UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





(Mark
One)


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





For the
quarterly period ended March 31, 2010




o TRANSITION REPORT
UNDER SECTION 13 OR 15 (D) OF THE EXCHANGE ACT





For the
transition period from 
to





Commission
File Number:  333-114564





CHINA
CARBON GRAPHITE GROUP, INC.


(Name
of Registrant as specified in its charter)





Nevada
            
            98-0550699(State
      or other jurisdiction of incorporation of organization)
            
            (I.R.S.
      Employer Identification No.)





China
Carbon Graphite Group, Inc.


c/o
Xinghe Yongle Carbon Co., Ltd.


787
Xicheng Wai


Chengguantown


Xinghe County


Inner
Mongolia, China


(Address
of principal executive office)





(86)
474-7209723


(Registrant’s
telephone number)








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 whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).


Yes o No o





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





Large
      accelerated filer
            o
            Accelerated
      filer
            oNon-accelerated
      filer
              (Do
      not check if smaller reporting company)
            o
            Smaller
      reporting company
            þ





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





Indicate
the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date: 20,160,161 shares of common stock
are issued and outstanding as of May 17, 2010.

















CHINA
CARBON GRAPHITE GROUP, INC. AND SUBSIDIARIES


FORM
10-Q


March
31, 2010





TABLE
OF CONTENTS








PART I - FINANCIAL
      INFORMATION
            Page
      No.Item
      1.
            Financial
      Statements:
            1Condensed
      Consolidated Balance Sheets at March 31, 2010 (unaudited) and December 31,
      2009
            1Condensed
      Consolidated Statements of Cash Flows for the Three months ended March 31,
      2010 and 2009 (unaudited)
            2Condensed
      Consolidated Statements of Income and Comprehensive Income for the Three
      months ended March 31, 2010 and 2009 (unaudited)
            3Notes
      to Condensed Consolidated Financial Statements
            4Item
      2.
            Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations.
            18Item
      3.
            Quantitative
      and Qualitative Disclosure About Market Risk
            27Item
      4.
            Controls
      and Procedures.
            27PART
      II - OTHER INFORMATIONItem
      2.
            Unregistered
      Sales of Equity Securities and Use of Proceeds.
            29Item
      6.
            Exhibits.
            29













China
      Carbon Graphite Group, Inc. and SubsidiariesCondensed
      Consolidated Balance SheetsMarch
      31, 2010
            
            
            December
      31, 2009(Unaudited)
            
            
            (Audited)ASSETSCurrent
      AssetsCash
      and cash equivalents
            
            $
            4,004,759
            
            
            $
            2,709,127Trade
      accounts receivable, net
            
            
            3,741,011
            
            
            
            5,170,419Notes
      receivable
            
            
            109,713
            
            
            
            248,452Other
      receivables
            
            
            307,829
            
            
            
            1,130,795Advance
      to suppliers, net
            
            
            1,061,849
            
            
            
            790,767Inventories
            
            
            17,030,696
            
            
            
            16,430,754Prepaid
      expenses
            
            
            100,762
            
            
            
            50,000Total
      current assets
            
            
            26,356,619
            
            
            
            26,530,314Property
      and equipment, net
            
            
            23,446,558
            
            
            
            23,913,965Construction
      in progress
            
            
            2,154,695
            
            
            
            2,045,176Land
      use rights, net
            
            
            8,449,438
            
            
            
            3,548,273Total Assets
            
            $
            60,407,310
            
            
            $
            56,037,728LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      LiabilitiesAccounts
      payable and accrued expenses
            
            $
            2,702,780
            
            
            $
            2,005,583Advance
      from customers
            
            
            922,365
            
            
            
            1,084,206Taxes
      payable
            
            
            193,703
            
            
            
            370,777Short
      term bank loans
            
            
            9,208,561
            
            
            
            8,573,901Long
      term bank loan - current portion
            
            
            1,609,121
            
            
            
            1,613,566Notes
      payable
            
            
            2,194,256
            
            
            
            -Dividends
      payable
            
            
            36,229
            
            
            
            -Other
      payables
            
            
            1,498,214
            
            
            
            922,109Total
      current liabilities
            
            
            18,365,229
            
            
            
            14,570,142Long
      Term LiabilitiesLong
      term bank loan - non-current portion
            
            
            1,609,121
            
            
            
            1,613,566Accounts
      payable in long term
            
            
            1,221,510
            
            
            
            1,243,842Warrant
      liabilities
            
            
            1,803,352
            
            
            
            708,091Total
      liabilities
            
            
            22,999,212
            
            
            
            18,135,641Stockholders'
      EquityConvertible
      preferred A stock, par value $0.001 per share,authorized
      20,000,000 shares, issued and outstanding 125,000shares
      December 31, 2009 and none at March 31, 2010
            
            $
            -
            
            
            $
            125Convertible
      series B preferred stock, par value $0.001 per share,authorized
      3,000,000 shares, issued and outstanding 1,448,000 and 2,160,500 shares
       at March 31, 2010 and December 31, 2009,
respectively
            
            
            1,448
            
            
            
            2,161Common
      stock, $0.001 par value,  authorized 100,000,000
      shares,issued
      and outstanding 19,467,161 and 18,121,661 sharesat
      March 31, 2010 and December 31, 2009, respectively
            
            
            19,467
            
            
            
            18,122Additional
      paid-in capital
            
            
            13,931,182
            
            
            
            13,298,332Accumulated
      other comprehensive income
            
            
            4,937,540
            
            
            
            5,037,062Retained
      earnings
            
            
            18,518,461
            
            
            
            19,546,285Total
      stockholders' equity
            
            
            37,408,098
            
            
            
            37,902,087Total liabilities and
      stockholders’ equity
            
            $
            60,407,310
            
            
            $
            56,037,728


The
accompanying notes are an integral part of these financial
statements




1




China Carbon Graphite Group, Inc
      and subsidiariesConsolidated
      Statements of Income and Comprehensive Income (Unaudited)Three
      months ended March 31,2010
            
            
            2009Sales
            
            $
            4,846,856
            
            
            $
            2,893,647Cost
      of Goods Sold
            
            
            3,822,666
            
            
            
            2,052,752Gross
      Profit
            
            
            1,024,190
            
            
            
            840,895Operating
      ExpensesSelling
      expenses
            
            
            24,993
            
            
            
            308,645General
      and administrative
            
            
            403,936
            
            
            
            135,995Depreciation
      and amortization
            
            
            27,340
            
            
            
            19,080456,269
            
            
            
            463,720Operating
      Income Before Other Income (Expense)and
      Income Tax Expense
            
            
            567,921
            
            
            
            377,175Other
      Income (Expense)Interest
      expense
            
            
            (206,148)
            
            
            
            (198,345)Interest
      income
            
            
            -
            
            
            
            94Other
      income
            
            
            -
            
            
            
            292,116Change
      in fair value of warrants
            
            
            (1,220,430)
            
            
            
            -(1,426,578)
            
            
            
            93,865(Loss)
      Income Before Income Tax Expense
            
            
            (858,657)
            
            
            
            471,040Income
      tax expense
            
            
            -
            
            
            
            -Net
      income (Loss)
            
            $
            (858,657)
            
            
            $
            471,040Deemed
      preferred stock dividend
            
            
            (132,778)
            
            
            
            -Dividends
            
            
            (36,229)
            
            
            
            -Net
      (Loss) income available to common shareholders
            
            $
            (1,027,664)
            
            
            $
            471,040Comprehensive
      incomeNet
      income (Loss)
            
            
            (858,657)
            
            
            
            471,040Other
      comprehensive incomeForeign
      currency translation gain
            
            
            (99,522)
            
            
            
            44,914Total
      Comprehensive (Loss) Income
            
            $
            (958,179)
            
            
            $
            515,954Share
      dataBasic
      earnings per share
            
            $
            (0.06)
            
            
            $
            0.04Diluted
      earnings per share
            
            $
            (0.06)
            
            
            $
            0.04Weighted
      average common shares outstanding,basic
            
            
            18,485,344
            
            
            
            12,768,144Weighted
      average common shares outstanding,diluted
            
            
            18,485,344
            
            
            
            13,847,244The
      accompanying notes are an integral part of these financial
      statements.





2




China
      Carbon Graphite Group, Inc and SubsidiariesCondensed
      Consolidated Statements of Cash Flows (Unaudited)Three
      months ended March 31,2010
            
            
            2009Cash
      flows from operating activitiesNet
      Income
            
            $
            (858,657)
            
            
            $
            471,040Adjustments
      to reconcile net cash provided byoperating
      activitiesDepreciation
      and amortization
            
            
            431,796
            
            
            
            328,355Share
      based compensation
            
            
            
            
            
            
            25,220Change
      in fair value of warrants
            
            
            1,220,430
            
            
            
            -Change
      in operating assets and liabilitiesAccounts
      receivable
            
            
            1,415,151
            
            
            
            208,734Notes
      receivable
            
            
            138,054
            
            
            
            (37,975)Other
      receivables
            
            
            819,844
            
            
            
            (82,334)Advance
      to suppliers
            
            
            (273,258)
            
            
            
            474,723Inventories
            
            
            (645,195)
            
            
            
            (102,113)Prepaid
      expenses
            
            
            (50,762)
            
            
            
            (20,350)Accounts
      payable and accrued expenses
            
            
            683,809
            
            
            
            (446,134)Advance
      from customers
            
            
            (158,853)
            
            
            
            145,785Taxes
      payable
            
            
            (176,050)
            
            
            
            (125,795)Other
      payables
            
            
            578,628
            
            
            
            (7,280)Net
      cash provided by operating activities
            
            
            3,124,938
            
            
            
            831,876Cash
      flows from investing activitiesAcquisition
      of property and equipment
            
            
            (2,926)
            
            
            
            (1,478,173)Construction
      in progress
            
            
            (115,152)
            
            
            
            1,178,041Acquisition
      of  land use rights
            
            
            (4,938,228)
            
            
            
            -Net
      cash used in investing activities
            
            
            (5,056,305)
            
            
            
            (300,132)Cash
      flows from financing activitiesProceeds
      from issuing series B preferred stock
            
            
            338,850
            
            
            
            -Proceeds
      from warrants exercise
            
            
            36,400
            
            
            
            -Proceeds
      from short term loan
            
            
            658,270
            
            
            
            -Proceeds
      from notes payable
            
            
            2,194,234
            
            
            
            -Repayment
      of bank loans
            
            
            -
            
            
            
            (438,174)Proceeds
      from issuing common stock for cash
            
            
            -
            
            
            
            67,900Net
      cash provided by (used in) financing activities
            
            
            3,227,754
            
            
            
            (339,941)Effect
      of exchange rate fluctuation
            
            
            (754)
            
            
            
            95Net
      increase in cash
            
            
            1,295,632
            
            
            
            191,898Cash
      and cash equivalents at beginning of period
            
            
            2,709,127
            
            
            
            51,799Cash
      and cash equivalents at end of period
            
            $
            4,004,759
            
            
            $
            243,697Supplemental
      disclosure of cash flow informationInterest
      paid
            
            $
            (206,148)
            
            
            $
            198,345Income
      taxes paid
            
            $
            -
            
            
            $
            -Non-cash
      financing and investing activities:Deemed
      preferred stock dividend
            
            $
            132,778
            
            
            $
            -Reclassfication
      of warrant liability from equity
            
            $
            34,770
            
            
            $
            -Issuance
      of common stock for consulting fee
            
            $
            -
            
            
            $
            90,000The
      accompanying footnotes are an integral part of these financial
      statements.





