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 September 30, 2009





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)





Copies
to:


Asher
S. Levitsky PC


Sichenzia
Ross Friedman Ference LLP


61
Broadway, 32nd Floor


New
York, New York 10006


Phone:
(212) 981-6767


Fax:
(212) 930 - 9725


E-mail:
alevitsky@srff.com





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: 16,210,791 shares of common stock are
issued and outstanding as of November 16, 2009.





CHINA
CARBON GRAPHITE GROUP, INC. AND SUBSIDIARIES


FORM
10-Q


September
30, 2009





TABLE
OF CONTENTS








PART I. - FINANCIAL
      INFORMATION
            Page
      No.Item
      1.
            Financial
      Statements:
            1Condensed Consolidated Balance
      Sheets at September 30, 2009 (unaudited) and December 31,
      2008
            1Condensed Consolidated Statements
      of Income and Comprehensive Income for the Nine months ended September 30,
      2009 and 2008 (unaudited)
            2Condensed Consolidated Statements
      of Income and Comprehensive Income for the three months ended September
      30, 2009 and 2008 (unaudited)
            3Condensed Consolidated Statements
      of Cash Flows for the Nine months ended September 30, 2009 and 2008
      (unaudited)
            4Notes to Condensed Consolidated
      Financial Statements
            5Item
      2.
            Management's Discussion and
      Analysis of Financial Condition and Results of
      Operations.
            21Item
      3.
            Quantitative and Qualitative
      Disclosure About Market Risk
            32Item
      4
            Controls and
      Procedures.
            32PART
      II - OTHER INFORMATIONItem
      2.
            Unregistered Sales of Equity
      Securities and Use of Proceeds.
            34Item
      6.
            Exhibits.
            34








China
      Carbon Graphite Group, Inc and SubsidiariesCondensed
      Consolidated Statements of Cash Flows (Unaudited)Nine
      months ended September 30,2009
              
              
              2008Cash
      flows from operating activitiesNet
      Income
              
              $
              1,835,855
              
              
              $
              4,330,024Adjustments
      to reconcile net cash provided byoperating
      activitiesDepreciation
      and amortization
              
              
              1,021,937
              
              
              
              954,924Share
      based compensation
              
              
              108,000
              
              
              
              -Change
      in operating assets and liabilitiesAccounts
      receivable
              
              
              (1,966,455
              )
              
              
              (680,934
              )Notes
      receivable
              
              
              (266,331
              )
              
              
              258,703Other
      receivables
              
              
              (1,214,925
              )
              
              
              323,933Advance
      to suppliers
              
              
              364,539
              
              
              
              (209,088
              )Inventories
              
              
              (655,104
              )
              
              
              (1,618,729
              )Prepaid
      expenses
              
              
              (47,200
              )
              
              
              (30,487
              )Accounts
      payable and accrued expenses
              
              
              920,089
              
              
              
              (36,385
              )Non-current
      accounts payable
              
              
              773,324
              
              
              
              -Advance
      from customers
              
              
              297,347
              
              
              
              899,273Trade
      notes payable
              
              
              5,847,013
              
              
              
              -Taxes
      payable
              
              
              (215,260
              )
              
              
              78,661Other
      payables
              
              
              471,259
              
              
              
              508,451Net
      cash provided by operating activities
              
              
              7,274,088
              
              
              
              4,778,346Cash
      flows from investing activitiesAcquisition
      of property and equipment
              
              
              (1,438,549
              )
              
              
              (132,731
              )Construction
      in progress
              
              
              (2,635,286
              )
              
              
              (2,625,861
              )Additional
      payment for land use rights
              
              
              
              
              
              
              (653,028
              )Net
      cash used in investing activities
              
              
              (4,073,835
              )
              
              
              (3,411,620
              )Cash
      flows from financing activitiesIssuance
      of common stock for cash
              
              
              67,900
              
              
              
              -Repayment
      of bank loans
              
              
              (2,784,640
              )
              
              
              -Proceeds
      from bank loans
              
              
              5,116,136
              
              
              
              -Repayment
      from related party
              
              
              290,965
              
              
              
              -Repayment
      to related party
              
              
              -
              
              
              
              (28,353
              )Repayment
      of notes payable
              
              
              -
              
              
              
              (1,506,456
              )Net
      cash provided by (used in) financing activities
              
              
              2,690,362
              
              
              
              (1,534,809
              )Effect
      of exchange rate fluctuation
              
              
              105,563
              
              
              
              215,688Net
      increase in cash
              
              
              5,996,178
              
              
              
              47,605Cash
      and cash equivalents at beginning of period
              
              
              51,799
              
              
              
              4,497Cash
      and cash equivalents at end of period
              
              $
              6,047,977
              
              
              $
              52,102Supplemental
      disclosure of cash flow informationInterest
      paid
              
              $
              761,586
              
              
              $
              413,039Income
      taxes paid
              
              $
              -
              
              
              $
              -Non-cash
      financing and investing activities:Deemed
      preferred stock dividend
              
              $
              -
              
              
              $
              854,300Issuance
      of common stock for consulting fee
              
              $
              108,000
              
              
              $
              -The
      accompanying footnotes are an integral part of these financial
      statements.
 
 1
  China Carbon Graphite Group, Inc and
      subsidiariesConsolidated
      Statements of Income and Comprehensive Income (Unaudited)Nine
      months ended September 30,2009
              
              
              2008Sales
              
              $
              12,131,938
              
              
              $
              21,160,851Cost
      of Goods Sold
              
              
              9,012,935
              
              
              
              15,567,633Gross
      Profit
              
              
              3,119,003
              
              
              
              5,593,218Operating
      ExpensesSelling
      expenses
              
              
              332,016
              
              
              
              439,004General
      and administrative
              
              
              675,932
              
              
              
              575,936Depreciation
      and amortization
              
              
              57,275
              
              
              
              49,3991,065,223
              
              
              
              1,064,339Operating
      Income Before Other Income (Expense)and
      Income Tax Expense
              
              
              2,053,780
              
              
              
              4,528,879Other
      Income (Expense)Other
      income
              
              
              545,122
              
              
              
              224,705Other
      expenses
              
              
              (1,462
              )
              
              
              (11,431
              )Interest
      income
              
              
              -
              
              
              
              910Interest
      expense
              
              
              (761,586
              )
              
              
              (413,039
              )(217,926
              )
              
              
              (198,855
              )Income
      Before Income Tax Expense
              
              
              1,835,854
              
              
              
              4,330,024Income
      tax expense
              
              
              -
              
              
              
              -Net
      income
              
              
              1,835,854
              
              
              
              4,330,024Deemed
      preferred stock dividend
              
              
              -
              
              
              
              (854,300
              )Net
      income available to common shareholders
              
              
              1,835,854
              
              
              
              3,475,724Comprehensive
      incomeNet
      income
              
              
              1,835,854
              
              
              
              4,330,024Other
      comprehensive incomeForeign
      currency translation gain
              
              
              124,645
              
              
              
              2,064,524Total
      Comprehensive Income
              
              $
              1,960,499
              
              
              $
              6,394,548Share
      dataBasic
      earnings per share
              
              
              0.13
              
              
              $
              0.27Diluted
      earnings per share
              
              
              0.13
              
              
              $
              0.18Weighted
      average common shares outstanding,basic
              
              
              13,800,052
              
              
              
              12,716,587Weighted
      average common shares outstanding,diluted
              
              
              14,392,450
              
              
              
              19,365,223The
      accompanying notes are an integral part of these financial
      statements.
  2
 China
      Carbon Graphite Group, Inc and subsidiariesConsolidated
      Statements of Income and Comprehensive Income (Unaudited)Three
      months ended September 30,2009
              
              
              2008Sales
              
              $
              5,580,776
              
              
              $
              7,509,072Cost
      of Goods Sold
              
              
              4,055,953
              
              
              
              5,384,214Gross
      Profit
              
              
              1,524,823
              
              
              
              2,124,858Operating
      ExpensesSelling
      expenses
              
              
              14,102
              
              
              
              269,002General
      and administrative
              
              
              218,522
              
              
              
              177,019Depreciation
      and amortization
              
              
              19,096
              
              
              
              18,672251,720
              
              
              
              464,693Operating
      Income Before Other Income (Expense)and
      Income Tax Expense
              
              
              1,273,103
              
              
              
              1,660,165Other
      Income (Expense)Other
      income
              
              
              19,053
              
              
              
              11,032Other
      expenses
              
              
              -
              
              
              
              (120
              )Interest
      income
              
              
              -
              
              
              
              493Interest
      expense
              
              
              (356,891
              )
              
              
              (143,482
              )(337,838
              )
              
              
              (132,077
              )Income
      Before Income Tax Expense
              
              
              935,265
              
              
              
              1,528,088Income
      tax expense
              
              
              -
              
              
              
              -Net
      income
              
              
              935,265
              
              
              
              1,528,088Comprehensive
      incomeNet
      income
              
              
              935,265
              
              
              
              1,528,088Other
      comprehensive incomeForeign
      currency translation gain
              
              
              75,900
              
              
              
              84,634Total
      Comprehensive Income
              
              $
              1,011,165
              
              
              $
              1,612,722Share
      dataBasic
      earnings per share
              
              $
              0.06
              
              
              $
              0.13Diluted
      earnings per share
              
              $
              0.06
              
              
              $
              0.08Weighted
      average common shares outstanding,basic
              
              
              15,002,785
              
              
              
              12,218,412Weighted
      average common shares outstanding,diluted
              
              
              15,085,202
              
              
              
              19,418,911The
      accompanying notes are an integral part of these financial
      statements.
 
