10-Q 1 form10q_17217.htm ZAP FORM 10-Q form10q_17217.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

Form 10-Q

(Mark One)
 
x
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
For the quarterly period ended September 30, 2011
 
o
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    001-32534
 
 
 
ZAP
(Exact name of registrant as specified in its charter)
   
California
94-3210624
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
   
501 4th Street Santa Rosa, CA           95401
(Address of principal executive offices) (Zip Code)
 
 (707) 525-8658
(Registrant’s telephone number)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
Yes  x   No  o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data Filer 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  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a small reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer  o Accelerated filer  o Non-accelerated filer  o 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  o   No  x
 
As of November 11, 2011, there were 227,375,240 shares outstanding of the issuer’s common stock.
 


 
 
 
 
FORM 10-Q
INDEX
 
 
 
 
Page
No
   
   
PART I.  Financial Information
 
   
             Item 1.
Financial Statements
3
   
 
Unaudited Condensed Consolidated Balance Sheets as of September 30, 2011 and December 31, 2010
3
   
 
Unaudited Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2011 and 2010
4
   
 
Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2011 and 2010
5
   
 
Notes to Unaudited Condensed Consolidated Financial Statements
6
   
             Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
24
   
             Item 3. 
Quantitative and Qualitative Disclosures About Market Risk
32
   
             Item 4. 
Controls and Procedures
33
   
   
PART II.  Other Information
 
   
             Item 1. 
Legal Proceedings
33
   
             Item 1A. 
Risk Factors
34
   
             Item 2. 
Unregistered Sales of Equity Securities and Use of Proceeds
53
   
             Item 3.
Defaults Upon Senior Securities
54
   
             Item 4. 
[Removed and Reserved]
54
   
             Item 5.
Other Information
54
   
             Item 6. 
Exhibits
54
 
 
 
 
2

 
PART I.  Financial Information
 
Item 1.  Financial Statements
 
ZAP AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
 (In thousands, except share data))
(Unaudited)
 
ASSETS
   
As of
   
As of
 
   
September 30,
   
December 31,
 
   
2011
   
2010
 
Current assets:
           
Cash and cash equivalents
 
$
1,451
   
$
1,503
 
Restricted cash
   
3,366
     
 
Accounts receivable, net of allowance of $17 in 2011 and $27 in 2010
   
4,108
     
294
 
Due from related party-Jonway
   
3,247
     
 
Marketable Securities
   
1,426
     
1,888
 
Notes receivable from Jonway dealers
   
1,477
     
 
Inventories, net of reserve of $877 in 2011 and $619 in 2010
   
10,294
     
1,822
 
Prepaid expenses and other current assets
   
2,591
     
266
 
Total current assets
   
27,960
     
5,773
 
                 
Property and equipment, net
   
46,172
     
173
 
                 
Other assets:
               
Investment in non-consolidated joint venture
   
601
     
808
 
Distribution fees for Jonway and Better World products
               
   net of amortization of $2.6 million in 2011 and $961 in 2010
   
13,979
     
15,599
 
Intangible assets, net of amortization of $905 in 2011 and $197 in 2010
   
17,449
     
97
 
Goodwill
   
6,637
     
 
Deposit on Zhejiang Jonway Auto
   
     
11,000
 
Deposits and other asset, net
   
77
     
62
 
Total assets
 
$
112,875
   
$
33,512
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
           
8 % Senior Convertible debt, net of discount
 
$
12,523
 
 
$
 
Short term debt and notes
   
9,473
     
668
 
Accounts payable
   
13,881
     
328
 
Accrued liabilities
   
10,141
     
2,197
 
Advances from customers
   
1,233
     
 
Other payables
   
473
     
 
Due to related party
   
2,138
     
 
Taxes payable
   
927
     
 
Total current liabilities
   
50,789
     
3,193
 
Long term liabilities:
               
Derivative liability
   
     
5,539
 
       Warranty  Liability
   
279
     
—-
 
Total long term liabilities
   
279
     
5,539
 
Total liabilities
   
51,068
     
8,732
 
                 
Commitments and contingencies
   
     
 
                 
                 
Equity:
    ZAP shareholders’ equity :
Common stock, 800 million shares authorized; no par value; 223,972,210 and 207,254,789 shares issued and outstanding at September 30, 2011 and December 31, 2010, respectively
   
216,821
     
179,691
 
Accumulated other comprehensive income ( loss)
   
1,742
     
(112
)
Notes receivable - Shareholders
   
(331
)
   
 
Accumulated deficit
   
(184,240
)
   
(154,799
)
Total ZAP shareholders’ equity
   
33,992
     
24,780
 
Non-controlling interest
   
27,815
     
 
Total  equity
   
61,807
     
24,780
 
                 
Total liabilities and  equity
 
$
112,875
   
$
33,512
 
 
See accompanying notes to condensed consolidated financial statements.
 
 
3

 
ZAP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(Thousands, except net loss per share amounts)
 
 
   
Three Months
ended
September 30,
2011
   
Three Months
ended
September 30,
2010
   
Nine Months
ended
September 30,
2011
   
Nine Months
ended
September 30,
2010
 
         
Restated
         
Restated
 
NET SALES
 
$
14,088
   
$
985
   
$
42,062
   
$
2,682
 
COST OF GOODS SOLD
   
11,951
     
837
     
37,310
     
2,318
 
GROSS PROFIT
   
2,137
     
148
     
4,752
     
364
 
OPERATING EXPENSES
                               
Sales and marketing
   
2,702
     
245
     
8,033
     
769
 
                                 
General and administrative (non-cash stock-based compensation of $1 million and $1.45 million and $1.0 million and $1.5 million for the three and nine Months ended September 30, 2011 and 2010, respectively)
   
3,562
     
1,564
     
13,981
     
5,579
 
                                 
Research and development
   
1,009
     
130
     
2,944
     
834
 
     
7,273
     
1,939
     
24,958
     
7,182
 
LOSS FROM OPERATIONS
   
(5,136)
     
(1,791)
     
(20,206)
     
(6,818)
 
OTHER INCOME (EXPENSE)
                               
Interest expense, net
   
(4,904)
     
(1)
     
(13,732)
     
(1,046)
 
Gain on extinguishment of debt
                           
817
 
Loss from equity interest in Joint Venture
   
(64)
     
(96)
     
(225)
     
(244)
 
Gain (Loss) on financial instruments
   
     
(373)
     
(349)
     
(257)
 
Other income (expense), net
   
221
     
     
                1,001
     
                (47)
 
     
(4,747)
     
(470)
     
(13,305)
     
(777)
 
LOSS  BEFORE INCOME TAXES
 
$
(9,883)
   
$
(2,261)
   
$
(33,511)
   
$
(7,595)
 
PROVISION (EXPENSE) BENEFIT FOR INCOME TAX
   
(5)
     
     
10
     
(4)
 
CONSOLIDATED NET LOSS
 
$
(9,888)
   
$
(2,261)
   
$
(33,501)
   
$
(7,599)
 
Less: net loss attributable to non controlling interest
   
1,026
     
     
4,060
     
 
Net loss attributable to ZAP
 
$
(8,862)
   
$
(2,261)
   
$
(29,441)
   
$
(7,599)
 
                                 
NET LOSS PER COMMON SHARE
                               
— BASIC AND DILUTED
 
$
(0.04)
   
$
(0.02)
   
$
(0.14)
   
$
(0.07)
 
WEIGHTED AVERAGE OF COMMON
                               
SHARES OUTSTANDING
                               
— BASIC AND DILUTED
   
219,097
     
109,611
     
215,044
     
106,846
 
 
 See accompanying notes to condensed consolidated financial statements.
 
 
4

 
ZAP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
(Unaudited)
 
   
For the Nine Months Ended
 
   
September 30,
 
   
2011
   
2010
 
         
Restated
 
Operating activities:
           
Consolidated net loss
 
$
(33,501)
     
(7,599)
 
Adjustments to reconcile net loss to cash used in operating activities:
               
Stock-based employee compensation
   
1,452
     
1,446
 
Stock-based compensation for consulting and other services
   
504
     
510
 
Depreciation and amortization
   
8,496
     
52
 
Derivative liability
   
     
257
 
Inventory Reserve
   
(11)
     
 
Provision for doubtful accounts
   
     
(19)
 
Investment in joint venture and other investments
   
224
     
243
 
Gain on extinguishment of debt
   
     
(817)
 
Gain on disposal of equipment
   
(55)
     
 
Deferred Tax
   
(28)
     
 
Management fees due to related party
   
1,875
     
 
Convertible debt discount
   
12,523
     
 
Changes in assets and liabilities (net of acquisition)
               
Accounts receivable
   
(813)
     
(125)
 
Notes receivable
   
3,597
     
(147)
 
Due from related parties
   
(1,402)
     
 
Inventories
   
4,212
     
133
 
Prepayments to suppliers
   
         
Prepaid expenses and other assets
   
(1,104)
     
387
 
Other Receivables
   
513
     
 
Accounts payable
   
(2,157)
     
(177)
 
Accrued liabilities
   
2,200
     
15
 
Notes payable
   
161
     
 
Due to related parties
   
(1,178)
     
 
Other payables
   
(1,827)
     
 
Taxes payable
   
(1,347)
     
 
Advances to customers
   
(850)
     
 
Restricted cash
   
(161)
     
 
Cash used in operating activities
   
(8,677)
     
(5,841)
 
                 
Investing activities:
               
Purchase of marketable securities
   
     
(2,000)
 
Acquisition of 51% Interest in Zhejiang Jonway Automobile, net
   
(18,477)
     
 
Acquisition of property and equipment
   
(1,093)
     
(5)
 
Proceeds from sale of equipment
   
110
     
25
 
Cash used in investing activities
   
(19,460)
     
(1,980)
 
                 
Financing activities:
               
Proceeds from issuance of common stock
   
3,236
     
1,008
 
Proceeds from issuance of convertible debt
   
19,000
     
3,000
 
Proceeds from stock subscription agreement
   
2,000
     
 
Loan receivable  from shareholder
   
(331)
     
 
Proceeds from insurance financing
   
174
     
 
Payment of short term debt
   
(848)
     
 
Proceeds from short term borrowing
   
4,799
     
31
 
Settlement of short term debt with Al Yousuf
   
     
(750)
 
Stock issuances for convertible debt discounts
   
     
667
 
Cash provided by financing activities
   
28,030
     
3,956
 
Effect of exchange rate changes on cash and cash equivalents
   
55
     
 
Decrease in cash and cash equivalents
   
(52)
     
(3,865)
 
Cash and cash equivalents at beginning of year
   
1,503
     
4,800
 
Cash and cash equivalents at end of year
 
$
1,451
     
935
 
Supplemental disclosure of cash flow information:
               
Cash paid during the period for interest
 
$
161
   
$
110
 
Cash paid during the period for income taxes
 
$
4
   
$
4
 
 
  See accompanying notes to condensed consolidated financial statements.
 
 
5

 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
NOTE 1 – ORGANIZATION AND OPERATIONS:
 
ZAP was incorporated in California in September 1994 (together with its subsidiaries, “the Company,” or “ZAP”). ZAP markets advanced transportation, including alternative energy and fuel efficient automobiles, motorcycles, bicycles, scooters, personal watercraft, hovercraft, neighborhood electric vehicles and commercial vehicles. The Company’s business strategy has been to develop, acquire and commercialize electric vehicles and electric vehicle power systems, which the Company believes have fundamental practical and environmental advantages over available internal combustion modes of transportation that can be produced commercially on an economically competitive basis. In pursuit of a manufacturing plant and a partner with an existing product line, a distribution and customer support network in China and experience in vehicle manufacturing, ZAP acquired a majority of the outstanding equity in Zhejiang Jonway Automobile Co., Ltd. (“Jonway”).
 
On January 21, 2011, the Company completed the acquisition of 51% of the equity shares of Jonway for a total purchase price of $35.9 million consisting of approximately $29 million in cash and 8 million shares of ZAP common stock. The Company believes that the acquisition will allow it to expand its electric vehicle (“EV”) business and distribution network around the world, give it access to the rapidly growing Chinese market for electric vehicles and have competitive production capacity in an ISO 9000 certified manufacturing facility with the capacity and resources to support production of ZAP’s electric vehicles and new product line of mini vans and mini SUVs.
 
Jonway is a limited liability company incorporated in Sanmen County, Zhejiang Province of the People’s Republic of China (“the PRC”) on April 28, 2004 by Jonway Group Co., Ltd. (“Jonway Group”). Jonway Group is under the control of three individuals, Wang Huaiyi, Alex Wang (the son of Wang Huaiyi) and Wang Xiao Ying (the daughter of Wang Huaiyi and all three individuals collectively referred to as the “Wang Family”)
 
Jonway’s approved scope of business operations includes the production and sale of vehicle spare parts, and the sale of UFO licensed SUV vehicles.  The principal activities of Jonway are the production and sale of automobile spare parts and the production and distribution of SUVs in China using the consigned UFO license from an affiliate of Jonway Group.
 
With the completion of the acquisition of a majority interest in Jonway, the combined companies’ new product lines planned for 2012 include the A380 SUV EV, and the mini van EV.  Both products leverage the production moldings, the manufacturing engineering infrastructure and facilities currently in place for the gasoline models of these vehicles.  Since the acquisition, the companies have been working on developing the joint product line, marketing and sales plans for the 2012 EV product lines.

Jonway is preparing for certification of the EV production line by the Chinese electric vehicle authorities, which we expect to occur in the first quarter of 2012, while we anticipate that the EV production facilities in Jonway will be ready for the certification process by the end of 2011.  Meanwhile, the engineering teams from both companies are undertaking extensive testing of the A380 SUV EV at the Hangzhou ZAP EV research and development center.

Our target is to deliver the EV A380 SUV and EV minivan in the first half of 2012, with the purpose of obtaining the Chinese central government electric vehicle incentives of up to 60,000 RMB per vehicle.  ZAP intends to use the existing manufacturing plant from Jonway that is being upgraded for the production of the electric vehicles and utilizing the existing Jonway models to gain economy of scale and reduce molding investment costs. ZAP also intends to leverage Jonway’s distribution and customer support centers in China to support the sales and marketing of its new EV product line.

ZAP’s strategy outside of China is to open up markets ready to accept affordable, fully electric SUVs and vans for fleets.

 
6

 
Basis of Presentation
 
The accompanying unaudited condensed consolidated financial statements include the financial statements of ZAP, its wholly owned subsidiaries Voltage Vehicles and ZAP Stores and its 51% owned subsidiary Jonway. All significant inter-company transactions and balances have been eliminated.  We account for our 37.5% interest in the ZAP Hangzhou Joint Venture using the equity method of accounting.  During the three and nine months ended September 30, 2011, ZAP Hangzhou incurred an operating loss of  $170,600 and $600,000 of which $64,000 and $225,000 is our share at three and nine months ended September 30, 2011 respectively.
 
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 8 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (all of which are of a normal recurring nature) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended  September 30 , 2011 are not indicative of the results that may be expected for the year ending December 31, 2011 or for any other future period.  Certain reclassifications have been made to the Company’s unaudited condensed consolidated financial statements for the nine month period ended September 30, 2011 to conform to the current period’s consolidated financial statement presentation. These condensed consolidated financial statements and the notes thereto should be read in conjunction with the audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2010 filed with the Securities and Exchange Commission (the “SEC”) on April 15, 2011 (our “10-K”).
 
ZAP’s common stock is quoted on the OTC Bulletin Board under the symbol “ZAAP.OB.”
 
 Recent Authoritative Guidance
 
 In September 2011, the FASB issued ASU No. 2011-08, Testing Goodwill for Impairment ("ASU 2011-08") that gives an entity the option of performing a qualitative assessment to determine whether it is necessary to perform Step 1 of the annual goodwill impairment test. An entity is required to perform Step 1 only if it concludes that it is more likely than not that a reporting unit's fair value is less than its carrying amount. An entity may choose to perform the qualitative assessment on none, some or all of its reporting units or an entity may bypass the qualitative assessment for any reporting unit in any period and proceed directly to Step 1 of the impairment test. ASU 2011-08 is effective January 1, 2012 and we do not believe that the adoption of ASU 2011-08 will have a significant effect on our results of operations or financial position.
 