3


China
Carbon Graphite Group, Inc. and Subsidiaries


Notes
to Condensed Consolidated Financial Statements


For
the three months ended March 31, 2010








1.  Organization
and Business





China
Carbon Graphite Group, Inc. (the “Company”), is a Nevada corporation,
incorporated on February 13, 2003 under the name Achievers Magazine
Inc.  The Company’s corporate name was changed to China Carbon
Graphite Group, Inc. on January 30, 2008.





The
Company is the sole stockholder of Talent International Investment Limited
(“Talent”), a British Virgin Islands corporation, which is the sole stockholder
of Xinghe Yongle Carbon Co., Ltd. (“Yongle”), a company organized under the laws
of the People’s Republic of China (the “PRC”).





Yongle is
a party to a series of contractual arrangements with Xinghe Xingyong Carbon Co.,
Ltd. (“Xingyong”), a corporation organized under the laws of the
PRC.  These agreements give the Company the ability to operate and
manage the business of Xingyong and to derive the profit (or sustain the loss)
from Xingyong’s business. As a result, the operations of Xingyong are
consolidated with those of the Company for financial reporting purposes. The
relationship among the above companies as follows:








The
Company manufactures graphite electrodes, fine grain graphite, high purity
graphite and other carbon derived products.





Stock
distribution





On
January 22, 2008, the Company effected a 1.6-for-one stock distribution whereby
each share of common stock became converted into 1.6 shares of common stock. All
references to share and per share information in these financial statements
reflect this stock distribution.






4





2.  Basis
of Preparation of Financial Statements





Management
acknowledges its responsibility for the preparation of the accompanying interim
condensed consolidated financial statements which reflect all adjustments,
consisting of normal recurring adjustments, considered necessary in its opinion
for a fair statement of its condensed consolidated financial position and the
results of its operations for the interim period presented. These condensed
consolidated financial statements should be read in conjunction with the summary
of significant accounting policies and notes to consolidated financial
statements included in the Company’s Form 10-K annual report for the year ended
December 31, 2009.





The
accompanying unaudited condensed consolidated financial statements for China
Carbon Graphite Group, Inc., its subsidiaries and variable interest entity, have
been prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with the
instructions to Form 10-Q and Article 8-03 of Regulation S-X. Operating results
for interim periods are not necessarily indicative of results that may be
expected for the fiscal year as a whole.





The
Company maintains its books and accounting records in Renminbi (“RMB”), and its
reporting currency is United States dollars.





The
financial statements have been prepared in order to present the financial
position and results of operations of the Company, its subsidiaries and
Xingyong, which is an affiliated company whose financial condition is
consolidated with the Company pursuant to Accounting Standard Codification (ASC)
Topic 810-10, formerly known as FIN 46R, in accordance with accounting
principles generally accepted in the United States of America (“US
GAAP”).





Yongle is
a party to a series of contractual arrangements with Xingyong. These agreements
include a management agreement pursuant to which80% to 100% of
Xingyong’s net income after deduction of necessary expenses, if any, is paid to
Yongle and Yongle is responsible for paying Xingyong’s obligations incurred in
connection with its business. For the three months ended March 31, 2010 and
2009, Xingyong paid 100% of net income to Yongle.Yongle manages and
controls all of the funds of Xingyong. Yongle also has the right to purchase
Xingyong’s equipment and patents and lease its manufacturing plants, land and
remaining equipment. This agreement is designed so that Yongle can conduct its
business in China. Pursuant to two other agreements, the sole stockholder of
Xingyong, who was, at the time of the transaction, the Company’s chief executive
officer, has pledged all of his equity in Xingyong as security for performance
of Xingyong’s obligations to Yongle. As a result, Xingyong is considered a
variable interest entity.





3.
Summary of Significant Accounting Policies





Use of estimates - The
preparation of these financial statements in conformity with US GAAP requires
management to make estimates and assumptions that affected the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities at
the dates of the financial statements and the reported amounts of net sales and
expenses during the reported periods.





Significant
estimates included values and lives assigned to acquired property, equipment and
intangible assets, reserves for customer returns and allowances, uncollectible
accounts receivable, slow moving, obsolete and/or damaged inventory and stock
warrant valuation. Actual results may differ from these estimates.





Cash and cash equivalents -The Company considers all highly liquid debt instruments purchased with
maturity period of three months or less to be cash equivalents. The carrying
amounts reported in the accompanying balance sheet for cash and cash equivalents
approximate their fair value. Most of the Company’s cash is held in bank
accounts in the PRC and is not protected by FDIC insurance or any other similar
insurance. The Company’s bank account in the United States is protected by FDIC
insurance






5





Inventory -Inventory is
stated at the lower of cost or market. Cost is determined using the weighted
average method. Market value represents the estimated selling price in the
ordinary course of business less the estimated costs necessary to complete the
sale.





The cost
of inventories comprises all costs of purchases, costs of conversion and other
costs incurred in bringing the inventories to their present location and
condition. The costs of conversion of inventories include fixed and variable
production overhead, taking into account the stage of completion.





Accounts receivable -Trade
receivables are recognized and carried at the original invoice amount less
allowance for any uncollectible amounts. An estimate for doubtful accounts is
made when collection of the full amount is no longer probable. Bad debts are
written off as incurred.





Property and equipment-
Property and equipment is stated at the historical cost, less accumulated
depreciation. Land use rights are being amortized to expense on a straight line
basis over the life of the rights. Depreciation on property, plant and equipment
is provided using the straight-line method over the estimated useful lives of
the assets for both financial and income tax reporting purposes as
follows:





Buildings
            
            
            25
      - 40 yearsMachinery
      and equipment
            
            
            10
      - 20 yearsMotor
      vehicles
            
            
            5
      years





Expenditures
for renewals and betterments were capitalized while repairs and maintenance
costs are normally charged to the statement of operations in the year in which
they are incurred. In situations where it can be clearly demonstrated that the
expenditure has resulted in an increase in the future economic benefits expected
to be obtained from the use of the asset, the expenditure is capitalized as an
additional cost of the asset.





Upon sale
or disposal of an asset, the historical cost and related accumulated
depreciation or amortization of such asset were removed from their respective
accounts and any gain or loss is recorded in the statements of
income.





The
Company reviews the carrying value of property, plant, and equipment for
impairment whenever events and circumstances indicate that the carrying value of
an asset may not be recoverable from the estimated future cash flows expected to
result from its use and eventual disposition. In cases where undiscounted
expected future cash flows are less than the carrying value, an impairment loss
is recognized equal to an amount by which the carrying value exceeds the fair
value of assets. The factors considered by management in performing this
assessment include current operating results, trends and prospects, the manner
in which the property is used, and the effects of obsolescence, demand,
competition, and other economic factors. Based on this assessment there was no
impairment recorded during the three months ended at March 31, 2010 and
2009.






6





Construction in progress -
Construction in progress represents the costs incurred in connection with the
construction of buildings or additions to the Company’s plant facilities. No
depreciation is provided for construction in progress until such time as the
assets are completed and placed into service.





Land use rights- There is no
private ownership of land in the PRC. The Company has acquired land use rights
to a total of 6,356,209 square feet, on which a 290,626 square feet facility is
located. The land use rights have terms of 50 years, with the land use right
relating to 1,207,388 square feet expiring in 2050 and the land use right with
respect to 1,148,821 square feet expiring in 2057. The cost of the land use
rights is amortized over the 50-year term of the land use right. The Company
evaluates the carrying value of intangible assets during the fourth quarter of
each year and between annual evaluations if events occur or circumstances change
that would more likely than not reduce the fair value of the intangible asset
below its carrying amount.





Income recognition- Revenue
is recognized in accordance with ASC 605-25, Revenue Recognition of Financial
Statements, formerly known as Staff Accounting Bulletin No. 104, Revenue
Recognition, which states that revenue should be recognized when the following
criteria are met: (1) persuasive evidence of an arrangement exists; (2) the
service has been rendered; (3) the selling price is fixed or determinable; and
(4) collection of the resulting receivable is reasonably assured. The Company
believes that these criteria are satisfied when the goods are shipped pursuant
to a purchase order.





Interest
income is recognized when earned.





Advertising - The Company
expenses all advertising costs as incurred. There was no advertising expense for
the three months ended March 31, 2010 and for 2009.





Shipping and handling costs-
The Company follows ASC 605-45, Handling Costs, Shipping Costs, formerly known
as Emerging Issues Task Force (“EITF”) No. 00-10, Accounting for Shipping and
Handling Fees and Costs.  The Company does not charge its customers
for shipping and handling. The Company classifies shipping and handling costs as
part of the operating expenses. For the three months ended March 31, 2010 and
2009, shipping and handling costs were $23,938 and $300,787,
respectively.





Segment reporting - ASC 280,
“Segment Reporting”, formerly known as Statement of Financial Accounting
Standards (“SFAS”) No 131, “Disclosure about Segments of an Enterprise and
Related Information,” requires use of the “management approach” model for
segment reporting. Under this model, segment reporting is consistent with the
manner that the Company’s management organizes segments within the company for
making operating decisions and assessing performance. Reportable segments are
based on products and services, geography, legal structure, management
structure, or any other manner in which management disaggregates a
company.





The
Company only sells carbon graphite products and sells only to Chinese
distributors and end users and is in only one business segment.





Taxation -Taxation on profits
earned in the PRC has been calculated on the estimated assessable profits for
the year at the rates of taxation prevailing in the PRC where the Company
operates after taking into effect the benefits from any special tax credits or
“tax holidays” allowed in the county of operations.





The
Company does not accrue United States income tax since it has no operation in
the United States. Its operating subsidiaries are organized and located in the
PRC and do not conduct any business in the United States.





In 2006,
the Financial Accounting Standards Board (FASB) issued ASC Topic 740 Income
Taxes, formerly known as  FIN 48, which clarifies the application of
SFAS 109 by defining a criterion that an individual income tax position must
meet for any part of the benefit of that position to be recognized in an
enterprise’s financial statements and provides guidance on measurement,
recognition, classification, accounting for interest and penalties, accounting
in interim periods, disclosure and transition. In accordance with the transition
provisions, the Company adopted FIN 48 effective January 1, 2007.






7





The
Company recognizes that virtually all tax positions in the PRC are not free of
some degree of uncertainty due to tax law and policy changes by the state. The
Company cannot reasonably quantify political risk factors and thus must depend
on guidance issued by current government officials.





Based on
all known facts and circumstances and current tax law, the Company believes that
the total amount of unrecognized tax benefits as of March 31, 2010 is not
material to its results of operations, financial condition or cash flows. The
Company also believes that the total amount of unrecognized tax benefits as of
March 31, 2010, if recognized, would not have a material effect on its effective
tax rate. The Company further believes that there are no tax positions for which
it is reasonably possible, based on current Chinese tax law and policy, that the
unrecognized tax benefits will significantly increase or decrease over the next
twelve months producing, individually or in the aggregate, a material effect on
the Company’s results of operations, financial condition or cash
flows.





Enterprise income tax -
Effective January 1, 2008, the new income tax law sets unified income tax rate
for domestic and foreign companies at 25% except a 15% corporation income tax
rate for qualified high technology and science enterprises. In accordance with
this new income tax law, low preferential tax rate in accordance with both the
tax laws and administrative regulations prior to the promulgation of this Law
shall gradually transit to the new tax rate within five years after the
implementation of this law.





The
Company has been recognized as a high technology and science company by the
Ministry of Science and Technology of the PRC. Therefore, Xing He District Local
Tax Authority in the Nei Mongol province granted tax holiday from 100% of
enterprises income tax for 10 years from 2008 through 2018. Afterwards, based on
the present tax law and the Company’s status as a high technology and science
company, the Company will be subject to a corporation income tax rate of 15%
effective in 2019.