 3
  China
      Carbon Graphite Group, Inc and SubsidiariesCondensed
      Consolidated Statements of Cash Flows (Unaudited)Nine
      months ended September 30,2009
              
              
              2008Cash
      flows from operating activitiesNet
      Income
              
              $
              1,835,855
              
              
              $
              4,330,024Adjustments
      to reconcile net cash provided byoperating
      activitiesDepreciation
      and amortization
              
              
              1,021,937
              
              
              
              954,924Share
      based compensation
              
              
              108,000
              
              
              
              -Change
      in operating assets and liabilitiesAccounts
      receivable
              
              
              (1,966,455
              )
              
              
              (680,934
              )Notes
      receivable
              
              
              (266,331
              )
              
              
              258,703Other
      receivables
              
              
              (1,214,925
              )
              
              
              323,933Advance
      to suppliers
              
              
              364,539
              
              
              
              (209,088
              )Inventories
              
              
              (655,104
              )
              
              
              (1,618,729
              )Prepaid
      expenses
              
              
              (47,200
              )
              
              
              (30,487
              )Accounts
      payable and accrued expenses
              
              
              920,089
              
              
              
              (36,385
              )Non-current
      accounts payable
              
              
              773,324
              
              
              
              -Advance
      from customers
              
              
              297,347
              
              
              
              899,273Trade
      notes payable
              
              
              5,847,013
              
              
              
              -Taxes
      payable
              
              
              (215,260
              )
              
              
              78,661Other
      payables
              
              
              471,259
              
              
              
              508,451Net
      cash provided by operating activities
              
              
              7,274,088
              
              
              
              4,778,346Cash
      flows from investing activitiesAcquisition
      of property and equipment
              
              
              (1,438,549
              )
              
              
              (132,731
              )Construction
      in progress
              
              
              (2,635,286
              )
              
              
              (2,625,861
              )Additional
      payment for land use rights
              
              
              
              
              
              
              (653,028
              )Net
      cash used in investing activities
              
              
              (4,073,835
              )
              
              
              (3,411,620
              )Cash
      flows from financing activitiesIssuance
      of common stock for cash
              
              
              67,900
              
              
              
              -Repayment
      of bank loans
              
              
              (2,784,640
              )
              
              
              -Proceeds
      from bank loans
              
              
              5,116,136
              
              
              
              -Repayment
      from related party
              
              
              290,965
              
              
              
              -Repayment
      to related party
              
              
              -
              
              
              
              (28,353
              )Repayment
      of notes payable
              
              
              -
              
              
              
              (1,506,456
              )Net
      cash provided by (used in) financing activities
              
              
              2,690,362
              
              
              
              (1,534,809
              )Effect
      of exchange rate fluctuation
              
              
              105,563
              
              
              
              215,688Net
      increase in cash
              
              
              5,996,178
              
              
              
              47,605Cash
      and cash equivalents at beginning of period
              
              
              51,799
              
              
              
              4,497Cash
      and cash equivalents at end of period
              
              $
              6,047,977
              
              
              $
              52,102Supplemental
      disclosure of cash flow informationInterest
      paid
              
              $
              761,586
              
              
              $
              413,039Income
      taxes paid
              
              $
              -
              
              
              $
              -Non-cash
      financing and investing activities:Deemed
      preferred stock dividend
              
              $
              -
              
              
              $
              854,300Issuance
      of common stock for consulting fee
              
              $
              108,000
              
              
              $
              -The
      accompanying footnotes are an integral part of these financial
      statements.
 4





FORWARD
LOOKING STATEMENTS





This
report contains forward-looking statements regarding our business, financial
condition, results of operations and prospects. Words such as “expects,”
“anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” and similar
expressions or variations of such words are intended to identify forward-looking
statements, but are not deemed to represent an all-inclusive means of
identifying forward-looking statements as denoted in this report. Additionally,
statements concerning future matters are forward-looking
statements.





Although
forward-looking statements in this report reflect the good faith judgment of our
management, such statements can only be based on facts and factors currently
known by us. Consequently, forward-looking statements are inherently subject to
risks and uncertainties and actual results and outcomes may differ materially
from the results and outcomes discussed in or anticipated by the forward-looking
statements. Factors that could cause or contribute to such differences in
results and outcomes include, without limitation, those specifically
addressed under the headings “Risks Factors” and “Management’s Discussion and
Analysis of Financial Condition and Results of Operations” in our annual report
on Form 10-K, in “Management’s Discussion and Analysis of Financial Condition
and Results of Operations” in this Form 10-Q and in other reports that we file
with the SEC.   You are urged not to place undue reliance on
these forward-looking statements, which speak only as of the date of this
report. We file reports with the SEC. The SEC maintains a website (www.sec.gov)
that contains reports, proxy and information statements, and other information
regarding issuers that file electronically with the SEC, including us. You can
also read and copy any materials we file with the SEC at the SEC’s Public
Reference Room at 100 F Street, NE, Washington, DC 20549. You can obtain
additional information about the operation of the Public Reference Room by
calling the SEC at 1-800-SEC-0330.





We
undertake no obligation to revise or update any forward-looking statements in
order to reflect any event or circumstance that may arise after the date of this
report, except as required by law. Readers are urged to carefully review and
consider the various disclosures made throughout the entirety of this quarterly
report, which are designed to advise interested parties of the risks and factors
that may affect our business, financial condition, results of operations and
prospects.


5


China
Carbon Graphite Group, Inc. and Subsidiaries


Notes
to Condensed Consolidated Financial Statements


For
the three months and nine months ended September 30, 2009








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.





6


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, 2008.





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 years ended December 31, 2008 and 2007,
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.





Yongle’s
business license was issued on September 13, 2007. According to PRC rules and
regulations, Talent was required to pay 20% of its capital investment in Yongle,
or $800,000, within three months, which would have been due on December 12,
2007, and the remaining 80%, or $3,200,000, within two years from the date of
issuance of business license, which would have been September 12, 2009.  On
May 21, 2009, the Company's board of directors approved the reduction of
Talent’s investment in Yongle from $4,000,000 to $100,000 and the reduction of
Yongle's registered capital from $4,000,000 to $100,000. The Company believes
that these actions effectively eliminated possible fines or penalties by the PRC
business bureau that could result from the Company’s failure to pay the
registered capital when required.  All governmental approval to the
reduction in capital was obtained and the Talent paid the $100,000 investment to
Yongle in full in August 2009.





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.





7





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 US is protected by FDIC
insurance





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 nine months ended at September 30, 2009 and
2008.





8





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 2,356,209 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 nine months ended September 30, 2009 and $7,400 for 2008.





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 nine months ended September 30, 2009 and
2008, shipping and handling costs were $318,604 and $396,119, respectively, and
for the three months ended September 30, 2009 and 2008, these costs were $9,867
and $243,643, 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.





9


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 September 30, 2009 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
September 30, 2009, 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 12 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 - On
March 16, 2007, the PRC’s parliament, the National People’s Congress, adopted
the Enterprise Income Tax Law, which took effect on 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.





10


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.





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- In September 2006, the FASB issued ASC 820, Fair Value Measurements and
Disclosures, formerly known as SFAS No. 157, Fair Value Measurements. SFAS No.
157 defines fair value, establishes a framework for measuring fair value in
accordance with generally accepted accounting principles, and expands
disclosures about fair value measurements. This statement does not require any
new fair value measurements; rather, it applies under other accounting
pronouncements that require or permit fair value measurements. The provisions of
this statement are to be applied prospectively as of the beginning of the fiscal
year in which this statement is initially applied, with any transition
adjustment recognized as a cumulative-effect adjustment to the opening balance
of retained earnings. The provisions of SFAS No. 157 are effective for the
fiscal years beginning after November 15, 2007.





Effective
January 1, 2008, the Company adopted SFAS No. 157. The adoption of SFAS No. 157
did not have a material impact on the Company’s fair value measurements. The
carrying amounts of certain financial instruments, including cash, accounts
receivable, notes receivable, other receivables, accounts payable, commercial
notes payable, accrued expenses, and other payables approximate their fair
values as of September 30, 2009 and December 31, 2008 because of the relatively
short-term maturity of these instruments.





Foreign currency translation-
The reporting currency of the Company is the U.S. dollar. The functional
currency of the Company is the local currency, the Chinese Renminbi (“RMB”).
Results of operations and cash flows are translated at average exchange rates
during the period, assets and liabilities are translated at the unified exchange
rate at the end of the period, and equity is translated at historical exchange
rates. Translation adjustments resulting from the process of translating the
local currency financial statements into U.S. dollars are included in
determining comprehensive income. Translation adjustments for the nine months
ended September 30, 2009 and 2008 are $124,645 and $2,064,524, respectively.





