UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 
WASHINGTON, D.C. 20549
 
FORM 10-K
(Mark One)
 
x
ANNUAL REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2013
Or
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ____________ to ____________
 
Commission File Number: 000-33123
 
CHINA AUTOMOTIVE SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
 
Delaware
 
33-0885775
(State or other jurisdiction of incorporation or
 
(I.R.S. Employer Identification No.)
organization)
 
 
 
 
 
No. 1 Henglong Road, Yu Qiao Development Zone
 
 
Shashi District, Jing Zhou City Hubei Province
 
 
The People’s Republic of China
 
434000
(Address of principal executive offices)
 
(Zip Code)
 
Registrant’s telephone number, including area code – (86) 716-412-7901
 
Securities registered pursuant to Section 12(b) of the Act:
 
Title of each Class
 
Name of each exchange on which registered
Common Stock, $0.0001 par value 
 
The Nasdaq Capital Market 
 
Securities registered pursuant to Section 12(g) of the Act:
 
 
Title of Class
 
 
None
 
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
 
Yes  ¨              No  x
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.
 
Yes  ¨             No  x
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes  x              No  ¨
 
Indicate by check mark 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  x              No ¨
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
 
Large Accelerated Filer
¨
Accelerated Filer
¨
 
Non-Accelerated Filer
¨
Smaller Reporting Company
x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes  ¨             No  x
 
The aggregate market value of voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2013, based upon the price of $5.15 that was the closing price of the common stock as reported on the NASDAQ Stock Market under the symbol “CAAS” on such date, was approximately $41.5 million.
 
The Company has 28,043,019 shares of Common Stock outstanding as of March 31, 2014.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
None.
 
 
 
CHINA AUTOMOTIVE SYSTEMS, INC.
 
FORM 10-K
 
INDEX
 
 
 
Page
PART I
 
 
 
Item 1.
Business.
 
4
Item 1A.
Risk Factors.
 
10
Item 1B.
Unresolved Staff Comments.
 
21
Item 2.
Properties.
 
22
Item 3.
Legal Proceedings.
 
22
Item 4.
Mine Safety Disclosures.
 
23
 
 
 
 
PART II
 
 
 
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
 
24
Item 6.
Selected Financial Data.
 
25
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
25
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk.
 
41
Item 8.
Financial Statements and Supplementary Data.
 
42
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
 
43
Item 9A.
Controls and Procedures.
 
43
Item 9B.
Other Information.
 
46
 
 
 
 
PART III
 
 
 
Item 10.
Directors, Executive Officers and Corporate Governance.
 
47
Item 11
Executive Compensation.
 
50
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
 
52
Item 13.
Certain Relationships and Related Transactions, and Director Independence.
 
53
Item 14.
Principal Accounting Fees and Services.
 
53
 
 
 
 
PART IV
 
 
 
Item 15.
Exhibits, Financial Statement Schedules.
 
55
 
 
 
 
Signatures
 
57
Financial Statements
 
59
 
 
2

 
Cautionary Statement
 
This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. These statements relate to future events or the Company’s future financial performance. The Company has attempted to identify forward-looking statements by terminology including “anticipates,” “believes,” “expects,” “can,” “continues,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “should” or “will” or the negative of these terms or other comparable terminology. Such statements are subject to certain risks and uncertainties, including the matters set forth in this Annual Report or other reports or documents the Company files with the Securities and Exchange Commission, the “SEC,” from time to time, which could cause actual results or outcomes to differ materially from those projected. Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, the Company cannot guarantee future results, levels of activity, performance or achievements. Undue reliance should not be placed on these forward-looking statements which speak only as of the date hereof. The Company’s expectations are as of the date this Form 10-K is filed, and the Company does not intend to update any of the forward-looking statements after the date this Annual Report on Form 10-K is filed to confirm these statements to actual results, unless required by law.
 
 
3

 
PART I
 
ITEM 1.     BUSINESS.
 
COMPANY HISTORY
 
China Automotive Systems, Inc., “China Automotive” or the “Company,” was incorporated in the State of Delaware on June 29, 1999 under the name Visions-In-Glass, Inc. On or around March 5, 2003, the Company acquired all of the issued and outstanding equity interests of Great Genesis Holdings Limited, “Genesis,” a corporation organized under the laws of the Hong Kong Special Administrative Region, China, by issuance of 20,914,250 shares of common stock to certain sellers. After the acquisition, the Company continued the operations of Genesis. On May 19, 2003, the Company changed its name from Visions-In-Glass, Inc. to China Automotive Systems, Inc. Currently, Genesis directly and indirectly owns interests in nine Sino-joint ventures and a wholly owned subsidiary in the People’s Republic of China, “China” or the “PRC,” which manufacture power steering systems and/or related products for different segments of the automobile industry. Genesis also owns interests in a Brazil-based trading company, which engages mainly in the import and sales of automotive parts in Brazil.
 
Unless the context indicates otherwise, the Company uses the terms “the Company,” “we,” “our” and “us” to refer to Genesis and China Automotive collectively on a consolidated basis.
 
BUSINESS OVERVIEW
 
The Company is a holding company and has no significant business operations or assets other than its interest in Genesis. Genesis mainly engages in the manufacture and sale of automotive systems and components through its controlled subsidiaries and the joint ventures, as described below.
 
Set forth below is an organizational chart as at December 31, 2013.
 
China Automotive Systems, Inc. [NASDAQ:CAAS]
100%
 
 
 
100%
Great Genesis Holdings Limited
 
 
 
Henglong USA Corporation
 
 
 
 
 
 
100.00%
 
 
 
 
 
 
70%
Hubei
 
 
 
 
 
 
Shenyang Jinbei
Henglong
 
 
 
 
 
 
Henglong
Automotive
 
 
 
 
 
 
Automotive
System Group
 
 
 
 
 
 
Steering System
Co., Ltd.
 
 
 
 
 
 
Co., Ltd.
Hubei
Henglong
1
 
 
 
 
 
 
Shenyang2
 
 
 
 
 
 
 
80%
81%
83.34%
77.33%
85%
50.00%
70%
80.00%
Jingzhou
Shashi
Universal
Wuhu
Wuhan
Beijing
Chongqing
CAAS
Henglong
Jiulong
Sensor
Henglong
Jielong
Henglong
Henglong
Brazil’s
Automotive
Power
Application,
Automotive
Electric
Automotive
Hongyan
Imports And
Parts Co.,
Steering
Inc.
Steering
Power
System Co.,
Automotive
Trade In
Ltd.
Gears
 
System Co.,
Steering Co.,
Ltd.,
System
Automotive
Henglong3
Co., Ltd.
USAI5
Ltd.
Ltd
Beijing
Co., Ltd
Parts Ltd.,
 
Jiulong4
 
Wuhu6
Jielong7
Henglong8
Chongqing Henglong9
Brazil
80.00%
 
 
 
 
 
 
Henglong10
Jingzhou
 
 
 
 
 
 
 
Henglong
 
 
 
 
 
 
 
Automotive
 
 
 
 
 
 
 
Technology
(Testing)
 
 
 
 
 
 
 
Center
 
 
 
 
 
 
 
Testing
 
 
 
 
 
 
 
Center11
 
 
 
 
 
 
 
 
 
4

 
1.
On March 7, 2007, Genesis established Hubei Henglong (formerly known as Jingzhou Hengsheng Automotive System Co., Ltd.), its wholly-owned subsidiary, to engage in the production and sales of automotive steering systems. The registered capital of Hubei Henglong at the time of establishment was $10 million. On February 10, 2010, the registered capital of Hubei Henglong was increased to $16 million. On October 12, 2011, the board of directors of the Company approved a reorganization of the Company’s subsidiaries operating in China. As a result of the reorganization, all of Genesis’s equity interests of its subsidiaries operating in China, except for Shenyang, were transferred to Hubei Henglong, the Company’s new China-based holding company. The reorganization was completed on January 19, 2012, subsequent to which the registered capital of Hubei Henglong was increased to $39.0 million. As the reorganized entities were under common control of the Company, the reorganization did not have any impact on the Company’s consolidated financial position or results of operations and should not impact the tax treatment of the Company or its subsidiaries in any material respect. On July 8, 2012, Hubei Henglong changed its name to Hubei Henglong Automotive System Group Co., Ltd.
 
 
2.
Shenyang was established in 2002 and focuses on power steering parts for light duty vehicles.
 
 
3.
Henglong was established in 1997 and mainly engages in the production of rack and pinion power steering gear for cars and light-duty vehicles.
 
 
4.
Jiulong was established in 1993 and mainly engages in the production of integral power steering gear for heavy-duty vehicles.
 
 
5.
USAI was established in 2005 and mainly engages in the production and sales of sensor modules.
 
 
6.
Wuhu was established in 2006 and mainly engages in the production and sales of automobile steering systems.
 
   
7.
Jielong was established in 2006 and mainly engages in the production and sales of electric power steering, “EPS.”
 
 
8.
Beijing Henglong was established in 2010 and mainly engages in the design, development and manufacture of both hydraulic and electric power steering systems and parts. According to the joint venture agreement, the Company does not have voting control of Beijing Henglong. Therefore, the Company’s consolidated financial statements do not include Beijing Henglong, and such investment is accounted for by the equity accounting method.
 
   
9.
On February 21, 2012, Hubei Henglong and SAIC-IVECO Hongyan Company, “SAIC-IVECO,” established a Sino-foreign joint venture company, Chongqing Henglong, to design, develop and manufacture both hydraulic and electric power steering systems and parts. The new joint venture is located in Chongqing City and has a registered capital of RMB60 million, of which RMB42 million, or 70%, is held by Hubei Henglong. The registered capital of Chongqing Henglong was fully contributed by Hubei Henglong in cash of $6.7 million (equivalent to RMB42 million) in January and February 2012 and by SAIC-IVECO in property, plant and equipment with a fair value of $2.8 million (equivalent to RMB18.0 million) in April 2012.
 
 
10.
On August 21, 2012, Hubei Henglong established a Sino-foreign joint venture company with two Brazilian citizens, Ozias Gaia Da Silva and Ademir Dal’ Evedove. The joint-venture company, Brazil Henglong, engages mainly in the import and sales of automotive parts in Brazil. The new joint venture is located in Brazil and has a registered capital of $1.0 million (equivalent to BRL1.6 million), of which $0.8 million (equivalent to BRL1.3 million), or 80%, is held by Hubei Henglong, and of which $0.2 million (equivalent to BRL0.3 million), or 20%, is held by Mr. Ozias Gaia Da Silva and Mr. Ademir Dal’ Evedove. As of December 31, 2012, Hubei Henglong and Mr. Ozias Gaia Da Silva and Mr. Ademir Dal’ Evedove have completed their capital contributions.
 
 
11.
Testing Center was established in 2009 and mainly engages in the research and development of new products.
 
 
5

 
The Company has business relationships with more than sixty vehicle manufacturers, including FAW Group and Dongfeng Auto Group Co., Ltd, two of the five largest automobile manufacturers in China; Shenyang Brilliance Jinbei Co., Ltd., the largest light vehicle manufacturer in China; Chery Automobile Co., Ltd, the largest state owned car manufacturer in China, and BYD Auto Co., Ltd and Zhejiang Geely Automobile Co., Ltd., the largest privately owned car manufacturers in China. The PRC-based joint ventures of General Motors (GM), Volkswagen, Citroen and Chrysler North America are all key customers of the Company. Starting in 2008, the Company has supplied power steering pumps and power steering gear to the Sino-foreign joint ventures established by GM, Citroen and Volkswagen in China. The Company has supplied power steering gear to Chrysler North America since 2009.
 
INTELLECTUAL PROPERTY RIGHTS
 
 Intellectual Property rights, “IP,” are important in helping the Company maintain its competitive position. Currently, the Company owns IP rights, including two trademarks covering automobile parts, “HL” and “JL,” and more than eighty-five patents registered in China covering power steering technology. The Company is in the process of integrating new advanced technologies such as electronic chips in power steering systems into its current production line and is pursuing aggressive strategies in technology to maintain a competitive edge within the automobile industry. In December 2009, the Company, through Henglong, formed Testing Center and cooperated with Nanyang Ind. Co. Ltd. and Tsinghua University to engage in the research and development of new products, such as EPS, integral rack and pinion power steering and high pressure power steering, to optimize current products design and to develop new, cost-saving manufacturing processes.
 
STRATEGIC PLAN
 
The Company’s short to medium term strategic plan is to focus on both domestic and international market expansion. To achieve this goal and higher profitability, the Company focuses on brand recognition, quality control, decreasing costs, research and development and strategic acquisitions. Set forth below are the Company’s programs:
 
Brand Recognition. Under the brands of Henglong and Jiulong, the Company offers four separate series of power steering sets and 310 models of power steering sets, steering columns and steering hoses.
 
Quality Control. The Henglong and Jiulong manufacturing facilities obtained the ISO/TS 16949 System Certification in January 2004, a well-recognized quality control system in the auto industry developed by TUVRheindland of Germany.
 
Decreasing Cost. By improving the Company’s production ability and enhancing equipment management, optimizing the process and products structure, perfecting the supplier system and cutting production cost, the Company’s goal is to achieve a more competitive profit margin.
 
Research and Development. The Company established Testing Center for the research and development of products and, by partnering with Nanyang Ind. Co. Ltd. and Tsinghua University for the development of advanced steering systems, the Company’s objective is to gain increased market share in China.
 
International Expansion. The Company has entered into agreements with several international vehicle manufacturers and auto parts modules suppliers and carried on preliminary negotiations regarding future development projects.
 
Acquisitions. The Company is exploring opportunities to create long-term growth through new ventures or acquisitions of other auto component manufacturers. The Company will seek acquisition targets that meet the following criteria:
 
· companies that can be easily integrated into product manufacturing and corporate management;
 
· companies that have strong joint venture partners that would become major customers; and
  
· companies involved with power steering systems.
 
 
6

 
CUSTOMERS
 
The Company’s ten largest customers represented 71.9% of the Company’s total sales for the year ended December 31, 2013. The following table sets forth information regarding the Company’s ten largest customers.
 
 
 
Percentage of Total
 
Name of Major Customers
 
Revenue in 2013
 
Chrysler North America
 
 
11.1
%
SAIC GM Wuling Automobile Co.
 
 
8.9
%
Zhejiang Geely Holding Group
 
 
7.8
%
Baoding Great Wall Automobile Holding Co., Ltd.
 
 
7.7
%
Shengyang Brilliance Jinbei Automobile Co., Ltd.
 
 
7.3
%
BYD Auto Co., Ltd
 
 
6.8
%
Beiqi Foton
 
 
6.5
%
Dongfeng Auto Group Co., Ltd.
 
 
6.3
%
China FAW Group Corporation
 
 
4.8
%
Chery Automobile Co., Ltd.
 
 
4.7
%
Total
 
 
71.9
%
 
The Company primarily sells its products to the above-mentioned original equipment manufacturing, “OEM,” customers; it also has excellent relationships with them, including serving as their first-rank supplier and developer for product development for new models. While the Company intends to continue to focus on retaining and winning this business, it cannot ensure that it will succeed in doing so. It is difficult to keep doing business with the above-mentioned OEM customers as a result of severe price competition and customers’ diversification of their supply base. The Company’s business would be materially and adversely affected if it loses one or more of these major customers.
 
SALES AND MARKETING
 
The Company’s sales and marketing team has 106 sales persons, which are divided into an OEM team, a sales service team and a working group dedicated to international business. These sales and marketing teams provide a constant interface with the Company’s key customers. They are located in all major vehicle producing regions to represent more effectively the Company’s customers’ interests within the Company’s organization, to promote their programs and to coordinate their strategies with the goal of enhancing overall service and satisfaction. The Company’s ability to support its customers is further enhanced by its broad presence in terms of sales offices, manufacturing facilities, engineering technology centers and joint ventures.
 
The Company’s sales and marketing organization and activities are designed to create overall awareness and consideration of, and therefore to increase sales of, the Company’s modular systems and components. To achieve that objective, the Company organized delegations to visit the United States, Korea, India and Japan and has supplied power steering gear to Chrysler North America. Through these activities, the Company has generated potential business interest as a strong base for future development.
 
