831,169 shares of our
common stock, as well as our special share. In March 2004, HLT and Coomber
Investments Limited, or Coomber, each registered shares for offer and sale from
time to time on a shelf registration statement which we filed on their behalf
pursuant to a registration rights agreement. If HLT reduces its shareholding
to less than 7,290,000 shares of our common stock as a result of such offering,
our Bye-Laws provide that the special share held by HLT will cease to carry any
rights, and HLA may as a result cease to have control over us. See Item 7.
Major Shareholders and Related Party Transactions  Major Shareholders  The
Special Share. We believe that our only other significant shareholder is
Coomber. If HLT sells all of the shares being registered for sale by HLT in
such offering, HLT will cease to own any of our shares. As a result, we cannot
determine what control arrangements will arise as a result of such offering
(including changes in our management arising therefrom), or assess what effect
those control arrangements may have, if any, on our business, results of
operations, financial condition, prospects or share price. We could be exposed to the impact of interest rates and foreign currency
movements with respect to our future borrowings. In addition, a devaluation of
the Renminbi will increase the Renminbi cost of repaying our foreign currency
denominated indebtedness and, therefore, could adversely affect our business,
financial condition and results of operations. A portion of our borrowings in the future may be structured on a floating
rate basis and denominated in U.S. dollars. An increase in interest rates, or
fluctuations in exchange rates between the Renminbi and other currencies, may
increase our borrowing costs or the availability of funding and could affect
our business, financial condition and results of operations. In particular, our
business, financial condition and results of operations could be adversely
affected by a devaluation of the Renminbi. The value of the Renminbi is subject to changes in Chinese government
policies and to international economic and political developments. Although the
official exchange rate for the conversion of Renminbi to U.S. dollars has been
stable, with Renminbi appreciating slightly against the U.S. dollar in recent
years, the exchange rate of the Renminbi could become volatile against the U.S.
dollar or other currencies. Since 1994, the conversion of Renminbi into Hong
Kong and United States dollars has been based on rates set by the Peoples Bank
of China, which are set daily based on the previous days Chinese interbank
foreign exchange market rate and current exchange rates on the world financial
markets. The Chinese government has stated publicly that it intends to make the
Renminbi freely convertible in the future. However, we cannot predict when the
Chinese government will allow free conversion of the Renminbi into foreign
currency, and we cannot assure you that the Chinese government will not take
steps that will cause the Renminbi to devalue. Substantially all of our
operating revenue is denominated in Renminbi, while a major portion of our
capital expenditures is denominated in U.S. dollars and Euros. Since we may not
be able to hedge effectively against Renminbi devaluations, future movements in
the exchange rate of Renminbi and other currencies could have an adverse effect
on our financial condition and results of operations. The market price for our common stock may be volatile. In recent periods, there has been volatility in the market price for our
common stock. The market price could fluctuate substantially in the future in
response to a number of factors, including the:  
    
    our interim operating results; 12




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
    
    the publics reaction to our press releases and announcements and our filings with the Securities
and Exchange Commission (or SEC);
    
    changes in financial estimates or recommendations by stock market analysts regarding us, our
competitors or other companies that investors may deem comparable;
    
    operating and stock price performance of our competitors or other companies that investors may deem
comparable;
    
    changes in general economic conditions;
    
    future sales of our common stock in the public market, or the perception that such sales could occur;
    
    the announcement by us or our competitors of a significant acquisition; and
    
    increases in labor and other costs. Recent market activity of our stock price on the New York Stock Exchange,
or NYSE, has been unpredictable. Since January 1, 2003 to
June 25, 2004, our
share price has ranged from US$4.45 to US$37.24. See Item 9. The Offer and
Listing below. During the same period, the average daily trading volume per
month for our shares has ranged from 25,957 shares to 4,111,878 shares. We
cannot assure you that the recent increased trading price and volume for our
shares will be sustained. In addition, in recent years, the stock market in
general has experienced extreme price and volume fluctuations. This volatility
has had a significant effect on the market prices of securities issued by many
companies for reasons unrelated to their operating performance. These broad
market fluctuations may materially adversely affect our stock price. Risks relating to Mainland China Substantially all of our assets are located in Mainland China, and
substantially all of our revenue is derived from our operations in Mainland
China. Accordingly, our business, financial condition and results of operations
are subject, to a significant degree, to economic, political and legal
developments in Mainland China. The economic system of Mainland China differs
from the economies of most developed countries in many respects, including
government investment, the level of development, control of capital investment,
control of foreign exchange and allocation of resources. Adverse changes in the economic policies of the Chinese government could have a
material adverse effect on the overall economic growth of Mainland China, which
could reduce the demand for our products and adversely affect our competitive
position. Since the late 1970s, the Chinese government has been reforming the
Chinese economic system from a planned economy to a market-oriented economy. In
recent years, the Chinese government has implemented economic reform measures
emphasizing decentralization, utilization of market forces in the development
of the Chinese economy and a higher level of management autonomy. These reforms
have resulted in significant economic growth and social progress, but the
growth has been uneven both geographically and among various sectors of the
economy. Economic growth has also been accompanied by periods of high
inflation. The Chinese government has implemented various policies from time to
time to restrain the rate of such economic growth, control inflation and
otherwise regulate economic expansion. For example, the Chinese government has
recently announced that it is considering introducing measures on certain
sectors to avoid overheating of the economy, which may include tighter bank
lending policies and increases in bank interest rates. In addition, the Chinese
government has also in the past attempted to control inflation by controlling
the prices of basic commodities. Severe measures or other actions by the
Chinese government, such as placing additional controls on the prices of diesel
and diesel-using products, could restrict our business operations and
adversely affect our financial position. Although we believe that the economic
reforms and macroeconomic policies and measures adopted by the Chinese
government will continue to have a 13




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positive effect on economic development in Mainland China and that we will
continue to benefit from these policies and measures, these policies and
measures may, from time to time, be modified or reversed. Adverse changes in
economic and social conditions in Mainland China, in the policies of the
Chinese government or in the laws and regulations in Mainland China, could have
a material adverse effect on the overall economic growth of Mainland China and
in infrastructure investment in Mainland China. These developments could
adversely affect our financial condition, results of operations and business,
by reducing the demand for our products, for example. Adverse economic developments in China or elsewhere in the Asian region could
have a material adverse effect on our business, financial condition and results
of operations. Since the late 1990s, many Asian countries have experienced significant
changes in economic conditions, including for example substantial depreciation
in currency exchange rates, increased interest rates, reduced economic growth
rates, corporate bankruptcies, declines in the market values of shares listed
on stock exchanges, decreases in foreign currency turnover and
government-imposed austerity measures. To date, Chinas economy has generally
been affected to a lesser extent than most other major Asian countries.
However, we cannot assure you that Chinas economy will not suffer more serious
difficulties in the future. Demand for trucks, construction machinery and
other applications of diesel engines generally increases during periods of
economic expansion and decreases during periods of economic slowdown. In the
event that adverse economic developments occur in China, our sales may decrease
and our business, financial condition and results of operations could therefore
suffer. The Chinese legal system embodies uncertainties, which could limit the legal
protections available to foreign investors. The Chinese legal system is a civil law system based on written statutes.
Unlike common law systems, it is a system in which decided legal cases have
little precedential value. In 1979, the Chinese government began to promulgate
a comprehensive system of laws and regulations governing economic matters in
general e.g., including with respect to the corporate organization and
governance, foreign investments, commerce, taxation and trade. Legislation over
the past 20 years has significantly enhanced the protections afforded to
various forms of foreign investment in Mainland China. However, these laws,
regulations and legal requirements are relatively recent, and their
interpretation and enforcement involve uncertainties, which may limit the legal
protections available to foreign investors. At the National Peoples Congress held in March 2004, the Chinese
government confirmed it will create more jobs and to continue expanding
domestic demand and implement a prudent fiscal and monetary policy. The
Chinese government has reiterated its policy of furthering reforms in the
socialist market economy and to increase the wealth of the rural population
through development and subsidies programs. No assurance can be given that
these changes will not have an adverse effect on business conditions in China
generally or on our business in particular. We may not freely convert Renminbi into foreign currency, which could limit our
ability to obtain sufficient foreign currency to satisfy our foreign currency
requirements or to pay dividends to shareholders. Substantially all of our revenues and operating expenses are generated by
our Chinese operating subsidiary and are denominated in Renminbi, while a
portion of our capital expenditures and indebtedness is, or in the future may
be, denominated in US dollars and other foreign currencies. The Renminbi is
currently freely convertible under the current account, which includes
dividends, trade and service-related foreign exchange transactions, but not
under the capital account, which includes foreign direct investment, except
with the prior approval of the State Administration for Foreign Exchange, or
SAFE. Our Chinese operating subsidiary, as a foreign invested enterprise, may
purchase foreign currency without the approval of SAFE for settlement of
current account transactions, including payment of dividends, by providing
commercial documents evidencing these transactions. Our Chinese operating
subsidiary may also retain foreign exchange in its current account (subject to
a cap approved by SAFE) to satisfy foreign currency liabilities or to pay
dividends. However, the relevant Chinese government authorities may limit or
eliminate our Chinese operating subsidiarys ability to purchase and retain
foreign currencies in the future. Our Chinese operating subsidiary, 14




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therefore, may not be able to obtain sufficient foreign currency to satisfy its
foreign currency requirements to pay dividends to us for our use in making any
future dividend payments or to satisfy other foreign currency payment
requirements. Foreign currency transactions under the capital account are still
subject to limitations and require approvals from SAFE. This could affect our
Chinese operating subsidiarys ability to obtain foreign currency through debt
or equity financing, including by means of loans or capital contributions from
us. The admission of China into the WTO could lead to increased foreign
competition. As a result of China becoming a member of the WTO import restrictions on
both motor vehicle components, including diesel engines, and motor vehicles are
expected to be gradually reduced. The WTO also requires China to lower its
import tariffs as a condition for membership. Reduced import restrictions
and/or lower tariffs may lead to increased imports of foreign diesel engines
and therefore lead to increased competition in the domestic diesel engine
markets. Similarly, reduced import restrictions and/or lower tariffs on
automobiles may affect the competition in the end-use markets of our customers
and indirectly affect our sales to such customers. Currently, China is
encouraging foreign investments into the motor vehicle engine manufacturing
industry. Outbreaks of infectious diseases, such as severe acute respiratory
syndrome (SARS) and bird flu, in various parts of China and other countries may
materially and adversely affect our business and operations, as well as our
financial condition and results of operations. In 2003, several countries, including China, experienced an outbreak of a
highly contagious form of atypical pneumonia known as severe acute respiratory
syndrome, or SARS, which severely restricted the level of economic activity in
affected areas, including Beijing and Guangdong Province. The SARS epidemic in
China had an adverse impact on the sale of engines, particularly during the
second and third quarters in 2003. Although this SARS outbreak was generally
believed to have been brought under control during 2003, there have been a
number of recent cases reported in China and elsewhere in the Asia region. In
addition, an infectious strain of influenza known as bird flu has also recently
been reported in China and Hong Kong. Outbreaks of infectious diseases such
as these could adversely affect general commercial activity, which could have a
material adverse effect on our financial condition, results of operations,
business or prospects. 
 ITEM 4.  INFORMATION ON THE COMPANY. History and Development The Company The Company is a Bermuda holding company established in April 1993 to own
a controlling interest in Yuchai and currently owns, through six wholly-owned
subsidiaries, 76.4% of the outstanding common shares of Yuchai (Yuchai
Shares). The Company operates under The Companies Act 1981 of Bermuda. The
principal executive office of the Company is located at 16 Raffles Quay #26-00,
Hong Leong Building, Singapore 048581. The Companys telephone number is (+65)
6220-8411. Until August 2002, the Company was controlled by Diesel Machinery (BVI)
Limited (DML), a company that was 53% owned by Hong Leong Asia Ltd. (HLA)
through its wholly-owned subsidiary, Hong Leong (China) Limited (HLC). HLC
owns HL Technology Systems Pte Ltd (HLT), which held shares in the Company
through DML. DML was also 47% owned by China Everbright Holdings Company
Limited (EB Holdings) through its wholly-owned subsidiary, Coomber
Investments Ltd. (Coomber). HLA, a company listed on the Singapore Stock
Exchange, is part of the Hong Leong Group, which was founded in 1941 by the
Kwek family of Singapore and is one of the largest privately-controlled
business groups in Southeast Asia. EB Holdings is a state-owned enterprise of
China. In 2002, EB Holdings and Coomber gave notice to DML and its other
shareholders of DML to effect a liquidation of DML. As a result of the
liquidation, HLA acquired the special share of the Company through HLT which
entitles HLA to elect a majority of the directors of the Company and veto any
resolution of shareholders of the Company. See Item 7. Major Shareholders and
Related Party Transactions  Major Shareholders. EB Holdings sold its
shareholding in Coomber, which held shares in the Company, in October 2002 to
Goldman 15




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Industrial Limited (Goldman), and EB Holdings is no longer a shareholder of
the Company. Goldman is a subsidiary of Zhong Lin Development Company Limited
(Zhong Lin), an investment vehicle of the city government of Yulin in
Guangxi, China. See Item 7. Major Shareholders and Related Party Transactions
 Major Shareholders and Item 8. Financial Information  Legal Proceedings. HLA provides certain management, financial planning and other services to
Yuchai and has designated one senior manager to work full-time at Yuchais
principal manufacturing facilities in Yulin City as part of Yuchais day-to-day
management team. To the Companys knowledge, since January 1, 2003, there have not been any
public takeover offers by third parties in respect of the Companys shares, nor
has the Company made any public takeover offers in respect of the shares of
other companies. The Companys sole operating asset is its ownership interest in Yuchai,
and its only sources of cash flow are its share of the dividends, if any, paid
by Yuchai and investment interest thereon. The following is primarily a
discussion of the business of Yuchai. Yuchai Yuchai is one of the largest medium-duty diesel engine manufacturers in
China and also produces diesel power generators and diesel engine parts. Yuchai is located in Yulin City, Guangxi Zhuang Autonomous Region in
southern China, approximately 280 miles west of Hong Kong. With a population of
approximately 3.0 million, greater Yulin City is believed to be the sixth
largest city in Guangxi Zhuang Autonomous Region. Yuchai was founded in 1951 and became a state-owned enterprise in 1959.
Prior to 1984, Yuchai was a small producer of low-power diesel engines for
agricultural machinery. In 1984, Yuchai introduced the earliest model of its
6105 medium-duty diesel engine for medium-duty trucks. In 1989, Yuchai became
one of Chinas 500 largest industrial enterprises in terms of profitability and
tax contribution. In July 1992, in order to raise funds for further expansion,
Yuchai became the first state-owned enterprise in the Guangxi Zhuang Autonomous
Region to be restructured into a joint stock company. As a result of this restructuring, Yuchai was incorporated as a joint
stock company in July 1992 and succeeded to the machinery business of Yulin
Diesel, and all of Yulin Diesels businesses, other than its machinery
business, as well as certain social service related operations, assets,
liabilities and employees (for example, cafeterias, cleaning and security
services, a hotel and a department store), were transferred to the State
Holding Company. The State Holding Company also became the majority shareholder
of Yuchai through its ownership stake of approximately 110 million shares of
Yuchai (State Shares). The State Holding Company is owned by the Guangxi
local government. In connection with its incorporation, Yuchai also issued 80
million shares to various Chinese institutional investors (Legal Person
Shares). In May 1993, in order to finance further expansion, Yuchai sold shares to
the Company and became a Sino-foreign joint stock company. The initial shareholders of the Company, consisting of HLT, Sun Yuan
Overseas (BVI) Ltd. (Sun Yuan BVI), the Cathay Investment Fund, Limited
(Cathay), GS Capital Partners L.P. (GSCP) and Coomber, then a wholly-owned
subsidiary of EB Holdings and, thus, controlled by China Everbright
International Limited (China Everbright International), made their initial
investments in Yuchai in May 1993, when their respective wholly-owned
subsidiaries purchased for cash 200 million newly-issued shares (51.3% of the
then-outstanding Yuchai Shares). These shareholders exchanged with the Company
their shareholdings in their wholly-owned subsidiaries, six companies which
held Foreign Shares of Yuchai, for 20 million shares of the Companys common
stock, par value US$0.10 per share (Common Stock) (after giving effect to a
10-for-1 stock split in July 1994 (the Stock Split)). In connection
therewith, Yuchai became a Sino-foreign joint stock company and became subject
to the laws 16




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and regulations relating to joint stock limited liability companies and
Sino-foreign joint venture companies in China. Foreign Shares may be held by
and transferred to non-Chinese legal and natural persons, subject to approval
of the Ministry of Commerce (MOC), the successor entity of the Ministry of
Foreign Trade and Economic Cooperation of China (MOFTEC). Foreign Shares are
entitled to the same economic rights as State Shares and Legal Person Shares.
State Shares are shares purchased with state assets by government departments
or organs authorized to represent state investment. Legal Person Shares are
shares purchased by Chinese legal persons or institutions or social groups with
legal person status and with assets authorized by the state for use in
business. In November 1994, the Company purchased from an affiliate of China
Everbright 78,015,500 Foreign Shares in exchange for the issuance of 7,801,550
shares of Common Stock (after giving effect to the Stock Split) (the China
Everbright Purchase). The 78,015,500 Foreign Shares of Yuchai held by Earnest
Assets Ltd, a subsidiary of EB Holdings and China Everbright before its sale to
the Company, had been originally issued as Legal Person Shares and State Shares
and were converted to Foreign Shares, pursuant to approvals granted by MOFTEC.
As a result, the Company became the owner of each of these six companies: Hong
Leong Technology Systems (BVI) Ltd., Tsang & Ong Nominees (BVI) Ltd., Cathay
Diesel Holdings Ltd., Goldman Sachs Guangxi Holdings (BVI) Ltd., Youngstar
Holdings Ltd. and Earnest Assets Ltd. In December 1994, the Company sold 7,538,450 shares of Common Stock in its
initial public offering (IPO) and used substantially all of the proceeds to
finance its six wholly-owned subsidiaries purchase of 83,404,650 additional
Foreign Shares from Yuchai. In connection with the Companys purchase, through its six wholly-owned
subsidiaries, of additional Foreign Shares from Yuchai with proceeds of its
IPO, Yuchai offered additional shares pro rata to its other existing
shareholders (30 shares for each 100 shares owned) in accordance with such
shareholders pre-emptive rights, and each of the Companys subsidiaries was
able to acquire these additional Yuchai Foreign Shares. Such pro rata offering
(including the offering to the Company) is referred to herein as the Yuchai
Offering. Certain Legal Person shareholders subscribed for additional shares
in the Yuchai Offering. The State Holding Company informed Yuchai at the time
that it would not subscribe for any of its portion of Yuchai Shares (31,345,094
shares) in the Yuchai Offering. In order to obtain MOFTEC approval of the
Yuchai Offering, the State Holding Company was given the right by Yuchais
Board of Directors to subscribe for approximately 31 million shares of Yuchai
at a price of Rmb 6.29 per share at any time prior to December 1998. This was
because provisional regulations of the State Administration Bureau of State
Property (SABSP) and the State Committee of Economic System Reform (SCESR),
published in November 1994, imposed on any holder of state-owned shares certain
obligations to protect its interest in any share offering. Under such
regulations, the State Holding Company could have been required to subscribe
for Yuchai Shares in the Yuchai Offering. Yuchais shareholders subsequently
agreed to extend the duration of such subscription right to March 31, 2002 (the
exercise of which would have reduced the Companys ownership of Yuchai from
76.4% to 71.7%). The State Holding Company informed the shareholders of Yuchai
that it had determined not to subscribe for additional Yuchai Shares and this
determination was minuted by the Yuchai Board of Directors on November 1, 2002.
However, given the November 1994 provisional regulations of the SABSP and the
SCESR, the SABSP, the SCESR and/or the MOC may take action against the State
Holding Company, and there can be no assurance that any such action would not,
directly or indirectly, have a material adverse effect on Yuchai or the
Company. Capital Expenditures Capital expenditures for routine upgrades to, and replacement of,
equipment, plant and property were Rmb 43.0 million, Rmb 174.9 million and Rmb
372.8 million in 2001, 2002 and 2003, respectively. The Company funded its
capital expenditures primarily from funds from operations generated by Yuchai
and, when necessary, from bank loans obtained by Yuchai. The Company incurred
capital expenditures in 2002 due to the 4-series light-duty diesel engine
series and the commencement of construction of the second foundry to produce
engine blocks to meet its expected increased unit production. The Company
incurred additional capital expenditures in 2003 relating to the completion of
the second foundry as well as for the production line of the
new 6113 heavy-duty diesel engine. The Companys capital expenditures for 2004
are estimated to exceed Rmb 200 million, most of which is expected to be used
to complete construction of the second foundry and the new production line for
6113 engines. The Company expects that it will be able to continue to fund its
capital expenditures in 2004 in the 17




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##### Table of Contents



same manner as in prior years, as described above and under Item 5. Operating
and Financial Review and Prospects  Liquidity and Capital Resources. Business Overview Product Development Overview The general market demand for trucks and buses has contributed to Yuchais
significant growth since 2001, with the continued expansion of the highways and
toll roads in China. The Company expects heavy-duty trucks to become an
increasingly important means of freight transportation as road conditions and
infrastructure in China improve. Both medium-duty and heavy-duty trucks are
increasingly fitted with diesel engines because of their higher power, fuel
efficiency and reliability as compared to gasoline engines. In addition, the
Chinese government had announced as a policy objective in 1994 that motor
vehicles weighing five tons or more should principally have diesel engines
after 2000. To take advantage of anticipated growth in demand for diesel engines in
China, Yuchai substantially expanded its manufacturing facilities from their
production capacity of 37,000 units of medium-duty diesel engines in 1993 to
approximately 140,000 units of medium-duty diesel engines and 50,000 units of
heavy-duty diesel engines in 1996. In response to the introduction of high
power medium-duty engines introduced by its competitors in 1995, Yuchai began
commercial production of the 6108 medium-duty engine in the third quarter of
1997. In addition, Yuchai began trial production of its 4-Series engines (as
defined in  4-Series Light-Duty Diesel Engines below) in late 1999 and
commenced commercial production of these engines in 2000. Due to strong
competition, quality defects and a high pricing structure, sales of the
4-Series engines were weak in 2000, but improved in 2001, 2002 and 2003, with
the total number of units sold reaching 4,747 units, 20,735 units and 46,022
units, respectively. Yuchai also commenced trial marketing of the 6112
heavy-duty engine in early 1999 and began commercial production of these
engines in the second half of 1999. The quality of the 6112 engine has improved
significantly due to the improvements made in the past two years, which the
Company believes has translated into higher sales. In addition, continued
economic growth in China, together with the development of new highway
infrastructure, has resulted in greater demand for long-haul, heavy-duty
trucks. As a result, sales of the 6112 engine increased from 2,651 units in
2000 to 6,737 units in 2001, 15,371 units in 2002 and 20,472 units in 2003.
The Company also commenced engine development work on its proposed new
heavy-duty 6113 engine in 2003, recording sales of 62 units to its customers
for testing purposes in 2003. 6105 Medium-Duty Diesel Engines The 6105 medium-duty engine was historically Yuchais primary product and
was principally installed in medium-duty trucks. However, in response to the
introduction of high-power medium-duty engines by its competitors in 1995,
Yuchai has been increasing its production and sales efforts on the 6108
medium-duty engine. In 2001, Yuchai produced 31,245 units of the 6105 engine,
or 39.7% of Yuchais total production volume of 78,800 units for that year.
Yuchai produced 39,644 units of the 6105 engine in 2002, representing 27.4% of
Yuchais total production volume of 144,463 units for that year. In 2003,
Yuchai produced 43,325 units of 6105 engines representing 24.0% of total
production volume of 180,423 units. The Company expects the 6108 engine to
eventually replace the 6105 engine as Yuchais primary product. See  Products
 Medium-Duty Diesel Engines  6105 Engines. 6108 Medium-Duty Diesel Engines The 6108 medium-duty engine is an overall improvement over the 6105
medium-duty engine. In particular, the Company expects the 6108 engine to
enhance Yuchais competitiveness in the medium-duty diesel engine market in
China. In 2002 and 2003, unit sales of the 6108 engine exceeded unit sales of
the 6105 engine. The 6108 engine has become Yuchais primary product. See 
Products  Medium-Duty Diesel Engines  6108 Engines. 18




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In 2001, Yuchai produced 33,062 units of the 6108 engine, or 42.0% of
Yuchais total production volume of 78,800 units for the year. Yuchai produced
61,950 units of the 6108 engine in 2002, representing 42.9% of Yuchais total
production volume of 144,463 units for the year. In 2003, Yuchai produced
64,054 units of 6108 engine, representing 35.5% of Yuchais total production
volume of 180,423 units. 6112 Heavy-Duty Diesel Engines In 1992, Yuchai purchased from an affiliate of Ford Motor Company in
Brazil the production line machinery for manufacturing 6112 heavy-duty engines
and moved the production line machinery to a factory in China (the 6112 Engine
Factory). The facilities were designed to have a production capacity of
approximately 50,000 units of the 6112 engine per year and could support
production of medium-duty engines when necessary. In addition, the facilities
could also perform product testing, production equipment repair and
maintenance, factory automation and other support functions. The 6112 Engine Factory was completed in 1995 and commercial production
was scheduled to commence in late 1997. However, primarily as a result of the
unreliable quality of key engine components supplied by domestic component
manufacturers, the 6112 engine encountered significant technical problems
during initial road testing, and did not perform satisfactorily under harsh
environmental conditions. Yuchai was able to resolve these technical problems
and commence trial marketing of the 6112 engine in early 1999. Commercial
production of these engines began in the second half of 1999. Due to the delay
in commencement of commercial production, however, Yuchai was not able to
benefit from the competitive advantages of an early entry into the domestic
market for heavy-duty engines. Consequently, the volume of sales and
profitability of the 6112 engine had been lower than previously expected.
However, during 2002, the volume of sales of the 6112 engine had increased
steadily to over 1,000 units per month, reaching 15,371 units in 2002. This
higher level of customer acceptance of the 6112 engine had led to unit sales
of 20,472 engines in 2003 which was 33.2% increase over 2002. See  Products
 Heavy-Duty Diesel Engines. In 2001, Yuchai produced 8,134 units of the 6112 engine, or 10.3% of total
production volume of 78,800 units for the year. Yuchai produced 17,201 units of
the 6112 engine in 2002, representing 11.9% of Yuchais total production volume
of 144,463 units for that year. In 2003, Yuchai produced 22,024 units of 6112
engine, representing 12.2% of Yuchais total production volume of 180,423
units. 4-Series Light-Duty Diesel Engines The 4-Series light-duty engines comprise of the 4108, 4110, 4110Q, 4110ZQ
and 4112 engines (collectively, the 4-Series engines). See  Products 
Light-Duty Diesel Engines. The 4110Q and 4110ZQ engines were developed to allow Yuchai to compete in
the light-duty diesel engine market. Trial production of the 4110 engines
commenced in late 1999. Sales of the 4110 engines in 2000 were weak due to
strong competition, minor technical problems and a high pricing structure.
Significant improvements to the technical specifications of the 4-Series
light-duty engines have resulted in higher customer acceptance resulting in
higher unit sales in 2003. The 4108 engine was based on the 6105 and the 6108 engines. The 4108
engine is designed for light trucks and passenger vehicles. Trial production of
the 4108 engine started in the third quarter of 2000, and commercial production
of the 4108 engine began in 2001. The 4112 engine was primarily based on the
6112 engine. The 4112 engine is designed for use in light- to medium-duty cargo
trucks and buses. The 4112 engine also features a low emission level that is
compliant with Euro 1 standards. Trial production of the 4112 engine started in
early 2001 and commercial production of the 4112 engine began in late 2001.
Both the 4108 and 4112 engines have experienced minor technical problems which
have since been resolved, and are facing strong competition. In 2001, Yuchai produced 6,359 units of 4-Series engines, or 8.0% of total
production volume of 78,800 units for the year. Yuchai produced 23,773 units of
the 4-Series engines in 2002, representing 16.5% of Yuchais total 19




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##### Table of Contents



production volume of 144,463 units for that year. In 2003, Yuchai produced
50,264 units of the 4-Series engines, representing 27.9% of Yuchais total
production volume of 180,423 units. Products Yuchai primarily manufactures and sells diesel engines for medium-duty
trucks in China. Yuchais primary products are its 6105 and 6108 medium-duty
engines, which are principally used in medium-duty trucks with a load capacity
of five to seven tons. In addition, Yuchai also offers the 4-Series light-duty
engines and the 6112 heavy-duty engines. See  Product Development. The
following table sets forth the technical specifications of the 4110ZQ engine,
the 6108 engine, the 6112 engine and the 6113 engine: Type and TechnicalSpecifications
    
    4110ZQ Engine
    
    6108 Engine
    
    6112 Engine
    
    6113 Engine*Type
    
    4-stroke,
turbo-charged,
water-cooling,
in-line vertical
    
    4-stroke, water
cooling,
in-line vertical
    
    4-stroke,
turbo-charged,
inner-cooling,
water cooling,
in-line vertical
    
    4-stroke,
turbo-charged,
inner-cooling or
water cooling,
4 valve per
cylinder in line
verticalRated Power
    
    136
horsepower
(100
kw)
    
    160
horsepower
(118
kw)
    
    270
horsepower
(199
kw)
    
    350
horsepower
(258
kw)Number of Cylinders
    
    4
    
    6
    
    6
    
    6Cylinder Displacement
    
    4.257L
    
    6.871 L
    
    7.8L
    
    8.424LRated Speed
    
    2800 r/min
    
    2800 r/min
    
    2400 r/min
    
    2200 r/minMaximum Torque
    
    392 N.m
    
    450 N.m
    
    980 N.m
    
    1400 N.mSpeed at Maximum Torque
    
    1600-1800 r/min
    
    1600-1900 r/min
    
    1500 r/min
    
    1400 r/minBore x Stroke
    
    110 x 112 mm
    
    108 x 125 mm
    
    112 x 132 mm
    
    113 x 140 mmMinimum Fuel Consumption
    
    < 248 g/kw.h
    
    < 228.5 g/kw.h
    
    < 200 g/kw.h
    
    < 198 g/kw.hConsumption Ratio
of Oil to Fuel
    
    < 0.5%
    
    < 1%
    
    < 0.5%
    
    < 0.1%Noise
    
    < 115 dB(A)
    
    < 117 dB(A)
    
    < 98 dB(A)
    
    < 98 dB(A)Smoke
    
    < 3.5 Bosch
    
    < 3.5 Bosch
    
    < 3 Bosch
    
    < 3 BoschNet Machine Weight
    
    380 kg
    
    550 kg
    
    642 kg
    
    750 kg
 20




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##### Table of Contents



Type and TechnicalSpecifications
    
    4110ZQ Engine
    
    6108 Engine
    
    6112 Engine
    
    6113 Engine*Dimensions
(length x width x height)
    
    863 x 664 x
843 mm
    
    1234 x 701 x
1000 mm
    
    1224 x 815 x
986 mm
    
    1388 x 716 x 1012 mm
   *
    
    Yuchais 6113 engines have a rated power ranging from 280 to 350 horsepower. The technical specifications set
forth for the 6113 engine in the table are for the 6113 engine with 350 horsepower. Diesel engines are commonly referred to by a four-digit numerical name,
such as 6108 or 6112. The first digit refers to the number of cylinders and the
last three digits refer to the cylinder bore diameter in millimeters. In
addition, the numerical name is often followed by a letter indicating the
design and use (for example, Q for motor vehicles). Besides diesel engines, Yuchai also produces a limited number of diesel
power generators and diesel engine parts. The following table sets forth a
breakdown of Yuchais sales by major product category for each of the three
years ended December 31, 2001, 2002 and 2003, respectively: 2001
    
    2002
    
    2003% of
    
    Units
    
    
    
    
    
    % of
    
    Units
    
    
    
    
    
    % of
    
    UnitsProduct
    
    Net Sales
    
    Net Sales
    
    Sold
    
    Net Sales
    
    Net Sales
    
    Sold
    
    Net Sales
    
    Net Sales
    
    SoldRmb
    
    
    
    
    
    
    
    
    
    Rmb
    
    
    
    
    
    
    
    
    
    Rmb(in thousands)
    
    
    
    
    
    
    
    
    
    (in thousands)
    
    
    
    
    
    
    
    
    
    (in thousands)Diesel engines6105
    
    
    581,086
    
    
    
    32.6
    %
    
    
    31,001
    
    
    
    706,442
    
    
    
    20.1
    %
    
    
    36,135
    
    
    
    911,190
    
    
    
    19.9
    %
    
    
    44,1316108
    
    
    713,369
    
    
    
    40.0
    %
    
    
    31,667
    
    
    
    1,602,545
    
    
    
    45.6
    %
    
    
    58,042
    
    
    
    1,504,140
    
    
    
    32.9
    %
    
    
    61,3616112
    
    
    317,141
    
    
    
    17.8
    %
    
    
    6,737
    
    
    
    753,559
    
    
    
    21.5
    %
    
    
    15,371
    
    
    
    1,003,791
    
    
    
    22.0
    %
    
    
    20,4726113
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,697
    
    
    
    0.1
    %
    
    
    624-Series
    
    
    74,236
    
    
    
    4.2
    %
    
    
    4,747
    
    
    
    376,931
    
    
    
    10.7
    %
    
    
    20,735
    
    
    
    769,805
    
    
    
    16.8
    %
    
    
    46,022Diesel power generators
    
    
    2,378
    
    
    
    0.1
    %
    
    
    62
    
    
    
    5,103
    
    
    
    0.2
    %
    
    
    101
    
    
    
    5,808
    
    
    
    0.1
    %
    
    
    171Other(1)
    
    
    95,119
    
    
    
    5.3
    %
    
    
    N/A
    
    
    
    68,467
    
    
    
    1.9
    %
    
    
    N/A
    
    
    
    371,519
    
    
    
    8.2
    %
    
    
    N/ATotal
    
    
    1,783,329
    
    
    
    100.0
    %
    
    
    74,214
    
    
    
    3,513,047
    
    
    
    100.0
    %
    
    
    130,384
    
    
    
    4,569,950
    
    
    
    100.0
    %
    
    
    172,219
   (1)
    
    Includes diesels engine parts, agricultural engines and industrial
engines. Figures for the number of units sold for this category are not
readily available. Medium-Duty Diesel Engines 6105 Engines The 6105 medium-duty engine, traditionally Yuchais principal product, is
a six-cylinder, four-stroke engine that offers up to 143 horsepower, and is
principally installed in medium-duty trucks. Yuchai believes that its 6105
engine has a reputation for fuel efficiency, low noise levels, firm uphill
traction and reliability. Yuchai also believes that its manufacturing quality
control and the design of its engine blocks, which are thicker than those of
its major domestic competitors as well as leading international manufacturers,
make its engines more durable. 21