 In June 2011, the FASB issued ASU No. 2011-05, "Comprehensive Income (ASC Topic 220): Presentation of Comprehensive Income," ("ASU 2011-05") which amends current comprehensive income guidance. This accounting update eliminates the option to present the components of other comprehensive income as part of the statement of shareholders' equity. Instead, the Company must report comprehensive income in either a single continuous statement of comprehensive income which contains two sections, net income and other comprehensive income, or in two separate but consecutive statements. ASU 2011-05 will be effective for public companies during the interim and annual periods beginning after Dec. 15, 2011 with early adoption permitted. The Company does not believe that the adoption of ASU 2011-05 will have a material impact on the Company's consolidated results of operation and financial condition.
 
 In May 2011, the FASB issued ASU 2011-04, "Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards ("IFRSs")." Under ASU 2011-04, the guidance amends certain accounting and disclosure requirements related to fair value measurements to ensure that fair value has the same meaning in U.S. GAAP and in IFRSs and that their respective fair value measurement and disclosure requirements are the same. ASU 2011-04 is effective for public entities during interim and annual periods beginning after December 15, 2011. Early adoption by public entities is not permitted. The Company does not believe that the adoption of ASU 2011-04 will have a material impact on the Company's consolidated results of operation and financial condition.
 
 
7

 
Liquidity and Capital Resources
 
In assessing our liquidity, we monitor and analyze our cash on-hand, liquidation value of our investment in securities, and our operating and capital expenditure commitments.  Our principal liquidity needs are to meet our working capital requirements, operating expenses and capital expenditure obligations. 
 
Our principal sources of liquidity consist of our existing cash on hand, bank loans, our investment in securities with Samyang Optics, Ltd. and transactions with Luo Hua Liang, the brother-in-law of Alex Wang, the Co-CEO and director of ZAP.  As previously disclosed in our 10-Q filed for the period ended March 31, 2011, we entered into private placement subscription agreements with Mr. Luo for the purchase of ZAP’s common stock for the aggregate purchase price of $7 million, of which we received $2 million as of the quarter ended March 31, 2011.  The private placement subscription agreements were superseded and terminated by a stock purchase agreement with Mr. Luo in August 2011. Pursuant to the stock purchase agreement, Mr. Luo will purchase ZAP’s common stock for an aggregate purchase price of $2 million in multiple closings. On September 8, 2011, we issued approximately 2.3 million shares of ZAP common stock in connection with the initial closing of $771,000. We received an additional $1.025 million in subsequent closings for which we have issued approximately 3.35 million shares of ZAP common stock.  We anticipate an additional closing for approximately $203,000.

               In the third quarter of 2011, we were approved to borrow up to an aggregate of US$6.2 million from the Taizhou Branch of China Merchants Bank and US$10 million from the Taizhou Branch of Everbright Bank of China, for a total of US$16.2 million through our majority-owned subsidiary, Jonway. Although we have been approved for the credit lines, there are no legal obligations or rights to the credit lines until we execute agreements with the respective lenders to borrow funds under the credit lines. When drawn down, the credit lines will be secured by lands owned by Jonway and guaranteed by Jonway Group.

In July 2011, Jonway was approved for a credit line in the aggregate amount of RMB40 million (which as of September 30, 2011 is approximately US$6.2 million) from the Taizhou Branch of China Merchants Bank.  On August 11, 2011, Jonway entered into a Credit Agreement with the Taizhou Branch of China Merchants Bank for a revolving short term bank loan in the aggregate amount of RMB21 million (which as of September 30, 2011  is approximately US$3.2 million). The loans issuable under the Credit Agreement are secured by a Maximum Amount Mortgage Contract by and between Jonway and China Merchants Bank dated August 11, 2011 in which land use rights over two parcels of land owned by Jonway at Sanmen, Jian Tiao Town, Da Tang Village, Shang Peng Factory have been pledged as security for the loans.

On September 15, 2011, Jonway was also approved for another credit line in the aggregate amount of RMB64.5 million (which as of September 30, 2011 is approximately US$10 million) from the Taizhou Branch of Everbright Bank of China. Jonway has not entered any agreements to borrow funds under this credit line.
 
               Jonway intends to utilize the credit lines to expand its electric vehicle business as well as other future vehicle models.  This includes on-going working capital needs, electric vehicle production equipment requirements, testing, homologation and new EV product molds. These credit lines will also be used to support the company’s expansion plans, with emphasis on its electric vehicle production line facilities in China. The credit will also help advance new electric vehicle initiatives, launch new strategic global sales and marketing operations, bolster infrastructure, and finance working capital.
 
In January 2011, ZAP issued $19 million of convertible debt to make a partial payment in connection with the Jonway Acquisition.  ZAP believes that CEVC will convert the note into shares of ZAP common stock, but if CEVC does not elect to so convert the note, the note will either be converted into shares of Jonway capital stock owned by ZAP or require cash repayment in February 2012.  Assuming that the note is converted into shares of ZAP common stock and does not require cash repayment in February 2012, we believe that we will have sufficient liquidity required to conduct operations through September 30, 2012.
 
At present, the Company will require additional capital to expand the current operations.  In particular, we require additional capital to expand our presence across the world, continue development of our electric vehicle business projects, expanding our market initiatives, continue building our dealer network and after-sale services and expanding our market initiatives.  We also require financing the investment for the continued roll-out of new products and to add qualified sales and professional staff to execute our efforts in of the business strategy of advanced technology vehicles, such as the new ZAP alias and other fuel efficient vehicle projects.
 
We intend to fund our long term liquidity needs related to operations through the incurrence of indebtedness, equity financing or a combination of both.  Although we believe that these sources will provide sufficient liquidity for us to meet our future liquidity and capital obligations, our ability to fund these needs will depend on our future performance, which will be subject in part to general economic, financial, regulatory and other factors beyond our control, including trends in our industry and technological developments.  However, we may not be able to obtain this additional financing on terms acceptable to us or at all.
 
8

 
NOTE 2 – RESTATEMENT OF 2010 FINANCIAL STATEMENTS
 
On January 1, 2009, the Company adopted new accounting guidance Accounting Standards Codification (“ASC”) 815-40, formerly EITF 07-5 “Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock”) that required additional analysis as to whether or not stock purchase warrants are indexed to the Company’s stock, a condition that is required to attain equity accounting.  Upon adoption of this guidance, the Company concluded that its previously issued stock purchase warrants should be classified as equity and therefore, the adoption of the new guidance did not have any impact on the historical financial statements or on the 2009 financial statements.
 
In connection with the review of certain equity transactions in 2010, the Company determined that certain stock purchase warrants issued in prior years should have been classified as derivative liabilities due to the presence of “price protection” provisions in those warrant agreements.  These provisions require that the Company modify existing warrants (as to the actual number of warrants and their exercise price) in the event that the Company issues subsequent equity (or equity linked instruments) at a price below the exercise price of the existing warrants.  As a result, the Company restated its 2010 financial information in its Annual Report on Form 10-K for the year ended December 31, 2010, as filed with the SEC on April 15, 2011, to correct the misapplication of the new accounting guidance related to the accounting and classification of stock purchase warrants.  The financial information in this quarterly report reflects the restated financial information.

 
   
(unaudited)
   
(unaudited)
   
(unaudited)
Amounts in (000s)
 
Qtr 1
3/31/10
   
Qtr 2
6/30/10
   
Qtr 3
9/30/10
Total liabilities as reported
 
$
12,715
   
$
8,594
    $
8,117
 
Adjustments
   
1,053
     
1,329
     
1,703
 
Restated total liabilities
 
$
13,768
   
$
9,923
     
9,820
 
Net loss as reported
 
$
(3,248
)
 
$
(2,206
)
  $
(1,888
)
Adjustments
   
392
     
(276
)
   
(373
)
Restated loss
 
$
(2,856
)
 
$
(2,482
)
  $
(2,261
)

 
NOTE 3 – SIGNIFICANT ACCOUNTING POLICIES
 
Use of Estimates
 
The preparation of financial statements in conformity with United States generally accepted accounting principles requires the Company to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. The more significant estimates relate to revenue recognition, contractual allowances and uncollectible accounts, intangible assets, accrued liabilities, derivative liabilities, beneficial conversion feature, income taxes, litigation and contingencies. Estimates are based on historical experience and on various other assumptions that the Company believes to be reasonable under the circumstances, the results of which form the basis for judgments about results and the carrying values of assets and liabilities. Actual results and values may differ significantly from these estimates.
 
Concentration of Credit Risk
 
Financial instruments which subject the Company to potential credit risk consist of its cash and cash equivalents and accounts receivable. The Company places its cash and cash equivalents with high credit quality financial institutions. Deposits may exceed the amount of federally insured limits; however, these deposits typically are redeemable upon demand and, therefore, the Company believes the financial risks associated with these financial instruments are minimal. The Company has not experienced any losses to date on its deposits.
 
The Company performs ongoing credit evaluations of its customers, and generally does not require collateral on its accounts receivable. The Company estimates the need for allowances for potential credit losses based on historical collection activity and the facts and circumstances relevant to specific customers and records a provision for uncollectible accounts when collection is uncertain. The Company has not experienced significant credit related losses to date.
 
 
9

 
The Company currently relies on various outside contract manufacturers in China to supply electric vehicles and products for its customers and management believes that other contract manufactures could provide similar services and intends to transition its manufacturing to Jonway’s facilities in Sanmen, China. However, if these Chinese companies are unable to supply electric vehicles and the Company is unable to transition manufacturing to Jonway’s facilities or find alternative sources for these product and services, the Company might not be able to fill existing backorders and/or sell more electric vehicles. Any significant manufacturing interruption could have a material adverse effect on the Company’s business, financial condition and results of operations.
 
Revenue Recognition
 
The Company records revenues for non-Jonway sales when all of the following criteria have been met:
 
 
·  
Persuasive evidence of an arrangement exists. The Company generally relies upon sales contracts or agreements, and customer purchase orders to determine the existence of an arrangement.
 
 
·  
Sales price is fixed or determinable. The Company assesses whether the sales price is fixed or determinable based on the payment terms and whether the sales price is subject to refund or adjustment.
 
 
·  
Delivery has occurred. The Company uses shipping terms and related documents, or written evidence of customer acceptance, when applicable, to verify delivery or performance. The Company’s customary shipping terms are FOB shipping point.
 
 
·  
Collectability is reasonably assured.  The Company assesses collectability based on creditworthiness of customers as determined by our credit checks and their payment histories. The Company records accounts receivable net of allowance for doubtful accounts and estimated customer returns.
 
The Company records revenues for Jonway sales only upon the occurrence of all of the following conditions:
 
 
·  
The Company has received a binding purchase order from the customer or distributor authorized by a representative empowered to commit the purchaser (evidence of a sale);
 
 
·  
The purchase price has been fixed, based on the terms of the purchase order;
 
 
·  
The Company has delivered the product from its factory to a common carrier acceptable to the customer; and
 
 
·  
The Company deems the collection of the amount invoiced probable.
 
The Company provides no price protection. Sales are recognized net of sale discounts, rebates and return allowances.
 
Shipping and Handling Costs
 
Shipping and handling costs have been included in cost of goods sold.
 
Research and Development
 
Research and product development costs are expensed as incurred.
 
Stock-based Compensation
 
The Company accounts for stock-based compensation under the provisions of FASB ASC Topic 718, Compensation—Stock Compensation (“ASC 718”), which requires the measurement and recognition of compensation expense for all stock-based awards made to employees and directors based on estimated fair values on the grant date. The Company adopted ASC 718 (previously Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards No. 123(R) on January 1, 2006 using the modified prospective method. The Company estimates the fair value of stock-based awards on the date of grant using the Black-Scholes-Merton option pricing model (the “Black-Scholes model”). The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods using the straight-line method. We estimate forfeitures at the time of grant and revise our estimate in subsequent periods if actual forfeitures differ from those estimates. See Note 4 “Stock-Based Compensation” for a complete discussion of our equity compensation programs and the fair value assumptions used to determine our stock-based compensation expense.
 
10

 
The Company accounts for stock-based compensation awards and warrants granted to non-employees in accordance with FASB ASC Topic 505-50, Equity-Based Payments to Non-Employees (“ASC 505-50”). Under ASC 505-50, the Company determines the fair value of the warrants or stock-based compensation awards granted as either the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable. If the fair value of equity instruments issued is used, it is measured using the stock price and other measurement assumptions as of the earlier of either (1) the date at which commitment for performance by the counterparty to earn the equity instruments is reached, or (2) the date at which the counterparty’s performance is complete.
 
Income Taxes
 
The Company uses the asset and liability method of accounting for income taxes. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. To the extent a deferred tax asset cannot be recognized under the preceding criteria, allowances are established.

Net Loss per Share Attributable to Common Stockholders
 
Basic and diluted net loss per share is computed by dividing consolidated net loss attributable to ZAP by the weighted-average number of common shares outstanding during the period. The Company’s potentially dilutive shares, which include outstanding common stock options, convertible debt and warrants, have not been included in the computation of diluted net loss per share for all periods presented as the result would be anti-dilutive. Such potentially dilutive shares are excluded when the effect would be to reduce a net loss per share. There were outstanding options and warrants exercisable to purchase 99.6 million and 94 million shares of ZAP common stock at September 30, 2011 and 2010, respectively. ZAP also had outstanding debt, which is convertible into 84 million shares of ZAP common stock or shares of Jonway capital stock owned by ZAP to be determined in accordance with the Note with CEVC dated January 12, 2011.

Cash and Cash Equivalents
 
The Company invests its excess cash in short-term investments with various banks and financial institutions. Short-term investments are cash equivalents, as they are part of the cash management activities of the Company and are comprised of investments having maturities of three months or less when purchased.  The Company considers all highly liquid investments with an original maturity of three months or less from the date of purchase to be cash equivalents
 
Restricted Cash
 
The Company has cash restricted in connection with the issuance of bank acceptance notes to various suppliers of spare parts which were issued through Jonway’s banks.  To issue these bank acceptance notes to Jonway’s suppliers, the banks require a deposit of approximately 40-60% of the full amount of such notes which are payable within 6 months from issuance.  Upon the maturity date, restricted funds will be used to settle the bank acceptance notes.
 
Due from/ (to) related parties
 
Due from related parties: UFO Sanmen Branch
     
- Accounts receivable
  $ 3,108  
- Other receivable
    205  
- Accounts payable
    (66 )
Total
    3,247  
         
Due to related parties: Jonway Group*
       
- Accounts payable
  $ 1,102  
- Notes payable
    315  
         
Due to related parties: Zhejiang UFO
       
- Accrued liabilities
    721  
Total
  $ 2,138  
 
* Jonway Group is considered as a related party as Wang Family, one of the shareholders of the Company, has controlling interests in Jonway Group.

 
11

 
Due to Related Party

Based on a contract by and among the Sanmen Branch of Zhejiang UFO Automobile Manufacturing Co., Ltd. (“Zhejiang UFO”), Jonway Group and Jonway dated as of January 1, 2006, Zhejiang UFO has authorized Jonway to operate its Sanmen Branch to assemble and sell UFO branded SUVs for a period of 10 years starting from January 1, 2006.
 
According to the contract, Jonway shall pay Zhejiang UFO a variable contractual fee which is calculated based on the number of SUVs that Jonway assembles in the Sanmen Branch every year, at the following rates:
 
The first 3,000 vehicles
$44 per vehicle
Vehicles from 3,001 to 5,000
$30 per vehicle
Vehicles over 5,000
$22 per vehicle
 
Zhejiang UFO is considered a related party because the Wang Family, who are shareholders of Jonway, have certain non-controlling equity interests in Zhejiang UFO.  The balance due to Zhejiang UFO at September 30, 2011 is $721,000.  The parties have agreed to defer payment without interest indefinitely.