DISTRIBUTION
 
The Company’s distribution system covers all of China. The Company has established sales and service offices with certain significant customers to deal with matters related to such customers in a timely fashion. The Company also established distribution warehouses close to major customers to ensure timely deliveries. The Company maintains strict control over inventories. Each of these sales and service offices sends back to the Company through e-mail or fax information related to the inventory and customers’ needs. The Company guarantees product delivery in 8 hours for those customers who are located within 200 km from the Company’s distribution warehouses, and 24 hours for customers who are located outside of 200 km from the Company’s distribution warehouses. Delivery time is a very important competitive factor in terms of customer decision making, together with quality, pricing and long-term relationships.
 
 
7

 
EMPLOYEES AND FACILITIES
 
As of December 31, 2013, the Company employed approximately 3,835 persons, including approximately:
 
· 2,566 by Henglong (including Testing Center formed by Henglong) and Jiulong;
· 306 by Shenyang;
· 28 by USAI;
· 143 by Wuhu;
· 238 by Jielong;
· 412 by Hubei Henglong;
· 12 by HLUSA;
· 125 by Chongqing Henglong; and
· 5 by Brazil Henglong.
 
As of December 31, 2013, each of Henglong and Jiulong (as a whole), Shenyang, Wuhu, Jielong and Hubei Henglong (as a whole), and Chongqing Henglong had a manufacturing and administration area of 150,689 square meters, 35,354 square meters, 83,750 square meters, 170,520 square meters and 17,188 square meters, respectively. The area of manufacturing facilities of Henglong was reduced due to the sale of the land use right of Henglong in the third quarter of 2013 (see Notes 9 and 20 to the consolidated financial statements in this Report).
 
Hubei Province, which is home to Dongfeng, one of the largest automakers in China, provides an ample supply of inexpensive but skilled labor to automotive-related industries. The annual production of one of the Company’s main products, power steering gear, was approximately 4.3 million units and 3.5 million units in 2013 and 2012, respectively. Although the production process continues to rely heavily on manual labor, the Company has invested substantially in high-level production machinery to improve capacity and production quality. Approximately $48.6 million was spent over the last three years to purchase professional-grade equipment and extend workshops, approximately 77.9% of which has been used in the production process as of December 31, 2013.
 
RAW MATERIALS
 
The Company purchases various manufactured components and raw materials for use in its manufacturing processes. The principal components and raw materials the Company purchases include castings, finished sub-components, aluminum, steel, fabricated metal electronic parts and molded plastic parts. The most important raw material is steel. The Company enters into purchase agreements with local suppliers. The annual purchase plans are determined at the beginning of the calendar year but are subject to revision every three months as a result of customers’ orders. A purchase order is made according to monthly production plans. This protects the Company from building up inventory when the orders from customers change.
 
The Company’s purchases from its ten largest suppliers represented in the aggregate 24.0% of all components and raw materials it purchased for the year ended December 31, 2013, and none of them provided more than 10% of total purchases.
 
All components and raw materials are available from numerous sources. The Company has not, in recent years, experienced any significant shortages of manufactured components or raw materials and normally does not carry inventories of these items in excess of what is reasonably required to meet its production and shipping schedules.
 
RESEARCH AND DEVELOPMENT
 
The Company owns the Testing Center, a Hubei Provincial-Level technical center, which has been approved by the Hubei Economic Commission. The center has a staff of about 306, including 35 senior engineers, 6 foreign experts and 195 engineers, primarily focusing on steering system R&D, tests, production process improvement and new material and production methodology application.
 
 
8

 
In addition, the Company has partnered with Tsinghua University to establish a steering system research center, called Tsinghua Henglong Automobile Steering Research Institute, for the purposes of R&D and experimentation for EPS.
 
The Company believes that its engineering and technical expertise, together with its emphasis on continuing research and development, allow it to use the latest technologies, materials and processes to solve problems for its customers and to bring new, innovative products to market. The Company believes that continued research and development activities, including engineering, are critical to maintaining its pipeline of technologically advanced products. The Company has aggressively managed costs in other portions of its business in order to increase its total expenditures for research and development activities, including engineering, at approximately $20.9 million, $14.9 million for the years ended December 31, 2013 and 2012, respectively. The significant increase in 2013 is mainly due to the large expenditure in EPS R&D, because the Company believes demands for new EPS products will increase significantly in the future. In 2012 and 2013, the sales of such newly developed products accounted for about 13.4% and 9.3%, respectively, of total sales.
 
COMPETITION
 
The automotive components industry is extremely competitive. The Company’s customers consider criteria including quality, price/cost competitiveness, system and product performance, reliability and timeliness of delivery, new product and technology development capability, excellence and flexibility in operations, degree of global and local presence, effectiveness of customer service and overall management capability. The power steering system market is fragmented in China, and the Company has seven major competitors. Of these competitors, two are Sino-foreign joint ventures while the other five are state-owned. Like many competitive industries, there is pressure on downward selling prices.
 
The Company’s major competitors, including Shanghai ZF and First Auto FKS, “FKS,” are component suppliers to specific automobile manufacturers. Shanghai ZF is the joint venture of SAIC and ZF Germany, which is an exclusive supplier to SAIC-Volkswagen and SAIC-GM. FKS is a joint venture between First Auto Group and Japan’s Koyo Company and its main customer is FAW-Volkswagen Company.
 
While the Chinese government limits foreign ownership of auto assemblers to 50%, there is no analogous limitation in the automotive components industry. Thus, opportunities exist for foreign component suppliers to set up factories in China. These overseas competitors employ technology that may be more advanced and may have existing relationships with global automobile assemblers, but they are generally not as competitive as the Company in China in terms of production cost and flexibility in meeting client requirements.
 
CHINESE AUTOMOBILE INDUSTRY
 
The Company is a supplier of automotive parts and most of its operations are located in China. An increase or decrease in the output and sales of Chinese vehicles could result in an increase or decrease of the Company’s results of operations. According to the latest statistics from the China Association of Automobile Manufacturers, “CAAM,” in 2013, the output and sales volume of vehicles in China have reached 22.12 million and 21.98 million units, respectively, an increase of 14.8% and 13.9% compared to 2012. The output and sales volume of passenger vehicles in 2013 was 18.09 million and 17.93 million units respectively, an increase of 16.5% and 15.7% compared to 2012. The output and sales volume of commercial vehicles in 2013 was 4.03 million and 4.06 million units, respectively, an increase of 7.6% and 6.4% compared to 2012. Accordingly, in 2013, the Company’s sales of steering gear for passenger vehicles and commercial vehicles increased by 23.9% and 11.0%, respectively, compared to 2012.
 
With the recovery of the overall economy of China and the continued increase in the income of China’s urban and rural residents, the automobile industry had double-digit growth in 2013. Industry analysts expect that market growth will continue in 2014 at an annual rate of about 8% to 10%.
 
Management believes that the continuing development of the highway system will have a significant positive long-term impact on the manufacture and sale of private automobiles in the PRC. Statistics from the Ministry of Transport show that 100,000 kilometers of highway and 8,000 kilometers of expressway were built in 2013. Total highways and expressways in the PRC now amount to 4,242,000 kilometers and 104,000 kilometers, respectively.
 
 
9

 
ENVIRONMENTAL COMPLIANCE
 
The Company is subject to the requirements of U.S. federal, state, local and non-U.S., including China’s, environmental and occupational safety and health laws and regulations. These include laws regulating air emissions, water discharge and waste management. The Company has an environmental management structure designed to facilitate and support its compliance with these requirements globally. Although the Company intends to comply with all such requirements and regulations, it cannot provide assurance that it is at all times in compliance. The Company has made and will continue to make capital and other expenditures to comply with environmental requirements, although such expenditures were not material during the past two years. Environmental requirements are complex, change frequently and have tended to become more stringent over time. Accordingly, the Company cannot assure that environmental requirements will not change or become more stringent over time or that its eventual environmental cleanup costs and liabilities will not be material.
 
During 2013, the Company did not make any material capital expenditures relating to environmental compliance.
 
FINANCIAL INFORMATION AND GEOGRAPHIC AREAS
 
Financial information about sales and long-term assets by major geographic region can be found in Note 32, “Segment Reporting” to the consolidated financial statements in this Report. The following table summarizes the percentage of sales and total assets by major geographic regions:
 
 
 
Net Sales
 
 
Long-term assets
 
 
 
Year Ended December 31,
 
 
As of December 31
 
 
 
2013
 
 
2012
 
 
2013
 
 
2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Geographic region:
 
 
 
 
 
 
 
 
 
 
 
 
United States
 
12.11
%
 
12.94
%
 
0.93
%
 
0.81
%
China
 
87.65
 
 
86.57
 
 
99.06
 
 
99.17
 
Other foreign countries
 
0.24
 
 
0.49
 
 
0.01
 
 
0.02
 
Total consolidated
 
100.00
%
 
100.00
%
 
100.00
%
 
100.00
%
 
WEBSITE ACCESS TO SEC FILINGS
 
The Company files electronically with (or furnishes to) the SEC its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports pursuant to Section 13(a) of the Securities Exchange Act of 1934. The Company makes available free of charge on its web site (www.caasauto.com) all such reports as soon as reasonably practicable after they are filed.
 
The SEC maintains an Internet site that contains reports, proxy information and information statements, and other information regarding issuers that file electronically with the SEC. The address of that website is http://www.sec.gov. The materials are also available at the SEC’s Public Reference Room, located at 100 F Street N.E., Washington, D.C. 20549. The public may obtain information through the public reference room by calling the SEC at 1-800-SEC-0330.
 
ITEM 1A. RISK FACTORS.
 
Any investment in the Company’s securities involves a high degree of risk. You should carefully consider the risks described below, together with the information contained elsewhere in this Annual Report, before you make a decision to invest in the Company. The Company’s business, financial conditions and results of operations could be materially and adversely affected by many risk factors. Because of these risk factors, actual results might differ significantly from those projected in any forward-looking statements. Factors that might cause such differences include, among others, the following:
 
 
10

 
RISKS RELATED TO THE COMPANY’S BUSINESS AND INDUSTRY
 
The cyclical nature of automotive production and sales could result in a reduction in automotive sales, which could adversely affect the Company’s business and results of operations.
 
The Company’s business relies on automotive vehicle production and sales by its customers, which are highly cyclical and depend on general economic conditions and other factors, including consumer spending and preferences and the price and availability of gasoline. They also can be affected by labor relations issues, regulatory requirements and other factors. In the last two years, the price of automobiles in China has generally declined. Additionally, the volume of automotive production in China has fluctuated from year to year, which gives rise to fluctuations in the demand for the Company’s products. Therefore, any significant economic decline could result in a reduction in automotive production and sales by the Company’s customers and could have a material adverse effect on the Company’s results of operations. Moreover, if the prices of automobiles keep declining, the selling price of automotive parts also would decrease, which would result in lower revenues and profitability.
 
Increasing costs for manufactured components and raw materials may adversely affect the Company’s profitability.
 
The Company uses a broad range of manufactured components and raw materials in its products, including castings, electronic components, finished sub-components, molded plastic parts, fabricated metal, aluminum and steel and resins. Because it may be difficult to pass increased prices for these items on to the Company’s customers, a significant increase in the prices of the Company’s components and materials could materially increase the Company’s operating costs and adversely affect its profit margins and profitability.
 
Because the Company is a holding company with substantially all of its operations conducted through its subsidiaries, its performance will be affected by the performance of its subsidiaries.
 
The Company almost has no operations independent of those of Genesis and its subsidiaries, and the Company’s principal assets are its investments in Genesis and its subsidiaries and affiliates. As a result, the Company is dependent upon the performance of Genesis and its subsidiaries and will be subject to the financial, business and other factors affecting Genesis as well as general economic and financial conditions. As substantially all of the Company’s operations are and will be conducted through its subsidiaries, the Company will be dependent on the cash flow of its subsidiaries to meet its obligations.
 
Because virtually all of the Company’s assets are and will be held by operating subsidiaries, the claims of the Company’s stockholders will be structurally subordinate to all existing and future liabilities and obligations, and trade payables of such subsidiaries. In the event of the Company’s bankruptcy, liquidation or reorganization, its assets and those of its subsidiaries will be available to satisfy the claims of the Company’s stockholders only after all of its and its subsidiaries’ liabilities and obligations have been paid in full.
 
With the automobile parts markets being highly competitive and many of the Company’s competitors having greater resources than it does, the Company may not be able to compete successfully.
 
The automobile parts industry is a highly competitive business. The Company’s customers consider criteria including:
 
 
·
quality;
 
·
price/cost competitiveness;
 
·
system and product performance;
 
·
reliability and timeliness of delivery;
 
·
new product and technology development capability;
 
·
excellence and flexibility in operations;
 
·
degree of global and local presence;
 
·
effectiveness of customer service; and
 
·
overall management capability.
 
 
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The Company’s competitors include independent suppliers of parts, as well as suppliers formed by spin-offs from the Company’s customers, who are becoming more aggressive in selling parts to other vehicle manufacturers. Depending on the particular product, the number of the Company’s competitors varies significantly. Many of the Company’s competitors have substantially greater revenues and financial resources than it does, as well as stronger brand names, consumer recognition, business relationships with vehicle manufacturers, and geographic presence than it has. The Company may not be able to compete favorably and increased competition may substantially harm its business, business prospects and results of operations.
 
Internationally, the Company faces different market dynamics and competition. The Company may not be as successful as its competitors in generating revenues in international markets due to the lack of recognition of its products or other factors. Developing product recognition overseas is expensive and time-consuming and the Company’s international expansion efforts may be more costly and less profitable than it expects. If the Company is not successful in its target markets, its sales could decline, its margins could be negatively impacted and it could lose market share, any of which could materially harm the Company’s business, results of operations and profitability.
 
Pricing pressure by automobile manufacturers on their suppliers may adversely affect the Company’s business and results of operations.
 
Recently, pricing pressure from automobile manufacturers has been prevalent in the automotive parts industry in China. Virtually all vehicle manufacturers seek price reductions each year. Although the Company has tried to reduce costs and resist price reductions, these reductions have impacted the Company’s sales and profit margins. If the Company cannot offset continued price reductions through improved operating efficiencies and reduced expenditures, price reductions will have a material adverse effect on the Company's results of operations.
 
The Company’s business, revenues and profitability would be materially and adversely affected if it loses any of its large customers.
 
For the year ended December 31, 2013, approximately 11.1% , 8.9%, 7.8% and 7.7% of the Company’s sales were to Chrysler North America, SAIC GM Wuling Automobile Co., Zhejiang Geely Holding Co., Ltd. and Baoding Great Wall Automobile Holding Co., Ltd., the Company’s four largest customers in 2013, respectively. In total, these four largest customers accounted for 35.5% of total sales in 2013. For the year ended December 31, 2012, approximately 11.7%, 9.4%, 9.0% and 7.9% of the Company’s sales were to Chrysler North America, Zhejiang Geely Holding Co., Ltd., Chery Automobile Co., Ltd. and Dongfeng Auto Group Co., Ltd., the Company’s four largest customers in 2012, respectively. In total, these four largest customers accounted for 38.0% of the total sales in 2012. The loss of, or significant reduction in purchases by, one or more of these major customers could adversely affect the Company’s business.
 
The Company may not be able to collect receivables incurred by customers.
 
Although the Company currently sells its products on credit, the Company’s ability to receive payment for its products depends on the continued creditworthiness of its customers. The Company’s customer base may change if its sales increase because of the Company’s expanded capacity. If the Company is not able to collect its receivables, its profitability will be adversely affected.
 
The Company may be subject to product liability and warranty and recall claims, which may increase the costs of doing business and adversely affect the Company’s financial condition and liquidity.
 
The Company may be exposed to product liability and warranty claims if its products actually or allegedly fail to perform as expected or the use of its products results, or is alleged to result, in bodily injury and/or property damage. The Company started to pay some of its customers’ increased after-sales service expenses due to consumer rights protection policies of “recall” issued by the Chinese government in 2004, such as the recalling flawed vehicles policy. Beginning in 2004, automobile manufacturers unilaterally required their suppliers to pay a “3-R Guarantees” service charge for repair, replacement and refund in an amount of about 2%–6% of the total amount of parts supplied. Accordingly, the Company has experienced and will continue to experience higher after sales service expenses. Product liability, warranty and recall costs may have a material adverse effect on the Company’s financial condition.
 