11


The
cumulative translation adjustment and effect of exchange rate changes on cash
for the nine months ended September 30, 2009 and 2008 was $105,563 and $215,687,
respectively. Transaction gains and losses that arise from exchange rate
fluctuations on transactions denominated in a currency other than the functional
currency are included in the results of operations as incurred.





Asset and
liability accounts at September 30, 2009 and December 31, 2008 were translated
at 6.8376 RMB to $1.00 USD and at 6.8542 RMB to $1.00 USD, respectively. Equity
accounts were stated at their historical rate. The average translation rates
applied to income statements for the nine months ended September 30, 2009 and
2008 were 6.8425 RMB and 6.9989 RMB to $1.00 USD, respectively. In accordance
with Statement of Financial Accounting Standards No. 95, “Statement of Cash
Flows,” cash flows from the Company's operations are calculated based upon the
local currencies using the average translation rate. As a result, amounts
related to assets and liabilities reported on the statement of cash flows will
not necessarily agree with changes in the corresponding balances on the balance
sheet.





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 125,000 shares of common stock at an exercise price of $2.0
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 nine months ended September 30, 2009 and 2008.





Nine
      Months Ended September 30,2009
            
            
            2008Weighted
      average shares of common stock outstanding (basic)
            
            
            13,800,052
            
            
            
            12,716,587Shares
      issuable upon conversion of series A preferred stock
            
            
            612,625
            
            
            
            1,200,499Shares
      issuable upon exercise of warrants
            
            
            -
            
            
            
            6,000,000Weighted
      average shares of common stock outstanding (diluted)
            
            
            14,392,450
            
            
            
            19,365,223Net
      income available to common shareholders
            
            $
            .13
            
            
            $
            .27Net
      income per shares of common stock (diluted)
            
            $
            .13
            
            
            $
            .18





For the
nine months ended September 30, 2009, the Company did not include any shares of
common stock issuable upon 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 nine months ended
September 30, 2009 and 2008 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.





12





Subsequent events - For
purposes of determining whether a post-balance sheet event should be evaluated
to determine whether it has an effect on the financial statements for the period
ending September 30, 2009, subsequent events were evaluated by the Company as of
November 16, 2009, the date on which the unaudited condensed consolidated
financial statements at and for the quarter ended September 30, 2009, were
available to be issued.





Recent
accounting pronouncements





In
December, 2007, the FASB issued ASC 805 “Business Combinations”, formerly known
as SFAS No. 141(R) “Business Combinations”. SFAS No. 141(R) requires an
acquiring entity to recognize all the assets acquired and liabilities assumed in
a transaction at the acquisition-date fair value, with limited exceptions, and
applies to a wider range of transactions or events. SFAS No. 141(R) is
effective for fiscal years beginning on or after December 15, 2008 and
early adoption and retrospective application is prohibited. Effective January 1,
2009. ASC 805 revised SFAS No. 141(R) and addresses the accounting and
disclosure for identifiable assets acquired, liabilities assumed, and
noncontrolling interests in a business combination. The adoption of SFAS 141(R)
does not have a material effect on the Company’s condensed consolidated
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 Company is in the process of
evaluating the effect, if any, the adoption of SFAS No. 167 will have on the
Company’s financial statements





In March
2008, the FASB issued ASC 815, “Derivatives and Hedging”, formerly known
as  SFAS No. 161 “Disclosures about Derivative Instruments and Hedging
Activities – An Amendment of FASB Statement No. 133”, which changes the
disclosure requirements for derivative instruments and hedging activities.
Entities are required to provide enhanced disclosures about (a) how and why an
entity uses derivative instruments, (b) how derivative instruments and related
hedged items are accounted for under Statement 133 and its related
interpretations, and (c) how derivative instruments and related hedged items
affect an entity’s financial position, financial performance, and cash flows.
This statement will be effective for financial statements issued for fiscal
years and interim periods beginning after November 15, 2008 (that is, the year
ended December 31, 2009 for the Company). This Statement does not have an effect
on the Company’s condensed consolidated financial statements.





In May
2008, the FASB issued ASC 470-20, “Debt with conversion and other options”,
formerly known as  FASB Staff Position (“FSP”) APB 14-1, “Accounting
for Convertible Debt Instruments That May Be Settled in Cash upon Conversion
(Including Partial Cash Settlement)”. FSP APB 14-1 clarifies that convertible
debt instruments that may be settled in cash upon either mandatory or optional
conversion (including partial cash settlement) are not addressed by paragraph 12
of APB Opinion No. 14, Accounting for Convertible Debt and
Debt issued with Stock Purchase Warrants. Additionally, FSP APB 14-1
specifies that issuers of such instruments should separately account for the
liability and equity components in a manner that will reflect the entity’s
non-convertible debt borrowing rate when interest cost is recognized in
subsequent periods. FSP APB 14-1 is effective for financial statements issued
for fiscal years beginning after December 15, 2008, and interim periods within
those fiscal years. The Company adopted FSP APB 14-1 beginning in the first
quarter of 2009, and this standard must be applied on a retroactive basis. This
Statement does not have an effect on the Company’s condensed consolidated
financial statements.





13


In
October 2008, the FASB issued FSP FAS 157-3, “Determining the Fair Value of a
Financial Asset in a Market That Is Not Active” (FSP 157-3), which clarifies the
application of ASC 820, “Fair Value Measurement Disclosures”, formerly known as
SFAS No. 57, when the market for a financial asset is inactive. Specifically,
FSP 157-3 clarifies how (1) management’s internal assumptions should be
considered in measuring fair value when observable data are not present, (2)
observable market information from an inactive market should be taken into
account, and (3) the use of broker quotes or pricing services should be
considered in assessing the relevance of observable and unobservable data to
measure fair value. The Company adopted the provisions of FSP 157-3, which did
not impact the Company’s financial position or results of
operations.





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 Company is in the process of
evaluating the effect, if any, the adoption of SFAS No. 167 will have 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.





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 US 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.





14


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
nine months ended September 30, 2009, two customers accounted for 10% or more of
sales revenues, representing 27.4% and 25.1%, respectively of the total sales.
No customer accounted for 10% or more of the Company’s revenue during the nine
months ended September 30, 2008.  As of September 30, 2009, there were
three customers that constitute 21.1%, 12.86% and 10.1%, respectively of the
accounts receivable. As of December 31, 2008, there were three customers that
accounted for 22.7%, 14.8%, and 12.5% respectively of the accounts
receivable.





For the
nine months ended September 30, 2009 and 2008, the Company had insurance expense
of $2,132 and $5,778 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 nine months
ended September 30, 2009 and 2008, the enterprise income tax at the statutory
rates would have been approximately $310,041 and $648,504, respectively, and for
the three months ended September 30, 2009 and 2008, the enterprise income tax at
the statutory rates would have been approximately $137,784 and $356,359,
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:





Nine
      months ended September 30,2009
            
            
            2008Computed
      tax at the PRC statutory rate of 15%
            
            $
            310,041
            
            
            $
            648,504Benefit
      of tax holiday
            
            
            (310,041
            )
            
            
            (648,504
            )Income
      tax expenses per books
            
            $
            -
            
            
            $
            -





Three
      months ended September 30,2009
            
            
            2008Computed
      tax at the PRC statutory rate of 15%
            
            $
            137,784
            
            
            $
            356,359Benefit
      of tax holiday
            
            
            (137,784
            )
            
            
            (356,359
            )Income
      tax expenses per books
            
            $
            -
            
            
            $
            -





15


6.  Trade
Accounts Receivable - net





As of
September 30, 2009 and December 31, 2008, trade accounts receivable consisted of
the following:





September
      30, 2009
            
            
            December
      31, 2008Amount
      outstanding
            
            $
            6,907,780
            
            
            $
            4,928,354Bad
      debt provision
            
            
            (705,653
            )
            
            
            (703,944
            )Net
      amount
            
            $
            6,202,127
            
            
            $
            4,224,410





For the
nine months ended September 30, 2009, $26,810 was charged to bad debt provision.
For the three and nine months ended September 30, 2008, no bad debt provision
was provided.





7.  Advance
to suppliers, net





As of
September 30, 2009 and December 31, 2008, advance to suppliers consisted of the
following:





September
      30, 2009
            
            
            December
      31, 2008Amount
      outstanding
            
            $
            824,795
            
            
            $
            1,186,640Bad
      debt provision
            
            
            (169,964
            )
            
            
            (169,552
            )Net
      amount
            
            $
            654,831
            
            
            $
            1,017,088





For the
three and nine months ended September 30, 2009 and 2008, no additional bad debt
provision on advance to suppliers was charged to expenses.





8.  
Inventories





As of
September 30, 2009 and December 31, 2008, inventories consisted of the
following:





September
      30, 2009
            
            
            December
      31, 2008Raw
      materials
            
            $
            1,450,304
            
            
            $
            820,250Work
      in process
            
            
            13,413,482
            
            
            
            13,193,750Finished
      goods
            
            
            1,665,919
            
            
            
            1,821,719Repair
      Parts
            
            
            53,960
            
            
            
            53,830$
            16,583,565
            
            
            $
            15,889,549





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
September 30, 2009 and December 31, 2008, property and equipment consist of the
following:





September
      30, 2009
            
            
            December
      31, 2008Building
            
            $
            7,871,298
            
            
            $
            7,956,770Machinery
      and equipment
            
            
            21,107,137
            
            
            
            19,515,684Motor
      vehicles
            
            
            40,950
            
            
            
            40,85129,019,385
            
            
            
            27,513,305Less:
      Accumulated depreciation
            
            
            7,094,646
            
            
            
            6,509,698$
            21,528,739
            
            
            $
            21,003,607





16


For the
nine months ended September 30, 2009 and 2008, depreciation expense amounted to
$635,329 and $601,822 was charged to cost of goods sold.For the three months ended
September 30, 2009 and 2008, depreciation expense amounted to $326,054 and
$294,373 was charged to cost of goods sold.