Marketable Securities
 
The Company has an investment that is comprised of marketable equity securities, which are classified as available-for-sale and recorded at fair value, the value of which fluctuates with the stock market value.   The securities are shares of Samyang Optics Co., Ltd., which shares are traded on the Korean stock exchange.  ZAP’s ownership is not material to Samyang Optics Co., Ltd. Net unrealized holding gains and losses, net of tax, are reported as a separate component of shareholders’ deficit, except where holding losses are determined to be “other-than-temporary”, whereby the losses are reported in gains and losses on investments in the consolidated statement of operations.  Gains and losses on disposals of marketable equity securities are determined using the specific identification method.

Notes Receivable

Notes receivable balances consist of bank acceptance notes received from various Jonway dealers to finance such dealer’s purchase of our vehicles products.  These bank acceptance notes can be endorsed to settle the payables to Jonway suppliers or discounted to fund cash flows. These notes are a means of financing working capital for orders that were placed by these dealers.
 
Fair Value of Financial Instruments
 
The Company measures its financial assets and liabilities at fair value. The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties. For certain of the Company’s financial instruments, including cash equivalents, accounts receivable, accounts payable and accrued liabilities, the carrying amount approximates fair value because of the short maturities. The fair value of debt is not determinable due to the terms of the debt and the lack of a comparable market for such debt.  These tiers include:
 
Level 1: Observable inputs such as quoted prices in active markets;
 
Level 2: Inputs other than quoted prices in active markets that are directly or indirectly observable;
 
Level 3: Unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions and methodologies that result in management’s best estimate of fair value.
 
The change in fair value of derivative liabilities is classified in other income (expense) in the Company’s statement of operations.  The fair value of the Company’s derivative liabilities related to stock purchase warrants was determined using the Black-Scholes option pricing model – a Level 3 input.
 
 
12

 
Derivative Financial Instruments
 
The Company generally does not use derivative financial instruments to hedge exposures to cash flow or market risks. However, certain other financial instruments, such as warrants, are classified as liabilities when either (a) the holder possesses rights to net-cash settlement or (b) physical or net-share settlement is not within the control of the Company. In such instances, net-cash settlement is assumed for financial accounting and reporting, even when the terms of the underlying contracts do not provide for net-cash settlement. Such financial instruments are initially recorded at fair value and subsequently adjusted to fair value at the close of each reporting period.
 
The Company accounts for derivative instruments and debt instruments in accordance with the interpretative guidance of ASC 815 (“Derivatives and Hedging”).   It is necessary for the Company to make certain assumptions and estimates to value derivatives and debt instruments.
 
Beneficial Conversion Feature

The Company accounts for potentially beneficial conversion features under GAAP. On January 12, 2011, the Company issued $19 million of convertible debt to CEVC which is convertible into 84 million shares of ZAP Stock or shares of Jonway capital stock owned by ZAP to be determined in accordance with the note. At the time of this issuance, the value of the common stock into which the note is convertible had a fair value greater than the proceeds for such issuance. Accordingly, the Company has recorded a beneficial conversion feature of $19.0 million since the value of the common stock into which the note is converted is greater than the proceeds for such issuance, which is being amortized over the life of the convertible note through February 2012.
 
Allowance for Doubtful Accounts
 
The Company provides an allowance for doubtful accounts when management estimates collectability to be uncertain. Accounts receivable are continually reviewed to determine which, if any, accounts are doubtful of collection. In making the determination of the appropriate allowance amount, the Company considers current economic and industry conditions, relationships with each significant customer, overall customer credit-worthiness and historical experience. The allowance for doubtful accounts was approximately $17,000 and $27,000 at September 30, 2011 and December 31, 2010, respectively for ZAP’s United States operations.  Jonway primarily sells vehicles to its qualified dealers. An on-going credit evaluation of its customers’ financial condition is performed. Jonway maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. As a result of this analysis no allowance for doubtful accounts was determined to be required at September 30, 2011.
 
Inventories
 
Inventories consist primarily of vehicles, both gas and electric, parts and supplies, and work in progress and are carried at the lower of cost (first-in, first-out basis) or market (net realizable value or replacement cost). The Company maintains reserves for estimated excess, obsolete and damaged inventory based on projected future shipments using historical selling rates, and taking into account market conditions, inventory on-hand, purchase commitments, product development plans and life expectancy, and competitive factors. If markets for the Company’s products and corresponding demand were to decline, then additional reserves may be deemed necessary. Any changes to the Company’s estimates of its reserves are reflected in cost of goods sold within the statement of operations during the period in which such changes are determined by management.
 
Property and Equipment
 
Property and equipment consists of land, building and improvements, machinery and equipment, office furniture and equipment, vehicles, and leasehold improvements. Property and equipment is stated at cost, net of accumulated depreciation and amortization, and is depreciated or amortized using straight-line method over the asset’s estimated useful life. Costs of maintenance and repairs are charged to expense as incurred; significant renewals and betterments are capitalized.  Leasehold improvements are amortized over 15 years using the straight-line method.
 
Long-lived Assets
 
Long-lived assets are comprised of property and equipment and intangible assets. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. An estimate of undiscounted future cash flows produced by the asset, or by the appropriate grouping of assets, is compared to the carrying value to determine whether impairment exists. If an asset is determined to be impaired, the loss is measured based on quoted market prices in active markets, if available. If quoted market prices are not available, the estimate of fair value is based on various valuation techniques, including a discounted value of estimated future cash flow and fundamental analysis. The Company reports an asset to be disposed of at the lower of its carrying value or its estimated net realizable value.
 
13

 
Intangible Assets
 
Intangible assets consist of trade names, developed technology, in process research and development and customer relationships (including client contracts). For financial statement purposes, identifiable intangible assets with a defined life are being amortized using the straight-line method over the estimated useful lives of seven years for developed technology and eight years for the customer relationships. Costs incurred by the Company in connection with trademark applications and approvals from governmental agencies, including legal fees and trademark fees and specific testing costs, are expensed as incurred. Purchased intangible costs of completed developments are capitalized and amortized over an estimated economic life of the asset commencing on the acquisition date. Costs subsequent to the acquisition date are expensed as incurred.
 
Product warranty costs
 
The Company provides 30 to 90 day warranties on its personal electric products, including the ZAPPY3 and the Zapino scooters, six month warranties for the Xebra®, the ZAPTRUCK XL, the ZAPVAN Shuttle vehicles, and a six month warranty for Xebra® vehicles repaired by ZAP pursuant to its product recall.  The Company records the estimated cost of the product warranties at the time of sale using the estimated costs of products warranties based on historical results. The estimated cost of warranties has not been significant to date. Should actual failure rates and material usage differ from our estimates, revisions to the warranty obligation may be required.
 
The Company provides a 2-year or 60,000 kilometer mileage warranty for its Jonway SUV products. The Company records the estimated cost of the product warranties at the time of sale using the estimated cost of product warranties based on historical results. The estimated cost of warranties has not been significant to date. Should actual failure rates and material usage differ from our estimates, revisions to the warranty obligation may be required
 
Common Stock
 
                At the ZAP Annual Meeting held on June 20, 2011, the shareholders approved the following proposed resolutions that affect our common stock:
 
·    
an amendment to increase the authorized shares of common stock from 400 million to 800 million;
·    
an amendment to our charter to effect a reverse stock split within a range of one-for-four or one–for-eight with the ultimate ratio to be determined by our Board of Directors; and
·    
an amended and restated 2008 equity plan to, among other things, increase the number of shares of common stock available for issuance under the plan to a total of 40 million shares.
 
Comprehensive loss
 
Comprehensive loss represents the net loss for the period plus the results of certain changes to shareholders’ equity that are not reflected in the consolidated statements of operations. The Company’s comprehensive loss consists of net losses, foreign currency cumulative translation adjustments and unrealized net losses on investments.  Comprehensive loss was as follows (in thousands):
 
14

 
 
   
Three months ended September 30,
   
Nine months ended September 30,
 
   
2011
   
2010
   
2011
   
2010
 
         
Restated
         
Restated
 
Consolidated net loss
  $ (9,888 )   $ (2,261 )   $ (33,501 )   $ (7,599 )
Increase in foreign cumulative translation adjustment
    445             902        
Increase  in net unrealized gains on available-for-sale securities
    55       199       (574 )     (15 )
Comprehensive loss
    (9,388 )     (2,062 )     (33,173 )     (7,614 )
Comprehensive loss attributable to non controlling interest
    1,026             4,060        
Comprehensive loss attributable to ZAP
  $ (8,362 )   $ (2,062 )   $ (29,133 )   $ (7,614 )
                                 



NOTE 4 – STOCK-BASED COMPENSATION
 
Services performed and other transactions settled in the Company’s common stock are recorded at the estimated fair value of the stock issued, if that value is more readily determinable than the fair value of the consideration received.
 
We have stock compensation plans for employees, directors and consultants which are described in Note 8 to our consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2010, as filed with the SEC on April 15, 2011. We recognize the stock-based compensation expense over the requisite service period of the individual grantees, which generally equals the vesting period. All of our stock-based compensation is accounted for as an equity instrument.
 
  A summary of options under the Company’s stock option plans from January 1, 2011 through September 30, 2011 is as follows (the number of shares is in thousands):
 
   
Number
of Shares
   
Weighted
Average
Exercise Price
   
Weighted
Average
Remaining
Contractual
Term
(in years)
 
Outstanding December 31, 2010
    26,778     $ 0.56       7.74  
Options granted under the plan
    500     $ 1.10       4.90  
Options exercised
    (659 )   $ 0.31        
Options forfeited and expired
                 
Outstanding March 31, 2011
    26,619     $ 0.49       7.74  
Options granted under the plan
 
   
   
 
Options exercised
    (1,198 )     0.26    
 
Options forfeited and expired
 
   
   
 
Outstanding June 30, 2011
    25,421     $ 0.50       7.25  
Options granted under the plan
    40       0.42       2.97  
Options exercised
    (56 )   $ 0.25        
Options forfeited and expired
    (1,015 )            
Outstanding September 30, 2011
    24,390     $ .050       6.75  


 
15

 
Aggregate intrinsic value is the sum of the amounts by which the quoted market price of our stock exceeded the exercise price of the options at September 30, 2011 for those options for which the quoted market price was in excess of the exercise price (“in-the-money options”).  There were 1.5 million options valued at $152,000 in the money at September 30, 2011.
 
As of September 30, 2011, total compensation cost of unvested employee and consultant stock options is $ 1.7 million. This cost is expected to be recognized through December 2012. We recorded no income tax benefits for stock-based compensation expense arrangements for the three months ended September 30, 2011, as we have cumulative operating losses, for which a valuation allowance has been established.
 
 
NOTE 5 – ACQUISITION
 
On January 21, 2011(the “Closing Date”), the Company completed the acquisition of 51% of the equity shares of Jonway.  The transaction was accounted for in accordance with the provisions of ASC 805-10, Business Combinations. The Company retained independent appraisers to advise management in the preliminary determination of the fair value of the various assets acquired and liabilities assumed. The values assigned in these financial statements are preliminary and represent management’s best estimate of fair values as of the Closing Date.
 
As required by ASC 805-20, Business Combinations—Identifiable Assets and Liabilities, and Any Noncontrolling Interest, management conducted a review to reassess whether they identified all the assets acquired and all the liabilities assumed, and followed ASC 805-20’s measurement procedures for Closing Date recognition of the fair value of net assets acquired.
 
The following are the preliminary estimated fair value of assets acquired and liabilities assumed as of the Closing Date (in thousands):  
 
       
Cash and cash equivalents
 
$
993
 
Restricted cash
   
3,088
 
Inventories, net
   
12,715
 
Property & equipment
   
46,322
 
Other tangible assets
   
14,167
 
Accounts payable
   
(14,549)
 
Notes payable
   
(4,261)
 
Deferred tax liability
   
(166)
 
Other liabilities assumed
   
(14,358)
 
Net tangible assets acquired
   
43,951
 
Goodwill and intangible assets
   
23,794
 
         
Net assets acquired
   
67,745
 
         
Non controlling interest
   
(31,875)
 
         
Purchase price
 
$
35,870
 


The fair value of the major components of the intangible assets acquired and their estimated useful lives is as follows (dollars in thousands):
 
   
Preliminary
Fair Value
   
Weighted
Average
Useful Life
(in Years)
 
Customer relationships
 
$
3,300
     
8
 
Developed technology
   
4,228
     
7
 
Tradename
   
9,326
   
(a)
 
In-process research and development costs
   
547
   
(b)
 
Total
 
$
17,401
         

(a)  The Jonway tradename has been determined to have an indefinite life.
(b)  In-process research and development is accounted for as an indefinite life intangible asset until the completion or abandonment of the associated research and development efforts.
 
16

 
Under ASC 805-10, acquisition-related costs (i.e., advisory, legal, valuation and other professional fees) are not included as a component of consideration transferred, but are accounted for as expenses in the periods in which the costs are incurred. Acquisition-related costs were $91,500 and $318,300 in the three and nine months ended September 30, 2011.
 
The following unaudited pro forma condensed financial information presents the combined results of operations of ZAP and Jonway as if the acquisition had occurred as of the beginning of each period presented (in thousands except per share amounts):

   
Pro Forma Consolidated
   
Pro Forma Consolidated
 
   
Nine Months Ended September 30,
   
Three Months ended September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Net sales
  $ 49,903       55,918       14,088       27,553  
Net( loss) Income
    (29,786 )     (5,497 )     (8,862 )     (1,315 )
Net loss per common share, basic and diluted
  $ (.014 )   $ (.05 )   $ (.04 )   $ (.01 )
Shares outstanding, basic and diluted
    215,044       106,846       219,097       109,611  

 
The unaudited pro forma condensed financial information is not intended to represent or be indicative of the consolidated results of operations of the Company that would have been reported had the acquisition been completed as of the beginning of the period presented, and should not be taken as being representative of the future consolidated results of operations of the Company.
 
The pro forma adjustments are based upon available information and certain assumptions that the Company believes are reasonable. The pro forma results of operations do not include the potential post-acquisition effects of any restructuring, impairment or integration costs related to the combined operations nor of any revenue opportunities, operating synergies or cost savings anticipated as eventual benefits of the acquisition.
 
 
NOTE 6 – INVENTORIES
 
Inventories at September 30, 2011 and December 31, 2010 are summarized as follows (in thousands):
 
   
September 30,
2011
   
December 31,
2010
 
Advanced technology vehicles
 
$
1,081
   
$
1,163
 
Vehicles-conventional
   
265
     
345
 
WIP Jonway SUV’s
   
3,180
     
 
Finished goods SUV’s
   
1,762
     
 
Parts and supplies
   
4,601
     
656
 
Finished goods
   
282
     
277
 
     
11,171
     
2,441
 
Less - inventory reserve
   
(877)
     
(619)
 
   
$
10,294
   
$
1,822
 
 
 
17

 
NOTE 7 – GOODWILL & OTHER INTANGIBLES
 
The intangible assets at September 30, 2011 are summarized as follows:
 
                           
Comprehensive
   
Net
 
         
Net
         
Accumulated
   
Translation
   
Book
 
   
Useful Life
   
Book Value
   
Additions
   
Amortization
   
Adjustment
   
Value
 
   
(In Years)
   
12/31/2010
   
2011
   
9/30/2011
   
9/30/2011
   
9/30/2011
 
Patents and Trademarks
    7     $ 295      
      (214 )  
    $ 81  
Customer Relationships
    8      
      3,300       (288 )     122       3,134  
Developed Technology
    7      
      4,228       (403 )     173       3,998  
In Process Technology
           
      547             20       567  
                                                 
Tradename
           
      9,326             343       9,669  
Intangibles
          $ 295       17,401       (905 )     658     $ 17,449  
                                                 
Goodwill Assets
                    6,393             244     $ 6,637  
 
 
As of September 30, 2011, estimated future amortization expense for intangibles assets, subject to amortization, is as follows (in thousands):
 
Year
 
Amortization
Expense
 
2011
 
$
264
 
2012
   
1,054
 
2013
   
1,054
 
2014
   
1,054
 
2015
   
1,054
 
Thereafter
   
2,733
 
   
$
7,213
 

 
 
NOTE 8 – DISTRIBUTION AGREEMENTS
 
Distribution agreements as of September 30, 2011 and December 31, 2010 are presented below (in thousands):
 
   
September 30, 2011
   
December 31, 2010
 
Better World Products
 
$
2,160
     
2,160
 
Jonway Products
   
14,400
     
14,400
 
     
16,560
     
16,560
 
Less amortization
   
(2,581)
     
(961)
 
                 
   
$
13,979
     
15,599
 


 Distribution Agreement with Better World International Limited
 
On January 15, 2010, ZAP entered into a Stock Purchase Agreement with Better World International Limited, a British Virgin Islands company focused on infrastructure technology and services for electric vehicles (“Better World”), whereby the Company issued 6 million shares of it common stock valued at $2.16 million in exchange for an agreement on terms relating to rights to the distribution of Better World’s products, such as charging stations for electric vehicles both in the United States and internationally.  Priscilla Lu, the chairman of the board of directors of ZAP, is also the director and a shareholder of Better World International Limited.
 