 
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The Company is subject to environmental and safety regulations, which may increase the Company’s compliance costs and may adversely affect its results of operations.
 
The Company is subject to the requirements of environmental and occupational safety and health laws and regulations in China. The Company cannot provide assurance that it has been or will be at all times in full compliance with all of these requirements, or that it will not incur material costs or liabilities in connection with these requirements. Additionally, these regulations may change in a manner that could have a material adverse effect on the Company’s business, results of operations and financial condition. The capital requirements and other expenditures that may be necessary to comply with environmental requirements could increase and become a material expense of doing business.
 
Non-performance by the Company’s suppliers may adversely affect its operations by delaying delivery or causing delivery failures, which may negatively affect demand, sales and profitability.
 
The Company purchases various types of equipment, raw materials and manufactured component parts from its suppliers. The Company would be materially and adversely affected by the failure of its suppliers to perform as expected. The Company could experience delivery delays or failures caused by production issues or delivery of non-conforming products if its suppliers fail to perform, and it also faces these risks in the event any of its suppliers becomes insolvent or bankrupt.
 
The Company’s business and growth may suffer if it fails to attract and retain key personnel.
 
The Company’s ability to operate its business and implement its strategies effectively depends on the efforts of its executive officers and other key employees. The Company depends on the continued contributions of its senior management and other key personnel. The Company’s future success also depends on its ability to identify, attract and retain highly skilled technical staff, particularly engineers and other employees with mechanics and electronics expertise, and managerial, finance and marketing personnel. The Company does not maintain a key person life insurance policy on Mr. Hanlin Chen or Mr. Qizhou Wu. The loss of the services of any of the Company’s key employees or the failure to attract or retain other qualified personnel could substantially harm the Company’s business.
 
The Company’s management controls approximately 72.01% of its outstanding common stock and may have conflicts of interest with the Company’s minority stockholders.
 
As of December 31, 2013, members of the Company’s management beneficially own approximately 72.01% of the outstanding shares of the Company’s common stock. As a result, except for the related party transactions that require approval of the audit committee of the board of directors of the Company, these majority stockholders have control over decisions to enter into any corporate transaction, which could result in the approval of transactions that might not maximize overall stockholders’ value. Additionally, these stockholders control the election of members of the Company’s board, have the ability to appoint new members to the Company’s management team and control the outcome of matters submitted to a vote of the holders of the Company’s common stock. The interests of these majority stockholders may at times conflict with the interests of the Company’s other stockholders. The Company regularly engages in transactions with entities controlled by one or more of its officers and directors, including those controlled by Mr. Hanlin Chen, the chairman of the board of directors of the Company and its controlling stockholder.
 
 
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There is a limited public float of the Company’s common stock, which can result in the Company’s stock price being volatile and prevent the realization of a profit on resale of the Company’s common stock or derivative securities.
 
There is a limited public float of the Company’s common stock. As of December 31, 2013, approximately 27.99% of the Company’s outstanding common stock is considered part of the public float. The term “public float” refers to shares freely and actively tradable on the NASDAQ Capital Market and not owned by officers, directors or affiliates, as such term is defined under the Securities Act. As a result of the limited public float and the limited trading volume on some days, the market price of the Company’s common stock can be volatile, and relatively small changes in the demand for or supply of the Company’s common stock can have a disproportionate effect on the market price for its common stock. This stock price volatility could prevent a security holder seeking to sell the Company’s common stock or derivative securities from being able to sell them at or above the price at which the stock or derivative securities were bought, or at a price which a fully liquid market would report.
 
The Company is subject to penny stock regulations and restrictions.
 
The SEC has adopted regulations which generally define so-called “penny stock” as an equity security that has a market price less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exemptions. As of December 31, 2013, the closing price for the Company’s common stock was $7.93. If the Company’s stock is a “penny stock”, it may become subject to Rule 15g-9 under the Securities Exchange Act of 1934, the “Penny Stock Rule.” This rule imposes additional sales practice requirements on broker-dealers that sell such securities to persons other than established customers and “accredited investors,” generally, individuals with a net worth in excess of $1.0 million or annual incomes exceeding $0.2 million, or $0.3 million together with their spouses. For transactions covered by Rule 15g-9, a broker-dealer must make a special suitability determination for the purchaser and have received the purchaser’s written consent to the transaction prior to sale. As a result, this rule may affect the ability of broker-dealers to sell the Company’s securities and may affect the ability of purchasers to sell any of the Company’s securities in the secondary market.
 
For any transaction involving a penny stock, unless exempt, the rules require delivery, prior to any transaction in a penny stock, of a disclosure schedule prepared by the SEC relating to the penny stock market. Disclosure also is required to be made about sales commissions payable to both the broker-dealer and the registered representative and current quotations for the securities. Finally, monthly statements are required to be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stock.
 
There can be no assurance that the Company’s common stock will qualify for exemption from the Penny Stock Rule. In any event, even if the Company’s common stock were exempt from the Penny Stock Rule, the Company would remain subject to Section 15(b)(6) of the Exchange Act, which gives the SEC the authority to restrict any person from participating in a distribution of penny stock if the SEC finds that such a restriction would be in the public interest.
 
Provisions in the Company’s certificate of incorporation and bylaws and the General Corporation Law of Delaware may discourage a takeover attempt.
 
Provisions in the Company’s certificate of incorporation and bylaws and the General Corporation Law of Delaware, the state in which it is organized, could make it difficult for a third party to acquire the Company, even if doing so might be beneficial to the Company’s stockholders. Provisions of the Company’s certificate of incorporation and bylaws impose various procedural and other requirements, which could make it difficult for stockholders to effect certain corporate actions and possibly prevent transactions that would maximize stockholders’ value.
 
Litigation arising from the need to restate certain previously issued historical financial statements of the Company could have a material adverse effect on the Company’s business, financial condition, results of operations or liquidity.
 
On March 17, 2011, the Company announced that it had identified historical accounting errors relating to the accounting treatment of the Company’s convertible notes issued on February 15, 2008. The accounting errors resulted in the misstatement of certain charges since the first quarter of 2009. The Company undertook a review to determine the total amount of the errors and the accounting periods in which the errors occurred. The Company’s review was overseen by the audit committee of the board of directors of the Company, the “Audit Committee,” with the assistance of management and accounting consultants engaged by management. The Audit Committee concluded on March 12, 2011 that the Company’s previously issued audited consolidated financial statements as of and for the year ended December 31, 2009, and related auditors’ report, and unaudited interim consolidated financial statements as of and for the quarterly periods ended March 31, June 30 and September 30, 2010 should no longer be relied upon because of these errors in the financial statements. The Company’s board of directors agreed with the Audit Committee’s conclusions. After analyzing the size and timing of the errors, the Company determined that, in the aggregate, the errors were material. The Company restated its previously issued financial statements for the years ended December 31, 2009 and 2008 on June 28, 2011.
 
 
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Securities Action - Southern District of New York. On October 25, 2011, a purported securities class action, the “Securities Action,” was filed in the United States District Court for the Southern District of New York on behalf of all purchasers of the Company’s securities between March 25, 2010 and March 17, 2011. On February 24, 2012, the plaintiffs filed an amended complaint, changing the purported class period to between May 12, 2009 and March 17, 2011. The amended complaint alleges that the Company, certain of its present officers and directors, and the Company’s former independent accounting firm violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and the rules promulgated thereunder, and seeks unspecified damages. The Company filed a motion to dismiss the amended complaint, which was fully briefed on April 18, 2012. On August 8, 2012, the court denied the Company’s motion to dismiss the amended complaint. On September 4, 2012, the Company filed an answer to the amended complaint. On January 15, 2013, plaintiffs filed a motion to certify the purported class, which was fully briefed on April 8, 2013. On May 31, 2013, the court denied plaintiffs’ motion to certify the purported class, and, on July 3, 2013, the court issued its order and opinion. On July 17, 2013, plaintiffs filed a petition for permission to appeal the order denying class certification, and, on August 1, 2013, the Company filed an answer in opposition to the petition. On October 23, 2013, the Court of Appeals for the Second Circuit denied plaintiffs’ petition for permission to appeal. On December 6, 2013, plaintiffs filed a motion for preliminary approval of a settlement with the Company’s former independent accounting firm and certification of a proposed settlement class. On January 7, 2014, the district court held a status conference. On January 15, 2014, the district court denied plaintiffs’ motion for preliminary approval of settlement and certification of a proposed settlement class. On February 20, 2014, the district court held a telephonic status conference regarding plaintiffs’ remaining individual claims and issued a scheduling order setting deadlines for fact and expert discovery (May 30, 2014 and June 30, 2014, respectively), motions for summary judgment (August 1, 2014), and pretrial materials (September 25, 2014). The Company and plaintiffs have reached a settlement in principle and, on March 28, 2014, entered into a settlement agreement, which includes a dismissal of all claims by plaintiffs against the Company and its current and former officers and directors, with no admission of any wrongdoing or liability. The settlement is not material to the consolidated financial statements for the year ended December 31, 2013.
 
Derivative Action - Delaware Chancery Court. On December 23, 2011, a purported shareholder derivative action was filed in the Court of Chancery of the State of Delaware, the “Court of Chancery,” on behalf of the Company. The complaint alleged that certain of the Company’s current officers and directors breached their fiduciary duties to the Company in relation to the Company’s accounting of convertible notes issued in February 2008. On January 25, 2012, a second purported shareholder derivative action was filed in the Court of Chancery on behalf of the Company. On February 3, 2012, the Court of Chancery consolidated the two cases, which were stayed pending the outcome of the motion to dismiss in the Securities Action. On October 23, 2012, the derivative plaintiffs filed a consolidated amended complaint on behalf of the Company, the “Derivative Action.” The consolidated complaint alleged that certain of the Company’s current officers and directors breached their fiduciary duties to the Company in relation to the Company’s accounting of the convertible notes issued in February 2008. The consolidated complaint set forth three causes of action for breach of fiduciary duties, unjust enrichment and insider trading. On January 7, 2013, the Company filed a motion to dismiss the Derivative Action. That motion was fully briefed on February 28, 2013, and oral argument was held before the Court of Chancery on May 6, 2013. On August 30, 2013, the Court of Chancery dismissed all of the derivative plaintiffs’ claims with prejudice. The time for the derivative plaintiffs to appeal the Court of Chancery’s decision expired on September 30, 2013 and, accordingly, the Derivative Action has terminated.
 
 
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Failure to maintain effective internal control over financial reporting could have a material adverse effect on the Company’s business, results of operations and the trading price of its shares.
 
The Company is subject to reporting obligations under the U.S. securities laws. The Securities and Exchange Commission, the “SEC,” as required by Section 404 of the Sarbanes-Oxley Act of 2002, has adopted rules requiring public companies to include a report of management in its annual report that contains an assessment by management of the effectiveness of such company’s internal control over financial reporting.
 
The Company’s management has conducted an evaluation of the effectiveness of its internal control over financial reporting and concluded that the Company’s internal control over financial reporting was not effective as of December 31, 2013.   Our management has identified control deficiencies as of December 31, 2013 that constituted a material weakness and resulted in the failure to properly identify and timely disclose certain related party transactions.  Although we have implemented measures to address the material weakness, the material weakness identified by management is not fully remediated as of the date of the filing of this Annual Report on Form 10-K.  We cannot assure you that we will not identify additional control deficiencies that may constitute significant deficiencies or material weaknesses in our internal controls in the future.  As a result, we may be required to implement further remedial measures and to design enhanced processes and controls to address issues identified through future reviews.
 
If we do not fully remediate the material weakness identified by management or fail to maintain the adequacy of our internal controls in the future, we will not be able to ensure that we can conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with the Sarbanes-Oxley Act.  Moreover, effective internal controls are necessary for us to produce reliable financial reports and are important to help prevent fraud.  Any failure to maintain effective internal control over financial reporting could result in the loss of investor confidence in the reliability of our financial statements, which in turn could harm our business and negatively impact the trading price of our common stock.  Furthermore, the Company may need to incur additional costs and use additional management and other resources in an effort to comply with Section 404 of the Sarbanes-Oxley Act and other requirements going forward.
 
The Company does not pay cash dividends on its common stock.
 
The Company has never declared or paid any cash dividends on its common stock and it does not anticipate paying any cash dividends in the foreseeable future. The Company currently intends to retain future earnings, if any, to finance operations and the expansion of its business. Any future determination to pay cash dividends will be at the discretion of the Company’s board of directors and will be based upon the Company’s financial condition, operating results, capital requirements, plans for expansion, restrictions imposed by any financing arrangements and any other factors that the Company’s board of directors deems relevant.
 
Techniques employed by short sellers may drive down the market price of the Company’s common stock.
 
Short selling is the practice of selling securities that the seller does not own but rather has borrowed from a third party with the intention of buying identical securities back at a later date to return to the lender. The short seller hopes to profit from a decline in the value of the securities between the sale of the borrowed securities and the purchase of the replacement shares, as the short seller expects to pay less in that purchase than it received in the sale. As it is in the short seller’s best interests for the price of the stock to decline, many short sellers publish, or arrange for the publication of, negative opinions regarding the relevant issuer and its business prospects in order to create negative market momentum and generate profits for themselves after selling a stock short. These short attacks have, in the past, led to selling of shares in the market.
 
In the recent past, public companies that have substantially all of their operations in China have been the subject of short selling. Much of the scrutiny and negative publicity has centered around allegations of a lack of effective internal control over financial reporting resulting in financial and accounting irregularities and mistakes, inadequate corporate governance policies or a lack of adherence thereto and, in many cases, allegations of fraud. As a result, many of these companies are now conducting internal and external investigations into the allegations and, in the interim, are subject to shareholder lawsuits and/or SEC enforcement actions.
 
 
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It is not clear what effect such negative publicity would have on the Company, if any. If the Company were to become the subject of any unfavorable allegations, whether such allegations are proven to be true or untrue, the Company could have to expend a significant amount of resources to investigate such allegations and/or defend itself. While the Company would strongly defend against any such short seller attacks, the Company may be constrained in the manner in which it can proceed against the relevant short seller by principles of freedom of speech, applicable state law or issues of commercial confidentiality. Such a situation could be costly and time-consuming, and could distract the Company’s management from growing the Company. Even if such allegations are ultimately proven to be groundless, allegations against the Company could severely impact its business operations and stockholders equity, and any investment in the Company’s stock could be greatly reduced or rendered worthless.
 
The Company’s secured credit facilities contain certain financial covenants that it may not satisfy, which, if not satisfied, could result in the acceleration of the amounts due under the Company’s secured credit facilities and the limitation of the Company’s ability to borrow additional funds in the future.
 
The agreements governing the Company’s secured credit facilities subject it to various financial and other restrictive covenants with which the Company must comply on an ongoing or periodic basis. These covenants include, but are not limited to, restrictions on the utilization of the funds and the maintenance of certain financial ratios. If the Company violate any of these covenants, the Company’s outstanding debt under the Company’s secured credit facilities could become immediately due and payable, the Company’s lenders could proceed against any collateral securing such indebtedness and the Company’s ability to borrow additional funds in the future may be limited. Alternatively, the Company could be forced to refinance or renegotiate the terms and conditions of the Company’s secured credit facilities, including the interest rates, financial and restrictive covenants and security requirements of the secured credit facilities, on terms that may be significantly less favorable to the Company.
 
RISKS RELATED TO DOING BUSINESS IN CHINA AND OTHER COUNTRIES BESIDES THE UNITED STATES
 
The Company may face a severe operating environment during times of economic recession.
 
The sales volume of the Company’s core products is largely influenced by the demand for its customers’ end products which are mostly sold in the Chinese markets. Future economic crises, either within China or without, may lead to a drastic drop in demand for the Company’s products.
 
Inflation in China could negatively affect the Company’s profitability and growth.
 