The
enterprise income tax is calculated on the basis of the statutory profit as
defined in the PRC tax laws. This statutory profit computed differently from the
Company’s net income under U.S. GAAP.





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 basis. Deferred tax
assets, including tax loss and credit carry forwards, and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect of deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.
Deferred income tax expense represents the change during the period in the
deferred tax assets and deferred tax liabilities. The components of the deferred
tax assets and liabilities are individually classified as current and
non-current based on their characteristics. Deferred tax assets are reduced by a
valuation allowance when, in the opinion of management, it is more likely than
not that some portion or all of the deferred tax assets will not be
realized.





Value added tax - The
Provisional Regulations of the PRC Concerning Value Added Tax promulgated by the
State Council came into effect on January 1, 1994. Under these regulations and
the Implementing Rules of the Provisional Regulations of the PRC Concerning
Value Added Tax, value added tax (“VAT”) is imposed on goods sold in or imported
into the PRC and on processing, repair and replacement services provided within
the PRC.





VAT
payable in the PRC is charged on an aggregated basis at a rate of 13% or 17%
(depending on the type of goods involved) on the full price collected for the
goods sold or, in the case of taxable services provided, at a rate of 17% on the
charges for the taxable services provided, but excluding, in respect of both
goods and services, any amount paid in respect of VAT included in the price or
charges, and less any deductible value added tax already paid by the taxpayer on
purchases of goods and services in the same financial year.





The
Company has been granted an exemption from VAT by the Xing He County People’s
Government and Xing He Tax Authority on some products in which an exchange
agreement is in place for raw materials and fuel.






8





Contingent liabilities and contingent
assets -A contingent liability is a possible obligation that arises from
past events and whose existence will only be confirmed by the occurrence or
non-occurrence of one or more uncertain future events not wholly within the
control of the Company. It can also be a present obligation arising from past
events that is not recognized because it is not probable that the Company will
incur a liability or obligations as a result. A contingent liability, which
might occur but is not probable, is not recorded but is disclosed in the notes
to the financial statements. The Company will recognize a liability or
obligation when it is probable that the Company will incur it.





A
contingent asset is an asset, which could possibly arise from past events and
whose existence will be confirmed only by the occurrence or non-occurrence of
one or more uncertain events not wholly within the control of the Company.
Contingent assets are not recorded but are disclosed in the notes to the
financial statements when it is likely that the Company will recognize an
economic benefit. When the benefit is virtually certain, the asset is
recognized.





Retirement benefit costs-
According to PRC regulations on pensions, the Company contributes to a defined
contribution retirement program organized by the municipal government in the
province in which the Company was registered and all qualified employees are
eligible to participate in the program. Contributions to the program are
calculated at 23.5% of the employees’ salaries above a fixed threshold amount
and the employees contribute 2% to 8% while the Company contributes the
remaining 15.5% to 21.5%. The Company has no other material obligation for the
payment of retirement benefits beyond the annual contributions under this
program.





In
addition, the Company is required by Chinese laws to cover employees in China
with various types of social insurance. The Company believes that it is in
material compliance with the relevant PRC laws.





Fair value of financial instruments- On January 1, 2008, the Company began recording financial assets and
liabilities subject to recurring fair value measurement at the price that would
be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants. On January 1, 2009 the Company began
recording non-recurring financial as well as all non-financial assets and
liabilities subject to fair value measurement under the same principles. These
fair value principles prioritize valuation inputs across three broad levels. The
three levels are defined as follows:





·
            Level
      1 inputs to the valuation methodology are quoted prices (unadjusted) for
      identical assets or liabilities in active
  markets.





·
            Level
      2 inputs to the valuation methodology include quoted prices for similar
      assets and liabilities in active markets, and inputs that are observable
      for the assets or liability, either directly or indirectly, for
      substantially the full term of the financial
  instruments.





·
            Level
      3 inputs to the valuation methodology are unobservable and significant to
      the fair value.





On
January 13, 2010, the Company sold in a private placement a total of 320,000
shares of Series B Convertible Preferred Stock and five-year warrants to
purchase 128,000 shares of common stock at an exercise price of $1.30 per share,
for an aggregate purchase price of $384,000.   The Company also
paid the private placement agent $38,400 and issued a five-year warrant expiring
to purchase 16,000 shares of common stock at an exercise price of $1.32 per
share.





On March
29, 2010, warrants to purchase 28,000 shares of common stock at $1.30 were
exercised.





As of
March 31, 2010, the Company had the following warrants outstanding:






9





Number
      of shares of common stock to purchase
            Average
      exercise price“2007
      Warrants”
            125,000
            $2.00“2009
      Warrants”
            300,000
            $2.67“2009
      Series B Warrants”
            1,144,225
            $1.30“2010
      Series B Warrants”
            144,000
            $1.30





The fair
value of the 2007 Warrants to purchase 125,000 shares of common stock was
$79,650 and $10,913 at March 31, 2010 and December 31, 2009, respectively. The
Company recognized a loss of $68,737 from the change in fair value of these
warrants for the three months ended March 31, 2010.





The fair
value of the 2009 Warrants to purchase 300,000 shares of common stock was
$132,040 and $22,190 at March 31, 2010 and December 31, 2009, respectively. The
Company recognized a loss of $109,850 from the change in fair value of these
warrants for the three months ended March 31, 2010.





The fair
value of the 2009 Series B Warrants to purchase 1,144,225 shares of common stock
was $1,418,572 and $508,205 at March 31, 2010 and December 31, 2009,
respectively. The Company recognized a loss of $910,367 from the change in fair
value of these warrants for the three months ended March 31, 2010.





Warrants
to purchase 28,000 shares of common stock was exercised on March 29, 2010, the
fair value of these warrants was $42,039 at the exercise date and $12,468 at
December 31, 2009, respectively. As a result, the Company recognized a loss of
$29,571 on these warrants.





The fair
value of 2010 Series B Warrants was $178,715 at March 31, 2010 and $76,810 at
the issuance date, respectively. As a result, the Company recognized a loss of
$101,905.





In
summary, the Company recorded a total amount of $1,220,430 of changes in fair
value of warrants in the Consolidate statement of income and comprehensive
income.





Warrants
referred to in the preceding paragraphs do not trade in an active securities
market, and as such, the Company estimates the fair value of these warrants
using the Black-Scholes option pricing model using the following
assumptions:





2007
      Warrants
            
            March
      31, 2010
            
            December
      31, 2009Annual
      dividend yield
            
            
            -
            
            
            
            -Expected
      life (years)
            
            
            2.75
            
            
            
            3Risk-free
      interest rate
            
            
            0.16
            %
            
            
            0.06
            %Expected
      volatility
            
            
            22
            %
            
            
            19
            %





2009
      Warrants
            
            March
      31, 2010
            
            December
      31, 2009Annual
      dividend yield
            
            
            -
            
            
            
            -Expected
      life (years)
            
            
            4.5
            
            
            
            4.75Risk-free
      interest rate
            
            
            0.16
            %
            
            
            0.06
            %Expected
      volatility
            
            
            22
            %
            
            
            19
            %







10




2009
      Series B Warrants
            
            March
      31, 2010
            
            December
      31, 2009Annual
      dividend yield
            
            
            -
            
            
            
            -Expected
      life (years)
            
            
            4.75
            
            
            
            5Risk-free
      interest rate
            
            
            0.16
            %
            
            
            0.06
            %Expected
      volatility
            
            
            22
            %
            
            
            19
            %





2010
      Series B Warrants
            
            March
      31, 2010
            
            Issuance
      dateAnnual
      dividend yield
            
            
            -
            
            
            
            -Expected
      life (years)
            
            
            4.8
            
            
            
            5Risk-free
      interest rate
            
            
            0.16
            %
            
            
            0.06
            %Expected
      volatility
            
            
            22
            %
            
            
            19
            %





Expected
volatility is based on the annualized daily historical volatility over a period
of one year.  The Company believes this method produces an estimate
that is representative of the Company’s expectations of future volatility over
the expected term of these warrants. The expected life is based on the remaining
term of the warrants. The risk-free interest rate is based on U.S. Treasury
securities according to the remaining term of the warrants.





The
following table sets forth by level within the fair value hierarchy of the
Company’s financial assets and liabilities that was accounted for at fair value
on a recurring basis as of March 31, 2010.





Carrying
      Value at
              March
      31,
            
            
            Fair
      Value Measurement at
              March
      31, 20102010
            
            
            Level
      1
            
            
            Level
      2
            
            
            Level
      3Warrant
      liability
            
            $
            1,803,352
            
            
            
            -
            
            
            
            -
            
            $
            
            1,803,352





The
Company did not identify any other non-recurring assets and liabilities that are
required to be presented on the balance sheet at fair value.





Earnings per share -Basic
earnings per share is computed by dividing net income available to common
shareholders by the weighted average number of shares of common stock
outstanding during the period. Diluted earnings per share is computed by
dividing net income available to common shareholders by the weighted average
number of shares of common stock, common stock equivalents and potentially
dilutive securities outstanding during each period. Potentially dilutive shares
of common stock consist of the common stock issuable upon the conversion of
convertible debt, preferred stock and warrants. The Company has outstanding
warrants to purchase 1,713,225 shares of common stock at an exercise price in
the range of $1.3- $3.0 per share. The Company uses if-converted method to
calculate the dilutive preferred stock and treasury stock method to calculate
the dilutive shares issuable upon exercise of warrants





The
following table sets forth the computation of the number of net income per share
for the three months ended March 31, 2010 and 2009.





Three
      Months Ended March 31,2010
            
            
            2009Weighted
      average shares of common stock outstanding (basic)
            
            
            18,485,344
            
            
            
            12,768,144Shares
      issuable upon conversion of series A preferred stock
            
            
            -
            
            
            
            453,441Shares
      issuable upon exercise of warrants
            
            
            -
            
            
            
            -Weighted
      average shares of common stock outstanding (diluted)
            
            
            18,485,344
            
            
            
            13,221,585Net
      income available to common shareholders
            
            $
            (1,027,664
            )
            
            $
            471,040Net
      income per shares of common stock (diluted)
            
            $
            (0.06
            )
            
            $
            .04




11


For the
three months ended March 31, 2010, the Company did not include any shares of
common stock issuable upon conversion of preferred stock and exercise of
warrants, since such issuance would be antidilutive.





Accumulated other comprehensive
income- The Company follows ASC 220 “Comprehensive Income”, formerly
known as SFAS No. 130, “Reporting Comprehensive Income”, to recognize the
elements of comprehensive income. Comprehensive income is comprised of net
income and all changes to the statements of stockholders' equity, except those
due to investments by stockholders, changes in paid-in capital and distributions
to stockholders. For the Company, comprehensive income for the three months
ended March 31, 2010 and 2009 included net income and foreign currency
translation adjustments.





Related parties- Parties are
considered to be related to the Company if the parties that, directly or
indirectly, through one or more intermediaries, control, are controlled by, or
are under common control with the Company. Related parties also include
principal owners of the Company, its management, members of the immediate
families of principal owners of the Company and its management and other parties
with which the Company may deal if one party controls or can significantly
influence the management or operating policies of the other to an extent that
one of the transacting parties might be prevented from fully pursuing its own
separate interests. Transactions with related parties are disclosed in the
financial statements.