18

 
Distribution Agreement with Goldenstone Worldwide Limited for Jonway Products
 
On October 10, 2010, ZAP entered into an International Distribution with Goldenstone Worldwide Limited as the distributor of Jonway products such as gas SUVs, both in the U. S. and internationally. In connection with the distribution agreement the Company also issued 30 million shares of ZAP common stock valued at $14.4 million.  The Jonway Group previously granted exclusive worldwide distribution of Jonway products to Goldenstone Worldwide Limited.   ZAP acquired a 51% equity interest in Jonway, but this equity interest did not include the world wide distribution rights for Jonway products.  Therefore, it was necessary for ZAP to acquire distribution rights for Jonway products.
 
Distribution Agreement with Samyang Optics
 
On January 27, 2010, ZAP entered into an International Distribution Agreement (the “Distribution Agreement”) with Samyang Optics Co. Ltd. (“Samyang”) pursuant to which ZAP appointed Samyang as the exclusive distributor of certain ZAP electric vehicles including the Jonway A380 5-door electric sports utility vehicle equipped with  ZAP’s electric power train, in the Republic of Korea. The Distribution Agreement also provides that ZAP and Samyang will negotiate to enter into additional agreements related to the manufacture and assembly of ZAP vehicles by Samyang in Korea.  The Distribution Agreement shall be in effect for one year and may be extended annually by Samyang provided that Samyang has satisfied sales quotas determined by ZAP and Samyang is otherwise in compliance with the Distribution Agreement. The parties are currently discussing the extension of the agreement.
 
In addition, on January 27, 2010, ZAP and Samyang entered into an initial purchase order pursuant to the Distribution Agreement for the purchase of one hundred ZAP Jonway UFO electric sports utility vehicles.  Selling prices have yet to be determined and no purchases have been made as of September 30, 2011.
 
 
 NOTE 9 – LONG-TERM AND SHORT-TERM DEBT AND NOTES

8% Senior Convertible Notes
 
On January 12, 2011, the Company entered into a Senior Secured Convertible Note and Warrant Purchase Agreement (the “Agreement”) with China Electric Vehicle Corporation (“CEVC”), a British Virgin Island company whose sole shareholder is Cathaya Capital, L.P., a Cayman Islands exempted limited partnership (“Cathaya”).  Priscilla Lu is the chairman of the board of directors of ZAP, a managing partner of Cathaya and a director of CEVC.
 
Pursuant to the Agreement, (i) CEVC purchased from the Company a Senior Secured Convertible Note (the “Note”) in the principal amount of US$19 million, as amended, (ii) the Company issued to CEVC a warrant (the “Warrant”) exercisable for two years for the purchase up to 20,000,000 shares of the Company’s Common Stock at $0.50 per share, as amended  (iii) the Company, certain investors and CEVC entered into an Amended and Restated Voting Agreement that amended and restated that certain Voting Agreement, dated as of August 6, 2009, (iv) the Company, certain investors and CEVC entered into an Amended and Restated Registration Rights Agreement that amended and restated that certain Registration Rights Agreement, dated as of August 6, 2009, which grants certain registration rights relating to the Note and the Warrant, and (v) the Company and CEVC entered into a Security Agreement that secures the Note with all of the Company’s assets other than those assets specifically excluded from the lien created by the Security Agreement.
 
The Note matures on February 12, 2012, accrues interest at a rate per annum of 8%, and is convertible upon the option of CEVC at any time, into (a) shares of Jonway capital stock owned by ZAP at a conversion rate of 0.003743% of shares of Jonway capital stock owned by ZAP for each $1,000 principal amount of the Note being converted or (b) shares of ZAP common stock at a conversion rate of 4,435 shares of common stock for each $1,000 principal amount of the Note being converted. Upon conversion, any accrued interest on the Note may be waived. Effective March 31, 2011, the Company and ZAP entered into an amendment to the Note and Warrant to remove certain price-based anti-dilution features.

Since the value of the common stock into which the above-mentioned note is converted is greater than the proceeds for such issuance, a beneficial conversion feature totaling $19 million was recorded and is amortized over 13 months. We amortized $4.4 million and $12.5 million of the beneficial conversion feature the three and nine months ended September 30, 2011, respectively.
 
 
19

 
In addition, the Company recorded $1 million in accrued interest through the first nine months ended September 30, 2011 related to this note.

The Company accounts for derivative instruments and debt instruments in accordance with the interpretative guidance of ASC 815, “Derivatives and Hedging”, which codified SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”), EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock,” APB No. 14, “Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants,” EITF 98-5, “Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios” (“EITF 98-5”), and EITF 00-27, “Application of Issue No. 98-5 to Certain Convertible Instruments” (“EITF 00-27”), and associated pronouncements related to the classification and measurement of warrants and instruments with conversion features. It is necessary for the Company to make certain assumptions and estimates to value derivatives and debt instruments.
  
Short Term Debt and Notes
 
In the third quarter of 2011, we were approved to borrow up to an aggregate of US$6.2 million from the Taizhou Branch of China Merchants Bank and US$10 million from the Taizhou Branch of Everbright Bank of China, for a total of US$16.2 million through our  majority-owned subsidiary, Jonway. Although we have been approved for the credit lines, there are no legal obligations or rights to the credit lines until we execute agreements with the respective lenders to borrow funds under the credit lines. When drawn down, the credit lines will be secured by lands owned by Jonway and guaranteed by Jonway Group.

In July 2011, Jonway was approved for a credit line in the aggregate amount of RMB40 million (which as of September 30, 2011 is approximately US$6.2 million) from the Taizhou Branch of China Merchants Bank.  On August 11, 2011, Jonway entered into a Credit Agreement with the Taizhou Branch of China Merchants Bank for a revolving short term bank loan in the aggregate amount of RMB21 million (which as of September 30, 2011  is approximately US$3.2 million). The loans issuable under the Credit Agreement are secured by a Maximum Amount Mortgage Contract by and between Jonway and China Merchants Bank dated August 11, 2011 in which land use rights over two parcels of land owned by Jonway at Sanmen, Jian Tiao Town, Da Tang Village, Shang Peng Factory have been pledged as security for the loans.

On September 15, 2011, Jonway was also approved for another credit line in the aggregate amount of RMB64.5 million (which as of September 30, 2011 is approximately US$10 million) from the Taizhou Branch of Everbright Bank of China. Jonway has not entered any agreements to borrow funds under this credit line.
 
Jonway intends to utilize the credit lines to expand its electric vehicle business as well as other future vehicle models.  This includes on-going working capital needs, electric vehicle production equipment requirements, testing, homologation and new EV product molds. These credit lines will also be used to support the company’s expansion plans, with emphasis on its electric vehicle production line facilities in China. The credit will also help advance new electric vehicle initiatives, launch new strategic global sales and marketing operations, bolster infrastructure, and finance working capital.
 
As of September 30, 2011, ZAP had $9.5 million in short term debt and notes, of which $3.2 million is a loan from a bank in China with an interest rate of 7.22% per annum due on August 18, 2012. Also included is another short term bank loan of $1.6 million with an interest rate of 14.47% per annum which was paid on November 1, 2011.  In addition, there was $4.6 million in bank acceptance notes payable to Jonway suppliers for spare parts. These bank acceptance notes are usually within 6 months from issuance.
 
 
NOTE 10 – SEGMENT REPORTING
 
Operating Segments
 
Financial Accounting Standards Board (“FASB”) ASC Topic 280, Segment Reporting (“ASC 280”), establishes standards for the way public business enterprises report information about operating segments. ASC 280 also establishes standards for related disclosures about products and services, geographic areas and major customers.
 
In accordance with ASC 280, the Company has identified four reportable segments consisting of Jonway Vehicles, Advanced Technology Vehicles, Consumer Product and Car Outlet.  The Jonway Vehicles segment represents sales of the gas fueled Jonway A380 three and five-door sports utility vehicles and spare parts principally through distributors in China. Jonway and ZAP are also jointly developing various electric vehicles anticipated to enter into the electric vehicle market in 2012.  The Advanced Technology Vehicles segment represents sales and marketing outside of China of the ZAPTRUCK XL, the ZAPVAN Shuttle and the Xebra® Sedan and will transition to selling mostly Jonway’s EV A380SUV and EV minivan by the first half of 2012. The Consumer Product segment represents rechargeable portable energy products, our Zapino scooter, and our ZAPPY3
 
20

 
personal transporters.  Our Car Outlet segment represents operation of a retail car outlet that sells pre-owned conventional vehicles and advanced technology vehicles.  These segments are strategic business units that offer different services.  They are managed separately because each business requires different resources and strategies.  The Company’s chief operating decision making group, which is comprised of the Co-Chief Executive Officers and the senior executives of each of ZAP’s strategic segments, regularly evaluate the financial information about these segments in deciding how to allocate resources and in assessing performance.  The performance of each segment is measured based on its profit or loss from operations before income taxes.
 
The performance of each segment is measured based on its profit or loss from operations before income taxes. Segment results are summarized as follows (in thousands):
  
   
Jonway
Vehicles
   
Consumer
Products
   
Car Outlet
   
Advanced
Technology
Vehicles
   
Total
 
                               
For the three months ended September 30, 2011:
                             
Net sales
   
13,734
     
155
     
196
     
3
     
14,088
 
Gross profit (loss)
   
1,979
     
47
     
74
     
37
     
2,137
 
Depreciation, amortization
   
1,138
     
551
     
3
     
7
     
1,699
 
Net loss
   
(2,093)
     
(7,622)
     
(12)
     
(161)
     
(9,888)
 
Total assets
   
93,369
     
17,744
     
704
     
1,058
     
112,875
 
For the three months ended September 30, 2010:  Restated
                                       
Net sales
   
     
75
     
419
     
491
     
985
 
Gross profit (loss)
   
     
16
     
45
     
87
     
148
 
Depreciation, amortization
   
     
10
     
2
     
8
     
20
 
Net loss (restated)
   
     
(2,065)
     
                 (49)
     
               (147)
     
(2,261)
 
  Total assets
   
     
20,013
     
440
     
1,969
     
22,422
 
                                         
For the Nine months ended September 30, 2011:
                                       
Net sales
   
40,402
     
457
     
810
     
393
     
42,062
 
Gross profit (loss)
   
4,336
     
120
     
227
     
69
     
4,752
 
Depreciation, amortization
   
6,802
     
1,664
     
7
     
23
     
8,496
 
Net loss
   
(5,588)
     
(26,679)
     
(83)
     
(1,151)
     
(33,501)
 
Total assets
   
93,369
     
17,744
     
704
     
1,058
     
112,875
 
For the Nine months ended September 30, 2010: Restated
                                       
Net sales
   
     
255
     
1,424
     
1,003
     
2,682
 
Gross profit (loss)
   
     
75
     
269
     
                    20
     
364
 
Depreciation, amortization
   
     
47
     
7
     
30
     
84
 
Net loss  (restated)
   
     
(6,485)
     
                 (92)
     
            (1,022)
     
                    (7,599)
 
  Total assets
   
     
20,013
     
440
     
             1,969
     
           22,422
 
                                         
 
Operating segments do not sell products to each other, and accordingly, there is no inter-segment revenue to be reported.
 
Jonway’s results of operations have been included since the acquisition date of January 21, 2011.
 
Customer Information
 
For the three months and nine months ended September 30, 2011 and 2010, no customers accounted for more than 10% of our revenue.
 
 
21

 
 NOTE 11 – RELATED PARTIES
 
Sale of Stock to a Party Related to ZAP’s CO-CEO and Director

As previously disclosed in our 10-Q filed for the period ended March 31, 2011, we entered into private placement subscription agreements with Luo Hua Liang, the brother-in-law of Alex Wang, the Co-CEO and director of ZAP.  As previously disclosed in our 10-Q filed for the period ended March 31, 2011, we entered into private placement subscription agreements with Mr. Luo for the purchase of ZAP’s common stock for the aggregate purchase price of $7 million, of which we received $2 million as of the quarter ended March 31, 2011.  The private placement subscription agreements were superseded and terminated by a stock purchase agreement with Mr. Luo in August 2011. Pursuant to the stock purchase agreement, Mr. Luo will purchase ZAP’s common stock for an aggregate purchase price of $2 million in multiple closings. On September 8, 2011, we issued approximately 2.3 million shares of ZAP common stock in connection with the initial closing of $771,000.  We received an additional $1.025 million in subsequent closings for which we have issued approximately 3.35 million shares of ZAP common stock. We anticipate an additional closing for approximately $203,000.
 
Rental Agreements
 
The Company rents office space, land and warehouse space from Mr. Steven Schneider, its CEO and a major shareholder. These properties are used to operate the car outlet and to store inventory. Rental expense was approximately $46,200 and $68,600 for the nine months ended September 30, 2011 and 2010.
 
8% Senior Convertible Debt Due to China Electric Vehicle Corporation
 
On January 12, 2011, ZAP entered into a Senior Secured Convertible Note and Warrant Purchase Agreement (the “Agreement”) with China Electric Vehicle Corporation (“CEVC”), a British Virgin Island company whose sole shareholder is Cathaya.  Priscilla Lu, the chairman of the board of directors of ZAP, is also a general partner of Cathaya and a director of CEVC.
 
Pursuant to the Agreement, (i) CEVC purchased from the Company a Senior Secured Convertible Note (the “Note”) in the principal amount of US$19 million, subject to adjustments as set forth therein, as amended, (ii) the Company issued to CEVC a warrant (the “Warrant”) exercisable for two years for the purchase up to 20,000,000 shares of the Company’s Common Stock at $0.50 per share, subject to adjustments as set forth therein, as amended (iii) the Company, certain investors and CEVC entered into an Amended and Restated Voting Agreement that amended and restated that certain Voting Agreement, dated as of August 6, 2009, (iv) the Company, certain investors and CEVC entered into an Amended and Restated Registration Rights Agreement that amended and restated that certain Registration Rights Agreement, dated as of August 6, 2009, which grants certain registration rights relating to the Note and the Warrant, and (v) the Company and CEVC entered into a Security Agreement that secures the Note with all of the Company’s assets other than those assets specifically excluded from the lien created by the Security Agreement.

The Note matures on February 12, 2012, accrues interest at a rate per annum of 8%, and is convertible upon the option of CEVC at any time, into (a) shares of Jonway capital stock owned by ZAP at a conversion rate of 0.003743% of shares of Jonway capital stock owned by ZAP for each $1,000 principal amount of the Note being converted or (b) shares of ZAP common stock at a conversion rate of 4,435 shares of common stock for each $1,000 principal amount of the Note being converted. Effective March 31, 2011, the Company and ZAP entered into an amendment to the Note and Warrant to remove certain price-based anti-dilution features.

Since the value of the common stock into which the above-mentioned note is converted is greater than the proceeds for such issuance, a beneficial conversion feature totaling $19 million was recorded and is amortized over 13 months. We amortized $4.4 million and $12.5 million of the beneficial conversion feature in the three and nine months ended September 30, 2011, respectively.  In addition, the Company recorded $1 million in accrued interest on the convertible note of $19 million, at 8% per annum through the first nine months ended September 30, 2011.

 
22

 
Management Agreement with Cathaya Capital, L.P.
 