China’s economy has experienced rapid growth, much of it due to the issuance of debt over the last few years. This debt-fueled economic growth has led to growth in the money supply, causing rising inflation. If prices for the Company’s products rise at a rate that is insufficient to compensate for the rise in the cost of production, it may harm the Company’s profitability. In order to control inflation, the Chinese government has imposed controls on bank credit, limits on loans and other restrictions on economic activities. Such policies have led to a slowing of economic growth. Additional measures could further slow economic activity in China, which could, in turn, materially increase the Company’s costs while also reducing demand for the Company’s products.
 
The Chinese government’s macroeconomic policies could have a negative effect on the Company’s business and results of operations.
 
The Chinese government has implemented various measures from time to time to control the rate of economic growth in the PRC. Some of these measures may have a negative effect on the Company over the short or long term. Recently, to cope with high inflation and economic imbalances, the Chinese government has tightened monetary policy and implemented floating exchange rate policy. In addition, in order to alleviate some of the effects of unbalanced growth and social discontent, the Chinese government has enacted a series of social programs and anti-inflationary measures. These, in turn, have increased the costs on the financial and manufacturing sectors, without having alleviated the effects of high inflation and economic imbalances. The Chinese government’s macroeconomic policies, even if effected properly, may significantly slow down China’s economy or cause great social unrest, all of which would have a negative effect on the Company’s business and results of operations.
 
 
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The economic, political and social conditions in China could affect the Company’s business.
 
Most of the Company’s business, assets and operations are located in China. The economy of China differs from the economies of most developed countries in many respects, including government involvement, level of development, growth rate, control of foreign exchange and allocation of resources. The economy of China has been transitioning from a planned economy to a more market-oriented economy. Although the Chinese government has implemented measures emphasizing the utilization of market forces for economic reform, the reduction of state ownership of productive assets and the establishment of sound corporate governance in business enterprises, a substantial portion of productive assets in China is still owned by the Chinese government.
 
In addition, the Chinese government continues to play a significant role in regulating industry by imposing industrial policies. It also exercises significant control over China’s economic growth through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies. Therefore, the Chinese government’s involvement in the economy could adversely affect the Company’s business operations, results of operations and/or financial condition.
 
Because the Company’s operations are mostly located outside of the United States and are subject to Chinese laws, any change of Chinese laws may adversely affect its business.
 
Most of the Company’s operations are in the PRC, which exposes it to risks, such as exchange controls and currency restrictions, currency fluctuations and devaluations, changes in local economic conditions, changes in Chinese laws and regulations, exposure to possible expropriation or other PRC government actions, and unsettled political conditions. These factors may have a material adverse effect on the Company’s operations or on its business, results of operations and financial condition.
 
The Company’s international expansion plans subject it to risks inherent in doing business internationally.
 
The Company’s long-term business strategy relies on the expansion of its international sales outside China by targeting markets, such as the United States and Brazil. Risks affecting the Company’s international expansion include challenges caused by distance, language and cultural differences, conflicting and changing laws and regulations, foreign laws, international import and export legislation, trading and investment policies, foreign currency fluctuations, the burdens of complying with a wide variety of laws and regulations, protectionist laws and business practices that favor local businesses in some countries, foreign tax consequences, higher costs associated with doing business internationally, restrictions on the export or import of technology, difficulties in staffing and managing international operations, trade and tariff restrictions, and variations in tariffs, quotas, taxes and other market barriers. These risks could harm the Company’s international expansion efforts, which could in turn materially and adversely affect its business, operating results and financial condition.
 
On September 17, 2012, the United States filed a trade case with the World Trade Organization, “WTO,” against the PRC with respect to the PRC government’s purported provision of subsidies to the automobile and automobile-parts enterprises in the PRC. If the WTO rules against China in this trade case, the cost of sales of the Company could increase due to the imposition of any tariff and/or the Company’s ability to export products to the United States could be limited, which could affect the Company’s business and operating results.
 
In addition, under Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC has adopted additional disclosure requirements related to the source of certain “conflict minerals” for issuers for which such “conflict minerals” are necessary to the functionality or production of a product manufactured, or contracted to be manufactured, by that issuer. The metals covered by the rules include tin, tantalum, tungsten and gold, commonly referred to as “3TG.” If these materials are necessary to the functionality or production of a product manufactured, or contracted to be manufactured, the rules require a reasonable country of origin inquiry be conducted to determine if an issuer knows, or has reason to believe, that any of the minerals used in the production process may have originated from the Democratic Republic of the Congo or an adjoining country. In such a case, if an issuer were not able to determine that the minerals did not originate from a covered country or conclude that there is no reason to believe that the minerals used in the production process may have originated in a covered country, that issuer could be required to perform supply chain due diligence on members of its supply chain. Global supply chains can have multiple layers, thus the costs of complying with these new requirements could be substantial. These new requirements may also reduce the number of suppliers that provide conflict-free metals, and may affect a company’s ability to obtain products in sufficient quantities or at competitive prices. If the Company was to source such 3TG minerals that are necessary to the functionality or production of a product manufactured, or contracted to be manufactured, compliance costs with these rules and/or the unavailability of raw materials could have a material adverse effect on the Company’s results of operations.
 
 
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The Company faces risks associated with currency exchange rate fluctuations; any adverse fluctuation may adversely affect its operating margins.
 
Although the Company is incorporated in the State of Delaware, in the United States, the majority of its current revenues are in Chinese currency. Conducting business in currencies other than U.S. dollars subjects the Company to fluctuations in currency exchange rates that could have a negative impact on its reported operating results. Fluctuations in the value of the U.S. dollar relative to other currencies impact the Company’s revenues, cost of revenues and operating margins and result in foreign currency translation gains and losses. Historically, the Company has not engaged in exchange rate hedging activities. Although the Company may implement hedging strategies to mitigate this risk, these strategies may not eliminate its exposure to foreign exchange rate fluctuations and involve costs and risks of their own, such as ongoing management time and expertise requirements, external costs to implement the strategy and potential accounting implications.
 
If relations between the United States and China worsen, the Company’s stock price may decrease and the Company may have difficulty accessing the U.S. capital markets.
 
At various times during recent years, the United States and China have had disagreements over political and economic issues. Controversies may arise in the future between these two countries. Any political or trade controversies between the United States and China could adversely affect the market price of the Company’s common stock and its ability to access U.S. capital markets.
 
The Chinese government could change its policies toward private enterprise, which could adversely affect the Company’s business.
 
The Company’s business is subject to political and economic uncertainties in China and may be adversely affected by China’s political, economic and social developments. Over the past several years, the Chinese government has pursued economic reform policies including the encouragement of private economic activity and greater economic decentralization. The Chinese government may not continue to pursue these policies or may alter them to the Company’s detriment from time to time. Changes in policies, laws and regulations, or in their interpretation or the imposition of confiscatory taxation, restrictions on currency conversion, restrictions or prohibitions on dividend payments to stockholders, devaluations of currency or the nationalization or other expropriation of private enterprises could have a material adverse effect on the Company’s business. Nationalization or expropriation could result in the total loss of the Company’s investment in China.
 
Government control of currency conversion and future movements in exchange rates may adversely affect the Company’s operations and financial results.
 
The Company receives most of its revenues in Chinese Renminbi (RMB). A portion of such revenues will be converted into other currencies to meet the Company’s foreign currency obligations. Foreign exchange transactions under the Company’s capital account, including principal payments in respect of foreign currency-denominated obligations, continue to be subject to significant foreign exchange controls and require the approval of the State Administration of Foreign Exchange in China. These limitations could affect the Company’s ability to obtain foreign exchange through debt or equity financing, or to obtain foreign exchange for capital expenditures.
 
The Chinese government controls its foreign currency reserves through restrictions on imports and conversion of RMB into foreign currency. In July 2005, the Chinese government has adjusted its exchange rate policy from “Fixed Rate” to “Floating Rate”. Between July 2005 to December 2013, the exchange rate between the RMB and the U.S. dollar appreciated from RMB1.00 to $0.1205 to RMB 1.00 to $0.1640. The Company believes that this significant appreciation will continue for the near future. Significant appreciation of the RMB is likely to decrease the income of export products and decrease the Company’s cash flow.
 
 
19

 
Because the Chinese legal system is not fully developed, the Company and its security holders’ legal protections may be limited.
 
The Chinese legal system is based on written statutes and their interpretation by the Supreme People’s Court. Although the Chinese government introduced new laws and regulations to modernize its business, securities and tax systems on January 1, 1994, China does not yet possess a comprehensive body of business law. Because Chinese laws and regulations are relatively new, interpretation, implementation and enforcement of these laws and regulations involve uncertainties and inconsistencies and it may be difficult to enforce contracts. In addition, as the Chinese legal system develops, changes in such laws and regulations, their interpretation or their enforcement may have a material adverse effect on the Company’s business operations. Moreover, interpretative case law does not have the same precedential value in China as in the United States, so legal compliance in China may be more difficult or expensive.
 
It may be difficult to serve the Company with legal process or enforce judgments against its management or the Company.
 
Most of the Company’s assets are located in China and twelve of its directors and officers are non-residents of the United States, and all or substantial portions of the assets of such non-residents are located outside the United States. As a result, it may not be possible to effect service of process within the United States upon such persons to originate an action in the United States. Moreover, there is uncertainty that the courts of China would enforce judgments of U.S. courts against the Company, its directors or officers based on the civil liability provisions of the securities laws of the United States or any state, or an original action brought in China based upon the securities laws of the United States or any state.
 
The Company may be subject to fines and legal sanctions imposed by State Administration of Foreign Exchange (SAFE) or other Chinese government authorities if it or its Chinese directors or employees fail to comply with recent Chinese regulations relating to employee share options or shares granted by offshore listed companies to Chinese domestic individuals.
 
On December 25, 2006, the People’s Bank of China, or PBOC, issued the Administration Measures on Individual Foreign Exchange Control, and the corresponding Implementation Rules were issued by SAFE on January 5, 2007. Both of these regulations became effective on February 1, 2007. According to these regulations, all foreign exchange matters relating to employee stock holding plans, share option plans or similar plans with Chinese domestic individuals’ participation require approval from the SAFE or its authorized branch. On March 28, 2007, the SAFE issued the Application Procedure of Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Holding Plan or Stock Option Plan of Overseas-Listed Company, or the Stock Option Rule. Under the Stock Option Rule, Chinese domestic individuals who are granted share options or shares by an offshore listed company are required, through a Chinese agent or Chinese subsidiary of the offshore listed company, to register with the SAFE and complete certain other procedures. As the Company is an offshore listed company, its Chinese domestic directors and employees who may be granted share options or shares shall become subject to the Stock Option Rule. Under the Stock Option Rule, employees stock holding plans, share option plans or similar plans of offshore listed companies with Chinese domestic individuals’ participation must be filed with the SAFE. After the Chinese domestic directors or employees exercise their options, they must apply for the amendment to the registration with the SAFE. As of December 31, 2013, the Company has completed such SAFE registration and other related procedures according to PRC law. If the Company or its Chinese domestic directors or employees fail to comply with these regulations in the future, the Company or its Chinese domestic directors or employees may be subject to fines or other legal sanctions imposed by the SAFE or other Chinese government authorities.
 
Capital outflow policies in China may hamper the Company’s ability to declare and pay dividends to its stockholders.
 
China has adopted currency and capital transfer regulations. These regulations may require the Company to comply with complex regulations for the movement of capital. Although the Company’s management believes that it will be in compliance with these regulations, should these regulations or the interpretation of them by courts or regulatory agencies change, the Company may not be able to pay dividends to its stockholders outside of China. In addition, under current Chinese law, the Company’s joint-ventures and wholly-owned enterprise in China must retain a reserve equal to 10% of its net income after taxes, not to exceed 50% of its registered capital. Accordingly, this reserve will not be available to be distributed as dividends to the Company’s stockholders. The Company presently does not intend to pay dividends for the foreseeable future. The Company’s board of directors intends to follow a policy of retaining all of its earnings to finance the development and execution of its strategy and the expansion of its business.
 
 
20

 
Registered public accounting firms in China, including the Company’s independent registered public accounting firm, are not inspected by the U.S. Public Company Accounting Oversight Board, which deprives the Company and its investors of the benefits of such inspection.
 
Auditors of companies whose shares are registered with the U.S. Securities and Exchange Commission and traded publicly in the United States, including the Company’s independent registered public accounting firm, must be registered with the U.S. Public Company Accounting Oversight Board, the “PCAOB,” and are required by the laws of the United States to undergo regular inspections by the PCAOB to assess their compliance with the laws of the United States and professional standards applicable to auditors. The Company’s independent registered public accounting firm is located in, and organized under the laws of, the PRC, which is a jurisdiction where the PCAOB, notwithstanding the requirements of U.S. law, is currently unable to conduct inspections without the approval of the Chinese authorities, which approval has not been granted for auditors such as the Company’s independent registered public accounting firm. This lack of PCAOB inspections in China prevents the PCAOB from fully evaluating audits and quality control procedures of the Company’s independent registered public accounting firm. As a result, the Company and investors in its common stock are deprived of the benefits of such PCAOB inspections.
 
The inability of the PCAOB to conduct inspections of auditors in China makes it more difficult to evaluate the effectiveness of the Company’s independent registered public accounting firm’s audit procedures or quality control procedures as compared to auditors outside of China that are subject to PCAOB inspections, which could cause investors and potential investors in the Company’s stock to lose confidence in its audit procedures and reported financial information and the quality of its financial statements.
 
If a recent initial decision rendered by the Administrative Law Judge (the “ALJ”) in administrative proceedings brought by the SEC against the Big Four PRC-based accounting firms, including our independent registered public accounting firm, becomes final, we could be unable to timely file future financial statements in compliance with the requirements of the Securities Exchange Act of 1934.
 
In December 2012, the SEC instituted administrative proceedings against the Big Four PRC-based accounting firms, including our independent registered public accounting firm, alleging that these firms had violated U.S. securities laws and the SEC’s rules and regulations thereunder by failing to provide to the SEC the firms’ audit work papers with respect to certain PRC-based companies that are publicly traded in the United States. On January 22, 2014, the ALJ presiding over the matter rendered an initial decision that each of the firms had violated the SEC’s rules of practice by failing to produce audit workpapers to the SEC. The initial decision censured each of the firms and barred them from practicing before the SEC for a period of six months. The Big Four PRC-based accounting firms recently appealed the ALJ’s initial decision to the SEC. The ALJ’s decision does not take effect unless and until it is endorsed by the SEC. Any SEC endorsement or other determination could be appealed by the accounting firms through the U.S. federal courts. While we cannot predict the outcome of the SEC’s review or that of any subsequent appeal process, if the accounting firms are ultimately temporarily denied the ability to practice before the SEC, our ability to file our financial statements in compliance with SEC requirements could be impacted. A determination that we have not timely filed financial statements in compliance with SEC requirements could ultimately lead to the delisting of our common stock from NASDAQ or the termination of the registration of our common stock under the Securities Exchange Act of 1934, or both, which would substantially reduce or effectively terminate the trading of our common stock in the United States.
 
ITEM 1B.
UNRESOLVED STAFF COMMENTS.
 
Not Applicable. 
 
 
21

 
ITEM 2. PROPERTIES.
 
The Company’s headquarters are located at No. 1 Henglong Road, Yu Qiao Development Zone, Shashi District, Jing Zhou City Hubei Province, the PRC. Set forth below are the manufacturing facilities operated by each joint venture. The Company has forty-five to fifty years long-term rights to use the lands and buildings (in thousands of USD, except for references to area in square meters).
  
 
 
 
 
Total Area
 
 
Building Area
 
Original Cost of
 
 
 
Name of Entity
 
Product
 
(sq.m.)
 
 
(sq.m.)
 