10.  Land
Use Right





As of
September 30, 2009 and December 31, 2008, land use rights consist of the
following:





September
      30, 2009
            
            
            December
      31, 2008Land
      Use Right
            
            $
            3,819,407
            
            
            $
            3,811,539Less:
      Accumulated amortization
            
            
            263,648
            
            
            
            207,215$
            3,555,759
            
            
            $
            3,604,324





For the
nine months ended September 30, 2009 and 2008, amortization expenses were
$57,275 and $30,727, respectively. For the three months ended September 30, 2009
and 2008, amortization expenses were $19,096 and $15,587,
respectively.





Future
amortization of the land use rights is as follows:





12-month period ended
      September 30,2010
            
            $
            76,4202011
            
            
            76,4202012
            
            
            76,4202013
            
            
            76,4202014
            
            
            76,4202015
      and thereafter
            
            
            3,173,659Total
            
            $
            3,555,759





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 one series of preferred stock
-- the series A convertible preferred stock (“series A preferred
stock”).





On
December 17, 2007, the Company issued its 3% promissory note in the amount of
$1,200,000. Pursuant to the agreement pursuant to which the note was issued,
upon the filing of restated articles of incorporation which provided for the
creation of a series of preferred stock and the filing of a certificate of
designation which created the series A preferred stock, the note would
automatically be converted into 1,200,499 shares of series A preferred stock and
warrants to purchase 3,000,000 shares of common stock at $1.20 per share and
3,000,000 shares of common stock at $2.00 per share. On January 22, 2008, upon
the filing of restated articles of incorporation and a statement of designation
for the series A convertible preferred stock, and the outstanding convertible
note was converted into such series A preferred stock and warrants.





17


The
statement of designation for the series A preferred stock provides the
following:





·
            Each
      share of series A preferred stock is convertible into one share of common
      stock, at a conversion price of $1.00, subject to
    adjustment.





·
            While
      the series A preferred stock is outstanding, if the Company issues common
      stock at a price or warrants or other convertible securities at a
      conversion or exercise price which is less than the conversion price then
      in effect, the conversion price shall be adjusted on a formula
      basis.





·
            While
      the Series A Preferred Stock is outstanding, without the approval of the
      holders of 75% of the outstanding shares of Series A Preferred Stock, the
      Company may not pay cash dividends or other distributions of cash,
      property or evidences of indebtedness, nor redeem any shares of Common
      Stock.





·
            No
      dividends are payable with respect to the series A preferred
      stock.





·
            Upon
      any voluntary or involuntary liquidation, dissolution or winding-up, the
      holders of the series A preferred stock are entitled to a preference of
      $1.00 per share before any distributions or payments may be made with
      respect to the common stock or any other class or series of capital stock
      which is junior to the series A preferred stock upon voluntary or
      involuntary liquidation, dissolution or
  winding-up.





·
            The
      holders of the series A preferred stock have no voting rights. However, so
      long as any shares of series A preferred stock are outstanding, the
      Company shall not, without the affirmative approval of the holders of 75%
      of the outstanding shares of series A preferred stock then outstanding,
      (a) alter or change adversely the powers, preferences or rights given to
      the series A preferred stock or alter or amend the certificate of
      designation, (b) authorize or create any class of stock ranking as to
      dividends or distribution of assets upon liquidation senior to or
      otherwise pari passu with the series A preferred stock, or any of
      preferred stock possessing greater voting rights or the right to convert
      at a more favorable price than the series A preferred stock, (c) amend our
      articles of incorporation or other charter documents in breach of any of
      the provisions thereof, (d) increase the authorized number of shares of
      series A preferred stock, or (e) enter into any agreement with respect to
      the foregoing








During
the nine months ended September 30, 2009, we issued 950,499 shares of common
stock upon conversion o f 950,499 shares of series A preferred
stock.  At September 30, 2009, 250,000 shares of series A preferred
stock were outstanding.





(b)
            Deemed
      Preferred Stock Dividend





Upon
filing of the Company’s amended and restated articles of incorporation on
January 22, 2008, $1,200,000 of convertible notes were automatically converted
into (i) 1,200,499 shares of preferred stock, with each share of series A
preferred stock being convertible into one share of common stock and (ii)
warrants to purchase 3,000,000 shares of the common stock at $1.20 and 3,000,000
shares at $2.00 per share. At December 17, 2007, the fair value of the warrants
used to calculate the intrinsic value of the conversion option was estimated at
$3,831,900 and was computed using the Black-Scholes option-pricing model based
on the assumed issuance of the warrants on the date the notes were issued.
Variables used in the option-pricing model include (1) risk-free interest
rate at the date of grant (3.5%), (2) expected warrant life of
5 years, (3) expected volatility of 100%, and (4) 0% expected
dividend.   The Company used the market price of its common stock at
December 17, 2007, $0.95 per share, and computed the effective preferred stock
conversion price to be $0.24 per share. The resulting intrinsic value of
the conversion feature was $854,300 reported as a deemed
dividend.





18


As the
series A preferred stock does not provide for redemption by the Company or have
a finite life, upon the conversion to preferred stock, a one-time preferred
stock deemed dividend of $854,300 was recognized immediately as a non-cash
charge. The deemed preferred stock dividend of $854,300 has been recorded as
additional paid-in capital and a reduction to retained earnings in
2008.





(c)
            Stock
      Issuances; Warrants





On July
29, 2009, the Company issued 887,500 shares of common stock in connection with
the cancellation of warrants to purchase 3,000,000 shares of common stock at
$1.20 per share and 2,875,000 shares of common stock at $2.00 per
share.  As a result, there remain outstanding warrants to purchase
125,000 shares at $2.00 per share.The warrants expire
December 3, 2012 and provide a cashless exercise feature which can only be
exercised if the underlying shares are not covered by an effective registration
statement.





We
estimated the fair value of the warrants that were canceled at $825,896 using
the Black-Scholes option valuation model. Variables used in the option-pricing
model include (i) expected terms of warrants life of 3.4 years (ii) the
weighted-average assumption of a risk free interest rate of 2.20% based on the
yield available on a U.S. Treasury note with a term equal to the estimated term
(iii) the expected volatility of 28% equals to the historical volatility of the
Company’s share price. The fair value of the common stock issued was $834,125.
Since the fair value of the warrants cancelled approximate the fair value of the
common stocks, no additional non-cash expense was recorded.




Pursuant
to a consulting agreement dated February 9, 2009, with Ventana Capital Partners,
the Company issued to Ventana 750,000 shares of common
stock.  Pursuant to an agreement dated July 22, 2009, with Ventana,
the Company issued to Ventana 375,000 shares of common stock.  The
issuance of these shares was exempt from registration pursuant to Section 4(2)
of the Securities Act and Regulation 506 of the SEC thereunder.
 
 In March
2009, the Company sold 70,000 shares of common stock to one investor at a
purchase price of $1.00 per share, for a total of $70,000.  The
Company paid $2,100 as a commission to a finder. The shares were issued pursuant
to Regulation S under the Securities Act.




12.  Short-term
bank loans





As of
September 30, 2009 and December 31, 2008, short term loans consisted of the
following:




September
      30, 2009
            
            
            December
      31, 2008Bank
      loans dated July 17, 2008, due May 6, 2009 with an interest rate of
      9.711%, interest payable monthly, secured by property and equipment and
      land use rights
            
            $
            
            
            
            $
            656,532Bank
      loans dated July 17, 2008, due May 25, 2009 with an interest rate of
      9.711%, interest payable monthly, secured by property and equipment and
      land use rights
            
            
            
            
            
            
            1,167,167Bank
      loans dated July 17, 2008, due June 15, 2009 with an interest rate of
      9.711%, interest payable monthly, secured by property and equipment and
      land use rights
            
            
            
            
            
            
            1,167,167Bank
      loans dated July 17, 2008, due July 1, 2009 with an interest rate of
      9.711%, interest payable monthly, secured by property and equipment and
      land use rights
            
            
            
            
            
            
            1,167,167Bank
      loans dated July 17, 2008, due July 13, 2009 with an interest rate of
      9.711%, interest payable monthly, secured by property and equipment and
      land use rights
            
            
            
            
            
            
            729,481Bank
      loans dated June 17, 2009, due June 15, 2010 with an interest rate of
      8.541%, interest payable monthly, secured by property and equipment and
      land use rights
            
            
            3,429,566
            
            
            
            -Bank
      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
            
            
            5,118,755
            
            
            
            -$
            8,548,321
            
            
            $
            4,887,514





19


13.  Long-term
bank loan





September
      30, 2009
            
            
            December
      31, 2008Bank
      loans dated October 10, 2008, due October 9, 2011 with an interest rate of
      6.75%, interest payable monthly.
            