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##### Table of Contents



In response to the introduction of high-power medium-duty engines by its
competitors in 1995, Yuchai began development of its 6108 medium-duty engine.
Commercial production of the 6108 engine began in the third quarter of 1997,
and in 2003 unit sales of the 6108 engine exceeded unit sales of the 6105
engine. The 6108 engine has replaced the 6105 engine as Yuchais primary
product. 6108 Engines The 6108 engine offers improved overall performance compared to the 6105
engine, principally because of greater horsepower, increased reliability and
improved acceleration. Commencing in the third quarter of 1997, Yuchai began
offering the 6108 engine to its customers as a premium model, along-side its
standard 6105 engine, and plans to eventually replace the 6105 engine with the
6108 engine. Yuchais existing and planned production facilities for
medium-duty diesel engines are designed to be capable of producing 6108 engines
without major modification. Yuchai sells its 6108 engine to the same customers which previously bought
its 6105 engines. Although the increased competition in the medium-duty diesel
market and Yuchais delay in commercially introducing the 6108 engine had
adversely affected Yuchais market share, through an aggressive marketing
program, Yuchai was able to increase its unit sales of the 6108 engine by 30.2%
to 31,667 units in 2001 from 2000. Unit sales of the 6108 further increased to
58,042 units in 2002, representing an increase of 83.3% over 2001. Due to the
overall decline in medium-duty trucks market in China in 2003, medium-duty
engines also decreased in unit quantity resulting in Yuchai achieving 61,361
units sales in 2003 as compared to 58,042 units in 2002. There can be no
assurance, however, that Yuchai will be able to maintain or improve its current
market share or develop new markets for the 6108 engine. See Item 5. Operating
and Financial Review and Prospects  Overview. An important part of Yuchais business strategy is to continually achieve
higher standards of quality in its diesel engines. Yuchai believes that its
engines have an established reputation among truck manufacturers and end-users
for durability and quality. Due to poor road conditions, lack of engine
maintenance by end-users and the common practice of overloading trucks in
China, Yuchai believes that the reliability and durability of its engines are
critical factors in maintaining competitiveness. By further improving the
reliability and overall quality of its engines and controlling the costs of
production, Yuchai believes it can command higher prices for its engines than
its competitors and remain competitive in China. Heavy-Duty Diesel Engines The 6112 heavy-duty engine is a six-cylinder, four-stroke engine with a
rated power ranging from 190 to 270 horsepower. Primarily as a result of
unreliable key engine components supplied by domestic component manufacturers,
the 6112 engine encountered significant technical problems during initial road
testing and failed to perform satisfactorily under harsh environmental
conditions. Although commercial production of the 6112 engine was delayed
beyond the previously scheduled date, Yuchai was able to resolve these
technical problems and commence trial marketing of the engine in early 1999.
Commercial production of these engines began during the second half of 1999. In
2001 and 2002, Yuchai produced 8,134 and 17,011 units of the 6112 engine,
respectively. In 2003, Yuchai produced 22,024 units 6112 engine. See Item 5.
Operating and Financial Review and Prospects  Overview. With the higher levels
of acceptance by customers, 6112 engine unit sales have increased in 2003 as
compared to 2002. The 6113 heavy-duty engine is a six-cylinder, four-stroke engine with a
rated power ranging from 300 to 350 horsepower. The Companys first sales of
the 6113 occurred in November 2003, and the Company expects growth of this new
engine to strengthen over the next few years and become a significant
contributor to profit growth for Yuchai. Early in 2003, Yuchai embarked upon a
major capital expenditure program to increase the production capacity of
heavy-duty engines by 20,000 units per year. The expansion is expected to
enable Yuchai to enter the higher margin market for engines over 300
horsepower, while eventually reducing is cost base by replacing imported
engines blocks and cylinder heads with production from Yuchais new foundry. 22




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##### Table of Contents



Light-Duty Diesel Engines The 4-Series engines utilize much of the same technology as the 6112
heavy-duty engine, modified to produce short-range and reduced cylinder engines
for lightweight cars and trucks. Despite their relatively small size (less than
half the size of the 6112 engine), they have the advantages of the 6112 engine,
including, reliability, high performance and a long life span. Due to its
versatility, the 4110Q engine is suitable for light vehicles and agricultural
trucks. The 4110ZQ engine, with features such as a low emission level that is
compliant with Euro 1 standards and low noise levels, is ideal for light
commercial vehicles and medium-size passenger vehicles. Trial production of the
4-Series engines commenced in late 1999. In 2000, due to strong competition in
the light-duty diesel engine market, minor technical problems and the high
pricing structure of the 4-Series engines, only 1,175 of the 2,220 units which
it produced were sold. In 2001, Yuchai produced less than 7,000 units and sold
fewer than 5,000 units in 2001, while working on resolving the technical
problems. In 2002, Yuchai achieved sales of 20,735 units, which is a
significant increase compared to 2001. In 2003, units sales of the 4-Series
engines further increased to 46,022 representing an increase of 122% over 2002. Other Products Diesel Power Generators Yuchai produces diesel power generators which are primarily used in the
construction and mining industries. The diesel power generators offer a rated
power of 12 kilowatts to 160 kilowatts. Yuchais diesel power generators use
both the 6105 and 6108 medium-duty engines as their power source. Diesel Engine Parts Yuchai supplies diesel engine parts to its nationwide chain of customer
service stations. Although sales of diesel engine parts do not constitute a
major percentage of Yuchais net sales, the availability of such parts to its
customers and to end-users through its nationwide chain of customer service
stations is an important part of Yuchais customer service program. Sales, Marketing and Services Sales and Marketing Yuchai distributes most of its engines directly to auto plants and
retailers from its primary manufacturing facilities in Yulin City. In addition,
Yuchai operates 28 regional sales offices in major geographic regions in China.
With a sales force of approximately 518 persons nationwide, Yuchai provides a
comprehensive range of services to its customers, including dispatching
engineers to provide on-site assistance to major customers in the resolution of
technical problems. Yuchai promotes its products primarily through television commercials,
advertisements in newspapers and industry journals. Since 1993, Yuchai has been
sponsoring an annual program, User Service Week, during which Yuchai provides
its customer service stations with information brochures, customer suggestion
cards for the improvement of Yuchais service and small gifts for end-users. In
connection with this promotion, Yuchais customer service stations also perform
minor repairs on end-users diesel engines free of charge. Yuchai believes that
its promotional efforts are unusual for an automotive component company in
China and lead to greater brand name recognition among end-users. Advertising
expenses increased by 28.5% in 2003 to Rmb 40.1 million from
Rmb 31.9 million in 2002. On the other hand, sales commissions decreased to Rmb
16.7 million in 2003 compared to Rmb 17.7 million in 2002. From 2002, Yuchai
has changed its promotion strategies by offering lower selling price
to its
customers rather than through sales commissions paid to sales agents. 23




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##### Table of Contents



Yuchai believes that proximity to its factories in Yulin City is an
important factor in the geographical make-up of its customers. Due in part to
transportation and shipping costs, a substantial majority of Yuchais engines
are sold to customers in southern and central eastern China. Yuchai currently
exports a minor portion of its diesel engines to Vietnam, and Yuchai is
exploring opportunities to export its diesel engines to other developing
countries. Yuchais sales are concentrated among Dongfeng Group, one of the largest
state-owned automobile companies in China, and other major diesel truck
manufacturers controlled by or affiliated with Dongfeng Group. Sales to the
Dongfeng Group accounted for approximately 45.0% and 31.3% of Yuchais total
net sales 2002 and 2003, respectively. Dongfeng is also a major competitor of
Yuchai. See  Competition. Yuchai has been continuing its sales efforts to retailers and end-users of
diesel engines. Yuchai seeks to convince end-users of gas engine trucks to
replace their gas engines with Yuchai diesel engines by advertising the
advantages of diesel engines. Such sales of replacement engines are generally
made through customer service centers at a retail price, which is higher than
the sales price to truck manufacturers. Prior to delivery, customer orders with Yuchai are subject to cancellation
by either Yuchai or the customers under the terms of the sales contracts. As
part of the continuing efforts to control the level of its trade accounts
receivable, Yuchai does not expect to fill all contracted customer orders.
There can be no assurance that such cost-controlling measures will successfully
control Yuchais trade receivable balance, or that they will not adversely
affect the future purchase decisions of Yuchais customers. Yuchai had net
trade accounts receivable of Rmb 1,003.1 million as of December 31, 2002,
representing 38.2% of the Companys total current assets at the same date. As
of December 31, 2003, Yuchai had net trade accounts receivable of Rmb 849.6
million, representing 34.5% of the Companys total current assets as of the
same date. Customer Service Yuchai believes that customer service is an important part of maintaining
its market competitiveness. In addition to various services provided initially
at its sales offices, Yuchai has a nationwide network of over 450 authorized
service stations that provide repair and maintenance services, spare parts,
retrofitting services and training to Yuchais customers. To ensure a
consistently high level of service, Yuchai trains the technicians at each of
these service stations. In addition, Yuchai also owns and operates over 30
repair training centers. Yuchais customer service program emphasizes a fast turnaround time on
repair requests. As part of this policy, Yuchai supplies authorized service
stations with spare parts for repairs and requires these service stations to
provide on-site assistance at the customers place of business within 24 to 48
hours, depending on the customers location. Yuchai provides a repair and replacement warranty for all of its engines.
Prior to 1993, Yuchais warranty was for 12 months or 30,000 kilometers. In
September 1993, Yuchai extended its warranty to 18 months or 50,000 kilometers
and, in September 1994, Yuchai further extended its warranty from a period of
12 months or 120,000 kilometers to a warranty period of 18 months or 180,000
kilometers, whichever is lower. For the years ended 2001, 2002 and 2003,
warranty costs represented approximately 3.3%, 3.5% and 3.6% of net sales,
respectively. Manufacturing Yuchais primary manufacturing facilities are located in Yulin City in the
Guangxi Zhuang Autonomous Region. The principal production land area currently
occupies approximately 960,900 square meters, including the existing production
factory for the 6105 medium-duty engines, the existing production factory for
the 6108 medium-duty engine (the 6108 Engine Factory), the 6112 Engine
Factory and various testing and supporting facilities. In 2003, the annual
production capacity of Yuchais manufacturing facilities was approximately
140,000 units of medium-duty diesel engines and 100,000 units of heavy-duty and
light-duty diesel engines. Yuchai operated at less than full capacity in 2003. Yuchais production process involves the manufacture of key components and
the assembly of the diesel engine from components and parts internally
manufactured or purchased from third parties. Yuchai manufactures a 24




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substantial portion of the key components of its diesel engines, including the
engine block, cylinder heads, crankshaft and camshaft. Yuchai cast and molded
approximately 134,110 engine blocks in 2003, satisfying approximately 73.6% of
its engine block needs in 2003. When necessary, Yuchai is able to purchase
additional engine blocks from a domestic foundry under an existing requirement
contract. Yuchai/ASIMCO Components Company Limited (Yuchai/ASIMCO) is one of
Yuchais principal suppliers of fuel injection pumps through two of its related
companies. Yuchai purchases the remaining parts and components for its 6105
engines as well as raw materials, principally steel and cast iron, from
domestic suppliers. Yuchai does not believe that it is dependent on any one
supplier as it generally purchases supplies from at least two sources (except
with respect to engine blocks where Yuchai currently has a purchase arrangement
only with the domestic foundry referred to above). In addition, the prices of
raw materials are not volatile. Yuchai manufactures internally the same key
components for its 6108 engine as it does for the 6105 engine and purchases the
remaining parts and components for its 6108 engine from domestic suppliers. The
main parts for the 6112 heavy-duty engine, which are the engine blocks,
cylinder heads, crankshaft and fuel pumps, are imported from foreign suppliers
and the other parts are purchased from domestic suppliers. To ensure that its standards and specifications are met, Yuchai conducts
routine checks at each stage of the production process, tests each diesel
engine prior to delivery to the customer, and inspects all raw materials, parts
and components purchased from suppliers to ensure that they meet Yuchais
requirements. To ensure the safety of its workers, Yuchai has established a
safety department to supervise the proper use of equipment, prevent fire and
explosions and promote safe practices and procedures in the workplace. Yuchai/ASIMCO is a joint venture between Yuchai and a subsidiary of Asian
Strategic Investments Corporation (ASIMCO) that invests in factories in China
that produce parts and components for diesel engines. ASIMCO is a joint venture
among The Pacific Alliance Group Limited, Dean Witter Capital Corporation and
TCW Capital Investment Corporation. As of December 31, 2003, Yuchai had
contributed Rmb 5.7 million to the joint venture and owned a 4.73% interest in
the common stock of the joint venture. During 2000, at the State Holding Companys initiative, Yuchai established
two new companies involved in the manufacture and sale of spare parts and
components for diesel engines in China. Yuchai contributed a total of Rmb 105
million in assets to the companies and received equity interests of 71.8% and
97.0%, respectively, in the two companies. During 2002, Yuchai increased its
equity interest in Guangxi Yulin Yuchai Machinery Spare Parts Manufacturing
Company Limited, the subsidiary involved in the manufacture of spare parts,
from 97% to 97.1% by an additional contribution of Rmb 4.3 million. The State
Holding Company owns the remaining equity interests in the companies. Yuchai
established these new companies to ensure access to a consistent and quality
supply of spare parts and components for its diesel engines and to improve the
quality of its customer service by maintaining a regular supply of these spare
parts. The establishment of these companies by Yuchai was initially not made
with the requisite corporate approvals, but was subsequently ratified by the
Board of Directors of Yuchai in October 2001. In March 2004, similarly at the State Holding Companys initiative, Yuchai
established a new company, Yuchai Express Guarantee Company Limited, which
Yuchai intends will be involved in providing financing for Yuchais customers
to purchase diesel engines manufactured by Yuchai. Yuchai has contributed Rmb
100 million for the establishment of this company, in return for 76.9% of its
share capital. The State Holding Company has issued a letter of commitment to
purchase from Yuchai approximately 55.1% of this companys shares, thereby
reducing Yuchais holding to 19.99% of this new company. This new company is
not yet operational. Yuchais investment in this new company has not to date
received the requisite corporate approvals. Seasonality Yuchais business generally is not seasonal. However, Yuchais results of
operations in the first and second quarters of recent calendar years have been
marginally higher than in the third and fourth quarters of the corresponding
year, due to slightly better production and sales performance in the first
compared to the second half of such calendar years. 25




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Trademarks Yuchai owns and maintains Chinese trademark registrations of its principal
trademarks. Yuchai believes that its logo is well recognized as a quality brand
in China. As Yuchai currently sells most of its products in the domestic
market, registration of its principal trademarks is not maintained in countries
outside China. Yuchai has not been involved in any material claim or dispute in
relation to trademarks or other intellectual property rights and, to the best
of Yuchais knowledge, no such claim or dispute is pending or threatened. Competition The diesel engine industry in China is highly competitive. Yuchai
believes, based on internal studies, that competition is based primarily on
performance, quality, price and after-sale service, and secondarily on noise,
size and weight. Yuchai believes that its engines have a strong reputation
among truck manufacturers and consumers for leading performance and
reliability. In addition, Yuchai believes that its after-sale service to
end-users of Yuchai engines, conducted through a nationwide network of over 450
authorized service stations and 30 Yuchai-owned repair training centers, gives
Yuchai a competitive advantage over other diesel engine producers. Most of Yuchais major domestic competitors are state-owned enterprises.
The Dongfeng Group, which is a major competitor of Yuchai and which controls
two of Yuchais largest competitors, is also one of Yuchais major customers
and controls Yuchais other major customers, accounting in the aggregate for
approximately 31% of Yuchais total net sales in 2003. Some of Yuchais
competitors have formed joint ventures with, or have technology assistance
arrangements with, foreign diesel engine manufacturers or engine design
consulting firms, and use foreign technology that is more advanced than
Yuchais technology. Yuchai believes several of its major competitors, as
Yuchai itself, have substantial unused production capacity. Yuchai expects
competition to intensify as a result of, among other things, improvements in
competitors products, increased production capacity of competitors, increased
utilization of unused capacity by competitors and price competition. In the medium-duty diesel engine market, Yuchais 6105 and 6108 engines
compete primarily against the 6110 engines produced by a number of Yuchais
competitors. Initially, the introduction of the 6110 engine in 1995 had put
considerable pressure on Yuchais competitiveness in the medium-duty diesel
market because it offered greater horsepower than Yuchais 6105 engine.
However, the commercial introduction of the 6108 engine in 1997 by Yuchai,
which offers substantially the same horsepower as the 6110 engine, has allowed
Yuchai to compete effectively in the medium-duty diesel engine market. In
competing with the 6110 engine, Yuchai focuses on the quality and price of, and
the after-sales service on, the 6108 engine. There can be no assurance,
however, that Yuchai will be able to maintain or improve its current market
share or develop new markets for its medium-duty diesel engines. In addition, Yuchai commenced trial marketing of its 6112 heavy-duty
engine in early 1999, and began commercial production of these engines in the
second half of 1999. Due to the delay in commercial production of the 6112
engine until 1999, however, Yuchai was not able to benefit from the competitive
advantages of an early entry into the domestic market for heavy-duty engines.
Moreover, the market for heavy-duty diesel engines in China is relatively price
sensitive, and customer acceptance of the 6112 engines pricing structure
requires considerable marketing efforts by Yuchai. As a result, the Company
lowered its expectations for future sales volume and profitability of the 6112
engine. In 2003, the sales volume of the 6112 engine was 20,472 units, which
was in line with the Companys expectations. However, there can be no assurance
that Yuchai will be able to compete successfully in the heavy-duty diesel
engine market in China with the existing producers (such as Weichei Power Co.,
Ltd.) or any new entrants. Yuchai also faces intense competition in the light-duty diesel engine
market. In this market, Yuchai competes primarily against Wuxi Diesel Engine
Factory First Auto Group and Dalian Diesel Engine Factory First Auto Group
(collectively, the First Auto Group). As Yuchai is a late entrant into the
light-duty diesel engine market relative to the First Auto Group, it will be
difficult for Yuchai to become a major market leader in the short-term. 26




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##### Table of Contents



As the Chinese automotive industry develops, Yuchai will have to
continuously improve its existing engine products and develop new diesel engine
products in order to remain competitive. Consequently, Yuchais long-term
business prospects will largely depend upon its ability to develop and
introduce new or improved products at competitive prices. Future products may
utilize different technologies and may require knowledge of markets that Yuchai
does not currently possess. Currently, Yuchai is heavily dependent on foreign
engine design consulting firms and foreign engine manufacturers for
technological assistance in improving its products and developing new products,
and expects such dependency to continue. The introduction of new diesel engine
products will also require significant capital expenditures, such as purchases
of foreign manufacturing equipment and technologies. In addition, Yuchais
competitors in the diesel engine markets may be able to introduce new or
improved models that are more favorably received by customers than Yuchais
products. Competition in the end-use markets, mainly the truck market, may also
lead to technological improvement and advances that render Yuchais current
products obsolete at an earlier than expected date, in which case Yuchai may
have to depreciate or impair its production equipment more rapidly than
planned. Failure to introduce, or delays in the introduction of, new or
improved products at competitive prices could have a material adverse effect on
the business and prospects of Yuchai. The admission of China into the WTO, which regulates trading among its
member states, could lead to increased foreign competition for Yuchai. As a
result of China becoming a member of the WTO, import restrictions on both motor
vehicle components, including diesel engines, and motor vehicles are expected
be reduced. China is also required to lower its import tariffs as a condition
for membership in the WTO. Reduced import restrictions and/or lower tariffs may
lead to increased imports of foreign diesel engines and, therefore, to
increased competition in the domestic diesel engine markets. Similarly, reduced
import restrictions and/or lower tariffs on automobiles may affect the
competition in the end-use markets of Yuchais customers and indirectly affect
Yuchais sales to such customers. Currently, China is encouraging foreign
investments into the motor vehicle engine manufacturing industry. Yuchai has
been in discussions with potential foreign diesel engine manufacturers on a
possible strategic joint venture to develop and manufacture new diesel engines. 27




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Organizational Structure The following chart illustrates the organizational structure of the
Company and Yuchai as at June 15, 2004, and is based on information generally known to
Company or otherwise disclosed in filings made with the SEC (see also Item 7.
Major Shareholders and Related Parties  Major Shareholders). (ORGANIZATIONAL CHART) 28




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Regulatory and Related Matters Governance, Operation and Dissolution of Yuchai Governance, operation and dissolution of Yuchai are governed by laws and
regulations of China relating to both joint stock limited liability companies
and Sino-foreign joint venture companies, as well as by Yuchais Articles of
Association. Yuchai is subject to the Sino-Foreign Equity Joint Venture Enterprise
Labor Management Regulations. Under these regulations, management may hire and
discharge employees and make other determinations with respect to wages,
welfare, insurance and employee discipline. Chinese laws and regulations applicable to a Sino-foreign joint stock
company require that, before Yuchai distributes profits, it must: (i) satisfy
all tax liabilities; (ii) recover losses in previous years; and (iii) make
contributions to certain statutory reserves in an amount equal to at least 15%
of net income for the year determined in accordance with generally accepted
accounting principles in China (PRC GAAP). Pursuant to Chinese law and Yuchais Articles of Association, Yuchai may
be dissolved upon the occurrence of certain events, including force majeure,
severe losses, lack of supply of necessary materials or other events that
render Yuchai unable to continue its operations. Upon dissolution, Yuchai will
form a liquidation committee. Final dissolution is subject to government review
and approval. During
2003, the Company believes affiliates of the State Holding Company caused various
Chinese government agencies to raise allegations of irregularities regarding
the status of the Companys ownership of and rights of control over Yuchai,
which the Company believes was intended to try to limit the Companys rights to
exercise control over Yuchai. The Company further believes that such
allegations were based on an inaccurate understanding of the structure of the
Companys ownership of and rights of control over Yuchai. The Company also
believes that Yuchais ownership structure has been validly approved by the
relevant Chinese authorities, and the Company has taken steps to communicate to
the relevant Chinese government agencies the reasons for its belief in respect
thereof. The Company believes the July 2003 Agreement has resolved the issues
raised by the various Chinese governmental agencies relating to its share
ownership in Yuchai. See also Item 8. Financial Statements  Legal
Proceedings and Item 3. Key Information  Risk Factors. Property, Plants and Equipment Yuchais headquarters is located in Yulin City in the Guangxi Zhuang
Autonomous Region. Yuchai has the right to use approximately 1.5 million square
meters of land, which is currently used primarily for the production of diesel
engines and employee housing. The principal production land area for the
manufacture of diesel engines currently occupies approximately 960,900 square
meters, including a building for the current 6105 manufacturing facilities and
recently completed facilities occupying approximately 620,000 square meters
that comprise the 6108 Engine Factory, the 6112 Engine Factory, administrative
offices and technical operations space. In addition, Yuchai leases a sales
office and an office for supplies near its headquarters and 28 other regional
sales offices. Environmental Matters China adopted its Environmental Protection Law in 1989, and the State
Council and the State Environmental Protection Agency promulgate regulations as
required from time to time. The Environmental Protection Law addresses issues
relating to environmental quality, waste disposal and emissions, including air,
water and noise emissions. Environmental regulations have not had a material
impact on Yuchais results of operations. Yuchai delivers, on a regular basis,
burned sand and certain other waste products to a waste disposal site approved
by the local government and makes payments in respect thereof. Yuchai expects
that environmental standards and their enforcement in China will, as in many
other countries, become more stringent over time, especially as technical
advances make achievement of higher standards more feasible. Yuchai has built
an air filter system to reduce the level of dust and fumes resulting from its
production of diesel engines. 29




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ITEM 5.  OPERATING AND FINANCIAL REVIEW AND PROSPECTS. The following discussion and analysis should be read in conjunction with
the consolidated financial statements and notes thereto contained in this
Annual Report. The consolidated financial statements of the Company are
prepared in conformity with US GAAP. The Company consolidates Yuchai into its
financial statements. The Companys sole operating asset is its 76.4% ownership interest in
Yuchai. As a result, the Companys financial condition and results of
operations depend entirely upon Yuchais financial condition and results of
operations. The Company acquired its initial 51.3% interest in Yuchai effective
April 1, 1993, increased its interest to 71.4% in November 1994 through the
China Everbright Purchase and then to 76.4% in December 1994 by purchasing
additional Yuchai Shares with the net proceeds of its initial public offering.
The Companys historical results of operations differ from those of Yuchai,
primarily as a result of amortization of goodwill prior to 2002 which arose in
connection with the three acquisitions, additional operating expenses and the
minority interest of other Yuchai shareholders in Yuchais income. Overview The various austerity measures taken by the Chinese government in recent
years to regulate economic growth and control inflation significantly weakened
demand for trucks in China. In particular, austerity measures that restricted
access to credit and slowed the rate of fixed investment (including
infrastructure development) adversely affected demand for, and production of,
trucks and other commercial vehicles. Such market conditions, together with
increased competition in the diesel engine market, resulted in various degrees
of financial and marketing difficulties for diesel engine producers, including
the Company. However, the Chinese government announced in 1998 a major
initiative to boost consumer demand through investments in infrastructure
projects, including the construction of highways and tollways, and also through
increased availability of bank credit. As a result, demand for trucks and other
commercial vehicles, and thus demand for diesel engines has been increasing
annually since 1999. Due to the increased demand for commercial vehicles in China during 2003,
the Companys net sales in 2003 increased by 30% to Rmb 4,570.0 million
compared to Rmb 3,513.0 million in 2002. This increase was primarily a result
of increased unit sales of diesel engines achieved through the Companys
aggressive marketing program. The Company had income before minority interests
of Rmb 583.9 million in 2003 compared to income before minority interests of
Rmb 542.2 million in 2002. The increase in income before minority interests was
primarily due to increase in sales volume. Sales of the 6108 and the 6112
medium-duty and heavy-duty engines accounted for 32.9% and 22.0%, respectively,
of the Companys net sales in 2003. The Company also introduced its new
heavy-duty 6113 engine in 2003, accounting for 0.1% of net sales in 2003. In 2003, the Company continued its efforts to control production costs and
operating expenses. However, a large portion of the Companys costs and
expenses relate to fixed costs incurred in connection with the production of
its diesel engines, which may limit the Companys ability to significantly
reduce its costs and expenses. The Companys cost of goods sold mainly includes
cost of materials consumed, factory overhead, direct labor and depreciation.
The Company analyzes its cost of goods sold based on its cost of manufacturing
for each period. Cost of manufacturing for each period equals cost of goods
sold for the period plus or minus the change in period end finished goods
inventory. In 2003, cost of materials consumed accounted for approximately
82.8% of the cost of manufacturing. The Companys selling, general and
administrative (SG&A) expenses include advertising expenses, provision for
doubtful accounts, salaries and wages, sales commission expenses and a large
number of smaller expenses. In 2003, the Companys SG&A included approximately
Rmb 12.0 million arising from legal and professional fees relating to the legal
and arbitration proceedings instituted by the Company in response to
difficulties encountered by the Company with respect to its investment in
Yuchai. The Company expects that it will continue to incur legal and
professional fees as it seeks to implement the terms of the July 2003
Agreement. The Company had effective income tax rates of (23.7%), 13.3% and 16.2% in
2001, 2002 and 2003, respectively. Yuchai was subject to PRC income tax at a
rate of 24% of its income determined in accordance with PRC GAAP in 1993 prior
to the restructuring. After becoming a Sino-foreign joint stock company, it was
exempt from PRC income tax in 1994 and 1995. Under current laws, Yuchai is
subject to PRC income tax at a rate of 7.5% for each of the  30




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three years from 1996 to 1998 and a rate of 10% for each of the three years
from 1999 to 2001. Since January 1, 2002, Yuchai is subject to tax at a rate of
15% so long as it continues to qualify as a foreign-invested enterprise
eligible for tax reductions under PRC income tax law. In addition to the PRC
income tax, Yuchai has been subject to value-added taxes on its sales since
January 1, 1994. Dividends received by the Company from Yuchai can be remitted
from China without any PRC taxation under current Chinese law. See Item 10.
Additional Information  Taxation  Peoples Republic of China Taxation. The Company commenced trial marketing of its 6112 heavy-duty engine in
early 1999, and began commercial production of these engines during the second
half of 1999. Due to the delay in commercial production of the 6112 engine
until 1999, however, the Company was not able to benefit from the competitive
advantages of an early entry into the domestic market for heavy-duty engines.
Moreover, the market for heavy-duty diesel engines in China is relatively price
sensitive, and customer acceptance of the 6112 engines pricing structure
requires considerable marketing efforts by the Company. Despite the high costs
incurred in the production of the 6112 engine, with more emphasis on promotion
and better customer acceptance, the Company currently has no plans to reduce
the price of the 6112 engine. With increasing customer acceptance of the 6112
engine in late 2001 through 2003, the sales volume of the 6112 engine improved
significantly. However, given the 6112 engines limited horsepower capacity,
there can be no assurance that the Company will be able to continue to compete
successfully in the heavy-duty diesel engine market in China with the existing
producers or any new entrants. The Companys future financial condition and results of operations could
be adversely affected as a result of China becoming a member of the WTO. See
Item 3. Key Information  Risk Factors  Risks relating to Mainland China 
The admission of China into the WTO could lead to increased foreign
competition. Currently, China is encouraging foreign investments into the
motor vehicle engine manufacturing industry. However, the Company believes that
foreign competition as a result of China becoming a member of the WTO is not
currently a major competitive concern because, among other reasons, (i) foreign
diesel engines are not generally price competitive, (ii) foreign producers do
not have the sales and distribution network or service and parts center
infrastructure of Chinese producers and (iii) while Chinas import tariffs on
motor vehicle components may be lowered, China has indicated that it does not
intend to eliminate such tariffs. The Companys future financial condition and results of operations could
also be adversely affected as a result of China macroeconomic policy changes
recently announced by the Chinese Government. The Chinese government has
announced that it is considering introducing measures in certain sectors to
avoid overheating of the economy, including tightening bank lending policies
and increases in bank interest rates. The market demand for diesel engines in
China may be adversely affected by these measures, particularly if diesel
engines are included in any specific economic sectoral caps or attempts to slow
down sectoral lending. See Item 3. Key Information  Risk Factors  Risks
relating to Mainland China  Adverse changes in the economic policies of the
Chinese government could have a material adverse effect on the overall economic
growth of Mainland China, which could reduce the demand for our products and
adversely affect our competitive position and  Risks relating to our Company
and our business  The diesel engine business in China is dependent in large
part on the performance of the Chinese economy, as well as Chinese government
policy. As a result, our business and prospects will be adversely affected by
slowdowns in the Chinese economy, as well as Chinese government policies that
de-emphasize the use of diesel engines. The recent epidemic of SARS, a new and highly-contagious form of atypical
pneumonia, in China had an adverse impact on the sale of engines in 2003. A
number of cases of SARS have also recently been reported in China and elsewhere
in the Asia region, as well as bird flu and other infectious diseases.
Outbreaks of infectious diseases such as these could adversely affect general
commercial activity in affected areas. See Item 3. Key Information  Risk
Factors  Risks relating to Mainland China  Outbreaks of infectious diseases,
such as severe acute respiratory syndrome (SARS) and bird flu, in various parts
of China and other countries may materially and adversely affect our business
and operations, as well as our financial condition and results of operations. 31




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Critical Accounting Policies The preparation of financial statements in accordance with US GAAP and
applicable accounting standards require the Companys management to make
judgments, estimates and assumptions regarding uncertainties that affect the
reported amounts of the Companys assets and liabilities, disclosures of
contingent liabilities and the reported amounts of revenues and expenses.
These judgments, assumptions and estimates are reflected in the Companys
accounting policies, which are more fully described in Note 3 to the
Consolidated Financial Statements appearing elsewhere herein. Certain of the Companys accounting policies are particularly important to
the portrayal of the Companys financial position and results of operations and
require the application of significant assumptions and estimates by the
Companys management. The Company refers to these accounting policies as its
critical accounting policies. The Companys management uses its historical
experience and analyses, the terms of existing contracts, historical cost
convention, industry trends, information provided by its agents and information
available from other outside sources, as appropriate, when forming its
assumptions and estimates. However, this task is inexact because the Companys
management is making assumptions and providing estimates on matters that are
inherently uncertain. On an ongoing basis, management evaluates its estimates.
Actual results may differ from those estimates under different assumptions and
conditions. While the Company believes that all aspects of its financial statements
should be studied and understood in assessing its current expected financial
condition and results, the Company believes that the following critical
accounting policies involve a higher degree of judgment and estimation and
therefore warrant additional attention:  
    
    Allowances for doubtful accounts;
    
    Provision for inventories;
    
    Allowance for product warranty;
    
    Valuation allowance for deferred tax assets;
    
    Impairment of long-lived assets; and
    
    Impairment of goodwill. Allowances for doubtful
accounts Allowance for doubtful accounts is managements best estimate of the
amount of probable credit losses in the Companys existing accounts receivable.
The Company determines the allowance based on historical write-off experience
by industry and national economic data. The Company reviews its allowance for
doubtful accounts monthly. Past due balances over 90 days and over a specified
amount are reviewed individually for collectibility. All other balances are
reviewed on a pooled basis by aging of such balances. Account balances are
charged off against the allowance after all means of collection have been
exhausted and the potential for recovery is considered remote. 32




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Changes in the allowances for doubtful accounts for each of the years in
the three-year period ended December 31, 2003 are summarized as follows: December 31,2001
    
    2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    Rmb
    
    US$Balance at beginning of year
    
    
    201,533
    
    
    
    164,924
    
    
    
    158,075
    
    
    
    19,099Less:Written back to statements
of income
    
    
    (36,609
    )
    
    
    (6,849
    )
    
    
    (493
    )
    
    
    (60
    )Doubtful debts written off
    
    
    
    
    
    
    
    
    
    
    (63,159
    )
    
    
    (7,631
    )Balance at end of year
    
    
    164,924
    
    
    
    158,075
    
    
    
    94,423
    
    
    
    11,408 The Company believes that the present level of its allowance for doubtful
debts adequately reflects probable losses related to impaired accounts
receivable. However, changes in the assumptions used to assess the frequency
and severity of doubtful accounts would have an impact on the Companys
allowance for doubtful debts. If economic or specific industry trends change,
the Company would adjust its allowances for doubtful accounts by recording
additional expense or benefit. Management studies show that a decrease or
increase of
5% in historical write-off experience would increase or decrease the provision
for doubtful accounts by approximately Rmb 26.3 million (US$3.2 million). Provision for inventories The Companys inventories are valued at the lower of cost or net
realizable value at the balance sheet date. Net realizable value represents the
estimated selling price less costs to be incurred in selling the inventories.
Net realizable value is estimated based on the age and market condition of
inventories. If market conditions or future product enhancements and developments
change, the Company would adjust its provision for inventories by recording
additional expense or benefit. Management studies show that a decrease or
increase of 5% in historical charge experience would increase or decrease the
provision for inventories by approximately Rmb 43.9 million (US$5.3 million). Allowance for product warranty The Company provides for estimated future costs to be incurred under a
warranty period or warranty mileage on various engine models, for which it
provides free repair and replacement. Warranties generally extend for a
duration (12 months to 18 months) or mileage (80,000 kilometers to 180,000
kilometers), whichever is the lower. Provisions for warranty are primarily
determined based on historical warranty cost per unit of engines sold adjusted
for specific conditions that may arise and the number of engines under warranty
at each financial year-end. 33




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Changes in the allowances for product warranty for each of the years in
the three-year period ended December 31, 2003 are summarized as follows: December 31,2001
    
    2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    Rmb
    
    US$Balance at beginning of year
    
    
    17,896
    
    
    
    29,699
    
    
    
    66,864
    
    
    
    8,079Allowance charged to income
statement
    
    
    58,582
    
    
    
    127,058
    
    
    
    162,369
    
    
    
    19,618Less: Allowance utilized
    
    
    (46,779
    )
    
    
    (89,893
    )
    
    
    (128,018
    )
    
    
    (15,467
    )Balance at end of year
    
    
    29,699
    
    
    
    66,864
    
    
    
    101,215
    
    
    
    12,230 The Companys estimate of its warranty obligations is evaluated on an
annual basis. In previous years, warranty claims have typically not been
higher than the relevant provisions made in the Companys balance sheet. If
the nature, frequency and average cost of warranty claims change, the Company
would adjust its allowances for product warranty by recording additional
expense or benefit so as to seek to ensure that accruals will be adequate to
meet expected future obligations. Management studies show that a decrease or
increase of 5% in historical claims experience would increase or decrease the
provision for product warranty by approximately Rmb 8.1 million (US$1.0
million). Valuation allowance for deferred
tax assets The Company recognizes deferred tax assets and liabilities for the future
tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carry-forwards. Deferred tax assets are
reduced by a valuation allowance to the extent the Company concludes it is more
likely than not that the assets will not be realized. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to
forecasted taxable income in future years in which those temporary differences
are expected to be recovered or settled. Forecasted taxable income may significantly differ from actual taxable
income in future years, which may result in material adjustment to the
valuation allowance for deferred tax assets. The Company believes that the
forecasted taxable income in future years is appropriate. Based on
managements analysis, no valuation allowance for deferred tax assets is
required at December 31, 2003. Impairment of long-lived assets Long-lived assets have been reviewed for impairment based on Statement of
Financial Accounting Standards (SFAS) No. 144, Accounting for the Impairment
or Disposal of Long-lived Assets. In accordance with SFAS No. 144, long-lived assets, such as property,
plant and equipment, and purchased intangibles subject to amortization, are
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying amount
of an asset to the estimated discounted future cash flows expected to be
generated by the asset. If the carrying amount of an asset exceeds its
estimated future cash flows, an impairment charge is recognized by the amount
by which the carrying amount of the asset exceeds the fair value of the asset. The Company has conducted a review on the conditions of the property,
plant and equipment. In 2003, management identified that certain property,
plant and equipment were no longer used in production due to the introduction
of new environmental regulations in 2003. These changes required an impairment
analysis to be performed in accordance with SFAS No. 144. The estimated
undiscounted future cash flows generated from such property, plant and
equipment were less than their carrying value. The carrying value of such
assets was therefore reduced to estimated fair value. Impairment loss of Rmb
12.4 million (US$1.5 million) has been charged to income statements in 2003. 34