Equipment
 
Site
 
Henglong
 
Automotive Parts
 
97,818
(1)
 
20,226
 
$
51,404
 
Jingzhou City, Hubei Province
 
 
 
 
 
13,393
 
 
13,707
 
$
-
 
Wuhan City, Hubei Province
 
Jiulong
 
Power Steering Gear
 
39,478
 
 
23,728
 
$
34,847
 
Jingzhou City, Hubei Province
 
Shenyang
 
Automotive Steering Gear
 
35,354
 
 
10,425
 
$
5,829
 
Shenyang City, Liaoning Province
 
Chongqing
 
Steering Pumps
 
17,188
 
 
10,413
 
$
2,245
 
Zhuji City, Zhejiang Province
 
Jielong
 
Electric Power Steering
 
-
 
 
-
 
$
3,830
 
Wuhan City, Hubei Province
 
USAI
 
Sensor Modular
 
-
 
 
-
 
$
960
 
Wuhan City, Hubei Province
 
Hubei Henglong
 
Automotive Steering Gear
 
170,520
 
 
65,749
 
$
14,804
 
Jingzhou City, Hubei Province
 
Wuhu
 
Automotive Steering Gear
 
83,705
 
 
15,273
 
$
4,407
 
Wuhu City, Anhui Province
 
Total
 
 
 
457,456
 
 
159,521
 
$
118,326
 
 
 
 
(1)
The total area of the manufacturing facilities of Henglong was reduced from 225,221 square meters as of December 31, 2012 to 97,818 square meters as of December 31, 2013. The reduction was due to the Company’s sale of an idle land use right, see note 20.
 
The Company is not involved in investments in (i) real estate or interests in real estate, (ii) real estate mortgages, and (iii) securities of or interests in persons primarily engaged in real estate activities, as all of its land rights are used for production purposes.
 
ITEM 3. LEGAL PROCEEDINGS.
 
Securities Action - Southern District of New York. On October 25, 2011, a purported securities class action, the “Securities Action,” was filed in the United States District Court for the Southern District of New York on behalf of all purchasers of the Company’s securities between March 25, 2010 and March 17, 2011. On February 24, 2012, the plaintiffs filed an amended complaint, changing the purported class period to between May 12, 2009 and March 17, 2011. The amended complaint alleges that the Company, certain of its present officers and directors, and the Company’s former independent accounting firm violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and the rules promulgated thereunder, and seeks unspecified damages. The Company filed a motion to dismiss the amended complaint, which was fully briefed on April 18, 2012. On August 8, 2012, the court denied the Company’s motion to dismiss the amended complaint. On September 4, 2012, the Company filed an answer to the amended complaint. On January 15, 2013, plaintiffs filed a motion to certify the purported class, which was fully briefed on April 8, 2013. On May 31, 2013, the court denied plaintiffs’ motion to certify the purported class, and, on July 3, 2013, the court issued its order and opinion. On July 17, 2013, plaintiffs filed a petition for permission to appeal the order denying class certification, and, on August 1, 2013, the Company filed an answer in opposition to the petition. On October 23, 2013, the Court of Appeals for the Second Circuit denied plaintiffs’ petition for permission to appeal. On December 6, 2013, plaintiffs filed a motion for preliminary approval of a settlement with the Company’s former independent accounting firm and certification of a proposed settlement class. On January 7, 2014, the district court held a status conference. On January 15, 2014, the district court denied plaintiffs’ motion for preliminary approval of settlement and certification of a proposed settlement class. On February 20, 2014, the district court held a telephonic status conference regarding plaintiffs’ remaining individual claims and issued a scheduling order setting deadlines for fact and expert discovery (May 30, 2014 and June 30, 2014, respectively), motions for summary judgment (August 1, 2014), and pretrial materials (September 25, 2014). The Company and plaintiffs have reached a settlement in principle and, on March 28, 2014, entered into a settlement agreement, which includes a dismissal of all claims by plaintiffs against the Company and its current and former officers and directors, with no admission of any wrongdoing or liability. The settlement is not material to the consolidated financial statements for the year ended December 31, 2013.
 
 
22

  
Derivative Action - Delaware Chancery Court. On December 23, 2011, a purported shareholder derivative action was filed in the Court of Chancery of the State of Delaware, the “Court of Chancery,” on behalf of the Company. The complaint alleged that certain of the Company’s current officers  and directors breached their fiduciary duties to the Company in relation to the Company’s accounting of convertible notes issued in February 2008. On January 25, 2012, a second purported shareholder derivative action was filed in the Court of Chancery on behalf of the Company. On February 3, 2012, the Court of Chancery consolidated the two cases, which were stayed pending the outcome of the motion to dismiss in the Securities Action. On October 23, 2012, the derivative plaintiffs filed a consolidated amended complaint on behalf of the Company, the “Derivative Action.” The consolidated complaint alleged that certain of the Company’s current officers and directors breached their fiduciary duties to the Company in relation to the Company’s accounting of the convertible notes issued in February 2008. The consolidated complaint set forth three causes of action for breach of fiduciary duties, unjust enrichment and insider trading. On January 7, 2013, the Company filed a motion to dismiss the Derivative Action. That motion was fully briefed on February 28, 2013, and oral argument was held before the Court of Chancery on May 6, 2013. On August 30, 2013, the Court of Chancery dismissed all of the derivative plaintiffs’ claims with prejudice. The time for the derivative plaintiffs to appeal the Court of Chancery’s decision expired on September 30, 2013 and, accordingly, the Derivative Action has terminated.
 
Other than the above, the Company is not a party to any pending or, to the best of the Company’s knowledge, any threatened legal proceedings. In addition, no director, officer or affiliate of the Company, or owner of record of more than five percent of the securities of the Company, or any associate of any such director, officer or security holder is a party adverse to the Company or has a material interest adverse to the Company in reference to pending litigation.
 
ITEM 4. MINE SAFETY DISCLOSURES.
 
Not applicable.
 
 
23

 
PART II
 
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
 
MARKET PRICES OF COMMON STOCK
 
The Company’s common stock has been traded on the NASDAQ Capital Market under the symbol “CAAS”. The high and low bid intra-day prices of the common stock in 2013 and 2012 were reported on NASDAQ for the time periods indicated on the table below. Accordingly, the table below contains the high and low bid closing prices of the common stock as reported on the NASDAQ for the time periods indicated.
 
 
 
Price Range
 
 
 
2013
 
2012
 
 
 
High
 
Low
 
High
 
Low
 
First Quarter
 
$
5.99
 
$
4.50
 
$
7.41
 
$
3.52
 
Second Quarter
 
$
5.53
 
$
4.01
 
$
7.18
 
$
3.80
 
Third Quarter
 
$
10.00
 
$
5.59
 
$
4.40
 
$
3.59
 
Fourth Quarter
 
$
8.78
 
$
6.32
 
$
5.29
 
$
3.88
 
 
STOCKHOLDERS
 
The Company’s common shares are issued in registered form. Securities Transfer Corporation in Frisco, Texas is the registrar and transfer agent for the Company’s common stock. As of December 31, 2013, there were 28,043,019 shares of the Company’s common stock (excluding 217,283 shares of the Company’s treasury stock) issued and outstanding and the Company had approximately 57 stockholders of record.
 
DIVIDENDS
 
The Company has never declared or paid any cash dividends on its common stock and it does not anticipate paying any cash dividends in the foreseeable future. The Company currently intends to retain future earnings, if any, to finance operations and the expansion of its business. Any future determination to pay cash dividends will be at the discretion of the Company’s board of directors and will be based upon the Company’s financial condition, operating results, capital requirements, plans for expansion, restrictions imposed by any financing arrangements and any other factors that the Company’s board of directors deems relevant.
 
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
 
The securities authorized for issuance under equity compensation plans at December 31, 2013 are as follows:
 
 
 
Number of securities to be
 
Weighted average
 
Number of securities
 
 
 
issued upon exercise of
 
exercise price of
 
remaining available for
 
Plan category
 
outstanding options
 
outstanding options
 
future issuance
 
Equity compensation plans approved by security holders
 
2,200,000
 
$
8.78
 
1,676,150
 
 
The stock option plan was approved at the Annual Meeting of Stockholders held on June 28, 2005, and the maximum common shares for issuance under this plan are 2,200,000. The term of the plan is 10 years.
 
 
24

 
ITEM 6.
SELECTED FINANCIAL DATA.
 
Not Applicable.
 
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
 
The following discussion and analysis should be read in conjunction with the Company’s consolidated financial statements and the related notes thereto and other financial information contained elsewhere in this report.
 
GENERAL OVERVIEW
 
China Automotive Systems, Inc., including, when the context so requires, its subsidiaries and the subsidiaries’ interests in the Sino-foreign joint ventures described below, is referred to herein as the “Company.” The Company, through its Sino-foreign joint ventures, engages in the manufacture and sales of automotive systems and components in the People’s Republic of China, the “PRC,” or “China.” Genesis, a company incorporated on January 3, 2003 under the Companies Ordinance of Hong Kong as a limited liability company, is a wholly-owned subsidiary of the Company. Henglong USA Corporation, “HLUSA,” which was incorporated on January 8, 2007 in Troy, Michigan, is a wholly-owned subsidiary of the Company, and mainly engages in marketing of automotive parts in North America, and provides after sales service and research and development support accordingly. Furthermore, the Company owns the following aggregate net interests in the following wholly-owned subsidiaries and joint ventures organized in the PRC as of December 31, 2013 and 2012.
 
 
 
Aggregate Net Interest
 
 
 
December 31,
 
December 31,
 
Name of Entity
 
2013
 
2012
 
Henglong
 
80.00
%
80.00
%
Jiulong
 
81.00
%
81.00
%
Shenyang
 
70.00
%
70.00
%
USAI
 
83.34
%
83.34
%
Wuhu
 
77.33
%
77.33
%
Jielong
 
85.00
%
85.00
%
Hubei Henglong (1)
 
100.00
%
100.00
%
Testing Center
 
80.00
%
80.00
%
Beijing HengLong
 
50.00
%
50.00
%
Chongqing Henglong(2)
 
70.00
%
70.00
%
Brazil Henglong (3)
 
80.00
%
80.00
%
 
(1)
On March 7, 2007, Genesis established Hubei Henglong (formerly known as Jingzhou Hengsheng Automotive System Co., Ltd), its wholly-owned subsidiary, to engage in the production and sales of automotive steering systems. The registered capital of Hubei Henglong at the time of establishment was $10.0 million. On February 10, 2010, the registered capital of Hubei Henglong was increased to $16.0 million. On October 12, 2011, the board of directors of the Company approved a reorganization of the Company’s subsidiaries operating in China. As a result of the reorganization, all of Genesis’s equity interests of its subsidiaries operating in China, except for Shenyang, were transferred to Hubei Henglong, the Company’s new China-based holding company. The reorganization was completed on January 19, 2012, subsequent to which the registered capital of Hubei Henglong was increased to $39.0 million. As the reorganized entities were under common control of the Company, the reorganization did not have any impact on the Company’s consolidated financial position or results of operations and should not impact the tax treatment of the Company or its subsidiaries in any material respect. On July 8, 2012, Hubei Henglong changed its name to Hubei Henglong Automotive System Group Co., Ltd.
 
 
25

 
(2) On February 21, 2012, Hubei Henglong and SAIC-IVECO established a Sino-foreign joint venture company, Chongqing Henglong, to design, develop and manufacture both hydraulic and electric power steering systems and parts. The new joint venture is located in Chongqing City and has a registered capital of RMB60.0 million, of which RMB42.0 million, or 70%, is held by Hubei Henglong. The registered capital of Chongqing Henglong was fully contributed by Hubei Henglong in cash of $6.7 million (equivalent to RMB42.0 million) in January and February 2012 and by SAIC-IVECO in property, plant and equipment with a fair value of $2.8 million (equivalent to RMB18.0 million) in April 2012.
 
(3) On August 21, 2012, Hubei Henglong established a joint venture company with two Brazilian citizens, Ozias Gaia Da Silva and Ademir Dal’ Evedove. The joint-venture company is Brazil Henglong. Brazil Henglong engages mainly in the import and sales of automotive parts in Brazil. The new joint venture is located in Brazil and has a registered capital of $1.0 million (equivalent to BLR1.6 million), of which $0.8 million (equivalent to BLR1.3 million), or 80%, is held by Hubei Henglong, and of which $0.2 million (equivalent to BLR0.3 million), or 20%, is held by Mr. Ozias Gaia Da Silva and Mr. Ademir Dal’ Evedove. As of December 31, 2013, Hubei Henglong and Mr. Ozias Gaia Da Silva and Mr. Ademir Dal’ Evedove have completed their capital contributions.
 
 
26

 
RESULTS OF OPERATIONS
 
2013 Versus 2012 Comparative
Net Sales and Cost of Sales
 
For the years ended December 31, 2013 and 2012, net sales and cost of sales are summarized as follows (figures are in thousands of USD):
 
 
 
Net Sales
 
 
Cost of sales
 
 
 
2013
 
2012
 
Change
 
 
2013
 
2012
 
Change
 
Henglong
 
$
260,636
 
$
187,051
 
$
73,585
 
39.3
%
 
$
215,481
 
$
147,737
 
$
67,744
 
45.9
%
Jiulong
 
 
77,691
 
 
71,120
 
 
6,571
 
9.2
 
 
 
67,989
 
 
63,450
 
 
4,539
 
7.2
 
Shenyang
 
 
41,536
 
 
31,068
 
 
10,468
 
33.7
 
 
 
36,752
 
 
27,295
 
 
9,457
 
34.6
 
Wuhu
 
 
26,333
 
 
30,687
 
 
(4,354)
 
-14.2
 
 
 
24,527
 
 
28,818
 
 
(4,291)
 
-14.9
 
Hubei Henglong
 
 
48,087
 
 
40,962
 
 
7,125
 
17.4
 
 
 
39,208
 
 
35,445
 
 
3,763
 
10.6
 
Other Sectors
 
 
36,444
 
 
47,202
 
 
(10,758)
 
-22.8
 
 
 
30,638
 
 
43,356
 
 
(12,718)
 
-29.3
 
Eliminations
 
 
(75,569)
 
 
(72,085)
 
 
(3,484)
 
4.8
 
 
 
(76,069)
 
 
(70,847)
 
 
(5,222)
 
7.4
 
Total
 
$
415,158
 
$
336,005
 
$
79,153
 
23.6
%
 
$
338,526
 
$
275,254
 
$
63,272
 
23.0
%
 
Net Sales
 
Net sales were $415.2 million for the year ended December 31, 2013, compared with $336.0 million for the year ended December 31, 2012, representing an increase of $79.2 million, or 23.6%. The increase was mainly due to the increased sales of newly developed products to North America and the continuing growth of automotive market demand in China.
 
The main market for the Company’s products is China. The Chinese government issued an incentive policy relating to purchase of low-emission cars and fuel-efficient cars in May 2012. Encouraged by such incentive policy, the sales volume of passenger vehicles in the China market increased by 15.7% in 2013 as compared to 2012.The Company’s sales volume of steering gear for passenger vehicles increased by 23.9% as compared to 2012. The Company’s higher rate of increase was mainly due to the introduction of certain new products to the market and improvement in the quality of some of the old products, which resulted in the expansion of the Company’s market share in China, especially among the joint-brands’ auto customers.
 
In the third quarter of 2013, the Chinese government increased investment in infrastructure industries, such as railways and highways, which led to an increase of 6.4% in the sales of commercial vehicles in the China market. The Company’s sales of steering gears for commercial vehicles, one of the main products of the Company, also increased by 11.0%.
 
To compete with joint-brands' cars and address the over-capacity issue, the domestic brands’ car manufacturers, which are the Company's main customers, had to lower their products' price to attract end customers. The price pressure was passed on from the domestic brands’ car manufacturers to the Company, which led to continuing price decreases for the Company’s main products.
 
The Company had an increase in sales volume leading to a sales increase of $78.4 million, a decrease in selling price leading to a sales decrease of $8.1 million, and the effect of foreign currency translation of the RMB against the U.S. dollar resulting in a sales increase of $8.9 million.
 
 
27

 
Further analysis is as follows:
 
Net sales for Henglong were $260.6 million for the year ended December 31, 2013, compared with $187.1 million for the year ended December 31, 2012, representing an increase of $73.5 million, or 39.3%, which was mainly due to an increase in sales volume with a sales increase of $76.6 million to the joint-brands auto companies and the effect of foreign currency translation of the RMB against the U.S. dollar resulting in a sales increase of $4.2 million, offset by a decrease in selling prices, which led to a sales decrease of $7.3 million.
 