            $
            3,802,504
            
            
            $
            5,106,358Less:
      current portion
            
            
            (1,608,752
            )
            
            
            (1,896,647
            )Non-current
      portion
            
            $
            2,193,752
            
            
            $
            3,209,711





14.  Trade
notes payable





As of
September 30, 2009 trade notes payable were $5,843,006.  There were no
trade notes payable at December 31, 2008. The Company was requested by certain
of its suppliers to settle trade liabilities incurred in the ordinary course of
business by issuance of notes guaranteed by a bank acceptable to the supplier.
The notes are interest-free with maturity of six months from date of
issuance.





15.  Subsequent
Events





On
October 12, 2009, the Company issued an aggregate of 750,000 shares of common
stock to two investors pursuant to subscription agreements dated as of July 30,
2009. The Company sold 493,760 shares at $.75 per share and 256,240 shares at
$1.00 per share.  The issuance of these securities was exempt from
registration under Regulation S of he Securities and Exchange Commission under
the Securities Act.  The investors are not “U.S. persons” as that term
is defined in Rule 902(k) of Regulation S under the Act, and that such investor
was acquiring our common stock, for investment purposes for their own respective
accounts and not as nominees or agents, and not with a view to the resale or
distribution thereof.





Pursuant
to agreements with two newly-elected independent directors, the Company issued
25,000 shares  of common stock to each of these directors on November
5, 2009.  On November 5, 2009, the Company issued 20,000 shares to
each of our chief executive officer and our chief financial
officer.  The issuance of these shares was exempt from registration
pursuant to Section 4(2) of the Securities Act and Regulation 506 of the SEC
thereunder.





Pursuant
to a consulting agreement dated October 15, 2009, with FirsTrust China Ltd.,
on  October 27, 2009, the Company issued to FirsTrust five year
warrants to purchase 100,000 shares of common stock at $2.00 per share and
100,000 shares of common stock at $3.00 per share.  The issuance of
these shares was exempt from registration pursuant to Section 4(2) of the
Securities Act and Regulation 506 of the SEC thereunder.





20





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
develop, manufacture and market graphite products. Our main products include
graphite electrode, fine grain graphite and high purity graphite. We produce all
of our products in China. Our products are generally used either as a component
in other products, as an element of a facility or in the manufacturing process
of other products. We sell our products to distributors who sell to producers of
in both the domestic Chinese market and the international market. We also sell
graphite electrodes directly to the end users. Although our products are
sold in the international market, substantially all of our sales are to Chinese
firms that may, in turn, sell the products in the international market. We
believe that our products are not subject to export restrictions.




Our sales
have suffered during 2009 as a result of the worldwide economic downturn, with
sales in the nine and three months ended September 30, 2009 declining by 42.67%
and 25.68%, respectively,from the
comparable periods of 2008 although sales in the third quarter reflected an
increase from sale of the prior two quarters. The sales decrease reflects the
effects of the negative global economic situation as well as the closure of
Xingyong’s plant facilities for almost two months during the third quarter of
2008 as part of the Chinese government’s program to reduce air pollution during
and in anticipation of the August 2008 Olympics.  This shutdown reduced
our sales in the first quarter of 2009 because it takes about three months
to six months to produce graphite products.





Our
principal raw materials are coal asphalt, asphalt coke, metallurgy coke, needle
coke, metallurgy coke power, quartzose sand, coal, petroleum coke and calcined
coke, all of which are carbon rich and used in manufacturing graphite with a
high degree of purity. We purchase most of our raw materials from domestic
Chinese suppliers. Because we do not have any long-term contracts for raw
materials, any increase in prices of raw material will affect the price at which
we can sell our product. If we are not able to raise our prices to pass on
increased costs, we would be unable to maintain our margins. Similarly, in times
of decreasing prices, we may have purchased raw materials at prices which are
high in terms of the price at which we can sell our products, which also can
impair our margins. The laws of the PRC give the government broad power to fix
and adjust prices. Although the government has not imposed price controls on our
raw materials such as coal, gas, oil, electricity and/or water or on our
products, it is possible that such controls may be implemented in the future.
Since most of our sales are made to domestic companies, our gross margins can be
affected by any price controls imposed by the government of the
PRC.





During
the nine months ended September 30, 2009, 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.





Our
internal financial statements are maintained in RMB. The financial statements
included in this Form 10-Q are expressed in United States dollars. The
translation adjustments in expressing the financial statements in United States
dollars is shown on the statements of operation as a translation adjustment, and
the cumulative translation adjustment is shown as an element of
stockholders’ equity.





21


Variable
Interest Entity





Our
relationships with Xingyong and its stockholders are governed by a series of
contractual arrangements between Yongle and Xingyong, the operating company in
the PRC. Under PRC laws, each of Yongle and Xingyong is an independent legal
person and is not exposed to liabilities incurred by the other
parties.   Yongle has a series of agreements with Xingyong
pursuant to which it manages the business of Xingyong and 80% to 100% of the
profit of Xingyong is paid to Yongle.  For 2007 and 2008, Xingyong
paid 100% of the profit to Yongle.  Xingyong is owned by Mr. Jin, who
is Yongle’s controlling stockholder and was our chief executive officer at the
time of we entered into our agreements with Xingyong.  Xingyong is
treated as a variable interest entity and its financial statements are included
as part of our consolidated financial statements under Accounting Standard
Codification (ASC) Topic 810-10, formerly known as  FIN 46(R),
“Consolidation of Variable Interest Entities,” referred to as FIN
46.





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.





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.





22


On March
16, 2007, China’s parliament, the National People’s Congress, adopted the
Enterprise Income Tax Law, which will take effect on January 1, 2008. The 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 September 30, 2009 or December 31,
2008.





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 2,356,209square 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.





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 nine months ended
September 30, 2009 and 2008 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.





23


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
December, 2007, the FASB issued ASC 805 “Business Combinations”, formerly known
as SFAS No. 141(R) “Business Combinations”. SFAS No. 141(R) requires an
acquiring entity to recognize all the assets acquired and liabilities assumed in
a transaction at the acquisition-date fair value, with limited exceptions, and
applies to a wider range of transactions or events. SFAS No. 141(R) is
effective for fiscal years beginning on or after December 15, 2008 and
early adoption and retrospective application is prohibited. Effective January 1,
2009. ASC 805 revised SFAS No. 141(R) and addresses the accounting and
disclosure for identifiable assets acquired, liabilities assumed, and
noncontrolling interests in a business combination. The adoption of SFAS 141(R)
does not have a material effect on the Company’s condensed consolidated
financial statements.





In
December 2007, the FASB issued ASC 810, “Consolidation”, formerly known
as  SFAS No. 160, “Noncontrolling Interests in Consolidated Financial
Statements - An Amendment of ARB No. 51”, which establishes new accounting and
reporting standards for the noncontrolling interest in a subsidiary and for the
deconsolidation of a subsidiary. Specifically, this statement requires the
recognition of a noncontrolling interest (minority interest) as equity in the
consolidated financial statements and separate from the parent’s equity. SFAS
No. 160 is effective for fiscal years, and interim periods within those fiscal
years, beginning on or after December 15, 2008 (that is, the year ended December
31, 2009 for the Company). This Statement does not have an effect on the
Company’s condensed consolidated financial statements.





In March
2008, the FASB issued ASC 815, “Derivatives and Hedging”, formerly known
as  SFAS No. 161 “Disclosures about Derivative Instruments and Hedging
Activities – An Amendment of FASB Statement No. 133”, which changes the
disclosure requirements for derivative instruments and hedging activities.
Entities are required to provide enhanced disclosures about (a) how and why an
entity uses derivative instruments, (b) how derivative instruments and related
hedged items are accounted for under Statement 133 and its related
interpretations, and (c) how derivative instruments and related hedged items
affect an entity’s financial position, financial performance, and cash flows.
This statement will be effective for financial statements issued for fiscal
years and interim periods beginning after November 15, 2008 (that is, the year
ended December 31, 2009 for the Company). This Statement does not have an effect
on the Company’s condensed consolidated financial statements.





In May
2008, the FASB issued ASC 470-20, “Debt with conversion and other options”,
formerly known as  FASB Staff Position (“FSP”) APB 14-1, “Accounting
for Convertible Debt Instruments That May Be Settled in Cash upon Conversion
(Including Partial Cash Settlement)”. FSP APB 14-1 clarifies that convertible
debt instruments that may be settled in cash upon either mandatory or optional
conversion (including partial cash settlement) are not addressed by paragraph 12
of APB Opinion No. 14, Accounting for Convertible Debt and
Debt issued with Stock Purchase Warrants. Additionally, FSP APB 14-1
specifies that issuers of such instruments should separately account for the
liability and equity components in a manner that will reflect the entity’s
non-convertible debt borrowing rate when interest cost is recognized in
subsequent periods. FSP APB 14-1 is effective for financial statements issued
for fiscal years beginning after December 15, 2008, and interim periods within
those fiscal years. The Company adopted FSP APB 14-1 beginning in the first
quarter of 2009, and this standard must be applied on a retroactive basis. This
Statement does not have an effect on the Company’s condensed consolidated
financial statements.