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If the estimates of cash flows and fair value of these long-lived assets
change, management studies show that a 5% variance in historical charge
experience would not have any significant impact to the Companys financial
statements. No other significant impairment existed at December 31, 2003 based on
managements analysis. Prior to the adoption of SFAS No. 144, the Company accounted for
long-lived assets in accordance with SFAS No. 121, Accounting for Impairment
of Long-lived Assets and for Long-lived Assets to be Disposed of. Impairment of goodwill Goodwill represents the excess of costs over fair value of net assets of
businesses acquired. The Company adopted the provisions of SFAS No. 142,
Goodwill and Other Intangible Assets, as of January 1, 2002. Pursuant to
SFAS No. 142, goodwill acquired in a purchase business combination and
determined to have an indefinite useful life is not amortized, but instead is
tested for impairment at least annually in accordance with the provisions of
SFAS No. 142. In connection with SFAS No. 142s transitional goodwill impairment
evaluation, the Company performed an assessment of whether there was an
indication that goodwill is impaired as of the date of adoption. To accomplish
this, the Company identified its single reporting unit, which is Yuchai and
determined the carrying value of the reporting unit by assigning the assets and
liabilities, including the existing goodwill, to this reporting unit as of
January 1, 2002. The Company determined the fair value of the reporting unit
and compared it to the carrying amount of the reporting unit. The fair value
of the reporting unit exceeded its carrying amount as of January 1, 2002.
However, under the circumstance that the carrying amount of a reporting unit
exceeded the fair value of the reporting unit, the Company would be required to
perform a second step of the transitional impairment test, as this is an
indication that the reporting units goodwill may be impaired. In this step,
the Company would compare the implied fair value of the reporting units
goodwill with the carrying amount of the reporting units goodwill. The
implied fair value of goodwill is determined by allocating the fair value of
the reporting unit to all of the assets (recognized and unrecognized) and
liabilities of the reporting unit in a manner similar to a purchase price
allocation, in accordance with SFAS No. 141, Business Combinations. The
residual fair value after this allocation is the implied fair value of the
reporting units goodwill. Determining the fair value of a reporting unit under the first step of the
goodwill impairment test and determining the fair value of individual assets
and liabilities of a reporting unit under the second step of the goodwill
impairment test is judgmental in nature and often involves the use of
significant estimates and assumptions. These estimates and assumptions could
significantly impact whether or not an impairment charge is recognized as well
as the magnitude of any such charge. In its impairment review, we perform
internal valuation analyses and consider other market information that is
publicly available. Estimates of fair value are primarily determined using
projected future cash flows, the timing of such cash flows, discount rates
reflecting the risk inherent in determination of whether a premium or discount
should be applied to comparables. Based on managements analysis, no
impairment existed at December 31, 2003. The Company believes that the estimates of future cash flows and fair
value are reasonable; however, changes in estimates resulting in lower future
cash flows and fair value due to unforeseen changes in business assumptions
could negatively affect the valuations, which may result in the Company
recognizing impairment charges for goodwill in the future. Management studies
show that a decrease of 5% in the fair value of the reporting unit would not
have resulted in a material impairment charge. 35




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##### Table of Contents



Results of Operations The following table sets forth the percentages of net sales of certain
income and expense items of Yuchai for the last three fiscal years ended
December 31, 2001, 2002 and 2003, respectively: Percentage of Net SalesYear Ended December 31,2001
    
    2002
    
    2003Net sales
    
    
    100.0
    %
    
    
    100
    %
    
    
    100
    %Cost of goods sold
    
    
    66.4
    
    
    
    67.5
    
    
    
    69.9Gross profit
    
    
    33.6
    
    
    
    32.5
    
    
    
    30.1Research and development costs
    
    
    2.5
    
    
    
    2.2
    
    
    
    2.1Selling, general and administrative expenses
    
    
    13.6
    
    
    
    12.1
    
    
    
    12.3Amortization of goodwill
    
    
    0.9
    
    
    
    
    
    
    
    Operating income
    
    
    16.5
    
    
    
    18.2
    
    
    
    15.8Interest expense
    
    
    1.7
    
    
    
    0.7
    
    
    
    0.5Other (income), net
    
    
    (0.2
    )
    
    
    (0.3
    )
    
    
    0.0Income before income taxes and minority interests
    
    
    15.0
    
    
    
    17.8
    
    
    
    15.2Income tax
(benefits)/expenses
    
    
    (3.6
    )
    
    
    2.4
    
    
    
    2.5Income before minority interests
    
    
    18.6
    
    
    
    15.4
    
    
    
    12.8Minority interests in income of consolidated subsidiaries
    
    
    4.6
    
    
    
    3.7
    
    
    
    3.2Net income
    
    
    14.0
    %
    
    
    11.7
    %
    
    
    9.6
    %
 2003 Compared to 2002 Net sales increased by 30.0% to Rmb 4,570.0 million (US$552.1 million) in
2003 compared to Rmb 3,513.0 million in 2002. The increase in net sales was
primarily due to higher sales volume due to more aggressive marketing programs.
Unit sales of diesel engines increased by 32.1% to 172,219 units in 2003 from
130,384 units in 2002. Cost of goods sold increased by 34.7% to Rmb 3,192.8 million (US$385.8
million) in 2003 from Rmb 2,371.1 million in 2002, and increased as a
percentage of net sales to 69.9% in 2003 from 67.5% in 2002. Cost of
manufacturing increased by 24.4% to Rmb 2,993.7 million (US$361.7 million) in
2003 from Rmb 2,407.3 million in 2002, while cost of manufacturing as a
percentage of net sales decreased to 65.5% from 68.5% in 2002. The 6112
heavy-duty engines have a higher cost of manufacturing as their components
include imported parts that are relatively more expensive. Cost of materials
consumed in costs of manufacturing increased by 25.9% to Rmb 2,479.9 million
(US$299.6 million) in 2003 from Rmb 1,969.1 million in 2002
(due to higher production throughput during 2003), while cost of
materials consumed as a percentage of net sales decreased to 54.3% in 2003 from
56.1% in 2002. Factory overhead (which does not include depreciation and
salaries) included in cost of manufacturing increased by 30.5% to Rmb 191.9
million (US$23.2 million) in 2003 from Rmb 147.1 million in
2002, due to higher variable factory expenses (such as utilities)
arising from higher diesel engine production in 2003. Factory
overhead as a percentage of net sales remained fairly stable at 4.2% for both
2003 and 2002. Depreciation included in cost of manufacturing decreased to Rmb
88.7 million (US$10.7 million) from Rmb 84.7 million in 2002. Depreciation as a
percentage of net sales decreased to 1.9% in 2003 from 2.4% in 2002. 36




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Gross profit increased by 20.6% to Rmb 1,377.2 million (US$166.4 million)
in 2003 from Rmb 1,142.0 million in 2002. Gross profit margin (gross profit
divided by net sales) decreased to 30.1% in 2003 compared to 32.5% in 2002,
reflecting a shift in the sales mix whereby the gross margin for the 4-Series
and industrial engines were lower than margins historically achieved for both
medium and heavy-duty engines. SG&A expenses (excluding research and development) increased by 31.7% to
Rmb 561.2 million (US$67.8 million) in 2003 from Rmb 426.1 million in 2002 and
increased as a percentage of net sales from 12.1% in 2002 to 12.3% in 2003.
This increase in SG&A was primarily due to the increase in sales and costs
arising from legal and professional fees incurred in connection with the legal
and arbitration proceedings instituted by the Company in 2003. Research and
development expenses increased to Rmb 94.6 million (US$11.4 million) in 2003
from Rmb 75.5 million in 2002. Such increased expenses were primarily due to
the development of the 6113 engine and Euro 2 compliance. Advertising expenses
included in SG&A increased by 28.5% to Rmb 41.0 million (US$4.9 million) in
2003 from Rmb 31.9 million in 2002. Advertising expenses as a percentage of net
sales decreased to 0.90% in 2003 from 0.91% in 2002. Sales commission expenses
included in SG&A expenses decreased by 5.6% to Rmb 16.7 million (US$2.0
million) in 2003 from Rmb 17.7 million in 2002. Sales commission expenses as a
percentage of net sales decreased to 0.4% in 2003 from 0.5% in 2002. The
decreases in advertising and sales commission expenses reflected primarily
lower costs incurred for the promotion of the 6112 and 4-Series engines in
2002 and the change in Yuchais promotion strategies by offering
lower selling prices to customers rather than through sales
commission paid to its sales agents. Salaries and wages as a percentage of net sales increased to 7.5% in 2003
compared to 6.5% in 2002, due primarily to an increase in production.
Amortization of goodwill was Rmb Nil in 2003 and 2002. As a result of the foregoing, profits from operations increased to Rmb
721.4 million (US$87.2 million) in 2003 compared to Rmb 640.3 million in 2002. Interest expenses decreased by 6% to Rmb 23.6 million (US$2.9 million) in
2003 from Rmb 25.1 million in 2002, primarily due to the repayment of loans
during the year. Income before income taxes and minority interests in 2003 was Rmb 696.9
million (US$84.2 million), as compared to Rmb 625.5 million in 2002. Income tax
expenses in 2003 was Rmb 112.9 million (US$13.6 million) compared to income tax
credit of Rmb 83.2 million in 2002. Yuchai was subject to PRC income tax at a
rate of 10% in 2000 and 2001, 15% in 2002 and 15% in 2003. As a result of the foregoing factors, the Company had income before
minority interests of Rmb 584.0 million (US$70.6 million) in 2003 compared to
Rmb 542.2 million in 2002, and net income of Rmb 438.2 million (US$52.9
million) in 2003 compared to Rmb 412.4 million in 2002. In light of the market conditions for diesel engines currently prevailing
in China, the Company has continued to implement measures to control production
costs and operating expenses. The Company has also continued to implement
measures to monitor its customers receivable balances and to control credit
risks. There can be no assurance that such measures will be sufficient to
improve the Companys financial condition and results of operations. See
Cautionary Statements with respect to Forward-Looking Statements. 2002 Compared to 2001 Net sales increased by 97.0% to Rmb 3,513.0 million (US$424.4 million) in
2002 compared to Rmb 1,783.3 million in 2001. The increase in net sales was
primarily due to higher sales volume due to more aggressive marketing programs.
Unit sales of diesel engines increased by 75.7% to 130,384 units in 2002 from
74,214 units in 2001. Cost of goods sold increased by 100.4% to Rmb 2,371.1 million (US$286.5
million) in 2002 from Rmb 1,183.4 million in 2001, and increased as a
percentage of net sales to 67.5% in 2002 from 66.4% in 2001. Cost of
manufacturing increased by 78.4% to Rmb 2,407.3 million (US$290.9 million) in
2002 from Rmb 1,349.4 million in 2001, while cost of manufacturing as a
percentage of net sales decreased to 68.5% from 75.7% in 2001. This percentage
increase was primarily attributable to the higher number of 6112 heavy-duty
engines sold. The 6112 heavy-duty engines have a higher cost of manufacturing
as their components include imported parts that are 37




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##### Table of Contents



relatively more expensive. Cost of materials consumed in costs of manufacturing
increased by 88.4% to Rmb 1,969.1 million (US$237.9 million) in 2002 from Rmb
1,045.4 million in 2001, while cost of materials consumed as a percentage of
net sales decreased to 56.1% in 2002 from 58.6% in 2001. Factory overhead
(which does not include depreciation and salaries) included in cost of
manufacturing increased by 32.0% to Rmb 147.1 million (US$17.8 million) in 2002
from Rmb 111.4 million in 2001, while factory overhead as a percentage of net
sales decreased to 4.2% in 2002 from 6.3% in 2001. Depreciation included in
cost of manufacturing increased to Rmb 84.7 million (US$10.2 million) from Rmb
91.6 million in 2001. Depreciation as a percentage of net sales decreased to
2.4% in 2002 from 5.1% in 2001. Gross profit increased by 90.4% to Rmb 1,142.0 million (US$137.9 million)
in 2002 from Rmb 599.9 million in 2001. Gross profit margin (gross profit
divided by net sales) decreased to 32.5% in 2002 compared to 33.6% in 2001,
reflecting a shift in the sales mix. In 2002, the Company sold more 6112
engines and 4-Series engines, where the margin is lower. SG&A expenses (excluding research and development) increased by 75.2% to
Rmb 426.1 million (US$51.5 million) in 2002 from Rmb 243.2 million in 2001 and
decreased as a percentage of net sales from 13.6% in 2001 to 12.1% in 2002.
This increase in SG&A was primarily due to the increase in sales. Research and
development expenses increased to Rmb 75.5 million (US$9.1 million) in 2002
from Rmb 44.7 million in 2001. Such increased expenses were primarily due to
the development of the 6113 engine and Euro 2 compliance. Advertising expenses
included in SG&A increased by 79.2% to Rmb 31.9 million (US$3.9 million) in
2002 from Rmb 17.8 million in 2001. Advertising expenses as a percentage of net
sales decreased to 0.9% in 2002 from 1.0% in 2001. Sales commission expenses
included in SG&A expenses increased by 40.5% to Rmb 17.7 million (US$2.1
million) in 2002 from Rmb 12.6 million in 2001. Sales commission expenses as a
percentage of net sales decreased to 0.5% in 2002 from 0.7% in 2001. The
decreases in advertising and sales commission expenses reflected primarily
lower costs incurred for the promotion of the 6112 and 4-Series engines in
2001. Salaries and wages as a percentage of net sales increased to 2.6% in 2002
compared to 2.2% in 2001, due primarily to an increase in production.
Amortization of goodwill was nil in 2002 and Rmb 16.9 million in 2001. As a result of the foregoing, profits from operations increased to Rmb
640.3 million (US$77.4 million) in 2002 compared to Rmb 295.1 million in 2001. Interest expenses decreased by 15.6% to Rmb 25.1 million (US$3.0 million)
in 2002 from Rmb 29.8 million in 2001, primarily due to the decrease in
interest rate during the year. Income before income taxes and minority interests in 2002 was Rmb 625.5
million (US$75.7 million), as compared to Rmb 269.2 million in 2001. Income tax
expenses in 2002 was Rmb 83.2 million (US$10.1 million) compared to income tax
credit of Rmb 63.6 million in 2001. The income tax credit in 2001 was primarily
due to the release of valuation allowance against deferred tax assets. The
Company believes that, having considered the expected future taxable profits of
Yuchai, it is more likely than not that the deferred tax assets will be
recoverable. See  Critical Accounting Policies. Yuchai was subject to PRC
income tax at a rate of 10% in 2000 and 2001, and 15% in 2002. As a result of the foregoing factors, the Company had income before
minority interests of Rmb 542.2 million (US$65.5 million) in 2002 compared to
Rmb 332.8 million in 2001, and net income of Rmb 412.4 million (US$49.8
million) in 2002 compared to Rmb 250.4 million in 2001. In light of the competitive market conditions for diesel engines currently
prevailing in China, the Company has continued to implement measures to control
production costs and operating expenses. The Company has also continued to
implement measures to monitor its customers receivable balances and to control
credit risks. There can be no assurance that such measures will be sufficient
to improve the Companys financial condition and results of operations. See
Cautionary Statements with respect to Forward-Looking Statements. 38




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##### Table of Contents



Inflation The general annual inflation rate in China was approximately 0.1%, (0.1)%
and 1.2% in 2001, 2002 and 2003, respectively. The Companys results of
operations may be affected by inflation, particularly rising prices for parts
and components, labor costs and other operating costs. Foreign Currency Fluctuations The Company is exposed to foreign currency risk as a result of having to
obtain certain key components used in the manufacturing of the 6112 engines
from overseas suppliers. As of December 31, 2003, the Company did not have any
loans denominated in a foreign currency. See Item 3. Key Information  Risk
Factors. Liquidity and Capital Resources The Companys primary sources of cash are funds from operations generated
by Yuchai and debt financing incurred by Yuchai. The Companys operations
provided cash in 2002 and 2003. In 2003, the Companys primary cash
requirements were for working capital to finance accounts receivable,
inventories and capital expenditures to complete the expansion of production
capacity. The Company believes that its working capital is sufficient for its
requirements over the next year. Factors which may affect the Companys ability
to generate funds from operations include increased competition (including as a
result of Chinas admission to the WTO), fluctuations in customer demand for
the Companys products, the status of the Companys investment in Yuchai under
Chinese law, and the Companys ability to collect and control its level of
accounts receivable. If the Company is considered on a stand-alone basis without taking into
account the financial contribution of Yuchai to the Company by way of
dividends, the Company would have approximately US$15.7 million in cash, which
the Company considers would be sufficient to meet the Companys operational
requirements at least for the next year. Such requirements would likely be
related to employee expenses and professional expenses incurred in the running
of the Company as a holding company, including meeting its SEC disclosure and
NYSE listing obligations. The Company believes that if the Company is
considered on a stand alone basis without its investment in Yuchai, the Company
would find it difficult to raise new capital (either debt or equity) on its
own. In 2003, the Company had net cash inflow from operating activities of Rmb
1,075.3 million, compared to net cash inflow from operating activities of Rmb
659.5 million in 2002. This increase in operating cash inflow was primarily due
to an increase in sales and profit in 2003. The following table summarizes the key elements of the Companys cash
flows for the last three years: Years ended December 31,2001
    
    2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    Rmb
    
    US$(in thousands)Net cash provided by operating
activities
    
    
    59,273
    
    
    
    659,500
    
    
    
    1,075,274
    
    
    
    129,916Net cash used in investing activities
    
    
    (42,682
    )
    
    
    (174,164
    )
    
    
    (372,373
    )
    
    
    (44,990
    )Net cash provided by (used in)
financing activities
    
    
    (25,077
    )
    
    
    (251,329
    )
    
    
    (714,163
    )
    
    
    (86,286
    )Net (decrease)/increase in cash and
cash equivalents
    
    
    (8,486
    )
    
    
    234,007
    
    
    
    (11,262
    )
    
    
    (1,360
    ) 39




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##### Table of Contents



Net cash provided by operating activities increased Rmb 415.8 million in
2003. This increase was principally caused by a decrease in trade accounts
receivable of Rmb 382.9 million, due to aggressive collection programs
undertaken by Yuchais sales personnel prior to the 2003 year end. The
extraordinary decrease in trade accounts receivable experienced in 2003 may not
recur in future years. In addition, the increase in net cash provided by
operating activities in 2003 was also partly attributable to a decrease in
prepaid expenses of Rmb 64.7 million due primarily to reduced advance payments
made to suppliers in respect of raw material purchasers. In addition, there
was an increase in trade accounts payable in 2003 of Rmb 103.1 million arising
from increased business activities from higher production. Net cash used in
investing activities increased Rmb 198.2 million in 2003, principally because
of amounts spent for purchases of property, plant and equipment, lease
prepayments and construction in progress increased by Rmb 197.9 million in 2003
due to additional capital expenditure mainly related to the second foundry
project and new heavy duty 6113 engine production. Net cash used in financing
activities increased by Rmb 462.8 million in 2003, principally due to an
increase of Rmb 549.8 million in dividends paid to shareholders, partially
offset by proceeds from bank financing. Cash provided by continuing operations is a major source of the Companys
working capital funding. Other than with respect to the application of cash
generated from operations for capital expenditure and dividend payments (see
Item 3. Item 8. Financial Information  Policy on Dividend Distributions),
the Company does not have a formal cash management policy. The Company expects that cash generated from operations and credit
collection arrangements should provide the Company with sufficient financial
flexibility to satisfy future bank obligations, capital expenditure and
projected working capital requirements. However, at certain times cash
generated from operations is subject to seasonal fluctuations. As a result,
the Company may use periodic borrowings to supplement its working capital
requirements. In the event that cash provided by operations is not at that
point in time sufficient for the Companys business purposes, the Company has
available to it a line of credit established by Yuchai with domestic Chinese
banks, up to Rmb 450.0 million in principal amount. The interest rate
applicable to amounts borrowed under the line of credit is between 4.98% and
5.94%. As at December 31, 2003, Rmb 290.0 million had been utilized under that
line of credit, and the remaining Rmb 160.0 million was available for future
drawdown. The Companys working capital as of December 31, 2003 was Rmb 962.8
million compared to Rmb 1,340.8 million as of December 31, 2002. The decrease
in working capital was primarily due to an increase in trade accounts payable
and a reduction in trade accounts receivable as a result of better debtors
collections and increases in trade accounts payable arising from higher
business volume in trade accounts payable. The Companys total liabilities
increased by 12.1% to Rmb 1,497.4 million from Rmb 1,336.1 million, primarily
as a result of higher accounts payable due to higher volume of purchase of raw
materials and components to meet expected higher sales in 2004. As of December
31, 2003, the Company had long-term debt, including current installments,
totaling Rmb 50.0 million, of which Rmb 50.0 million will mature in 2004. The
Company had short term debt totaling Rmb 248.0 million as of December 31, 2003. The Companys capital expenditures were Rmb 372.8 million in 2003, Rmb
174.9 million in 2002 and Rmb 43.0 million in 2001. As of December 31, 2003,
the Company had authorized and contracted for capital expenditure for
improvement to existing production facilities in the amount of Rmb 66.8
million. As the Companys business continues to grow, it will also require
additional funds for increased working capital requirements, including to
finance increased accounts receivable. The Company expects to fund its capital
expenditures and working capital requirements primarily from funds from
operations generated by Yuchai and, to the extent that is insufficient, from
bank loans incurred by Yuchai. Yuchais ability to obtain financing is limited
by government regulation and a general shortage of debt and equity financing in
China. Any additional capital contribution by the Company to 40




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##### Table of Contents



Yuchai would require, among other things, the approval of the MOC, which has
broad discretion with respect to such approval. As part of its business strategy, the Company seeks opportunities to
invest through Yuchai in domestic manufacturers of diesel engine parts and
components. The Company may also acquire indirectly through Yuchai interests in
other related automotive businesses, including truck manufacturers. The Company
may make such investments and acquisitions with funds provided by operations,
future debt or equity financings or a combination thereof. The following table sets forth information on the Companys material
contractual obligation payments for the periods indicated as of December 31,
2003: Payments Due by PeriodLess than
    
    
    
    
    
    
    
    
    
    More thanContractual Obligations
    
    Total
    
    1 Year
    
    1-3 Years
    
    4-5 Years
    
    5 Years(in Rmb millions)Short-Term Debt
    
    
    240
    
    
    
    240
    
    
    
    
    
    
    
    
    
    
    
    Long-Term Debt
    
    
    50
    
    
    
    50
    
    
    
    
    
    
    
    
    
    
    
    Equipment
    
    
    0
    
    
    
    0
    
    
    
    
    
    
    
    
    
    
    
    Purchase Obligations
    
    
    84
    
    
    
    84
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    374
    
    
    
    374
    
    
    
    
    
    
    
    
    
    
    
    
 The following table sets forth information on the Companys other
commercial commitments for the periods indicated as of December 31, 2003: Amount of CommitmentExpiration Per PeriodTotalOther Commercial
    
    Amounts
    
    Less thanCommitments
    
    Committed
    
    1 Year
    
    1-3 Years
    
    4-5 Years
    
    Over 5 years(in Rmb millions)Line of Credit
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
 Off-Balance Sheet Arrangements Outstanding bills discounted As of December 31, 2002 and 2003, outstanding bills discounted with banks
for which the Company has retained a recourse obligation totaled Rmb 193.1
million and Rmb 729.6 million (US$88.1 million), respectively. Outstanding letter of credits As of December 31, 2002 and 2003, the irrevocable letter of credits
outstanding in the Companys books amounted to Rmb 81.4 million and Rmb 172.0
million (US$20.8 million), respectively. Except
for the above off-balance sheet arrangements, the Company has no
other outstanding derivative financial instruments, off-balance sheet
arrangements or guarantees. 41




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##### Table of Contents



Recently Issued Accounting Standards Financial Accounting Standards Board (FASB) Interpretation No. (FIN) 46
(revised) In December 2003, the FASB issued FIN 46 (revised December 2003).
Consolidation of Variable Interest Entities, which addresses how a business
enterprise should evaluate whether it has a controlling financial interest in
an entity through means other than voting rights and accordingly should
consolidate the entity. FIN 46R replaces FIN 46, Consolidation of Variable
Interest Entities, which was issued in January 2003. The Company will be
required to apply FIN 46R to variable interests in Variable Interest Entities
(VIEs) created after December 31, 2003. For variable interests in VIEs
created before January 1, 2004, the interpretation will be applied beginning on
January 1, 2005. For any VIEs that must be consolidated under FIN 46R that were
created before January 1, 2004, the assets, liabilities and non-controlling
interests of the VIE initially would be measured at their carrying amounts with
any difference between the net amount added to the balance sheet and any
previously recognized interest being recognized as the cumulative effect of an
accounting change. If determining the carrying amounts is not practicable, fair
value at the date Fin 46R first applies may be used to measure the assets,
liabilities and non-controlling interest of the VIE. While the Company has evaluated the impact of applying FIN 46R, the
Company does not believe it has an interest in any VIEs that are within the
scope of this statement. Therefore, the application of this interpretation did
not have a material effect on the Companys consolidated financial statements. Statement of Financial Accounting Standards (SFAS) No. 150 In May 2003, the FASB issued SFAS No. 150 Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity.
This statement establishes standards for the classification and measurement of
certain financial instruments with characteristics of both liabilities and
equity. The statement also includes required disclosures for financial
instruments within its scope. The statement was generally effective for
instruments entered into or modified after May 31, 2003 and otherwise will be
effective as of January 1, 2004, except for mandatorily redeemable financial
instruments. For certain mandatorily redeemable financial instruments, the
statement will be effective for the Company on January 1, 2005. The effective
date has been deferred indefinitely for certain other types of mandatorily
redeemable financial instruments. The Company currently does not have any
financial instruments that are within the scope of this statement. Research and Development The Company has committed substantial resources to continually improve the
technology of its products. The Companys internal development effort focuses
primarily on improving manufacturing processes and adapting foreign technology
to the Chinese market. In addition, the Company plans to continue to acquire
advanced technology from Chinese research institutes, foreign engine design
consulting firms and foreign diesel engine and engine parts manufacturers. As
of December 31, 2003, the Company employed over 1,350 engineers,
approximately 274 of whom were devoted to research and development, product
enhancement and new designs. In 2001, 2002 and 2003, the Company spent
approximately Rmb 44.7 million, Rmb 75.5 million and Rmb 94.6 million,
respectively, on research and development. The Company has been able to control
research and development expenses due to the relatively low salary levels of
engineers in China. 
 ITEM 6.  DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES. Directors and Senior
Management of the Company The Board of Directors of the Company consists of eleven members.
Currently, there are eight members elected to and serving on the Companys
Board of Directors, with three vacancies. Pursuant to the Shareholders
Agreement (as defined in Item 7. Major Shareholders and Related Party
Transactions  Related Party Transactions  Shareholders Agreement), HLA is
entitled to designate six directors and Cathay is entitled to designate one
director. Until October 2002, China Everbright was entitled to designate two
directors; however, upon the sale of all 42




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of its shares in the Company held through Coomber in October 2002, China
Everbrights designation rights were terminated. In accordance with the
Shareholders Agreement, the Chief Executive Officer of Yuchai is also a member
of the Companys Board of Directors. HLA has designated Messrs. Wrixon Frank
Gasteen, Gan Khai Choon, Gao Jia Lin, Kwek Leng Peck, Wong Hong Ren and Philip
Ting Sii Tien as its directors. The directors and executive officers of the Company as of June 15, 2004
are identified below. Year First Elected orAppointed DirectorName
    
    Position
    
    or OfficerWrixon Frank GASTEEN(1)(4)
    
    President and Director
    
    
    2002GAO Jia Lin(1)(4)
    
    Vice President and Director
    
    
    1995GAN Khai Choon
    
    Director
    
    
    1995Raymond C. K. HO(2)(4)
    
    Director
    
    
    2004
    (5)KWEK Leng Peck(3)
    
    Director
    
    
    1994LIU Chee Ming(2)
    
    Director
    
    
    2004
    (5)WONG Hong Ren(1)(3)(4)
    
    Director
    
    
    1994Philip TING Sii Tien(2)
    
    Director and Chief Financial Officer
    
    
    1994
    (6)Sheila MURUGASU
    
    General Counsel
    
    
    2003Ira Stuart OUTERBRIDGE III
    
    Secretary
    
    
    2001
   (1)
    
    Also a director of Yuchai.(2)
    
    Member of the Audit Committee.(3)
    
    Member of the Compensation Committee.(4)
    
    Member of the Special Committee.(5)
    
    Appointed on May 28, 2004 to fill casual vacancy until next annual general meeting of shareholders.(6)
    
    Appointed as director in 2004. Mr. Wrixon Frank Gasteen is the President of the Company and a Director of
Yuchai. He is also the Chief Executive Officer and a director of HLA, as well
as a director of Xinfei-Electric and various building materials companies
within the Hong Leong Group. Prior to joining the Hong Leong Group, Mr. Gasteen
was the executive director of Quantum Explosives Pte. Ltd. Mr. Gasteen served
as principal consultant to Kerrix Consulting from 1998 to 1999, managing
director of The Brandnam Group from 1993 to 1998, business development manager
of CSR Limited from 1992 to 1993 and divisional manager of CSR Humes Pty
Limited from 1989 to 1992. Mr. Gasteen has managed businesses in manufacturing,
building and construction materials, mining and service industries. Mr. Gasteen
holds a bachelor of engineering (honors) degree from the University of
Queensland and a master of business administration (with distinction) from the
University of Geneva. Mr. Gasteen recently announced his intention to resign
as the Chief Executive Officer of HLA effective September 30, 2004 and to
remain a director of HLA thereafter. Mr. Gasteen has indicated to the Company
that he intends to remain as President of the Company until at least December
31, 2004. Mr. Gao Jia Lin is the Vice-President and a Director of the Company and
Deputy Chairman and a Director of Yuchai. He has a mechanical engineering
degree from Qinghua University, and joined Hong Leong (China) Limited in 1982.
He is currently the Group Business Development Manager of Yuchai. Mr. Gan Khai Choon is a Director of the Company. He is currently the
managing director of Hong Leong International (Hong Kong) Limited. He holds a
bachelors degree (economics honors) from the University of Malaya. Mr. Raymond C. K. Ho is a partner of Fred Kan & Co., a Hong Kong based law
firm. He has been in private practice as a solicitor since 1983 in Hong Kong,
Mainland China and Vancouver. He has held various public service 43




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positions with the Law Society of Hong Kong, Hong Kong Trade Development
Council and Hong Kong International Arbitration Centre. He is also currently
the Chairman of the Mainland Legal Affairs Committee of the Law Society of Hong
Kong. During 2004, Fred Kan & Co. rendered legal advice to the Company in
connection with the implementation of the July 2003 Agreement, for which CYI
paid approximately US$30,000. The Companys Board of Directors has determined
that Mr. Ho is independent within the meaning of NYSEs recently adopted
corporate governance standards, on the basis that the amount paid for the legal
services provided by Fred Kan & Co is not material to either the Company or
Fred Kan & Co and that the Company has no other relationship, direct or
indirect, which is material with Mr. Ho. Mr. Kwek Leng Peck is a Director of the Company. Mr. Kwek is a member of
the Kwek family, which controls the Hong Leong Group. Mr. Kwek serves as
Executive Director of the Hong Leong Group, and has over 23 years of experience
in trading, manufacturing, property investment and development, hotel
operations, corporate finance and management. Mr. Kwek holds directorships on
the boards of several Hong Leong Group companies, including HLA, City
Developments Limited, HLC, Hong Leong Finance Limited, Hong Leong Foundation,
Hong Leong Holdings Limited and CDL Hotels International Limited. Mr. Liu Chee Ming is the Managing Director of Platinum Holdings Company
Limited, an Asian-focused integrated financial services group. Between 1976
and 1995, he held various positions with companies in the Jardine Fleming
group, including as head of investment banking and a member of the executive
committee of Jardine Fleming Holdings Limited between 1988 and 1995. He is
also currently a member of the Takeovers Appeal Committee and Takeovers Panel
of the Hong Kong Securities and Futures Commission. The Companys Board of
Directors has determined that Mr. Liu is independent within the meaning of
NYSEs recently adopted corporate governance standards, on the basis that the
Company has no material relationship with Mr. Liu. Mr. Wong Hong Ren has been a Director of the Company since 1994. He has
also been a Director of Yuchai since 1993. Since 1988, he has served as Group
Investment Manager of Hong Leong Management Services Pte. Ltd. in Singapore.
Prior to his joining the Hong Leong Group in January 1988, Mr. Wong was
Director and General Manager (Investment and Property) of Haw Par Brothers
International Ltd. and Director of Investment with Royal Trust Asset Management
Pte. Ltd. and First Capital Corporation Ltd., where he was actively involved in
management of the companies funds in international equities. Mr. Philip Ting Sii Tien has been the Chief Financial Officer of the
Company since 1994 and became a Director in February 2004. He was appointed
Chief Financial Officer of HLA in 1994. In 2001, he became the Group Chief
Financial Officer for the HLA group of companies. Prior to joining HLA, from
1993 to 1994, Mr. Ting served as Regional Controller of Quantum Asia Pacific,
Singapore, a leading disk drive manufacturer. Mr. Ting served as Regional
Controller of Black & Decker Asia Pacific Pte. Ltd. (Singapore) from 1990 to
1993 and as Controller of Deutsche Bank (Singapore) from 1987 to 1989. Mr. Ting
is an Associate Member of the Institute of Chartered Accountants in England and
Wales. Ms. Sheila Murugasu is the Group Counsel of the Company. Ms. Murugasu has
been the Group Legal Counsel for the HLA group of companies since 1996. Ms.
Murugasu is a qualified Singapore lawyer, and prior to joining HLA, was in
private legal practice in Singapore. Mr. Ira Stuart Outerbridge III is the Secretary of the Company. Mr.
Outerbridge is a graduate of the University of North Carolina at Chapel Hill
and is a fellow of the Institute of Chartered Secretaries and Administrators.
He joined Codan Services Limited as a Corporate Manager in February 1996. Audit Committee The members of the Audit Committee are Messrs. Liu Chee Ming, Raymond C.
K. Ho and Philip Ting Sii Tien. The Audit Committee oversees the actions of the
Companys independent public accountants and reviews the Companys internal
accounting procedures. Although not considered independent pursuant to SEC
rules relating to audit committees, the Board has designated Mr. Philip Ting Sii Tien as the Companys Audit
Committee Financial Expert. Mr Raymond Ho is also not considered
independent pursuant to SEC rules relating to audit committees. Although the Company does not currently have an
audit committee which meets all of the requirements of the Sarbanes-Oxley 44