Recent
accounting pronouncements
 
 In May
2009, the FASB issued ASC 855, “Subsequent Events”, formerly known as SFAS No.
165. SFAS No. 165 is intended to establish general standards of accounting for
and disclosures of events that occur after the balance sheet date but before
financial statements are issued or are available to be issued. It requires the
disclosure of the date through which an entity has evaluated subsequent events
and the basis for selecting that date, that is, whether that date represents the
date the financial statements were issued or were available to be issued. SFAS
165 No. is effective for interim or annual financial periods ending after June
15, 2009. The Company adopted this statement for the financial statements since
the quarter ended June 30, 2009.
 
 In June
2009, the FASB issued ASC 860, “Transfers and servicing”, formerly known as SFAS
No. 166, a revision to SFAS No. 140, “Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities”, and will require more
information about transfers of financial assets and where companies have
continuing exposure to the risks related to transferred financial assets. SFAS
166 is effective at the start of a company’s first fiscal year beginning after
November 15, 2009, or January 1, 2010 for companies reporting earnings on a
calendar-year basis. The adoption of this statement is not expected to have a
material effect on the Company's financial statements.
 
 In June
2009, the FASB issued ASC 810, “Consolidation”, formerly known as SFAS No. 167,
a revision to FASB Interpretation No. 46(R), Consolidation of Variable Interest
Entities, and will change how a company determines when an entity that is
insufficiently capitalized or is not controlled through voting (or similar
rights) should be consolidated. Under SFAS No. 167, determining whether a
company is required to consolidate an entity will be based on, among other
things, an entity's purpose and design and a company's ability to direct the
activities of the entity that most significantly impact the entity's economic
performance. SFAS No. 167 is effective at the start of a company’s first fiscal
year beginning after November 15, 2009, or January 1, 2010 for companies
reporting earnings on a calendar-year basis. The adoption of SFAS No. 167 will
not have an effect on the Company’s financial statements
 
 In June
2009, the FASB issued SFAS No. 168, "The Financial Accounting Standards Board
(FASB) Accounting Standards Codification (ASC) and the Hierarchy of Generally
Accepted Accounting Principles (GAAP) - a replacement of SFAS No. 162" (SFAS
168), which establishes the FASB ASC as the source of authoritative U.S. GAAP
recognized by the FASB to be applied by non-governmental entities. As a result
of the adoption of SFAS 168, the majority of references to historically issued
accounting pronouncements are now superseded by references to the FASB ASC, with
no financial impact.
 
 In August
2009, the FASB issued an Accounting Standards Update (“ASU”) regarding measuring
liabilities at fair value. This ASU provides additional guidance clarifying the
measurement of liabilities at fair value in circumstances in which a quoted
price in an active market for the identical liability is not available; under
those circumstances, a reporting entity is required to measure fair value using
one or more of valuation techniques, as defined. The adoption of this guidance
did not have a material impact on the Company’s consolidated financial
statements.
 
 In
October 2009, the FASB issued an ASU regarding accounting for own-share lending
arrangements in contemplation of convertible debt issuance or other
financing.  This ASU requires that at the date of issuance of the
shares in a share-lending arrangement entered into in contemplation of a
convertible debt offering or other financing, the shares issued shall be
measured at fair value and be recognized as an issuance cost, with an offset to
additional paid-in capital. Further, loaned shares are excluded from basic and
diluted earnings per share unless default of the share-lending arrangement
occurs, at which time the loaned shares would be included in the basic and
diluted earnings-per-share calculation.  This ASU is effective for
fiscal years beginning on or after December 15, 2009, and interim periods within
those fiscal years for arrangements outstanding as of the beginning of those
fiscal years. The adoption of this guidance did not have a material impact on
the Company’s consolidated financial statements.
 
 In
November 2009, the FASB issued an ASU regarding accounting for stock dividends,
including distributions to shareholders with components of stock and cash. This
ASU clarifies that the stock portion of a distribution to shareholders that
contains components of cash and stock and allows shareholders to select their
preferred form of the distribution (with a limit on the amount of cash that will
be distributed in total) should be considered a stock dividend and included in
EPS calculations as a share issuance. The adoption of this guidance did not have
a material impact on the Company’s consolidated financial
statements
 
 In
December 2009, FASB issued ASU No. 2009-16, Accounting for Transfers of
Financial Assets. This Accounting Standards Update amends the FASB Accounting
Standards Codification for the issuance of FASB Statement No. 166,Accounting for Transfers
of Financial Assets—an amendment of FASB Statement No. 140. The
amendments in this Accounting Standards Update improve financial reporting by
eliminating the exceptions for qualifying special-purpose entities from the
consolidation guidance and the exception that permitted sale accounting for
certain mortgage securitizations when a transferor has not
 
 12
 
 surrendered
control over the transferred financial assets. In addition, the amendments
require enhanced disclosures about the risks that a transferor continues to be
exposed to because of its continuing involvement in transferred financial
assets. Comparability and consistency in accounting for transferred financial
assets will also be improved through clarifications of the requirements for
isolation and limitations on portions of financial assets that are eligible for
sale accounting. The Company does not expect the adoption of this ASU to have a
material impact on its consolidated financial statements.
 
 In
December, 2009, FASB issued ASU No. 2009-17, Improvements to Financial Reporting
by Enterprises Involved with Variable Interest Entities. This Accounting
Standards Update amends the FASB Accounting Standards Codification for the
issuance of FASB Statement No. 167,Amendments to FASB Interpretation
No. 46(R) . The amendments in this Accounting Standards Update replace
the quantitative-based risks and rewards calculation for determining which
reporting entity, if any, has a controlling financial interest in a variable
interest entity with an approach focused on identifying which reporting entity
has the power to direct the activities of a variable interest entity that most
significantly impact the entity’s economic performance and (1) the obligation to
absorb losses of the entity or (2) the right to receive benefits from the
entity. An approach that is expected to be primarily qualitative will be more
effective for identifying which reporting entity has a controlling financial
interest in a variable interest entity. The amendments in this Update also
require additional disclosures about a reporting entity’s involvement in
variable interest entities, which will enhance the information provided to users
of financial statements. The Company is currently evaluating the impact of this
ASU, however, the Company does not expect the adoption of this ASU to have a
material impact on its consolidated financial statements.
 
 In
January 2010, FASB issued ASU No. 2010-01- Accounting for Distributions to
Shareholders with Components of Stock and Cash. The amendments in this Update
clarify that the stock portion of a distribution to shareholders that allows
them to elect to receive cash or stock with a potential limitation on the total
amount of cash that all shareholders can elect to receive in the aggregate is
considered a share issuance that is reflected in EPS prospectively and is not a
stock dividend for purposes of applying Topics 505 and 260 (Equity and Earnings
Per Share). The amendments in this update are effective for interim and
annual periods ending on or after December 15, 2009, and should be applied on a
retrospective basis. The Company does not expect the adoption of this ASU to
have a material impact on its consolidated financial
statements.
 
 In
January 2010, FASB issued ASU No. 2010-02 – Accounting and Reporting for
Decreases in Ownership of a Subsidiary – a Scope Clarification. The amendments
in this Update affect accounting and reporting by an entity that experiences a
decrease in ownership in a subsidiary that is a business or nonprofit activity.
The amendments also affect accounting and reporting by an entity that exchanges
a group of assets that constitutes a business or nonprofit activity for an
equity interest in another entity.  The amendments in this update are
effective beginning in the period that an entity adopts SFAS No. 160,
“Non-controlling Interests in Consolidated Financial Statements – An Amendment
of ARB No. 51.” If an entity has previously adopted SFAS No. 160 as of the date
the amendments in this update are included in the Accounting Standards
Codification, the amendments in this update are effective beginning in the first
interim or annual reporting period ending on or after December 15, 2009. The
amendments in this update should be applied retrospectively to the first period
that an entity adopted SFAS No. 160. The Company does not expect the adoption of
this ASU to have a material impact on the Company’s consolidated financial
statements.
 
 In
January 2010, FASB issued ASU No. 2010-06 – Improving Disclosures about Fair
Value Measurements. This update provides amendments to Subtopic 820-10 that
requires new disclosure as follows: 1) Transfers in and out of Levels 1 and
2.  A reporting entity should disclose separately the amounts of
significant transfers in and out of Level 1 and Level 2 fair value measurements
and describe the reasons for the transfers.  2)  Activity in
Level 3 fair value measurements.  In the reconciliation for fair value
measurements using significant unobservable inputs (Level 3), a reporting entity
should present separately information about purchases, sales, issuances, and
settlements (that is, on a gross basis rather than as one net number). This
update provides amendments to Subtopic 820-10 that clarify existing disclosures
as follows: 1) Level of disaggregation. A reporting entity should provide
fair value measurement disclosures for each class of assets and liabilities. A
class is often a subset of assets or liabilities within a line item in the
statement of financial position. A reporting entity needs to use judgment in
determining the appropriate classes of assets and liabilities.
2) Disclosures about inputs and valuation techniques. A reporting entity
should provide disclosures about the valuation techniques and inputs used to
measure fair value for both recurring and nonrecurring fair value measurements.
Those disclosures are required for fair value measurements that fall in either
Level 2 or Level 3. The new disclosures and clarifications of existing
disclosures are effective for interim and annual reporting periods beginning
after December 15, 2009, except for the disclosures about purchases, sales,
issuances, and settlements in the roll forward of activity in Level 3 fair value
measurements. These disclosures are effective for fiscal years beginning after
December 15, 2010, and for interim periods within those fiscal years. The
Company is currently evaluating the impact of this ASU, however, the Company
does not expect the adoption of this ASU to have a material impact on its
consolidated financial statements.


4.  Concentration
of Business and Credit Risk





Most of
the Company’s bank accounts are in banks located in the PRC and are not covered
by any type of protection similar to that provided by the FDIC on funds held in
U.S. banks. The Company’s bank account in the United States is covered by FDIC
insurance.





The
Company is operating in the PRC, which may give rise to significant foreign
currency risks from fluctuations and the degree of volatility of foreign
exchange rates between U.S. dollars and the Chinese RMB.




13




Financial
instruments that potentially subject the Company to concentration of credit risk
consist principally of cash, trade accounts receivables and inventories, the
balances of which are stated on the balance sheet. The Company places its cash
in banks located in China. Concentration of credit risk with respect to trade
accounts receivables is limited due to the Company's large number of diverse
customers in different locations in China. The Company does not require
collateral or other security to support financial instruments subject to credit
risk.





For the
three months ended March 31, 2010, [two customers accounted for 10% or more of
sales revenues, representing 30.1% and 17.9%, respectively of the total
sales. As of March 31, 2010, there were three customers that constitute
24.2%, 17.5% and 11.2%, respectively of the accounts receivable. As of December
31, 2009, there were three customers that accounted for 17.6%, 15.4%, and 14%
respectively of the accounts receivable.





For the
three months ended March 31, 2010 and 2009, the Company had insurance expense of
$26,992 and $0 respectively. Accrual for losses is not recognized until such
time a loss has occurred.





5.  Income
Taxes





Under the
Provisional Regulations of The People’s Republic of China Concerning Income Tax
on Enterprises promulgated by the PRC, which took effect on January 1, 2008,
domestic and foreign companies pay a unified corporate income tax of 25% except
a 15% corporation income tax rate for qualified high technology and science
enterprises.





The
Company has been granted a 100% tax holiday from enterprises income tax from the
Xing He District Local Tax Authority for the ten years 2008 through 2018. This
tax holiday could be challenged by higher taxing authorities in the PRC, which
could result in taxes and penalties owed for those years. For the three months
ended March 31, 2010 and 2009, the enterprise income tax at the statutory rates
would have been approximately $86,674 and $70,656, respectively.