24


In
October 2008, the FASB issued FSP FAS 157-3, “Determining the Fair Value of a
Financial Asset in a Market That Is Not Active” (FSP 157-3), which clarifies the
application of ASC 820, “Fair Value Measurement Disclosures”, formerly known as
SFAS No. 57, when the market for a financial asset is inactive. Specifically,
FSP 157-3 clarifies how (1) management’s internal assumptions should be
considered in measuring fair value when observable data are not present, (2)
observable market information from an inactive market should be taken into
account, and (3) the use of broker quotes or pricing services should be
considered in assessing the relevance of observable and unobservable data to
measure fair value. The Company adopted the provisions of FSP 157-3, which did
not impact the Company’s financial position or results of
operations.





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 Company is in the process of
evaluating the effect, if any, the adoption of SFAS No. 167 will have 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" , 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.





25


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):




Nine
      months ended September 30,2009
            
            
            2008US
      Dollars
            
            
            Percentage
            
            
            US
      Dollars
            
            
            PercentageSales
            
            $
            12,132
            
            
            
            100
            %
            
            $
            21,161
            
            
            
            100.00
            %Cost
      of sales
            
            
            9,013
            
            
            
            74.29
            %
            
            
            15,568
            
            
            
            73.57
            %Gross  profit
            
            
            3,119
            
            
            
            25.71
            %
            
            
            5,593
            
            
            
            26.43
            %Operating
      expenses
            
            
            1,065
            
            
            
            8.78
            %
            
            
            1,064
            
            
            
            5.03
            %Income
      from operations
            
            
            2,054
            
            
            
            16.93
            %
            
            
            4,529
            
            
            
            21.40
            %Other
      income
            
            
            545
            
            
            
            4.49
            %
            
            
            225
            
            
            
            1.06
            %Other
      expense
            
            
            (1
            )
            
            
            (0.01
            )%
            
            
            (11
            )
            
            
            (0.05
            )%Interest
      income
            
            
            -
            
            
            
            -
            %
            
            
            1
            
            
            
            -
            %Interest
      expense
            
            
            (762
            )
            
            
            (6.28
            )%
            
            
            (413
            )
            
            
            (1.95
            )%Income
      before income tax expense
            
            
            1,836
            
            
            
            15.13
            %
            
            
            4,330
            
            
            
            20.46
            %Provision
      for income taxes
            
            
            -
            
            
            
            -
            %
            
            
            -
            
            
            
            -
            %Net
      income
            
            $
            1,836
            
            
            
            15.13
            %
            
            $
            4,330
            
            
            
            20.46
            %Foreign
      currency translation adjustment
            
            
            125
            
            
            
            1.03
            %
            
            
            2,065
            
            
            
            9.76
            %Comprehensive
      income
            
            $
            1,961
            
            
            
            16.16
            %
            
            $
            6,395
            
            
            
            30.22
            %





26





Three
      months ended September 30,2009
            
            
            2008US
      Dollars
            
            
            Percentage
            
            
            US
      Dollars
            
            
            PercentageSales
            
            $
            5,581
            
            
            
            100.00
            %
            
            $
            7,509
            
            
            
            100
            %Cost
      of sales
            
            
            4,056
            
            
            
            72.68
            %
            
            
            5,384
            
            
            
            71.70
            %Gross
      profit
            
            
            1,525
            
            
            
            27.32
            %
            
            
            2,125
            
            
            
            28.30
            %Operating
      expenses
            
            
            252
            
            
            
            4.51
            %
            
            
            465
            
            
            
            6.19
            %Income
      from operations
            
            
            1,273
            
            
            
            22.81
            %
            
            
            1,660
            
            
            
            22.11
            %Other
      income
            
            
            19
            
            
            
            0.34
            %
            
            
            11
            
            
            
            0.15
            %Interest
      income
            
            
            -
            
            
            
            -
            %
            
            
            493
            
            
            
            0.01
            %Interest
      expense
            
            
            (357
            )
            
            
            (6.40
            )%
            
            
            (143
            )
            
            
            (1.91
            )%Income
      before income tax expense
            
            
            935
            
            
            
            16.75
            %
            
            
            1,528
            
            
            
            20.35
            %Provision
      for income taxes
            
            
            -
            
            
            
            -
            %
            
            
            -
            
            
            
            -
            %Net
      income
            
            $
            935
            
            
            
            16.75
            %
            
            $
            1,528
            
            
            
            20.35
            %Foreign
      currency translation adjustment
            
            
            76
            
            
            
            1.36
            %
            
            
            85
            
            
            
            1.13
            %Comprehensive
      income
            
            $
            1,011
            
            
            
            18.11
            %
            
            $
            1,613
            
            
            
            21.48
            %





Sales. During the nine
months ended September 30, 2009, we had sales of $12,132,000 as compared to
sales of $21,161,000 for the nine months ended September 30, 2008, a
decrease of $9,029,000, or approximately 42.67%.  During the three
months ended September 30, 2009, we had sales of $5,581,000, as compared to
sales of $7,509,000 for the three months ended September 30, 2008, a
decrease of $1,928,000, or approximately 25.68%.  The sales decrease
reflects the effects of the negative global economic situation as well as the
closure of Xingyong’s plant facilities for almost two months during the third
quarter of 2009 as part of the Chinese government’s program to reduce air
pollution during and in anticipation of the August 2008 Olympics.  This
shutdown reduced our sales in the first quarter of 2009 because it takes
about three months to six months to produce graphite products. During the nine
and three months ended September 30, 2009, sales decreased primarily due to
weaker demand of graphite products, graphite electrode in particular. Sales for
the third quarter of 2009 improved modestly from the level of the second
quarter, but reflected a decline of 25.68% from sales of the third quarter of
2008.





Cost of sales; gross margin.
During the nine months ended September 30, 2009, our cost of sales was
$9,013,000, as compared to $15,568,000 during the nine months ended September
30, 2008, a decrease of $6,555, or 42.11%. During the three months ended
September 30, 2009, our cost of sales was $4,056,000, as compared to $5,384,000
during the three months ended September 30, 2008, a decrease of $1,328,000, or
24.67%. The decrease in cost of sales was directly associated with the decrease
in sales. As a result, our gross profit decreased $2,474,000 and $600,000,
or 44.23% and 28.24%, respectively for the nine and three months ended September
30, 2009. Our gross margin decreased slightly from 26.43% and 28.30% for the
nine and three months ended September 30, 2008 to 25.71% and 27.32% for the
nine and three months ended September 30, 2009. The decrease reflects the
variance in production mix as the percentage of our sales of graphite
electrodes, a lower margin product, increased.




27


Selling,
general and administrative expenses.





Selling,
general and administrative expenses totaled $1,065,000 for the nine months ended
September 30, 2009, as compared to $1,064,000 for the nine months ended
September 30, 2008.  Selling, general and administrative expenses totaled
$251,000 for the three months ended September 30, 2009, as compared to
$465,000 for the three months ended September 30, 2008, an increase of $18,000,
or approximately 3.87%.





Selling
expenses decreased from $439,000 for the nine months ended September 30, 2008 to
$332,000 for the nine months ended September 30, 2009, or 24.37%. The decrease
reflected a decline in shipping and handling expenses as a result of lower sales
in 2009.  Selling expenses decreased from $269,000 for the three
months ended September 30, 2008 to $14,000 for the three months ended September
30, 2009, or 94.80%.  The decrease was a result of lower marketing
expenses of fine grain graphite and high purity graphite products in the third
quarter 2009 compared to 2008 as well as a decrease in shipping
expenses.





General
and administrative expenses were $676,000 for the nine months ended September
30, 2009, compared to $576,000 for the nine months ended September 30, 2008.
General and administrative expenses were $218,000 for the three months ended
September 30, 2009, compared to $177,000 for the three months ended September
30, 2008.  The increase in general administrative expense was
primarily due to the increase in public company expenses.





Depreciation and amortization
expense. Depreciation and amortization amounted to$1,022,000 for the nine
months ended September 30, 2009 and $955,000 for the nine months ended September
30, 2008, of which $965,000 for 2009 and $905,000 for 2008
were included in cost of sales and $57,000 for 2009 and $50,000 for
2008 were included in operating expenses. Depreciation and
amortization amounted to $326,000 for the three months ended September
30, 2009 and $322,000 for the three months ended September 30, 2008, of
which $307,000 for 2009 and $303,000 for 2008 were included in cost of
sales and $19,000 for 2009 and $19,000 for 2008 were included in operating
expenses.





Income from
operations. As a result of the factors described above, income from
operations amounted to $2,054,000 for the nine months ended September 30, 2009,
as compared to $4,529,000 for the nine months ended September 30, 2008, a
decrease of approximately $2,475,000 or 54.65%.  Incomefrom operations
amounted to $1,273,000 for the three months ended September 30, 2009, as
compared to $1,660,000 for the three months ended September 30, 2008, a
decrease of approximately $387,000, or 23.31%.





Other income
(expenses). Interest expense was $762,000 and $357,000 for the
nine and three months ended September 30, 2009, as compared with $413,000 and
$143,000 for the nine and three months ended September 30, 2008, reflecting both
increased borrowings and an increase in the interest rate.  We had
nominal interest income during the nine and three months ended September 30,
2009 and 2008. Other income, which consisted of government grants, was $545,000
and $19,000 for the nine months ended September 30, 2009 and 2008, respectively,
as compared with $225,000 and $11,000 for the nine months ended September 30,
2008.