 
Net sales for Jiulong were $77.7 million for the year ended December 31, 2013, compared with $71.1 million for the year ended December 31, 2012, representing an increase of $6.6 million, or 9.2%, which was mainly due to an increase in sales volume with a sales increase of $6.6 million due to an increase in the demand for commercial vehicles in the Chinese market and the effect of foreign currency translation of the RMB against the U.S. dollar, which led to a sales increase of $1.5 million, which was offset by a decrease in selling prices, which led to a sales decrease of $1.5 million.
 
Net sales for Shenyang were $41.5 million for the year ended December 31, 2013, compared with $31.1 million for the year ended December 31, 2012, representing an increase of $10.4 million, or 33.7%. The net sales increase was mainly due to an increase in sales volumes with a sales increase of $9.5 million, the effect of foreign currency translation of the RMB against the U.S. dollar, which led to a sales increase of $0.7 million, and an increase in selling price which led to a sales increase of $0.2 million.
 
Net sales for Wuhu were $26.3 million for the year ended December 31, 2013, compared with $30.7 million for the year ended December 31, 2012, representing a decrease of $4.4 million, or 14.2%. Since the majority of the products of Wuhu was sold to local Chinese brand auto distributors, the decreasing demand for local Chinese brand autos from end customers due to the aggressive pricing strategy adopted by Sino-foreign joint venture brands auto manufacturers led to the decrease in sales volumes and prices for Wuhu's products. There was a decrease in sales volumes with a sales decrease of $5.0 million, a decrease in selling prices, which led to a sales decrease of $0.1 million, and the effect of foreign currency translation of the RMB against the U.S. dollar, which led to a sales increase of $0.7 million.
 
Net sales for Hubei Henglong were $48.1 million for the year ended December 31, 2013, compared with $41.0 million for the year ended December 31, 2012, representing an increase of $7.1 million, or 17.4%. All of Hubei Henglong’s products were sold to the United States. The net sales increase was mainly due to sales of the newly developed products to a United States customer. An increase in sales volumes led to a sales increase of $4.2 million, an increase in selling prices, which led to a sales increase of $2.0 million, and the effect of foreign currency translation of the RMB against the U.S. dollar, which led to a sales increase of $0.9 million.
 
Net sales for Other Sectors were $36.4 million for the year ended December 31, 2013, compared with $47.2 million for the year ended December 31, 2012, representing a decrease of $10.8 million or 22.8%, mainly due to lower sales volume of the new products launched in 2013 as compared to the sales volume of the old products sold in 2012, which led to a sales decrease of $9.1 million.
 
Cost of Sales
 
For the year ended December 31, 2013, the cost of sales was $338.5 million, compared with $275.3 million for the year ended December 31, 2012, an increase of $63.2 million, or 23.0%. The increase in cost of sales was mainly due to a net increase in sales volumes with a cost of sales increase of $72.7 million, a decrease in unit cost with a cost of sales decrease of $17.5 million and the appreciation of the RMB against the U.S. dollar with a cost of sales increase of $8.0 million. The decrease in the unit cost of sales was primarily due to a decrease in the costs of raw materials, such as steel. Further analysis is as follows:
 
Cost of sales for Henglong was $215.5 million for the year ended December 31, 2013, compared with $147.8 million for the year ended December 31, 2012, representing an increase of $67.7 million, or 45.9%. The increase in cost of sales was mainly due to an increase in sales volumes resulting in a cost of sales increase of $71.1 million, the adoption of technical innovations in production processes in 2013 and a decrease in unit material costs leading to a cost of sales decrease of $6.7 million, which were offset by the effect of foreign currency translation of the RMB against the U.S. dollar with a cost of sales increase of $3.3 million.
 
  
28

 
Cost of sales for Jiulong was $68.0 million for the year ended December 31, 2013, compared with $63.5 million for the year ended December 31, 2012, representing an increase of $4.5 million, or 7.2%. The increase in cost of sales was mainly due to an increase in sales volumes resulting in a cost of sales increase of $5.5 million, a decrease in unit cost resulting in a cost of sales decrease of $2.4 million and the effect of foreign currency translation of the RMB against the U.S. dollar resulting in a cost of sales increase of $1.4 million.
 
Cost of sales for Shenyang was $36.8 million for the year ended December 31, 2013, compared with $27.3 million for the year ended December 31, 2012, representing an increase of $9.5 million, or 34.6%. The increase in cost of sales was mainly due to an increase in sales volumes resulting in a cost of sales increase of $9.6 million, a decrease in unit cost resulting in a cost of sales decrease of $0.8 million and the effect of foreign currency translation of the RMB against the U.S. dollar resulting in a cost of sales increase of $0.7 million.
 
Cost of sales for Wuhu was $24.5 million for the year ended December 31, 2013, compared with $28.8 million for the year ended December 31, 2012, representing a decrease of $4.3 million, or 14.9%. The decrease in cost of sales was mainly due to a decrease in sales volumes resulting in a cost of sales decrease of $4.7 million and a decrease in unit cost resulting in a cost of sales decrease of $0.3 million, which were offset by the effect of foreign currency translation of the RMB against the U.S. dollar resulting in a cost of sales increase of $0.7 million.
 
Cost of sales for Hubei Henglong was $39.2 million for the year ended December 31, 2013, compared with $35.5 million for the year ended December 31, 2012, representing an increase of $3.7 million, or 10.6%.  The net increase in cost of sales was mainly due to an increase in sales volumes resulting in a cost of sales increase of $4.1 million, a decrease in unit cost resulting in a cost of sales decrease of $1.2 million and the appreciation of the RMB against U.S. dollar resulting in a cost of sales increase of $0.8 million.
 
Cost of sales for Other Sectors was $30.6 million for the year ended December 31, 2013, compared with $43.4 million for the year ended December 31, 2012, representing a decrease of $12.8 million, or 29.3%. The decrease in cost of sales was mainly due to a decrease in sales volumes resulting in a cost of sales decrease of $7.6 million and a decrease in unit cost resulting in a cost of sales decrease of $6.1 million, which were offset by the effect of foreign currency translation of the RMB against the U.S. dollar resulting in a cost of sales increase of $0.9 million.
 
Gross margin was 18.5% for the year ended December 31, 2013, representing a 0.4% increase from 18.1% for the year ended December 31, 2012, which was primarily due to an increase in sales volume of high gross margin products.
 
Gain on Other Sales
 
Gain on other sales mainly consisted of net amount retained from sales of materials and scraps. For the year ended December 31, 2013, gain on other sales amounted to $7.6 million, while it amounted to $4.4 million for the year ended December 31, 2012. The significant increase of $3.2 million, or 72.7%, was mainly due to the Company’s sale of part of its land use rights in the third quarter of 2013, which resulted in a recognition of a gain of $4.1 million (before tax) during the year ended December 31, 2013, representing the difference between the total selling price of $4.6 million and the net book value of the land use rights of $0.5 million.
 
Selling Expenses
 
For the years ended December 31, 2013 and 2012, selling expenses are summarized as follows (figures are in thousands of USD):
 
 
 
 
Year Ended December 31,
 
 
 
 
 
 
 
 
2013
 
2012
 
Increase/(Decrease)
 
Percentage
 
Salaries and wages
 
$
3,919
 
$
2,496
 
$
1,423
 
57.0
%
Office expense
 
 
1,928
 
 
1,574
 
 
354
 
22.5
 
Transportation expense
 
 
5,450
 
 
4,253
 
 
1,197
 
28.1
 
Rent expense
 
 
1,883
 
 
1,030
 
 
853
 
82.8
 
Other expense
 
 
151
 
 
204
 
 
(53)
 
-26.2
 
Total
 
$
13,331
 
$
9,557
 
$
3,774
 
39.5
%
 
 
29

 
Selling expenses were $13.3 million for the year ended December 31, 2013. As compared to $9.6 million for the year ended December 31, 2012, there was an increase of $3.7 million, or 39.5%, which was mainly due to:
 
·
an increase in salaries and wages for the Company’s salesmen, as a result of higher sales commsions paid for their improved sales performance in 2013;
 
·
an increase in office expenses (including office supplies, travel expenses and meeting expenses), as a result of an increase in marketing activities;
 
·
an increase in transportation expenses due to an increase in sales activities and expansion of the Company’s domestic and international markets, which are located farther away from the Company’s production bases; and
 
·
an increase in rent expense due to the increase of product warehouse rental space for the expansion of sales and commercial networks.
 
General and Administrative Expenses
 
For the years ended December 31, 2013 and 2012, general and administrative expenses are summarized as follows (figures are in thousands of USD):
 
 
 
 
Year Ended December 31,
 
 
 
 
 
 
 
 
2013
 
2012
 
Increase/(Decrease)
 
Percentage
 
Salaries and wages
 
$
4,777
 
$
4,559
 
$
218
 
4.8
%
Labor insurance expenses
 
 
1,854
 
 
1,549
 
 
305
 
19.7
 
Maintenance and repair expenses
 
 
510
 
 
727
 
 
(217)
 
-29.9
 
Property and other taxes
 
 
1,490
 
 
1,259
 
 
231
 
18.4
 
Provision for bad debts
 
 
60
 
 
74
 
 
(14)
 
-19.2
 
Office expense
 
 
1,330
 
 
1,270
 
 
60
 
4.8
 
Depreciation and amortization expense
 
 
822
 
 
939
 
 
(117)
 
-12.5
 
Listing expenses(1)
 
 
2,387
 
 
2,299
 
 
88
 
3.8
 
Others expenses
 
 
23
 
 
260
 
 
(237)
 
-91.2
 
Total
 
$
13,253
 
$
12,936
 
$
317
 
2.5
%
 
(1)
Listing expenses consisted of the costs associated with legal, accounting and auditing fees for operating a public company. The expenses also included share-based compensation expense for options granted to members of the audit committee.
 
General and administrative expenses were $13.3 million for the year ended December 31, 2013, compared with $12.9 million for the year ended December 31, 2012, representing an increase of $0.3 million, or 2.5%.
 
The analysis of expense items with significant fluctuation is as follows:
 
·
An increase in salaries and wages mainly due to the increase in management’s performance bonus in 2013 as the Company achieved the performance targets as pre-determined by the board of directors, while the Company did not achieve its performance targets for 2012;
 
· An increase in labor insurance expenses mainly because of the Company’s improvement in welfare benefits for the management and improvement of certain labor protection facilities.
 
·
There was a decrease in maintenance and repair expenses in 2013, which was mainly due to the scale down of repair and maintenance projects on the Company’s office facilities in 2013.
 
 
30

 
·
There was an increase in property tax and other taxes in 2013, which was mainly due to the Company’s housing property increase in 2013.
 
·
There was an increase in office expense which was mainly due to the Company’s replacement of office appliances.
 
· There was a decrease in depreciation and amortization expense, which was mainly due to certain office equipment that continued to be utilized in 2013 having been fully depreciated at the beginning of the year.
 
Research and Development Expenses
 
Research and development expenses, “R & D” expenses, were $20.9 million for the year ended December 31, 2013 as compared to $14.9 million for the year ended December 31, 2012, an increase of $6.0 million, or 40.3%, which was mainly due to the development and trial production of EPS. Expenses for mold improvement increased by $1.0 million, external technical support fees increased by $0.9 million and the salaries and wages expenses of research and development related staff increased by $4.1 million.
 
The global automotive parts industry is highly competitive; winning and maintaining new business requires suppliers to rapidly produce new and innovative products on a cost-competitive basis. In 2013, foreign OEMs significantly increased their demand for EPS, but the related technology in China was still in the research and development and testing stage. In order to expand into the market for EPS, the Company increased its investment in the research and development of EPS in 2013, including assigning the Company’s senior technicians and advanced manufacturing equipment to EPS, establishing the EPS trail-production department, hiring technologists and purchasing advanced technology and testing equipment. At present, the Company has developed several types of EPSs suitable for small-engine cars, and has sold certain quantities of EPS.
 
Income from Operations
 
Income from operations was $36.7 million for the year ended December 31, 2013 as compared to $27.8 million for the year ended December 31, 2012, an increase of $8.9 million, or 32.0%, which mainly consisted of an increase of $15.8 million, or 26.0%, in gross profit and an increase of $3.2 million, or 72.7%, in gain on other sales (such as raw materials and property, plant and equipment sales), offset by an increase in operating expenses of $10.1 million, or 27.0%.
 
Other Income, Net
 
Other income, net was $1.1 million for the year ended December 31, 2013 as compared to $0.5 million for the year ended December 31, 2012, an increase of $0.6 million, or 120.0%, primarily as a result of an increase in the unspecific purpose subsidies being recognized in 2013.
 
The Company’s government subsidies consisted of specific subsidies and other subsidies. Specific subsidies are the subsidies that the Chinese government has specified its purpose for, such as product development and renewal of production facilities. Other subsidies are the subsidies that the Chinese government has not specified its purpose for and are not tied to future trends or performance of the Company; receipt of such subsidy income is not contingent upon any further actions or performance of the Company and the amounts do not have to be refunded under any circumstances. The Company recorded specific purpose subsidies as advances payable when received. For specific purpose subsidies, upon government acceptance of the related project development or asset acquisition, the specific purpose subsidies will be recognized to reduce related R&D expenses or cost of asset acquisition. The unspecific purpose subsidies are recognized as other income upon receipt as future performance by the Company is not required.
 
 
31

 
Financial Income/(Expenses),Net
 
Financial income, net was $0.4 million for the year ended December 31, 2013 as compared to financial expenses, net of $2.2 million for the year ended December 31, 2012, a decrease of $2.6 million, or 118.2%, primarily as a result of: (a) the redemption of all outstanding convertible notes on May 25, 2012, the “Redemption,” which led to a decrease in financial expenses of $1.6 million; and (b) an increase in interest income of $1.4 million that was generated from the higher balance of time deposits during 2013. 
 
Loss on Change in Fair Value of Derivatives
 
Loss on change in fair value of derivatives was $0.5 million for the year ended December 31, 2012. Due to the Redemption, there was no gain or loss on change of fair value of derivative associated with convertible notes for the year ended December 31, 2013.
 
Estimating fair values of derivative financial instruments requires the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors. In addition, option-based techniques are highly volatile and sensitive to changes in the trading market price of the Company's common stock, which has a high estimated volatility. Derivative financial instruments are initially and subsequently carried at fair values and gain or loss on change in fair value of derivative liabilities is equal to the difference between the beginning and ending balances of the Company's derivative liabilities (see Note 23 to the consolidated financial statements in this Report). As of January 1, 2012 and December 31, 2012, the Company calculated the fair value of derivative liabilities at $0.5 million and $0, respectively. Therefore, the Company recorded a loss on change in fair value of derivative of $0.5 million for the year ended December 31, 2012.
 
Gain on Redemption of Convertible Notes
 
For the year ended December 31, 2012, the Company recorded a gain of $1.4 million for the Redemption. There was no gain on redemption of convertible notes for the year ended December 31, 2013.
 
Income Before Income Tax Expenses and Equity In Earnings Of Affiliated Companies
 
Income before income tax expenses and equity in earnings of affiliated companies was $38.2 million for the year ended December 31, 2013 compared with $27.1 million for the year ended December 31, 2012, an increase of $11.1 million, or 41.0%, including an increase in income from operations of $8.9 million, an increase in gain on other income of $0.6 million, a decrease in financial expense of $2.6 million, a decrease in loss on change in fair value of derivative of $0.5 million and a decrease in gain on redemption of convertible notes of $1.4 million.
 
Income Taxes
 
Income tax expense was $5.5 million for the year ended December 31, 2013 compared to $4.4 million for the year ended December 31, 2012, representing an increase of $1.1 million, or 25.0%, which was mainly due to an increase in income before tax and a decrease in effective tax rate. The effective tax rate decreased from 16.2% for the year ended December 31, 2012 to 14.4% for the year ended December 31, 2013, primarily due to an increase in technological development expenses of the Company in 2013. According to PRC tax regulations, the Company can deduct up to 150% of the technological development expenses when its tax payable was calculated.
 