A
reconciliation of the provision for income taxes with amounts determined by the
PRC statutory income tax rate to income before income taxes is as
follows:





Three
      months ended March 31,2010
            
            
            2009Computed
      tax at the PRC statutory rate of 15%
            
            $
            86,674
            
            
            $
            70,656Benefit
      of tax holiday
            
            
            (86,674)
            
            
            
            (70,656)Income
      tax expenses per books
            
            $
            -
            
            
            $
            -





6.  Trade
Accounts Receivable - net





As of
March 31, 2010 and December 31, 2009, trade accounts receivable consisted of the
following:





March
      31, 2010
            
            
            December
      31, 2009Amount
      outstanding
            
            $
            4,735,946
            
            
            $
            6,168,102Bad
      debt provision
            
            
            (994,934)
            
            
            
            (997,683)Net
      amount
            
            $
            3,741,012
            
            
            $
            5,170,419





7.  Advance
to suppliers, net





As of
March 31, 2010 and December 31, 2009, advance to suppliers consisted of the
following:




14




March31,
      2010
            
            
            December
      31, 2009Advance
      to suppliers
            
            $
            1,098,458
            
            
            $
            827,477Bad
      debt provision
            
            
            (36,609)
            
            
            
            (36,710)Advance
      to suppliers, net
            
            $
            1,061,849
            
            
            $
            790,767





For the
three months ended March 31, 2010 and 2009, no additional bad debt provision on
advance to suppliers was charged to expenses.





8.  
Inventories





As of
March 31, 2010 and December 31, 2009, inventories consisted of the
following:





March31,
      2010
            
            
            December
      31, 2009Raw
      materials
            
            $
            3,247,793
            
            
            $
            1953,374Work
      in process
            
            
            11,964,498
            
            
            
            12,531,362Finished
      goods
            
            
            1,763,449
            
            
            
            1,891,706Repair
      Parts
            
            
            54,956
            
            
            
            54,312$
            17,030,696
            
            
            $
            16,430,754





Raw
materials consist primarily of asphalt, petroleum coke, needle coke and other
materials used in production. Finished goods consist of graphite electrodes,
fine grain graphite and high purity graphite. The costs of finished goods
include direct costs of raw materials as well as direct labor used in
production. Indirect production costs such as utilities and indirect labor
related to production are also included in the cost of inventory.





9.  Property
and Equipment, net





As of
March 31, 2010 and December 31, 2009, property and equipment consist of the
following:





March31,
      2010
            
            
            December
      31, 2009Building
            
            $
            11,170,551
            
            
            $
            11,201,405Machinery
      and equipment
            
            
            20,906,425
            
            
            
            20,961,237Motor
      vehicles
            
            
            40,959
            
            
            
            41,073Constructions
      Progress
            
            
            2,154,695
            
            
            
            2,045,17634,272,630
            
            
            
            34,248,891Less
      accumulated depreciation
            
            
            (8,671,377
            )
            
            
            (8,289,750
            )$
            25,601,253
            
            
            $
            25,959,141





For the
three months ended March 31, 2010 and 2009, depreciation expense amounted to
$404,456 and $309,275 was charged to cost of goods sold.






15




10.  Land
Use Right





As of
March 31, 2010 and December 31, 2009, land use rights consist of the
following:





March31,
      2010
            
            
            December
      31, 2009Land
      Use Right
            
            $
            8,758,563
            
            
            $
            3,830,836Less:
      Accumulated amortization
            
            
            309,125
            
            
            
            282,563$
            8,449,438
            
            
            $
            3,548,273





For the
three months ended March 31, 2010 and 2009, amortization expenses were $27,340
and $19,080, respectively.





Future
amortization of the land use rights is as follows:





12-month period ended March
      31,2010
            
            $
            175,2042011
            
            
            175,2042012
            
            
            175,2042013
            
            
            175,2042014
            
            
            175,2042015
      and thereafter
            
            
            7,573,418Total
            
            $
            8,449,438





11.   Stockholders’
equity





(a)
            Restated
      Articles of Incorporation





On
January 22, 2008, the Company changed its authorized capital stock to
120,000,000 shares of capital stock, of which 20,000,000 shares are shares of
preferred stock, par value $0.001 per share, and 100,000,000 shares are shares
of common stock, par value $0.001 per share. The restated articles of
incorporation give the directors the authority to issue one or more series of
preferred stock and to designate the rights, preferences, privileges and
limitation of the holders of each set. The board of directors has designated the
rights, preferences, privileges and limitation of two series of preferred stock
-- the series A convertible preferred stock (“series A preferred stock”) and the
the series B convertible preferred stock (“series B preferred
stock”).





(b)           
Stock Issuances; Warrants





On
January 13, 2010, the Company sold in a private placement a total of 320,000
shares of Series B Convertible Preferred Stock and five-year warrants to
purchase 128,000 shares of common stock at an exercise price of $1.30 per share,
for an aggregate purchase price of $384,000.   The Company also
paid the private placement agent $38,400 and issued a five-year warrant expiring
to purchase 16,000 shares of common stock at an exercise price of $1.32 per
share. In connection with the private placement and pursuant to the transaction
agreements, the Company deposited into escrow 16,000 shares of common stock,
which are to be held in escrow to be returned to the Company or delivered to the
investors, depending on whether the Company meets certain financial performance
targets for the years ending December 31, 2010 and December 31,
2011.





On March
29, 2010, we issued 28,000 shares of common stock to Series B preferred stock
shareholders upon exercise of warrants at $1.3.






16





(c)
Deemed Preferred Stock Dividend





Upon
completion of the private placement on December 22, 2009, the Company issued (i)
2,160,500 shares of series B preferred stock, with each share of series B
preferred stock being convertible into one share of common stock (ii) warrants
to purchase 1,064,200 shares of common stock at $1.30 per share to investors and
warrants to purchase 108,025 shares of common stock at $1.32 per share to the
placement agent. At December 22, 2009, the fair value of the warrants used to
calculate the intrinsic value of the conversion option was estimated at $286,801
and was computed using the Black-Scholes option-pricing model include
(1) risk-free interest rate at the date of grant (0.06%), (2) expected
warrant life of 5 years, (3) expected volatility of 19%, and
(4) 0% expected dividend.   The Company used the market price of
its common stock at December 22, 2009, $1.38 per share, computed fair value of
the series B preferred stock at December 22, 2009 was $2,981,490 and the
effective preferred stock conversion price to be $0.95 per share. The
proceeds were allocated to the fair value of the warrant liability, the fair
value of the conversion option and then the residual to the preferred stock. The
difference between the face value of the preferred stock and the allocated value
was recorded as an additional preferred stock dividend at the date of issuance
as the preferred stock was convertible to common at issuance. The other
preferred stock dividend amounted to $772,982 from the
transactions.





Upon
completion of the private placement on January 13, 2010, the Company issued (i)
320,000 shares of series B preferred stock, with each share of series B
preferred stock being convertible into one share of common stock (ii) warrants
to purchase 128,000 shares of common stock at $1.30 per share to investors and
warrants to purchase 16,000 shares of common stock at $1.32 per share to the
placement agent. At January 13, 2010, the fair value of the warrants used to
calculate the intrinsic value of the conversion option was estimated at $76,810
and was computed using the Black-Scholes option-pricing model include
(1) risk-free interest rate at the date of grant (0.06%), (2) expected
warrant life of 5 years, (3) expected volatility of 19%, and
(4) 0% expected dividend.   The Company used the market price of
its common stock at January 13, 2010, $1.74 per share, computed fair value of
the series B preferred stock at January 13, 2010 was $556,800 and the effective
preferred stock conversion price to be $0.93 per share. The proceeds were
allocated to the fair value of the warrant liability, the fair value of the
conversion option and then the residual to the preferred stock. The difference
between the face value of the preferred stock and the allocated value was
recorded as an additional preferred stock dividend at the date of issuance as
the preferred stock was convertible to common at issuance. The other preferred
stock dividend amounted to $132,778 from the transactions.





12.  Short-term
bank loans





As of
March 31, 2010 and December 31, 2009, short term loans consisted of the
following:





March31,
      2010
            
            
            December
      31, 2009Bank
      loans dated February 8, 2010, due February 8, 2011 with an interest rate
      of 10.18%, interest payable monthly.
            
            
            658,276
            
            
            
            -Bank
      loans dated June 17, 2009, due June 15, 2010 with an interest rate of
      7.13%, interest payable monthly, secured by property and equipment and
      land use rights
            
            
            5,119,931
            
            
            
            5,173,072Bank
      loan dated June 16, 2009, due June 1, 2010 with an interest rate of
      7.434%, interest payable quarterly, secured by equipment and land use
      rights
            
            
            3,430,354
            
            
            
            3,439,829$
            9,208,561
            
            
            $
            8,573,901





13.  Long-term
bank loan





March
      31, 2010
            
            
            December
      31, 2009Bank
      loans dated October 10, 2008, due October 9, 2011 with an interest rate of
      6.75%, interest payable monthly.
            
            $
            3,218,242
            
            
            $
            3,227,132Less:
      current portion
            
            
            (1,609121
            )
            
            
            (1,613,566
            )Non-current
      portion
            
            $
            1,609,121
            
            
            $
            1,613,566







17




Item 2.   Management’s Discussion
and Analysis Financial Condition and Results of Operations.





The
following discussion of the results of our operations and financial condition
should be read in conjunction with our financial statements and the related
notes, which appear elsewhere in this report. The following discussion includes
forward-looking statements. For a discussion of important factors that
could cause actual results to differ from results discussed in the
forward-looking statements, see“Forward Looking Statements.”





Overview





We are
engaged in the manufacture of graphite based products in the People’s Republic
of China.  Our products are either used in the manufacturing process
for other products, particularly metals, or for incorporation in various types
of products or processes. Based on information we receive about our industry in
the course of our business, we believe that we are the largest wholesale
supplier of fine grain graphite and high purity graphite in China and one of
China’s largest producers and suppliers of graphite products
overall.  We currently manufacture and sell the following types of
graphite products:




●
            graphite
      electrodes;




●
            fine
      grain graphite ; and




●
            high
      purity graphite.




Approximately
40% to 50% of our graphite electrodes are sold directly to end users in China,
primarily consisting of steel manufacturers.  All other sales are made
to over 200 distributors located throughout 22 provinces in
China.  Our distributors then sell our products to end customers both
in China and in foreign countries, including, among others, Japan, the United
States, Spain, England, South Korea and India.




Until the
third quarter of 2008, we experienced rapid growth in our
operations.  Since the fourth quarter of 2008, however, as a result of
the global economic crisis, the steel industry in general has slowed, which has
caused our revenues to decline.  Although we saw improvements during
the third quarter of 2009, our revenues and gross margins declined significantly
in the fourth quarter. Although conditions improved slightly in the first
quarter of 2010, as the demand for of graphite electrodes improved slightly over
the previous quarter, our industry is still slower than in the past. We also
incurred several non-cash expenses aggregating $1.2 million  in the
first quarter of 2010 which resulted in a net loss of approximately $0.9 million
for the quarter.  Specifically, the volume of our sales has been slow
and remained slow in the first quarter of 2010 because the demand for products
made by steel manufacturers, who comprise a large percentage of the end users of
our graphite electrodes, decreased significantly during 2009 and remained slow
in the first quarter of 1020.  We also had a decrease in the demand of
high purity graphite in the first quarter of 2010. In addition, our accounts
receivable have remained at higher levels than in the past, thereby affecting
our cash flows, because we have experienced delays in payments by our customers
whose cash reserves have been negatively affected.  We expect the
downturn in the graphite electrode market to continue to extend into 2010 and we
cannot predict when or whether the economic downturn will cease to affect our
business.  If the global financial crisis continues to negatively
affect our revenues and cash flows, we may need to borrow additional funds or
raise additional capital.  There can be no assurance that such sources
of funding would be available upon terms favorable to us, if at
all.  In the event that we raised capital through the issuance of
equity or convertible securities, the holdings of existing shareholders would be
diluted.