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Act and related SEC rules, the Company is taking steps towards meeting such
requirements by the required compliance date of July 31, 2005. Compensation Committee The members of the Compensation Committee are Messrs. Kwek Leng Peck and
Wong Hong Ren. The Compensation Committee reviews and approves executive
appointments and remuneration, and administers the Companys employee benefit
plans, including the Companys Stock Option Plan. See  Share Ownership 
Stock Option Plan for further details. Special Committee The members of the Special Committee are Messrs. Wrixon Frank Gasteen,
Wong Hong Ren, Raymond C.K. Ho and Gao Jia Lin. The Special Committee was
established in 2003 in response to the difficulties which the Company faced
with respect to its investment in Yuchai, and is not a permanent committee of
the Companys Board of Directors. Steps taken by the Special Committee included
instituting legal and arbitration proceedings against the Chinese shareholders
of Yuchai in May 2003, and subsequently discontinuing these proceedings
following an agreement which CYI entered into with Yuchai in July 2003. The
Special Committees mandate has subsequently been further expanded to address
issues relating to the implementation of the July 2003 Agreement, as well as to
review and resolve any difficulties which CYI may experience in obtaining the
cooperation of the Chinese shareholders of Yuchai in the management and
operation of Yuchai, including if necessary the commencement of litigation
and/or arbitration. See also Item 8. Financial Information  Legal
Proceedings. Directors and Executive Officers of Yuchai The Board of Directors of Yuchai consists of thirteen members. Currently,
there are nine members elected to and serving on Yuchais Board of Directors,
with four vacancies. Yuchais Articles of Association entitle the Company (as
the indirect holder of the Foreign Shares) to designate nine directors and
entitle the Chinese shareholders to designate four directors. Pursuant to and
subject to the conditions in the Shareholders Agreement described under Item
7. Major Shareholders and Related Party Transactions, and by virtue of the
Special Share, HLA is entitled to designate six of the nine Yuchai directors
designated by the Company, and Cathay is entitled to designate one such
director. Until October 2002, China Everbright was entitled to designate the
other two directors; however, upon the sale of all of its shares in the Company
in October 2002, China Everbrights designation rights were terminated.
Pursuant to the agreement reached with Yuchai and its related parties in July
2003, as described under Item 8. Financial Information  Legal Proceedings,
the Company designated Messrs. Gao Jia Lin, Wong Hong Ren, Wrixon Frank
Gasteen, Paul Wolansky, Qin Xiao Cong, Yuan Xu Cheng and Hermann Leung as
Yuchais directors; Messrs. Paul Wolansky and Hermann Leung who were nominee
directors of Cathay resigned from the Board of Yuchai in January 2004 following
Cathays disposal of its investment in the Company. Pursuant to the
Shareholders Agreement and the Bye-laws of the Company, the Yuchai directors
designated by the Company will vote as a block in accordance with the vote of
the majority of such directors. The directors and executive officers of Yuchai as of June 15, 2004 are
identified below. Year First Elected orAppointed DirectorName
    
    Position
    
    or OfficerWANG Jianming
    
    Chairman of the Board of Directors and
Chief Executive Officer
    
    
    1993GAO Jia Lin(1)
    
    Deputy Chairman of the Board of Directors
    
    
    1995Wrixon Frank GASTEEN(1)
    
    Director
    
    
    2001WONG Hong Ren(1)
    
    Director
    
    
    1993LI Tiansheng
    
    General Manager and Director
    
    
    2001ZENG Shiqiang
    
    Director
    
    
    1998
 45




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##### Table of Contents

'

Year First Elected orAppointed DirectorName
    
    Position
    
    or OfficerSHAO Qihui
    
    Director
    
    
    2003QIN Xiao Cong
    
    Director
    
    
    2003YUAN Xu Cheng
    
    Director
    
    
    2003LIANG Weijian
    
    Deputy General Manager
    
    
    1992YANG Jianjun
    
    Deputy General Manager
    
    
    1997YANG Weizhong
    
    Chief Accountant
    
    
    1992SHEN Jie
    
    Chief Engineer
    
    
    2002LIM Poh Lea
    
    Deputy Financial Controller
    
    
    2002
   (1)
    
    Also a Director of the Company. For information about Messrs. Gao Jia Lin, Wrixon Frank Gasteen and Wong
Hong Ren, see  Directors and Senior Management of the
Company. For additional information
regarding Mr. Wang Jianmings current employment status with Yuchai, see 
Compensation  Yuchai and Item 8. Financial Information  Legal Proceedings. Mr. Wang Jianming is the Chief Executive Officer and Chairman of the Board
of Directors of Yuchai. Mr. Wang was the Chairman and a Director of Yuchai from
1994 to 2000 and the Chief Executive Officer of Yuchai from 1993 to 2000. Mr.
Wang is also the legal personal representative of Yuchai. Mr. Wang has also
previously served as a Director of the Company, but at the annual general
meeting of shareholders of the Company held on July 9, 2003, Mr. Wang was not
reelected as Director of the Company. Mr. Wang is a graduate of Shanghai
Communications University. Mr. Li Tiansheng is a Director and Deputy General Manager of Yuchai. He
previously served as the principal coordinator for liaison with Chinese
government agencies, banks and tax department. Mr. Zeng Shiqiang is a Director of Yuchai and Assistant to the Chairman of
the State Holding Company. He previously held the position of Chief Accountant
at Yuchai. Mr. Shao Qihui is an independent director of Yuchai. He previously served
as the Minister of Machinery Industry Ministry. He is the Honorary President
of China Machinery Association. Mr. Qin Xiao Cong is a director of Yuchai and Coomber Investments Limited.
He also serves as a director and General Manager of Zhonglin Development
Company. Mr. Yuan Xu Cheng is a director of Yuchai. He previously served as the
director and assistant General Manager of Guijiang Enterprise Co. Mr. Liang Weijian serves as Deputy General Manager in charge of parts and
supplies. Prior thereto, he served as Deputy Factory Manager of Yuchai and
prior to that, he held the posts of Auto Branch Factory Manager, Technological
Equipment Branch Factory Manager and General Engineering Office Director. Mr. Yang Jianjun is the Deputy General Manager and is in charge of sales
and marketing. Prior to joining Yuchai, he was Vice-Mayor of Yulin City. Mr. Yang Weizhong joined Yuchai in 1969. He has been the Chief Accountant
since 1993. Prior thereto, he served as Assistant Chief of Yuchais Finance
Division. Mr. Shen Jie is the Chief Engineer and is responsible for all matters
relating to engine design, testing and quality control. He joined Yuchai over
20 years ago as an engineer. 46




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##### Table of Contents



Mr. Lim Poh Lea is the Deputy Financial Controller assigned by the Company
to assist in the financial administration, budgeting and planning of Yuchais
financial matters. Mr. Lim is a senior financial controller employed by HLA.
Mr. Lim is a fellow of the Association of Chartered Certified Accountants,
United Kingdom and a Certified Public Accountant of Singapore. Pursuant to Yuchais Articles of Association, Yuchais shareholders have
authority over all matters of importance relating to Yuchai, including: (i) the
review and approval of reports submitted by the Board of Directors of Yuchai;
(ii) the approval of Yuchais plans for distribution of profits and recovery of
losses; (iii) the approval of Yuchais annual capital and operating budget and
year-end financial statements; (iv) the issuance of new common shares or other
securities, the increase in the scope of any subscription of shares and the
transfer procedures for Yuchais share certificates; (v) the nomination,
election, dismissal and compensation of members of the Board of Directors; and
(vi) significant sales or purchases of assets, or any division, merger,
acquisition, termination, liquidation or other major corporate action of
Yuchai. Yuchai shareholders are entitled to preemptive rights to subscribe pro
rata in accordance with their ownership percentage for any new Yuchai shares or
other equity interests offered by Yuchai at a price and on terms at least
equivalent to those offered to new subscribers. Yuchais Board of Directors reports directly to the shareholders of Yuchai
and is the principal executive authority responsible for major decisions
relating to Yuchai, including: (i) the execution of resolutions adopted by the
shareholders; (ii) the formulation and review of Yuchais development plans;
(iii) the review of Yuchais annual business plans; (iv) the review of Yuchais
financial budget, final accounts, dividend distribution plan, plans for
issuances of Yuchai Shares and plans for merger, division and transfer of
assets; (v) the election and dismissal of the Chief Executive Officer; (vi) the
adoption of various corporate policies and rules; (vii) the appointment and
dismissal of senior executive officers as recommended by the Chief Executive
Officer; (viii) major external matters; (ix) sales, purchases, transfers and
leases of material assets with a value in excess of US$3 million and which are
not contemplated in Yuchais approved budgets; and (x) any other matters that
may be determined by the Board of Directors in accordance with Yuchais
Articles of Association. In order to further strengthen its level of corporate governance, the
Company has continued to seek to cause Yuchai to adopt comprehensive corporate
governance guidelines, which seek to put procedures in place to improve the
management and corporate governance of Yuchai. Corporate governance guidelines
were unanimously approved by Yuchais Board of Directors in November 2002,
however it appears that no steps were ever taken by Yuchai management to submit
the amendments to Yuchais Articles of Association required in order to adopt
and fully implement these guidelines to the relevant Chinese governmental
authorities for approval. As such, the guidelines have not yet been officially
implemented. Following the execution of the July 2003 Agreement, a further set
of corporate governance guidelines were approved by Yuchais board of directors
in November 2003, which also have not to date been implemented, as Yuchais
management has not to date taken steps to obtain the necessary government
approvals. Pursuant to Yuchais Articles of Association, the Board of Directors of
Yuchai consists of thirteen directors appointed for three-year terms. So long
as the present ratio of Foreign Shares to the total number of State Shares and
Legal Person Shares of Yuchai remains unchanged, a total of nine directors
shall be elected from nominees of holders of Foreign Shares and a total of four
directors shall be elected from nominees of holders of State Shares and Legal
Person Shares. Actions generally may be taken by a majority vote of the
directors present at a meeting at which a quorum is present. Attendance of at
least seven directors (at least four representing holders of Foreign Shares and
at least three representing holders of State Shares or Legal Person Shares)
constitutes a quorum. The Company is entitled under Yuchais Articles of Association to elect
nine of Yuchais thirteen directors, thereby entitling it to effect all major
decisions relating to Yuchai. A two-thirds vote of the outstanding shares at a
shareholders meeting at which a quorum is present is required for major
corporate actions, such as an amendment to Yuchais Articles of Association,
significant sales or purchases of assets or a division, merger, acquisition or
liquidation of Yuchai, or issuances of new common shares or other securities of
Yuchai. Attendance of shareholders representing at least two-thirds of the
outstanding Yuchai shares constitutes a quorum for shareholder meetings
considering such major corporate actions. 47




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However, although the Companys nominees constitute a majority of the
Board of Directors of Yuchai, no Board of Directors meeting has been held
since November 2003, despite Yuchais Articles of Association requiring the
Board of Directors to meet at least once every six months as well as repeated
requests by the Company. Due to the stringent quorum requirements set forth in
Yuchais Articles of Association, three of the four directors elected by
holders of State Shares or Legal Person Shares are required to attend, in order
for quorum to be achieved, and as a result Board of Directors meetings to be
held. There is no provision in Yuchais Articles of Association providing for
circumstances in which a quorum for a Board of Directors meeting is not met,
nor are there provisions pursuant to which shareholders can require the board
of directors to meet. Yuchais management consists of a Chief Executive Officer, a General
Manager and several Deputy General Managers, other senior officers designated
by the board of directors and one senior manager designated by the Company.
Yuchais management handles daily operations and implements the corporate
policies under the direction and guidance of the Board of Directors of the
Company. In November 2003, Mr. Wang Jianming entered into a new contract of
employment with Yuchai, pursuant to which he was appointed as Chief Executive
Officer of Yuchai. Yuchais Board of Directors has established an Investment Review
Committee, which is responsible for reviewing the necessity and feasibility of
investment projects and making recommendations to the Board of Directors.
Although significant investment decisions should be made by a majority vote of
the Board of Directors, not all investments undertaken by Yuchai have been
submitted to this Committee for approval or have received this or other
required corporate approvals. For example, Yuchais recent appointment of a
consultant to advise on the formation of and Yuchais investment in a new
logistics company named Yuchai Logistic Operations Company Limited (Yuchai
Logistics), the payment of a consultancy fee of Rmb 60.0 million, and the
disbursement of funds to acquire headquarters in Guilin for this new logistics
company, has similarly to date not received the requisite corporate approvals.
See also the formation of Yuchai Express Guarantee Company Limited, described
under Item 4. Information on the Company  Business Overview  Manufacturing,
and the recent loans made by Yuchai, described under Item 7. Major
Shareholders and Related Party Transactions  Related Party Transactions 
Other Transactions. Compensation Company For 2003, HLA charged Yuchai a management fee of US$500,000 for management
services, including the services of the Companys President and Chairman and
the Companys Chief Financial Officer each of whom are employees of HLA. The
Company paid service fees in 2003 of US$30,000 to each of the Companys
directors and US$20,000 to each of the Companys principal officers. See Item
7. Major Shareholders and Related Party Transactions. Yuchai The aggregate amount of compensation paid by Yuchai to all directors and
executive officers of Yuchai during 2003 was approximately Rmb 32.9 million
(US$4.0 million). Yuchai has a management bonus plan for its executive,
mid-level and junior officers under which annual incentive bonuses in an
aggregate amount equal to 5.5% (3.5% for executive officers (allocated as 2.5%
for the Chief Executive Officer and 1.0% for other executive officers) and 2.0%
for mid-level and junior officers and employees) of Yuchais after-tax profit
must be paid if Yuchai achieves the after-tax profit approved in the annual
budget by Yuchais board of directors or, in the case of certain bonuses, if
Yuchai achieves 80% of such budgeted after-tax profit. In addition, Yuchais
officers participate in an incentive pay program which is available to all
employees and is based on performance and productivity. There are no benefits provided to the directors of the Company or Yuchai
upon their termination of employment. Pursuant to an Appointment Agreement, the Company appointed Mr. Wang
Jianming as Chief Executive Officer of Yuchai for a term of six years beginning
in May 1993, and then subsequently renewed for a one-year period which ended in
May 2000. In October 2001, the Company entered into a new employment contract
with Mr. Wang. 48




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Under the terms of the contract, Mr. Wang agreed to serve as a Director of the
Company and the Chief Executive Officer of Yuchai for a period of three years
beginning November 2001. The Company gave Mr. Wang 60 days notice of
termination of this contract on May 19, 2003, effective July 18, 2003 in
connection with the legal and arbitration proceedings brought by the Company in
2003. Following the execution of the July 2003 Agreement, Mr. Wang entered into
a new employment contract with Yuchai in September 2003, pursuant to which
Yuchai has agreed to pay Mr. Wang a monthly base salary of Rmb 40,000 and an
incentive bonus based on the sales and net after tax profit of Yuchai, as well
as other performance criteria. Employees As of December 31, 2003, Yuchai employed approximately 6,717 people
nationwide, inclusive of a sales force of 518 employees. Yuchai provides its
employees with a fixed base salary and a bonus that is determined by the
employees performance and productivity. Yuchai also provides its employees
with housing and meal subsidies and medical insurance. In the year ended
December 31, 2003, the average annual base salary and bonus of an employee was
approximately Rmb 46,000 (US$5,558), an increase of approximately 70% from the
previous year. Yuchai has not experienced any strikes or similar significant
work stoppages. Yuchai believes that its employee relations are good. Share Ownership Stock Option Plan The Company had granted stock options to purchase an aggregate of
1,850,522 shares of Common Stock at an exercise price of US$7.80 per share to
certain executive officers of the Company and Yuchai. Such stock options
expired in December 1999 without any having been exercised. The Company has also adopted a Stock Option Plan (the Plan) to award
stock options to key employees and outside directors. The Plan is administered
by the Compensation Committee. The Compensation Committee has the absolute
discretionary authorities to administer and interpret the plan, including the
sole authority to determine who of those eligible will be granted stock
options, when such options will be granted, the terms of such options and the
number of shares for which options will be granted. Members of the Compensation
Committee are not eligible to receive stock options under the Plan. The
exercise price of each stock option will be determined by the Compensation
Committee but may not be less than the fair market value of the Companys
common stock on the date the option is granted, as determined by the
Compensation Committee. The maximum number of shares of the Companys common
stock that may be purchased pursuant to stock options granted under the Plan is
750,000 shares. The Plan will expire in 2004 unless terminated earlier by the
Board of Directors. As of December 31, 2003, no options had been granted under
the Plan. 
 ITEM 7.  MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS. Major Shareholders The following table sets forth certain information regarding ownership of
the Companys shares of Common Stock as of June 15, 2004 by all persons who are
known to the Company to own five percent (5%) or more of the outstanding shares
of Common Stock. 49




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Shares OwnedIdentity of Person or Group
    
    Number
    
    Percentage (%)Hong Leong Asia Ltd.(1)
    
    
    7,831,169
    
    
    
    22.2The Yulin City Government(2)
    
    
    8,601,550
    
    
    
    24.3R.B. Haave Associates, Inc.(3)
    
    
    3,458,300
    
    
    
    9.79Americas Century Companies, Inc.(4)
    
    
    1,848,860
    
    
    
    5.20
   (1)
    
    Information based upon a report on Schedule 13D jointly filed by HLA
and its wholly-owned subsidiaries, HLC, HLT, Flite Technology
Industries Pte Ltd and Lydale Pte Ltd, with the SEC on July 19,
2002, as amended on September 10, 2003, October 7, 2003, October 15,
2003 and December 1, 2003.(2)
    
    Information based on a report on Schedule 13D filed by Coomber,
Goldman, Zhong Lin and the State Holding Company, with the SEC on
December 16, 2002, as amended on June 23, 2003, July 9, 2003,
December 23, 2003 and March 15, 2004. Based on Amendment No. 4 to
the Schedule 13D filed by Coomber and others with the SEC on
December 23, 2003, Coomber is a wholly-owned subsidiary of Goldman,
which is indirectly owned and controlled by Yulin City Municipal
Government, or Yulin City Government, in Guangxi Zhuang Autonomous
Region, PRC. Accordingly, the Yulin City Government is the ultimate
beneficial owner of the 8,601,550 shares of the Companys Common
Stock held of record by Coomber. Coomber has advised the Company of
the following information. Coomber has entered into forward sale
agreements with a financial institution as a counterparty, with
respect to a total of 1,900,000 shares of the Companys Common
Stock. On the respective settlement dates of these forward sales
agreements, Coomber will have the option to settle the forward sales
by delivery of cash or the Companys Common Stock. The counterparty
may borrow the pledged shares from Coomber in connection with that
partys hedging of its exposure under the forward sale arrangements.
Coomber will temporarily cease to have voting rights with respect to
any common stock borrowed by the counterparty but will reacquire
such voting rights when the counterparty returns the borrowed shares
to Coomber. In the event Coomber elects to settle the forward sale
agreement or agreements entirely by delivering shares of the
Companys Common Stock, its beneficial ownership of the Companys
Common Stock could, depending on the number of shares of the
Companys Common Stock delivered, decrease to 6,701,550 shares, or
approximately 19% of the Companys Common Stock, or to 4,601,550
shares, or approximately 13% of the Companys Common Stock, if it
sells 2,100,000 shares pursuant to the Companys prospectus dated
March 24, 2004.(3)
    
    Information based on a report on Schedule 13G filed by R.B. Haave
Associates Inc., a Delaware Corporation, with the SEC on March 1,
2002.(4)
    
    Information based on a report on Schedule 13G jointly filed by
American Century Investment Management, Inc. and its wholly-owned
subsidiary, American Century Investment Management, Inc., with the
SEC on February 13, 2004. HLA exercises control over and is the beneficial owner of 7,831,169 or
approximately 22.2% of shares of the Companys Common Stock through its
wholly-owned subsidiary, HLT. See   Related Party Transactions  Shareholders
Agreement. Other than as described under Item 3. Key Information  Risk
Factors  Risks relating to our Company and our business  We may experience a
change of control as a result of offerings of shares by our controlling
shareholders and  The Special Share below, the Company is not aware of any
arrangement which may, at a subsequent date, result in a change of control of
the Company. On June 23, 2003, Coomber, Goldman, Zhong Lin, the State Holding Company
and certain individuals filed an amended Schedule 13D reporting beneficial
ownership of 8,601,550 shares, or 24.3%, of the Company. This Schedule 13D
amended and restated in its entirety the Schedule 13D dated November 13, 2002
and filed December 16, 2002, which reported beneficial ownership by Coomber and
Goldman of 8,601,550 shares of the Company (the Coomber Shares). This
Schedule 13D reports beneficial ownership of the Coomber Shares by (i) Coomber,
a wholly-owned subsidiary of Goldman, and the record holder of such 8,601,550
shares of the Company; (ii) Goldman, a company owned by Qin Xiao Cong, Zhu
Guoxin and Yuan Xu Cheng, each of whom 50




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holds their respective shares in Goldman on trust for the benefit Zhong Lin;
(iii) Zhong Lin, a company owned by Qin Xiao Cong and Zhu Guoxin, each of whom
holds their respective shares in Zhong Lin on trust for the benefit of the
Yulin City Government; and (iv) the State Holding Company, which, acting under
the direction of the Yulin City Government, financed Goldmans purchase of the
Coomber Shares from China Everbright in October 2002. Qin Xiao Cong, Zhu Guoxin
and Yuan Xu Cheng reported but disclaimed beneficial ownership. This Schedule
13D also reports that the ultimate beneficial owner of the Coomber Shares is
the Yulin City Government, and discloses certain financing and control
arrangements with respect to the Coomber Share acquisition, as well as the
Yulin City Governments intentions with respect to the Company. This Schedule
13D was most recently amended on March 15, 2004. As
of the record date on June 11, 2004, there were 20,802,396 shares of Common Stock,
or 58.86% shares of Common Stock, held of record by 48 persons with registered
addresses in the United States. The Special Share The Special Share entitles the holder thereof to elect a majority of the
directors of the Company. In addition, no shareholders resolution may be passed
without the affirmative vote of the Special Share, including any resolution to
amend the Memorandum of Association or Bye-laws of the Company. The Special
Share is not transferable except to HLA, HLC or any of its affiliates. In 1994,
the Company issued the Special Share to DML, a holding company of the Company
then controlled by Hong Leong Corporation Limited, now known as Hong Leong
(China) Limited, or HLC. During 2002, following the decision of the
shareholders of DML to dissolve DML, DML redeemed all of the redeemable stock
issued by it to its shareholders. Per the DML Shareholders Agreement, DML
transferred all its shares of the Company to its shareholders, which included
HLC and their wholly-owned subsidiaries. Because Coomber, an affiliate of China
Everbright, was the shareholder of DML which gave notice of the dissolution of
DML, the Special Share was transferred from DML to HLT, an affiliate of HLA,
pursuant to the terms of the DML Shareholders Agreement, as amended on January
21, 2002 and on May 17, 2002. The Companys Bye-Laws provide that the Special Share shall cease to carry
any rights in the event that, if HLA and its affiliates own the Special Share,
HLA and its affiliates cease to own, directly or indirectly, at least 7,290,000
shares of Common Stock (or such equivalent number upon a consolidation or
subdivision of shares of Common Stock), or if China Everbright and its
affiliates own the Special Share, China Everbright and its affiliates cease to
own, directly or indirectly, at least 6,570,000 shares of Common Stock (or such
equivalent number upon a consolidation or subdivision of shares of Common
Stock). The Bye-Laws also provide for circumstances in which DML holds the
Special Share; however, DML was dissolved in 2002. HLT, an affiliate of HLA,
holds the Special Share in addition to 7,831,169 shares of Common Stock, which
is greater than the number stipulated in the provisions of the Companys
Bye-Laws set forth above. Related Party Transactions Shareholders Agreement HLC, China Everbright, Cathay, GSCP, the Sun Yuan Shareholders (14
shareholders who initially invested in the Company through Sun Yuan BVI) and
the Company entered into an amended and restated Shareholders Agreement (the
Shareholders Agreement) in 1994, which provides for certain matters relating
to the management of the Company and Yuchai and the ownership of the Companys
Common Stock. The Shareholders Agreement provides that the Board of Directors
of the Company will consist of eleven directors, the Controlling Shareholder
(as described below) will be entitled to designate six directors, the Major
Shareholder (as described below) will be entitled to designate two directors,
and each of Cathay and GSCP will be entitled to designate one director and the
Chief Executive Officer of Yuchai will initially be the other director. The
Shareholders Agreement also provides that the Controlling Shareholder will be
entitled to designate five of the nine Yuchai directors designated by the
Company, the Major Shareholder will be entitled to designate two such directors
and each of Cathay and GSCP will be entitled to designate one such director.
Under the Shareholders Agreement, the nine Yuchai directors designated by the
Company will vote as a block in accordance with the vote of the majority of
such nine directors. The Shareholders Agreement provides that the Controlling
Shareholder will be the person holding the Special Share, 51




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provided that at all times the Controlling Shareholder will be either HLA or
China Everbright, and the other will be the Major Shareholder. Since the
Companys initial public offering in 1994, HLA has been the Controlling
Shareholder and China Everbright has been the Major Shareholder. However, in
October 2002, China Everbright sold all of its shares in the Company to Goldman
in October 2002 and is no longer the Major Shareholder of the Company. The
Shareholder Agreement provides that if any shareholder (other than the
Controlling Shareholder) ceases to own at least 4% of the Companys Common
Stock, such shareholder shall no longer be entitled to designate any directors.
Accordingly, China Everbright no longer has director designation rights. The
Shareholders Agreement also provides that, so long as HLA is the Controlling
Shareholder, Yuchai or the Company will pay HLA an annual management fee of not
less than US$500,000 for management services provided by HLA, including the
services of the Companys President and Chief Financial Officer. The
Shareholders Agreement will terminate upon the occurrence of an event resulting
in the Special Share ceasing to carry any rights. In addition to the Shareholders Agreement, HLA, China Everbright and DML
had entered into a Subscription and Shareholders Agreement (the DML
Shareholders Agreement), which provided for certain matters relating to the
management of DML, the Company and Yuchai and the ownership of DML stock. The
DML Shareholders Agreement provided that HLA would control DML, provided,
however, that if HLA and its affiliates ceased to own directly or through DML
at least 7,290,000 shares of Common Stock when China Everbright and its
affiliates own directly or through DML at least 6,570,000 shares of Common
Stock, China Everbright would control DML. The DML Shareholders Agreement
provided that all rights of the Special Share held by DML would be exercised as
directed by the shareholder that controls DML. With the dissolution of DML and
the sale by China Everbright of all of its shares in the Company to Goldman in
October 2002, the DML Shareholders Agreement no longer directly affects the
Company. Registration Rights Agreement Pursuant to a Registration Rights Agreement (the Registration Rights
Agreement), the Company has granted two demand registration rights to each
of HLC, China Everbright, Cathay, GSCP and the Sun Yuan Shareholders (the
Selling Stockholders) requiring the Company, subject to certain conditions,
to use its best efforts to prepare and file a registration statement on behalf
of such shareholder under the Securities Act and to use its best efforts to
qualify the shares for offer and sale under any applicable U.S. state
securities laws. Expenses incurred in connection with one demand registration
for each such shareholder will be borne by the Company, and the Company and
Yuchai will be required to indemnify the underwriters in connection with any
demand registration. The Registration Rights Agreement also grants each such
shareholder certain piggyback registration rights entitling each shareholder
to sell Common Stock in any registered offerings of equity securities of the
Company, for the account of the Company or on behalf of its security holders.
China Everbright, GSCP and the Sun Yuan shareholders are no longer shareholders
of the Company. Pursuant to the demand registration rights, the Company filed a
Registration Statement (Registration No. 333-111106) on Form F-3 (the
Registration Statement) with the SEC in December 2003, registering an
aggregate of 9,931,169 shares of the Companys Common Stock for sale by the
Selling Stockholders from time to time, depending on market conditions and
other factors, in one or more transactions on the NYSE, in the over-the-counter
market or otherwise, at market prices prevailing at the time of sale, at
negotiated prices or at fixed prices. Other Transactions During 2003, HLA charged Yuchai a management fee of US$500,000 for
management, financial planning and control and other services, including the
services of the Companys President and Chairman and its Chief Financial
Officer, each of whom are employees of HLA. Such charges represent HLAs
estimated direct costs of providing these services. During 2003, the State Holding Company charged Yuchai Rmb 30.6 million
(US$3.7 million) for certain general and administrative expenses on an actually
incurred basis. The Company believes that the expenses charged to Yuchai by the
State Holding Company would not have been materially different on a stand alone
basis because Yuchai could provide these services for itself at approximately
the same cost. 52




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During 2004, Yuchai granted a loan of Rmb 10.0 million to Guangxi Yulin
Yuchai Jidan Company Limited (GYYJCL), as well as a loan of Rmb 60.0 million
to (Yuchai Logistics), a subsidiary of GYYJCL. Yuchai has also recently
disbursed Rmb 140.0 million to acquire Coombers stake in Yuchai Logistics.
None of these transactions have to date received the requisite corporate
approvals. The Company has undertaken other significant business transactions with
related parties during the three years ended December 31, 2003, as set forth
under Note 24 to the Companys Consolidated Financial Statements. 
 ITEM 8.  FINANCIAL INFORMATION. Consolidated Financial Statements See Item 18. Financial Statements. Legal Proceedings Other than as set forth below, neither the Company nor its sole operating
subsidiary, Yuchai, is currently involved in any material legal proceedings
that the Company believes would, individually or taken as whole, adversely
affect the financial condition or results of operations of the Company. Proceedings with Yuchai The Company has from time to time encountered difficulties in obtaining
the cooperation of the State Holding Company and Mr. Wang Jianming in the daily
management and operation of Yuchai. The State Holding Company is a minority
shareholder of Yuchai and is wholly-owned by the municipal government of Yulin
City in the Guangxi Zhuang Autonomous Region. Mr. Wang is the Chairman, legal
representative and Chief Executive Officer of Yuchai, as well as the Chairman
and legal representative of the State Holding Company. These difficulties have
been most noticeably with respect to implementation of the decisions of the
Companys Board of Directors with respect to certain corporate governance
measures and capital expenditures at Yuchai and the payment to the Company of
its share of dividends declared by Yuchai. In response to these continued
difficulties, the Company initiated legal and arbitration proceedings in New
York, London and Singapore against Yuchai, Mr. Wang and other related parties
in May 2003. On June 16, 2003, the Company received from Yuchai copies of recent
letters from various Chinese government agencies stating that the transfer of
ownership of shares with respect to Yuchai in November 1994, in connection with
its IPO, was not validly approved by the Chinese authorities, and that as a
result its exercise of control over Yuchai has been improper. Based on advice from its special Chinese counsel, the Company believes
that this correspondence is based on an incorrect understanding of the facts
and circumstances of the November 1994 share transfers and an incorrect
interpretation of the language of its IPO approval. The Company further
believes, similarly based on advice from its special Chinese counsel, that
Yuchais ownership structure has been validly approved by the relevant Chinese
authorities. In addition, legal opinions were given at the time of the
Companys IPO stating that all necessary approvals had been granted and that
Yuchais ownership structure was valid under Chinese law. Prior to the
Companys difficulties in 2002 with Yuchai, Yuchais current ownership structure
had been unchallenged, and payments have been made by Yuchai to the Company for
each dividend declared prior to the August 2002 dividend. The Company believes
that no changes have occurred in the ownership structure that would invalidate
the Chinese governmental approvals that were obtained in 1994. The Company subsequently discontinued its claims and these proceedings as
a result of the agreement reached with Yuchai and its related parties in July
2003. As a result of a number of meetings between the parties in dispute and
subsequent communications related to the July 2003 Agreement, the Company
agreed with Yuchai that the relevant parties would also take the following
actions: 53




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##### Table of Contents




    
    Yuchai paid to the Company in August 2003 its share of the dividends
declared by Yuchai in August 2002, amounting to Rmb 245.8 million
(US$29.7 million).
    
    Yuchai reinstated two of the Companys senior managers who report to
the Board of Directors and who had been seconded to Yuchai, and
afforded them access to Yuchais operating and financial information.
    
    The Company changed its nominees on Yuchais Board of Directors to the
following: Gao Jia Lin, Paul Wolansky, Wrixon Gasteen, Wong Hong Ren,
Qin Xiao Cong, Yuan Xu Cheng and Hermann Leung (Paul Wolansky and
Hermann Leung subsequently resigned as Yuchai directors).
    
    The Company declared and paid a dividend to its shareholders
representing 90% of the August 2002 dividends received from Yuchai.
    
    Yuchai agreed to the extent consistent with Chinese law and
international practice that it will implement corporate management
procedures to improve the management and corporate governance of
Yuchai.
    
    The Company and Yuchai agreed that to work together in trying to
jointly promote mutual plans to enhance shareholder value, possibly
including, to the extent permitted by applicable laws and regulations,
by way of (i) creating a new Yuchai holding company and spinning it
off (along with all of the Yuchai shares it owns) to the Companys
shareholders in proportion to their economic interests and the listing
of the new Yuchai holding company (without any golden or special
share) on an international capital market; and (ii) restructuring
and/or recapitalizing the Companys assets and capital so as to allow
the Company to maintain its NYSE listing. The parties also agreed to
consider alternatives if the foregoing cannot be achieved.
    
    A new employment contract with Mr. Wang Jianming, the Chief Executive
Officer and Chairman of the Board of Directors of Yuchai, was entered
into in September 2003. For the past several months, the parties to the July 2003 Agreement and
their advisors have been actively seeking to agree on a restructuring plan for
the Company. However, the Company believes that the parties may not be able to
implement a restructuring in the manner contemplated in the July 2003 Agreement
in the near future. The Company remains committed to working towards an agreed
plan with the parties to the July 2003 Agreement with the goal of enhancing
value for its shareholders as expeditiously as possible. The Company has
delegated authority to its Special Committee to investigate and consider the
restructuring plans. Discussions with the parties concerned and the Companys
professional advisors are ongoing. The Company is unable to determine when such restructuring will likely be
completed and the form that it is likely to take. No assurance can be given
that the Company will be able to secure the agreement of the Chinese
stakeholders to any alternative restructuring arrangement, or that
implementation of any such restructuring will effectively resolve all of the
difficulties faced by the Company with respect to its investment in Yuchai. If
the Company undertakes a restructuring, no assurance can be given that the
implementation thereof will be beneficial to CYIs shareholders. In addition, the Company from time to time experiences certain problems in
obtaining the cooperation of the Chinese shareholders of Yuchai in the daily
management and operation of Yuchai to fully exercise its controlling interest
in Yuchai. The Company is currently seeking to resolve these problems through
continued dialogue with representatives of Yuchais Chinese shareholders. The
Company is considering alternatives to address these difficulties, including
the commencement of litigation and/or arbitration. Other Legal Proceedings Yuchai is involved in legal proceedings instituted by the Yulin Road
Bureau against Yuchai and Nanning Hengji, an unrelated third party. In these
proceedings, the Yulin Road Bureau has sought payment of RMB 7.3 million 54




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##### Table of Contents



(US$0.9 million) from Yuchai and Nanning Hengji, as the construction cost of a
road built by Yulin Road Bureau near Yuchais factory. At trial, a Yulin court
ordered Yuchai and Nanning Hengji to pay Rmb 4.6 million (US$0.6 million) to
the Yulin Road Bureau. Yuchai has appealed this decision to a Guangxi court and
is awaiting the outcome of this appeal. The Company has made a provision of Rmb
4.6 million, which has been included in Selling, general and administrative
expense and Accrued expense and other liabilities in 2002. In 2003, the Yulin Branch of Bank of China (BOC) initiated legal
proceedings to recover Rmb 6.6 million (US$0.8 million) from Yuchai based on an
irrevocable letter of guarantee issued by Yuchai to BOC in 1993 to secure a
loan of US$0.6 million to Great Wall Machinery Plant (Great Wall). At trial,
a Yulin court ruled that if Great Wall could not repay the loan Yuchai would be
liable to the BOC. Yuchai subsequently appealed, but lostthe appeal. In
January 2004, the State Holding Company issued a letter of commitment
confirming that it would reimburse Yuchai in the event that Yuchai was required
to pay on this guarantee. Based on the advice of its Chinese legal counsel,
the Company has recorded a loss contingency equal to the amount of the claim,
which has been offset by amounts to be reimbursed by the State Holding Company.
The amount due to BOC and the amount due from State Holding Company have been
recorded in Accrued expenses and other liabilities and Amounts due from
related companies, respectively. See also Note 22 to the Companys Consolidated Financial Statements
included elsewhere herein for a description of other legal claims which Yuchai
is involved in. Policy on Dividend Distributions The Companys principal source of cash flow is its share of the dividends,
if any, paid by Yuchai to the Company, as described under Item 5. Operating
and Financial Review and Prospects  Liquidity and Capital Resources. Chinese laws and regulations applicable to a Sino-foreign joint stock
company require that before Yuchai distributes profits, it must: (i) satisfy
all tax liabilities; (ii) recover losses in previous years; and (iii) make
contributions to certain statutory reserves in an amount equal to at least 15%
of net income for the year determined in accordance with PRC GAAP. Any determination by Yuchai to declare a dividend will be at the
discretion of Yuchais shareholders and will be dependent upon Yuchais
financial condition, results of operations and other relevant factors. Yuchais
Articles of Association provide that dividends may be paid once a year. To the
extent Yuchai has foreign currency available, dividends declared by
shareholders at a shareholders meeting to be paid to holders of Foreign Shares
(currently only the Company) will be payable in foreign currency, and such
shareholders will have priority thereto. If the foreign currency available is
insufficient to pay such dividends, such dividends may be payable partly in
Renminbi and partly in foreign currency. Dividends allocated to holders of
Foreign Shares may be remitted in accordance with the relevant Chinese laws and
regulations. In the event that the dividends are distributed in Renminbi, such
dividends may be converted into foreign currency and remitted in accordance
with the relevant Chinese laws, regulations and policies. 
 ITEM 9.  THE OFFER AND LISTING. Since December 16, 1994, the Common Stock has been listed and traded on
the NYSE under the symbol CYD. The Common Stock is not listed on any other
exchanges within or outside the United States. The high and low sales prices for shares of the Common Stock on the NYSE
for the periods indicated were as follows: 55




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US$
    
    US$Period
    
    High
    
    Low1999
    
    
    2.875
    
    
    
    0.3752000
    
    
    2.000
    
    
    
    0.8752001
    
    
    1.150
    
    
    
    0.3002002
    
    
    5.95
    
    
    
    0.952003
    
    
    37.24
    
    
    
    4.452004
(through June 25, 2004)
    
    
    32.22
    
    
    
    16.10
 US$
    
    US$Period
    
    High
    
    Low2002 First Quarter
    
    
    1.800
    
    
    
    0.9502002 Second Quarter
    
    
    3.45
    
    
    
    1.602002 Third Quarter
    
    
    3.60
    
    
    
    2.552002 Fourth Quarter
    
    
    5.95
    
    
    
    3.352003 First Quarter
    
    
    7.10
    
    
    
    4.452003 Second Quarter
    
    
    9.20
    
    
    
    5.602003 Third Quarter
    
    
    19.30
    
    
    
    6.592003 Fourth Quarter
    
    
    37.24
    
    
    
    17.002004 First Quarter
    
    
    32.22
    
    
    
    18.532004 Second
Quarter (through June 25, 2004)
    
    
    32.50
    
    
    
    16.10
 US$
    
    US$Period
    
    High
    
    LowDecember 2003
    
    
    32.25
    
    
    
    27.57January 2004
    
    
    32.22
    
    
    
    21.80February 2004
    
    
    22.50
    
    
    
    19.27March 2004
    
    
    22.75
    
    
    
    18.53April 2004
    
    
    22.50
    
    
    
    16.48May 2004
    
    
    19.90
    
    
    
    16.10June 2004
(through June 25, 2004)
    
    
    17.98
    
    
    
    16.26
 
 ITEM 10.  ADDITIONAL INFORMATION. The Companys objects are to perform all the functions of a holding
company and to coordinate the policy and administration of any subsidiary
company. See paragraphs 6 and 7 of the Companys Memorandum of Association for
further information on the objects and powers of the Company. Memorandum of Association and Bye-Laws Corporate Governance The Company is an exempted company incorporated in Bermuda and is subject
to the laws of that jurisdiction. The legal framework in Bermuda which applies
to exempted companies is flexible and allows an exempted company to comply with
the corporate governance regime of the relevant jurisdiction in which the
company operates or applicable listing standards. Under Bermuda law, members of
a board of directors owe a fiduciary duty to the company to act in good faith
in their dealings with or on behalf of the company and to exercise their powers
and fulfill the duties of their office honestly. In addition, the Bermuda
company legislation imposes a duty on directors and officers of an exempted
company to act honestly and in good faith with a view to the best interests of
the company and requires them to exercise the care, diligence and skill that a
reasonably prudent person would 56




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##### Table of Contents



exercise in comparable circumstances. Bermuda legislation also imposes certain
specific duties and obligations on companies and directors, both directly and
indirectly, including duties and obligations with respect to matters such as
(a) loans to directors and related persons and (b) limits on indemnities for
directors and officers. Bermuda law does not impose specific obligations in
respect of corporate governance, such as those prescribed by NYSE listing
standards, requiring a company to (i) appoint independent directors to their
boards; (ii) hold regular meetings of non-management directors; (iii) establish
audit, nominating and governance or compensation committees; (iv) have
shareholders approve equity compensation plans; (v) adopt corporate governance
guidelines; or (vi) adopt a code of business conduct and ethics. The Company is also subject to the NYSE listing standards, although,
because it is a foreign private issuer, those standards are considerably
different from those applied to U.S. companies. Under the NYSE rules, the
Company need only (i) establish an independent audit committee that has
specified responsibilities as described in the following table; (ii) provide
prompt certification by its chief executive officer of any material
non-compliance with any corporate governance rules; and (iii) provide a brief
description of significant differences between its corporate governance
practices and those followed by U.S. companies. The following table compares the Companys principal corporate governance
practices to those required of U.S. companies. Standard for U.S. Listed Companies
    
    China Yuchai International Limited's PracticeDirector Independence
    
    A majority of the board must consist
of independent directors.
    