As previously disclosed in the Company’s Current Report on Form 8-K filed on August 10, 2009, on August 6, 2009, Cathaya purchased 20 million shares of the Company’s Common Stock. On August 6, 2009, the Company entered into a Secured Convertible Promissory Note with Cathaya for aggregate principal advances of up to $10 million. In addition, the Company issued two warrants to Cathaya exercisable for shares of the Company’s Common Stock.
 
On July 9, 2010, Cathaya entered into a securities purchase agreement, pursuant to which, Cathaya purchased 44 million shares of the Company’s Common Stock at a price of $0.25 per share for an aggregate purchase price of $11 million.
 
Priscilla Lu, the chairman of the board of directors of ZAP, is also a general partner of Cathaya.
 
On November 10, 2010, ZAP entered into a Management Agreement with Cathaya, for the payment of $2.5 million in exchange for Cathaya’s prior and ongoing transaction advisory, financial and management consulting services.  Pursuant to the agreement, principals of Cathaya will be available to serve on the Board and will devote such time and attention to the Company’s affairs as reasonably necessary to accomplish the purposes of the agreement.  The agreement is renewable yearly and the management fee was payable in cash or in common stock of ZAP at $0.50 per share.  Five million shares were issued to Cathaya Capital L.P. on behalf of Cathaya Management Co. Ltd. in payment of this fee.  As of September 30, 2011, ZAP has accrued $1.87 million for management fees due to Cathaya.

Joint Venture ZAP Hangzhou
 
On December 11, 2009, the Company entered into a Joint Venture Agreement to establish a new US-China company incorporated as ZAP Hangzhou to design and manufacture electric vehicle and infrastructure technology with Holley Group, the parent company of a global supplier of electric power meters and Better World.  Priscilla Lu, Ph.D. who is the current Chairman of the Board of ZAP is also a director and shareholder of Better World. In January of 2011, Holley Group’s interest in ZAP Hangzhou was purchased by Alex Wang, Co-CEO and director of ZAP. ZAP and Better World each own 37.5% of the equity shares of ZAP Hangzhou, and Alex Wang owns 25% of the equity shares of ZAP Hangzhou. The joint venture partners have also funded the initial capital requirements under the agreement for a total of $3 million, of which ZAP’s portion is $1.1 million.
 
We account for 37.5% interest in the ZAP Hangzhou Joint Venture by the equity method of accounting.  For the three and nine months ended September 30, 2011 and 2010, the joint venture incurred an operating losses of $170,445 and $599,675, of which $63,917 and $224,878 are our share.
 
Jonway Agreement with Zhejiang UFO
 
Based on a contract by and among the Zhejiang UFO, Jonway Group and Jonway dated as of January 1, 2006, Zhejiang UFO has authorized Jonway to operate its Sanmen Branch to assemble and sell UFO branded SUVs for a period of 10 years starting from January 1, 2006.

According to the contract, Jonway shall pay Zhejiang UFO a variable contractual fee which is calculated based on the number of SUVs that Jonway assembles in the Sanmen Branch every year, at the following rates:
 
The first 3,000 vehicles
$44 per vehicle
Vehicles from 3,001 to 5,000
$30 per vehicle
Vehicles over 5,000
$22 per vehicle
 
 
Zhejiang UFO is considered a related party because the Wang Family, who are shareholders of Jonway, have certain non-controlling equity interests in Zhejiang UFO.  The balance due to Zhejiang UFO at September 30, 2011 is $721,000.  The parties have agreed to defer payment without interest indefinitely.
 
Transactions with Jonway Group

Jonway Group is considered as a related party as Wang Family, one of the shareholders of the Company, has controlling interests in Jonway Group. Jonway Group supplies some of plastics spare parts to Jonway and gave guarantees on Jonway short term bank loans from China-based banks.

 
23

 
NOTE 12 – LITIGATION
 
In the normal course of business, we may become involved in various legal proceedings. Except as stated below, we know of no pending or threatened legal proceeding to which we are or will be a party which, if successful, might result in a material adverse change in our business, properties or financial condition. However, as with most businesses, we are occasionally parties to lawsuits incidental to our business, none of which are anticipated to have a material adverse impact on our financial position, results of operations, liquidity or cash flows. The Company estimates the amount of potential exposure it may have with respect to litigation claims and assessments.
 
Rainbow Cycle & Marine & Siloam Springs Cycle, v. Voltage Vehicles, Arkansas Motor Vehicle Commission, Case No. 10-008. On April 1, 2010, Rainbow Cycle & Marine & Siloam Spring Cycle (the “Dealer”), an automobile dealer in the State of Arkansas, submitted a complaint to the Arkansas Motor Vehicle Commission (the “Commission”) regarding 6 Xebra® vehicles purchased from ZAP in 2008, for a total purchase price of $65,000.  Due to a concern related to the vehicles raised by the Dealer, the Dealer requested that the Commission order the Company to refund all monies paid by the Dealer to the Company to pay all transportation costs, and in addition to assess penalties and interest charges against ZAP in an unspecified amount.  The Commission issued a Notice of Hearing on August 11, 2010, setting a hearing for September 15, 2010 on the Dealer’s Complaint. ZAP responded with a Motion to Dismiss, which the Commission set for hearing on December 15, 2010 and at the same time continued the hearing on the Dealer’s Complaint to the same date. After the hearing, the Commission ruled that ZAP was required to refund the Dealer’s purchase price for the vehicles and to pay for transportation of the vehicles off of the Dealer’s premises. In response, ZAP filed an appeal on April 25, 2011 in Superior Court, State of Arkansas, challenging the Commission’s decision. A brief in support of petition for judicial review was filed by ZAP on August 5, 2011 requesting that the decision of the Arkansas Motor Vehicle Commission be reversed and the complaints of the Dealer be dismissed with prejudice and for all other just and proper relief.

 
NOTE 13 – SUBSEQUENT EVENTS

As of the date of filing, there are no subsequent events to include in this report.

 Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
This quarterly report of Form 10-Q including the following management’s discussion and analysis, and other reports filed by the registrant from time to time with the securities and exchange commission (collectively the “filings”) contain forward-looking statements which are intended to convey our expectations or predictions regarding the occurrence of possible future events or the existence of trends and factors that may impact our future plans and operating results. These forward-looking statements are derived, in part, from various assumptions and analyses we have made in the context of our current business plan and information currently available to us and in light of our experience and perceptions of historical trends, current conditions and expected future developments and other factors we believe to be appropriate in the circumstances. you can generally identify forward-looking statements through words and phrases such as “seek”, “anticipate”, “believe”, “estimate”, “expect”, “intend”, “plan”, “budget”, “project”, “may be”, “may continue”, “may likely result”, and similar expressions. when reading any forward-looking statement you should remain mindful that all forward-looking statements are inherently uncertain as they are based on current expectations and assumptions concerning future events or future performance of our company, and are subject to risks, uncertainties, assumptions and other factors relating to our industry and results of operations, including but not limited to the following factors:

 
·  
our ability to maintain effective disclosure controls and procedures;

 
·  
our limited operating history, particularly of ZAP and Jonway on a consolidated basis;

 
·  
our history of losses and the uncertainty of our future profitability;

·  
whether the alternative energy and gas-efficient vehicle market for our products continues to grow and, if it does, the pace at which it may grow;

·  
our ability to keep up with advances in technology and compete against large competitors in a rapidly changing market for electric and conventional fuel vehicles;

·  
our ability to maintain competitive costs of our vehicles given the technologies that we adopt for our new electric vehicle design due to low initial demand for our vehicles;

 
24

 
·  
our ability to pass all required type approvals for countries in which we intend to sell our vehicles;

·  
our ability to operate internationally, particularly in China;

·  
our ability to establish, maintain and strengthen our brand;

·  
our ability to successfully integrate acquired subsidiaries, particularly Jonway, into our company and business;

·  
our ability to attract and retain the personnel qualified to implement our growth strategies;

·  
our ability to obtain type approval from government authorities in the United States, China and internationally for our products;

·  
our ability to protect the patents on our proprietary technology;

·  
our ability to fund our short-term and long-term financing needs;

·  
changes in our business plan and corporate strategies; and

·  
other risks and uncertainties discussed in greater detail in various sections of this report, particularly the section captioned “Risk Factors.”
 
Should one or more of these risks or uncertainties materialize, or should the underlying assumptions prove incorrect, actual results may differ significantly from those anticipated, believed, estimated, expected, intended or planned.
 
Each forward-looking statement should be read in context with, and with an understanding of, the various other disclosures concerning our company and our business made in our filings. You should not place undue reliance on any forward-looking statement as a prediction of actual results or developments. We are not obligated to update or revise any forward-looking statement contained in this report to reflect new events or circumstances unless and to the extent required by applicable law.
 
In this quarterly report on Form 10-Q the term “ZAP” refers to ZAP, the term “Jonway” refers to Zhejiang Jonway Automobile Co. Ltd., of which ZAP owns 51% of the equity shares, “ZAP Jonway” refers to both ZAP and Jonway on a consolidated basis, and “we,” “us” and “our” refer to ZAP or ZAP Jonway, as the context indicates.
 
Recent Developments

The Company designs, develops, manufactures and sells fully electric and advanced technology vehicles, as well as conventional fuel sports utility vehicles. ZAP markets and sells our electric vehicles directly to consumers by phone over the internet, in-person at our Santa Rosa location, by direct outreach through GSA and participating in bid applications with government and corporate fleets.  Jonway markets and sells our conventional fuel sports utility vehicles through distributors in China and internationally. Type approval of ZAP and Jonway’s A380 SUV EV is underway and will continue over the next several months and into 2012. The extensive certification process includes not only the vehicle endurance testing and safety analysis, but also key supplier qualification certification as well as Jonway’s EV manufacturing process qualification and certification.  The EV type approval requirements in China have evolved in the last year to provide more comprehensive qualification and certification testing, and accordingly have taken a longer period of time for completion.  We anticipate that the EV production facilities in Jonway will be ready for the certification process by the end of 2011. We are targeting certification completion within one quarter after the completion of the facilities. Type approval of the EV is required to manufacture and sell the electric vehicles in China, but the type approval is not required for the export of vehicles for sale outside of China.

In September of 2011, we celebrated our 17th Anniversary in the industry.  We are undertaking efforts to make changes we believe will make us more competitive in the global market, especially in China. In addition to continuing to develop new vehicles, ZAP completed its majority acquisition of Chinese automobile manufacturer Zhejiang Jonway Automobile Co. Ltd. in January 2011 and added several new executives with experience in the Chinese automobile and technology industries.  Alex Wang, CEO of Zhejiang Jonway Automobile, has been named Co-CEO. Benjamin Zhu, with his extensive international financial management and automotive experience has been appointed CFO. Tony Nie, formerly of Lotus Engineering China, has taken charge of the Company's Hangzhou technology center as VP of Business Development to help prepare electric vehicles for type approval and safety certification. Additionally, new board members Georges Penalver, Goman Chong, and Patrick Sevian were elected in June 2011. ZAP is currently focusing on EV engineering and integration of sales and marketing.  We believe ZAP's US operations now possesses the agility and flexibility to respond to ever-changing market demands.
 
25

 
One thing that remains unchanged as ZAP has evolved and grown over the last 17 years is its commitment to electric vehicles. Since 1994, the company has delivered to market more than 117,000 electric vehicles, including bicycles, scooters, motorcycles, ATVs, cars, trucks, and vans, while continuing to push the envelope when it comes to engineering.

Business Segments

We operate our business in four reportable segments: Jonway Vehicles, Advanced Technology Vehicles, Consumer Products and Car Outlet. These segments are strategic business units that offer different services.  They are managed separately because each business requires different resources and strategies.   The Jonway Vehicles segment represents sales of the gas fueled Jonway A380 three and five-door sports utility vehicles and spare parts principally through distributors in China and some sales internationally. The Jonway Vehicles segment also includes manufacturing facilities and the development of the EV production line for the A380 SUV and Jonway’s EV mini van, both of which are undergoing type approval.  The Advanced Technology Vehicles segment currently represents sales and marketing of the ZAPTRUCK XL, the ZAPVAN Shuttle and the Xebra® Sedan and will include the electric vehicles sales of Jonway’s A380 SUV model which is currently undergoing type approval for manufacturing production in early 2012.  The Consumer Product segment represents the sales and marketing of rechargeable portable energy products, our Zapino scooter, and our ZAPPY3 personal transporters. Our Car Outlet segment represents operation of a retail car outlet that sells pre-owned conventional vehicles and advanced technology vehicles.  ZAP’s Co-Chief Executive Officers and the senior executives of each of ZAP’s strategic segments regularly evaluate the financial information about these segments in deciding how to allocate resources and in assessing performance.  The performance of each segment is measured based on its profit or loss from operations before income taxes.
 
Results of Operations
 
The following table sets forth, as a percentage of net sales, certain items included in ZAP’s Statements of Operations (see Financial Statements and Notes) for the periods indicated:
  
   
Three Months
ended September 30,
   
Nine Months
ended September 30,
 
   
2011
   
     2010
   
2011
   
2010
 
Statements of Operations Data:
       
Restated
         
Restated
 
Net sales
   
             100 %
     
            100 %
     
             100 %
     
            100 %
 
Cost of sales
   
(84.8)
     
(84.9)
     
(88.7)
     
(86.4)
 
Operating expenses
   
(51.6)
     
(196.9)
     
(59.3)
     
(267.8)
 
Loss from operations
   
(36.4)
     
(181.8)
     
(48.0)
     
(254.2)
 
Net loss attributable to ZAP
   
(62.8)
     
(229.5)
     
(70.0)
     
(283.3)
 
 
We present results of operations that have been derived from our financial statements, which were prepared in accordance with accounting principles generally accepted in the United States of America and that include the results of operations of Jonway in our unaudited condensed consolidated financial statements since the date of ZAP’s acquisition of 51% of the equity shares of Jonway on January 21, 2011.
 
Three Months Ended September 30, 2011 Compared to Three Months Ended September 30, 2010
 
Net sales increased by $13.1 million in the three months ended September 30, 2011 from $985,000 in September 30, 2010 to $14.1 million for the three months ended September 30, 2011.  This increase related principally to the contribution of Jonway’s revenue consolidation due to the acquisition of a majority interest in Jonway in January 2011.  Jonway’s sales contributed $13.7 million in net sales.

In the three months ended September 30, 2011, Jonway sold 1,164 vehicles with a total revenue of approximately $13.7 million as compared to the three months ended September 30, 2010 in which Jonway sold over 1,513 vehicles with a total revenue of approximately $16.1 million. Two factors contributed to the Chinese automobile industry’s overall reduction in sales this year. The Chinese government constrained the issuing of new gasoline vehicle licenses per family, canceled some incentives and subsidies for purchasing gas vehicles and placed credit restriction policies on the banks to reduce credit facilities available to businesses.  Consequently, the automobile dealers in China, including Jonway’s automobile dealers, have had a reduction in sales orders and overall sales throughput. In this year, more SUV models are launched into market by auto makers , which intensified the competition. Thus far, Jonway has not provided a floor to finance dealers’ orders; payments are made largely 100% upfront prior to delivery.

Approximately thirty-five percent of the Jonway vehicles sold in 2011 contained the Mitsubishi fully automatic transmission and engine rather than the Mitsubishi manual transmission and engine. The automatic transmission is priced higher than the manual transmission, but the sales return yields at a lower overall margin contribution due to relatively high cost and increased marketing costs—an inherent feature of new model launching.

 
26

 
In our Advanced Technology Vehicles segment, net sales decreased by $488,000 from $491,000 in the three months ended September 30, 2010 to $3,000 for the three months ended September 30, 2011, primarily due to slower sales resulting from a tight United States credit and general economic conditions negatively impacted our sales to dealers in the United States. We also began the transition of moving our operations from the United States to China and switching suppliers for advanced technology vehicles from outside contract manufacturers to our auto manufacturing plant in China. This transition has resulted in fewer sales in the United States of advanced technology vehicles.
 
In our Consumer Product segment, net sales increased by $80,000 from $75,000 in the three months ended September 30, 2010 to $155,000 in the three months ended September 30, 2011.  The increase is principally due to higher sales of our ZAPPY 3 electric scooters to two catalog distribution companies.
 