18




During
the three months ended March 31, 2010, our declining margin reflected changes in
our product mix, with an increasing percentage of sales being sales of graphite
electrodes.  We plan to seek to increase our marketing effort for fine
grain graphite and high purity graphite products which generate a better margin,
but we cannot assure you that we will be successful in these
efforts.




In 2010,
our primary strategy is to increase our gross profits by better aligning our
overhead costs with existing levels of sales and pricing and to acquire other
businesses in our industry that manufacture products that we do not currently
manufacture which we would expect to generate significant profits.  In
that regard, on March 3, 2010, we entered into a letter of intent which provided
that we intend to enter into definitive agreements with Chiyu Carbon Graphite
Ltd., a down stream producer of graphite products in China, to acquire 100% of
Chiyu Carbon’s assets.  We believe that if the acquisition closes,
sales by this entity would generate significant profits for us and that demand
for these products is currently greater than demand for some of our existing
products.




Variable
Interest Entity





We were
incorporated in Nevada on February 13, 2003 as Achievers Magazine
Inc.  On December 14, 2007, we completed a reverse merger transaction
with Talent International Investment Limited, or Talent, a company incorporated
in the British Virgin Islands on February 1, 2007.  Following the
reverse merger, our name was changed to China Carbon Graphite Group,
Inc.




As a
result of the reverse merger, we wholly own Talent.  Talent wholly
owns Xinghe Yongle Carbon Co., Ltd., or Yongle, a wholly foreign owned
enterprise organized under the laws of the PRC on September 18,
2007.  On December 14, 2007, Yongle executed a series of exclusive
contractual agreements with Xinghe Xingyong Carbon Co., Ltd., or Xingyong, an
operating company organized under the laws of the PRC in December
2001.




PRC law
currently has limits on foreign ownership of certain companies. To comply with
these foreign ownership restrictions, we operate our businesses in the PRC
through Xingyong. Xingyong has the licenses and approvals necessary to operate
its business in the PRC. We have contractual arrangements with Xingyong and its
stockholders pursuant to which we have the ability to substantially influence
Xingyong’s daily operations and financial affairs, appoint its senior executives
and approve all matters requiring stockholder approval. As a result of these
contractual arrangements, we are able to control Xingyong. Consequently, we
consolidate Xingyong’s financial statements with our financial
statements.  There are certain risks related to these contractual
obligations.  See “Risk Factors—Risks Related to Our Capital
Structure” below.




Xingyong’s
principal stockholder is Dengyong Jin, our former chief executive officer who,
together with family members, controls Sincere, which owns approximately 47% of
the outstanding shares of our common stock.




On
December 14, 2007, we entered into the following contractual
arrangements:






19




Business
Operations Agreement




Pursuant
to this agreement, Xingyong is obligated to pay between 80% and 100% of its net
income to Yongle, subject to annual negotiations between the
parties.  In each of 2008 and 2009, Xingyong paid 100% of its net
income to Yongle. In order to guarantee Xingyong’s performance under this
agreement, the stockholders of Xingyong agreed to obtain Yongle’s written
consent prior to allowing Xingyong to enter into any transaction which may
materially affect Xingyong’s assets, obligations, rights or
operations.




Option
Agreement




Pursuant
to the option agreement, Yongle was granted an exclusive option to purchase all
of the capital stock of Xingyong at the lowest price permitted by PRC laws
applicable at the time of the exercise of such option. Yongle may exercise such
option, in part or whole, at any time until December 2017.




Share
Pledge Agreement




Under the
share pledge agreement, the stockholders of Xingyong, pledged all of their
equity interests in Xingyong to Yongle to guarantee Xingyong’s performance of
its obligations under all other related agreements by and between Yongle and
Xingyong.  None of these shares may be transferred without the
permission of Yongle.




Exclusive
Technical and Consulting Services Agreement




Under the
exclusive technical and consulting services agreement between Yongle and
Xingyong, Yongle agreed to provide certain technical consulting and services to
Xingyong, and Xingyong agreed not to accept any technical consulting services
from any third party without the consent of Yongle. In addition, Yongle is the
sole and exclusive owner of all rights, title and interests arising from the
performance of the agreement.




Significant
Accounting Estimates and Policies





The
discussion and analysis of our financial condition and results of operations is
based upon our financial statements that have been prepared in accordance with
accounting principles generally accepted in the United States of America. The
preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets and liabilities. On an
on-going basis, we evaluate our estimates including the allowance for doubtful
accounts, the salability and recoverability of our products, income taxes and
contingencies. We base our estimates on historical experience and on other
assumptions that we believe to be reasonable under the circumstances, the
results of which form our basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions.





Revenue
Recognition





We
recognize revenue in accordance with ASC 605-25, Revenue Recognition of
Financial Statements, formerly known as Staff Accounting Bulletin No. 104,
Revenue Recognition, which states that revenue should be recognized when the
following criteria are met: (1) persuasive evidence of an arrangement
exists; (2) the service has been rendered; (3) the selling price is
fixed or determinable; and (4) collection of the resulting receivable is
reasonably assured. Sales represent the invoiced value of goods, net of value
added tax (“VAT”), if any, and are recognized upon delivery of goods and passage
of title.





Comprehensive
Income





We have
adopted Statements of ASC 220, Comprehensive Income, formerly known as SFAS No.
130, Reporting Comprehensive Income, which establishes standards for reporting
and presentation of comprehensive income (loss) and its components in a full set
of general-purpose financial statements. We have chosen to report comprehensive
income (loss) in the statements of operations and comprehensive
income.







20




Income
Taxes





We
account for income taxes under the provisions of ASC 740 Income Tax, formerly
known as SFAS No. 109, Accounting for Income Taxes, which requires recognition
of deferred tax assets and liabilities for the expected future tax consequences
of events that have been included in the consolidated financial statements or
tax returns. Deferred tax assets and liabilities are recognized for the future
tax consequence attributable to the difference between the tax bases of assets
and liabilities and their reported amounts in the financial statements. Deferred
tax assets and liabilities are measured using the enacted tax rate expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that
includes the enactment date.





Effective
January 1, 2008, the Chinese new income tax law sets unified income tax rate for
domestic and foreign companies at 25% except a 15% corporate income tax rate for
qualified high technology and science enterprises. In accordance with this new
income tax law, low preferential tax rate in accordance with both the tax laws
and administrative regulations prior to the promulgation of this Law gradually
becomes subject to the new tax rate within five years after the implementation
of this law.





We have
been recognized as a high technology and science company by the Ministry of
Science and Technology of the PRC. The Xing He District Local Tax Authority in
the Nei Mongol province granted us a 100% tax holiday with respect to enterprise
income tax for ten years 2008 through 2018. Afterwards, based on the present tax
law and our status as a qualified high technology and science company, we will
be subject to a corporation income tax rate of 15% effective in 2019.





Inventories





Inventories
are stated at the lower of cost, determined on a weighted average basis, and net
realizable value. Work in progress and finished goods are composed of direct
material, direct labor and a portion of manufacturing overhead. Net realizable
value is the estimated selling price, in the ordinary course of business, less
estimated costs to complete and dispose. Management believes that there was no
obsolete inventory as of March 31, 2010 or December 31, 2009.





Property,
Plant and Equipment





Property,
plant and equipment are stated at cost. Major expenditures for betterments and
renewals are capitalized while ordinary repairs and maintenance costs are
expensed as incurred. Depreciation and amortization is provided using the
straight-line method over the estimated useful life of the assets after taking
into account the estimated residual value.





Land
Use Rights





There is
no private ownership of land in China. All land ownership is held by the
government of China, its agencies and collectives. Land use rights are obtained
from government, and are typically renewable. Land use rights can be transferred
upon approval by the land administrative authorities of China (State Land
Administration Bureau) upon payment of the required transfer fee. We own the
land use right for 6,356,209square feet, of which
290,626 square is occupied by our facilities, for a term of 50 years, beginning
from issuance date of the certificates granting the land use right. We record
the property subject to land use rights as intangible asset.





Each
intangible asset is reviewed periodically or more often if circumstances
dictate, to determine whether its carrying value has become impaired. We
consider assets to be impaired if the carrying value exceeds the future
projected cash flows from related operations. We also re-evaluate the
amortization periods to determine whether subsequent events and circumstances
warrant revised estimates of useful lives.






21




Research
and development





Research
and development costs are expensed as incurred, and are included in general and
administrative expenses. These costs primarily consist of cost of material used
and salaries paid for the development of our products and fees paid to third
parties. Our research and development expense for the three months ended March
31, 2010 and 2009 has not been significant.





Value
added tax





Pursuant
to China’s VAT rules and regulations, as an ordinary VAT taxpayer we are subject
to a tax rate of 17% (“output VAT”). The output VAT is payable after offsetting
VAT paid by us on purchases (“input VAT”). Under the commercial practice of the
PRC, the Company paidVAT and business tax
based on tax invoices issued.





The tax
invoices may be issued subsequent to the date on which revenue is recognized,
and there may be a considerable delay between the date on which the revenue is
recognized and the date on which the tax invoice is issued. In the event that
the PRC tax authorities dispute the date of which revenue is recognized for tax
purposes, the PRC tax office has the right to assess a penalty, which can range
from zero to five times the amount of the taxes that are determined to be late
or deficient. In the event that a tax penalty is assessed on late or deficient
payments, the penalty will be expensed as a period expense if and when a
determination has been made by the taxing authorities that a penalty is
due. We have been granted an exemption from VAT by the Xinghe County
People’s Government and Xinghe Tax Authority on some products for which an
exchange agreement is in place for raw materials and fuel.  We have
been granted an exemption from VAT by the Xing He County People’s Government and
Xing He Tax Authority on some products in which an exchange agreement is in
place for raw materials and fuel.





Recent
accounting pronouncements
 
 In
May 2009, the FASB issued ASC 855, “Subsequent Events”, formerly known as SFAS
No. 165. SFAS No. 165 is intended to establish general standards of accounting
for and disclosures of events that occur after the balance sheet date but before
financial statements are issued or are available to be issued. It requires the
disclosure of the date through which an entity has evaluated subsequent events
and the basis for selecting that date, that is, whether that date represents the
date the financial statements were issued or were available to be issued. SFAS
165 No. is effective for interim or annual financial periods ending after June
15, 2009. The Company adopted this statement for the financial statements since
the quarter ended June 30, 2009.
 
 In
June 2009, the FASB issued ASC 860, “Transfers and servicing”, formerly known as
SFAS No. 166, a revision to SFAS No. 140, “Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities”, and will
require more information about transfers of financial assets and where companies
have continuing exposure to the risks related to transferred financial assets.
SFAS 166 is effective at the start of a company’s first fiscal year beginning
after November 15, 2009, or January 1, 2010 for companies reporting earnings on
a calendar-year basis. The adoption of this statement is not expected to have a
material effect on the Company's financial statements.
 