    
    
    Two of the Companys eight directors, Mr.
Ho and Mr. Liu, are independent within the
meaning of the NYSE standards.Independence is defined by various
criteria including the absence of
a material relationship between
the director and the listed
company. Directors who are
employees, are immediate family of
the chief executive officer or
receive over $100,000 per year in
direct compensation from the
listed company are not
independent. Directors who are
employees of or otherwise
affiliated through immediate
family with the listed companys
independent auditor are also not
independent.
    
    The non-management directors of each
company must meet at regularly
scheduled executive sessions without
management.
    
    
    
    The Companys non-management directors do
not meet periodically without management
directors.
 57




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##### Table of Contents



Standard for U.S. Listed Companies
    
    China Yuchai International Limited's PracticeAudit Committee
    
    Listed companies must have an audit
committee that satisfies the
requirements of Rule 10A-3 under the
Securities Exchange Act. The rule
requires that the audit committee (i)
be comprised entirely of independent
directors; (ii) be directly responsible
for the appointment, compensation and
oversight of the independent auditor;
(iii) adopt procedures for the receipt
and treatment of complaints with
respect to accounting and auditing
issues; (iv) be authorized to engage
independent counsel and other advisors
it deems necessary in performing its
duties; and (v) be given sufficient
funding by the board of directors to
compensate the independent auditors and
other advisors as well as for the
payment of ordinary administrative
expenses incurred by the committee.
    
    
    
    The Company does not currently have an
audit committee which meets all of the
requirements of Rule 10A-3, although it is
taking steps towards meeting such
requirements (such as establishing
procedures for receiving complaints). The
Company fully expects to have the measures
required under Rule 10A-3 implemented by
July 31, 2005.
    
    The audit committee must consist of
at least three members, and each member
must be independent within the meaning
established by the NYSE.
    
    
    
    The Companys audit committee consists of
three members. Although both Mr. Ho and Mr.
Liu are considered independent as directors
generally under the NYSEs rules, only Mr.
Liu is considered independent within the
meaning of the SECs rules specifically
relating to independence of listed company
audit committee members.
    
    The audit committee must have a
written charter that addresses the
committees purpose and
responsibilities.
    
    
    
    The Companys audit committee has a
charter outlining the committees purpose
and responsibilities, which are similar in
scope to those required of U.S. companies.At a minimum, the committees
purpose must be to assist the
board in the oversight of the
integrity of the companys
financial statements, the
companys compliance with legal
and regulatory requirements, the
independent auditors
qualifications and independence
and the performance of the
companys internal audit function
and independent auditors.The audit committee is also
required to review the independent
auditing firms annual report,
describing the firms internal
quality control procedures, any
material issues raised by the most
recent internal quality control
review or peer review of the firm
and any steps taken to address
such issues. The audit committee
is also to assess the auditors
independence by reviewing all
relationships between the company
and its auditor. It must establish
the companys hiring guidelines
for employees and former employees
of the independent auditor.The committee must also discuss
the companys annual audited
financial statements and quarterly
financial statements with
management and the independent
auditors, the companys earnings
press releases, as well as
financial information and earnings
guidance provided to analysts and
rating agencies, and policies with
respect to risk assessment and
risk management. It must also meet
periodically with the internal
auditors and the board of
directors.
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Standard for U.S. Listed Companies
    
    China Yuchai International Limiteds Practice
    
    Each listed company must have
disclose whether their board of
directors has identified an Audit
Committee Financial Expert, and if not
the reasons why the board has not done
so.
    
    
    
    Although not independent, the Board of
Directors has identified Philip Ting Sii
Tien as the Companys Audit Committee
Financial Expert.
    
    Each listed company must have an
internal audit function.
    
    
    
    The Companys internal audit function is
provided by HLA.Compensation Committee
    
    Listed companies must have a
compensation committee composed
entirely of independent board members
as defined by the NYSE listing
standards.
    
    
    
    The Companys compensation committee has
two members, neither of whom are independent
within the meaning of the NYSE standards.
    
    The committee must have a written
charter that addresses its purpose and
responsibilities.
These responsibilities include (i) reviewing and approving corporate
goals and objectives relevant to
CEO compensation; (ii) evaluating
CEO performance and compensation
in light of such goals and
objectives for the CEO; (iii)
based on such evaluation,
reviewing and approving CEO
compensation levels; (iv)
recommending to the board non-CEO
compensation, incentive
compensation plans and
equity-based plans; and (v)
producing a report on executive
compensation as required by the
Securities and Exchange Commission
to be included in the companys
annual proxy statement or annual
report. The committee must also
conduct an annual performance
self-evaluation.
    
    
    
    The Companys compensation committee
reviews among other things the Companys
general compensation structure, and reviews
and recommends the compensation and benefits
of directors and the chief executive
officer, subject to ratification by the
Board of Directors.Nominating/Corporate Governance Committee
    
    Listed companies must have a
nominating/corporate governance
committee composed entirely of
independent board members.
    
    
    
    The Company does not have a
nominating/corporate governance committee.The committee must have a written
charter that addresses its purpose
and responsibilities, which
include (i) identifying qualified
individuals to become board
member; (ii) selecting, or
recommending that the board
select, the director nominees for
the next annual meeting of
shareholders; (iii) developing and
recommending to the board a set of
corporate governance principles
applicable to the company; (iv)
overseeing the evaluation of the
board and management; and (v)
conducting an annual performance
evaluation of the committee.
 59




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Standard for U.S. Listed Companies
    
    China Yuchai International Limited's PracticeEquity-Compensation Plans
    
    Shareholders must be given the
opportunity to vote on all
equity-compensation plans and material
revisions thereto, with limited
exceptions.
    
    
    
    The Company intends to have its
shareholders approve equity-compensation
plans.Corporate Governance Guidelines
    
    Listed companies must adopt and
disclose corporate governance
guidelines.
    
    
    
    The Company does not have a formal set of
corporate governance guidelines other than
the Code of Business Conduct and Ethics
described below.Code of Business Conduct and Ethics
    
    All listed companies, U.S. and
foreign, must adopt and disclose a code
of business conduct and ethics for
directors, officers and employees, and
promptly disclose any waivers of the
code for directors or executive
officers.
    
    
    
    The Company has recently adopted a Code of
Business Conduct and Ethics Policy, a copy
of which is available upon request from the
Company.
 Directors Director Interests and Voting A Director of the Company cannot vote or be counted in the quorum with
regard to any contract or arrangement or any other proposal in which he has any
interest or in respect of which he has any duty which conflicts with his duty
to the Company. The restriction from voting and being counted in the quorum
does not apply if the only interest the Director has is included in the
following list:  (a)
    
    a resolution regarding granting any security or indemnity for any
money lent or obligation incurred by such Director at the request, or
for the benefit, of the Company or any of its subsidiaries (or a
company of which the Company is a beneficially wholly-owned
subsidiary);(b)
    
    a resolution regarding granting any security or indemnity to any third
party for a debt or obligation which is owed by the Company or any of
its subsidiaries (or a company of which the Company is a beneficially
wholly-owned subsidiary) to the third party, for which such Director
has assumed responsibility in whole or in part under a guarantee or
indemnity;(c)
    
    a resolution about an offer of shares, debentures or other securities
of the Company or any of its subsidiaries (or a company of which the
Company is a beneficially wholly-owned subsidiary) for subscription or
purchase in which such Director is to be a participant in the
underwriting or sub-underwriting of the offer; 60




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(d)
    
    a resolution about any proposal involving any other company in which
such Director is interested, whether directly or indirectly and
whether as an officer or shareholder or otherwise, provided that such
Director is not the holder of, or directly or indirectly beneficially
interested in, 5% or more of (i) any class of the equity share capital
of such company or in any third company through which such Directors
interest is derived or (ii) the voting rights in that company;(e)
    
    any contract arrangement or proposal for the benefit of employees of
the Company under which such Director benefits in a similar manner as
the employees and does not receive any privileges or advantages not
provided to the employees; or(f)
    
    any proposal in which such Director is interested in the same manner
as other holders of shares or debentures or other securities of the
Company or any of its subsidiaries by virtue only of such Directors
interest in shares or debentures or other securities of the Company or
any of its subsidiaries. If the Board of Directors of the Company is considering proposals about
appointing two or more Directors to positions with the Company or any company
in which the Company is interested, each such Director (if not disqualified
from voting under proviso to item (d) above) can vote and be included in the
quorum for each resolution, except the one concerning such Director. Remuneration and Pensions The total fees paid to the Directors (other than Directors appointed to an
executive office) for performing their services as Directors must not exceed
US$250,000 each year or such lesser amount as the Board of Directors of the
Company may determine. The Directors may decide the way in which the total sum
shall be divided among them, except that any Director holding office for less
than the whole of the relevant period for which the fees are paid will only
receive part of the amount in proportion to the amount of time he has been a
Director. The shareholders of the Company may by ordinary resolution increase
the amount of the fees payable to the Directors. The Board of Directors of the Company may grant special remuneration to
any Director who shall render any special or extra services to or at the
request of the Company. Such special remuneration may be paid to such Director
in addition to or in substitution for his ordinary remuneration as a Director
and may be payable by way of lump sum, participation in profits or as otherwise
determined by the Board of Directors of the Company. The Board of Directors of the Company may provide pensions or other
benefits to any Director or former Director, or any of their family members or
dependants. Borrowing Powers The Board of Directors of the Company may exercise all the powers of the
Company to borrow money and to mortgage or charge its undertaking, property and
uncalled capital or any part thereof and to issue debentures and other
securities. Qualification of Directors No person is required to vacate office or is ineligible for re-election or
re-appointment as a Director, and no person is ineligible for appointment as a
Director, by reason only of his having attained any particular age. No Director
is required to hold any shares of the Company. Rights of Holders of shares of Common Stock The holders of shares of Common Stock shall: 61




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
    
    be entitled, on a show of hands, to one vote and, on a poll, to one vote per share;
    
    be entitled to such dividends as the Board of Directors of the Company may from time to time declare;
    
    in the event of a winding-up or dissolution of the Company, whether voluntary or involuntary or for
the purpose of the reorganization or otherwise or upon any distribution of capital, be entitled to a
return of the amount paid up on the Common Stock and thereafter to the surplus assets of the
Company; and
    
    generally, be entitled to enjoy all the rights attaching to shares. All unclaimed dividends or distributions out of contributed surplus
account may be invested or otherwise made use of by the Board of Directors of
the Company for the benefit of the Company until claimed. No dividend or
distribution shall bear interest against the Company. Any dividend or
distribution which has remained unclaimed for a period of 12 years from the due
date for payment thereof shall at the expiration of that period be forfeited
and shall belong to the Company absolutely. Rights of Holder of the Special Share The holder of the Special Share shall be entitled to the following rights:  
    
    to elect six Directors of the Company and to remove Directors so appointed;
    
    no shareholder resolution may be passed without the affirmative vote of
the holder of the Special Share, including any resolution to amend the
Memorandum of Association or Bye-Laws of the Company. The holder of the Special Share shall not be entitled to any dividends and
in the event of a winding up or dissolution of the Company, the holder of the
Special Share shall be entitled only to a return of the amount paid up on the
Special Share. The Special Share is not transferable except to HLA and its affiliates or
to China Everbright and its affiliates. The Special Share shall cease to carry
any rights in the event that, if HLA and its affiliates own the Special Share,
HLA and its affiliates cease to own, directly or indirectly, at least 7,290,000
shares of Common Stock (or such equivalent number upon a consolidation or
subdivision of shares of Common Stock), or if China Everbright and its
affiliates own the Special Share, China Everbright and its affiliates cease to
own, directly or indirectly, at least 6,570,000 shares of Common Stock (or such
equivalent number upon a consolidation or subdivision of shares of Common
Stock). Modification of Shareholders Rights The rights attached to any class of shares (unless otherwise provided by
the terms of issue of the shares of that class) may be varied, modified or
abrogated with the consent in writing of the holders of not less than
three-fourths of the issued shares of that class or with the sanction of an
ordinary resolution passed at a separate general meeting of the holders of the
shares of the class. The rights conferred upon the holders of the shares of any
class issued with preferred or other rights shall not, unless otherwise
expressly provided by the terms of issue of the shares of that class, be deemed
to be varied by the creation or issue of further shares ranking pari passu
therewith. Annual General and Special General Meetings The Company must hold an annual general meeting each year. The Directors
of the Company decide where and when it will be held. Not more than fifteen
months may elapse between the date of one annual general meeting and the next.
At least 14 clear days written notice must be given for every annual general
meeting and for every special general meeting. The notice for any annual
general meeting must state the date, place and time at which the meeting
is to be held, and the business to be conducted at the meeting, including, if
applicable, any election of Directors. The notice for any special general
meeting must state the time, place and the general nature of the business to be 62




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considered at the meeting and shall state that a shareholder entitled to attend
and vote is entitled to appoint one or more proxies to attend and vote instead
of him. In the case of a meeting convened for passing a special resolution, the
notice shall specify the intention to propose the resolution as a special
resolution. Shareholders holding not less than one-tenth in value of the paid up share
capital of the Company and having the right to attend and vote at general
meetings of the Company shall have the right, by written request to the
Chairman or President (as applicable), Deputy Chairman or Vice President (as
applicable) or Secretary of the Company, to require that a special general
meeting be convened by the Directors for the transaction of any business
specified in the request. Such meeting shall be held within two months after
the request has been made. If within 21 days of such deposit of the request the
Board fails to convene the meeting, the petitioners may convene the meeting
themselves in accordance with Section 74(3) of the Companies Act of Bermuda. Limitations on Rights to Own Securities There are no limitations under Bermuda law or the Companys Memorandum of
Association and Bye-Laws on the rights of non-Bermuda owners of shares of the
Company to hold or vote their shares. The Company is exempt from the laws of Bermuda which restrict the
percentage of share capital that may be held by non-Bermudians, but as an
exempted company the Company may not participate in certain business
transactions, including: (i) the acquisition or holding of land in Bermuda
(except that required for its business held by way of lease or tenancy for a
term not exceeding 50 years or, with the consent of the Minister of Finance of
Bermuda, land by way of lease or tenancy for a term not exceeding 21 years in
order to provide accommodation or recreational facilities for its employees);
(ii) the taking of mortgages on land in Bermuda to secure an amount in excess
of 50,000 Bermuda dollars without the prior consent of the Minister of Finance
of Bermuda; (iii) the acquisition of any bonds or debentures secured by any
land in Bermuda other than those issued by the Government of Bermuda or a
public authority; or (iv) the carrying on of business of any kind or type
whatsoever in Bermuda either along or in partnership or otherwise except, inter
alia, carrying on business with persons outside Bermuda, in furtherance of the
business of the Company carried on outside Bermuda or under a license granted
by the Minister of Finance of Bermuda. In accordance with the Companys Bye-Laws, share certificates are only
issued to members of the Company (i.e., persons registered in the register of
members as holders of shares in the Company). The Company is not bound to
investigate or incur any responsibility in respect of the proper administration
or execution of any trust to which any of the Companys shares are subject. The
Company will take no notice of any trust applicable to any of its shares
whether or not it had notice of such trust. Exchange Controls Bermuda Exchange Controls The Company has been designated as a non-resident for exchange control
purposes by the Bermuda Monetary Authority. The Company has received the permission of the Bermuda Monetary Authority
under the Exchange Control Act of 1972 and regulations thereunder for the
transfer of shares of Common Stock to and between persons regarded as resident
outside Bermuda for exchange control purposes and the issue of shares within
the existing authorized capital of the Company to such persons for so long as
such shares are listed on the NYSE. Issues and transfers of shares involving
any person regarded as resident in Bermuda for exchange control purposes
require specific prior approval under the Exchange Control Act of 1972. Because the Company has been designated as a non-resident for Bermuda
exchange control purposes, there are no restrictions on its ability to transfer
funds in and out of Bermuda or to pay dividends to United States residents who
are holders of the shares of Common Stock, other than in respect of local
Bermuda currency. 63




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China Exchange Controls The Renminbi currently is not a freely convertible currency. The State
Administration for Foreign Exchange (the SAFE), under the authority of the
Peoples Bank of China (the PBOC), controls the conversion of Renminbi into
foreign currency. Prior to January 1, 1994, Renminbi could be converted to
foreign currency through the Bank of China or other authorized institutions at
official rates fixed daily by the SAFE. Renminbi could also be converted at
swap centers (Swap Centers) open to Chinese enterprises and foreign invested
enterprises (FIEs), subject to SAFE approval of each foreign currency trade,
at exchange rates negotiated by the parties for each transaction. In the year
ended December 31, 1993, as much as 80% by value of all foreign exchange
transactions in China took place through the Swap Centers. The exchange rate
quoted by the Bank of China differed substantially from that available in the
Swap Centers. Effective January 1, 1994, a unitary exchange rate system was
introduced in China, replacing the dual-rate system previously in effect. In
connection with the creation of a unitary exchange system, the China Foreign
Exchange Trading System (CFETS) inter-bank foreign exchange market was
established. Under the unitary foreign exchange system, PBOC sets daily
exchange rates (the PBOC Rates) for conversion of Renminbi into U.S. dollars
and other currencies based on the CFETS interbank market rates, and the Bank of
China and other authorized banks may engage in foreign exchange transactions at
rates that vary within a prescribed range above or below PBOC Rates. Yuchai, as a FIE, is permitted to retain its foreign currency earnings and
maintain foreign currency accounts at designated foreign exchange banks.
However, there can be no assurance that the current authorizations for FIEs to
retain their foreign exchange to satisfy foreign exchange liabilities in the
future will not be limited or eliminated or that Yuchai will be able to obtain
sufficient foreign exchange to satisfy their foreign exchange requirements.
Foreign exchange transactions under the capital account continue to be subject
to limitations and require approvals of the SAFE, which could affect the
ability of the Yuchai to obtain foreign exchange through debt or equity
financing, including by means of loans or capital contributions from the
Company. In the event of shortages of foreign currencies, Yuchai may be unable to
convert sufficient Renminbi into foreign currency to meet its foreign currency
obligations or to pay dividends in foreign currency. Yuchai requires foreign
currency to purchase a substantial portion of the manufacturing equipment
required for the planned expansion of its manufacturing facilities and to meet
foreign currency-denominated debt payment obligations. Yuchai will also require
foreign currency for payment of its imported engine components. The value of the Renminbi is subject to changes in Chinese government
policies and to international economic and political developments. During the
few years prior to 1994, the Renminbi experienced a devaluation against most
major currencies, and a devaluation of approximately 50% of the Renminbi
against the U.S. dollar occurred on January 3, 1994 in connection with the
adoption of the new unitary exchange rate system. Since 1994, the official
exchange rate for the conversion of Renminbi to U.S. dollars has been stable,
and the Renminbi has appreciated slightly against other currencies. Any future
devaluation of the Renminbi would increase the effective cost to Yuchai of
foreign manufactured equipment or components, and of satisfying any other
foreign currency denominated liabilities. In addition, any such devaluation
would reduce the U.S. dollar value of any dividends declared in Renminbi.
During 2001, 2002 and 2003 the Renminbi has remained stable against the U.S.
dollar. 64




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Taxation Bermuda Taxation There is no Bermuda income, corporation or profits tax, withholding tax,
capital gains tax, capital transfer tax, estate duty or inheritance tax payable
by shareholders of the Company other than by shareholders ordinarily resident
in Bermuda. Neither the Company nor its shareholders (other than shareholders
ordinarily resident in Bermuda) are subject to stamp or other similar duty on
the issue, transfer or redemption of Common Stock. The Company has received
from the Minister of Finance of Bermuda under the Exempted Undertakings Tax
Protection Act of 1966, as amended, an assurance that, in the event that
Bermuda enacts any legislation imposing any tax computed on profits or income,
or computed on any capital assets, gain or appreciation, or any tax in the
nature of estate duty or inheritance tax, the imposition of such tax shall not
be applicable to the Company or to any of its operations, shares, debentures or
other obligations of the Company, until March 28, 2016. This assurance does
not, however, prevent the imposition of any such tax or duty on such persons as
are ordinarily resident in Bermuda and holding such shares, debentures or
obligations of the Company or on land in Bermuda leased or let to the Company. As an exempted company, the Company is required to pay a registration fee
in Bermuda based upon its authorized share capital and the premium on the issue
of its shares, at rates calculated on a sliding scale not exceeding US$27,825
per annum. Peoples Republic of China Taxation The following discussion summarizes the taxes applicable to the Companys
investment in Yuchai and applicable to Yuchai under Chinese law. Taxation of Dividends from Yuchai Dividends distributed by Yuchai to the Company can be remitted from China
without any Chinese taxation. Although the Income Tax Law on Foreign Investment
Enterprises and Foreign Enterprises (the Foreign Investment Enterprise Tax
Law) provides that certain remittances of foreign exchange earnings from China
are subject to Chinese withholding tax, dividends received by foreign investors
from a foreign investment enterprise are exempt from withholding tax. Yuchai is
qualified as a foreign investment enterprise and, as a result, withholding tax
is not applicable to dividends received by the Company from Yuchai. Taxation of Disposition of Yuchai Shares In the event the Company transfers any of its current holding of the
Yuchai Shares, the amount received in excess of its original capital
contribution would be subject to Chinese withholding tax at a rate of 10%. In the event that Yuchai is liquidated, the portion of the balance of its
net assets or remaining property, after deducting undistributed profits,
various funds and liquidation expenses, that exceeds Yuchais paid-in capital
would be subject to withholding tax at a rate of 10%. Income Tax Yuchai is subject to the Foreign Investment Enterprise Tax Law. Pursuant
to this law, Sino-foreign joint stock companies generally are subject to an
income tax at a rate of 33%, including a national tax of 30% and a local tax of
3%. If an enterprise is located in specially designated regions, more favorable
effective rates apply. The Foreign Investment Enterprise Tax Law generally
exempts Sino-foreign joint stock companies engaged in manufacturing with an
operation term of more than ten years from national and local income taxes for
two years starting from the first profitable year of operations, followed by a
50% exemption for the next three years. The Detailed Rules for Performance of
the Foreign Investment Enterprise Tax Law (the Detailed Rules) and the
Guangxi Zhuang Autonomous Region Foreign Joint Venture Tax Incentives
Regulation (the Guangxi Tax Regulation) generally 65




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provide a three-year extension of the 50% tax exemption if a company meets the
standards of an advanced technology enterprise as defined under the regulation
and will be or has been operating for at least ten years. The Foreign
Investment Enterprise Tax Law and the Detailed Rules and the Guangxi Tax
Regulation also generally provide for a tax reduction to a 15% tax rate for
certain foreign-invested enterprises meeting the following criteria: (i) the
enterprise is in an industry involving energy, transportation, port or special
knowledge or technology, (ii) the enterprise is located in a coastal special
economic zone and (iii) the enterprise has foreign investment exceeding US$30
million. Under the tax law and regulations described above, Yuchai is qualified for
the reduced tax rate of 15%. As a Sino-foreign joint stock company, Yuchai was
also exempt from Chinese income tax for the years 1994 and 1995 and was
entitled to a 50% tax exemption for each of the years 1996 to 1998. In
addition, Yuchai has obtained approval to extend the 50% tax exemption for
three additional years from 1999 to 2001 based on its qualification as an
advanced technology enterprise as defined under the relevant local tax law and
regulations. However, based on current interpretations of the PRC income tax
law, Yuchai will be subject to a minimum tax rate of 10% during this three-year
extension. As a result, under current laws, Yuchai was subject to tax at a rate
of 7.5% during the three years from 1996 through 1998 and a rate of 10% during
the three years from 1999 through 2001. Since January 1, 2002, Yuchai is
subject to tax at a rate of 15% so long as it continues to qualify as a
foreign-invested enterprise eligible for such reduction. Value-Added Tax In addition to Chinese income tax, Yuchai is subject to tax on its sales.
Effective January 1, 1994, the Value-Added Tax Provisional Regulations subject
all goods produced or processed in China, other than real property and goods
produced or processed for export, to a value-added tax (VAT) at each stage or
sale in the process of manufacture, processing, distribution and sale to the
ultimate consumer. The basic VAT rate is 17% of the sale price of the item,
although certain goods are assessed at a preferential 13% VAT rate. The seller
of the goods adds 17% to the sale price of the item, which is separately
invoiced (except in the case of retail sales), and collects the applicable
amount of VAT through the sale of the item. The amount of the sellers VAT
liability to the Taxation Bureau is calculated as the amount of sales
multiplied by the applicable VAT rate. The amount of the sellers VAT liability
may be reduced by deducting the VAT included in the materials, parts and other
items purchased by the seller and used in producing the goods. The Value-Added Tax Provisional Regulations do not permit the seller to
deduct from its VAT liability the amount of VAT included in the purchase price
of fixed assets purchased by the seller. Thus, although the book value of fixed
assets, including plant and equipment, purchased by Yuchai will be the
depreciated cost (ordinarily the purchase price plus VAT in the case of
non-real property) of the fixed assets, Yuchai cannot deduct the amount of VAT
paid at the time of such purchase from its VAT liability in respect of products
sold. According to the Decision on the Use of Interim Regulations Concerning
Value-Added Taxes, Consumption Taxes and Business Taxes on Foreign-Funded
Enterprises and Foreign Enterprises adopted at the Fifth Meeting of the Eighth
Standing Committee of the National Peoples Congress on December 29, 1993, the
increased tax payment from the tax obligations arising from the levy of the
VAT, consumption taxes and business taxes will be refunded to foreign-funded
enterprises established prior to December 31, 1993 upon their application and
the relevant tax offices approval, for a period of no more than five years. In
August 1994, the Ministry of Finance and State Tax Bureau announced that the
goods produced and directly exported by foreign-funded enterprises are exempt
from VAT and consumption tax, but the following goods are excepted: (i) crude
oil, (ii) goods prohibited from being exported by the state include natural
bezoar, musk, bronze and acid bronze alloy, platinum and (iii) sugar. United States Federal Income Taxation This section describes the material United States Federal income tax
consequences of owning shares of Common Stock. It applies to a U.S. Holder (as
defined below) that holds the shares as capital assets for tax purposes. This 66




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section does not apply to a U.S. Holder that is a member of a special class of
holders subject to special rules, including:  
    
    a financial institution,  
    
    a dealer in securities,  
    
    a trader in securities that elects to use a mark-to-market method of accounting for its securities holdings,  
    
    a tax-exempt organization,  
    
    an insurance company,  
    
    a person liable for alternative minimum tax,  
    
    a person that actually or constructively owns 10% or more of the voting stock of the Company,  
    
    a person that holds shares as part of a straddle or a hedging or conversion transaction, or  
    
    a person whose functional currency is not the U.S. dollar. This section is based on the Internal Revenue Code of 1986, as amended,
its legislative history, existing and proposed regulations, published rulings
and court decisions, all as currently in effect. These laws are subject to
change, possibly on a retroactive basis. There is currently no comprehensive
income tax treaty between the United States and Bermuda. For purposes of this discussion, a U.S. Holder is a beneficial owner of
shares that is:  
    
    a citizen or resident of the United States,  
    
    a domestic corporation,  
    
    an estate the income of which is subject to United States Federal income tax regardless of its source, or  
    
    a trust, if a United States court can exercise primary supervision over the trusts administration and
one or more United States persons are authorized to control all substantial decisions of the trust. U.S. Holders should consult their own tax advisor regarding the United
States Federal, state and local and other tax consequences of owning and
disposing of shares in their particular circumstances. Taxation of Dividends Under the United States Federal income tax laws, and subject to the
passive foreign investment company (PFIC) rules discussed below, U.S. Holders
will include in gross income the gross amount of any dividend paid by the
Company out of its current or accumulated earnings and profits (as determined
for United States Federal income tax purposes). The dividend is ordinary income
that the U.S. Holder must include in income when the dividend is actually or
constructively received. The dividend will not be eligible for the
dividends-received deduction generally allowed to United States corporations in
respect of dividends received from other United States corporations. The amount
of the dividend distribution includible in the income of a U.S. Holder will be
the U.S. dollar value of the Bermuda dollar payments made, determined at the
spot Bermuda dollar/U.S. dollar rate on the date the dividend distribution is
includible in the income of the U.S. Holder, regardless of whether the payment
is in fact converted 67




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into U.S. dollars. Generally, any gain or loss resulting from currency exchange
fluctuations during the period from the date the dividend payment is includible
in income to the date such payment is converted into U.S. dollars will be
treated as ordinary income or loss. Such gain or loss generally will be income
or loss from sources within the United States for foreign tax credit limitation
purposes. Distributions in excess of current and accumulated earnings and
profits, as determined for United States Federal income tax purposes, will be
treated as a non-taxable return of capital to the extent of the U.S. Holders
basis in the shares and thereafter as capital gain. Under recently enacted legislation, with respect to noncorporate taxpayers
for taxable years beginning after December 1, 2002 and before January 1, 2009,
dividends may be taxed at the lower applicable capital gains rate provided that
(1) the common stock is readily tradable on an established securities market in
the United States, (2) the Company is not a passive foreign investment company
(as discussed below) for either the Companys taxable year in which the
dividend was paid or the preceding taxable year, and (3) certain holding period
requirements are met. Common stock is considered for purposes of clause (1)
above to be readily tradable on an established securities market if it is
listed on the New York Stock Exchange. U.S. Holders should consult their tax
advisors regarding the availably of the lower rate for dividends paid with
respect to the Companys common stock. For foreign tax credit limitation purposes, the dividend will be income
from sources outside the United States, but generally will be treated
separately, together with other items of passive income or financial
services income. Taxation of Capital Gains Subject to the PFIC rules discussed below, upon the sale or other
disposition of shares, a U.S. Holder will recognize capital gain or loss for
United States Federal income tax purposes equal to the difference between the
U.S. dollar value of the amount realized and the U.S. Holders tax basis,
determined in U.S. dollars, in such shares. Capital gain of a non-corporate
U.S. Holder is generally taxed at a reduced rate where the property is held
more than one year. The gain or loss will generally be income or loss from
sources within the United States for foreign tax credit limitation purposes. PFIC Rules The Company believes that its shares should not be treated as stock of a
PFIC for United States Federal income tax purposes, but this conclusion is a
factual determination that is made annually and thus may be subject to change.
If the Company were to be treated as a PFIC, unless a U.S. Holder elects to be
taxed annually on a mark-to-market basis with respect to the shares (which
election may be made only if the Companys shares are marketable stock), gain
realized on the sale or other disposition of such shares would in general not
be treated as capital gain. Instead, a U.S. Holder would be treated as if such
holder had realized such gain and certain excess distributions ratably over
the holders holding period for the shares and would be taxed at the highest
tax rate in effect for each such year to which the gain was allocated, together
with an interest charge in respect of the tax attributable to each such year. Documents on Display It is possible to read and copy documents referred to in this annual
report on Form 20-F that have been filed with the SEC at the SECs public
reference room located at 450 Fifth Street, NW, Washington, D.C. 20549. Please
call the SEC at 1-800-SEC-0330 for further information on the public reference
rooms and their copy charges. Additional information may also be obtained over
the internet at the SECs website at http://www.sec.gov. 68




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ITEM 11.  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK. The Company is subject to market rate risks due to fluctuations in
interest rates. The majority of the Companys debt is variable rate short-term
and long-term Renminbi denominated loans obtained from banks in China. The
interest rates of such loans are generally established in accordance with
directives announced from time to time by the Peoples Bank of China, which are
in turn affected by various factors such as the general economic conditions in
China and the monetary polices of the Chinese government. There is no ready
market in China for the Company to enter into interest rate swaps or other
instruments designed to mitigate its exposure to interest rate risks. The Company is exposed to foreign currency risk as a result of having to
obtain certain key components used in the manufacturing of the 6112 heavy-duty
engine from overseas suppliers. At December 31, 2003, the Company did not have
any loans that were denominated in a foreign currency. The following table provide certain interest rate risk information
regarding the Companys short-term and long-term bank loans as of December 31,
2003: As of December 31, 2003
    