In our Car Outlet segment, net sales decreased by $223,000 from $419,000 in the three months ended September 30, 2010 to $196,000 in the three months ended September 30, 2011. This decrease was due in part to the poor United States economy and the lower number of consigned vehicles available for resale in the three months ended September 30, 2011.
 
Gross profit increased by $2 million from $148,000 in the three months ended September 30, 2010 to $2.1 million in the three months ended September 30, 2011.  The increase in gross profit in the three months ended September 30, 2011 principally related to the Jonway Acquisition. Jonway’s gross profit contributed approximately $1.9 million.
 
In the Advanced Technology Vehicles segment, gross profit decreased by $50,000 from a gross profit of $87,000 in the three months ended September 30, 2010, to $37,000 in the three months ended September 30, 2011.  This decrease was due to a lower volume of sales of the ZAPTRUCK XL.
 
In the Consumer Products segment, gross profit increased by $31,000 from $16,000 in the three months ended September 30, 2010 to $47,000 in the three months ended September 30, 2011. The increase was primarily due to higher sales of our ZAPPY3 electric scooters.
 
In the Car Outlet segment, gross profit increased by $29,000 from $45,000 in the three months ended September 30, 2010 to $74,000 for the three months ended September 30, 2011. The higher gross profit was due to product mix and overall higher market wholesale prices for automobiles.
 
Sales and marketing expenses increased by $2.5 million from $245,000 in the three months ended September 30, 2010 to $2.7 million in the three months ended September 30, 2011.  The increase in sales and marketing expenses in the three months ended September 30, 2011 were principally related to Jonway’s business in dealership rebates and new model promotions, which were included during the period due to the Jonway Acquisition in January 2011.  Jonway’s sales and marketing costs contributed approximately $1.9 million this quarter as a result of this acquisition, which substantially included transportation, special supporting fees to strategic dealers, marketing, promotion and advertisement of new models, the rebranding of Jonway from the former name of UFO and payroll. In addition, we inccurred approximately $540,000 for the quarterly amortization of the distribution agreement for Jonway’s products and Better World’s charging stations. See further explanation in Note 8, Distribution Agreements.
 
General and administrative expenses increased by $1.9 million from $1.6 million in the three months ended September 30, 2010 to $3.5 million in the three months ended September 30, 2011.  This increase was due to the inclusion of $1.3 million in general and administrative expenses from Jonway as a result of the Jonway Acquisition, which were principally related to Jonway’s on-going general and administrative expenses, including business management, payroll, taxes and other administrative activities. In the three months ended September  30, 2011, we also recorded  $625,000 for quarterly fees under a management agreement entered into between ZAP and Cathaya Capital, L.P., a Cayman Islands exempted limited partnership and ZAP’s largest shareholder, or Cathaya.

Research and development expenses increased by $934,000 from $130,000 in the three months ended September 30, 2010 to $1.1 million in the three months ended September 30, 2011. This increase was due to the inclusion of $901,000 in research and development expenses relating to electric vehicle type approval testing, manufacturing, production, tools, development and contracting work associated with the electric vehicle and new model developments, including EV type approval testing, EV production facilities and new model engineering development.
 
27

 
Interest expense increased by $4.9 million from $1,000 in the three months ended September 30, 2010 to $4.9 million in the three months ended September 30, 2011.  This increase was principally due to the amortization $4.4 million of the beneficial conversion feature related to the $19 million in convertible debt issued by ZAP to China Electric Vehicle Corporation on January 12, 2011, the proceeds of which were used to finance the Jonway Acquisition.

Joint operations We account for 37.5% interest in the ZAP Hangzhou Joint Venture by the equity method of accounting.  For the three months ended September 30, 2011, the joint venture incurred an operating loss of $170,600 of which $64,000 is our share.
 
Other income increased by $317,000 from an expense of $96,000 in the three months ended September 30, 2010 to income of $221,000 in the three months ended September 30, 2011. This increase was due to the inclusion of $219,000 of other income contributed by Jonway as a result of the Jonway Acquisition, which mainly includes the incentive of $72,000 from the Chinese government and income of $120,000 from scrap sales.
 
 Net loss attributable to ZAP for the three months ended September 30, 2011 was $8.9 million loss compared to $2.3 million loss for the three months ended September 30, 2010.

Nine Months Ended September 30, 2011 Compared to Nine Months Ended September 30, 2010

                 Net sales increased by $39 million in the nine months ended September 30, 2011 from $2.7 million for the nine months ended September 30, 2010 to $42 million in September 30, 2011.  This increase related principally to the Jonway Acquisition that occurred in January 2011. Jonway’s sales contributed $40 million in net sales.

In the nine months ended September 30, 2011, Jonway sold 4,430 gasoline vehicles with total revenue of approximately $40 million as compared to the nine months ended September 30, 2010 in which Jonway sold 4,949 vehicles with total revenue of over $53 million. Two factors contributed to the Chinese automobile industry’s overall reduction in sales this year. The Chinese government constrained the issuing of new gasoline vehicle licenses per family, and canceled some incentives and subsidies for purchasing gas vehicles, and placed credit restriction policies on the banks to reduce credit facilities available to businesses.  Consequently, the automobile dealers in China, including Jonway’s automobile dealers, have had a reduction in sales orders and overall sales throughput. In this year, more SUV models are launched into market by auto makers , which intensified the competition. Thus far, Jonway has not provided a floor to finance dealers’ orders; payments are made largely 100% upfront prior to delivery.

Approximately thirty-five percent of the Jonway vehicles sold in 2011 contained the Mitsubishi fully automatic transmission and engine rather than the Mitsubishi manual transmission and engine. The automatic transmission is priced higher than the manual transmission, but the sales return yields at a lower overall margin contribution due to relatively high cost and increased marketing costs—an inherent feature of new model launching.

In our Advanced Technology segment, sales decreased by $607,000 from $1 million for the nine months ended September 30, 2010 to $393,000 for the nine months ended September 30, 2011. The tight United States credit and general economic conditions negatively impacted our dealer sales in the first nine months of 2011. We are also in the process of moving our operations and production to Jonway, our Chinese automobile plant.
 
 
28

 
In our Consumer Product segment, sales increased by $202,000 from $255,000 for the nine months ended September 30, 2010 to $457,000 for the nine months ended September 30, 2011 due to increases in sales of ZAPPY 3 scooters to two catalog distributors for resale.
 
In our Car Outlet segment, sales decreased by $614,000 from $1.4 million for the nine months ended September 30, 2010 to $810,000 for the nine months ended September 30, 2011. The decrease was due to a limited supply of consignment cars available for sale and a general downturn in the economy.

Gross profit increased by $4.4 million from $364,000 for the nine months ended September 30, 2010 to $4.7 million for the nine months ended September 30, 2011.  The increase in gross profit in the nine months ended September 30, 2011 principally related to the inclusion of Jonway expenses since January 2011. Jonway’s gross profit contributed approximately $4.3 million as a result of this acquisition for the nine months ended September 30, 2011.
 
In our Advanced Technology segment, our gross profit increased by $49,000 from a gross profit of $20,000 for the nine months ended September 30, 2010 to a gross profit of $69,000 for the nine months ended September 30, 2011.  The increase was due to sales of the XL models, which have been designed for fleets.
 
In our Consumer Products segment, we experienced an increase of $45,000 in gross profits from a gross profit of $75,000 for the nine months ended September 30, 2010 to a gross profit of $120,000 for the nine months ended September 30, 2011. The increase was due to the sales of the Zappy 3 Pro to two major customers.
 
Gross profits in our retail car lot decreased by $42,000 from $269,000 for the nine months ended September 30, 2010 to $227,000 for the nine months ended September 30, 2011. The decrease in gross profits was due to lower sales volumes and a decline of consignment cars available for sale.
 
Sales and marketing expenses in the first nine months ended September 30, 2011 increased by $7.3 million from $769,000 for the nine months ended September 30, 2010 to $8 million for the nine months ended September 30, 2011.  The increase in selling and marketing expense in the nine months ended September 30, 2011 principally related to the Jonway Acquisition in January 2011. Jonway’s sales and marketing costs contributed approximately $5.7 million as a result of this acquisition, which substantially included the transportation, special supporting fees to strategic dealers, marketing, promotion and advertisement of new models, the rebranding of Jonway from the former name of UFO and payroll. In addition, we incurred approximately $1.62 million for the quarterly amortization of the distribution agreement for Jonway’s products and Better World’s charging stations. See further explanation in Note 8, Distribution Agreements.
 
General and administrative expenses for the nine months ended September 30, 2011 increased by approximately $8.4 million from $5.5 million for the nine months ended September 30, 2010 to $13.9 million for the nine months ended September 30, 2011. This increase related principally related to the inclusion of Jonway’s expenses since the Jonway Acquisition in January 2011. Jonway’s general and administrative expenses contributed $5.6 million to total expenses.  The increase was due to greater professional fees for legal and accounting services in connection with the Jonway Acquisition, an increase in salaries due to hiring additional personnel, higher consulting expenses and increased expenses for employee stock options to reflect recent issuances in the nine months ended September 30, 2011.  In the nine months ended September 30, 2011, we also recorded $1.87 million in fees under a management agreement entered into between ZAP and Cathaya Capital, L.P., or Cathaya; a Cayman Islands exempted limited partnership and our largest shareholder.
 
Research and development expenses increased by $2.2 million from $834,000 for the nine months ended September 30, 2010 to $3 million for the nine months ended September 30, 2011. The increase was the result of the inclusion of $2 million in research and development expenses relating to further developing new gasoline and electric vehicle models, including EV type approval testing, EV production facilities and new model engineering development.
      
Interest expense, net increased by $12.6 million from an interest expense of $1 million for the nine months ended September 30, 2010 to an interest expense of $13.7 million for the nine months ended September 30, 2011.The increase was primarily due to amortization of the beneficial conversion feature recorded on the $19 million convertible debt which resulted from a discounted stock conversion price. Also included is interest expense of $1.1 million relating to the $19 million convertible debt at 8% per annum and bank loans.

Joint venture operations We account for 37.5% interest in the ZAP Hangzhou Joint Venture by the equity method of accounting.  For the nine months ended September 30, 2011, the joint venture incurred an operating loss of $600,000 of which $225,000 is our share.

Other income (expense) increased $1.3 million from an expense of $291,000 for the nine months ended September 30, 2010 to other income of $1 million for the nine months ended September 30, 2011, which reflected the inclusion of other income principally related to the inclusion of Jonway’s expenses since the Jonway Acquisition in January 2011 which includes the incentive of $449,000 from the Chinese government and income of $0.5 million from scrap sale.
  
Net loss attributable to ZAP for the nine months ended September 30, 2011 was $29.4 million loss compared to $7.6 million loss for the nine months ended September 30, 2010.

Liquidity and Capital Resources
 
In assessing our liquidity, we monitor and analyze our cash on-hand, liquidation value of our investment in securities, and our operating and capital expenditure commitments.  Our principal liquidity needs are to meet our working capital requirements, operating expenses and capital expenditure obligations. 
 
29

 
Our principal sources of liquidity consist of our existing cash on hand, bank loans, our investment in securities with Samyang Optics, Ltd. and transactions with Luo Hua Liang, the brother-in-law of Alex Wang, the Co-CEO and director of ZAP.  As previously disclosed in our 10-Q filed for the period ended March 31, 2011, we entered into private placement subscription agreements with Mr. Luo for the purchase of ZAP’s common stock for the aggregate purchase price of $7 million, of which we received $2 million as of the quarter ended March 31, 2011.  The private placement subscription agreements were superseded and terminated by a stock purchase agreement with Mr. Luo in August 2011. Pursuant to the stock purchase agreement, Mr. Luo will purchase ZAP’s common stock for an aggregate purchase price of $2 million in multiple closings. On September 8, 2011, we issued approximately 2.3 million shares of ZAP common stock in connection with the initial closing of $771,000. We received an additional $1.025 million in subsequent closings for which we have issued approximately 3.35 million shares of ZAP common stock. We anticipate an additional closing for approximately $203,000.
 
In the third quarter of 2011, we were approved to borrow up to an aggregate of US$6.2 million from the Taizhou Branch of China Merchants Bank and US$10 million from the Taizhou Branch of Everbright Bank of China, for a total of US$16.2 million through our majority-owned subsidiary, Jonway. Although we have been approved for the credit lines, there are no legal obligations or rights to the credit lines until we execute agreements with the respective lenders to borrow funds under the credit lines. When drawn down, the credit lines will be secured by lands owned by Jonway and guaranteed by Jonway Group.

In July 2011, Jonway was approved for a credit line in the aggregate amount of RMB40 million (which as of September 30, 2011 is approximately US$6.2 million) from the Taizhou Branch of China Merchants Bank.  On August 11, 2011, Jonway entered into a Credit Agreement with the Taizhou Branch of China Merchants Bank for a revolving short term bank loan in the aggregate amount of RMB21 million (which as of September 30, 2011  is approximately US$3.2 million). The loans issuable under the Credit Agreement are secured by a Maximum Amount Mortgage Contract by and between Jonway and China Merchants Bank dated August 11, 2011 in which land use rights over two parcels of land owned by Jonway at Sanmen, Jian Tiao Town, Da Tang Village, Shang Peng Factory have been pledged as security for the loans.

On September 15, 2011, Jonway was also approved for another credit line in the aggregate amount of RMB64.5 million (which as of September 30, 2011 is approximately US$10 million) from the Taizhou Branch of Everbright Bank of China. Jonway has not entered any agreements to borrow funds under this credit line.
 
               Jonway intends to utilize the credit lines to expand its electric vehicle business as well as other future vehicle models.  This includes on-going working capital needs, electric vehicle production equipment requirements, testing, homologation and new EV product molds. These credit lines will also be used to support the company’s expansion plans, with emphasis on its electric vehicle production line facilities in China. The credit will also help advance new electric vehicle initiatives, launch new strategic global sales and marketing operations, bolster infrastructure, and finance working capital.
 
In January 2011, ZAP issued $19 million of convertible debt to make a partial payment in connection with the Jonway Acquisition.  ZAP believes that CEVC will convert the note into shares of ZAP common stock, but if CEVC does not elect to so convert the note, the note will either be converted into shares of Jonway capital stock owned by ZAP or require cash repayment in February 2012.  Assuming that the note is converted into shares of ZAP common stock and does not require cash repayment in February 2012, we believe that we will have sufficient liquidity required to conduct operations through September 30, 2012.

We will require additional capital to expand our current operations.  In particular, we require additional capital to expand our presence across the world, to continue development of our electric vehicle business, to continue strengthening our dealer network and after-sale service centers and expanding our market initiatives.  We also require financing the investment for the continued roll-out of new products and to add qualified sales and professional staff to execute on our business plan and pursue our efforts in the research and development of advanced technology vehicles, such as the new ZAP Alias, the electric and other fuel efficient vehicles.

We intend to fund our long term liquidity needs related to operations through the incurrence of indebtedness, equity financing or a combination of both.  Although we believe that these sources will provide sufficient liquidity for us to meet our future liquidity and capital obligations, our ability to fund these needs will depend on our future performance, which will be subject in part to general economic, financial, regulatory and other factors beyond our control, including trends in our industry and technological developments.  However, we may not be able to obtain this additional financing on terms acceptable to us or at all.
 
Net cash used for operating activities increased by $2.9 million from $5.8 million in the nine months ended September 30, 2010 to $8.7 million in the nine months ended September 30, 2011. Cash used in operations was comprised of the net loss attributable to ZAP incurred of $33.5 million plus net non-cash expenses of $25million and the net increase of $156,000  in working capital.

 
30

 
Cash used in the nine months ended September 30, 2010 was comprised of the net loss incurred of $7.6 million plus net non-cash expenses of $1.67 million and the net decrease of $86,000 in working capital.
 