Income From Continuing Operations
 
Income from continuing operations was $33.0 million for the year ended December 31, 2013, compared with $22.8 million for the year ended December 31, 2012, representing an increase of $10.2 million, or 44.7%, mainly due to an increase in income before income tax expenses and equity in earnings of affiliated companies of $11.1 million offset by an increase in income tax expense of $1.1 million.
 
 
32

 
Income From Discontinued Operations
 
The Company sold its 51% equity interest in Zhejiang Henglong & Vie Pump-Manu Co., Ltd., “Zhejiang,” in May 2012 (see Note 25 to the consolidated financial statements in this Report). The net income from the discontinued operations was $2.7 million for the year ended December 31, 2012, which included a gain on such sale of Zhejiang of $2.5 million (after tax) and net operating income of $0.2 million.
 
Net Income
 
Net income was $33.0 million for the year ended December 31, 2013, compared with net income of $25.5 million for the year ended December 31, 2012, representing an increase of $7.5 million, or 29.4%, mainly due to an increase in income from continuing operations of $10.2 million offset by a decrease in income from discontinued operations of $2.6 million.
 
Net Income Attributable to Noncontrolling Interests
 
The Company recorded net income attributable to noncontrolling interests of $6.3 million for the year ended December 31, 2013, compared to $4.7 million for the year ended December 31, 2012, representing an increase of $1.6 million, or 34.0%.
 
The Company owns different equity interests in ten non-wholly owned subsidiaries established in the PRC and Brazil, through which it conducts its operations. Except for Beijing Henglong, which is accounted for under the equity method, all of the operating results of these non-wholly owned subsidiaries were consolidated in the Company’s consolidated financial statements as of December 31, 2013 and 2012. For the year ended December 31, 2013 and 2012, the Company recorded $6.3 million and $4.7 million, respectively, for the noncontrolling interests’ share in the earnings of the consolidated non-wholly owned subsidiaries.
 
Net Income Attributable to Parent Company
 
Net income attributable to parent company was $26.8 million for the year ended December 31, 2013. As compared to $20.7 million for the year ended December 31, 2012, there was an increase of $5.9 million, due to an increase in net income of $7.6 million, offset by an increase in net income attributable to noncontrolling interests of $1.6 million.
 
LIQUIDITY AND CAPITAL RESOURCES
 
Capital Resources and Use of Cash
 
The Company has historically financed its liquidity requirements from a variety of sources, including short-term borrowings under bank credit agreements, bankers’ acceptances, issuances of capital stock and notes and internally generated cash. As of December 31, 2013, the Company had cash and cash equivalents and short-term investments of $89.5 million, compared with $87.6 million as of December 31, 2012, an increase of $1.9 million, or 2.2%.
 
The Company had working capital of $179.3 million as of December 31, 2013, compared with $138.8 million as of December 31, 2012, representing an increase of $40.5 million, or 29.2%.
 
The Company intends to indefinitely reinvest the funds in subsidiaries established in the PRC.
 
The Company believes that, in view of its current cash position as of December 31, 2013, the cash expected to be generated from the operations and funds available from bank borrowings will be sufficient to meet its working capital and capital expenditure requirements (including the repayment of bank loans) for at least twelve months commencing from December 31, 2013.
 
Capital Source
 
The Company’s capital source is multifaceted, such as bank loans and banker’s acceptance facilities. In financing activities and operating activities, the Company’s banks require the Company to sign line of credit agreements and repay such facilities within one year. On the condition that the Company can provide adequate mortgage security and has not violated the terms of the line of credit agreement, such one year facilities can be extended for another year.
 
 
33

 
As of December 31, 2013, the Company had short-term bank loans of $37.4 million and bankers’ acceptances of $78.2 million (see Note 11 to the consolidated financial statements in this Report).
 
The Company currently expects to be able to obtain similar bank loans (i.e., RMB loans) and bankers’ acceptance facilities in the future if it can provide adequate mortgage security following the termination of the above-mentioned agreements (see the table under “Bank Arrangements” below for more information). If the Company is not able to do so, it will have to refinance such debt as it becomes due or repay that debt to the extent it has cash available from operations or from the proceeds of additional issuances of capital stock. Owing to depreciation, the value of the mortgages securing the above-mentioned bank loans and banker's acceptances will be reduced by approximately $14.7 million over the next 12 months. If the Company wishes to obtain the same amount of bank loans and banker's acceptances, it will have to provide additional mortgages of $14.7 million as of the maturity date of such line of credit agreements (see the table under “Bank Arrangements” below for more information). The Company can still obtain a reduced line of credit with a reduction of $9.0 million, which is 61.4% (the mortgage rate) of $14.7 million, if it cannot provide additional mortgages. The Company expects that the reduction in bank loans will not have a material adverse effect on its liquidity.
 
On May 18, 2012, the Company entered into a credit agreement with Industrial and Commercial Bank of China (Macau) Limited, “ICBC Macau,” to obtain a non-revolving facility of $30 million, the “Credit Facility.” The Credit Facility would have expired on November 3, 2012, unless the Company drew down the line of credit in full prior to such expiration date and the maturity date for the loan drawdown was the earlier of (i) 18 months from the drawdown or (ii) 1 month before the expiry of the Henglong Standby Letter of Credit issued by Industrial and Commercial Bank of China, Jingzhou Branch, “ICBC Jingzhou,” as described below.
 
The interest rate of the Credit Facility is calculated based on a three-month LIBOR plus 2.25% per annum, subject to the availability of funds and fluctuation at ICBC Macau’s discretion. The interest is calculated daily on a 360-day basis and is to be fixed one day before the first day of each interest period. The interest period is defined as three months from the date of drawdown.
 
As security for the Credit Facility, the Company was required to provide ICBC Macau with the Henglong Standby Letter of Credit for a total amount of not less than $31.6 million if the Credit Facility were to be fully drawn.
 
On May 22, 2012, the Company drew down the full amount of $30.0 million under the Credit Facility and provided the Henglong Standby Letter of Credit for an amount of $31.6 million in favor of ICBC Macau. The Henglong Standby Letter of Credit issued by ICBC Jingzhou is collateralized by Henglong’s notes receivable of RMB196.3 million (equivalent to approximately $32.2 million). The Company also paid an arrangement fee of $0.1 million to ICBC Macau and $0.1 million to ICBC Jingzhou. The original maturity date of the Credit Facility was May 22, 2013. On May 7, 2013, ICBC Macau agreed to extend the maturity date of the Credit Facility to May 13, 2014. The interest rate of the Credit Facility under the extended term is calculated based on the three-month LIBOR plus 2.0% per annum. Except for the above, all other terms and conditions as stipulated in the ICBC Macau credit agreement remain unchanged. As of December 31, 2013, the interest rate on the Credit Facility was 2.24% per annum.
 
 
34

 
Bank Arrangements
 
As of December 31, 2013, the principal outstanding under the Company’s credit facilities and lines of credit was as follows:
 
 
 
 
 
 
 
Amount
 
 
 
 
Assessed
 
 
 
 
 
Due
 
Available
 
 
 
 
Mortgage Value
 
 
 
Bank
 
Date
 
(4)
 
Amount Used
 
 
(6)
 
1. Comprehensive credit facilities(7)
 
Bank of China
 
Mar 2014
 
$
23,127
 
$
9,787
 
 
$
15,793
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2. Comprehensive credit facilities
 
Jingzhou Commercial Bank
 
Jul 2014
 
 
32,804
 
 
26,340
 
 
 
63,087
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
3. Comprehensive credit facilities
 
China Construction Bank
 
Nov 2014
 
 
11,481
 
 
1,640
 
 
 
31,040
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
4. Comprehensive credit facilities(1)(5)
 
Shanghai Pudong Development Bank
 
Dec 2013
 
 
16,402
 
 
13,179
 
 
 
13,297
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
5. Comprehensive credit facilities(1)
 
China CITIC Bank
 
Nov 2014
 
 
20,338
 
 
11,398
 
 
 
15,262
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
6. Comprehensive credit facilities
 
Industrial and Commercial Bank of China
 
Sep 2014
 
 
13,121
 
 
3,280
 
 
 
3,280
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
7. Comprehensive credit facilities(1)
 
China Hua Xia Bank
 
Sep 2014
 
 
26,243
 
 
2,839
 
 
 
-
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
8. Comprehensive credit facilities
 
China Everbright Bank
 
Aug 2014
 
 
4,921
 
 
4,189
 
 
 
8,398
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
9. Comprehensive credit facilities
 
ICBC Macau
 
May 2014
 
 
30,000
 
 
30,000
 
 
 
32,193
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
 
 
 
 
 
$
178,437
 
$
102,652
(2)
 
$
182,350
(3)
 
 
(1)
Henglong’s comprehensive credit facility provided by China CITIC Bank and China Hua Xia Bank and each of Henglong and Jielong’s comprehensive credit facilities provided by Shanghai Pudong Development Bank are required to be guaranteed by Jiulong, another subsidiary of the Company, in addition to the above pledged assets.
 
 
 
 
(2)
The amount used includes bank loans of $37.4 million and notes payable of $65.3 million as of December 31, 2013. The remainder of $12.9 million of notes payable out of the total notes payable of $78.2 million (see Note 13 to the consolidated financial statements in this Report) was 100% secured by bank notes without utilization of credit lines.
 
 
 
 
(3)
As of December 31, 2013, the pledged assets included $51.3 million accounts and notes receivable and other pledged assets with assessed value of $131.1 million.
 
 
 
 
(4)
The amount available is used for the drawdown of bank loans and issuance of bank notes. For the drawdown of bank loans, this amount represents the amount that the Company can borrow immediately; for issuance of bank notes, the Company needs to pledge additional collateral in order to utilize these bank facilities.
 
 
 
 
(5)
As at the date of this Report, the comprehensive credit facilities with Shanghai Pudong Development Bank have expired. The Company is negotiating the renewal of the credit facilities with the bank and expects to obtain the renewal in early April 2014. As the Company has obtained sufficient comprehensive lines of credit from other banks, the Company does not anticipate any significant adverse impact on its financial position if the Company fails to renew these credit facilities.
 
 
           
 
(6)
The pledged cash deposits, which are disclosed in Note 3 to the consolidated financial statements in this Report, were not included in the assessed mortgage value.
 
 
 
 
(7)
As at the date of this Report, the comprehensive credit facilities with Bank of China have expired. The Company is negotiating the renewal of the credit facilities with the bank and expects to obtain the renewal in late April 2014As the Company has obtained sufficient comprehensive lines of credit from other banks, the Company does not anticipate any significant adverse impact on its financial position if the Company fails to renew these credit facilities.
 
The Company may request the banks to issue notes payable or bank loans within its credit line using a 365-day revolving line (see Notes 12 and 11 to the consolidated financial statements in this Report).
 
 
35

 
The Company renewed its existing short-term bank loans and borrowed new bank loans during 2013 at annual interest rates of 2.24% to 7.20%, and maturity terms of twelve months. Pursuant to the comprehensive credit line arrangement the Company pledged: (1) accounts receivable of $15.8 million as security for its comprehensive credit facility with the Bank of China; (2) equipment with an assessed value of approximately $63.1 million as security for its revolving comprehensive credit facility with Jingzhou Commercial Bank; (3) equipment, land use rights and buildings with an assessed value of approximately $31.0 million as security for its comprehensive credit facility with China Construction Bank; (4) land use rights and buildings with an assessed value of approximately $13.3 million as security for its comprehensive credit facility with Shanghai Pudong Development Bank; (5) land use rights and buildings with an assessed value of approximately $15.3 million as security for its comprehensive credit facility with China CITIC Bank; (6) accounts receivable of $3.3 million as security for its comprehensive credit facility with Industrial and Commercial Bank of China; (7) Henglong’s comprehensive credit facility with China Hua Xia Bank is guaranteed by Jiulong, another subsidiary of the Company; (8) land use rights and buildings with an assessed value of approximately $8.4 million as security for its comprehensive credit facility with China Everbright Bank; and (9) $32.2 million of notes receivable held by Henglong.
 
Cash Requirements 
 
The following table summarizes the Company’s expected cash outflows resulting from financial contracts and commitments. The Company has not included information on its recurring purchases of materials for use in its manufacturing operations. These amounts are generally consistent from year to year, closely reflecting the Company’s levels of production, and are not long-term in nature (being less than three months in length).
 
 
 
Payment Due Dates
 
 
 
( in thousands of USD)
 
 
 
 
 
Less than 1
 
 
 
 
 
More than 5
 
 
 
Total
 
year
 
1-3 years
 
3-5 years
 
Years
 
Short-term loan including interest payable
 
$
37,012
 
$
37,012
 
$
-
 
$
-
 
$
-
 
Notes payable (1)
 
 
78,217
 
 
78,217
 
 
-
 
 
-
 
 
-
 
Other contractual purchase commitments, including service agreements
 
 
9,775
 
 
9,542
 
 
233
 
 
-
 
 
-
 
Total
 
$
125,004
 
$
124,771
 
$
233
 
$
-
 
$
-
 
 
(1)
Notes payable do not bear interest.
 
Short-term Bank Loans
 
The following table summarizes the contract information of short-term borrowings between the banks and the Company as of December 31, 2013 (figures are in thousands of USD).
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Borrowing
 
Annual
 
Date of
 
 
 
 
Amount
 
 
 
 
 
Borrowing
 
Term
 
Percentage
 
Interest
 
 
 
 
Payable on
 
Bank
 
Purpose
 
Date
 
(Months)
 
Rate
 
Payment
 
Due Date
 
 
Due Date
 
ICBC Macau
 
Working Capital
 
13 May 2013
 
12
 
2.24
%
Pay quarterly
 
13 May 2014
 
 
 
30,000
 
China CITIC Bank
 
Working Capital
 
7 Aug 2013
 
12
 
7.20
%
Pay monthly
 
7 Aug 2014
 
 
 
2,460
 
Industrial and Commercial Bank of China
 
Working Capital
 
1 Oct 2013
 
5
 
5.60
%
Pay monthly
 
27 Feb 2014
(1)
 
 
3,280
 
China Construction Bank
 
Working Capital
 
18 Jul 2013
 
12
 
6.00
%
Pay monthly
 
18 Jul 2014
 
 
 
1,641
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
$
37,381
 
 
 
(1)
Such borrowing was duly repaid.
 
 The Company must use the bank loans for the purpose described in the table. If the Company fails to do so, it will be charged a penalty interest at 100% of the specified loan rate listed in the table above. Except for the loan granted by ICBC Macau as disclosed in the section “Capital Source” above, the Company has to pay interest at the interest rate described in the table on the 20th of each month. If the Company fails to do so, it will be charged compound interest at the specified rate in the above table. The Company has to repay the principal outstanding on the specified date in the table. If it fails, it will be charged a penalty interest at 50% of the specified loan rate.
 
 
36

 
Management believes that the Company had complied with such financial covenants as of December 31, 2013, and will continue to comply with them.
 
Notes Payable
 
The following table summarizes the contract information of issuing notes payable between the banks and the Company as of December 31, 2013 (figures are in thousands of USD):
 
 
 
 
 
 
 
Amount Payable on
 
Purpose
 
Term (Month)
 
Due Date
 
Due Date
 
Working Capital (1)
 
3-6
 
Jan 2014
 
$
16,101
 
Working Capital (1)
 
3-6
 
Feb 2014
 
 
12,047
 
Working Capital (1)
 
3-6
 
Mar 2014
 
 
12,428
 
Working Capital
 
3-6
 
Apr 2014
 
 
13,493
 
Working Capital
 
3-6
 
May 2014
 
 
11,792
 
Working Capital
 
3-6
 
Jun 2014
 
 
12,356
 
Total
 
 
 
 
 
$
78,217
 
 
 
(1)
The notes payable were repaid in full on their respective due dates.
 
The Company must use notes payable for the purpose described in the table. If it fails to do so, the banks will no longer issue the notes payable, and it may have an adverse effect on the Company’s liquidity and capital resources. The Company has to deposit sufficient cash in the designated account of the bank on the due date of notes payable for payment to the suppliers. If the bank has advanced payment for the Company, it will be charged a penalty interest at 50% of the loan rate that is published by the People’s Bank of China in the same period.
 