Income tax.  During
the nine and three months ended September 30, 2009 and 2008, 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 income for the nine months ended
September 30, 2009 was $ 1,836,000 as compared to $4,330,000 for the nine
months ended September 30, 2008, a decrease of $2,494,000. Our net income for
the three months ended September 30, 2009 was $935,000, as compared to
$1,528,000 for the three months ended September 30, 2008, a decrease of
$593,000, or 38.81%.





Deemed preferred dividend. As
a result of the automatic conversion of our 3% convertible notes into shares of
series A preferred stock and warrants in January 2008, we incurred a preferred
stock deemed dividend of $854,300, representing the intrinsic value of the
beneficial conversion feature of the series A preferred stock resulting from the
warrant issuance. The deemed preferred stock dividend was a non-cash charge
which did not affect our operations or cash flow for the nine months ended
September 30, 2008.  There was no comparable item in the nine and
three months ended September 30, 2009 or the three months ended September 30,
2008.





28


Net income available to common
shareholders.  Net income available for common shareholders was
$1,836,000, or $0.13 per share (basic and diluted), for the nine months ended
September 30, 2009 and $3,476,000, or $0.27 per share (basic) and $0.18 per
share (diluted), for the nine months ended September 30, 2008. Net
income available for common shareholders was $935,000, or $0.06 per share (basic
and diluted), for the three months ended September 30, 2009 and $1,528,000, or
$0.13 per share (basic) and $0.08 per share (diluted), for the three months
ended September 30, 2008.





Liquidity
and Capital Resources





Liquidity
is the ability of a company to generate funds to support its current and future
operations, satisfy its obligations and otherwise operate on an ongoing
basis.  At September 30, 2009, we had a cash balance of $6,048,000,
almost all of which was in banks in China.





The
following table sets forth information as to the principal changes in the
components of our working capital from December 31, 2008 to September 30,
2009





All
amounts, other than percentages, in thousands of U.S. dollars





Category
            
            September
      30, 2009
            
            
            December
      31, 2008
            
            
            Change
            
            
            Percent
      ChangeCurrent
      assets:Cash
      and cash equivalents
            
            $
            6,047
            
            
            $
            52
            
            
            $
            5,995
            
            
            
            11,528.85
            %Trade
      accounts receivable
            
            
            6,202
            
            
            
            4,224
            
            
            
            1,978
            
            
            
            46.83
            %Notes
      receivable
            
            
            294
            
            
            
            28
            
            
            
            266
            
            
            
            950.00
            %Other
      receivables
            
            
            1,367
            
            
            
            151
            
            
            
            1,216
            
            
            
            805.30
            %Advances
      to suppliers
            
            
            655
            
            
            
            1,017
            
            
            
            (362)
            
            
            
            (35.59)
            %Advances
      to related party
            
            
            -
            
            
            
            291
            
            
            
            (291)
            
            
            
            *Prepaid
      expenses
            
            
            47
            
            
            
            -
            
            
            
            47
            
            
            
            *Inventories
            
            
            16,584
            
            
            
            15,890
            
            
            
            694
            
            
            
            4.37
            %Current
      liabilities:Accounts
      payable and accrued expenses
            
            
            2,176
            
            
            
            1,253
            
            
            
            923
            
            
            
            73.66
            %Advances
      from customers
            
            
            939
            
            
            
            640
            
            
            
            299
            
            
            
            46.72
            %Taxes
      payable
            
            
            148
            
            
            
            362
            
            
            
            (214)
            
            
            
            (59.12)
            %Trade
      notes payable
            
            
            5,850
            
            
            
            -
            
            
            
            5,850
            
            
            
            *Short
      term bank loan
            
            
            8,548
            
            
            
            4,888
            
            
            
            3,660
            
            
            
            74.88
            %Long
      term bank loan – current portion
            
            
            1,609
            
            
            
            1,897
            
            
            
            (288)
            
            
            
            (15.18)
            %Other
      payables
            
            
            1024
            
            
            
            551
            
            
            
            473
            
            
            
            85.84
            %Working
      capital:Total
      current assets
            
            
            31,197
            
            
            
            21,652
            
            
            
            9,545
            
            
            
            44.08
            %Total
      current liabilities
            
            
            20,295
            
            
            
            9,591
            
            
            
            10,704
            
            
            
            111.60
            %Working
      capital
            
            
            10,902
            
            
            
            12,061
            
            
            
            (1,159)
            
            
            
            (9.61)
            %




Our
working capital position decreased $1,159,000 to $10,902,000 at September
30, 2009 from a working capital of $12,061,000 at December 31,
2008.  Although our cash position increased significantly, by
$5,995,000 from December 31, 2008 to September 30, 2009, the increase was more
than offset by increases in current bank debt of $3,660,000, and trade notes
payable, which increased from zero to $5,850,000.   During the
nine months ended September 30, 2009, we were requested by certain of our
suppliers to settle trade liabilities incurred in the ordinary course of
business by the issuance of notes guaranteed by a bank.  We had no
comparable obligations at December 31, 2008.





29


We have
financed our operations principally through bank loans. At September 30, 2009,
we have short-term bank loans totaling $8,548,000 and long-term bank loan of
$3,803,000 outstanding.  Our short term bank loans, which are due in
June 2010, bear interest of 8.541% per annum as to $3,429,000 and 7,434% per
annum as to $5,119,000. The short term bank loans are secured by a security
interest on our fixed assets and land use rights.  A long-term bank
loan, in the amount of $3,803,000 is due October 9, 2011, and bears interest at
6.75% per annum. The current portion of the long term bank loan is $1,609,000.
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.





Although
our sales have decreased significantly in 2009, we believe that our working
capital, together with the cash flow from our ongoing business and our bank
financing will be sufficient to enable us to meet our normal cash requirements
for the next twelve months provided that:





•        We
generate sufficient business so that we are able to generate a profit, which
cannot be assured;





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





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





We will
require additional working capital if we are going to make any acquisitions or
to purchase equipment to expand our production capacity. Further, we expect that
both revenue and the results of our operations will continue to decline from the
comparable period of 2008 as a result of the effects of the global economic
downturn as discussed under “Overview.”  We cannot assure you that
funding will be available if and when we require funding.





Net cash
flow provided by operating activities was $7,274,000 for the nine
months ended September 30, 2009 as compared to $4,778,000 for the nine
months ended September 30, 2008, an increase of $2,496,000. Net cash flow
provided by operating activities in the nine months ended September 30, 2009 was
mainly due to our net income of $1,836,000 an increase in trade notes payable of
$5,847,000, an increase in accounts payable and accrued expenses of $1,693,000
and an increase in advance from customers of $297,000 offset by an increase of
accounts receivable of $1,966,000, other receivable of $1,215,000 and a decrease
in taxes payable of $215,000.





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 nine months ended
September 30, 2009, the inventory turnover slowed down slightly compared to
December 31, 2008 due to the decreased sales of graphite electrodes. Increased
production of fine grain and high purity graphite also contributed to the
increase in inventory because these products have a longer production
process.





Net cash
flow used in investing activities was $4,074,000 for the nine months ended
September 30, 2009, of which $1,439,000 was used to purchase properties and
equipments and $2,635,000 was used in constructing new
buildings.   Cash flow use in investing activities for the nine
months ended September 30, 2008 was $3,412,000.





Net cash
flow provided by financing activities was $2,690,000 for the nine months ended
September 30, 2009 as compared to net cash used in financing activities of
$1,535,000 for the nine months ended September 30, 2008. We received $68,000
from the private sale of common stock. We received $5,116,000 from bank loans
and repaid $2,785,000 of bank loan. In addition, we received repayment of
$291,000 from our former chief executive officer.





30


Contractual
Obligations and Off-Balance Sheet Arrangements





Contractual
Obligations





We have
certain fixed contractual obligations and commitments that include future
estimated payments. Changes in our business needs, cancellation provisions,
changing interest rates, and other factors may result in actual payments
differing from the estimates. We cannot provide certainty regarding the timing
and amounts of payments. We have presented below a summary of the most
significant assumptions used in our determination of amounts presented in the
tables, in order to assist in the review of this information within the context
of our consolidated financial position, results of operations, and cash
flows.





The
following tables summarize our contractual obligations as of September 30, 2009,
and the effect these obligations are expected to have on our liquidity and cash
flows in future periods (dollars in thousands).





Payments
      Due by PeriodTotal
            
            Less
      than 1 year
            
            1-3
      Years
            
            3-5Years
            
            5
      Years+Contractual
      Obligations :Bank
      indebtedness
            $
            12,351
            
            $
            10,157
            
            $
            2,194
            
            $
            -
            
            $
            -Notes
      payable
            
            5,850
            
            
            5,850
            
            
            -
            
            
            -
            
            
            -Total
      Contractual Obligations:
            $
            18,201
            
            $
            16,007
            
            $
            2,194
            
            $
            -
            
            $
            -





Off-balance
Sheet Arrangements





We have
not entered into any other financial guarantees or other commitments to
guarantee the payment obligations of any third parties. We have not entered into
any derivative contracts that are indexed to our shares and classified as
shareholder’s equity or that are not reflected in our consolidated financial
statements. Furthermore, we do not have any retained or contingent interest in
assets transferred to an unconsolidated entity that serves as credit, liquidity
or market risk support to such entity. We do not have any variable interest in
any unconsolidated entity that provides financing, liquidity, market risk or
credit support to us or engages in leasing, hedging or research and development
services with us.