    As of December 31, 2002Expected maturity dates
    
    Total
    
    Estimated
    
    Total
    
    Estimatedcarrying
    
    fair
    
    carrying
    
    fair2003
    
    2004
    
    amount
    
    value(2)
    
    amount
    
    value(2)(Expressed in Rmb thousands, except interest rate)Floating
rate debt:(i)
    
    Short-term bank loans denominated in Rmb
    
    
    240,000
    
    
    
    
    
    
    
    240,000
    
    
    
    240,000
    
    
    
    135,000
    
    
    
    135,000Weighted average interest
rate(1)
    
    
    4.98%
    
    
    
    
    
    
    
    4.98%
    
    
    
    
    
    
    
    5.12%(ii)
    
    Long-term bank loans denominated in Rmb
    
    
    
    
    
    
    50,000
    
    
    
    50,000
    
    
    
    50,000
    
    
    
    180,000
    
    
    
    180,000Weighted average interest
rate(1)
    
    
    
    
    
    
    5.94%
    
    
    
    5.94%
    
    
    
    
    
    
    
    5.94%
   (1)
    
    Weighted average interest rate is calculated based on the estimated interest rates applicable to individual bank loans outstanding as of
December 31, 2003 and 2002.(2)
    
    Fair value was estimated based on the floating interest rates applicable to similar loan instruments. 
 ITEM 12.  DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES. Not Applicable. 
 PART II 
 ITEM 13.  DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES. There has not been any dividend arrearage or other material delinquency
with respect to preferred stock of either the Company or Yuchai. 
 ITEM 14.  MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS. Not Applicable. 69




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ITEM 15.  CONTROLS AND PROCEDURES. The Company maintains disclosure controls and procedures that are designed
to ensure that information required to be disclosed in its SEC reports 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 its management, including its Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions regarding required
disclosures. In designing and evaluating the disclosure controls and
procedures, management recognized that any controls and procedures, no matter
how well designed and operated, can provide only a reasonable level of
assurance of achieving the desired control objectives, and, in reaching a
reasonable level of assurance, management necessarily was required to apply its
judgment in evaluating the cost-benefit relationship of possible controls and
procedures. As required by SEC Rule 13a-15(b), the Company has carried out an
evaluation, under the supervision and with the participation of its management,
including its Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of its disclosure controls and
procedures as of the end of the period covered by this report. Based on the
foregoing, the Companys Chief Executive Officer and Chief Financial Officer
concluded that its disclosure controls and procedures were effective at the
reasonable assurance level, except as set forth below. As a general matter, the Company requires access to certain financial
books and records of Yuchai so as to be able to monitor its investment in
Yuchai and to prepare the Companys consolidated financial statements. In
early 2004, Yuchai management temporarily denied the Company such access. In
response, the Company initiated dialogue with representatives of Yuchai and
shortly thereafter persuaded Yuchai management to re-allow the Company full
access to the financial books and records of Yuchai. Other than as described
above, there have been no significant changes in the Companys disclosure
controls and procedures or in other factors that could significantly affect its
disclosure controls and procedures subsequent to the date the Company completed
its evaluation. 
 ITEM 16A.  AUDIT COMMITTEE FINANCIAL EXPERT. The Companys Audit Committee members are Messrs. Liu Chee Ming
(chairman), Raymond C. K. Ho and Philip Ting Sii Tien. Please see Item 6.
Directors, Senior Management and Employees for their experience and
qualifications. Although not considered independent pursuant to the SECs
rules, the Board has designated Mr. Philip Ting Sii Tien as the Companys Audit
Committee Financial Expert. 
 ITEM 16B.  CODE OF ETHICS. The Company adopted a Code of Ethics in May 2004 that is applicable to all
its directors, senior management and employees. The Code of Ethics contains
general guidelines for conducting the business of the Company. The Company
will make available a copy of the Code of Ethics to any person without charge,
if a written request is made to the Companys executive office at 16 Raffles
Quay #26-00 Hong Leong Building, Singapore 048581. Since adoption of the
Companys Code of Ethics, the Company has not granted any waivers or exemption
therefrom. 
 ITEM 16C.  PRINCIPAL ACCOUNTANTS FEES AND SERVICES. The following table set forth the total remuneration that was paid by the
Company and Yuchai to its independent accountants, KPMG, in each of our
previous two fiscal years: 70




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Audit fees
    
    Audit-related fees
    
    Tax fees
    
    Others
    
    Total(Expressed in Rmb thousands)2002
    
    
    1,862
    
    
    
    414
    
    
    
    
    
    
    
    
    
    
    
    2,2762003
    
    
    2,830
    
    
    
    689
    
    
    
    
    
    
    
    
    
    
    
    3,519
 Audit fees Services provided primarily consist of professional services relating to
the annual audits of consolidated financial statements as well as statutory
audits required by foreign jurisdictions and quarterly reviews. Audit-related fees Services provided primarily consist of services connected with securities
filing documents, issuance of consents, accounting issues research and
technical assistance. Tax fees Services provided primarily consist of routine corporate tax advisory
services and compilation of corporate tax returns. Others Services provided primarily consist of provision of training and research
materials. The Companys Audit Committee has pre-approved the terms of KPMGs
engagement by the Company for services to be performed for the Company during
2004. 
 ITEM 16D.  EXEMPTION FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES. The current NYSE rules require that the Companys Audit Committee be
comprised solely of independent directors. Although two of the Companys Audit
Committee members qualify as independent directors under the NYSE rules, the
Company is currently exempt from this requirement pursuant to an exemption
previously received from the NYSE. The Company intends to change the
composition of its Audit Committee so that it is fully compliant with the new
audit committee requirements promulgated by the SEC and NYSE by July 2005, when
compliance with such rules becomes mandatory. 
 ITEM 16E.  PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS. Not Applicable. 
 PART III 
 ITEM 17.  FINANCIAL STATEMENTS. The Company has elected to provide the financial statements and related
information specified in Item 18 in lieu of Item 17. 71




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ITEM 18.  FINANCIAL STATEMENTS. Index to Financial Statements China Yuchai International Limited Report of Independent Registered Public Accounting Firm
    
    
    F-2Consolidated Statements of Income for Years Ended December 31, 2001, 2002 and 2003
    
    
    F-3Consolidated Balance Sheets as of December 31, 2002 and 2003
    
    
    F-4Consolidated Statements of Changes in Stockholders Equity for Years Ended December
31, 2001, 2002 and 2003
    
    
    F-6Consolidated Statements of Cash Flows for Years Ended December 31, 2001, 2002 and 2003
    
    
    F-7Notes to Consolidated Financial Statements
    
    
    F-10
 
 ITEM 19.  EXHIBITS. Exhibits to this Annual Report:1.1
    
    Memorandum of Association of China Yuchai International Limited (the
Registrant) (incorporated herein by reference to the Registration Statement
on Form F-1, filed by the Registrant on November 9, 1994 (File No. 33-86162)
(the Form F-1)).1.2
    
    Bye-laws of the Registrant (incorporated herein by reference to the Form F-1).3.1
    
    Subscription and Shareholders Agreement of Diesel Machinery (BVI) Limited,
dated November 9, 1994, among Diesel Machinery (BVI) Limited, Hong Leong Asia
(HLA) and China Everbright Holdings Company Limited (EB Holdings)
(incorporated herein by reference to the Form F-1).3.2
    
    Supplemental Subscription and Shareholders Agreement, dated January 21, 2002,
between EB Holdings and HLA (incorporated herein by reference to the Annual
Report on Form 20-F for fiscal year ended December 31, 2001, filed by the
Registrant on June 25, 2002 (the Form 20-F FY 2001).3.3
    
    Second Supplemental Subscription and Shareholders Agreement, dated May 17,
2002, between EB Holdings and HLA (incorporated herein by reference to the Form
20-F FY 2001).4.1
    
    Contract for the Subscription of Foreign Common Shares in Guangxi Yuchai
Machinery Company Limited (Yuchai) and Conversion from a Joint Stock Limited
Company into a Sino-Foreign Joint Stock Limited Company, dated April 1, 1993,
among Yuchai, Guangxi Yuchai Machinery Holdings Company, Hong Leong Technology
Systems (BVI) Ltd., Cathay Clemente Diesel Holdings Limited, Goldman Sachs
Guangxi Holdings (BVI) Ltd., Tsang & Ong Nominees (BVI) Ltd. and Youngstar
Holdings Limited, with amendments, dated May 27, 1994 and October 10, 1994
(incorporated herein by reference to the Form F-1).4.2
    
    Subscription and Transfer Agreement (with Shareholders Agreement), dated April
1993, among Cathay Clemente (Holdings) Limited, GS Capital Partners L.P., Sun
Yuan Overseas Pte Ltd., HL Technology Systems Pte Ltd. and Coomber Investments
Limited (incorporated herein by reference to the Form F-1).4.3
    
    Amended and Restated Shareholders Agreement, dated as of November 9, 1994
among the Cathay Investment Fund, Limited, GS Capital Partners L.P., HL
Technology Systems Pte. Ltd., Coomber Investments Limited, owners of shares
formerly held by Sun Yuan Overseas (BVI) Ltd., and the Registrant (incorporated
herein by reference to the Form F-1).
 72




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##### Table of Contents



4.4
    
    Form of Amended and Restated Registration Right Agreement, dated as of November
9, 1994, among the Cathay Investment Fund, Limited, GS Capital Partners L.P.,
HL Technology Systems Pte. Ltd., Coomber Investments Limited, owners of shares
formerly held by Sun Yuan Overseas (BVI) Ltd,. and the Registrant (incorporated
herein by reference to the Form F-1).4.5
    
    Form of Subscription Agreement between the Registrant, its wholly-owned
subsidiaries named therein and Yuchai (incorporated herein by reference to the
Form F-1).4.6
    
    Form of Term Loan Agreement between the Registrant and Yuchai (incorporated
herein by reference to the Form F-1).4.7
    
    Share Purchase and Subscription Agreement, dated as of November 9, 1994,
between (i) the Registrant, (ii) China Everbright Holdings Company Limited and
(iii) Coomber Investments Limited (incorporated herein by reference to the Form
F-1).4.8
    
    Investment and Shareholders Agreement between CACG Limited IV and Guangxi
Yuchai Machinery Company Limited, dated July 14, 1994, with a First Amendment
dated September 5, 1994 (incorporated herein by reference to the Form F-1).4.9
    
    Employment Agreement, dated September 5, 2003, between Yuchai and Wang Jianming.4.10
    
    Form of indemnification agreement entered into by the Company with each of
Wrixon Frank Gasteen, Gao Jia Lin, Gan Khai Choon, Raymond C.K. Ho, Kwek Leng
Peck, Liu Chee Ming, Wong Hong Ren, Philip Ting Sii Tien, Lim Poh Lea and
Sheila Murugasu.4.11
    
    Agreement between the Company and Yuchai, dated July 19, 2003.8.1
    
    Subsidiaries of the Registrant.12.1
    
    Certifications furnished
pursuant to Section 302 of the Sarbanes-Oxley Act.13.1
    
    Certifications furnished
pursuant to Section 906 of the Sarbanes-Oxley Act.14.1
    
    Consent of Independent Registered Public Accounting Firm.
 73




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SIGNATURES Pursuant to the requirements of Section 12 of the Securities Exchange Act
of 1934, the registrant certifies that it meets all of the requirements for
filing on Form 20-F and has duly caused this Annual Report to be signed on its
behalf by the undersigned, thereunto duly authorized.  CHINA YUCHAI INTERNATIONAL LIMITEDBy:
    /s/ Philip Ting Sii TienName:
    Philip TING Sii TienTitle:
    Chief Financial Officer and Director Date: June 29, 2004 74




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##### Table of Contents



Exhibit Index ExhibitNumber
    
    Description of Exhibit1.1
    
    Memorandum of Association of China Yuchai International Limited (the
Registrant) (incorporated herein by reference to the Registration Statement on
Form F-1, filed by the Registrant on November 9, 1994 (File No. 33-86162) (the
Form F-1)).1.2
    
    Bye-laws of the Registrant (incorporated herein by reference to the Form F-1).3.1
    
    Subscription and Shareholders Agreement of Diesel Machinery (BVI) Limited,
dated November 9, 1994, among Diesel Machinery (BVI) Limited, Hong Leong Asia
(HLA) and China Everbright Holdings Company Limited (EB Holdings)
(incorporated herein by reference to the Form F-1).3.2
    
    Supplemental Subscription and Shareholders Agreement, dated January 21, 2002,
between EB Holdings and HLA (incorporated herein by reference to the Form 20-F
FY 2001).3.3
    
    Second Supplemental Subscription and Shareholders Agreement, dated May 17,
2002, between EB Holdings and HLA (incorporated herein by reference to the Form
20-F FY 2001).4.1
    
    Contract for the Subscription of Foreign Common shares in Guangxi Yuchai
Machinery Company Limited (Yuchai) and Conversion from a Joint Stock Limited
Company into a Sino-Foreign Joint Stock Limited Company, dated April 1, 1993,
among Yuchai, Guangxi Yuchai Machinery Holdings Company, Hong Leong Technology
Systems (BVI) Ltd., Cathay Clemente Diesel Holdings Limited, Goldman Sachs
Guangxi Holdings (BVI) Ltd., Tsang & Ong Nominees (BVI) Ltd. and Youngstar
Holdings Limited with amendments, dated May 27, 1994 and October 10, 1994
(incorporated herein by reference to the Form F-1).4.2
    
    Subscription and Transfer Agreement (with Shareholders Agreement), dated April
1993, among Cathay Clemente (Holdings) Limited, GS Capital Partners L.P., Sun
Yuan Overseas Pte Ltd., HL Technology Systems Pte Ltd. and Coomber Investments
Limited (incorporated herein by reference to the Form F-1).4.3
    
    Amended and Restated Shareholders Agreement, dated as of November 9, 1994
among The Cathay Investment Fund, Limited, GS Capital Partners L.P., HL
Technology Systems Pte. Ltd., Coomber Investments Limited, owners of shares
formerly held by Sun Yuan Overseas (BVI) Ltd. and the Registrant (incorporated
herein by reference to the Form F-1).4.4
    
    Form of Amended and Restated Registration Right Agreement, dated as of November
9, 1994, among The Cathay Investment Fund, Limited, GS Capital Partners L.P.,
HL Technology Systems Pte. Ltd., Coomber Investments Limited, owners of shares
formerly held by Sun Yuan Overseas (BVI) Ltd. and the Registrant (incorporated
herein by reference to the Form F-1).4.5
    
    Form of Subscription Agreement between the Registrant and its wholly-owned
subsidiaries named therein and Yuchai (incorporated herein by reference to the
Form F-1).4.6
    
    Form of Term Loan Agreement between the Registrant and Yuchai (incorporated
herein by reference to the Form F-1).4.7
    
    Share Purchase and Subscription Agreement, dated as of November 9, 1994,
between (i) the Registrant, (ii) China Everbright Holdings Company Limited and
(iii) Coomber Investments Limited (incorporated herein by
reference to the Form F-1).
 75




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##### Table of Contents



ExhibitNumber
    
    Description of Exhibit4.8
    
    Investment and Shareholders Agreement between CACG Limited IV and Guangxi
Yuchai Machinery Company Limited, dated July 14, 1994 with a
First Amendment dated September 5, 1994 (incorporated herein by reference to the Form F-1).4.9
    
    Employment Agreement, dated September 5, 2003, between Yuchai and Wang Jianming.4.10
    
    Form of indemnification agreement entered into by the Company with each of
Wrixon Frank Gasteen, Gao Jia Lin, Gan Khai Choon, Raymond C.K. Ho, Kwek Leng
Peck, Liu Chee Ming, Wong Hong Ren, Philip Ting Sii Tien, Lim Poh Lea and
Sheila Murugasu.4.11
    
    Agreement between the Company and Yuchai, dated July 19, 2003.8.1
    
    Subsidiaries of the Registrant.12.1
    
    Certifications furnished pursuant to Section 302 of the Sarbanes-Oxley Act.13.1
    
    Certifications furnished pursuant to Section 906 of the Sarbanes-Oxley Act.14.1
    
    Consent of Independent Registered Public Accounting Firm.
 76




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001, 2002 and 2003 (With Independent Auditors Report Thereon) Index to Financial Statements China Yuchai International Limited Report of Independent Registered Public Accounting Firm
    
    
    F-2Consolidated Statements of Income for Years Ended December 31, 2001, 2002 and 2003
    
    
    F-3Consolidated Balance Sheets as of December 31, 2002 and 2003
    
    
    F-4Consolidated Statements of Changes in Stockholders Equity for Years Ended December 31, 2001, 2002 and 2003
    
    
    F-6Consolidated Statements of Cash Flows for Years Ended December 31, 2001, 2002 and 2003
    
    
    F-7Notes to Consolidated Financial Statements
    
    
    F-10
 F-1




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##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders
China Yuchai International Limited (the Company) We have audited the accompanying consolidated balance sheets of the Company and
subsidiaries as of December 31, 2002 and 2003, and the related consolidated
statements of income, stockholders equity and cash flows for each of the years
in the three-year period ended December 31, 2003, all expressed in Renminbi.
These consolidated financial statements are the responsibility of the Companys
management. 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
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the 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. In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company and
subsidiaries as of December 31, 2002 and 2003, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2003 in conformity with accounting principles generally
accepted in the United States of America. As discussed in Notes 3(n) and 16 to the consolidated financial statements, the
Company changed its method of accounting for goodwill in 2002. The accompanying consolidated financial statements as of and for the year ended
December 31, 2003 have been translated into United States dollars solely for
the convenience of the reader. We have audited the translation and, in our
opinion, the consolidated financial statements expressed in Renminbi have been
translated into United States dollars on the basis set forth in Note 3(i) to
the consolidated financial statements. /s/ KPMG Certified Public Accountants
Hong Kong,
March 24, 2004 F-2




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CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003(Rmb and US$ amounts expressed in thousands, except per share data) Years ended December 31,Note
    
    2001
    
    2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    Rmb
    
    US$Net sales
    
    
    3(k), 29
    
    
    
    1,783,329
    
    
    
    3,513,047
    
    
    
    4,569,950
    
    
    
    552,146Cost of goods sold
    
    
    4
    
    
    
    1,183,403
    
    
    
    2,371,080
    
    
    
    3,192,794
    
    
    
    385,756Gross profit
    
    
    
    
    
    
    599,926
    
    
    
    1,141,967
    
    
    
    1,377,156
    
    
    
    166,390Research and development
cost
    
    
    3(m)
    
    
    
    44,721
    
    
    
    75,532
    
    
    
    94,594
    
    
    
    11,429Selling, general and
administrative
expense
    
    
    3(m), 4, 12,
    
    
    
    243,231
    
    
    
    426,128
    
    
    
    561,151
    
    
    
    67,80022, 24(b)Amortization of goodwill
    
    
    3(n), 16
    
    
    
    16,859
    
    
    
    
    
    
    
    
    
    
    
    Operating income
    
    
    
    
    
    
    295,115
    
    
    
    640,307
    
    
    
    721,411
    
    
    
    87,161Interest cost
    
    
    3(u), 5
    
    
    
    29,784
    
    
    
    25,144
    
    
    
    23,624
    
    
    
    2,854Other (income)/expense, net
    
    
    6
    
    
    
    (3,858
    )
    
    
    (10,287
    )
    
    
    881
    
    
    
    106Income before income taxes
and minority interests
    
    
    
    
    
    
    269,189
    
    
    
    625,450
    
    
    
    696,906
    
    
    
    84,201Income tax (credit)/expense
    
    
    7
    
    
    
    (63,584
    )
    
    
    83,242
    
    
    
    112,924
    
    
    
    13,644Income before minority
interests
    
    
    
    
    
    
    332,773
    
    
    
    542,208
    
    
    
    583,982
    
    
    
    70,557Minority interests in income of
consolidated subsidiaries
    
    
    
    
    
    
    82,386
    
    
    
    129,775
    
    
    
    145,800
    
    
    
    17,615Net income
    
    
    
    
    
    
    250,387
    
    
    
    412,433
    
    
    
    438,182
    
    
    
    52,942Net income attributable
to common sharesBasic and diluted
    
    
    3(l)
    
    
    
    7.09
    
    
    
    11.67
    
    
    
    12.40
    
    
    
    1.50Weighted average number
of shares
    
    
    3(l)
    
    
    
    35,340,000
    
    
    
    35,340,000
    
    
    
    35,340,000
    
    
    
    35,340,000
 See accompanying notes to consolidated financial statements. F-3




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CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2002 AND 2003(Rmb and US$ amounts expressed in thousands, except per share data) December 31,Note
    
    2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    US$ASSETSCurrent assetsCash and cash equivalents
    
    
    
    
    
    
    643,200
    
    
    
    631,938
    
    
    
    76,352Trade accounts receivable, net
    
    
    8
    
    
    
    1,003,135
    
    
    
    849,611
    
    
    
    102,651Amounts due from related companies
    
    
    9, 24(d)
    
    
    
    16,367
    
    
    
    55,011
    
    
    
    6,646Inventories, net
    
    
    10
    
    
    
    843,229
    
    
    
    877,334
    
    
    
    106,000Prepaid expenses
    
    
    
    
    
    
    102,248
    
    
    
    37,496
    
    
    
    4,531Other receivables, net
    
    
    11
    
    
    
    18,718
    
    
    
    8,833
    
    
    
    1,067Total current assets
    
    
    
    
    
    
    2,626,897
    
    
    
    2,460,223
    
    
    
    297,247Property, plant and equipment, net
    
    
    12
    
    
    
    772,968
    
    
    
    735,641
    
    
    
    88,881Construction in progress
    
    
    13
    
    
    
    121,867
    
    
    
    397,644
    
    
    
    48,044Lease prepayments, net
    
    
    14
    
    
    
    85,576
    
    
    
    78,216
    
    
    
    9,450Investments
    
    
    15
    
    
    
    5,705
    
    
    
    5,705
    
    
    
    689Amount due from a related company
    
    
    9, 24(d)
    
    
    
    9,990
    
    
    
    
    
    
    
    Goodwill
    
    
    16
    
    
    
    212,636
    
    
    
    212,636
    
    
    
    25,691Deferred income taxes
    
    
    7
    
    
    
    149,820
    
    
    
    143,567
    
    
    
    17,346Total assets
    
    
    
    
    
    
    3,985,459
    
    
    
    4,033,632
    
    
    
    487,348LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilitiesShort-term bank loans
    
    
    17(a)
    
    
    
    135,000
    
    
    
    240,000
    
    
    
    28,997Current installments of long-term bank
loans
    
    
    17(b)
    
    
    
    130,000
    
    
    
    50,000
    
    
    
    6,041Amount due to holding company
    
    
    24(f)
    
    
    
    2,100
    
    
    
    6,208
    
    
    
    750Amounts due to related companies
    
    
    9, 24(d)
    
    
    
    25,409
    
    
    
    25,617
    
    
    
    3,095Trade accounts payable
    
    
    
    
    
    
    628,901
    
    
    
    731,966
    
    
    
    88,437Income taxes payable
    
    
    
    
    
    
    58,410
    
    
    
    47,229
    
    
    
    5,706Accrued expense and other liabilities
    
    
    18
    
    
    
    306,245
    
    
    
    396,399
    
    
    
    47,894Total current liabilities
    
    
    
    
    
    
    1,286,065
    
    
    
    1,497,419
    
    
    
    180,920Long-term bank loans, excluding
current instalments
    
    
    17(b)
    
    
    
    50,000
    
    
    
    
    
    
    
    Total liabilities carried forward
    
    
    
    
    
    
    1,336,065
    
    
    
    1,497,419
    
    
    
    180,920
 F-4




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2002 AND 2003 (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data) December 31,Note
    
    2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    US$Total liabilities brought forward
    
    
    
    
    
    
    1,336,065
    
    
    
    1,497,419
    
    
    
    180,920Minority interests
    
    
    
    
    
    
    487,491
    
    
    
    544,526
    
    
    
    65,790Stockholders equityCommon stock
    
    
    
    
    
    
    30,349
    
    
    
    30,349
    
    
    
    3,667Ordinary shares US$0.10 par value:authorized 100,000,000 shares;
issued and outstanding 35,340,000
shares at December 31, 2002 and 2003Special share US$0.10 par value:authorized 1 share; issued and
outstanding 1 share at December 31,
2002 and 2003
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Contributed surplus
    
    
    
    
    
    
    1,486,934
    
    
    
    1,486,934
    
    
    
    179,653Statutory reserves
    
    
    20
    
    
    
    170,806
    
    
    
    229,920
    
    
    
    27,779Retained earnings
    
    
    
    
    
    
    473,814
    
    
    
    244,484
    
    
    
    29,539Total stockholders equity
    
    
    
    
    
    
    2,161,903
    
    
    
    1,991,687
    
    
    
    240,638Commitments and contingencies
    
    
    21,22Total liabilities and stockholders equity
    
    
    
    
    
    
    3,985,459
    
    
    
    4,033,632
    
    
    
    487,348
 See accompanying notes to consolidated financial statements. F-5




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
FOR YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003(Rmb and US$ amounts expressed in thousands, except per share data) (Accumulateddeficits)/
    
    TotalCommon
    
    Contributed
    
    Statutory
    
    retained
    
    stockholders'Note
    
    stock
    
    surplus
    
    reserves
    
    earnings
    
    equityRmb
    
    Rmb
    
    Rmb
    
    Rmb
    
    RmbBalance at January 1,
2001
    
    
    
    
    
    
    30,349
    
    
    
    1,486,934
    
    
    
    117,786
    
    
    
    (74,561
    )
    
    
    1,560,508Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    250,387
    
    
    
    250,387Transfer to statutory
reserves
    
    
    20
    
    
    
    
    
    
    
    
    
    
    
    898
    
    
    
    (898
    )
    
    
    Dividend declared
(US$0.02 per share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,850
    )
    
    
    (5,850
    )Balance at December
31, 2001
    
    
    
    
    
    
    30,349
    
    
    
    1,486,934
    
    
    
    118,684
    
    
    
    169,078
    
    
    
    1,805,045Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    412,433
    
    
    
    412,433Transfer to statutory
reserves
    
    
    20
    
    
    
    
    
    
    
    
    
    
    
    52,122
    
    
    
    (52,122
    )
    
    
    Dividend declared
(US$0.19 per share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (55,575
    )
    
    
    (55,575
    )Balance at December
31, 2002
    
    
    
    
    
    
    30,349
    
    
    
    1,486,934
    
    
    
    170,806
    
    
    
    473,814
    
    
    
    2,161,903Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    438,182
    
    
    
    438,182Transfer to statutory
reserves
    
    
    20
    
    
    
    
    
    
    
    
    
    
    
    59,114
    
    
    
    (59,114
    )
    
    
    Dividend declared
(US$2.08 per share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (608,398
    )
    
    
    (608,398
    )Balance at December
31, 2003
    
    
    
    
    
    
    30,349
    
    
    
    1,486,934
    
    
    
    229,920
    
    
    
    244,484
    
    
    
    1,991,687
 See accompanying notes to consolidated financial statements. F-6




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003(Rmb and US$ amounts expressed in thousands) Years ended December 31,2001
    
    2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    Rmb
    
    US$Cash provided by
operating activitiesNet income
    
    
    250,387
    
    
    
    412,433
    
    
    
    438,182
    
    
    
    52,942Adjustments to reconcile
net income to net cash
provided by operating
activities: Depreciation and
amortization of
property, plant and
equipment, and lease
prepayments
    
    
    113,680
    
    
    
    118,872
    
    
    
    125,519
    
    
    
    15,165 Impairment of property,
plant and equipment
    
    
    
    
    
    
    23,120
    
    
    
    12,405
    
    
    
    1,499 Loss on disposal of
property, plant and
equipment
    
    
    249
    
    
    
    7,276
    
    
    
    3,359
    
    
    
    406 Deferred income taxes
    
    
    (94,404
    )
    
    
    (31,221
    )
    
    
    6,253
    
    
    
    755 Amortization of goodwill
    
    
    16,859
    
    
    
    
    
    
    
    
    
    
    
     Minority interests
    
    
    82,386
    
    
    
    129,775
    
    
    
    145,800
    
    
    
    17,615Decrease/(increase) in
assets Inventories, net
    
    
    (175,774
    )
    
    
    (298,560
    )
    
    
    (34,105
    )
    
    
    (4,120
    ) Amounts due from/(to)
related companies
    
    
    40,965
    
    
    
    20,926
    
    
    
    (36,446
    )
    
    
    (4,404
    ) Trade accounts
receivable, net
    
    
    (245,225
    )
    
    
    (229,346
    )
    
    
    153,524
    
    
    
    18,549 Prepaid expenses
    
    
    (106,485
    )
    
    
    79,577
    
    
    
    64,752
    
    
    
    7,824 Other receivables
    
    
    2,826
    
    
    
    8,631
    
    
    
    9,885
    
    
    
    1,194Increase/(decrease) in
liabilities Trade accounts payable
    
    
    136,785
    
    
    
    279,588
    
    
    
    103,065
    
    
    
    12,452 Income taxes payable
    
    
    5,743
    
    
    
    53,260
    
    
    
    (11,181
    )
    
    
    (1,351
    ) Accrued expense and
other liabilities
    
    
    30,474
    
    
    
    92,843
    
    
    
    90,154
    
    
    
    10,893 Amount due to holding
company
    
    
    807
    
    
    
    (7,674
    )
    
    
    4,108
    
    
    
    497Net cash provided by
operating activities
    
    
    59,273
    
    
    
    659,500
    
    
    
    1,075,274
    
    
    
    129,916
 F-7




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003 (CONTINUED)(Rmb and US$ amounts expressed in thousands) Years ended December 31,2001
    
    2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    Rmb
    
    US$Cash flow from investing
activitiesPurchase of property, plant
and equipment, lease
prepayments and
construction in progress
    
    
    (43,043
    )
    
    
    (174,850
    )
    
    
    (372,775
    )
    
    
    (45,039
    )Proceeds from disposal of
property, plant and
equipment
    
    
    298
    
    
    
    686
    
    
    
    402
    
    
    
    49Proceeds from redemption
of government bonds
    
    
    63
    
    
    
    
    
    
    
    
    
    
    
    Net cash used in investing
activities
    
    
    (42,682
    )
    
    
    (174,164
    )
    
    
    (372,373
    )
    
    
    (44,990
    )Cash flow from financing
activitiesProceeds from short-term
bank loans
    
    
    215,000
    
    
    
    135,000
    
    
    
    230,000
    
    
    
    27,789Proceeds from short-term
borrowing from a
related party
    
    
    
    
    
    
    
    
    
    
    8,000
    
    
    
    967Proceeds from long-term
bank loans
    
    
    80,000
    
    
    
    
    
    
    
    
    
    
    
    Repayment of short-term
bank loans
    
    
    (225,000
    )
    
    
    (225,000
    )
    
    
    (125,000
    )
    
    
    (15,103
    )Repayment of long-term
bank loans
    
    
    (70,000
    )
    
    
    (40,000
    )
    
    
    (130,000
    )
    
    
    (15,707
    )Capital contribution from
minority shareholders
    
    
    164
    
    
    
    
    
    
    
    
    
    
    
    Dividend paid by
subsidiaries to minority
shareholders
    
    
    (22,316
    )
    
    
    (62,829
    )
    
    
    (88,765
    )
    
    
    (10,725
    )Dividend paid to
shareholders
    
    
    (2,925
    )
    
    
    (58,500
    )
    
    
    (608,398
    )
    
    
    (73,507
    )Net cash used in financing
activities
    
    
    (25,077
    )
    
    
    (251,329
    )
    
    
    (714,163
    )
    
    
    (86,286
    )
 F-8




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003 (CONTINUED)(Rmb and US$ amounts expressed in thousands) Years ended December 31,2001
    
    2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    Rmb
    
    US$Net (decrease)/increase
in cash and cash equivalents
    
    
    (8,486
    )
    
    
    234,007
    
    
    
    (11,262
    )
    
    
    (1,360
    )Cash and cash equivalents
at beginning of year
    
    
    417,679
    
    
    
    409,193
    
    
    
    643,200
    
    
    
    77,712Cash and cash equivalents
at end of year
    
    
    409,193
    
    
    
    643,200
    
    
    
    631,938
    
    
    
    76,352Supplemental disclosures
of cash flow informationCash paid during the year
for: Interest, net of amount
capitalized
    
    
    29,784
    
    
    
    25,144
    
    
    
    23,624
    
    
    
    2,854 Income taxes
    
    
    25,077
    
    
    
    61,203
    
    
    
    117,852
    
    
    
    14,239
 See accompanying notes to consolidated financial statements. F-9




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Rmb and US$ amounts expressed in thousands, except per share data)  1.
    
    Background and principal activities China Yuchai International Limited (the Company) was incorporated under the
laws of Bermuda on April 29, 1993. The Company was established to acquire a
controlling interest in Guangxi Yuchai Machinery Company Limited (Yuchai), a
Sino-foreign joint stock company which manufactures, assembles and sells diesel
engines in the Peoples Republic of China (the PRC). The principal markets
for Yuchais diesel engines are medium-duty truck manufacturers in the PRC. The Company owns, through six wholly-owned subsidiaries, 361,420,150 shares or
76.41% of the issued share capital of Yuchai which it acquired through a series
of share transfer, purchase and subscription transactions entered into between
1993 and 1994. In connection with these transactions, the Company recorded
goodwill of Rmb 337,164. Guangxi Yuchai Machinery Holdings Company Limited
(State Holding Company), a state-owned enterprise, owns 22.09% of the issued
share capital of Yuchai. In December 1994, the Company issued a special share (the Special Share) at
par value of US$0.10 to Diesel Machinery (BVI) Limited (DML), an ex-holding
company of the Company, controlled by Hong Leong Corporation Limited, now known
as Hong Leong (China) Limited (HLC). The Special Share entitles its holder
to designate the majority of the Companys Board of Directors (six of eleven).
The Special Share is not transferable except to Hong Leong Asia Ltd. (HLA),
the holding company of HLC, or any of its affiliates. Since virtually all
decisions can be made by a majority of the Board of Directors of the Company,
HLA is deemed to have control of the Company and Yuchai. HLA is the only party
that can initiate any action to lose control of the Company. During 2002, following the decision of DML shareholders to dissolve DML, DML
redeemed all the redeemable shares issued by it to its shareholders and as
consideration for the redemption, DML transferred all of its shares in the
Company to its shareholders, which included HLC and its wholly-owned
subsidiaries, Flite Technology Industries Pte Ltd and HL Technology Systems Pte
Ltd (HLT). HLT is currently one of the Companys substantial shareholders.
Following the above redemption exercise, DML was eventually wound up in early
2003. The Special Share was transferred from DML to HLT, an affiliate of HLA.
The Company considers its holding company as of December 31, 2002 and 2003 to
be HLA. State Holding Company had the right to subscribe for approximately 31 million
shares of Yuchai at a subscription price of Rmb 6.29 per share. Such
subscription right had an original termination date of December 1998 and was
extended to March 31, 2002. Such subscription right was not exercised by State
Holding Company by March 31, 2002, and has lapsed. F-10




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  1.
    
    Background and principal activities (continued)Yuchai established two companies, Yuchai Machinery Monopoly Company
Limited (YMMC) and Guangxi Yulin Yuchai Machinery Spare Parts
Manufacturing Company Limited (GYSPM). These companies are involved in
the manufacture and sale of spare parts and components for diesel engines
in the PRC. Yuchai holds an equity interest of 71.83% and 97.14%
respectively in these companies while State Holding Company holds the
remaining equity interest therein. As at December 31, 2003, YMMC had
direct interests in twenty-two (2002: nineteen) subsidiaries, which are
involved in the trading and distribution of spare parts of diesel engines,
all of which are established in the PRC.The particulars of the Companys subsidiaries are set out below: Attributableequity interestsRegistered
    
    
    
    PrincipalName of company
    
    capital
    
    Direct
    
    Indirect
    
    activitiesRmbGuangxi Yuchai Machinery
Company Limited
    
    
    472,989
    
    
    
    76.41
    %
    
    
    
    
    
    Manufacturing,
assembling and
selling diesel
engines in the PRCGuangxi Yulin Yuchai
Machinery Spare Parts
Manufacturing
Company Limited
    
    
    90,170
    
    
    
    
    
    
    
    74.22
    %
    
    Manufacturing and
selling spare parts
of diesel engines
in the PRCYuchai Machinery Monopoly
Company Limited
    
    
    30,000
    
    
    
    
    
    
    
    54.89
    %
    
    Trading of spare
parts of diesel
engines in the PRCHangzhou Yuchai Machinery
Monopoly Company Limited
    
    
    500
    
    
    
    
    
    
    
    54.89
    %
    
    Trading of spare
parts of diesel
engines in the PRCNanchang Yuchai Machinery
Monopoly Company Limited
    
    
    500
    
    
    
    
    
    
    
    54.89
    %
    
    Trading of spare
parts of diesel
engines in the PRC
 F-11




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  1.
    