 In
June 2009, the FASB issued ASC 810, “Consolidation”, formerly known as SFAS No.
167, a revision to FASB Interpretation No. 46(R), Consolidation of Variable
Interest Entities, and will change how a company determines when an entity that
is insufficiently capitalized or is not controlled through voting (or similar
rights) should be consolidated. Under SFAS No. 167, determining whether a
company is required to consolidate an entity will be based on, among other
things, an entity's purpose and design and a company's ability to direct the
activities of the entity that most significantly impact the entity's economic
performance. SFAS No. 167 is effective at the start of a company’s first fiscal
year beginning after November 15, 2009, or January 1, 2010 for companies
reporting earnings on a calendar-year basis. The adoption of SFAS No. 167 will
not have an effect on the Company’s financial statements
 
 In
June 2009, the FASB issued SFAS No. 168, "The Financial Accounting Standards
Board (FASB) Accounting Standards Codification (ASC) and the Hierarchy of
Generally Accepted Accounting Principles (GAAP) - a replacement of SFAS No. 162"
(SFAS 168), which establishes the FASB ASC as the source of authoritative U.S.
GAAP recognized by the FASB to be applied by non-governmental entities. As a
result of the adoption of SFAS 168, the majority of references to historically
issued accounting pronouncements are now superseded by references to the FASB
ASC, with no financial impact.
 
 In
August 2009, the FASB issued an Accounting Standards Update (“ASU”) regarding
measuring liabilities at fair value. This ASU provides additional guidance
clarifying the measurement of liabilities at fair value in circumstances in
which a quoted price in an active market for the identical liability is not
available; under those circumstances, a reporting entity is required to measure
fair value using one or more of valuation techniques, as defined. The adoption
of this guidance did not have a material impact on the Company’s consolidated
financial statements.
 
 In
October 2009, the FASB issued an ASU regarding accounting for own-share lending
arrangements in contemplation of convertible debt issuance or other
financing.  This ASU requires that at the date of issuance of the
shares in a share-lending arrangement entered into in contemplation of a
convertible debt offering or other financing, the shares issued shall be
measured at fair value and be recognized as an issuance cost, with an offset to
additional paid-in capital. Further, loaned shares are excluded from basic and
diluted earnings per share unless default of the share-lending arrangement
occurs, at which time the loaned shares would be included in the basic and
diluted earnings-per-share calculation.  This ASU is effective for
fiscal years beginning on or after December 15, 2009, and interim periods within
those fiscal years for arrangements outstanding as of the beginning of those
fiscal years. The adoption of this guidance did not have a material impact on
the Company’s consolidated financial statements.
 
 In
November 2009, the FASB issued an ASU regarding accounting for stock dividends,
including distributions to shareholders with components of stock and cash. This
ASU clarifies that the stock portion of a distribution to shareholders that
contains components of cash and stock and allows shareholders to select their
preferred form of the distribution (with a limit on the amount of cash that will
be distributed in total) should be considered a stock dividend and included in
EPS calculations as a share issuance. The adoption of this guidance did not have
a material impact on the Company’s consolidated financial
statements
 
 In
December 2009, FASB issued ASU No. 2009-16, Accounting for Transfers of
Financial Assets. This Accounting Standards Update amends the FASB Accounting
Standards Codification for the issuance of FASB Statement No. 166,Accounting
for Transfers of Financial Assets—an amendment of FASB Statement No. 140.
The amendments in this Accounting Standards Update improve financial reporting
by eliminating the exceptions for qualifying special-purpose entities from the
consolidation guidance and the exception that permitted sale accounting for
certain mortgage securitizations when a transferor has not
 
 22
 
 surrendered
control over the transferred financial assets. In addition, the amendments
require enhanced disclosures about the risks that a transferor continues to be
exposed to because of its continuing involvement in transferred financial
assets. Comparability and consistency in accounting for transferred financial
assets will also be improved through clarifications of the requirements for
isolation and limitations on portions of financial assets that are eligible for
sale accounting. The Company does not expect the adoption of this ASU to have a
material impact on its consolidated financial statements.
 
 In
December, 2009, FASB issued ASU No. 2009-17, Improvements to Financial Reporting
by Enterprises Involved with Variable Interest Entities. This Accounting
Standards Update amends the FASB Accounting Standards Codification for the
issuance of FASB Statement No. 167,Amendments to
FASB Interpretation No. 46(R) . The amendments in this Accounting
Standards Update replace the quantitative-based risks and rewards calculation
for determining which reporting entity, if any, has a controlling financial
interest in a variable interest entity with an approach focused on identifying
which reporting entity has the power to direct the activities of a variable
interest entity that most significantly impact the entity’s economic performance
and (1) the obligation to absorb losses of the entity or (2) the right to
receive benefits from the entity. An approach that is expected to be primarily
qualitative will be more effective for identifying which reporting entity has a
controlling financial interest in a variable interest entity. The amendments in
this Update also require additional disclosures about a reporting entity’s
involvement in variable interest entities, which will enhance the information
provided to users of financial statements. The Company is currently evaluating
the impact of this ASU, however, the Company does not expect the adoption of
this ASU to have a material impact on its consolidated financial
statements.
 
 In
January 2010, FASB issued ASU No. 2010-01- Accounting for Distributions to
Shareholders with Components of Stock and Cash. The amendments in this Update
clarify that the stock portion of a distribution to shareholders that allows
them to elect to receive cash or stock with a potential limitation on the total
amount of cash that all shareholders can elect to receive in the aggregate is
considered a share issuance that is reflected in EPS prospectively and is not a
stock dividend for purposes of applying Topics 505 and 260 (Equity and Earnings
Per Share). The amendments in this update are effective for interim and
annual periods ending on or after December 15, 2009, and should be applied on a
retrospective basis. The Company does not expect the adoption of this ASU to
have a material impact on its consolidated financial
statements.
 
 In
January 2010, FASB issued ASU No. 2010-02 – Accounting and Reporting for
Decreases in Ownership of a Subsidiary – a Scope Clarification. The amendments
in this Update affect accounting and reporting by an entity that experiences a
decrease in ownership in a subsidiary that is a business or nonprofit activity.
The amendments also affect accounting and reporting by an entity that exchanges
a group of assets that constitutes a business or nonprofit activity for an
equity interest in another entity.  The amendments in this update are
effective beginning in the period that an entity adopts SFAS No. 160,
“Non-controlling Interests in Consolidated Financial Statements – An Amendment
of ARB No. 51.” If an entity has previously adopted SFAS No. 160 as of the date
the amendments in this update are included in the Accounting Standards
Codification, the amendments in this update are effective beginning in the first
interim or annual reporting period ending on or after December 15, 2009. The
amendments in this update should be applied retrospectively to the first period
that an entity adopted SFAS No. 160. The Company does not expect the adoption of
this ASU to have a material impact on the Company’s consolidated financial
statements.
 
 In
January 2010, FASB issued ASU No. 2010-06 – Improving Disclosures about Fair
Value Measurements. This update provides amendments to Subtopic 820-10 that
requires new disclosure as follows: 1) Transfers in and out of Levels 1 and
2.  A reporting entity should disclose separately the amounts of
significant transfers in and out of Level 1 and Level 2 fair value measurements
and describe the reasons for the transfers.  2)  Activity in
Level 3 fair value measurements.  In the reconciliation for fair value
measurements using significant unobservable inputs (Level 3), a reporting entity
should present separately information about purchases, sales, issuances, and
settlements (that is, on a gross basis rather than as one net number). This
update provides amendments to Subtopic 820-10 that clarify existing disclosures
as follows: 1) Level of disaggregation. A reporting entity should provide
fair value measurement disclosures for each class of assets and liabilities. A
class is often a subset of assets or liabilities within a line item in the
statement of financial position. A reporting entity needs to use judgment in
determining the appropriate classes of assets and liabilities.
2) Disclosures about inputs and valuation techniques. A reporting entity
should provide disclosures about the valuation techniques and inputs used to
measure fair value for both recurring and nonrecurring fair value measurements.
Those disclosures are required for fair value measurements that fall in either
Level 2 or Level 3. The new disclosures and clarifications of existing
disclosures are effective for interim and annual reporting periods beginning
after December 15, 2009, except for the disclosures about purchases, sales,
issuances, and settlements in the roll forward of activity in Level 3 fair value
measurements. These disclosures are effective for fiscal years beginning after
December 15, 2010, and for interim periods within those fiscal years. The
Company is currently evaluating the impact of this ASU, however, the Company
does not expect the adoption of this ASU to have a material impact on its
consolidated financial statements.
 
 RESULTS
OF OPERATIONS





The
following table sets forth the results of our operations for the periods
indicated as a percentage of net sales (dollars in thousands):




23




Three
      months ended March 31,2010
            
            
            2009US
      Dollars
            
            
            Percentage
            
            
            US
      Dollars
            
            
            PercentageSales
            
            $
            4,847
            
            
            
            100
            %
            
            $
            2,894
            
            
            
            100.0
            %Cost
      of sales
            
            
            3,823
            
            
            
            78.9
            %
            
            
            2,053
            
            
            
            70.9
            %Gross  profit
            
            
            1,024
            
            
            
            21.1
            %
            
            
            841
            
            
            
            29.1
            %Operating
      expenses
            
            
            456
            
            
            
            9.4
            %
            
            
            464
            
            
            
            16.0
            %Income
      from operations
            
            
            568
            
            
            
            11.7
            %
            
            
            377
            
            
            
            13.0
            %Other
      income
            
            
            -
            
            
            
            -
            %
            
            
            292
            
            
            
            10.1
            %Other
      expense
            
            
            (1,220
            )
            
            
            (25.2
            )%
            
            
            -
            
            
            
            -
            %Interest
      income
            
            
            -
            
            
            
            -
            %
            
            
            -
            
            
            
            -
            %Interest
      expense
            
            
            (206
            )
            
            
            (4.3
            )%
            
            
            (198
            )
            
            
            (6.8
            )%Income
      before income tax expense
            
            
            (859
            )
            
            
            (17.8
            )%
            
            
            471
            
            
            
            16.3
            %Provision
      for income taxes
            
            
            -
            
            
            
            -
            %
            
            
            -
            
            
            
            -
            %Net
      income
            
            $
            (859
            )
            
            
            (17.8
            )%
            
            $
            471
            
            
            
            16.3
            %Deemed
      preferred stock dividend
            
            
            (132
            )
            
            
            (2.7
            )%
            
            
            -
            
            
            
            -
            %Dividend
            
            
            (36)
            
            
            
            (0.7
            )%
            
            
            471
            
            
            
            16.3
            %Net
      income available to common shareholders
            
            
            (1,028)
            
            
            
            (21.2)
            %
            
            
            -
            
            
            
            -
            %Foreign
      currency translation adjustment
            
            
            (100
            )
            
            
            (2.1
            )%
            
            
            45
            
            
            
            1.5
            %Comprehensive
      income
            
            $
            (958
            )
            
            
            (19.9
            )%
            
            $
            516
            
            
            
            17.8
            %




Sales.During
the three months ended March 31, 2010, we had sales of $4,847,000 as compared to
sales of $2,894,000 for the three months ended March 31, 2009, an increase of
$1,953,000 , or approximately 67.5%. During the three months ended March
31, 2010, we experienced a slight increase in the demand for our graphite
electrodes over the previous quarter. . The lower sales revenue in the first
quarter 2009 was lower due to weak demand for our graphite products, and
graphite electrode in particular, as well as the residual effect of the
closedown of our facility in 2008 during the Olympic games.