ZAP completed the Jonway Acquisition on January 21, 2011, pursuant to that certain Equity Transfer Agreement entered into between ZAP and Jonway Group Co., Ltd. dated July 2, 2010. ZAP has paid a total purchase price of $35.9 million consisting of approximately $29 million in cash and 8 million shares of ZAP common stock pursuant to this agreement. ZAP funded a portion of the purchase price of the Jonway Acquisition through a Senior Secured Convertible Note and Warrant Purchase Agreement, or the CEVC Agreement, dated as of January 12, 2011, with China Electric Vehicle Corporation, or CEVC, a British Virgin Island company whose sole shareholder is Cathaya. Priscilla Lu, chairman of the board of directors of ZAP is also a general partner of Cathaya and a director of CEVC.
 
Pursuant to the CEVC Agreement, (i) CEVC purchased from ZAP a Senior Secured Convertible Note in the principal amount of $19 million, (ii) ZAP issued to CEVC a warrant exercisable for two years for the purchase up to 20,000,000 shares of ZAP’s Common Stock at $0.50 per share, subject to adjustments as set forth therein, (iii) ZAP, certain investors of ZAP and CEVC entered into an Amended and Restated Voting Agreement that amended and restated that certain Voting Agreement, dated as of August 6, 2009, (iv) ZAP, certain investors of ZAP and CEVC entered into an Amended and Restated Registration Rights Agreement that amended and restated that certain Registration Rights Agreement, dated as of August 6, 2009, as amended, to grant certain registration rights relating to the note and the warrant, and (v) ZAP and CEVC entered into a Security Agreement securing the note with all of ZAP’s assets and property. Effective as of March 31, 2011, ZAP and CEVC entered into an amendment to the Note to remove certain price-based anti-dilution features.  ZAP believes there is some uncertainty regarding whether this $19 million note will be converted to equity or require cash repayment in February 2012.
 
Investing activities used cash of $19.5 million in the nine months ended September 30, 2011, as compared with $2 million in the nine months ended September 30, 2010. This increase of $17.4 million was primarily due to making a partial payment related to the Jonway Acquisition, in the first quarter ended March 31, 2011, and the fixed assets procurements.
 
Financing activities provided cash of $28 million in the nine months ended September 30, 2011, as compared with $4 million in the nine months ended September 30, 2010.  This increase of $24 million was primarily due to the issuance in the first quarter ended March 31, 2011 of $19 million in convertible debt to CEVC, the proceeds of which were used to make a partial payment related to the Jonway Acquisition and other private placements of shares of ZAP common stock.
 
ZAP has cash of $1.5 million at September 30, 2011, as compared to $935,000 at September 30, 2010.  ZAP had working capital deficits of $22.8 million and $2.6 million for the nine months ended September 30, 2011 and 2010, respectively.  The $20.2 million increase in working capital deficits was primarily due to the issuance of convertible debt under the CEVC Agreement, the proceeds of which were used to make a partial payment related to the Jonway Acquisition, and the inclusion of Jonway’s working capital deficit of $7.7 million in our consolidated financial statements as a result of the Jonway Acquisition.

Critical Accounting Policies and Use of Estimates
 
Estimates
 
The preparation of financial statements in conformity with United States generally accepted accounting principles requires the Company to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. The more significant estimates relate to revenue recognition, contractual allowances and uncollectible accounts, intangible assets, accrued liabilities, derivative liabilities, income taxes, litigation and contingencies. Estimates are based on historical experience and on various other assumptions that the Company believes to be reasonable under the circumstances, the results of which form the basis for judgments about results and the carrying values of assets and liabilities. Actual results and values may differ significantly from these estimates
 
Stock Based Compensation
 
The Company accounts for stock-based compensation under the provisions of FASB ASC Topic 718, Compensation—Stock Compensation (“ASC 718”), which requires the measurement and recognition of compensation expense for all stock-based awards made to employees and directors based on estimated fair values on the grant date. The Company estimates the fair value of stock-based awards on the date of grant using the Black-Scholes-Merton option pricing model (the “Black-Scholes model”). The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods using the straight-line method. We estimate forfeitures at the time of grant and revise our estimate in subsequent periods if actual forfeitures differ from those estimates.
 
 
31

 
The Company accounts for stock-based compensation awards and warrants granted to non-employees in accordance with FASB ASC Topic 505-50, Equity-Based Payments to Non-Employees (“ASC 505-50”). Under ASC 505-50, the Company determines the fair value of the warrants or stock-based compensation awards granted as either the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable. If the fair value of equity instruments issued is used, it is measured using the stock price and other measurement assumptions as of the earlier of either (1) the date at which commitment for performance by the counterparty to earn the equity instruments is reached, or (2) the date at which the counterparty’s performance is complete.
 
Derivative Financial Instruments
 
The Company generally does not use derivative financial instruments to hedge exposures to cash flow or market risks. However, certain other financial instruments, such as warrants, are classified as liabilities when either (a) the holder possesses rights to net-cash settlement or (b) physical or net-share settlement is not within the control of the Company. In such instances, net-cash settlement is assumed for financial accounting and reporting, even when the terms of the underlying contracts do not provide for net-cash settlement. Such financial instruments are initially recorded at fair value and subsequently adjusted to fair value at the close of each reporting period.
 
The Company accounts for derivative instruments and debt instruments in accordance with the interpretative guidance of ASC 815 which codified SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”), EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock,” APB No. 14, “Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants,” EITF 98-5, “Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios” (“EITF 98-5”), and EITF 00-27, “Application of Issue No. 98-5 to Certain Convertible Instruments” (“EITF 00-27”), and associated pronouncements related to the classification and measurement of warrants and instruments with conversion features. It is necessary for the Company to make certain assumptions and estimates to value derivatives and debt instruments.
 
Allowance for Doubtful Accounts
 
The Company provides an allowance for doubtful accounts when management estimates collectability to be uncertain. Accounts receivable are continually reviewed to determine which, if any, accounts are doubtful of collection. In making the determination of the appropriate allowance amount, the Company considers current economic and industry conditions, relationships with each significant customer, overall customer credit-worthiness and historical experience. The allowance for doubtful accounts was $17,500 and $27,000 at September 30, 2011 and December 31, 2010, respectively for ZAP’s U.S. operations.  Jonway primarily sells vehicles to its qualified dealers. An on-going credit evaluation of its customers’ financial condition is performed. Jonway maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. As a result of this analysis no allowance for doubtful accounts was determined to be required at September 30, 2011.
 
Inventories
 
Inventories consist primarily of vehicles, both gas and electric, parts and supplies, and work in progress and are carried at the lower of cost (first-in, first-out basis) or market (net realizable value or replacement cost). The Company maintains reserves for estimated excess, obsolete and damaged inventory based on projected future shipments using historical selling rates, and taking into account market conditions, inventory on-hand, purchase commitments, product development plans and life expectancy, and competitive factors. If markets for the Company’s products and corresponding demand were to decline, then additional reserves may be deemed necessary. Any changes to the Company’s estimates of its reserves are reflected in cost of goods sold within the statement of operations during the period in which such changes are determined by management.
 
Off-Balance Sheet Arrangements
 
None.
 
Item 3.    Quantitative and Qualitative Disclosures about Market Risk
 
Quantitative and Qualitative Disclosures about Market Risk
 
The Company foreign currency exchange risks are as follows:
 
 
32

 
The financial position and results of operations of our Chinese subsidiary Jonway are measured using Chinese Renminbi (RMB) as the functional currency.  The financial position and results of operations of our Chinese subsidiary are reported in United States dollars (USD) and included in our consolidated financial statements.  Our exposure to foreign currency fluctuation is mitigated, in part, by the fact that we incur certain operating costs in the same foreign currencies in which revenues are denominated.  The foreign currency transaction gain (loss) is attributable to the impact of foreign currency exchange rate changes on intercompany debt balances and on receivable and payables denominated in a currency other than a subsidiary’s functional currency.  ZAP benefits from a weaker dollar and is adversely affected by a stronger dollar relative to major currencies worldwide.  Accordingly, changes in exchange rates, and in particular a strengthening of the United States dollar, may negatively affect the company’s consolidated revenues or operating costs and expenses as expressed in United States Dollars.  Adjustments resulting from the process of translating foreign functional currency financial statements into United States dollars are included in accumulated other comprehensive income (loss) a separate component of common shareholders equity.
 
 Item 4.    Controls and Procedures
 
Disclosure Controls and Procedures

Our management, under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, and advice from our retained independent consulting firms, conducted an evaluation of the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports filed, furnished or submitted under the Exchange Act.

In our Annual Report on Form 10-K for the year ended December 31, 2010, as filed with the Securities and Exchange Commission on April 15, 2011, we identified the following internal control over financial reporting matter that rose to the level of a material weakness: we did not maintain effective controls over the identification, recording and oversight of certain derivative liabilities and the evaluation of the application of generally accepted accounting principles relating to these complex accounting instruments.  
 
Since the date of our filing, we have retained the independent consulting firms to advise us on complex accounting instruments and we have continuously conducted an extensive review of our debt instruments and have determined that they have been properly accounted for in our financial statements.  We have developed and established effective internal controls and testing guidelines over the identification, recording and oversight of certain derivative liabilities and the evaluation of the application of generally accepted accounting principles relating to these complex accounting instruments.

Changes in internal control over financial reporting
 
We have reviewed our system of internal controls over financial reporting in light of our acquisition of Jonway in January 2011.  As a result of our review, we hired additional finance personnel and independent consulting firms at Jonway to further strengthen our existing internal controls over financial reporting.
 
 
PART II – OTHER INFORMATION
 
Item 1.    Legal Proceedings
 
In the normal course of business, ZAP Jonway may become involved in various legal proceedings. Except as stated below, we know of no pending or threatened legal proceeding to which we are or will be a party which, if successful, might result in a material adverse change in our business, properties or financial condition. However, as with most businesses, we are occasionally parties to lawsuits incidental to our business, none of which are anticipated to have a material adverse impact on our financial position, results of operations, liquidity or cash flows. ZAP Jonway estimates the amount of potential exposure it may have with respect to litigation claims and assessments.

Rainbow Cycle & Marine & Siloam Springs Cycle, v. Voltage Vehicles, Arkansas Motor Vehicle Commission, Case No. 10-008. On April 1, 2010, Rainbow Cycle & Marine & Siloam Spring Cycle (the “Dealer”), an automobile dealer in the State of Arkansas, submitted a complaint to the Arkansas Motor Vehicle Commission (the “Commission”) regarding 6 Xebra® vehicles purchased from ZAP in 2008, for a total purchase price of $65,000.  Due to a concern related to the vehicles raised by the Dealer,
 
 
33

 
the Dealer requested that the Commission order the Company to refund all monies paid by the Dealer to the Company to pay all transportation costs, and in addition to assess penalties and interest charges against ZAP in an unspecified amount.  The Commission issued a Notice of Hearing on August 11, 2010, setting a hearing for September 15, 2010 on the Dealer’s Complaint. ZAP responded with a Motion to Dismiss, which the Commission set for hearing on December 15, 2010 and at the same time continued the hearing on the Dealer’s Complaint to the same date. After the hearing, the Commission ruled that ZAP was required to refund the Dealer’s purchase price for the vehicles and to pay for transportation of the vehicles off of the Dealer’s premises. In response, ZAP filed an appeal on April 25, 2011 in Superior Court, State of Arkansas, challenging the Commission’s decision. A brief in support of petition for judicial review was filed by ZAP on August 5, 2011 requesting that the decision of the Arkansas Motor Vehicle Commission be reversed and the complaints of the Dealer be dismissed with prejudice and for all other just and proper relief.

Item 1A.  Risk Factors
 
If  ZAP Jonway does not maintain proper disclosure controls and procedures, our ability to produce accurate and timely financial statements could be impaired, which could adversely affect our business, operating results, and financial condition.
 
During our management’s review of our financial statements and results for the year ended December 31, 2010, our management assessed the effectiveness of our internal control over financial reporting and identified a material weakness in our identification, recording and oversight of certain derivative liabilities and the evaluation of the application of generally accepted accounting principles relating to these complex accounting instruments.  A material weakness is a deficiency or a combination of deficiencies in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of ZAP’s annual or interim financial statements will not be prevented or detected on a timely basis.  In the first quarter of 2011, our management also determined that that our disclosure controls and procedures were not effective with respect to accounting for derivative liabilities to ensure timely decisions regarding disclosures in the reports filed or submitted under the Exchange Act.  Management has since determined that the material weaknesses in our internal control over financial reporting have been addressed and that disclosure controls and procedures are effective.
 
While the audit of our financial statements by our independent registered public accounting firm has included a consideration of internal control over financial reporting as a basis of designing audit procedures, our independent registered public accounting firm has not considered internal controls over financial reporting for the purpose of expressing an opinion with respect to the effectiveness of our internal controls over financial reporting. If such an evaluation had been performed, material weaknesses or other control deficiencies may have been identified.  In addition, material weaknesses and other control deficiencies may be identified when our management performs evaluations of internal controls in the future.  Ensuring that ZAP has adequate internal financial and accounting controls and procedures that allows us to produce accurate financial statements on a timely basis is costly and time-consuming, and we are required to evaluate these controls freque

             ZAP has a history of losses and ZAP Jonway’s future profitability on a quarterly or annual basis is uncertain, which could have a harmful effect on ZAP Jonway’s business and the value of ZAP’s common stock.
 
ZAP Jonway incurred net losses attributable to ZAP of $29.4 million, $19.0 million, and $11.3 million for the nine months ended September 30, 2011 and for years ended December 31, 2010 and 2009, respectively and has had net losses in each quarter since its inception.  Jonway incurred net losses of $ 4.7 million, $0.4 million and $5.2 million for the nine months ended September 30, 2011 and for the years ended December 31, 2010 and 2009, respectively, and has had net losses annually since inception.
 
ZAP Jonway believes that it may continue to incur operating and net losses for our gas and electric vehicles until at least the time ZAP Jonway begins significant deliveries of the Alias and the gas and electric vehicle models, which we expect to occur in 2012, and may occur later or not at all. We plan to begin limited trial production of the enhanced version of the gas A380 SUV in late 2011. Even if we are able to successfully develop the Alias and the gas and electric vehicle models, there can be no assurance that it will be commercially successful.  Our profitability will be dependent upon the successful development and successful commercial introduction and acceptance of our gas and electric vehicles models, which may not occur.
 
ZAP Jonway expects the rate at which we will incur losses to increase significantly in future periods from current levels as we:
 
 
· 
expand our business and manufacturing activities in China;
 
 
· 
begin international business and manufacturing activities;
 
 
34

 
 
· 
design, develop and manufacture our planned new gas and electric vehicles;
 
 
· 
bolstering our after-sale services network;
 
 
· 
build inventories of parts and components for our new gas and electric vehicles;
 
 
· 
develop and equip manufacturing facilities to produce our new gas and electric vehicle models;
 
 
· 
expand our design, development, maintenance and repair capabilities;
 
 
· 
increase our sales and marketing activities; and
 
 
· 
increase our general and administrative functions to support our growing operations.
 
Because ZAP Jonway will incur the costs and expenses from these efforts before we receive substantial incremental revenues with respect thereto, ZAP Jonway’s losses in future periods will be significantly greater than the losses we would incur if we developed our business more slowly. In addition, we may find that these efforts are more expensive than we currently anticipate or that these efforts may not result in increases in our revenues, which would further increase ZAP Jonway’s losses.
 
ZAP Jonway’s limited operating history makes evaluating our business and future prospects difficult, and may increase the risk of your investment.
 
You must consider the risks and difficulties we face as a company with a limited operating history. If ZAP Jonway does not successfully address these risks, our business, prospects, operating results and financial condition will be materially and adversely harmed. ZAP was formed in September 1994, but only began manufacturing electric automobiles in 2006. ZAP Jonway’s net losses attributable to ZAP were $11.3 million for the year ended December 31, 2009 and $19.0 million for the year ended December 31, 2010 and $29.4 million for the nine months ended September 30, 2011. ZAP acquired 51% of the equity shares of Jonway in January 2011.  ZAP Jonway has a very limited operating history on which investors can base an evaluation of our business, operating results and prospects. To date, ZAP has derived revenues principally from sales of customized versions of our standard vehicles, and to a lesser extent on consumer products.  Jonway has derived revenues principally from sales of its conventional fuel SUVs. ZAP Jonway intends in the longer term to derive substantial revenues from the sales of our planned electric and the upgraded conventional fuel vehicles which are in development and which we intend to begin producing in 2012. ZAP Jonway has no operating history with respect to its newer vehicles, which limits our ability to accurately forecast the cost of the vehicles.
 