    Background and principal activities (continued) Attributableequity interestsRegistered
    
    
    
    PrincipalName of company
    
    capital
    
    Direct
    
    Indirect
    
    activitiesRmbXiamen Yuchai
Machinery Monopoly
Company Limited
    
    
    520
    
    
    
    
    
    54.89
    %
    
    Trading of spare parts of
diesel engines in the PRCWulumuqi Yuchai
Machinery Monopoly
Company Limited
    
    
    500
    
    
    
    
    
    54.89
    %
    
    Trading of spare parts of
diesel engines in the PRCGuiyang Yuchai
Machinery Monopoly
Company Limited
    
    
    500
    
    
    
    
    
    54.89
    %
    
    Trading of spare parts of
diesel engines in the PRCGuangzhou Yuchai
Machinery Monopoly
Company Limited
    
    
    550
    
    
    
    
    
    * 27.99
    %
    
    Trading of spare parts of
diesel engines in the PRCChengdu Yuchai
Machinery Monopoly
Company Limited
    
    
    500
    
    
    
    
    
    54.89
    %
    
    Trading of spare parts of
diesel engines in the PRCNanjing Yuchai
Machinery Monopoly
Company Limited
    
    
    500
    
    
    
    
    
    54.89
    %
    
    Trading of spare parts of
diesel engines in the PRC
   *
    
    It is a subsidiary that is controlled by the Company. Control exists
when the Company has the power, directly or indirectly, to govern the
financial and operating policies of an enterprise so as to obtain
benefits from its activities. F-12




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  1.
    
    Background and principal activities (continued) Attributableequity interestsRegistered
    
    
    
    PrincipalName of company
    
    capital
    
    Direct
    
    Indirect
    
    activitiesRmbXian Yuchai Machinery
Monopoly Company
Limited
    
    
    500
    
    
    
    
    
    54.89
    %
    
    Trading of spare parts of
diesel engines in the PRCHefei Yuchai Machinery
Monopoly Company
Limited
    
    
    500
    
    
    
    
    
    54.89
    %
    
    Trading of spare parts of
diesel engines in the PRCShijiazhuang Yuchai
Machinery Monopoly
Company Limited
    
    
    500
    
    
    
    
    
    54.89
    %
    
    Trading of spare parts of
diesel engines in the PRCChangsha Yuchai
Machinery Monopoly
Company Limited
    
    
    550
    
    
    
    
    
    54.89
    %
    
    Trading of spare parts of
diesel engines in the PRCJinan Yuchai Machinery
Monopoly Company
Limited
    
    
    500
    
    
    
    
    
    54.89
    %
    
    Trading of spare parts of
diesel engines in the PRCChongqing Yuchai
Machinery Monopoly
Company Limited
    
    
    550
    
    
    
    
    
    * 43.91
    %
    
    Trading of spare parts of
diesel engines in the PRC
   *
    
    It is a subsidiary that is controlled by the Company. Control exists
when the Company has the power, directly or indirectly, to govern the
financial and operating policies of an enterprise so as to obtain
benefits from its activities. F-13




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  1.
    
    Background and principal activities (continued) Attributableequity interestsRegistered
    
    
    
    PrincipalName of company
    
    capital
    
    Direct
    
    Indirect
    
    activitiesRmbWuhan Yuchai
Machinery Monopoly
Company Limited
    
    
    500
    
    
    
    
    
    54.89
    %
    
    Trading of spare parts of
diesel engines in the PRCZhengzhou Yuchai
Machinery Monopoly
Company Limited
    
    
    520
    
    
    
    
    
    54.89
    %
    
    Trading of spare parts of
diesel engines in the PRCKunming Yuchai
Machinery Monopoly
Company Limited
    
    
    500
    
    
    
    
    
    54.89
    %
    
    Trading of spare parts of
diesel engines in the PRCShenyang Yuchai
Machinery Monopoly
Company Limited
    
    
    530
    
    
    
    
    
    54.89
    %
    
    Trading of spare parts of
diesel engines in the PRCLanzhou Yuchai
Machinery Monopoly
Company Limited
    
    
    530
    
    
    
    
    
    54.89
    %
    
    Trading of spare parts of
diesel engines in the PRCBeijing Jingdu Yuchai
Trading Company
Limited
    
    
    500
    
    
    
    
    
    54.89
    %
    
    Trading of spare parts of
diesel engines in the PRCBaotou Yuchai Machinery
Monopoly Company
Limited
    
    
    500
    
    
    
    
    
    54.89
    %
    
    Trading of spare parts of
diesel engines in the PRCTaiyuan Yuchai
Machinery Monopoly
Company Limited
    
    
    500
    
    
    
    
    
    54.89
    %
    
    Trading of spare parts of
diesel engines in the PRC
 F-14




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  2.
    
    Basis of presentationThe accompanying consolidated financial statements are prepared in
accordance with accounting principles generally accepted in the United
States of America (U.S. GAAP). This basis of accounting differs from
that used in the statutory financial statements of Yuchai, which are
prepared in accordance with the accounting principles and the relevant
financial regulations applicable to joint stock companies as promulgated
by the Ministry of Finance of the PRC (PRC GAAP).The significant adjustments made to conform to U.S. GAAP include the
following:  (i)
    
    Recognition of capitalized interest under U.S. GAAP
methodology;(ii)
    
    No reversal of impairment losses on plant and equipment and
construction in progress under U.S. GAAP methodology;(iii)
    
    Difference between PRC GAAP and U.S. GAAP depreciation due to
difference in the timing of depreciation commencement;(iv)
    
    Recognition of fair value adjustment for receivables; and(v)
    
    Deferred tax effect on the items (i), (ii), (iii) and (iv)
above.  3.
    
    Summary of significant accounting policies and practices  (a)
    
    Principles of consolidationThe consolidated financial statements include the financial
statements of the Company and its subsidiaries (See Note 1). All
significant intercompany balances and transactions have been
eliminated on consolidation.(b)
    
    Cash and cash equivalentsCash includes cash on hand and demand deposits with banks. For
purposes of the consolidated statements of cash flows, the Company
considered all highly liquid debt instruments with original
maturities of three months or less to be cash equivalents. None of
the Companys cash is restricted as to withdrawal. See Note 25 for
discussion of restrictions on the Renminbi. F-15




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  3.
    
    Summary of significant accounting policies and practices (continued)  (c)
    
    Trade accounts receivableTrade accounts receivable are recorded at the invoiced value of
goods sold after deduction of trade discounts, value added taxes and
allowances, if any. The allowance for doubtful accounts is the
Companys best estimate of the amount of probable credit losses in
the Companys existing accounts receivable. The Company determines
the allowance based on historical write-off experience by industry
and national economic data. The Company reviews its allowance for
doubtful accounts monthly. Past due balances over 90 days and over
a specified amount are reviewed individually for collectibility.
All other balances are reviewed on a pooled basis by aging of such
balances. Account balances are charged off against the allowance
after all means of collection have been exhausted and the potential
for recovery is considered remote. The Company does not have any
off-balance-sheet credit exposure, except for outstanding bills
discounted with banks, that are subject to recourse for non-payment
(see Note 22(g)).(d)
    
    Inventories, netInventories are stated at the lower of cost or market. Cost is
determined using the weighted average cost method. Cost of work in
progress and finished goods comprises direct materials, direct labor
and an attributable portion of production overheads.(e)
    
    Property, plant and equipmentProperty, plant and equipment are stated at cost less accumulated
depreciation. Depreciation is computed using the straight-line
method over the estimated useful lives of the assets, taking into
account the estimated residual value. The estimated useful lives are
as follows: Buildings
    
    
    30 to 40 yearsMachinery and equipment
    
    
    5 to 15 years
 F-16




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CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  3.
    
    Summary of significant accounting policies and practices (continued)  (f)
    
    Construction in progressConstruction in progress represents factories and office buildings
under construction and plant and machinery pending installation. All
direct costs relating to the acquisition or construction of buildings
and plant and machinery, including interest charges on borrowings,
are capitalized as construction in progress. No depreciation is
provided in respect of construction in progress.Construction of plant is considered to be complete on the date when
the plant is ready for its intended use notwithstanding whether the
plant is capable of producing saleable output in commercial
quantities.(g)
    
    Lease prepaymentsLease prepayments represent land use rights paid to the PRC land
bureau. Land use rights are carried at cost and amortized on a
straight-line basis over the respective periods of the rights which
are 15 to 50 years.(h)
    
    InvestmentsInvestments in unlisted equity securities in which the company does
not maintain significant influence are stated at cost less provision
for impairment loss, if any. In the opinion of management, there is
no impairment in the value of investments.(i)
    
    Translation of foreign currenciesForeign currency transactions during the year are translated into
Renminbi at the applicable rates of exchange quoted by the Peoples
Bank of China at the transaction dates. Foreign currency monetary
assets and liabilities are translated into Renminbi at rates quoted
by the Peoples Bank of China ruling at the balance sheet date. The
resulting exchange differences are recorded in the statements of
income.The Companys functional and reporting currency is Renminbi and its
sole operating asset and source of cash flows is its investment in
Yuchai and its subsidiaries. There are no subsidiaries that use
different functional currency. For the United States dollar
convenience translation amounts included in the accompanying
consolidated financial statements, the Renminbi equivalent amounts
were translated into United States dollars at the rate of US$1.00 =
Rmb 8.2767, the rate quoted by the Peoples Bank of China at the
close of business on December 31, 2003. No representation is made
that the Renminbi amounts could have been, or could be, converted
into United States dollars at that rate or at any other certain rate
on December 31, 2003 or at any other date. F-17




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  3.
    
    Summary of significant accounting policies and practices (continued)  (j)
    
    Income taxesIncome taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and
their respective tax bases and operating loss and tax credit
carry-forwards. Deferred tax assets are reduced by a valuation
allowance to the extent the Company concludes it is more likely than
not that the assets will not be realized. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to
forecasted taxable income in future years in which those temporary
differences are expected to be recovered or settled. The Company
believes that the forecasted taxable income in future years are
appropriate. However, forecasted taxable income may significantly
differ from actual taxable income in future years, which may result
in material revisions to the valuation allowance for deferred tax
assets. The effect on deferred tax assets and liabilities of a
change in tax rates, if any, is recognized in the statement of income
in the financial year that includes the enactment date.(k)
    
    Net salesThe Company recognizes sales when products are delivered and the
customer takes ownership and assumes risk of loss, collection of the
relevant receivable is probable, persuasive evidence of an
arrangement exists and the sales price is fixed or determinable.Net sales represent the invoiced value of goods, net of value added
taxes (VAT), sales returns, trade discounts and allowances. Yuchai
and its subsidiaries are subject to VAT which is levied on the
majority of Yuchai and its subsidiaries products at the rate of 17%
on the invoiced value of sales. Output VAT is borne by customers in
addition to the invoiced value of sales. VAT paid by Yuchai and its
subsidiaries on its purchases is recoverable out of VAT collected
from its customers on its sales. F-18




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  3.
    
    Summary of significant accounting policies and practices (continued)  (l)
    
    Basic and diluted earnings per shareBasic earnings per share (EPS) excludes dilution and is computed by
dividing income attributable to common shares by the weighted average
number of common shares outstanding for the period. Diluted EPS
reflects the potential dilution that could occur if securities or
other contracts to issue common shares were exercised or converted
into common shares or resulted in issuance of common shares that then
shared in earnings.The EPS reconciliation of the Company is as follows: Years ended December 31,2001
    
    2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    Rmb
    
    US$Net income attributable
to common shares
    
    
    250,387
    
    
    
    412,433
    
    
    
    438,182
    
    
    
    52,942Basic earnings per share Weighted average common
shares outstanding
during the year
    
    
    35,340,000
    
    
    
    35,340,000
    
    
    
    35,340,000
    
    
    
    35,340,000 Basic earnings per share
of common shares
    
    
    7.09
    
    
    
    11.67
    
    
    
    12.40
    
    
    
    1.50
  There were no dilutive securities outstanding during all periods
presented.State Holding Company had the right to subscribe for approximately 31
million shares of Yuchai at a subscription price of Rmb 6.29 per
share (see Note 1). Such subscription right had an original
termination date of December 1998 and was extended to March 31, 2002.
Such subscription right was not exercised by State Holding Company
and has lapsed. Such subscription right was not included in the
computation of diluted EPS in 2001 because the effect was
anti-dilutive. F-19




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  3.
    
    Summary of significant accounting policies and practices (continued)  (m)
    
    Advertising, research and development costsAdvertising, research and development costs are expensed as incurred.
Advertising cost included in Selling, General and Administrative
Expense, amounted to Rmb 17,846, Rmb 31,935 and Rmb 40,961
(US$4,949), respectively, for the years ended December 31, 2001, 2002
and 2003. Research and development cost amounted to Rmb 44,721, Rmb
75,532 and Rmb 94,594 (US$11,429), respectively, for the years ended
December 31, 2001, 2002 and 2003.(n)
    
    GoodwillGoodwill represents the excess of costs over fair value of net assets
of businesses acquired. The Company adopted the provisions of
Statement of Financial Accounting Standards (SFAS) No. 142
Goodwill and Other Intangible Assets, issued by the Financial
Accounting Standards Board (FASB), as of January 1, 2002. Pursuant
to SFAS No. 142, goodwill acquired in a purchase business combination
and determined to have an indefinite useful life is not amortized,
but instead is tested for impairment at least annually in accordance
with the provisions of SFAS No. 142.In connection with SFAS No. 142s transitional goodwill impairment
evaluation, the Company performed an assessment of whether there was
an indication that goodwill is impaired as of the date of adoption.
To accomplish this, the Company identified its single reporting unit,
which is Yuchai and determined the carrying value of the reporting
unit by assigning the assets and liabilities, including the existing
goodwill, to this reporting unit as of January 1, 2002. The Company
determined the fair value of the reporting unit and compared it to
the carrying amount of the reporting unit. The fair value of the
reporting unit exceeded its carrying amount as of January 1, 2002.
However, under the circumstance that the carrying amount of a
reporting unit exceeded the fair value of the reporting unit, the
Company would be required to perform a second step of the
transitional impairment test, as this is an indication that the
reporting units goodwill may be impaired. In this step, the Company
would compare the implied fair value of the reporting units goodwill
with the carrying amount of the reporting units goodwill. The
implied fair value of goodwill is determined by allocating the fair
value of the reporting unit to all of the assets (recognized and
unrecognized) and liabilities of the reporting unit in a manner
similar to a purchase price allocation, in accordance with SFAS No.
141, Business Combinations. The residual fair value after this
allocation is the implied fair value of the reporting units
goodwill.Prior to the adoption of SFAS No. 142, goodwill was amortized on a
straight-line basis over the expected periods to be benefited,
generally 20 years, and assessed for recoverability by determining
whether the amortization of the goodwill balance over its remaining
life could be recovered through undiscounted future operating cash
flows of the acquired operation. The amount of goodwill impairment,
if any, was measured based on projected discounted future operating
cash flows. F-20




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  3.
    
    Summary of significant accounting policies and practices (continued)  (o)
    
    Product warrantyThe Company provides for estimated future costs to be incurred under
a warranty period or warranty mileage on various engine models, which
the Company provides free repair and replacement. Warranties
generally extend for a duration (12 months to 18 months) or mileage
(80,000 kilometres to 180,000 kilometres), whichever is the lower.
Provisions for warranty are primarily determined based on historical
warranty cost per unit of engines sold adjusted for specific
conditions that may arise and the number of engines under warranty at
each financial year-end.(p)
    
    Segmental reportingSFAS No. 131, Disclosures about Segments of an Enterprise and
Related Information, establishes standards for reporting information
about operating segments in financial statements. Operating segments
are defined as components of an enterprise about which separate
financial information is available that is evaluated regularly by the
chief operating decision maker, or decision making group, in deciding
how to allocate resources and in assessing performance.The Companys principal operations comprise the manufacture and
distribution of light-duty, medium-duty and heavy-duty diesel
engines. The Company combines these operations into a single
operating segment as they are expected to exhibit similar future
economic characteristics. In view of the fact that the operations of
Company and its subsidiaries are almost entirely within the PRC, no
geographical segment information is presented.(q)
    
    Use of estimatesThe preparation of the consolidated financial statements in
accordance with U.S. GAAP requires management of the Company to make
a number of estimates and assumptions relating to the reported amount
of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and
the reported amounts of revenues and expenses during the period.
Significant items subject to such estimates and assumptions include
the carrying amount of goodwill, property, plant and equipment,
construction in progress and lease prepayments; fair value adjustment
of receivable from a related party; valuation allowances for
receivables and inventories; and allowance for sales discounts and
warranty costs. Actual results could differ from those estimates. F-21




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  3.
    
    Summary of significant accounting policies and practices (continued)  (r)
    
    Impairment of long-lived assetsThe Company adopted SFAS No. 144 on January 1, 2002. The adoption of
SFAS No. 144 did not materially affect the Companys consolidated
financial statements.SFAS No. 144 Accounting for Impairment or Disposal of Long-Lived
Assets provides a single accounting model for long-lived assets to
be disposed of. SFAS No. 144 also changes the criteria for
classifying an asset as held for sale; and broadens the scope of
businesses to be disposed of that qualify for reporting as
discontinued operations and changes the timing of recognizing losses
on such operations.In accordance with SFAS No. 144, long-lived assets, such as property,
plant and equipment, and purchased intangibles subject to
amortization, are reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may
not be recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of an asset to
estimated undiscounted future cash flows expected to be generated by
the asset. If the carrying amount of an asset exceeds its estimated
future cash flows, an impairment charge is recognized by the amount
by which the carrying amount of the asset exceeds the fair value of
the asset. Assets to be disposed of would be separately presented in
the balance sheet and reported at the lower of the carrying amount or
fair value less costs to sell, and are no longer depreciated. The
assets and liabilities of a disposed group classified as held for
sale would be presented separately in the appropriate asset and
liability sections of the balance sheet.Prior to the adoption of SFAS No. 144, the Company accounted for
long-lived assets in accordance with SFAS No. 121, Accounting for
Impairment of Long-Lived Assets and for Long-Lived Assets to be
Disposed Of.(s)
    
    Commitments and contingenciesLiabilities for loss contingencies, including arising from claims,
assessments, litigation, and penalties and other sources are recorded
when it is probable that a liability has been incurred and the amount
of the assessment and/or remediation can be reasonably estimated. F-22




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  3.
    
    Summary of significant accounting policies and practices (continued)  (t)
    
    Stock option planThe Company applies the intrinsic-value-based method of accounting
prescribed by Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, and related
interpretations including FASB Interpretation No. (FIN) 44,
Accounting for Certain Transactions involving Stock Compensation, an
interpretation of APB Opinion No. 25, issued in March 2000, to
account for its fixed-plan stock options. Under this method,
compensation expense is recorded on the date of grant only if the
current market price of the underlying stock exceeded the exercise
price. SFAS No. 123, Accounting for Stock-Based Compensation, and
SFAS No. 148, Accounting for Stock-Based Compensation-Transition and
Disclosure, an amendment of SFAS No. 123, established accounting and
disclosure requirements using a fair-value-based method of accounting
for stock-based employee compensation plans. As permitted by
existing accounting standards, the Company has elected to continue to
apply the intrinsic-value-based method of accounting described above,
and has adopted only the disclosure requirements of SFAS No. 123 and
SFAS No. 148, as amended. See also Note 24(h) for further
discussion.(u)
    
    Sales of bills receivableThe Company sold bills receivable to banks on an ongoing basis and
with full recourse in the event of default by the customer. The
buyer is responsible for servicing the receivables upon maturity of
the bills receivable. The sales of the bills receivable were
accounted for under SFAS No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities.
Accordingly, bills receivable are extinguished, and the Company
records a discount equal to the difference between the carrying value
of the bills receivable and cash received. The Company has received
proceeds for the sales of the bills receivables of Rmb 331,900, Rmb
703,416 and Rmb 1,730,627 (US$209,096), for the years ended December
31, 2001, 2002 and 2003, respectively. The Company has recorded
discount of Rmb 6,331, Rmb 6,768 and Rmb 22,042 (US$2,663) in respect
of discounted bills receivable for the years ended December 31, 2001,
2002 and 2003, respectively, which have been included in interest
cost.(v)
    
    Comprehensive incomeThe Group had no other comprehensive income for the years ended
December 31, 2001, 2002 and 2003. F-23




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  3.
    
    Summary of significant accounting policies and practices (continued)  (w)
    
    Recently issued accounting standardsFIN 46 (revised)In December 2003, the FASB issued FIN 46 (revised December 2003),
Consolidation of Variable Interest Entities, which addresses how a
business enterprise should evaluate whether it has a controlling
financial interest in an entity through means other than voting
rights and accordingly should consolidate the entity. FIN 46R
replaces FIN 46, Consolidation of Variable Interest Entities, which
was issued in January 2003. The Company will be required to apply
FIN 46R to variable interests in Variable Interest Entities (VIEs)
created after December 31, 2003. For variable interests in VIEs
created before January 1, 2004, the interpretation will be applied
beginning on January 1, 2005. For any VIEs that must be consolidated
under FIN 46R that were created before January 1, 2004, the assets,
liabilities and non-controlling interests of the VIE initially would
be measured at their carrying amounts with any difference between the
net amount added to the balance sheet and any previously recognized
interest being recognized as the cumulative effect of an accounting
change. If determining the carrying amounts is not practicable, fair
value at the date FIN 46R first applies may be used to measure the
assets, liabilities and non-controlling interest of the VIE.While the Company is evaluating the impact of applying FIN 46R and
has not yet completed this evaluation, the Company does not believe
it has an interest in any VIEs that are within the scope of this
statement. Therefore, the application of this interpretation is not
expected to have a material effect on the Companys consolidated
financial statements.SFAS No. 150In May 2003, the FASB issued SFAS No. 150 Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and
Equity. This statement establishes standards for the classification
and measurement of certain financial instruments with characteristics
of both liabilities and equity. The statement also includes required
disclosures for financial instruments within its scope. The
statement was generally effective for instruments entered into or
modified after May 31, 2003 and otherwise will be effective as of
January 1, 2004, except for mandatorily redeemable financial
instruments. For certain mandatorily redeemable financial
instruments, the statement will be effective for the Company on
January 1, 2005. The effective date has been deferred indefinitely
for certain other types of mandatorily redeemable financial
instruments. The Company currently does not have any financial
instruments that are within the scope of this statement. F-24




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  4.
    
    Depreciation, sales commissions, shipping and handling expensesDepreciation of property, plant and equipment and amortization of lease
prepayments are included in the following captions: Years ended December 31,2001
    
    2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    Rmb
    
    US$Cost of goods sold
    
    
    91,612
    
    
    
    93,237
    
    
    
    88,737
    
    
    
    10,721Selling, general and
administrative expense
    
    
    22,068
    
    
    
    25,635
    
    
    
    36,782
    
    
    
    4,444113,680
    
    
    
    118,872
    
    
    
    125,519
    
    
    
    15,165
  Sales commissions to sales agents incurred by the Company are
included in the following caption: Years ended December 31,2001
    
    2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    Rmb
    
    US$Selling, general and
administrative expense
    
    
    12,583
    
    
    
    17,721
    
    
    
    16,724
    
    
    
    2,021
  Sales related shipping and handling expenses incurred by the
Company and not separately billed to customers are included in the
following caption: Years ended December 31,2001
    
    2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    Rmb
    
    US$Selling, general and
administrative expense
    
    
    30,383
    
    
    
    49,696
    
    
    
    64,991
    
    
    
    7,852
 F-25




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CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  5.
    
    Interest costThe Company capitalizes interest cost as a component of the cost of
construction in progress. The following is a summary of interest cost
incurred during 2001, 2002 and 2003: Years ended December 31,2001
    
    2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    Rmb
    
    US$Interest cost capitalized
    
    
    2,214
    
    
    
    4,598
    
    
    
    12,146
    
    
    
    1,468Interest cost charged to
statements of income
    
    
    29,784
    
    
    
    25,144
    
    
    
    23,624
    
    
    
    2,854Total interest cost incurred
    
    
    31,998
    
    
    
    29,742
    
    
    
    35,770
    
    
    
    4,322
  6.
    
    Other (income)/expense, netOther (income)/expense, net consist of: Years ended December 31,2001
    
    2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    Rmb
    
    US$Interest income
    
    
    (9,558
    )
    
    
    (4,664
    )
    
    
    (3,587
    )
    
    
    (433
    )Foreign exchange loss, net
    
    
    
    
    
    
    639
    
    
    
    27
    
    
    
    3Other
    
    
    5,700
    
    
    
    (6,262
    )
    
    
    4,441
    
    
    
    536(3,858
    )
    
    
    (10,287
    )
    
    
    881
    
    
    
    106
 F-26




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CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  7.
    
    Income tax (credit)/expenseBermuda taxThe Company was incorporated under the laws of Bermuda and, under
current Bermuda laws, is not subject to tax on income or capital gains.The Company has received an undertaking from the Minister of Finance in
Bermuda pursuant to the provisions of the Exempted Undertakings Tax
Protection Act, 1966, which exempts the Company and its shareholders,
other than shareholders ordinarily resident in Bermuda, from any Bermuda
taxes computed on profit, income or any capital assets, gain or
appreciation, or any tax in the nature of estate duty or inheritance tax
at least until the year 2016.PRC income taxAs Yuchai is a Sino-foreign enterprise, its PRC income tax rate is 15%
under the relevant PRC income tax laws.An extension of the reduction in the PRC income tax rate to 10% for the
three years ended December 31, 2001 was granted to Yuchai pursuant to
the relevant PRC income tax laws (the tax holiday). The 10% rate was
based on the interpretations of the PRC income tax law that subjects
entities such as Yuchai to a minimum tax rate of 10% following an
extension of the initial tax holiday.As a result of the above tax holiday, Yuchai was subject to PRC income
taxes at a rate of 10% in 2001 and 15% in 2002 and 2003.If Yuchai was not in a tax holiday period, income tax expense for the
year ended December 31, 2001 would have increased by Rmb 42,489. Net
income of the Company for the year ended December 31, 2001 would have
reduced by Rmb 32,464 or Rmb 0.92 per share.The PRC income tax rates of Yuchais subsidiaries under the relevant PRC
income tax laws are as follows: Year ended December 31,
    
    PRC income tax rate2001
    
    
    33
    %2002
    
    
    15%  33
    %2003
    
    
    15%  33
    %
 F-27




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  7.
    
    Income tax (credit)/expense (continued)Income tax (credit)/expense in the consolidated statements of income
consists of: Years ended December 31,2001
    
    2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    Rmb
    
    US$Current tax expense
    
    
    30,820
    
    
    
    114,463
    
    
    
    106,671
    
    
    
    12,889Deferred tax (credit)/charge
    
    
    (94,404
    )
    
    
    (31,221
    )
    
    
    6,253
    
    
    
    755(63,584
    )
    
    
    83,242
    
    
    
    112,924
    
    
    
    13,644
  Income tax expense reported in the consolidated statements of
income differs from the amount computed by applying the PRC income tax
rate of 15% for the three years ended December 31, 2003 for the
following reasons: Years ended December 31,2001
    
    2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    Rmb
    
    US$Computed expected tax
expense
    
    
    40,378
    
    
    
    93,818
    
    
    
    104,536
    
    
    
    12,630Adjustments resulting from: Non-deductible staff
expenses
    
    
    1,000
    
    
    
    401
    
    
    
    256
    
    
    
    31 Non-deductible business
entertainment
    
    
    773
    
    
    
    442
    
    
    
    
    
    
    
     Non-deductible goodwill
amortization
    
    
    2,529
    
    
    
    
    
    
    
    
    
    
    
     Other non-deductible
expenses
    
    
    325
    
    
    
    88
    
    
    
    976
    
    
    
    118 Deductible expenses
previously recognized as
non-deductible items
(see Note)
    
    
    
    
    
    
    (13,358
    )
    
    
    
    
    
    
     Rate differential of
subsidiaries tax assets
    
    
    
    
    
    
    1,851
    
    
    
    7,156
    
    
    
    865 Change in valuation
allowance for deferred
tax assets
    
    
    (66,100
    )
    
    
    
    
    
    
    
    
    
    
     Tax holiday
    
    
    (42,489
    )
    
    
    
    
    
    
    
    
    
    
    Net tax expense
    
    
    (63,584
    )
    
    
    83,242
    
    
    
    112,924
    
    
    
    13,644
  Note: Prior to 2002, certain expenses totaling Rmb 89,053 have been
previously included by the relevant tax authorities as non-deductible
expenses in the period in which they were recorded. During the year
ended December 31, 2002, deductibility of such expenses was agreed by
the tax authorities. F-28




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CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  7.
    
    Income tax (credit)/expense (continued)The significant components of deferred income tax (benefit)/expense
attributable to income for the years ended December 31, 2001, 2002 and
2003 are as follows: Years ended December 31,2001
    
    2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    Rmb
    
    US$Deferred tax (benefit)/
expense
    
    
    (28,304
    )
    
    
    (31,221
    )
    
    
    6,253
    
    
    
    755Decrease in beginning of
the year balance of the
valuation allowance for
deferred tax assets
    
    
    (66,100
    )
    
    
    
    
    
    
    
    
    
    
    (94,404
    )
    
    
    (31,221
    )
    
    
    6,253
    
    
    
    755
  The tax effects of temporary differences that give rise to
significant portions of the deferred tax assets at December 31, 2002 and
2003 are presented below: December 31,2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    US$Accounts receivable
    
    
    24,378
    
    
    
    23,658
    
    
    
    2,858Fair value adjustment for amount
due from a related party
    
    
    1,019
    
    
    
    
    
    
    
    Property, plant and equipment
    
    
    78,051
    
    
    
    72,594
    
    
    
    8,772Accrued liabilities
    
    
    35,914
    
    
    
    32,752
    
    
    
    3,957Inventories
    
    
    10,458
    
    
    
    12,616
    
    
    
    1,524Tax losses carried forward
    
    
    
    
    
    
    1,947
    
    
    
    235Total deferred tax assets
    
    
    149,820
    
    
    
    143,567
    
    
    
    17,346
  In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of
the deferred tax assets will not be realized. The ultimate realization
of deferred tax assets is dependent upon the generation of future
taxable income during the periods in which those temporary differences
become deductible. Management considers the scheduled reversal of
deferred tax liabilities, projected future taxable income, and tax
planning strategies in making this assessment. In order to fully
realize the deferred tax asset, the Company will need to generate future
taxable income of approximately Rmb 957,113 (US$115,639). Taxable
income for the years ended December 31, 2001, 2002 and 2003 amounted to
Rmb 235,096, Rmb 692,542 and Rmb 684,408 (US$82,691), respectively.
Based upon the level of historical taxable income and projections for
future taxable income over the periods in which the deferred tax assets
are deductible, management believes it is more likely than not that the
Company will realize the benefits of these deductible differences at
December 31, 2003. F-29




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CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  7.
    
    Income tax (credit)/expense (continued)At December 31, 2003, a subsidiary of the Company has net operating loss
carryforwards for PRC income tax purposes of Rmb 14,687 (US$1,774),
which are available to offset future PRC taxable income, if any, through
2008.8.
    
    Trade accounts receivable, netTrade accounts receivable, net comprise: December 31,2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    US$Trade accounts receivable
    
    
    450,127
    
    
    
    526,052
    
    
    
    63,558Less: Allowance for doubtful accounts
    
    
    158,075
    
    
    
    94,423
    
    
    
    11,408292,052
    
    
    
    431,629
    
    
    
    52,150Bills receivable
    
    
    711,083
    
    
    
    417,982
    
    
    
    50,5011,003,135
    
    
    
    849,611
    
    
    
    102,651
  An analysis of the allowance for doubtful accounts for 2001, 2002
and 2003 is as follows: December 31,2001
    
    2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    Rmb
    
    US$Balance at beginning of year
    
    
    201,533
    
    
    
    164,924
    
    
    
    158,075
    
    
    
    19,099Less:Written back to statements
of income
    
    
    36,609
    
    
    
    6,849
    
    
    
    493
    
    
    
    60Doubtful debts written off
    
    
    
    
    
    
    
    
    
    
    63,159
    
    
    
    7,631Balance at end of year
    
    
    164,924
    
    
    
    158,075
    
    
    
    94,423
    
    
    
    11,408
  At December 31, 2002 and 2003, gross trade accounts receivable due
from major customers, Dongfeng Automobile Company and its affiliates
(the Dongfeng companies), were Rmb 140,781 and Rmb 242,376
(US$29,284), respectively. In establishing the allowance for doubtful
accounts, the Company considered all known facts and conditions of its
customer base, and the general macroeconomic conditions in the PRC. See
Note 29 for further discussion of business concentration risk. During
2003, the directors considered that doubtful debts of Rmb 63,159
(US$7,631) would unlikely be recovered. Hence, the directors decided to
write off these doubtful debts. F-30




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CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  9.
    
    Amounts due from/to related companiesAmounts due from related companies comprise: December 31,2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    US$Due within one year
    
    
    16,367
    
    
    
    55,011
    
    
    
    6,646Due over one year
    
    
    9,990
    
    
    
    
    
    
    
    26,357
    
    
    
    55,011
    
    
    
    6,646
  Amounts due to related companies comprise: December 31,2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    US$Due within one year
    
    
    25,409
    
    
    
    25,617
    
    
    
    3,095
  Related companies include State Holding Company and its subsidiaries and
associated companies. The amounts due from/to related companies are
unsecured and interest free except for a loan from State Holding
Company, totaling Rmb 8,000, that is carrying an annual interest rate of
5.04% (see Notes 22(e) and 24(d)). All balances are repayable on demand
except for the loan from State Holding Company that is repayable within
1 year. At December 31, 2002, an amount due from Guangxi Yuchai
Machinery & Electrical Company (GYMEC), a wholly-owned subsidiary of
State Holding Company was classified as long term receivable and was
recorded at its net present value based on a discount rate of 5.94%,
which represented a rate generally available at the inception of the
credit for discounting similar instruments with banks in the PRC (see
Note 24). The amount was subsequently settled. The Company
re-negotiated the repayment terms of new balance due from GYMEC in 2003
and the amount due from GYMEC has been revised to repayable on demand.
The amount has been reclassified as a current asset in the consolidated
balance sheets at December 31, 2003. Accordingly, fair value adjustment
amounted to Rmb 6,794 (US$821) has been reversed and included in
Selling, General and Administrative Expense. F-31




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CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  10.
    
    Inventories, netInventories comprise: December 31,2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    US$Raw materials
    
    
    426,950
    
    
    
    507,147
    
    
    
    61,273Work in progress
    
    
    112,459
    
    
    
    105,732
    
    
    
    12,775Finished goods
    
    
    303,820
    
    
    
    264,455
    
    
    
    31,952843,229
    
    
    
    877,334
    
    
    
    106,000
  11.
    
    Other receivables, netOther receivables, net comprise: December 31,2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    US$VAT recoverable
    
    
    8,927
    
    
    
    
    
    
    
    Staff loans
    
    
    6,877
    
    
    
    6,428
    
    
    
    777Other
    
    
    2,914
    
    
    
    2,405
    
    
    
    29018,718
    
    
    
    8,833
    
    
    
    1,067
 F-32




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CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  12.
    