Cost of sales; gross margin.
During
the three months ended March 31, 2010, our cost of sales was $3,823,000, as
compared to $2,053,000 during the three months ended March 31, 2009, an increase
of $1,770,000, or 86.2%. The increase in cost of sales was directly associated
with the increase in sales. Our gross margin decreased from 29.1% for the
three months ended March 31, 2009 to 21.1% for the three months ended March
31, 2010. The decrease reflects the variance in production mix, as the
percentage of our sales of graphite electrodes, a lower margin product,
increased.





Selling,
general and administrative expenses.





Selling,
general and administrative expenses totaled $456,000 for the three months ended
March 31, 2010, as compared to $445,000 for the three months ended March 31,
2009, an increase of $11,000, or approximately 2.5%.





Selling
expenses decreased from $309,000 for the three months ended March 31, 2009 to
$25,000 for the three months ended March 31, 2010, or 91.9%. The decrease
was due to lower shipping and handling expenses in the first quarter 2010
compared to 2009.





General
and administrative expenses were $404,000 for the three months ended March 31,
2010, compared to $136,000 for the three months ended March 31,
2009.  The increase in general administrative expense was primarily
due to the increase in public company expenses, in particular additional
expenses in respect to a private offering and related S-1
registration.





Depreciation and amortization
expense. Depreciation and amortization amounted to $432,000 for the
three months ended March 31, 2010 and $328,000 for the three months ended March
31, 2009, of which $405,000 for 2010 and $309,000  for 2009
were included in cost of sales and $27,000 for 2010 and $19,000 for 2009
were included in operating expenses.





24




Income from
operations. As a result of the factors described above, incomefrom operations
amounted to $568,000 for the three months ended March 31, 2010, as compared to
$377,000 for the three months ended March 31, 2009, an increase of approximately
$191,000, or 50.7%.





Other income
(expenses). Interest expense was $206,000 for the three months
ended March 31, 2010, as compared with $198,000 for the three months ended March
31, 2009, reflecting increased borrowings. We had nominal interest income
during the three months ended March 31, 2010 and 2009. Other income, which
consisted of government grants, was $292,000 for the three months ended March
31, 2009 and none for the three months ended March 31, 2010. Other expense was
$1,220,000 for the three months ended March 31, 2010 and none for 2009. The
significant increase was attributable to a non-cash charge of $1,220,000
resulting from the change in fair value of warrants as a result of adopting ASC
820-10, Fair value measurement for non-financial assets and
liabilities.





Income tax.  During
the three months ended March 31, 2010 and 2009, we benefited from a 100% tax
holiday from the PRC enterprise tax.  As a result, we had no income
tax due for these periods..





Net income. As a result of
the factors described above, our net loss for the three months ended March
31, 2010 was $(859,000), as compared to net income of $471,000 for the three
months ended March 31, 2009, a decrease of $1,330,000, or
282.4%.





Deemed preferred dividend. As
a result of the private placement on January 13, 2010, we incurred a preferred
stock deemed dividend of $132,778, of which $86,227 representing the intrinsic
value of the conversion feature of the warrants issued with the preferred stock
and $46,551 representing the allocated value of the warrants.  The deemed
preferred stock dividend is a non-cash charge which did not affect our
operations or cash flow for the three months ended March 31, 2010.  There
was no comparable item in the three months ended March 31, 2009.





Dividend. Pursuant to the
terms of private offering, the Series B preferred stock offers a 6% coupon. The
preferred stock dividend is payable quarterly commencing April 1, 2010. As a
result, we incurred dividend expense of  $36,000 for the three months
ended March 31, 2010.





Net income available to common
shareholders.  Net loss available for common shareholders was
$(1,027,000), or $(0.06) per share (basic and diluted), for the three months
ended March 31, 2010 compared to net income of $471,000, or $0.04 per share
(basic and diluted), for the three months ended March 31, 2009.





Liquidity
and Capital Resources





General




Our
primary capital needs have been to fund our working capital
requirements.  Our primary sources of financing have been cash
generated from operations, short-term and long-term loans from banks in China,
and loans from a related party. At March 31, 2010, we had loans in the aggregate
amount of $12.4 million outstanding, which included short term bank loans of
$9.2 million, the current portion of a long term-loan of $1.6 million and a
long-term loan of $1.6 million.  Our short-term bank loans, which are
due in June 2010, bear interest at an annual rate of 7.13% as to $5.1 million of
the principal and 7.434% as to $3.4 million of the principal, and also $0.7
million short term bank loan due February 8, 2011, bear interest at an annual
rate of 10.18%.  The short-term bank loans are secured by a security
interest on our fixed assets and land use rights.  We have also
obtained a long-term bank loan, in the principal amount of $3.2 million, $1.6
million of which is due in October 2010 and the remainder in October
2011.  This loan bears interest at an annual rate of
6.75%.  Although we believe that we will be able to obtain extensions
of these loans when they mature, we cannot assure you that such extensions will
be granted.




25




We expect
that anticipated cash flows from operations, short-term and long-term bank loans
and loans from a related party will be sufficient to fund our operations through
at least the next twelve months, provided that:




●
            We
      generate sufficient business so that we are able to generate substantial
      profits, which cannot be assured;




●
            Our
      banks continue to provide us with the necessary working capital financing;
      and




●
            We
      are able to generate savings by improving the efficiency of our
      operations.




In
December 2009 and January 2010, we raised an aggregate of approximately $3
million in a private placement transaction.  We may require additional
equity, debt or bank funding to finance acquisitions or to allow us to produce
graphite for the nuclear industry, which are our primary growth
strategies.  We can provide no assurances that we will be able to
enter into any financing agreements on terms favorable to us, if at all,
especially considering the current global instability of the capital
markets.  In addition, although we expect to refinance our bank loans
when they mature, we can provide no assurances that we will be able to refinance
such loans on terms favorable to us, if at all.




At March
31, 2010, cash and cash equivalents were $4,004,759, as compared to $2,709,127
at December 31, 2009.  Our working capital decreased by $4.0 million
to $8.0 million at March 31, 2010 from a working capital of $12.0 at December
31, 2009.  Our cash position increased significantly, by $3.7 million
from March 31, 2009 to March 31, 2010, due to the capital raise of $3.0 million
in a private placement transactions in December 2009 and January 2010, as well
as additional borrowing from banks.




First
Quarter Ended March 31, 2010 Compared to First Quarter Ended March 31,
2009




The
following table sets forth information about our net cash flow for the years
indicated:




Cash
      Flows Data:
            
            For First Quarter Ended March
      312010
            
            
            2009NetNet
      cash flows provided by operating activities
            
            
            3,124,938
            
            
            
            831,876NetNet
      cash flows used in investing activities
            
            
            (5,056,305
            )
            
            
            (300,132
            )NetNet
      cash flows provided by (used in) financing activities
            
            
            3,227,754
            
            
            
            (339,941
            )





Net cash
flow provided by operating activities was $3,124,938in first
quarter 2010 as compared to net cash flow provided by operating
activities was $831,876 in first quarter 2009, an increase of
$2,293,062.   Net cash flow provided by operating activities in
first quarter 2010 was mainly due to our net loss of $(858,657), a decrease in
accounts receivable of $1,415,151, a decrease in other receivable of $819,814,
an increase in accounts payable and other payable of $683,809 and $578,628,
respectively, and the add-back of non-cash items of depreciation and
amortization of $431,796 and change in fair value of warrants of $1,220,430,
offset by an increase in inventory of $645,195 .




Net cash flow provided by
operating activities in the three months ended March 31, 2009 was mainly due to
our net income of $471,040, a decrease in account receivable of $208,734, a
decrease in advance to suppliers of $474,723 and the add-back of non-cash
items of depreciation and amortization of $328,355, offset by a decrease in
accounts payable and accrued expenses of $446,134 and a decrease in taxes
payable of $125,795.






26




Net cash
flow provided by operating activities is sensitive to many factors, including
our operating results, inventory management, ability to collect accounts
receivable and timing of cash receipts and payments.  For the first
quarter ended March 31, 2010, the inventory turnover did not vary much from
December 31, 2009.




Net cash
flow used in investing activities was $5,056,305 for first quarter 2010 and
$300,132 for first quarter 2009.  For 2010, approximately all of the
$5 million cash flow was used in acquisition of land use rights. Net cash flow
used in investing activities was $300,132 for the three months ended March 31,
2009 to purchase properties and equipments.




Net cash
flow provided by financing activities was $3,227,754 for first quarter
2010.  We received proceeds from bank loans at the amount of
$658,270.  We also received net proceeds of $2,194,234 from notes
payable. In addition, we received a net proceed of $338,850 by issuing common
and Series B preferred stock to shareholders. Net cash flow used in financing
activities was $339,941 for first quarter 2009. We received $67,900 from
investor by issuing 70,000 shares of restricted common stocks pursuant to a
share purchase agreement. We received $30,333 proceeds from related party and
repaid $438,174 bank loan.




Off-Balance
Sheet Arrangements





Off-balance
Sheet Arrangements





We have
not entered into any off-balance sheet arrangements.




Item 3.  Quantitative and Qualitative
Disclosures About Market Risk





Not
applicable to smaller reporting companies.





Item 4.  Controls and
Procedures





Evaluation
of Disclosure Controls and Procedures





Our
management, including Donghai Yu, our chief executive officer, and Ting Chen,
our chief financial officer, evaluated the effectiveness of the design and
operation of our disclosure controls and procedures as of March 31,
2010.





Disclosure
controls and procedures refer to controls and other procedures designed to
ensure that information required to be disclosed in the reports we file or
submit under the Securities Exchange Act of 1934, as amended, is recorded,
processed, summarized and reported within the time periods specified in the
rules and forms of the SEC and that such information is accumulated and
communicated to our management, including our chief executive officer and chief
financial officer, as appropriate, to allow timely decisions regarding required
disclosure. In designing and evaluating our disclosure controls and
procedures, management recognizes that any controls and procedures, no matter
how well designed and operated, can provide only reasonable assurance of
achieving the desired control objectives, and management is required to apply
its judgment in evaluating and implementing possible controls and
procedures.





Management
conducted its evaluation of disclosure controls and procedures under the
supervision of our chief executive officer and our chief financial officer.
Based on that evaluation, our chief executive and financial officers concluded
that because of the significant deficiencies in internal control over financial
reporting, our disclosure controls and procedures were not effective as of March
31, 2010.








27





Changes
in Internal Control over Financial Reporting





No
changes in the internal control over our financial reporting have come to
management's attention during our last fiscal quarter that have materially
affected, or are likely to materially affect, our internal control over
financial reporting.





Limitations
on Controls





Management
does not expect that our disclosure controls and procedures or our internal
control over financial reporting will prevent or detect all error and fraud. Any
control system, no matter how well designed and operated, is based upon certain
assumptions and can provide only reasonable, not absolute, assurance that its
objectives will be met. Further, no evaluation of controls can provide absolute
assurance that misstatements due to error or fraud will not occur or that all
control issues and instances of fraud, if any, within the Company have been
detected.





PART
II – OTHER INFORMATION





Item 2.  Unregistered Sales of Equity
Securities and Use of Proceeds.








[Disclose
any issuances made during the first quarter]





Item 6. Exhibits





31.1      Rule
13a-14(a)/15d-14(a) certification of Chief Executive Officer


31.2      Rule
13a-14(a)/15d-14(a) certificate of Principal Financial Officer


32.1      Section
1350 certification of Chief Executive Officer and Chief Financial
Officer














28








SIGNATURES





Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.





CHINA
      CARBON GRAPHITE GROUP, INC.Date:
      May 17, 2010
            By:
            /s/ Donghai
      YuDonghai
      YuChief
      Executive Officer





Date:
      May 17, 2010
            By:
            /s/ Ting
      ChenTing
      ChenChief
      Financial Officer