Management believes that the Company had complied with such financial covenants as of December 31, 2013, and will continue to comply with them.
 
Cash flows
 
(a) Operating activities
 
 
Net cash provided by operations for the year ended December 31, 2013 was $12.9 million, compared with net cash provided of $16.2 million for the year ended December 31, 2012, representing a decrease of $3.3 million.
 
For the year ended December 31, 2013, the decrease in net cash provided by operations was mainly due to the net effect of (1) the increase in net income (excluding non-cash items) by $9.9 million, (2) the change in the balance of accounts and notes receivable which led to a decrease in net cash provided by operations of $35.2 million, which was mainly due to the sales of the Company’s products generally on credit terms which range from 4 to 6 months, and the fact that, during the year ended December 31, 2013, there was a significant increase in sales revenue of the Company’s products which led to an increase in the ending balance of the accounts receivable; (3) the change in the balance of inventories which led to a decrease in net cash provided by operations of $8.9 million, which was mainly due to the increase in inventory as a result of an increase in sales; (4) the change in the balance of accounts and notes payable which led to an increase in net cash provided by operations of $18.9 million, which was mainly due to an increase in purchases of raw materials by the Company for the year ended December 31, 2013. The credit terms for which the Company obtained from its suppliers generally range from 4 to 6 months, and as a result, the ending balance of account payable significantly increased; (5) the change in the balance of accrued expenses and other accounts payable which led to an increase in net cash provided by operations of $10.8 million, which was mainly due to the Redemption and the Company’s payment of the make-whole redemption interest of $8.0 million pursuant thereto, and an increase in sales which led to an increase in warranty expenses of the Company; and (6) the change in the balance of tax payable which led to a decrease in cash provided by operations of $2.2 million.
 
 
37

 
(b) Investing activities
 
 
The Company used net cash of $43.1 million in investment activities for the year ended December 31, 2013, compared with $6.3 million used during the year ended December 31, 2012, representing an increase of $36.8 million, which was mainly due to an increase of $35.1 million in time deposits with banks with original maturities of over three months which are due within one year and a net cash decrease of $7.5 million pursuant to the Company’s sale of its 51% equity interest in Zhejiang in May 2012 (see Note 25), whereas there was no such income in 2013, offset by an increase in receipt of cash from sale of property, plant and equipment of $2.3 million and a decrease in the payment for the acquisition of equipment of $4.3 million.
 
(c) Financing activities
 
During the year ended December 31, 2013, the Company used net cash of $5.8 million in financing activities, compared to net cash of $4.6 million provided by financing activities for the same period of 2012, which was mainly due to the net effect of: (1) decreased proceeds of $25.0 million from government loans and bank loans; (2) the decrease in dividends paid to the non-controlling shareholders of joint ventures of $1.5 million; and (3) the Redemption in the year ended December 31, 2012, which resulted in a $23.6 million cash outflow.
 
OFF-BALANCE SHEET ARRANGEMENTS
 
At December 31, 2013 and 2012, the Company did not have any transactions, obligations or relationships that could be considered off-balance sheet arrangements.
 
COMMITMENTS AND CONTINGENCIES
 
In addition to bank loans, notes payables and the related interest, the following table summarizes the Company’s irrevocable commitments having initial terms in excess of one year as of December 31, 2013 (figures are in thousands of USD): 
 
 
 
Payment Obligations by Period
 
 
 
2014
 
2015
 
2016
 
2017
 
Thereafter
 
Total
 
Obligations for service agreements
 
$
374
 
$
-
 
$
-
 
$
-
 
$
-
 
$
374
 
Obligations for purchasing agreements
 
 
9,168
 
 
233
 
 
-
 
 
-
 
 
-
 
 
9,401
 
Total
 
$
9,542
 
$
233
 
$
-
 
$
-
 
$
-
 
$
9,775
 
 
SUBSEQUENT EVENTS
 
The Company and plaintiffs have reached a settlement in principle and, on March 28, 2014, entered into a settlement agreement, which includes a dismissal of all claims by plaintiffs against the Company and its current and former officers and directors, with no admission of any wrongdoing or liability. For more information, please see Item 3 - Legal Proceedings in this Annual Report on Form 10-K.
 
INFLATION AND CURRENCY MATTERS
 
China’s economy has experienced rapid growth recently, mostly through the issuance of debt. Debt-induced economic growth can lead to growth in the money supply and rising inflation. If prices for the Company’s products rise at a rate that is insufficient to compensate for the rise in the cost of supplies, it may harm the Company’s profitability. In order to control inflation in the past, the Chinese government has imposed controls on bank credit, limits on loans for fixed assets and restrictions on state bank lending. Such policies can lead to a slowing of economic growth. Rises in interest rates by the central bank would likely slow economic activity in China which could, in turn, materially increase the Company’s costs and also reduce demand for the Company’s products.
 
Foreign operations are subject to certain risks inherent in conducting business abroad, including price and currency exchange controls, and fluctuations in the relative value of currencies. During 2013, the Company supplied products to North America and settled in cash in U.S. dollars. As a result, appreciation or currency fluctuation of the RMB against the U.S. dollar would increase the cost of export products, and adversely affect the Company’s financial performance.
 
 
38

 
In July 2005, the Chinese government adjusted its exchange rate policy from “Fixed Rate” to “Floating Rate.” During December 2012 to December 2013, the exchange rate between RMB and U.S. dollar appreciated from RMB1.00 to $0.1591 to RMB1.00 to $0.1640. The appreciation of the RMB may continue in the near term, as the Chinese government attempts to slow the rate of inflation in the PRC. Significant appreciation of the RMB is likely to decrease the amount of export products, thus decreasing the Company’s income.
 
RECENT ACCOUNTING PRONOUNCEMENTS
 
In February 2013, the FASB issued ASU 2013-04,“Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation is Fixed at the Reporting Date”. This update provides guidance for the recognition, measurement and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this update is fixed at the reporting date, except for obligations addressed within existing guidance in U.S. GAAP. The guidance requires an entity to measure those obligations as the sum of the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors and any additional amount the reporting entity expects to pay on behalf of its co-obligors. The guidance in this update also requires an entity to disclose the nature and amount of the obligation as well as other information about those obligations. This update is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. This update should be applied retrospectively to all prior periods presented for those obligations resulting from joint and several liability arrangements within this update’s scope that exist at the beginning of an entity’s fiscal year of adoption. An entity may elect to use hindsight for the comparative periods (if it changed its accounting as a result of adopting the amendments in this update) and should disclose that fact. Early adoption is permitted. The adoption of this standard is not expected to have any impact on the Company’s financial position.
 
On July 18, 2013, the FASB issued ASU 2013-11, "Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists” (Income Taxes - Topic 740). This update applies to all entities that have unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists at the reporting date. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, unless otherwise provided in the update. To the extent that a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date. For example, an entity should not evaluate whether the deferred tax asset has expired before the statute of limitations on the tax position or whether the deferred tax asset may be used prior to the unrecognized tax benefit being settled. The amendments in this update do not require new recurring disclosures. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The Company is currently evaluating the impact of adopting this update on its financial statements.
 
 
39

 
SIGNIFICANT ACCOUNTING POLICIES AND CRITICAL ACCOUNTING ESTIMATES
 
The Company prepares its consolidated financial statements in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amount of revenues and expenses during the reporting periods. Management periodically evaluates the estimates and judgments made. Management bases its estimates and judgments on historical experience and on various factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates as a result of different assumptions or conditions. The following critical accounting policies affect the more significant judgments and estimates used in the preparation of the Company’s consolidated financial statements.
 
The Company considers an accounting estimate to be critical if:
 
· it requires the Company to make assumptions about matters that were uncertain at the time it was making the estimate; and
 
· changes in the estimate or different estimates that the Company could have selected would have had a material impact on the Company’s financial condition or results of operations.
 
The table below presents information about the nature and rationale for the Company critical accounting estimates:
 
 
 
Critical
 
 
 
 
 
 
Balance Sheet
 
Estimate
 
 
 
Assumptions/Approaches
 
 
Caption
 
Item
 
Nature of Estimates Required
 
Used
 
Key Factors
Accrued liabilities and other long-term liabilities
 
Warranty obligations
 
Estimating warranty requires the Company to forecast the resolution of existing claims and expected future claims on products sold. VMs (Vehicle Manufacturer) are increasingly seeking to hold suppliers responsible for product warranties, which may impact the Company’s exposure to these costs.
 
The Company bases its estimate on historical trends of units sold and payment amounts, combined with its current understanding of the status of existing claims and discussions with its customers.
 
· VM sourcing
· VM policy decisions regarding warranty claims
 
 
 
 
 
 
 
 
 
Property, plant and equipment, intangible assets and other long-term assets
 
Valuation of long- lived assets and investments
 
The Company is required from time-to-time to review the recoverability of certain of its assets based on projections of anticipated future cash flows, including future profitability assessments of various product lines.
 
The Company estimates cash flows using internal budgets based on recent sales data, independent automotive production volume estimates and customer commitments.
 
· Future production estimates
· Customer preferences and decisions
 
 
 
 
 
 
 
 
 
Accounts and notes receivables
 
Provision for doubtful accounts and notes receivable
 
Estimating the provision for doubtful accounts and notes receivable requires the Company to analyze and monitor each customer’s credit standing and financial condition regularly. The Company grants credit to its customers, generally on an open account basis. It will impact the Company’s expense disclosure and results of operations if such estimate is improper.
 
The Company grants credit to its customers for three to four months based on each customer’s current credit standing and financial data. The Company assesses allowance on an individual customer basis, under normal circumstances. The Company records provision for bad debts based on specific identification methods.
 
·Customers’ credit standing and financial condition
 
 
40

 
Deferred income taxes
 
Recoverability of deferred tax assets
 
The Company is required to estimate whether recoverability of its deferred tax assets is more likely than not based on forecasts of taxable earnings in the related tax jurisdiction.
 
The Company uses historical and projected future operating results, based upon approved business plans, including a review of the eligible carry forward period, tax planning opportunities and other relevant considerations.
 
· Tax law changes
· Variances in future projected profitability, including by taxing entity
 
 
 
 
 
 
 
 
 
Convertible notes payable, warrant liabilities, compound derivative liabilities
 
Warrant liabilities and compound derivative liabilities
 
The Company is required to estimate the fair value of warrant liabilities and compound derivative liabilities at conception and completion of each reporting period.
 
The Company uses Black-Scholes option pricing model to determine fair value of warrant; uses Monte Carlo simulation (“MCS”) valuation techniques to determine fair value of compound derivative liabilities.
 
· Expected volatility
· Risk-free rate
· Interest market risk
· Credit risk
· Redemption activities before maturity
 
 
 
 
 
 
 
 
 
Uncertain tax
 
Uncertain tax positions
 
The Company is required to determine and assess all material positions, including all significant uncertain positions in all tax years that are still subject to assessment or challenge under relevant tax statutes.
 
The Company applies a more likely than not threshold and a two-step approach for tax position measurement and financial statement recognition. For the two-step approach, the first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely to be realized upon settlement.
 
· An allocation or a shift of income between jurisdictions
· The characterization of income or a decision to exclude reporting taxable income in a tax return
·A decision to classify a transaction, entity, or other position in a tax return as tax exempt
 
In addition, there are other items within the Company’s financial statements that require estimation, but are not as critical as those discussed above. These include the allowance for reserves for excess and obsolete inventory. Although not significant in recent years, changes in estimates used in these and other items could have a significant effect on the Company’s consolidated financial statements.
 
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
 
The Company is exposed to market risk from changes in interest rates and foreign currency exchange rates. For purposes of specific risk analysis, the Company uses sensitivity analysis to determine the effects that market risk exposures may have.
 
FOREIGN CURRENCY RISK
 
The Company’s reporting currency is the U.S. dollar and the majority of its revenues will be settled in RMB and U.S. dollars. The Company’s currency exchange rate risks come primarily from the sales of products to international customers. Most of the Company’s assets are denominated in RMB except for part of cash and accounts receivable. As a result, the Company is exposed to foreign exchange risk as its revenues and results of operations may be affected by fluctuations in the exchange rate between the U.S. dollar and the RMB.
 
The value of the RMB fluctuates and is affected by, among other things, changes in China's political and economic conditions. In addition, the RMB is not readily convertible into U.S. dollars or other foreign currencies. All foreign exchange transactions continue to take place either through the Bank of China or other banks authorized to buy and sell foreign currencies at the exchange rate quoted by the People’s Bank of China. The conversion of RMB into foreign currencies such as the U.S. dollar has been generally based on rates set by the People's Bank of China, which are set daily based on the previous day's interbank foreign exchange market rates and current exchange rates on the world financial markets. On December 31, 2013 and 2012, the exchange rates of RMB against U.S. dollar were RMB1.00 to $0.1591 and RMB1.00 to $0.1640, respectively. This floating exchange rate, and any appreciation of the RMB that may result from such rate, could have various adverse effects on the Company’s business. If the RMB appreciates against foreign currencies, it will make the Company’s sales income increase.
 
 
41

 
In order to mitigate the currency exchange rate risk, the Company has inserted a currency exchange rate fluctuation compensation provision in its sales contracts with its international customers to the effect that both parties will bear 50% of such loss when the fluctuation is over 8% within that contract year.
 
CREDIT RISK
 
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of trade accounts receivable. The Company does not require collateral or other security to support client receivables since most of its customers are large, well-established companies. The Company's credit risk is also mitigated because its customers are all selected enterprises supported by the local government. One customer, Chrysler North America, accounted for more than 10% (11.1%) of the Company’s consolidated revenues in 2013. The Company maintains an allowance for doubtful accounts for any potential credit losses related to its trade receivables. The Company does not use foreign exchange contracts to hedge the risk in receivables denominated in foreign currencies and the Company does not hold or issue derivative financial instruments for trading or speculative purposes.
 
INTEREST RATE RISK
 
The Company’s exposure to changes in interest rates results primarily from its credit facility borrowings. As of December 31, 2013, the Company had $30.0 million of outstanding indebtedness, which is subject to interest rate fluctuations. Based on the amount of such borrowings as of December 31, 2013, it is expected that a hypothetical 100 basis point increase in the then current LIBOR rate would increase the Company’s interest expense by $0.3 million on an annual basis.
 
The Company’s level of outstanding indebtedness fluctuates from time to time and may result in additional payable.
 
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
 
(a)
The financial statements required by this item begin on page 59.
(b)
Selected quarterly financial data for the past two years are summarized in the following table (figures are in thousands of USD, except those for items headed “Basic” and “Diluted”): 
 
 
 
Quarterly Results of Operations
 
 
 
First
 
Second
 
Third
 
Fourth
 
 
 
2013
 
2012
 
2013
 
2012
 
2013
 
2012
 
2013
 
2012
 
Net sales
 
$
97,164
 
$
80,920
 
$
97,889
 
$
80,379
 
$
90,919
 
$
73,184
 
$
129,187
 
$
101,523
 
Gross profit
 
 
19,362
 
 
15,378
 
 
18,389
 
 
15,632
 
 
16,525
 
 
12,501
 
 
22,357
 
 
17,240
 
Operating income from continuing operations
 
 
9,346
 
 
6,336
 
 
7,814
 
 
8,574
 
 
10,970
 
 
5,463
 
 
8,589
 
 
7,425
 
Net income from continuing operations
 
 
7,526
 
 
254
 
 
6,206
 
 
11,631
 
 
10,429
 
 
4,400
 
 
8,904
 
 
6,551
 
Net income from discontinued operations
 
 
-
 
 
31
 
 
-
 
 
2,620
 
 
-
 
 
-
 
 
-
 
 
-
 
Net income
 
 
7,526
 
 
285
 
 
6,206
 
 
14,251
 
 
10,429
 
 
4,400
 
 
8,904
 
 
6,551
 
Net income attributable to noncontrolling interest
 
 
1,586
 
 
1,054
 
 
1,225
 
 
1,229
 
 
1,805
 
 
996
 
 
1,659
 
 
1,465
 
Net income (loss) attributable to parent company
 
 
5,940
 
 
(769)