    Property, plant and equipment, netProperty, plant and equipment, net comprise: December 31,2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    US$Buildings
    
    
    490,685
    
    
    
    510,034
    
    
    
    61,623Machinery and equipment
    
    
    1,195,889
    
    
    
    1,246,970
    
    
    
    150,6601,686,574
    
    
    
    1,757,004
    
    
    
    212,283Less: Accumulated depreciation and
impairment loss
    
    
    913,606
    
    
    
    1,021,363
    
    
    
    123,402Net property, plant and equipment
    
    
    772,968
    
    
    
    735,641
    
    
    
    88,881
  Management has conducted a review on the conditions of the
property, plant and equipment. In 2003, management identified that
certain property, plant and equipment were no longer used in production
due to the introduction of new environmental regulations in 2003. In
2002, management identified that certain property, plant and equipment
related to the 6105 production line and other factory auxiliary
facilities were no longer used in production due to the introduction of
replacement of property, plant and equipment. These changes required an
impairment analysis to be performed in accordance with SFAS No. 144.
The estimated undiscounted future cash flows generated from such
property, plant and equipment were less than their carrying value. The
carrying value of such assets were therefore reduced to estimated fair
value. Impairment loss of Rmb 23,120 and Rmb 12,405 (US$1,499) has been
included in Selling, General and Administrative Expense in 2002 and
2003, respectively.Management estimated fair value using internal appraisals and value of
similar assets in the market.All of Yuchai and its subsidiaries buildings are located in the PRC.As of December 31, 2002 and 2003, certain plant and equipment of Yuchai
with an aggregate carrying amount of Rmb 98,901 and Rmb 236,995
(US$28,634), respectively, were pledged as security under certain loan
arrangements respectively (see Note 17). Certain plant and equipment of
Yuchai with an aggregate carrying amount of Rmb 11,652 (US$1,408) were
pledged as security under corporate guarantee arrangements to State
Holding Company as of December 31, 2003 (see Note 22(e)). F-33




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  12.
    
    Property, plant and equipment, net (continued)Loss on disposal of property, plant and equipment for the years ended
December 31, 2001, 2002 and 2003 is included in Selling, General and
Administrative Expense as follows: December 31,2001
    
    2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    Rmb
    
    US$Loss on disposal of
property, plant and equipment
    
    
    249
    
    
    
    7,276
    
    
    
    3,359
    
    
    
    406
  The Company has several non-cancelable operating leases, primarily
for offices and warehouses that expire over the next five years. These
leases generally contain renewal options for periods ranging from one
year to three years. Rental expense for operating leases is included in
Selling, General and Administrative Expense as follows: December 31,2001
    
    2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    Rmb
    
    US$Rental expense
    
    
    6,965
    
    
    
    4,241
    
    
    
    5,159
    
    
    
    623
  Future minimum lease payments under non-cancelable operating leases
(with initial or remaining lease terms in excess of one year) as of
December 31, 2003 are: December 31,
    
    Operating lease paymentsRmb
    
    US$2004
    
    
    2,740
    
    
    
    3312005
    
    
    826
    
    
    
    1002006
    
    
    415
    
    
    
    502007
    
    
    176
    
    
    
    214,157
    
    
    
    502
 F-34




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CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  13.
    
    Construction in progressConstruction in progress comprises capital expenditures relating to the
construction of facilities and assembly lines for the following
projects: December 31,2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    US$Diesel engine production line and facilities projects
    
    
    19,860
    
    
    
    119,045
    
    
    
    14,383Factories auxiliary facilities
    
    
    21,250
    
    
    
    31,216
    
    
    
    3,772Office building
    
    
    21,884
    
    
    
    49,092
    
    
    
    5,931Second foundry
    
    
    50,108
    
    
    
    174,670
    
    
    
    21,104Others
    
    
    8,765
    
    
    
    23,621
    
    
    
    2,854121,867
    
    
    
    397,644
    
    
    
    48,044
 F-35




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  14.
    
    Lease prepayments, net December 31,2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    US$Lease prepayments
    
    
    99,175
    
    
    
    99,111
    
    
    
    11,975Less: Accumulated amortization
    
    
    13,599
    
    
    
    20,895
    
    
    
    2,525Net lease prepayments
    
    
    85,576
    
    
    
    78,216
    
    
    
    9,450
  The land on which the Companys buildings are erected is owned by the
PRC Government. Yuchai and its subsidiaries are granted the land use
rights of 15 to 50 years in respect of such land.As of December 31, 2002 and 2003, land use rights of Yuchai with a
carrying amount of Rmb 17,430 and Rmb 14,914 (US$1,802), respectively
were pledged as security under certain short-term bank loan arrangements
(see Note 17(a)).Certain land use right of Yuchai with a carrying amount of Rmb 5,480
(US$662) was pledged as security under corporate guarantee arrangements
to State Holding Company as of December 31, 2003 (see Note 22(e)).15.
    
    InvestmentsNon-current investments represent an equity interest in Yuchai/ASIMCO
Components Company Limited (YACC), which was established as a joint
venture in the Cayman Islands on June 30, 1994. Yuchais effective
interest in the equity of YACC was 4.73%.The fair value of the unlisted equity investments cannot be measured
reliably because they are not traded in an open market and there were no
transactions for the investments during the year. The unlisted equity
investments are stated at cost as management considers no indication of
impairment in view of the profitability of the YACC. F-36




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CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  16.
    
    GoodwillAmortization expense related to goodwill was Rmb 16,859 for the year
ended December 31, 2001. With the adoption of SFAS No. 142 as of
January 1, 2002, goodwill is assessed to determine if there was an
indication of impairment. The following table reconciles previously
reported net income as if the provisions of SFAS No. 142 were in 2001
presented: December 31,2001RmbReported net income
    
    
    250,387Add back goodwill amortization
    
    
    16,859Adjusted net income
    
    
    267,246Basic and diluted earnings per share: Reported basic and diluted earnings
per share
    
    
    7.09 Goodwill amortization
    
    
    0.48 Adjusted basic and diluted earnings
per share
    
    
    7.57Average number of shares outstanding: Basic and diluted
    
    
    35,340,000
  There is no change in the carrying amount of goodwill for the years
ended December 31, 2002 or 2003.Upon adoption of SFAS No. 142, the Company is required to evaluate its
existing intangible assets and goodwill that were acquired in purchase
business combinations, and to make any necessary reclassifications in
order to conform to the new classification criteria in SFAS No. 141 for
recognition separate from goodwill. The Company also is required to
reassess the useful lives and residual values of all intangible assets
acquired, and make any necessary amortization period adjustments by the
end of the first interim period after adoption. The Company was required
to test goodwill for impairment as of January 1, 2002 and annually
thereafter, in accordance with the provisions of SFAS No. 142. The
results of these analyses did not require the Company to recognize an
impairment loss. F-37




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  17.
    
    Debt  (a)
    
    Short-term bank loansShort-term bank loans were denominated in Renminbi as follows: December 31,2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    US$Rmb denominated loans
    
    
    135,000
    
    
    
    240,000
    
    
    
    28,997
  The weighted average interest rate of short-term bank loans at
December 31, 2002 and 2003 was 5.12% and 4.98% per annum,
respectively.As of December 31, 2002 and 2003, short-term bank loans of Rmb
10,000 and Rmb 10,000 (US$1,208), respectively, were secured by the
pledge of land use rights (see Note 14). As of December 31, 2002
and 2003, short-term bank loans of Rmb 20,000 and Rmb 60,000
(US$7,249), respectively, and current portion of long-term bank
loans of Rmb 60,000 and Rmb 50,000 (US$6,041), respectively, were
secured by the pledge of certain of Yuchais plant and equipment
(see Note 12).(b)
    
    Long-term bank loansYuchais long-term bank loans comprise: Interest rate atDecember 31,
    
    December 31,2003
    
    2002
    
    2003
    
    2003(per annum)
    
    Rmb
    
    Rmb
    
    US$Rmb denominated loans: due in 2003
    
    5.94
    %
    
    
    130,000
    
    
    
    
    
    
    
     due in 2004
    
    5.94
    %
    
    
    50,000
    
    
    
    50,000
    
    
    
    6,041Total long-term bank loans
outstanding
    
    
    
    
    
    180,000
    
    
    
    50,000
    
    
    
    6,041Less:
    Amounts due within
1 year included
under current
liabilities
    
    
    
    
    
    130,000
    
    
    
    50,000
    
    
    
    6,041Amounts due after 1 year
    
    
    
    
    
    50,000
    
    
    
    
    
    
    
    
  As of December 31, 2002 and 2003, long-term bank loans totaling
Rmb 130,000 and Rmb 50,000 (US$6,041) respectively, were secured by
pledge of certain of Yuchais plant and equipment (see Note 12). F-38




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  18.
    
    Accrued expense and other liabilitiesAccrued expense and other liabilities comprise: December 31,2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    US$VAT payable
    
    
    
    
    
    
    7,086
    
    
    
    856Deposits from customers
    
    
    56,033
    
    
    
    41,342
    
    
    
    4,995Staff welfare fund (Note)
    
    
    15,041
    
    
    
    15,041
    
    
    
    1,817Allowance for product warranty (Note 19)
    
    
    66,864
    
    
    
    101,215
    
    
    
    12,230Wages payable
    
    
    55,950
    
    
    
    77,216
    
    
    
    9,329Management bonus payable (Note 24(g))
    
    
    41,071
    
    
    
    33,492
    
    
    
    4,047Payable for construction in progress
    
    
    13,678
    
    
    
    24,848
    
    
    
    3,002Accrued research and development
expense
    
    
    11,963
    
    
    
    9,497
    
    
    
    1,147Accrued advertising expense
    
    
    4,478
    
    
    
    8,249
    
    
    
    997Accrued payable for lawsuit compensation
(see Note 22(c)(d)(i))
    
    
    4,595
    
    
    
    15,268
    
    
    
    1,844Accrued legal fee and other professional
fee
    
    
    1,024
    
    
    
    3,829
    
    
    
    463Individual income tax payable
    
    
    696
    
    
    
    3,978
    
    
    
    481Other accrual and liabilities
    
    
    34,852
    
    
    
    55,338
    
    
    
    6,686306,245
    
    
    
    396,399
    
    
    
    47,894
  Note:
    
    Staff welfare fund is allocated at the discretion of
Yuchais Board of Directors. The fund can be applied in the
payment of special bonuses or collective welfare benefits to staff
and workers of Yuchai, such as staff dormitories, staff welfare
facilities. Assets acquired using this fund should not be taken
as assets of Yuchai. The fund is not distributable to the owners
of Yuchai. F-39




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  19.
    
    Allowance for product warrantyAn analysis of the allowance for product warranty for 2001, 2002 and 2003
is as follows: December 31,2001
    
    2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    Rmb
    
    US$Balance at beginning of year
    
    
    17,896
    
    
    
    29,699
    
    
    
    66,864
    
    
    
    8,079Allowance charged to income
statement
    
    
    58,582
    
    
    
    127,058
    
    
    
    162,369
    
    
    
    19,618Less: Allowance utilized
    
    
    46,779
    
    
    
    89,893
    
    
    
    128,018
    
    
    
    15,467Balance at end of year
    
    
    29,699
    
    
    
    66,864
    
    
    
    101,215
    
    
    
    12,230
  20.
    
    Statutory reservesYuchai and its subsidiaries follow PRC GAAP in the preparation of their
accounting records and PRC GAAP statutory financial statements. PRC
GAAP requires Yuchai and its subsidiaries to provide for certain
statutory reserves which are designated for specific purposes. Such
reserves are not distributable in the form of cash dividends (see Note
26).Article 177 of the Company Law of the PRC requires companies to allocate
10% of their annual net income to their statutory general reserve and 5%
to 10% to their statutory public welfare fund. Yuchai and its
subsidiaries made total appropriations of 15% of its net income to the
statutory reserves for the years ended December 31, 2001, 2002 and 2003.
For the purpose of calculating the transfers to reserves, net income is
determined based on the distributable profit reported in the PRC GAAP
financial statements. F-40




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CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  20.
    
    Statutory reserves (continued)The Companys attributable share in the statutory reserves of Yuchai and
its subsidiaries for the three years ended December 31, 2003 is as
follows: December 31,2001
    
    2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    Rmb
    
    US$Statutory general reserve
(Note (a))Balance at January 1
    
    
    81,355
    
    
    
    81,953
    
    
    
    116,702
    
    
    
    14,100Transfer from statement
of income
    
    
    598
    
    
    
    34,749
    
    
    
    39,409
    
    
    
    4,761Balance at December 31
    
    
    81,953
    
    
    
    116,702
    
    
    
    156,111
    
    
    
    18,861Statutory public welfare
fund (Note (b))Balance at January 1
    
    
    10,725
    
    
    
    11,025
    
    
    
    28,398
    
    
    
    3,431Transfer from statement
of income
    
    
    300
    
    
    
    17,373
    
    
    
    19,705
    
    
    
    2,381Balance at December 31
    
    
    11,025
    
    
    
    28,398
    
    
    
    48,103
    
    
    
    5,812General surplus reserve
(Note (c))Balance at January 1 and
December 31
    
    
    25,706
    
    
    
    25,706
    
    
    
    25,706
    
    
    
    3,106Total
    
    
    118,684
    
    
    
    170,806
    
    
    
    229,920
    
    
    
    27,779
 F-41




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CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  20.
    
    Statutory reserves (continued)  Notes:(a)
    
    In accordance with the relevant regulations in the PRC, the
10% appropriations to the statutory general reserve are required
until the balance reaches 50% of the authorized share capital of
Yuchai and its subsidiaries. Statutory general reserve can be used
to make good previous years losses, if any, and may be converted
into share capital by the issue of new shares to shareholders in
proportion to their existing shareholdings, or by increasing the
par value of the shares currently held by them, provided that the
reserve balance after such issue is not less than 25% of the
authorized share capital.(b)
    
    Yuchai and its subsidiaries shall determine to transfer 5% to
10% of its net income to the statutory public welfare fund. There
is no limit on the amount that may be allocated to this fund. This
fund can only be utilized on capital expenditure for the collective
welfare of Yuchai and its subsidiaries employees, such as the
construction of dormitories, canteen and other welfare facilities,
and cannot be utilized to pay staff welfare expenses. The transfer
to this fund must be made before the distribution of a dividend to
shareholders.(c)
    
    Yuchai and its subsidiaries shall transfer from the statutory
public welfare fund to the general surplus reserve an amount equal
to the cost of assets acquired during the year for the collective
welfare of its employees. These assets belong to Yuchai and its
subsidiaries, and depreciation expense and any profit or loss on
disposal will be reflected in the statements of income. On
disposal of these assets, the original transfers to this reserve
should be reversed to the statutory public welfare fund. As of
December 31, 2002 and 2003, the carrying amounts of assets acquired
utilizing the statutory public welfare fund amounted to Rmb 23,347
and Rmb 22,534 (US$2,723), respectively.  21.
    
    CommitmentsAs of December 31, 2003, Yuchai had the following commitments: December 31,2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    US$Authorized and contracted for:Improvement to existing
production facilities
    
    
    42,419
    
    
    
    66,825
    
    
    
    8,074Construction of office building
    
    
    35,067
    
    
    
    17,048
    
    
    
    2,06077,486
    
    
    
    83,873
    
    
    
    10,134
 F-42




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CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  21.
    
    Commitments (continued)In 2003, the Company entered into an agreement, totaling Rmb 60,000
(US$7,249) with a consultancy company in connection with the design of an
information system of a PRC logistic services project to be undertaken by
Coomber Investment Limited (Coomber), the Companys shareholder. In
addition, Coomber has entered into an agreement to undertake all expenses
incurred by the Company in respect of this project on or before 31
December 2004. In 2003, the Company incurred payments totaling Rmb 13,347
(US$1,613) in respect of the project, which has been capitalized in
amounts due from related companies. See Note 24(d).22.
    
    Contingencies  (a)
    
    Product liabilityThe General Principles of the Civil Law of China and the Industrial
Product Quality Liability Regulations provide for the liability of
manufacturers and sellers for loss and injury caused by defective
products. Yuchai and its subsidiaries do not carry product
liability insurance. However, the laws have seldom been applied.
Yuchai and its subsidiaries have not had any significant product
liability claims brought against them.(b)
    
    Environmental liabilityIn accordance with the relevant environment protection laws in the
PRC, diesel engines have to comply with least emission standards
approximately equivalent to the EURO I standard commencing 2000.
Management reviewed the potential effects following the adoption of
SFAS No.143 Accounting for Asset Retirement Obligations and the
policy above and considers that it will not have any material
adverse impact to Yuchai and its subsidiaries.(c)
    
    Dispute with Yulin Road BureauIn 2002, the Companys sole operating subsidiary, Yuchai, was
involved in legal proceedings instituted by the Yulin Road Bureau
against Yuchai and Nanning Hengji Company, an unrelated third party.
In these proceedings, the Yulin Road Bureau sought payment of Rmb
7,259 from Yuchai and Nanning Hengji Company, which allegedly
represents the construction cost of a road built by the Yulin Road
Bureau near Yuchais factory. At trial, a Yulin court ordered
Yuchai and Nanning Hengji Company to pay Rmb 4,595 to the Yulin Road
Bureau. Yuchai appealed this decision to a Guangxi court and Yuchai
won this appeal. The Yulin Road Bureau has subsequently applied for
a further appeal, which if granted would result in a re-trial. The
Company recorded a provision of Rmb 4,595 during 2002 which has been
included in Selling, General and Administrative Expense and
Accrued Expense and Other Liabilities.As the outcome of the appeal is uncertain, the Company has retained
the provision of Rmb 4,595 (US$555). The Company does not believe
that the resolution of these proceedings will have a material
adverse effect on its consolidated financial position, results on
operations, or liquidity. F-43




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CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  22.
    
    Contingencies (continued)  (d)
    
    Dispute with Bank of ChinaIn 2003, the Yulin Branch of Bank of China (BOC) initiated legal
proceedings to recover Rmb 6,603 (US$798) from Yuchai based on an
irrevocable letter of guarantee issued by Yuchai to the BOC in
1993 to secure a loan of US$550 to Great Wall Machinery Plant
(Great Wall). At trial, a Yulin court ruled that if Great Wall
could not repay the loan Yuchai would be liable to the BOC.
Yuchai subsequently appealed, but lost the appeal. In January
2004, State Holding Company issued a letter of commitment
confirming that it would reimburse Yuchai in the event that Yuchai
was required to pay on this guarantee. Based on the advice of the
Companys legal counsel, the Company has recorded a loss
contingency equal to the amount of the claim, which has been
offset by amounts to be reimbursed by State Holding Company. The
amount due to BOC and the amount due from State Holding Company
have been recorded in Accrued expenses and other liabilities and
Amounts due from related companies, respectively.(e)
    
    Pledged assetsIn 2003, GYSPM has entered into an agreement with State Holding
Company for a borrowing of Rmb 8,000 (US$967) for its operating
activities as of December 31, 2003. The borrowing was included in
the amounts due from related companies (See Note 24(d)).As of December 31, 2003, GYSPM (Note 1) pledged certain of its
assets with a net book value of Rmb 17,132 (US$2,070) (See Note 12
and Note 14) against bank loan of Rmb 8,000 (US$967) borrowed by
State Holding Company. The terms set out in the loan agreement
entered into between State Holding Company and the bank and the
loan agreement entered into between GYSPM and State Holding
Company are identical. The loan proceeds from the bank borrowed
by State Holding Company were solely lent to GYSPM. State Holding
Company will make repayments to the bank upon receipt of loan
repayment from GYSPM. F-44




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CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  22.
    
    Contingencies (continued)  (f)
    
    Dispute with State Holding CompanyDuring 2003, the Company had difficulties in obtaining the
cooperation of State Holding Company and Mr Wang Jianming in the
daily management and operation of Yuchai, including obtaining
payments of the Companys share of the final 2001 dividend
declared in August 2002. Mr Wang Jianming is the chairman, legal
representative and chief executive officer of Yuchai, as well as
the chairman and legal representative of State Holding Company,
Yuchais principal Chinese shareholder.The Company initiated civil and arbitration proceedings against
Yuchai, State Holding Company, Mr Wang Jianming as Yuchais
chairman, legal representative, and chief executive officer and
related parties on May 19, 2003.On June 16, 2003, the Company received from Yuchai copies of
recent letters from various Chinese government agencies stating
that the transfer of ownership of shares with respect to Yuchai in
November 1994, in connection with the Companys initial public
offering (IPO), was not validly approved by the Chinese
authorities, and that as a result thereof its exercise of control
over Yuchai has been improper.The Company has attempted to obtain the assistance of the relevant
government authorities in China for a comprehensive resolution of
the matters in dispute, including the various legal and
arbitrational proceedings initiated against Yuchai, as well as
against State Holding Company and Mr Wang Jianming.Based in part on updated legal advice obtained in the PRC and
Bermuda in 2003, it is the opinion of the Companys management
that: (a) the Company has proper legal title to its interest in
Yuchai, and (b) the issues discussed above would be resolved
without any material adverse effect on the results of operations
or financial position of the Company and its subsidiaries.As a result of a number of meetings between the parties in dispute
and subsequent communications, the parties have taken/or agreed to
take the following actions:  
    
    Yuchai had paid to the Company its share of the
dividends declared by Yuchai in August 2002, amounting to Rmb
245,760 (US$29,693).
    
    Yuchai had reinstated two senior managers of the
Company who report to the Board of Directors and who have
been seconded to Yuchai, and afforded them access to Yuchais
operating and financial information.
    
    The Company and Yuchai withdrew their respective
legal and arbitrational claims against each other and the
related parties. F-45




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CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  22.
    
    Contingencies (continued)  (f)
    
    Dispute with State Holding Company (continued)As a result of number of meetings and subsequent communications,
the parties have taken/or agreed to take the following actions:
(continued)  
    
    The Company changed its nominees on Yuchais
Board of Directors to the following: Gao Jia Lin, Paul
Wolansky, Wrixon Gasteen, Wong Hong Ren, Qin Xiao Cong, Yuan
Xu Cheng and Hermann Leung.
    
    The Company declared and paid a dividend to its
shareholders representing 90% of the August 2002 dividends
received from Yuchai.
    
    Yuchai agreed that to the extent consistent with
Chinese Law and international practice it will implement
corporate management procedures to improve the management and
corporate governance of Yuchai.
    
    The Company and Yuchai agreed that they would
work together in trying to jointly promote mutual plans to
enhance the Companys shareholder value, possibly including,
to the extent permitted by applicable laws and regulations,
by way of (1) creating a new Yuchai holding company and
spinning it off (along with all of the Yuchai shares it owns)
to the Companys shareholders in proportion to their economic
interests and the listing of the new Yuchai holding company
(without any golden or special share) on an international
capital market; and (2) restructuring and/or recapitalizing
the assets and capital of the Company so as to allow the
Company to maintain its New York Exchange listing. If the
foregoing cannot be achieved, the parties have agreed to
consider alternatives. The Company has delegated authority
to its Special Committee to investigate and consider the
foregoing. However, the Company recognizes that there are
substantial impediments to achieving any such plans, and the
Company intends to continue to work with the relevant Chinese
authorities in considering the practicability to the plan
mentioned in clause (1) above.
    
    A new employment contract with Mr Wang Jianming,
the Chief Executive Officer and Director of Yuchai, was
renewed in September 2003. F-46




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CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  22.
    
    Contingencies (continued)  (g)
    
    Outstanding bills discountedAs of December 31, 2002 and 2003, outstanding bills discounted
with banks for which the Company has retained a recourse
obligation totaled Rmb 193,144 and Rmb 729,580 (US$88,149),
respectively.(h)
    
    Outstanding letter of creditsAs of December 31, 2002 and 2003, the irrevocable letter of
credits outstanding in the Companys books amounted to Rmb 81,409
and Rmb 171,963 (US$20,777), respectively.(i)
    
    Other outstanding litigationThe Company is involved in various other claims and legal actions
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 liquidity.  23.
    
    Retirement and other postretirement benefitsAs stipulated by the regulations of the PRC, Yuchai and its subsidiaries
participate in a defined contribution retirement plan organized by the
Guangxi Regional Government for its staff. All staff are entitled to an
annual pension equal to a fixed proportion of their final basic salary
amount at their retirement date. For the years ended December 31, 2001,
2002 and 2003, Yuchai and its subsidiaries were required to make
contributions to the retirement plan at a rate of 20.0% of the basic
salary of their staff. The Guangxi Regional Government is responsible
for the entire obligations of all Yuchai and its subsidiaries retirees.
Expenses incurred in connection with the plan were Rmb 31,906, Rmb
22,012 and Rmb 24,101 (US$2,912), respectively, for the years ended
December 31, 2001, 2002 and 2003. Yuchai and its subsidiaries have no
obligation for the payment of pension benefits or any other
postretirement benefits beyond the annual contributions described above. F-47




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  24.
    
    Related party transactionsThe Company has undertaken significant business transactions with
related companies during the three years ended December 31, 2003. The
following is a summary of these transactions: Years ended December 31,2001
    
    2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    Rmb
    
    US$Sales of trucks from
customers to GYMEC
(Note (a))
    
    
    18,062
    
    
    
    
    
    
    
    1,346
    
    
    
    163Purchases of trucks from
GYMEC to suppliers
(Note (a))
    
    
    32,289
    
    
    
    2,657
    
    
    
    7,066
    
    
    
    854Sales of diesel engines to
State Holding Company,
its subsidiaries and
associated companies
(Note (d))
    
    
    1,311
    
    
    
    2,601
    
    
    
    23,611
    
    
    
    2,853Purchase of raw materials
and supplies from
subsidiaries and associated
companies of State
Holding Company
(Note (d))
    
    
    25,066
    
    
    
    65,353
    
    
    
    93,056
    
    
    
    11,243Delivery expense charged by
a subsidiary of State
Holding Company
(Note (d))
    
    
    
    
    
    
    44,747
    
    
    
    62,206
    
    
    
    7,516General and administrative
expenses charged by State Holding
Company (Note (b))
    
    
    25,029
    
    
    
    24,186
    
    
    
    30,607
    
    
    
    3,698 charged by HLA
(Note (b))
    
    
    4,139
    
    
    
    4,200
    
    
    
    4,427
    
    
    
    535Loan from State Holding
Company (Note (d))
    
    
    
    
    
    
    
    
    
    
    8,000
    
    
    
    967Interest charged by State
Holding Company
(Note (d))
    
    
    
    
    
    
    
    
    
    
    34
    
    
    
    4
 F-48




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  24.
    
    Related party transactions (continued)Notes:  (a)
    
    Sales and purchases of diesel trucksDuring 2000 and 2001, Yuchai received diesel trucks from certain
customers as part of the settlement of their trade accounts
receivable. Pursuant to an agreement between Yuchai and GYMEC,
Yuchai sold such diesel trucks at cost to GYMEC, which owns a
business license for selling diesel trucks in the PRC. Yuchai
recorded a receivable from GYMEC in connection with the truck
sales.GYMEC either sold the diesel trucks to external parties, in which
case GYMEC earned the difference between the selling price and the
cost of the diesel truck, or offset the amounts due from GYMEC
against Yuchais trade accounts payable.Amount due from GYMEC as at December 31, 2002 was classified as
long term receivable and it was recorded at its net present value
based on a discount rate of 5.94% generally available for
discounting similar instruments with banks in the PRC. The amount
was subsequently settled. The Company re-negotiated the repayment
term of new balance due from GYMEC in 2003 and the amount due from
GYMEC is repayable on demand (See Note 9).(b)
    
    General and administrative expenseState Holding Company charges Yuchai for certain general and
administrative expenses. The expenses are charged to Yuchai and
its subsidiaries by State Holding Company on an actually incurred
basis. The Company believes that the expenses charged to Yuchai by
State Holding Company would not have been materially different on a
stand-alone basis because Yuchai could provide these services for
itself at approximately the same cost. HLA provides certain
management, financial planning and control and other services to
Yuchai. Such charge represent HLAs estimated direct costs of
providing these services.(c)
    
    Assignment of debt to GYMECIn 2003, the Company entered into a deed of assignment (the Deed)
whereby one of the Companys customers assigned all the rights and
liabilities of the outstanding amount due to the Company totaling
approximately Rmb 15,000 (US$1,812) to GYMEC. Pursuant to the
Deed, GYMEC becomes one of the sales agents of this customer who is
principally engaged in manufacturing and sales of motor vehicles.
As of December 31, 2003, the outstanding balances due from GYMEC
related to this debt assignment was Rmb 3,700 (US$447). The amount
due from GYMEC is interest free and repayable on demand. F-49




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CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  24.
    
    Related party transactions (continued)Notes: (continued)  (d)
    
    Amounts due from/to related companiesAmounts due from/to related companies comprise mainly (i) prepaid
general and administrative expenses to State Holding Company (ii)
loan from State Holding Company (iii) receivables for trading of
diesel trucks with GYMEC (iv) normal sales and purchases to and
from the subsidiaries and associated companies of State Holding
Company (v) delivery expense charged by a subsidiary of State
Holding Company (vi) the awarded damages of the lawsuit undertaken
by State Holding Company (Note 22(d))(vii) assignment of debt to
GYMEC and (viii) expense paid on behalf of Coomber (see Note 21).The loan from State Holding Company is short-term, interest bearing
with annual interest rate of 5.04% and expected to repay by the end
of 2004 (see Note 22(e)).In addition to the above, Yuchai also entered into transactions
with other PRC Government owned enterprises. The Company considers
that these transactions were entered into in the normal course of
business and expects that these transactions will continue on
normal commercial terms. Balances with other PRC entities are
excluded from this caption.(e)
    
    GuaranteeIn 2001, certain of Yuchais bank loans were secured by a corporate
guarantee issued by State Holding Company. The guarantee was
released in 2002.(f)
    
    Amount due to the holding companyThe balance is unsecured, interest free and repayable within one
year.(g)
    
    Management incentive plansYuchai has a management bonus plan under which annual incentive
bonuses in an aggregate amount equal to 2.5% of after-tax profit
are mandatorily required to be paid to Mr Wang Jianming, the
Chairman and Chief Executive Officer of Yuchai if Yuchai achieves
80% of the after-tax profit approved in the annual budget by
Yuchais Board of Directors. Bonus expense recognized in
accordance with such plan in the years ended December 31, 2001,
2002 and 2003 amounted to Rmb 8,500, Rmb 13,506 and Rmb 17,721
(US$2,141), respectively.Mr Wang Jianming is also the legal person representative of State
Holding Company and is in charge of and responsible for the
operations of State Holding Company. Mr Wang Jianming does not
have any ownership interest in and does not receive any
compensation from State Holding Company. F-50




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CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  24.
    
    Related party transactions (continued)Notes: (continued)  (h)
    
    Stock option planThe Company had granted stock options to purchase an aggregate of
1,850,522 shares of common stock at an exercise price of US$7.80
per share to certain executive officers of the Company and Yuchai
in 1994. Such stock options expired in December 1999 without any
having been exercised.The Company adopted a stock option plan (the Plan) in December
1994 to award stock options to key employees and outside directors.
The Plan is administered by a committee (the Committee)
appointed by the Board of Directors consisting of at least two
directors. The Committee is to administer and interpret the Plan
and has the sole authority to determine who will be eligible and
who will be granted stock options and the timing, terms and number
of share options to be granted. Members of the Committee are not
eligible to receive stock options under the Plan. The Plan
provides for the granting of incentive stock options (within the
meaning of section 422(a) of the United States Internal Revenue
Code of 1986, as amended) to employees and outside directors who
are citizens or residents of the United States. The exercise price
of each stock option will be determined by the Committee, but may
not be less than the fair value as determined by the Committee of
the Companys common stock on the date the option is granted. The
total number of shares of the Companys common stock that may be
purchased pursuant to stock options granted under the Plan shall
not exceed in the aggregate 750,000 shares of the common stock.
The Plan will expire in 2004 unless terminated earlier by the Board
of Directors. The Company will reimburse the Plan for the
administrative expenses incurred. For the year ended December 31,
2003 no options had been granted under the Plan.  25.
    
    Foreign currency exchangeThe Renminbi is not freely convertible into foreign currencies. All
foreign exchange transactions involving Renminbi must take place either
through the Peoples Bank of China or other institutions authorized to
buy and sell foreign exchange or at a swap center. The exchange rate
adopted for the foreign exchange transactions are the rates of exchange
quoted by the Peoples Bank of China which are determined largely by
supply and demand.Foreign currency payments, including the remittance of earnings outside
of the PRC, are subject to the availability of foreign currency which is
dependent on the foreign currency denominated earnings of Yuchai or must
be arranged with government approval. F-51




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CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  26.
    
    Distribution of profitsThe Companys only sources of cash flow are its share of the dividends,
if any, paid by Yuchai to the Company and retained net proceeds (and
investment interest thereon) from its initial public offering. With
respect to dividends by Yuchai, applicable PRC laws and regulations
require that, before it can distribute profit to investors it must
satisfy all tax liabilities, recover losses in previous years and make
contributions to certain statutory reserves as discussed in note 20. If
available foreign currency to Yuchai is insufficient to pay declared
dividends, such dividends may be paid partly in Renminbi and partly in
foreign currency. In the event that dividends are distributed in
Renminbi, such dividends may be converted into foreign currency and
remitted in accordance with relevant PRC laws, regulations and policies
and to the extent permitted by PRC market conditions. Dividends of
Yuchai are determined based on distributable profit reported in its PRC
GAAP financial statements, after appropriation to statutory reserves.
Such distributable profits differ from the amounts reported under U.S.
GAAP (See Note 20).Under the Companies Act of 1981 of Bermuda (as amended), the Companys
contributed surplus is available for distribution to shareholders.27.
    
    Derivative instrument and hedging activitiesThe Company and its subsidiaries do not enter into derivative
instruments for any purpose. The Company and its subsidiaries do not
hedge risk exposures or speculate using derivative instruments.28.
    
    Fair value of financial instrumentsThe fair value of a financial instrument is the amount at which the
instrument could be exchanged in a current transaction between willing
parties. The carrying amount of cash and cash equivalents, trade
accounts receivable, bills receivable, short term amounts due from
related companies, prepaid expenses, other receivables, short-term bank
loans, current installments of long-term bank loans, trade accounts
payable, amount due to the holding company, amounts due to related
companies, accrued expense and other liabilities approximates their fair
value because of the short maturity of these instruments. It was not
practicable for Yuchai to estimate the fair value of its equity
investment for which a quoted market price is not available because it
has not yet obtained or developed the valuation model necessary to make
the estimate, and the cost of obtaining an independent valuation appears
excessive considering the materiality of the equity investment to
Yuchai. Yuchai does not believe the carrying value of the equity
investment will be significantly different from its fair value.Cash and cash equivalents of Yuchai and its subsidiaries denominated in
foreign currencies have been translated at the balance sheet date into
Renminbi at rates quoted by the Peoples Bank of China. Yuchai did not
have and does not believe it will have any difficulty in exchanging its
foreign currency cash for Renminbi.Amount due from GYMEC as of December 31, 2002 was recorded in its net
present value based on a discount rate of 5.94%, the rate generally
available for discounting similar instruments with banks in the PRC.The carrying amount of long-term bank loans approximates their fair
value based on the borrowing rates currently available for bank loans
with similar terms and average maturities. F-52




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##### Table of Contents



CHINA YUCHAI INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(Rmb and US$ amounts expressed in thousands, except per share data)  29.
    
    Business credit concentrationSubstantially all of the Companys customers are located in the PRC.
The following are the customers that individually comprise 10% or more
of gross revenue in any of the relevant periods: Years ended December 31,2001
    
    2002
    
    2003
    
    2003Rmb
    
    Rmb
    
    Rmb
    
    US$Hubei Dongfeng
Automobile
    
    
    272,469
    
    
    
    359,598
    
    
    
    613,448
    
    
    
    74,117Liuzhou Dongfeng
Automobile (Note (a))
    
    
    420,171
    
    
    
    513,789
    
    
    
    391,086
    
    
    
    47,251Dongfeng Special
Automobile (Note (b))
    
    
    200,937
    
    
    
    327,475
    
    
    
    202,341
    
    
    
    24,447
  Notes:(a)
    
    Sales to Liuzhou Dongfeng Automobile for the year ended
December 31, 2003 was approximately 8.6% of total sales.(b)
    
    Sales to Dongfeng Special Automobile for the years ended
December 31, 2002 and 2003 were approximately 9.3% and 4.4% of total
sales, respectively.  All the above customers are controlled by or affiliated with Dongfeng
Automobile Company. At December 31, 2002 and 2003, approximately 31% and
46% of gross trade accounts receivable, respectively, were due from these
customers. The Company considers its relationships with these major
customers to be good; however, the loss of one or more of the Companys
major customers would have a material adverse effect on the Companys
results of operations.During periods of economic expansion, the demand of trucks, construction
machinery and other application of diesel engines generally increase.
Conversely, during economic slowdowns the diesel engine industry is
generally adversely affected by a decline in demand. As a result, the
performance of Chinese economy will affect the Companys business and
prospects by a significant degree. F-53