We do not
use derivative financial instruments in our investment portfolio and we have no
foreign exchange contracts. Our financial instruments consist of cash and cash
equivalents, trade accounts receivable, accounts payable and long-term
obligations. We consider investments in highly liquid instruments purchased with
a remaining maturity of 90 days or less at the date of purchase to be cash
equivalents. However, in order to manage the foreign exchange risks, we may
engage in hedging activities to manage our financial exposure related to
currency exchange fluctuation. In these hedging activities, we might use
fixed-price, forward, futures, financial swaps and option contracts traded in
the over-the-counter markets or on exchanges, as well as long-term structured
transactions when feasible.





Interest Rates. Our exposure
to market risk for changes in interest rates relates primarily to our short-term
investments and short-term obligations; thus, fluctuations in interest rates
would not have a material impact on the fair value of these securities. At
September 30, 2009, we had $6,047,977 in cash and cash equivalents. A
hypothetical 2% increase or decrease in interest rates would not have a material
impact on our earnings or loss, or the fair market value or cash flows of these
instruments.





31


Foreign Exchange Rates. All
of our sales are denominated in Renminbi (“RMB”). As a result, changes in the
relative values of U.S. Dollars and RMB affect our reported levels of revenues
and profitability as the results are translated into U.S. Dollars for reporting
purposes. In particular, fluctuations in currency exchange rates could have a
significant impact on our financial stability due to a mismatch among various
foreign currency-denominated sales and costs. Fluctuations in exchange rates
between the U.S. dollar and RMB affect our gross and net profit margins and
could result in foreign exchange and operating losses.





Our
exposure to foreign exchange risk primarily relates to currency gains or losses
resulting from timing differences between signing of sales contracts and
settling of these contracts. Furthermore, we translate monetary assets and
liabilities denominated in other currencies into RMB, the functional currency of
our operating business. Our results of operations and cash flow are translated
at average exchange rates during the period, and assets and liabilities are
translated at the unified exchange rate as quoted by the People’s Bank of China
at the end of the period. Translation adjustments resulting from this process
are included in accumulated other comprehensive income in our statement of
shareholders’ equity. We have not used any forward contracts, currency options
or borrowings to hedge our exposure to foreign currency exchange risk. We cannot
predict the impact of future exchange rate fluctuations on our results of
operations and may incur net foreign currency losses in the future. As our sales
denominated in foreign currencies, such as RMB and Euros, continue to grow, we
will consider using arrangements to hedge our exposure to foreign currency
exchange risk.





Our
financial statements are expressed in U.S. dollars but the functional
currency of our operating subsidiary is RMB. The value of your investment in our
stock will be affected by the foreign exchange rate between U.S. dollars
and RMB. To the extent we hold assets denominated in U.S. dollars,
including the net proceeds to us from this offering, any appreciation of
the RMB against the U.S. dollar could result in a change to our statement
of operations and a reduction in the value of our U.S. dollar denominated
assets. On the other hand, a decline in the value of RMB against the
U.S. dollar could reduce the U.S. dollar equivalent amounts of our
financial results, the value of your investment in our company and the dividends
we may pay in the future, if any, all of which may have a material adverse
effect on the price of our stock.





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 September 30,
2009.





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 described below, our disclosure controls and procedures were not
effective as of September 30, 2009.





32


Management’s
Report of Internal Control over Financial Reporting.





Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f)
under the Securities Exchange Act.  Our management is also required to
assess and report on the effectiveness of our internal control over financial
reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002
(“Section 404”).  Management assessed the effectiveness of our
internal control over financial reporting as of September 30, 2009.  In
making this assessment, we used the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO) in Internal
Control - Integrated Framework.  During our assessment of the effectiveness
of internal control over financial reporting as of September 30, 2009,
management identified significant deficiencies related to (i) the U.S. GAAP
expertise of our internal accounting staff, (ii) our internal audit functions
and, and (iii) a lack of segregation of duties within accounting
functions. However, management believes that these deficiencies do not
amount to a material weakness. Therefore, our internal control over financial
reporting was effective as of September 30, 2009.





A material weakness (within the meaning
of PCAOB Auditing Standard No. 5) is a deficiency, or a combination of
deficiencies, in internal control over financial reporting, such that there is a
reasonable possibility that a material misstatement of our annual or interim
financial statements will not be prevented or detected on a timely basis. A
significant deficiency is a deficiency, or a combination of deficiencies, in
internal control over financial reporting that is less severe than a material
weakness, yet important enough to merit attention by those responsible for
oversight of the company's financial reporting.





We became
a reporting company in December 2007.  Prior to December 2007, our
operations were conducted by Xingyong, which is a company organized under the
laws of the PRC and owned by our former chief executive officer. We began
preparing to be in compliance with the internal control obligations, including
Section 404, for our fiscal year ending December 31, 2007. During almost all of
2007 our internal accounting staff was primarily engaged in ensuring compliance
with PRC accounting and reporting requirements for our operating affiliates and
was not required to meet or apply U.S. GAAP requirements.  As a result,
with the exception of certain additional persons hired at the end of 2007
to address these deficiencies, our current internal accounting department
responsible for financial reporting of the Company, on a consolidated basis, is
relatively new to U.S. GAAP and the related internal control procedures required
of U.S. public companies. Although our accounting staff is professional and
experienced in accounting requirements and procedures generally accepted in the
PRC, management has determined that they require additional training and
assistance in US GAAP matters.  Management has determined that our internal
audit function is also significantly deficient due to insufficient qualified
resources to perform internal audit functions.  Finally, management
determined that the lack of an Audit Committee of the board of directors of the
Company also contributed to insufficient oversight of our accounting and audit
functions.





In order
to correct the foregoing deficiencies, we are seeking to engage an experienced
accountant or firm to assist us in establishing procedures that will enable us
to have, on an ongoing basis, personnel who understand US GAAP and the
disclosure obligations under the Securities Exchange Act. We are committed to
the establishment of effective internal audit functions, however, due to the
scarcity of qualified candidates with extensive experience in US GAAP reporting
and accounting in the region, we were not able to hire sufficient internal audit
resources in order to enable us to have such procedures and controls established
by September 30, 2009.





We also
intend to elect additional directors, who will be independent and one of whom
could serve as the audit committee financial expert. We believe that the
appointment of such directors will strongly influence our management in
establishing the necessary controls.





However,
due to our size and nature, the segregation of all conflicting duties may not
always be possible and may not be economically feasible.  However, to
the extent possible, we will implement procedures to assure that the initiation
of transactions, the custody of assets and the recording of transactions will be
performed by separate individuals.





33


We
believe that the foregoing steps will remediate the significant deficiency
identified above, and we will continue to monitor the effectiveness of these
steps and make any changes that our management deems appropriate.





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.





On
October 12, 2009, we issued an aggregate of 750,000 shares of common stock to
two investors pursuant to subscription agreements dated as of July 30, 2009. We
sold 493,760 shares at $.75 per share and 256,240 shares at $1.00 per share.The issuance of these securities was exempt
from registration under Regulation S of he Securities and Exchange Commission
under the Securities Act.  The investors are not “U.S. persons” as
that term is defined in Rule 902(k) of Regulation S under the Act, and that such
investor was acquiring our common stock, for investment purposes for their own
respective accounts and not as nominees or agents, and not with a view to the
resale or distribution thereof.





Pursuant
to agreements with two newly-elected independent directors, we issued 25,000
shares of common stock to each of these directors on November 5,
2009.  On November 5, 2009, we issued 20,000 shares to each of our
chief executive officer and our chief financial officer.  The issuance
of these shares was exempt from registration pursuant to Section 4(2) of the
Securities Act and Regulation 506 of the SEC thereunder.





Pursuant
to a consulting agreement dated October 15, 2009, with FirsTrust China Ltd., on
October 27, 2009, we issued to FirsTrust five year warrants to purchase 100,000
shares of common stock at $2.00 per share and 100,000 shares of common stock at
$3.00 per share.  The issuance of these shares was exempt from
registration pursuant to Section 4(2) of the Securities Act and Regulation 506
of the SEC thereunder.





Pursuant
to an agreement dated July 22, 2009, with Ventana Capital Partners, we issued to
Ventana 375,000 shares of common stock.  The issuance of these shares
was exempt from registration pursuant to Section 4(2) of the Securities Act and
Regulation 506 of the SEC thereunder.





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


34


SIGNATURES





In
accordance with the requirements of the Exchange Act, the registrant caused this
report to be signed on its behalf by the undersigned, thereunto duly
authorized.





CHINA
      CARBON GRAPHITE GROUP, INC.Date:
      November 16 , 2009
            By:
            /s/ Donghai
      YuDonghai
      YuChief
      Executive Officer





Date:
      November 16, 2009
            By:
            /s/ Ting
      ChenTing
      ChenChief
      Financial Officer