It is difficult to predict ZAP Jonway’s future revenues and appropriately budget for our expenses, and we have limited insight into trends that may emerge and affect our business. For example, in the four most recent fiscal quarters ended September 30, 2011, ZAP Jonway recorded quarterly revenue of as much as $16.26 million and as little as $545,000 million and quarterly operating losses of as much as $12.58 million and as little as $1.1 million.  ZAP Jonway has not completely recorded quarterly financials statements on a consolidated basis in the past, which makes it difficult to predict what ZAP Jonway’s consolidated future revenues will be in order to appropriately budget for our expenses.  In the event that actual results differ from ZAP Jonway’s estimates or we adjust our estimates in future periods, our operating results and financial position could be materially affected.
 
ZAP Jonway’s financial results may vary significantly from period-to-period due to the seasonality of our business and fluctuations in our operating costs.
 
ZAP Jonway’s operating results may vary significantly from period-to-period due to many factors, including seasonal factors that may have an effect on the demand for our gas and electric vehicles. Demand for new cars in the automobile industry in general, and for electric vehicles in particular, typically decline over the winter months in the United States, while sales are generally higher as compared to the winter months during the spring and summer months. In China, sales declined over the spring and summer months and were higher in the autumn and winter months. ZAP Jonway expects sales of our vehicles to fluctuate on a seasonal basis. We note that, in general, automotive sales tend to decline over the winter months and we anticipate that our sales of the electric vehicles we introduce may have similar seasonality. However, ZAP Jonway’s limited operating history makes it difficult for us to judge the exact nature or extent of the seasonality of our business. Also, any unusually severe weather conditions in some markets may impact demand for ZAP Jonway’s vehicles. ZAP Jonway’s operating results could also suffer if we do not achieve revenue consistent with our expectations for this seasonal demand because many of our expenses are based on anticipated levels of annual revenue.
 
 
35

 
ZAP Jonway also expects our period-to-period operating results to vary based on our operating costs which we anticipate will increase significantly in future periods as we, among other things, design, develop and manufacture our planned vehicles, build and equip new manufacturing facilities to produce them, incur costs for warranty repairs or product recalls, if any, increase our sales and marketing activities, and increase our general and administrative functions to support our growing operations.
 
As a result of these factors, ZAP Jonway believes that quarter-to-quarter comparisons of our operating results are not necessarily meaningful and that these comparisons cannot be relied upon as indicators of future performance. Moreover, ZAP Jonway’s operating results may not meet expectations of equity research analysts or investors. If this occurs, the trading price of ZAP’s common stock could fall substantially either suddenly or over time.
 
The future growth of our electric vehicle business is dependent upon consumers’ willingness to adopt electric vehicles.
 
ZAP Jonway’s growth is highly dependent upon the adoption by consumers of, and we are subject to an elevated risk of any reduced demand for, alternative fuel vehicles in general and electric vehicles in particular. If the market for electric vehicles does not develop as we expect or develops more slowly than we expect, our business, prospects, financial condition and operating results will be harmed. The market for alternative fuel vehicles is relatively new, rapidly evolving, characterized by rapidly changing technologies, price competition, additional competitors, evolving government regulation and industry standards, frequent new vehicle announcements and changing consumer demands and behaviors. Factors that may influence the adoption of alternative fuel vehicles, and specifically electric vehicles, include:
 
·  
perceptions about electric vehicle quality, safety (in particular with respect to lithium-ion battery packs), design, performance and cost, especially if adverse events or accidents occur that are linked to the quality or safety of electric vehicles;
 
·  
perceptions about vehicle safety in general, in particular safety issues that may be attributed to the use of advanced technology, including vehicle electronics and regenerative braking systems, such as the possible perception that Toyota’s recent vehicle recalls may be attributable to these systems;
 
·  
the limited range over which electric vehicles may be driven on a single battery charge;
 
·  
the decline of an electric vehicle’s range resulting from deterioration over time in the battery’s ability to hold a charge;
 
·  
concerns about electric grid capacity and reliability, which could derail our past and present efforts to promote electric vehicles as a practical solution to vehicles which require gasoline;
 
·  
the availability of alternative fuel vehicles, including plug-in hybrid electric vehicles;
 
·  
improvements in the fuel economy of the internal combustion engine;
 
·  
the availability of service for electric vehicles;
 
·  
the environmental consciousness of consumers;
 
·  
volatility in the cost of oil and gasoline;
 
·  
consumers’ perceptions of the dependency of the United States on oil from unstable or hostile countries;
 
·  
government regulations and economic incentives promoting fuel efficiency and alternate forms of energy;
 
·  
access to charging stations, standardization of electric vehicle charging systems and consumers’ perceptions about convenience and cost of charging an electric vehicle;
 
·  
the availability of tax and other governmental incentives to purchase and operate electric vehicles or future regulation requiring increased use of nonpolluting vehicles;
 
·  
perceptions about and the actual overall cost of electric vehicles; and
 
·  
macroeconomic factors.
 
36

 
In addition, recent reports have suggested the potential for extreme temperatures to affect the range or performance of electric vehicles. To the extent customers have concerns about such reductions or third party reports which suggest reductions in range greater than our estimates gain widespread acceptance, ZAP Jonway’s ability to market and sell our vehicles, particularly in colder climates, may be adversely impacted.
 
Additionally, ZAP Jonway may become subject to regulations that may require us to alter the design of our vehicles, which could negatively impact consumer interest in our vehicles. For example, ZAP Jonway’s electric vehicles make less noise than internal combustion vehicles. We are aware of advocacy groups, such as the United States National Federation of the Blind, which are lobbying for regulations to require electric vehicle manufacturers to adopt minimum sound standards.
 
The influence of any of the factors described above may cause current or potential customers not to purchase ZAP Jonway’s electric vehicles, which would materially adversely affect ZAP Jonway’s business, operating results, financial condition and prospects.
 
If ZAP Jonway is unable to keep up with advances in electric vehicle technology, we may suffer a decline in our competitive position.
 
ZAP Jonway may be unable to keep up with changes in electric vehicle technology and, as a result, may suffer a decline in our competitive position. Any failure to keep up with advances in electric vehicle technology would result in a decline in ZAP Jonway’s competitive position which would materially and adversely affect our business, prospects, operating results and financial condition. ZAP Jonway’s research and development efforts may not be sufficient to adapt to changes in electric vehicle technology. As technologies change, we plan to upgrade or adapt our vehicles and introduce new models in order to continue to provide vehicles with the latest technology, in particular battery cell technology. However, ZAP Jonway’s vehicles may not compete effectively with alternative vehicles if ZAP Jonway is not able to source and integrate the latest technology into our vehicles. For example, we do not manufacture engines, which make us dependent upon other suppliers of engine technology for our vehicles.
 
Manufacturing internationally may cause problems and present risks for ZAP Jonway.
 
ZAP Jonway has been focusing on manufacturing internationally, particularly in China. There are many risks associated with international business.  These risks include, but are not limited to, language barriers, fluctuations in currency exchange rates, political and economic instability, regulatory compliance difficulties, problems enforcing agreements, and greater exposure of ZAP Jonway’s intellectual property to markets where a high probability of unlawful appropriation may occur.  A failure to successfully mitigate any of these potential risks could damage our business.
 
ZAP Jonway is required to comply with all applicable domestic and foreign export control laws, including the International Traffic in Arms Regulations and the Export Administration Regulations, or EAR. Some items manufactured by us are controlled for export by the United States Department of Commerce’s Bureau of Industry and Security under the EAR. In addition, ZAP Jonway is subject to the Foreign Corrupt Practices Act and international counterparts that generally bar bribes or unreasonable gifts for foreign governments and officials. Violation of any of these laws or regulations could result in significant sanctions, including large monetary penalties and suspension or debarment from participation in future government contracts, which could reduce ZAP Jonway’s future revenue and net income.
 
Because ZAP Jonway manufactures and sell a substantial portion of our products abroad, its operating costs are subject to fluctuations in foreign currency exchange rates. If the U.S. dollar weakens against the foreign currencies in which we denominate certain of our trade accounts payable, fixed purchase obligations and other expenses, the U.S. dollar equivalent of such expenses would increase. We can provide no assurances that we will not experience losses arising from currency fluctuations in the future, which could be significant.
 
The range of ZAP’s electric vehicles on a single charge declines over time, which may negatively influence potential customers’ decisions whether to purchase our vehicles.
 
The range of ZAP electric vehicles on a single charge declines principally as a function of usage, time and charging patterns. For example, a customer’s use of their ZAP vehicle as well as the frequency with which they charge the battery of their vehicle can result in additional deterioration of the battery’s ability to hold a charge. Battery deterioration and the related decrease in range may negatively influence potential customer decisions whether to purchase ZAP Jonway’s vehicles, which may harm our ability to market and sell our vehicles.
 
37

 
Developments in alternative technologies or improvements in the internal combustion engine may materially adversely affect the demand for ZAP Jonway’s vehicles.
 
Significant developments in alternative technologies, such as advanced diesel, ethanol, fuel cells or compressed natural gas, or improvements in the fuel economy of the internal combustion engine, may materially and adversely affect our business and prospects in ways ZAP Jonway does not currently anticipate. For example, fuel which is abundant and relatively inexpensive in North America, such as compressed natural gas may emerge as consumers’ preferred alternative to petroleum based propulsion. Any failure by ZAP Jonway to develop new or enhanced technologies or processes, or to react to changes in existing technologies, could materially delay our development and introduction of new and enhanced vehicles, which could result in the loss of competitiveness of our vehicles, decreased revenue and a loss of market share to competitors.
 
 ZAP Jonway’s future success will depend upon our ability to design and achieve market acceptance of new vehicle models.
 
ZAP anticipates that a substantial amount of its revenue in the future will be generated from the sale of its electric vehicles. Jonway currently generates a substantial amount of its revenue from the sale of its gas fueled vehicles.  Of ZAP Jonway’s planned vehicles, our electric vehicles, such as the Alias, electric A380 SUV and the improved gas fueled vehicle models are expected to be in production in 2012.  All of our planned products require significant investment prior to commercial introduction, and may never be successfully developed or commercially successful. There can be no assurance that ZAP Jonway will be able to design future models of electric or gas vehicles that will meet the expectations of our customers or that our future model will become commercially viable. Additionally, historically, automobile customers have come to expect new and improved vehicle models to be introduced frequently. In order to meet these expectations, ZAP Jonway may in the future be required to introduce on a regular basis new vehicle models as well as enhanced versions of existing vehicle models. As technologies change in the future for automobiles in general and performance electric vehicles specifically, we will be expected to upgrade or adapt our vehicles and introduce new models in order to continue to provide vehicles with the latest technology. To date ZAP Jonway has limited experience simultaneously designing, testing, manufacturing and selling our vehicles.
 
Any changes to the Federal Trade Commission’s electric vehicle range testing procedure or the United States Environmental Protection Agency’s energy consumption regulations for electric vehicles could result in a reduction to the advertised range of ZAP Jonway’s electric vehicles which could negatively impact our sales and harm our business.
 
The Federal Trade Commission, or FTC, requires us to calculate and display the range of ZAP Jonway’s electric vehicles sold in the United States on a label we affix to the vehicle’s window. The FTC specifies that we follow testing requirements set forth by the Society of Automotive Engineers, or SAE, which further requires that we test vehicles sold in the United States using the United States Environmental Protection Agency’s, or the EPA’s, combined city and highway testing cycles. The EPA recently announced that it would develop and establish new energy efficiency testing methodologies for electric vehicles.  However, there can be no assurance that the modified EPA testing cycles will not result in a greater reduction. Any reduction in the advertised range of ZAP Jonway vehicles could negatively impact our vehicle sales and harm our business.
 
If ZAP Jonway is unable to reduce and adequately control the costs associated with operating our business, including our costs of manufacturing, sales and materials, our business, financial condition, operating results and prospects will suffer.
 
If ZAP Jonway is unable to reduce and/or maintain a sufficiently low level of costs for designing, manufacturing, marketing, selling and distributing and servicing our vehicles relative to their selling prices, our operating results, gross margins, business and prospects could be materially and adversely impacted. We have made, and will be required to continue to make, significant investments for the design, manufacture and sales of our vehicles. There can be no assurances that our costs of producing and delivering our vehicles will be less than the revenue we generate from sales at the time of the launch of such vehicle or that we will ever achieve a positive gross margin on sales of any specific vehicle.
 
ZAP Jonway incurs significant costs related to contracting for the manufacture of our vehicles, procuring the materials required to manufacture our electric cars, assembling vehicles and compensating our personnel. Although we expect manufacturing expenses to proportionally decrease with the localization of manufacturing in Jonway’s facilities, if ZAP Jonway is unable to keep our operating costs aligned with the level of revenues we generate, our operating results, business and prospects will be harmed. Many of the factors that impact our operating costs are beyond our control. For example, the costs of our raw materials and components, such as lithium-ion battery cells used in our vehicles could increase due to shortages as global demand for these products increases. Indeed, if the popularity of electric vehicles exceeds current expectations without significant expansion in battery cell production capacity and advancements in battery cell technology, shortages could occur which would result in increased materials costs to us.
 
 
38

 
The automotive market is highly competitive, and ZAP Jonway may not be successful in competing in this industry. ZAP Jonway currently faces competition from established competitors and expect to face competition from others in the future.
 
The worldwide automotive market, particularly for alternative fuel vehicles, is highly competitive today and ZAP Jonway expects it will become even more so in the future. ZAP Jonway currently faces strong competition from established automobile manufacturers, including manufacturers of all-electric vehicles such as the Nissan LEAF.
 
BYD Auto has also announced plans to bring an electric vehicle into the United States market in 2012, and Ford has announced that it plans to introduce an electric vehicle in late 2011 and the Tesla Roadster is on the market, although it targets a more luxury-brand audience. In addition, several manufacturers, including General Motors, Toyota, Ford, and Honda, are each selling hybrid vehicles, and certain of these manufacturers have announced plug-in versions of their hybrid vehicles, such as the Chevrolet Volt, which is a plug-in hybrid vehicle that operates purely on electric power for a limited number of miles, at which time an internal combustion engine engages to recharge the battery.
 
Moreover, it has been reported that Daimler, Lexus, Audi, Renault, Mitsubishi, Volkswagen and Subaru are also developing electric vehicles. Several new start-ups have also announced plans to enter the market for performance electric vehicles, although none of these have yet come to market. Finally, electric vehicles have already been brought to market in China and other foreign countries where ZAP Jonway operates or hopes to operate and we also expect a number of those manufacturers to enter the United States market as well. ZAP Jonway faces competition on its conventional fuel vehicles in China from established multi-national automobile manufacturers, and from China-based manufacturers such as Geely, Chery, BYD, Great Wall Auto and Zotye.
 
Most of ZAP Jonway’s current and potential competitors have significantly greater financial, manufacturing, marketing and other resources than we do and may be able to devote greater resources to the design, development, manufacturing, distribution, promotion, sale and support of their products. Virtually all of our incumbent competitors have more extensive customer bases and broader customer and industry relationships than we do. In addition, many of these companies have longer operating histories and greater name recognition than we do. Our competitors may be in a stronger position to respond quickly to new technologies and may be able to design, develop, market and sell their products more effectively.

Furthermore, certain large manufacturers offer financing and leasing options on their vehicles and also have the ability to market vehicles at a substantial discount, provided that the vehicles are financed through their affiliated financing company. ZAP Jonway does not currently offer or plan to offer, any form of direct financing on our vehicles. ZAP Jonway has not in the past, and does not currently, offer substantial customary discounts on our vehicles. The lack of direct financing options and the absence of substantial customary vehicle discounts could put ZAP Jonway at a competitive disadvantage.
 
ZAP Jonway expects competition in our industry to intensify in the future in light of increased demand for conventional and alternative fuel vehicles, continuing globalization and consolidation in the worldwide automotive industry. Factors affecting competition include pr